## cr18330

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### The Drivers of Spain’s Export Growth
- Export growth supported Spain’s recovery but decelerated in the first three quarters of 2018 due to weaker foreign demand and lower tourist arrivals.
- Despite a CPI-based REER appreciation of nearly 2 percent, export volumes grew robustly through 2017.
- Recent developments:
  - Tourism: exceptionally strong tourism boosted the services trade surplus; Spain became the world’s second-most visited country in 2017.
  - Goods: slower goods exports contributed to the 2018 slowdown while imports are rising.
  - External demand and energy prices: weaker trading-partner demand and higher oil prices slowed activity in 2018 more than authorities expected.
- Domestic constraints:
  - Competitiveness largely restored since the crisis, supporting exports even with REER appreciation.
  - Continued low productivity (but turnaround from pre-crisis negative trends) and high structural unemployment limit faster export-led convergence.
  - Regional heterogeneity may imply inefficient allocation of resources affecting export capacity.
- Outlook and risks:
  - GDP growth: 3 percent in 2017; 2.6 percent in first three quarters of 2018; projected 2.5 percent in 2018; medium-term potential around 1.75 percent.
  - Downside risks: rising global protectionism and a no-deal Brexit; renewed euro-area market instability raising bond yields; sharp tightening of global financial conditions; prolonged domestic political uncertainty (e.g., Catalonia).
  - Upside: further payoffs from past structural reforms or stronger-than-expected investment recovery.

### External Position, Valuation, and External Gaps
- Current account and NIIP:
  - Current account surplus: 2.3 percent of GDP in 2016; 1.8 percent of GDP in 2017; staff projects close to 1 percent of GDP over the medium term.
  - NIIP: minus 84 percent of GDP in 2017 (large and negative), with adverse valuation effect mainly explained by the euro appreciation.
- External gaps and REER:
  - 2017 current account gap: estimated at -2.5 to -0.5 percent of GDP.
  - REER overvaluation gap: assessed at 3 to 10 percent (staff); two EBA REER models estimate overvaluation in the range of 5.1 to 5.8 percent for 2017; CA model implies close-to-zero overvaluation.
  - Staff’s assessment of external position improved from “weaker” in 2016 to “moderately weaker” in 2017; preliminary 2018 estimates broadly unchanged.
- Key statistics:
  - REER appreciation: nearly 2 percent (CPI-based) prior to and through 2017.
  - NIIP: minus 84 percent of GDP in 2017.
  - Exports: increased from 26 percent of GDP in 2007 to 34 percent in 2017.
  - Average real growth rates: goods exports 4.5 percent (2001–07) to 5.4 percent (2010–17); services 2.9 percent to 4.3 percent.

### Fiscal Policy — Findings, Projections, and Recommendations
- Recent stance and projections:
  - Fiscal stance easing in 2018 amid rising social and political demands.
  - Staff projects headline deficit to reach 2.8 percent of GDP in 2018, above the 2.2 percent of GDP budget target but compatible with exit from the excessive deficit procedure.
  - Staff estimates the projected 2018 outcome would imply a worsening of the structural primary balance by about ¼ percent of GDP.
  - Debt-to-GDP ratio hovering around 100 percent of GDP poses public debt sustainability risks.
- 2019 draft budget measures (authorities’ estimated fiscal impact, percent of GDP):
  - Reduce exemptions to dividends and capital gains generated abroad and ensure minimum effective CIT for large companies: 0.14
  - Reduction of CIT rate for SMEs (income less than €1 million) from 25% to 23%: -0.02
  - 0.2% financial transaction tax on purchase of shares issued in Spain by listed companies with market cap > €1 billion: 0.07
  - 3% tax on online advertising/intermediation/data (large companies only): 0.10
  - Increase PIT rate by 2 ppts for income above €130,000 and 4 ppts for income above €300,000: 0.03
  - Increase tax on wealth by 1% for inheritance exceeding €10 million: 0.03
  - Increase diesel tax for automotive uses by €38 per thousand liters: 0.05
  - Efforts to fight tax fraud: 0.07
  - Total impact: 0.45
- Staff advice:
  - Resume consolidation of the structural primary deficit by at least 0.5 percent of GDP per year until structural balance and a clear downward debt path are achieved.
  - Add measures in the budget and be ready with contingency actions if revenue shortfalls arise; additional revenue measures preferable, but spending-side options should be identified.
  - If 2018 budget is extended (no 2019 budget passed), deficit estimated to fall to around 2 percent of GDP.
  - In a no-policy-change scenario, deficit projected to reach 2.4 percent in 2019 (includes legislated pension increase, PIT measures for 2019, and public wage increases agreed with unions).
- Composition and medium-term options:
  - Public primary spending at 38.5 percent of GDP is relatively low vs EU peers; scope for expenditure rationalization limited.
  - Preferred revenue options: expand VAT collection, raise excise duties and environmental levies, reduce tax inefficiencies — less distortive short-term.
  - If implemented gradually, these measures could yield extra revenue of up to 2–3 percent of GDP, accompanied by targeted spending for the most vulnerable.
  - Digital and financial transaction taxes may yield short-term revenue but are more distortive and are best embedded in internationally coordinated frameworks.
- Pensions:
  - 2011/13 pension reforms appropriate to address ageing pressures; limiting pension increases to 0.25 percent per annum would eliminate structural deficit of social security budget and keep pension spending broadly stable relative to GDP.
  - Deviation from the pension formula in 2018–19 and delay in implementing the “sustainability factor” from 2019 to 2023 estimated to cost about 0.3 percent of GDP in short run.
  - Relinking pensions permanently to inflation would add about 3–4 percent of GDP in outlays by 2050 under current projections.
  - Policy options include incentivizing longer work lives, raising revenues without increasing contribution rates (e.g., increase minimum contribution for self-employed and maximum earnings subject to contributions), and encouraging supplementary savings (e.g., automatic enrollment with opt-out).
- Regional and local finance:
  - Reform the regional public finance framework to increase transparency and consistency and strengthen regions’ incentives and capacity to meet fiscal targets.
  - Allow local governments with sound finances to use surpluses to fund investments, but avoid general exemptions (“golden rules”) that can lead to higher debt.

### Labor Market, Wages, and Activation Policies
- Structural unemployment and duality:
  - Structural unemployment estimated in the range of 12–16 percent, below long-term average of 18 percent.
  - Spain has the largest share of temporary employment in the euro area, especially among younger workers.
  - Internal mobility: gross flows across regions accounted for 0.3 percent of the working-age population over the past decade versus 1.2 percent in Germany and 2.4 percent in the United Kingdom.
  - During 2008–17, average unemployment gap between top and bottom regions about 18 percentage points.
- Wage flexibility:
  - Future wage increases should follow productivity growth; preserving firm-level wage setting is critical to external competitiveness.
  - Government proposed statutory minimum wage increases by 22 percent to €12,600 in 2019 and €14,000 by 2020; staff warns these could put at risk employment opportunities for low-skilled and young and sharply raise minimum-to-average wage ratio.
  - Policy implication: allowing greater minimum wage differentiation is warranted.
- Activation and ALMPs:
  - Expedite implementation of plans to improve education outcomes and upgrade skills, including the multi-year strategy on employment activation.
  - Consolidate ALMPs, expand promising programs (e.g., those with personal tutor support), centralize information on social benefits across regions, and provide incentives for mobility (moving expense subsidies, targeted housing assistance).
- Recommended labor market reforms:
  - Narrow gap between costs to hire permanent and temporary workers; make open-ended contracts more attractive rather than increasing temporary contract costs.
  - Measures could include further reducing hiring costs and severance for permanent workers, creating an employer-based separation fund (“Austrian backpack”), and simplifying causes for nullifying dismissals to reduce legal uncertainty.
  - Forcefully tackle abuse of temporary contracts while adopting holistic measures to lower cost of open-ended contracts, improve training, and raise labor mobility.

### Structural Reform Priorities to Raise Productivity
- Productivity and regional disparity:
  - Total factor productivity (TFP) growth reached 0.7 percent in 2017 after pre-crisis decline.
  - Spain’s productivity gap remains “more than 10 percent relative to Germany.”
  - TFP in most productive region about 60 percent higher than in least productive region.
- Scenarios on inefficiency reduction:
  - If regions performing below average improved to the regions’ average, GDP would be 1.4 percent higher.
  - If regions close half of their distance to the production frontier, GDP would be 4 percent higher.
- Skills and R&D:
  - Overqualification: 25 percent of workers over-qualified.
  - Those with at most lower secondary education nearly 40 percent of the labor force (in some regions over 50 percent).
  - R&D spending averaged 1.2 percent of GDP since 2000 (range 0.3 to 1.8 percent across regions) versus over 2 percent in Germany and France.
  - Spending efficiency is low and diverse (e.g., patents per money spent).
- Policy implications:
  - Reduce regulatory fragmentation and barriers to firm growth (apply Market Unity Law; liberalize professional services).
  - Remove size-contingent regulations creating a “small business trap”; avoid reintroducing disincentives to firm growth.
  - Improve coordination across government levels for R&D and clarify eligibility for R&D incentives.
  - Enhance regional active labor market and education policies focused on targeted training, private sector–university cooperation, and reducing school drop-outs.

### Financial Sector Resilience and Institutional Oversight
- FSAP priority areas:
  - (i) accelerated cleanup of legacy bank assets; (ii) improve bank profitability and capitalization; (iii) rigorous interest and liquidity risk management; (iv) reform institutional framework for financial oversight.
- NPLs and asset quality:
  - Implementation of ECB’s NPL guidance is critical; several major banks announced NPL disposals since August 2017 (at least one transaction completed).
  - Staff calls for tough stance on NPL guidance implementation, disclosure of NPL reduction targets and progress, and careful evaluation of banks’ property price assumptions.
  - Monitor consumer lending growth as NPLs tend to be relatively high in that segment.
- Capitalization and profitability:
  - CET1 on a fully-loaded basis remains lower than many European peers despite lower leverage.
  - Some estimates suggest large shortfalls to comply with upcoming MREL targets.
  - Recommendation: continue buildup of capital buffers and “bail in-able” debt; further cost cutting, branch consolidation, evaluation of mergers and business-model adjustments.
- Liquidity and interest rate risk:
  - Banco Popular failure in 2017 and deposit outflows during Catalonia crisis highlight need for strong liquidity management.
  - Stress tests indicate sharp interest rate increases could erode margins; some banks vulnerable due to significant exposures to long-duration sovereign bonds.
  - Spanish banks lend most mortgages at variable rates and should manage credit and funding risks as rates rise and Euribor methodology changes.
- Prudential oversight and resolution:
  - Increase supervisory focus on corporate governance across credit institutions and nonbanks, particularly credit cooperatives.
  - Improve resolvability of small banks; efforts to create a resolution fund for credit cooperatives under way.
  - Sareb: Bank of Spain should regularly monitor and review Sareb’s business plan to ensure realistic assumptions.
  - AML/CFT enhancements: amend AML/CFT Law to eliminate delays in implementing targeted financial sanctions; ensure risk-based supervision of money and value transfer services; add resources to SEPBLAC beyond planned increase.
- Institutional modernization:
  - Recommendation: establish a Systemic Risk Council chaired by the Bank of Spain with Treasury and other agencies to bolster systemic risk surveillance and interagency coordination.
  - Authorities drafting proposal for national macroprudential authority, proposing independent insurance and pension supervisor, and a financial consumer protection authority.
  - Near-term priorities: set up national macroprudential authority; transpose EU mortgage directive into national law; launch a financial innovation sandbox.
- Macroprudential toolkit:
  - Staff recommends legal basis and swift expansion to include borrower-based tools (loan-to-value and debt service-to-income limits) so the Bank of Spain can act promptly if misalignments emerge.

### Housing, Exports, and Cycle — Boxed Highlights
- Housing market:
  - House prices increased by around 15 percent between 2014–17, with fast recoveries in Madrid and Barcelona.
  - No strong evidence of clear overvaluation as of 2017:Q4 using price-to-rent and price-to-income ratios; both ratios roughly similar to mid-2003 and less than one standard deviation above historical averages.
  - Regression model suggests slight overvaluation in 2017:Q4 but limited in capturing supply-side dynamics.
  - Recommendations: expand macroprudential toolkit; improve balance sheets in construction and real estate sectors; encourage greater use of fixed-rate mortgages; ensure prudent eligibility criteria for social home loans and rent subsidies; improve housing development regulation to address supply constraints.
  - Home ownership declined from 80 to 77 percent between 2008–17.
  - Contribution of construction sector value added nearly half its pre-crisis level.
- Exports:
  - Exports rose from 26 percent of GDP in 2007 to 34 percent in 2017.
  - Average annual real growth rate of goods exports increased from 4.5 percent (2001–07) to 5.4 percent (2010–17); services from 2.9 percent to 4.3 percent.
  - Drivers: foreign demand, geographic diversification, regained cost competitiveness (ULC), substitution from low domestic demand.
  - Labor market reforms (2010 and 2012) estimated to account for nearly one-tenth to above one-quarter of real export growth over 2010–13; panel regressions imply LMR associated with faster real export growth of 1 to 4 percentage points.
- Economic cycle:
  - Output gap estimates range from -1.8 to +2.0 percent of potential GDP for 2018.
  - IMF baseline (multivariate filter) suggests a slightly positive output gap for 2018 and potential growth of 1.5 percent for 2018; other methods produce potential growth 0.9 to 2 percent for 2018.
  - Several indicators point to the cycle being largely completed: unemployment at end-2017 slightly below long-term average; vacancies-to-unemployed ratio approached long-term average; capacity utilization surpassed long-term average in 2017.

### Debt Sustainability — Public and External (Appendix IV)
- Public debt sustainability (summary):
  - Baseline: public debt projected to decline slowly to about 92.5 percent of GDP in 2023.
  - Policy priority: return to gradual persistent fiscal consolidation; annual structural adjustment of about 0.5 percent of GDP would bring debt to around 87 percent of GDP by 2023 (about 5 percentage points lower than baseline).
  - Gross financing needs:
    - Projected at 17.4 percent of GDP in 2018.
    - Projected 16.5 percent of GDP in 2023 under baseline.
- Historical and baseline figures:
  - Public debt-to-GDP: increased from 35.5 percent in 2007 to 100.4 percent in 2014; declined to 98.1 percent at end-2017.
  - Baseline debt path: 97.3 percent in 2018, declining to 92.5 percent by 2023.
  - Key macro-fiscal assumptions: growth 2.5 percent in 2018; 2.2 percent in 2019; medium-term potential ~1.75 percent; structural loosening ~0.2 percent of GDP in 2018–19 then broadly neutral.
  - Effective interest rate: 2.6 percent in 2017; projected 2.7 percent in 2023.
- Stress test scenarios (selected outcomes):
  - Growth shock: debt-to-GDP rises to 105 percent in 2020, declining to 102 percent in 2023 (almost 10 percentage points higher than baseline); gross financing needs 20.8 percent in 2020.
  - Primary balance shock (cumulative deterioration 1.8 percent of GDP): debt peaks at 98.5 percent in 2020; 97.4 percent in 2023 (nearly 5 percentage points higher than baseline).
  - Interest rate shock (real interest +325 bps during 2019–23): effective interest rate increases to 4.1 percent by 2023; debt-to-GDP broadly stable at 95.8 percent in 2023.
  - Combined shock: debt-to-GDP increases to 107.7 percent in 2023; gross financing needs 21.4 percent in 2023.
  - Contingent liability shock (one-time increase in non-interest public expenditures in 2019 equivalent to 10 percent of banking sector assets): primary deficit ~10 percent of GDP in 2019; gross financing needs 27.5 percent of GDP in 2019; debt peaks at 111.7 percent in 2020 and ~109.8 percent in 2023.
  - Heat map: 85 percent of GDP benchmark breached under baseline and each shock scenario.
- External debt sustainability:
  - Baseline: external debt projected to decline from 167 percent of GDP in 2017 to 144 percent in 2023.
  - Gross external financing needs remain high—around 60 percent of GDP in 2023.
  - Alternative scenarios:
    - Historical shock: external debt increases to 204 percent of GDP by 2023.
    - Interest rate shock (+0.5 std dev): external debt higher by ~4 percentage points at end-2023.
    - Growth shock (real GDP growth 0.6 percent avg 2019–23): external debt 154 percent in 2023.
    - Combined shocks: external debt-to-GDP 154 percent in 2023.
  - Real depreciation shock (one-time 30 percent in 2019) would increase external debt over the medium term by around 5 percent of GDP per year; Spain has low share of foreign-currency debt so transmission via valuation effects dominates.
- Baseline selected indicators (selected):
  - Nominal gross public debt: 99.0 in 2017; 98.1 in 2018; 97.3 in 2019; 93.0 in 2023; 92.5 in 2024 (percent of GDP).
  - Public gross financing needs: 19.2 (2017); 18.9 (2018); 17.4 (2019); 16.5 (2023); 16.5 (2024) (percent of GDP).
  - External debt (selected years baseline): 2017: 166.6; 2018: 164.9; 2019: 160.1; 2020: 155.7; 2021: 151.6; 2022: 147.7; 2023: 144.1 (percent of GDP).

### Risk Assessment Matrix — Selected External and Domestic Risks
- External risks (selected entries and policy responses):
  - Weaker-than-expected global growth
    - Relative Likelihood: Medium; Time Horizon: MT; Impact: Medium.
    - Policy Response: enhance labor market performance and lower duality; deepen product market reforms; let automatic stabilizers play and formulate credible medium-term fiscal path; strengthen financial sector.
  - Rising protectionism and retreat from multilateralism
    - Relative Likelihood: High; Time Horizon: ST, MT; Impact: Medium.
    - Policy Response: accelerate structural reforms to strengthen competitiveness; let automatic stabilizers play; formulate credible fiscal path.
  - Sharp tightening of global financial conditions
    - Relative Likelihood: High; Time Horizon: ST; Impact: Medium.
    - Policy Response: accelerate structural reforms and credible fiscal path; banks to build capital buffers; possible further ECB policy actions.
  - Sizeable deviations from baseline energy prices
    - Relative Likelihood: Medium; Time Horizon: ST, MT; Impact: Medium.
    - Policy Response: use windfalls to reduce public debt; let automatic stabilizers operate; formulate credible fiscal path.
- Domestic risks (selected entries and policy responses):
  - Prolonged political uncertainty related to Catalonia
    - Relative Likelihood: Medium; Time Horizon: MT; Impact: Medium.
    - Policy Response: advance structural reforms; formulate credible fiscal path.
  - Weak implementation or reversal of fiscal commitments and structural reforms
    - Relative Likelihood: Medium; Time Horizon: ST, MT; Impact: High.
    - Policy Response: advance structural reforms; return to gradual growth-friendly fiscal consolidation; reform regional financing framework.
  - Higher-than-estimated growth momentum from past reforms
    - Relative Likelihood: Medium; Time Horizon: ST; Impact: Medium.
    - Policy Response: use windfalls to reduce public debt; continue structural reforms.

_International Monetary Fund — selected excerpts from “SPAIN” (CR18330)._

### 1. The Drivers of Spain’s Export Growth __________________________________________________________ 25

### 1. The Drivers of Spain’s Export Growth

### Overview
- Export growth has been an important component of Spain’s recovery but decelerated in the first three quarters of 2018 due to weaker foreign demand and lower tourist arrivals.
- Despite a CPI-based real effective exchange rate (REER) appreciation of nearly 2 percent, export volumes continued to grow robustly through 2017.

### Recent developments affecting exports
- Tourism: An exceptionally strong tourism sector boosted the services trade surplus; Spain became the world’s second-most visited country in 2017, surpassing the United States.
- Goods trade: Slower goods exports contributed to the export growth slowdown in the first three quarters of 2018; imports are rising.
- External demand and energy prices: Weaker demand from trading partners and higher oil prices slowed overall activity in 2018 more than expected by authorities.

### External position and valuation
- Current account:
  - Surplus declined from 2.3 percent of GDP in 2016 to 1.8 percent of GDP in 2017, marking the fifth consecutive annual surplus.
  - Staff’s projection: the current account surplus is projected to be close to 1 percent of GDP over the medium term.
- Net international investment position (NIIP): remained large and negative at minus 84 percent of GDP in 2017, with an adverse valuation effect mainly explained by the euro appreciation.
- Gaps and assessments:
  - The 2017 current account gap was estimated at -2.5 to -0.5 percent of GDP.
  - The REER overvaluation gap was assessed at 3 to 10 percent.
  - Staff’s assessment of the external position improved from “weaker” in 2016 to “moderately weaker” in 2017.
- Preliminary 2018 estimates of external gaps and positions were broadly unchanged relative to 2017.

### Domestic factors influencing export performance
- Competitiveness: Much of competitiveness has been restored since the crisis, supporting export performance even amid REER appreciation.
- Structural constraints: Continued low productivity (despite a turnaround from pre-crisis negative trends) and high structural unemployment limit faster export-led convergence.
- Regional heterogeneity: Persistent economic disparities across regions may imply inefficient allocation of resources affecting export capacity.

### Outlook and risks for exports
- Growth outlook: GDP growth is projected to ease to 2.5 percent in 2018 before gradually slowing to potential of around 1.75 percent over the medium term; export composition expected to remain broad-based.
- Downside risks to exports:
  - Rising global protectionism and a no-deal Brexit could weigh on trade and hurt exports and investment.
  - Renewed market instability in key euro area countries could raise Spain’s bond yields and borrowing costs, indirectly affecting export competitiveness.
  - A sharp tightening of global financial conditions or abrupt changes in global risk appetite could rekindle sovereign and financial sector stress, harming export prospects.
  - Prolonged domestic political uncertainty (e.g., related to Catalonia) could undermine confidence and investment, with negative consequences for exports.
- Upside potential: Further payoffs from past structural reforms or stronger-than-expected investment recovery could boost potential growth and export performance.

### Key statistics and indicators (as reported)
- REER appreciation: nearly 2 percent (CPI-based) prior to and through 2017.
- Current account surplus: 2.3 percent of GDP in 2016; 1.8 percent of GDP in 2017.
- NIIP: minus 84 percent of GDP in 2017.
- 2017 current account gap estimate: -2.5 to -0.5 percent of GDP.
- REER overvaluation gap: 3 to 10 percent.
- GDP growth: 3 percent in 2017; 2.6 percent in first three quarters of 2018; projected 2.5 percent in 2018; medium-term potential around 1.75 percent.
- Tourism rank: Spain became the world’s second-most visited country in 2017.

*International Monetary Fund, Selected chapter content from “SPAIN” (CR18330).*

### 15.      The authorities broadly shared staff’s assessment of the outlook and the downside

### 15.      The authorities broadly shared staff’s assessment of the outlook and the downside

### Outlook and Authorities’ Assessment
- Authorities and staff expect GDP growth to moderate but stay above the euro area average.
- Authorities view external factors as the main downside risks; domestic risks are considered more limited.
- External risks highlighted by authorities:
  - escalation of global trade tensions and resulting slowdown in trading partners' growth
  - tightening of financial conditions due to monetary policy normalization
  - increase of oil prices
- Authorities argued past economic activity was resilient to political uncertainty and that healthier bank and non-bank balance sheets would help withstand shocks.

### Policy Agenda — High-level Priorities
- Heightened urgency to bolster the resilience and inclusiveness of the economy as the cycle matures and external risks rise.
- Fiscal policy should use good economic conditions to reduce public debt and gross financing needs to create room to counter future shocks.
- Preserve and enhance past reforms, especially to address joblessness and poverty among the young.

### A. Fiscal Policy: Creating Needed Fiscal Space — Findings and Projections
- The fiscal stance is easing in 2018 amid rising social and political demands.
- Several measures adopted to support pensioners and low-income households, including broad increases in pension benefits in 2018–19 (higher than the 0.25 percent implied by the pension formula) and expansions in PIT deductions for households with specific needs.
- Budget execution up to August: revenue performance in line with budget target; expenditure expected to outrun the budget due to higher-than-expected public employment and pensions spending.
- Staff projects the headline deficit to reach 2.8 percent of GDP in 2018, above the 2.2 percent of GDP budget target but compatible with exit from the excessive deficit procedure.
- Staff estimates the projected 2018 outcome would imply a worsening of the structural primary balance by about ¼ percent of GDP.
- Fiscal consolidation has come to a standstill since 2015; structural deficit deteriorated to about 2½ percent of GDP.
- Debt-to-GDP ratio hovering around 100 percent of GDP poses public debt sustainability risks.
- Staff recommendation: resume consolidation of the structural primary deficit by at least 0.5 percent of GDP per year until a fiscal structural balance is reached and debt is on a clear downward path.
- Risks noted: future increases in borrowing cost and pressure from population ageing.

### A. Fiscal Policy: 2019 Budget and Measures
- Government draft budgetary plan envisages headline deficit of 1.8 percent of GDP in 2019 and an implied improvement in the structural deficit of about 0.5 percent of GDP.
- Main revenue proposals listed in the draft budgetary plan (with authorities' estimated fiscal impact, percent of GDP):
  - Changes to the corporate income tax (CIT) system to (i) reduce exemptions to dividends and capital gains generated abroad from 100% to 95%; and (ii) ensure a minimum effective CIT rate for large companies: 0.14
  - Reduction of the CIT rate for SMEs (income less than €1 million) from 25% to 23%: -0.02
  - Introduction of 0.2% financial transaction tax on purchase of stock market shares issued in Spain by listed companies whose market capitalization is more then €1 billion: 0.07
  - Introduction of a 3% tax on online advertising services, online intermediation services, and the sale of data (for large companies only): 0.10
  - Increase in the personal income tax (PIT) rate by 2 ppts for income above €130,000 and 4 ppts for income above €300,000: 0.03
  - Increase the tax rate on wealth by 1% for the inheritance exceeding €10 million: 0.03
  - Increase in the tax of diesel for automotive uses by €38 per thousand liters: 0.05
  - Efforts to fight against tax fraud: 0.07
  - Total impact: 0.45
- Some measures have uncertain yields; several are entirely new taxes or policy actions.
- Staff advice: add measures in the budget and be ready to take contingency actions if revenue shortfalls arise; additional revenue measures preferable, but options on the spending side should also be identified.
- If 2018 budget is extended (no 2019 budget passed), deficit estimated to fall to around 2 percent of GDP.
- In a no-policy-change scenario, staff projects the deficit to reach 2.4 percent in 2019 (this includes already legislated pension increase, PIT measures for 2019, and public wage increases agreed with the unions).

### A. Fiscal Policy: Composition and Medium-Term Options
- Spain’s public primary spending at 38.5 percent of GDP is relatively low compared to EU peers; scope for expenditure rationalization is limited.
- Revenue measures can both reduce the deficit and finance social/distributional objectives; careful design is essential to limit distortions and growth implications.
- Preferred revenue options: expand VAT collection, raise excise duties and environmental levies, and reduce inefficiencies in the tax system — these are less distortive in the short term.
- If implemented gradually, these measures could yield extra revenue of up to 2–3 percent of GDP, accompanied by targeted spending for the most vulnerable.
- Planned introduction of digital and financial transaction taxes may yield short-term revenue but would be more distortive and are best embedded in an internationally coordinated framework.

### A. Fiscal Policy: Pensions — Findings and Recommendations
- 2011/13 pension reforms address ageing pressures; limiting pension increases to the legislated minimum rate of 0.25 percent per annum over many years would eliminate the structural deficit of social security budget and keep pension spending relative to GDP broadly stable.
- Deviation from the pension formula in 2018–19 and delay in implementation of the discount factor for changes in life expectancy (“sustainability factor”) from 2019 to 2023 is estimated to cost about 0.3 percent of GDP in the short run.
- Relinking pensions permanently to inflation would add about 3–4 percent of GDP in outlays by 2050 under current demographic and macroeconomic projections, moving Spain nearly to the top in the EU in pension spending.
- Space to finance some additional pension spending is limited given already high contribution rates.
- Recent Toledo Pact recommendation to permanently link pension increases to an indicator of purchasing power should be carefully evaluated as part of a sustainable package.

- Range of reform options to address pension tensions:
  - incentivize longer work lives (e.g., extension of the pensionable earnings reference period to a contributor’s full career; automatic indexation of the retirement age to changes in life expectancy)
  - raise revenues without raising already high contribution rates (e.g., increase minimum contribution for self-employed and the maximum earnings subject to contributions)
  - encourage supplementary savings (e.g., automatic enrollment in a saving plan with the ability to opt out)
- Emphasize transparency and equity in how adjustment is split between generations so future pensioners can make informed choices.

### A. Fiscal Policy: Regional and Local Finance
- Reforms to the regional public finance framework should aim to increase transparency and consistency and strengthen regions’ incentives and capacity to meet fiscal targets over the medium term.
  - Example: provide regions greater power to mobilize own revenues to match expenditure responsibilities.
- Local government financing: allowing local governments with sound finances to use surpluses to fund investments has been proposed to be made permanent; general exemptions (“golden rules”) should be avoided as they can lead to higher debt when returns do not cover costs.

### Authorities’ Views on Fiscal Policy
- Authorities expressed strong commitment to meet fiscal targets while preserving growth and fostering social inclusion.
- Exit from the excessive deficit procedure in 2018 seen as a positive signal.
- For 2019, government plans a structural adjustment of 0.4 percent of GDP and an increase in the revenue-to-GDP ratio by 0.6 percent of GDP, aimed at redistribution, reducing social and gender inequality, and supporting transition to a low carbon economy.
- Authorities stressed prudent yield projections for new measures; the 2019 budgetary process would include a comprehensive gender perspective.
- On pensions, authorities emphasized safeguarding financial sustainability while protecting purchasing power of benefits through measures that boost future wage and GDP growth to recover social security contributions.

### B. Labor Market Policy: Findings and Policy Recommendations
- Structural unemployment remains stubbornly high; estimates put current structural unemployment in the range of 12–16 percent, below its long-term average of 18 percent.
- 2012 labor market reforms have supported reduction in structural unemployment and helped export performance; evidence includes an inward shift in the Beveridge curve.
- Spain’s internal mobility rate historically low: gross flows of internal migration across regions accounted for 0.3 percent of the working age population over the past decade, versus 1.2 percent in Germany and 2.4 percent in the United Kingdom.
- During 2008–17, average gap of the unemployment rate between top and bottom regions was about 18 percentage points.
- Staff analysis attributes limited regional labor mobility to housing market prices, labor market conditions, and labor market duality, among other factors.

- Policy focus to tackle labor market rigidities and high structural unemployment:
  - Narrow the gap between costs for firms to hire permanent and temporary workers; prioritize making open-ended contracts more attractive rather than increasing costs of temporary contracts.
  - Specific measures could include:
    - further reducing hiring costs and severance payments for permanent workers
    - creating an employer-based separation fund (“Austrian backpack”)
    - simplifying the list of possible causes for nullifying a dismissal to reduce legal uncertainties
  - The recently adopted plan to tackle the abuse of temporary contracts is an important complementary effort.

- Concern: Spain has the largest share of temporary employment in the euro area, especially among younger workers; labor market duality contributes to limited regional mobility and lower productivity.

_Italic: Source — cr18330, IMF staff report excerpt (section 15–16–26), extracted from the supplied content._

### 29.      Preserving wage flexibility is critical. Future wage increases should follow productivity

### Preserving wage flexibility is critical. Future wage increases should follow productivity growth.

### Wage flexibility, minimum wage, and labor mobility
- Future wage increases should follow productivity growth to promote reallocation of labor toward more productive sectors and regions.
- It is critical to continue allowing firms to set wages in line with their business condition to preserve external competitiveness amid new risks.
- The guideline of the latest collective bargaining agreement as regards general wage increase is welcome.
- The government’s proposed sharp increases in the annual statutory minimum wage by 22 percent to €12,600 in 2019 and €14,000 by 2020 could:
  - put at risk employment opportunities for the low-skilled and the young;
  - swiftly lift Spain’s minimum-to-average wage ratio to one of the highest among EU peers.
- Policy implication: allowing greater minimum wage differentiation is warranted.
- Policies to enhance employability and incentives for labor mobility remain priorities:
  - Expedite implementation of plans that improve education outcomes and upgrade skills, including implementing the multi-year strategy on employment activation.
  - Consolidate the vast amount of ALMPs (active labor market policies) — many have low participation, receive little funding and are not well-known — and expand the most promising programs (for example, those involving support by a personal tutor).
  - Policies to incentivize mobility could include subsidies for moving expense and temporary and targeted housing assistance.
  - Centralize information on social benefits across regions to ensure benefits support unemployed workers without distorting job search and reallocation.

### Authorities’ views on wages and activation
- Authorities’ main priority: improve the quality of jobs to boost productivity and wage growth, not to reverse past labor market reforms but to fine-tune aspects that created bargaining-power imbalances while maintaining flexibility.
- Authorities argue planned minimum wage increases would contribute to stronger wage growth and "does not raise substantial concerns regarding negative employment effects," citing past rapid minimum wage increases coinciding with strong employment growth.
- Government measures in support of wage growth include:
  - An action plan to upgrade education outcomes, with more opportunities for vocational training and life-long learning.
  - Measures to lower pervasive labor duality and confront gender inequality.
  - A “masterplan for fair and decent jobs” to tackle abuse of temporary and involuntary part-time contracts and improper claims of self-employed status.
  - Plans to strengthen ALMP effectiveness via greater coordination between regions with enhanced profiling tools and information systems, and better identification of skills required by the labor market.

### Structural reform priorities: tapping forgone potential
- After a pre-crisis decline, total factor productivity (TFP) growth reached 0.7 percent in 2017.
- Spain narrowed its productivity gap, but disparity remains "more than 10 percent relative to Germany."
- Notable regional variation: TFP in the most productive region is about 60 percent higher than in the least productive one.
- Staff scenarios on reducing inefficiency:
  - If regions performing below average improved their efficiency up to the regions’ average, GDP would be 1.4 percent higher.
  - If regions close half of their distance to the production frontier, GDP would be 4 percent higher.
- Main drivers to reduce technical inefficiency: better skills match and greater reliance on R&D activities.

### Skills, R&D, and regional imbalances
- Skill mismatch and gaps:
  - Overqualification is very high, with 25 percent of workers being over-qualified.
  - Those with at most lower secondary education make up nearly 40 percent of the labor force — in some regions even over 50 percent — one of the highest shares among Euro Area countries.
- R&D spending and efficiency:
  - Since 2000, Spain spent on average 1.2 percent of GDP annually on R&D — ranging from 0.3 to 1.8 percent of GDP across regions.
  - By comparison, Germany and France spent over 2 percent of GDP.
  - Spending efficiency is low and diverse (e.g., measured by new patents per money spent on R&D).
- Policy implications to boost potential growth:
  - Reduce regulatory fragmentation and lower barriers to firm growth.
  - Encourage labor mobility and better skills-matching; train the low-skilled; expand firms’ innovation capacity.
  - Narrow interregional productivity gaps.
  - Apply the Market Unity Law more effectively to reduce cross-regional barriers; advance liberalization of professional services.
  - Modify or eliminate identified size-contingent regulations that create a “small business trap” and avoid measures that could reintroduce disincentives for firms to grow (note: the 2019 budgetary plan proposes to reintroduce a reduced corporate income tax (CIT) rate for certain SMEs).
  - Improve coordination across government levels for research and innovation policy; clarify and simplify eligibility criteria for R&D incentives to increase demand.
  - Enhance active labor market and education policies at the regional level, focusing on well-targeted training, increasing labor-market relevance of tertiary education through private sector–university cooperation, reducing school drop-out rates, and systematic exchanges of best practices and peer review among regions.

### Authorities’ views on structural reforms
- Authorities appreciate the multifaceted approach and are working on targeted growth-enhancing initiatives to fit within the 2019 budget.
- Recognize political constraints in achieving broader legislative changes; have started consultative processes with social partners and political parties.
- Ongoing/planned actions include strengthening support for SMEs (e.g., financial counseling), implementing the Market Unity Law via strengthened coordination with regions, preparing a digitalization strategy to enhance innovation, and adopting some liberalization measures in transport and energy sectors.

### Financial sector: strengthening resilience and upgrading the financial architecture
- Priorities: put legacy issues fully behind and prepare to deal with new challenges to enhance banking resilience and support credit intermediation.
- The 2017 FSAP identified four priority areas:
  - (i) accelerated cleanup of legacy bank assets;
  - (ii) further improvement in bank profitability and capitalization;
  - (iii) rigorous management of interest and liquidity risks;
  - (iv) reform of the institutional framework for financial oversight.
- Implementation of the ECB’s NPL guidance is critical to continue reducing impaired assets; since August 2017 several major banks announced plans to dispose of NPLs and foreclosed real estate assets (at least one transaction completed).
- Banks still need to lower elevated levels of NPLs and foreclosed assets; FSAP calls for:
  - a tough stance on implementation of the ECB’s NPL guidance, including promoting banks’ disclosure of NPL reduction targets and progress;
  - evaluation of NPL reduction strategies and targets based on careful analysis of banks’ property price assumptions.
- Risks from expanding consumer lending (a segment where NPLs tend to be relatively high) warrant close monitoring.
- Capitalization and profitability:
  - Common equity tier-1 (CET1) capital on a fully-loaded basis remains lower than that of many European peers even though Spanish banks are generally less leveraged.
  - Some estimates suggest Spanish banking system may face relatively large shortfalls to comply with upcoming MREL targets.
  - Recommendation: continue buildup of capital buffers and “bail in-able” debt in the largest banks to shield against shocks, including interest rate and sovereign risks; larger buffers also help protect against spillovers from emerging markets.
  - To improve structural profitability: further cost cutting, branch consolidation, evaluation of mergers and business-model adjustments given digitalization and Fintech challenges.
- Liquidity and interest rate risk management:
  - The failure of Banco Popular in 2017 on liquidity grounds and temporary deposit outflows during the Catalonia political crisis underscore the need for strong liquidity management.
  - Stress tests indicate sharp interest rate increases could erode margins via higher funding costs; some banks are vulnerable to interest rate and government bond yield shocks given significant exposures to long-duration sovereign bonds.
  - Spanish banks lend most mortgages at variable rates and should manage credit and funding risks as rates rise and as the transition to the new Euribor methodology occurs.
- Prudential oversight and resolution:
  - Need greater supervisory focus on corporate governance across credit institutions and nonbanks, particularly credit cooperatives.
  - Draft Mortgage Law presents an opportunity to improve conduct risk management.
  - Resolvability of small banks needs improvement; efforts underway to create a resolution fund for credit cooperatives to mutualize potential losses.
  - For Sareb (asset management company), Bank of Spain should regularly monitor and review its business plan to ensure realistic macrofinancial assumptions.
  - AML/CFT enhancements needed, including:
    - amending the AML/CFT Law to eliminate delays in implementing targeted financial sanctions relating to terrorist financing;
    - ensuring implementation of a risk-based supervisory framework over money and value transfer services;
    - adding resources to the AML/CFT supervisor (SEPBLAC) beyond the planned increase.

*IMF staff summary based on the provided chapter content.*

### 41.      The plans to modernize the institutional framework for financial oversight are

### 41.      The plans to modernize the institutional framework for financial oversight are

### Institutional modernization for financial oversight
- Spain’s financial sector oversight follows a strong sectoral approach; increasing intra-system connectedness creates an urgent need for timely information sharing, monitoring, and coordinated action among agencies.
- FSAP recommendation: establish a Systemic Risk Council—chaired by the Bank of Spain and comprising the Treasury and other financial oversight agencies—to bolster systemic risk surveillance and promote interagency coordination.
- Authorities’ actions underway:
  - Drafting a proposal for a national macroprudential authority.
  - Focus on creating an independent insurance and pension supervisor.
  - Focus on creating a financial consumer protection authority.
  - Enhancing the transparency of the appointment process for senior positions at financial oversight agencies.

### Macroprudential toolkit and legal basis
- Rising urgency to enhance the macroprudential toolkit despite no clear evidence so far of a generalized house price overvaluation (see Box 2).
- Recommendation: establish the legal basis for use of macroprudential tools, including limits on loan-to -value and debt service-to -income, so the Bank of Spain can act promptly if misalignments emerge.
- Staff recommendation: swiftly expand Bank of Spain’s macroprudential toolkit to include borrower-based tools to counter excessive risk-taking should financial stability threats arise.

### Authorities’ views and near-term priorities
- Authorities emphasized:
  - Improvement of banks’ asset quality.
  - Ongoing work to establish a macroprudential authority over the next months.
  - Banks’ strategies to reduce NPLs and foreclosed assets have become more ambitious.
  - Importance of monitoring growth of consumer credit, mainly used to finance purchases of durable goods.
  - Need for banks to further increase their CET1 capital ratios because low profitability remains a challenge.
- Views on external risks and bank resolution:
  - Multiple Point of Entry resolution strategy used by Spanish global banks mitigates spillover risks from emerging market volatility; authorities expect the impact of those risks to be manageable.
- Supervisory practices:
  - Bank of Spain regularly reviews banks’ funding plans and conducts annual liquidity stress tests since 2017.
- Housing market assessment:
  - Authorities did not see signs of overvaluation or financial stability risks stemming from the housing sector.
  - To tackle rent price pressures in some cities, authorities are evaluating measures to boost housing supply.
- Three near-term priority financial sector projects:
  - Setting up a national macroprudential authority.
  - Transposing the EU mortgage directive into national law.
  - Launching a sandbox for facilitating innovation in financial activities within a controlled framework.

### Staff appraisal — macroeconomic and fiscal issues
- Economic outlook and risks:
  - Spain’s economic recovery is maturing while downside risks are building.
  - After structural changes post-crisis, resilience and flexibility will be tested; preserve past structural reforms and use strong growth to reinforce the economy by accelerating public debt reduction and building capital buffers in the banking system.
- Fiscal policy recommendations:
  - Restart structural fiscal adjustment now: with a debt-to -GDP ratio close to 100 percent, public debt sustainability remains at risk.
  - 2019 budget must be the turning point toward persistently rebuilding fiscal buffers after four years of widening structural fiscal deficit.
  - Critical to meet the announced 1.8 percent of GDP deficit target in 2019.
  - Require adopting a reliable package of structural measures and planning contingency actions to promptly compensate potential revenue shortfalls.
  - Recommendation: a structural fiscal adjustment of at least ½ percent of GDP annually should persist until there is fiscal structural balance and debt is on a clear downward path.
  - Rationale: otherwise Spain would be forced to undertake a procyclical fiscal tightening when the economy is hit by adverse shocks.
  - Fiscal consolidation would also help strengthen the external position, which staff assesses as moderately weaker than suggested by fundamentals and desirable policies.
- Fiscal policy and inequality:
  - Spain’s revenue-to-GDP ratio is 7 percentage points below that of euro area peers.
  - Narrowing this gap with revenue measures would contribute to sustained medium-term fiscal adjustment and help finance social and distributional objectives, especially opportunities for the young.
  - Policy options to consider: lowering tax exemptions, increasing environmental taxes, and shifting more items to the standard VAT rate.
  - Offset unintended distributional effects with targeted spending measures.

### Staff appraisal — pensions, labor market, and productivity
- Pensions:
  - 2011/13 pension reforms were financially appropriate given demographics, but social acceptability is in question.
  - Need a sustainable and comprehensive package to avoid shifting the burden onto future contributors and pensioners.
  - Critical to decide now on a sustainable and equitable solution; avoiding a future reduction in real pension benefits will be extremely difficult unless there are fundamental changes to contributions and the labor market.
- Labor market:
  - Better-functioning labor market is core to more inclusion and higher wages.
  - Preserve greater wage flexibility from earlier reforms, particularly prevalence of firm-level over sector agreements.
  - High structural unemployment and pervasive duality indicate the job market is not yet healthy.
  - Additional reforms should:
    - Address weaknesses and promote social cohesion and wage gains aligned with productivity.
    - Forcefully tackle abuses of temporary contracts, but also adopt holistic measures to lower the cost of open-ended contracts, improve training and education outcomes, and raise low labor mobility across regions.
  - Concern: planned sharp increases in the statutory minimum wage could put at risk job opportunities of the young and low-skilled.
- Productivity:
  - Structural reform agenda needs new impetus to lift productivity.
  - Productivity gap to European peers is large, particularly among small and micro firms; labor productivity varies widely across regions.
  - Policy focus: eliminate disincentives for firms to grow, improve market access, expand firms’ innovation capacity.
  - Because regulatory policies, R&D initiatives, and education responsibility lie at regional level, enhance coordination between levels of government.

### Staff appraisal — banking system and financial stability
- Banking sector health:
  - Decline in nonperforming loans and foreclosed assets has accelerated, helping clean up banks’ balance sheets, but the process is not yet complete.
  - Spanish banks still lag European peers in capital ratios and would benefit from accelerating build-up of high-quality capital buffers to protect against shocks (including emerging market volatility and legal risks).
- Risk management:
  - Need rigorous management of liquidity and interest rate risks, particularly ahead of eventual normalization of the ECB’s accommodative policies.
- Macroprudential and systemic oversight:
  - As consumer lending and housing-related new loans are picking up, Bank of Spain’s macroprudential toolkit should be expanded to include borrower-based tools.
  - Critical to complete the setup for systemic risk oversight, including a robust macroprudential framework, and to continue following up on the 2017 FSAP recommendations.
- Institutional recommendation:
  - Expedite modernization of institutional framework for financial oversight and establish mechanisms for timely information sharing, monitoring, and coordinated action.

### Boxed findings on housing, exports, and cycle (highlights)
- Housing market (Box 2):
  - House prices increased by around 15 percent between 2014–17, boosted by fast recoveries in cities like Madrid and Barcelona.
  - No strong evidence of a clear overvaluation as of 2017:Q4 using price-to-rent and price-to-income ratios; both ratios roughly similar to mid-2003 and less than one standard deviation above historical averages.
  - A regression model suggests a slight overvaluation in 2017:Q4 but is limited in capturing supply-side dynamics.
  - Housing market recommendations: expand macroprudential toolkit; (i) improve balance sheets in construction and real estate sectors; (ii) encourage greater use of fixed-rate mortgages; (iii) ensure eligibility criteria for social home loans and rent subsidies are prudently assessed; (iv) improve housing development regulation to address supply constraints.
  - Caution: any measures aimed at reducing rent pressures should avoid negative supply-side effects with adverse impact on low-income renters.
  - Home ownership declined from 80 to 77 percent between 2008–17.
  - Contribution of construction sector value added is nearly half its pre-crisis level.
- Exports (Box 1):
  - Exports increased from 26 percent of GDP in 2007 to 34 percent in 2017.
  - Average annual real growth rate of goods exports increased from 4.5 percent in 2001–07 to 5.4 percent in 2010–17; services grew from 2.9 to 4.3 percent over the same periods.
  - Drivers: foreign demand, greater geographic diversification (including non-EU markets), regained cost competitiveness (ULC), and substitution from low domestic demand.
  - Labor market reforms (2010 and 2012) are estimated to account for nearly one-tenth to above one-quarter of real export growth over 2010–13; panel regressions imply LMR associated with faster growth of real exports in the order of 1 to 4 percentage points.
- Economic cycle (Box 3):
  - Traditional and non-traditional output gap estimates range from -1.8 to +2.0 percent of potential GDP for 2018.
  - IMF baseline (multivariate filter) suggests a slightly positive output gap for 2018 and potential growth of 1.5 percent for 2018.
  - Other methods produce potential growth estimates ranging from 0.9 to 2 percent for 2018.
  - Several labor and capacity indicators point to the cycle being largely completed: unemployment at end-2017 slightly below long-term average; vacancies-to-unemployed ratio approached long-term average; capacity utilization for overall economy surpassed long-term average in 2017.

### Procedural recommendation
- It is recommended that Spain remain on the standard 12-month Article IV cycle.

*International Monetary Fund — selected excerpts from the staff report and staff appraisal contained in the source content.*

### Box 4. Inequality and Poverty Across Generations

### Box 4. Inequality and Poverty Across Generations

### Key findings
- The global financial crisis increased inequality and poverty across generations in most of Europe; Spain was particularly affected.
- Spain’s youth were hard hit by economic stagnation, while the older generation was largely protected by the pension system.
- When revising the pension system, it is important to explicitly consider the impact on intergenerational equity.

### Income developments by age group
- The median net income ratio of those over age 65 to those between the ages of 18–24 increased in 24 of 28 EU countries following the global financial crisis; Spain experienced the second largest increase.
- In 2015 those over 65 years earned 20 percent more than those between the ages of 18–24, a reversal from the pre-crisis years.
- The gap narrowed to 10 percent in 2017, helped by the recovery in youth employment.
- In 2015–17 the older age group saw its mean income increase annually by 1.7 percent on average, while the younger group enjoyed a larger average annual rise of 6 percent.

### Poverty trends
- The risk of youth poverty surged in Spain over the past decade.
- During the pre-crisis years, youth poverty risk was slightly below the euro area average, supported by employment in the construction sector.
- When the economy went into recession and youth job opportunities disappeared, poverty for that age group rose rapidly.
- In 2015, one in three youths was at risk of poverty (defined as the share of persons with equivalized disposable income after social transfers of less than 60 percent of the median disposable income).
- For the elderly, the poverty rate dropped sharply from 30 percent in 2005 to 12 percent in 2015.
- Since 2015, trends started to reverse with youth poverty on the decline.

### Role of the pension system and redistribution
- The pension system helped shield the elderly through the worst of the crisis.
- Market income inequality in Spain is significantly higher for the elderly, but after accounting for fiscal redistribution through taxes and transfers, disposable income inequality for the elderly is lower than for the working age population.

*Source: Box 4. Inequality and Poverty Across Generations.*

### Box 5. Regional Labor Market Mobility

### Box 5. Regional Labor Market Mobility

### Regional labor market disparities
- The gap in the unemployment rates between the top (90 percentile) and bottom (10 percentile) regions fluctuated around 15 percentage points over the last decade.
- Regions in the Northeast were consistently the best performers with an average unemployment rate of 13 percent.
- The jobless rates in the Canary Islands and the South (average of 25 percent) were continuously among the highest.
- The regional dispersion increased notably during the crisis but has declined since 2013 on the back of strong economic recovery.

### Labor mobility patterns
- About 3 percent of the population changed residence across regions during 1998–2016 (Residential Variation Statistics, INE).
- The internal mobility rate grew steadily during the economic boom years but declined following the crisis as the overall labor market deteriorated.
- Much of the underlying trend was driven by labor movement of immigrants, whereas the mobility rate of Spaniards was relatively stable.
- On average, regional mobility among foreigners was around three times higher than that of Spaniards.
- In net terms, only a few regions have been consistently a net receiver (Navarra and Balearic Islands) or a net sender (Aragon and Extremadura).
- The crisis brought some changes to the pattern of mobility flows, with some regions (e.g. Madrid and Basque Country) switching from net senders before the crisis to net receivers afterwards.
- Internal mobility rate definition: calculated as the number of residential variations within Spain divided by the size of the corresponding population.

### Determinants of internal mobility (staff analysis)
- Main factors explaining Spain’s interregional migration flows: housing prices, labor market conditions, and labor market duality.
- Regression analysis controls for standard macroeconomic, demographic, and geographic factors.
- All else equal, the following have a negative effect on labor mobility:
  - Higher housing prices in destination regions.
  - Larger unemployment rates in destination regions.
  - Greater share of temporary employment in origin regions.
- Regions with a larger share of low education labor force tend to generate more population outflows particularly after the global financial crisis.
- Spaniards tend to have a strong “home bias”, which could be attributed to culture and unknown institutional factors.
- When comparing Spaniards and foreigners:
  - Push factors tend to be more important for foreigners’ mobility.
  - Pull factors matter more for Spaniards.

### Policy implications and recommendations
- Given Spaniards’ strong “home bias”, there may be a role for policies to provide additional incentives to promote labor movement.
- Addressing housing price differentials, labor market duality (temporary employment share), and region-specific unemployment could facilitate greater interregional mobility, especially for low-education workers.

*For more details see Lucy Liu, “Regional Labor Market Mobility in Spain”, IMF Working Paper (forthcoming).*

### Appendix I. Main Recommendations of the 2017 Article IV

### Appendix I. Main Recommendations of the 2017 Article IV

### Fiscal Policy — IMF 2017 Article IV Recommendations and Authorities Actions
- Recommendation: Implement gradual adjustment with an annual reduction in the structural primary deficit by about 0.5 percent of GDP until structural balance is reached.
  - Authorities actions: Following a broadly neutral fiscal stance in 2017, in 2018 the structural primary balance is set to deteriorate by 0.2 percent of GDP. For 2019, the authorities plan to lower the structural deficit by 0.4 percent of GDP, with the budget still to be adopted.
- Recommendation: Identify measures to improve VAT collection, reduce tax system inefficiencies, consider raising environmental taxes and levies, and enhancing expenditure efficiency.
  - Authorities actions: CIT and VAT measures implemented in 2017 yielded a much lower revenue than budgeted. For 2018, the budget lowered the PIT threshold for low-income workers. For 2019, the government plans to increase the revenue-to -GDP ratio by 0.6 percent of GDP, with the budget still to be adopted. The expenditure review is progressing, with recommendations on subsidies expected for end-2018.
- Recommendation: Implement fully the 2011/13 pension reforms, and explore refinement options to balance pension sustainability and social acceptability.
  - Authorities actions: The 2018 budget includes general pension increases in 2018–19 deviating from the 0.25 percent implied by the pension formula. It also delays the implementation of the “sustainability factor” from 2019 to 2023. The parliamentary pension committee (Toledo Pact) recommended to link pension increases permanently to an indicator of purchasing power.
- Recommendation: Reform the regional financing framework to improve compliance with fiscal targets in the short term and enhance regions’ revenue-raising capacity in the medium term.
  - Authorities actions: Fiscal compliance of regional governments improved. Two expert reports with recommendations to reform the regional and local public finance were published in August 2017. The new government has not yet made reform proposals, but is analyzing reform options. It is already allowing some regions to gradually return to market financing.

### Structural Reforms
- Labor market reforms
  - Recommendation: Improve the efficiency and design of active labor market policies (ALMPs), strengthen the Public Employment Services’ capacity to better support the employability of the young and long-term unemployed, and conduct regular evaluations of existing ALMPs.
    - Authorities actions: The authorities published a multi-year strategy on employment activation. It lists initiatives to improve ALMPs’ effectiveness, including by conducting an external evaluation in 2018. A new bonus for the young working under apprenticeship contracts was introduced.
  - Recommendation: Reduce labor market segmentation by improving the attractiveness of open-ended contracts for employers and reducing administrative and legal obstacles that add to the cost of such contracts.
    - Authorities actions: The authorities have intensified inspections and increased sanctions to reduce the abuse of temporary contracts. The government adopted a “masterplan for fair and decent jobs” to tackle the abuse of temporary and involuntary part-time contracts as well as improper claim of self-employed status.
- Productivity growth
  - Recommendation: Advance the implementation of the Market Unity Law and liberalization of professional services; tackle remaining size-related regulations; deepen market-based financing for young and innovative start-ups; and increase the efficiency of public R&D and improve public-private cooperation.
    - Authorities actions: The government has published a catalogue with good and bad regulatory practices and recommends all government levels to assess the compatibility of any new legislation with the Market Unity Law before it is adopted. The 2019 draft budgetary plan proposes to reintroduce differentiated corporate income tax rates for SMEs by lowering the CIT rate for certain SMEs to 23 percent (from 25 percent). The 2018–21 ICO Strategic Plan includes actions to strengthen venture capital.

### Financial Sector Policies
- Recommendation: Accelerate banks’ balance sheet cleanup by implementing ECB guidance and BdE rules on NPLs, assessing banks’ NPL reduction strategies, and strengthening the insolvency framework including for SME.
  - Authorities actions: NPLs and foreclosed assets continued to decline as several significant banks made important progress in selling distressed assets last year. According to the SSM, progress is broadly in line with banks’ NPLs reduction plans. The government has established an expert group to draft a transposition proposal of the still-to-be-finalized EU directive on insolvency procedures.
- Recommendation: Advance privatization of state-owned banks and manage the performance of Sareb by regularly reviewing its business plan.
  - Authorities actions: A merger between the state-owned banks Bankia and BMN was completed last year, but the public ownership in Bankia remains to be divested. Sareb conducted sensitivity analysis in its business plan, including extreme adverse scenarios. No changes were made to the review process of Sareb’s business plan.
- Recommendation: Explore the scope for further banking consolidation, encourage banks to raise high-quality capital, and enhance monitoring and management of liquidity and interest rate risks.
  - Authorities actions: Banks continued to build capital buffers, but progress has been slow and uneven. Interest rate risk in the banking book (IRRBB) is monitored in the annual Supervisory Review and Evaluation Process (SREP) as one of the risks to capital. The Bank of Spain introduced regular liquidity stress tests. Liquidity monitoring is being reinforced at the EU level.
- Recommendation: Strengthen systemic risk oversight by setting up a Systemic Risk Council and enhance BdE’s macroprudential toolkit.
  - Authorities actions: The Treasury is drafting a proposal for a national macroprudential authority. The authorities are working on the introduction of new borrower-based macroprudential tools.
- Recommendation: Improve corporate governance of Spanish financial institutions, particularly the credit cooperative sector, and enhance the governance of certain parts of the institutional architecture.
  - Authorities actions: The work for transposing the EU mortgage directive into national law is proceeding. The new law would aim, among other things, at improving the management of banks conduct risk. Efforts are also underway to create a credit cooperative fund to facilitate resolution. Draft laws on the creation of an independent insurance and pension supervisor as well as a financial consumer protection authority are being prepared.

### Spain — Overall Assessment: Foreign Asset and Liability Position and Trajectory
- Background facts and levels:
  - NIIP dropped from -35 percent of GDP in 2000 to -94 percent of GDP in 2009.
  - NIIP remained elevated at -81 percent of GDP at end-2017, and has improved by 14 percentage points since 2013.
  - Gross liabilities stood at 242 percent of GDP in 2017, with more than 2/3 in the form of external debt.
  - The share of NIIP accounted for by the general government and the central bank increased from around ¼ in 2010 to ¾ in 2017.
  - TARGET2 liabilities reached 32 percent of GDP by end-2017.
- Assessment:
  - Large negative NIIP creates external vulnerabilities, including large gross financing needs from external debt and potentially adverse valuation effects.
  - Mitigating factors: favorable maturity structure of outstanding sovereign debt (averaging 7 years) and current ECB measures, such as QE, that lower the cost of debt.
  - Overall Assessment: The external position in 2017 was moderately weaker than consistent with medium-term fundamentals and desirable policy settings. Based on preliminary 2018 estimates, that assessment remains unchanged. As the current account remains in surplus, the external position continues to gradually strengthen.
  - Staff assesses Spain’s CA norm to be relatively high, in part due to external sustainability risks from a large negative NIIP. Achieving both a sufficiently strong NIIP and further reductions in unemployment continues to require a moderately lower real effective exchange rate for a sustained period.

### Current Account (CA) Assessment and Real Exchange Rate
- CA background and projections:
  - CA deficit peaked at 9.6 percent of GDP in 2007.
  - CA surplus reached 1.9 percent of GDP in 2017.
  - Projected CA surplus for 2018 is around 1 percent of GDP.
- CA norm and gap:
  - EBA CA model suggests a norm of 1.4 percent of GDP for 2017; cyclically-adjusted CA balance is 1.5 percent of GDP.
  - Staff’s external-sustainability-guided CA norm: about 3 percent of GDP, with a range of 2-4 percent of GDP.
  - Staff CA gap: -1.5 (implied by staff adjustments in the summary).
  - EBA CA Gap: 0.1; Staff Adj.: 1.6; Staff CA Gap: -1.5 (table excerpt from source).
- Real exchange rate (REER) background and assessment:
  - In 2017, CPI-based and ULC-based REER appreciated by 2 percent from their average 2016 levels.
  - CPI-based REER is about 8 percent lower than its 2009 peak; ULC-based REER depreciated by 17 percent after its 2008 peak.
  - As of August 2018, the ULC-based REER and the CPI-based REER appreciated an additional 1 to 1.7 percent relative to 2017 averages.
  - Two EBA REER models estimate an overvaluation in the range of 5.1 to 5.8 percent for 2017; CA model implies close-to-zero overvaluation.
  - Staff assesses a 2017 REER gap in the range of 3 to 10 percent.

### Capital and Financial Accounts: Flows and Policy Measures
- Background and assessment:
  - Financing conditions favorable; sovereign bond yields near historical lows.
  - Private sector continued deleveraging against the rest of the world.
  - TARGET2 liabilities increased during 2015–17 at an annual average pace of 5 percent of GDP.
  - Resident agents increased net investment in foreign assets; net liability flows against the rest of the world (excluding the Bank of Spain) declined.
  - Recent net capital outflows also explained by a net FDI outflow.
  - Assessment: ECB actions and domestic reforms and fiscal consolidation improved investor sentiment. However, large external financing needs in public and private sectors leave Spain vulnerable to sudden changes in market sentiment and spillovers from Europe.

### FX Intervention and Reserves Level
- Background: The euro has the status of a global reserve currency.
- Assessment: Reserves held by the euro area are typically low relative to standard metrics, but the currency is free floating.

### Risk Assessment Matrix — External Risks (selected entries)
- Weaker-than-expected global growth
  - Relative Likelihood: Medium
  - Time Horizon: MT
  - Impact if Realized: Medium — Slowing external demand would weigh on growth and employment; a rise in NPLs combined with higher borrowing cost could generate a vicious circle of debt overhang and low growth.
  - Policy Response:
    - Enhance labor market performance and lower duality.
    - Deepen product market reforms and other structural reforms to raise productivity.
    - Let automatic stabilizers play in case the output gap widens and formulate credible medium-term fiscal path in support of public debt sustainability.
    - Continue strengthening the financial sector and its capacity to support growth.
- Rising protectionism and retreat from multilateralism
  - Relative Likelihood: High
  - Time Horizon: ST, MT
  - Impact if Realized: Medium — Escalating trade tensions could increase uncertainty and financial market volatility, disrupting global supply chains.
  - Policy Response:
    - Accelerate structural reforms to strengthen competitiveness, in particular enhance labor market performance and lower duality.
    - Let automatic stabilizers play and formulate credible medium-term fiscal path.
- Sharp tightening of global financial conditions
  - Relative Likelihood: High
  - Time Horizon: ST
  - Impact if Realized: Medium — Tighter conditions increase debt service and refinancing risks; could re-emerge bank-sovereign-real economy links.
  - Policy Response:
    - Accelerate structural reforms and formulate credible medium-term fiscal path to support investor confidence.
    - Banks to continue building capital buffers.
    - Further ECB policy actions could help depending on the nature of the shock.
- Sizeable deviations from baseline energy prices
  - Relative Likelihood: Medium
  - Time Horizon: ST, MT
  - Impact if Realized: Medium — Higher oil prices would push up CPI inflation weighing on consumer spending and growth; lower oil prices would benefit the Spanish economy.
  - Policy Response:
    - Use any windfall revenues to reduce the high public debt.
    - Allow automatic stabilizers to operate and formulate credible medium-term fiscal path.

### Risk Assessment Matrix — Domestic Risks (selected entries)
- Prolonged period of uncertainty related to political crisis in Catalonia
  - Relative Likelihood: Medium
  - Time Horizon: MT
  - Impact if Realized: Medium — Could weaken business confidence and weigh on investment.
  - Policy Response:
    - Advance ongoing structural reforms and enhance labor market performance.
    - Formulate credible medium-term fiscal path to support investor confidence.
- Weak implementation of fiscal commitments and structural reforms or reversal of past policy achievements
  - Relative Likelihood: Medium
  - Time Horizon: ST, MT
  - Impact if Realized: High — Lack of or reversal of reforms and fiscal consolidation could weaken confidence, investment, and employment; adversely impact public debt dynamics and trigger adverse market reactions.
  - Policy Response:
    - Advance structural reforms and enhance labor market performance.
    - Return to gradual, steady and growth-friendly fiscal consolidation.
    - Reform the regional financing framework to reduce fiscal risks.
- Higher-than-estimated growth momentum created by past reforms
  - Relative Likelihood: Medium
  - Time Horizon: ST
  - Impact if Realized: Medium — Robust job creation could continue without creating wage pressures, sustaining strong private consumption growth.
  - Policy Response:
    - Use any windfall revenues to reduce the high public debt.
    - Continue structural reform efforts, given still considerable structural weaknesses.

*Source: Appendix I. Main Recommendations of the 2017 Article IV (cr18330) — IMF staff summary of recommendations, authorities’ actions, assessments, and Risk Assessment Matrix.*

### Appendix IV. Debt Sustainability Analysis

### Appendix IV. Debt Sustainability Analysis

### A. Public Debt Sustainability Analysis — Summary and Key Findings
- Spain’s public debt sustainability remains at risk despite the sizeable reduction of the headline fiscal deficit since 2010.
- Baseline projection: public debt is projected to decline slowly, reaching about 92.5 percent of GDP in 2023.
- Largest risks: a negative growth shock and the realization of contingent liabilities.
- Policy priority: returning to a gradual but persistent fiscal consolidation.
  - An annual structural adjustment of about 0.5 percent of GDP over the medium term would bring debt to around 87 percent of GDP by 2023—about 5 percentage points lower than under the baseline.
- Gross financing needs:
  - Declined below the 20 percent of GDP early warning benchmark.
  - Projected at 17.4 percent of GDP in 2018 (one of the highest in the euro area).
  - Projected to be 16.5 percent of GDP in 2023 under the baseline.

### Background: Definitions and Coverage
- Public debt comprises Excessive Deficit Procedure (EDP) debt in the hands of the General Government.
- General Government includes the Central Government, Regional Governments, Local Governments, and Social Security Funds.
- EDP debt is a subset of General Government consolidated debt and stocks are recorded at nominal value.

### Developments (Historical Evolution)
- Public debt-to-GDP ratio:
  - Increased from 35.5 percent in 2007 to a peak of 100.4 percent in 2014.
  - Drivers: excessive fiscal deficits (about 8.3 percent of GDP on average during 2008–14) and an unfavorable growth-interest rate differential (annual average contribution of about 2½ percent of GDP).
  - Banking sector support added about 4½ percent of GDP to the public debt stock.
  - Declined to 98.1 percent of GDP at end-2017.
- Gross financing needs:
  - Peaked at 22 percent in 2012; dropped to below 20 percent of GDP afterward.
  - Contributing factors: maturity extension, nominal deficit reduction, ECB quantitative easing and sovereign bond purchases.
  - 10-year bond yield declined from about 6¾ percent in mid-2012 to about 1.5 percent at end-October 2018.
  - Effective interest rate on outstanding debt declined; interest payments expected to fall below 2½ percent of GDP in 2018.

### Other Factors (Debt Structure and Holdings)
- Amortization profile: tilted to the long term—93 percent of total debt on a residual maturity basis.
- Average life:
  - At issuance: increased from 5 years in 2012 to nearly 11 years in 2017.
  - Outstanding debt average life: increased from 6.3 to 7 years over the same period.
- Average cost of outstanding debt: fell to 2.6 percent in 2017 (all-time low).
- Holdings:
  - Share of marketable debt held by Spanish banking system: about 18 percent.
  - Share held by the ECB: about 21 percent.
  - Share held by residents declined by 11 percentage points since 2012 to 56 percent by end-2017 (above 2007 level of 50 percent).
- Stock of financial assets: about 33 percent of GDP in 2017.
  - Net public debt levels: 85 percent of GDP at end-2017.

### Baseline Projections and Assumptions
- Baseline debt path:
  - Public debt: 97.3 percent of GDP in 2018, declining slowly to 92.5 percent by 2023.
  - Gross financing needs: remain below 20 percent, gradually declining; still relatively high at 16.5 percent of GDP in 2023 compared to other euro area countries.
- Key macro-fiscal assumptions:
  - (i) Growth: 2.5 percent in 2018; 2.2 percent in 2019.
  - (ii) Medium-term growth convergence toward potential of around 1¾ percent.
  - (iii) Fiscal stance: a structural loosening of around 0.2 percent of GDP in 2018 and 2019, followed by broadly neutral fiscal stance over the medium term in structural primary terms.
  - (iv) Inflation (GDP deflator): increase from 1.2 percent in 2017 to 1.9 percent in 2023.
  - (v) Long-term sovereign spreads: 10-year bond yields increase moderately to 3.6 percent in line with gradual normalization of monetary policy.

### Realism of Baseline Projections
- Median forecast errors (2009–17):
  - Real GDP growth: 0.62 percent (moderate downward bias in staff projections).
  - Primary balance: -0.95 percent (some upward bias in staff projections).
  - Inflation: -0.31 percent (some upward bias in staff projections).
- Comparison with high debt country experience: projected adjustment and level of the CAPB in Spain are below thresholds that would question feasibility.

### Stress Tests — Scenarios and Results
- General: public debt would either remain broadly flat or increase under several standard shock scenarios; contingent liabilities and negative growth shocks produce the worst outcomes.
- Peak debt outcomes under key scenarios:
  - Contingent liabilities materialization: peak around 111.7 percent of GDP in 2020 (see detailed contingent liability shock).
  - Combined adverse shocks (growth, primary balance, interest): public debt peaking in 2020 around 112 percent of GDP and 106 percent of GDP under alternative combinations referenced.
- Growth Shock:
  - Assumption: real GDP growth lower by one (10-year historical) standard deviation for two consecutive years (2019–20).
  - Implication: real GDP contract by an average of 0.5 percent per year in 2019–20 versus annual average growth of 2.0 percent under baseline.
  - Effects: inflation lower by average 0.6 percentage points per year; primary balance weaker by about 1.9 percent of GDP per year in recession years.
  - Debt path:
    - Debt-to-GDP: rise to 105 percent in 2020, declining to 102 percent in 2023 (almost 10 percentage points higher than baseline).
    - Gross financing needs: increase to 20.8 percent in 2020 (slightly above 20 percent benchmark).
    - If no fiscal tightening post-recession (primary expenditure remains at baseline nominal levels), debt reaches 110 percent of GDP in 2023.
- Primary Balance Shock:
  - Assumption: relaxation of fiscal policy in 2019–20, cumulative deterioration of primary balance of 1.8 percent of GDP (½ the 10-year historical standard deviation).
  - Debt path: peak at 98.5 percent of GDP in 2020; decline to 97.4 percent in 2023 (nearly 5 percentage points higher than baseline).
  - Gross financing requirements larger than baseline.
- Interest Rate Shock:
  - Assumption: real interest rate shock of about 325 basis points during 2019–23.
  - Effects: effective interest rate increases to 4.1 percent by 2023 versus 2.9 percent in baseline.
  - Debt-to-GDP: broadly stable at 95.8 percent in 2023.
  - Note: long debt maturity and high share of fixed-rate debt help withstand the shock, but fiscal space is reduced.
- Combined Shock:
  - Simultaneous combination of growth, primary balance, and interest shocks.
  - Debt-to-GDP: increase to 107.7 percent in 2023 (about 15 percentage points higher than baseline).
  - Gross financing needs: rise to 21.4 percent in 2023.
- Contingent Liability Shock:
  - Assumption: one-time increase in non-interest public expenditures in 2019 equivalent to 10 percent of banking sector assets, combined with lower growth and inflation in 2019–20 (growth reduced by 1 standard deviation).
  - Effects:
    - Primary deficit: about 10 percent of GDP in 2019.
    - Gross financing needs: 27.5 percent of GDP in 2019 (about 7 percentage points above standard early warning benchmark levels).
    - Debt-to-GDP: peak at 111.7 percent in 2020; decline to about 109.8 percent in 2023 (about 17 percentage points higher than baseline).
- Heat Map Assessment:
  - Benchmark level of 85 percent of GDP is breached under baseline and each shock scenario.
  - Gross financing needs: below 20 percent in baseline but surpass the benchmark under output and primary balance shocks and contingent liabilities.
  - Profile risks: stem from high level of external financing needs and, to a lesser extent, the share of public debt held by non-residents.

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### B. External Debt Sustainability Analysis — Summary and Key Findings
- Baseline: external debt projected to decline from peak of 168 percent of GDP in 2015 to about 144 percent of GDP in 2023, aided by accumulation of trade surpluses.
- Vulnerabilities remain due to high external debt, but mitigating factors include low cost of debt, limited share of debt in foreign currency, favorable maturity structure, and diversified exports.
- Gross external financing needs: will continue to decrease but remain high—around 60 percent of GDP in 2023.

### Methodology
- External DSA complements the External Sector Assessment (Appendix II).
- Estimates external debt paths under several scenarios using mechanistic assumptions to gauge potential impacts of shocks.

### Baseline Assumptions and Projections
- Medium-term macro projections:
  - Gradual convergence of real GDP growth to estimated potential of around 1.75 percent.
  - Trade surplus forecast to gradually improve.
  - External current account balance remains close to 1 percent of GDP.
- External debt trajectory:
  - 167 percent of GDP in 2017 to 144 percent of GDP in 2023.
  - External debt-to-exports ratio: projected to sharply decline during 2018–23 due to good export performance.

### Alternative Scenarios and Stress Tests — External Debt
- General: external debt remains relatively high though declining; crisis-like macro variables would increase external debt.
- Historical Shock Scenario:
  - Based on 2008–17 historical properties for real GDP growth, external interest rate, GDP deflator in US dollars, and current account (excl. interest).
  - External debt increases to 204 percent of GDP by 2023.
  - Driven partly by real GDP growth path of 0.3 percent since 2019 and a lower current account surplus (excluding interest).
- Interest Rate Shock:
  - One-half standard deviation interest rate shock (increase from 2 percent baseline to 2.5 percent).
  - External debt higher by about 4 percentage points of GDP at end-2023 compared to baseline.
- Growth Shock:
  - Assumption: real GDP growth averages 0.6 percent between 2019 and 2023 versus 1.8 percent in baseline.
  - External debt reaches 154 percent of GDP in 2023.
- Non-interest Current Account Shock:
  - Assumption: current account surplus excluding interest averages 2.3 percent of GDP rather than 3.8 percent in baseline.
  - External debt stock of 151 percent of GDP in 2023.
- Combined Shock:
  - Combination of ¼ standard deviation shocks to real GDP growth, external interest rate, and current account balance.
  - External debt-to-GDP ratio of 154 percent in 2023.
- Real Depreciation Shock: scenario listed but detailed results not provided in the supplied content.

*Appendix IV. Debt Sustainability Analysis.*

### 23.      Compared to the baseline projection, a 30 percent real depreciation shock would

### 23.      Compared to the baseline projection, a 30 percent real depreciation shock would

### Summary findings
- A 30 percent real depreciation shock would increase the external debt over the medium term, on average, by around 5 percent of GDP per year.
- In the external DSA, the mechanical transmission channel is via valuation effects, but Spain has a low share of debt denominated in foreign currency.

### External debt dynamics and transmission
- Baseline external debt (in percent of GDP), selected years: 2013: 160.2; 2014: 168.0; 2015: 168.4; 2016: 167.0; 2017: 166.6; 2018: 164.9; 2019: 160.1; 2020: 155.7; 2021: 151.6; 2022: 147.7; 2023: 144.1.
- Change in external debt (yearly): 2013: -6.0; 2014: 7.8; 2015: 0.4; 2016: -1.4; 2017: -0.4; 2018: -1.7; 2019: -4.8; 2020: -4.4; 2021: -4.0; 2022: -3.9; 2023: -3.6.
- Identified external debt-creating flows (sum of current account deficit excluding interest, net non-debt creating capital inflows, and automatic debt dynamics): 2013: -4.0; 2014: -7.1; 2015: -6.7; 2016: -9.1; 2017: -8.8; 2018: -6.2; 2019: -5.7; 2020: -5.1; 2021: -4.9; 2022: -4.8; 2023: -4.8.
- Current account deficit, excluding interest payments (in percent of GDP): 2013: -5.5; 2014: -4.6; 2015: -4.0; 2016: -4.7; 2017: -4.1; 2018: -3.2; 2019: -3.0; 2020: -3.4; 2021: -3.8; 2022: -4.2; 2023: -4.5.
- Net non-debt creating capital inflows (negative, in percent of GDP): 2013: -4.0; 2014: -4.2; 2015: -2.3; 2016: -1.2; 2017: 0.2; 2018: -1.5; 2019: -1.5; 2020: -1.5; 2021: -1.5; 2022: -1.5; 2023: -1.5.
- Automatic debt dynamics (contribution, percent of GDP): 2013: 5.5; 2014: 1.6; 2015: -0.4; 2016: -3.1; 2017: -4.9; 2018: -1.5; 2019: -1.2; 2020: -0.2; 2021: 0.4; 2022: 0.8; 2023: 1.2.
- Contribution from nominal interest rate (percent): 2013: 4.0; 2014: 3.5; 2015: 2.9; 2016: 2.5; 2017: 2.2; 2018: 2.2; 2019: 2.3; 2020: 2.6; 2021: 2.9; 2022: 3.3; 2023: 3.5.
- Contribution from real GDP growth (percent): 2013: 2.8; 2014: -2.2; 2015: -7.0; 2016: -5.2; 2017: -4.7; 2018: -3.7; 2019: -3.5; 2020: -2.9; 2021: -2.6; 2022: -2.4; 2023: -2.4.
- Residual, including change in gross foreign assets (percent of GDP): 2013: -2.0; 2014: 15.0; 2015: 7.1; 2016: 7.6; 2017: 8.4; 2018: 4.5; 2019: 0.8; 2020: 0.7; 2021: 0.9; 2022: 0.9; 2023: 1.2.

### Baseline macro and debt indicators (selected)
- Real GDP growth (percent): 2016: -1.7; 2017: 1.4; 2018: 3.6; 2019: 3.2; 2020: 3.0; 2021: 0.3; 2022: 2.6; 2023: 2.5; 2024: 2.2; 2025: 1.9; 2026: 1.7; 2027: 1.7; 2028: 1.7.
- Nominal gross public debt (in percent of GDP): 2016: 70.9; 2017: 99.0; 2018: 98.1; 2019: 97.3; 2020: 96.0; 2021: 94.8; 2022: 93.9; 2023: 93.0; 2024: 92.5.
- Public gross financing needs (in percent of GDP): 2016: 16.9; 2017: 19.2; 2018: 18.9; 2019: 17.4; 2020: 16.8; 2021: 16.6; 2022: 16.5; 2023: 16.5; 2024: 16.5.
- Effective interest rate (in percent): 2016: 4.0; 2017: 2.9; 2018: 2.7; 2019: 2.6; 2020: 2.5; 2021: 2.5; 2022: 2.6; 2023: 2.7; 2024: 2.9.
- Inflation (GDP deflator, percent): 2016: 0.7; 2017: 0.3; 2018: 1.2; 2019: 1.3; 2020: 1.7; 2021: 1.9; 2022: 1.9; 2023: 2.0; 2024: 1.9.
- Primary balance (percent of GDP): 2016: -0.6; 2017: 1.9; 2018: 0.7; 2019: 0.6; 2020: 0.3; 2021: 0.2; 2022: 0.3; 2023: 0.3; 2024: 0.4.
- Primary (noninterest) revenue and grants (percent of GDP): 2016: 37.2; 2017: 37.5; 2018: 37.7; 2019: 38.2; 2020: 38.2; 2021: 38.1; 2022: 38.0; 2023: 37.9; 2024: 37.8.
- Primary (noninterest) expenditure (percent of GDP): 2016: 41.9; 2017: 39.4; 2018: 38.4; 2019: 38.8; 2020: 38.5; 2021: 38.3; 2022: 38.3; 2023: 38.2; 2024: 38.1.
- Change in gross public sector debt (cumulative percent of GDP, 2016–2024 in table): 2016: 6.7; 2017: -0.4; 2018: -0.8; 2019: -0.8; 2020: -1.4; 2021: -1.2; 2022: -0.9; 2023: -0.8; 2024: -0.5; cumulative to 2024: -5.6.
- Public sector defined as general government.

### Alternative scenarios and stress tests (selected)
- Stress tests include: Primary Balance Shock; Real GDP Growth Shock; Real Interest Rate Shock; Real Exchange Rate Shock (one-time 30 percent depreciation in 2019); Combined Shock; Contingent Liability Shock; Combined Macro-Fiscal Shock.
- In bound tests and scenario charts, a one-time real depreciation of 30 percent occurs in 2019 (noted as Real depreciation shock 4/).
- Boxed figures in debt charts represent average projections for variables in baseline and scenario; ten-year historical averages are also shown.
- Historical scenario (ten-year historical average projection) for external debt level example: scenario with key variables at their historical averages yields external debt pathways (e.g., 164.9; 172.1; 180.0; 187.7; 196.0; 204.4 in projection horizon).

### Key external sector indicators (selected)
- External debt-to-exports ratio (in percent), selected values: 2013: 496.7; 2014: 513.2; 2015: 510.3; 2016: 503.2; 2017: 484.8; 2018: 483.8; 2019: 470.2; 2020: 452.0; 2021: 434.3; 2022: 417.8; 2023: 404.2.
- Gross external financing need (in billions of US dollars): 2013: 1058.0; 2014: 963.4; 2015: 971.9; 2016: 876.9; 2017: 908.1; 2018: 998.4; 2019: 1103.1; 2020: 1124.6; 2021: 1145.3; 2022: 1164.0; 2023: 1182.5.
- Gross external financing need (in percent of GDP), selected: 2013: 77.7; 2014: 69.9; 2015: 81.0; 2016: 70.8; 2017: 69.0; 2018: 66.5; 2019: 69.8; 2020: 67.8; 2021: 66.1; 2022: 64.3; 2023: 62.8.

### Notes on methodology and assumptions
- External financing requirement is defined as the sum of current account deficit, amortization of medium and long-term total external debt, and short-term total external debt at the end of previous period.
- Automatic debt dynamics formula referenced: derived as [(r - π(1+g) - g + ae(1+r)]/(1+g+π+gπ)) times previous period debt ratio, with r = interest rate; π = growth rate of GDP deflator; g = real GDP growth rate; a = share of foreign-currency denominated debt; e = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).
- Exchange rate contribution derived as ae(1+r) in automatic debt dynamics.
- One-time real depreciation shock applied in the stress test framework: 30 percent in 2019 (Real depreciation shock 4/).

*Source: IMF staff (Spain Public DSA—Risk Assessment and External Debt Sustainability Framework, as provided in the supplied content).*

### Appendix V. Implementation Status FSAP Recommendations

### Appendix V. Implementation Status FSAP Recommendations

### To address crisis legacy issues and mitigate other risks to financial stability
- Recommendation 1: Enforce implementation of the ECB guidance on NPLs, including promoting banks’ disclosure of targets and progress (SSM, BdE)
  - Status: SSM assessing credibility and ambition of bankś NPL reduction plans; progress in line with bank strategies.
  - Significant transactions in 2017: sales of distressed assets by the two largest banks amounting to about €41 billion in gross value. One transaction completed in H1 2018. Other wholesale transactions announced in 2018.
  - Enhanced disclosure requirements on asset quality and NPLs mandated by end-2018. EBA planning additional disclosure items aligned with ECB guidance.

- Recommendation 2: Improve recovery of viable businesses by enabling the stay and involvement of public creditors in all pre-insolvency processes and enhancing the OCAP process for SMEs; strengthen commercial courts by resourcing them better (MoE, MoJ)
  - Status: Government intends to use transposition of forthcoming Insolvency EU Directive to improve restructuring and second chance procedures; proposed Directive includes public credit in restructuring procedures.
  - A high-level expert group established to prepare a report for legislative changes to improve restructuring and out-of-court agreements; pre-insolvency proceedings; and to define basis of exemption for outstanding debt.

- Recommendation 3: Evaluate scope for further banking consolidation through mergers, branch reduction, and business model adjustments (SSM, BdE)
  - Status: Bank business models are an SSM supervisory priority for 2018. BdE supervision frequently reviews banks’ profitability and analyzes possibilities to reduce structural costs.
  - Branch reduction has been significant and continues.

- Recommendation 4: Monitor rigorously interest rate and government bond market risks; ensure appropriate capital requirements to mitigate such risks (SSM, BdE)
  - Status: Interest rate risk in the banking book monitored in annual SREP as one of four risks to capital.
  - SSM conducted in 2017 a sensitivity analysis of interest rate risk in the banking book: provided additional information on sensitivity of the Economic Value of Equity (EVE) and Net Interest Income (NII) to hypothetical interest rate shocks. Bottom-up component fed into SREP to ensure SIs’ capital adequacy.

- Recommendation 5: Improve liquidity monitoring, including by closing reporting gaps; critically review funding structures and policies of banks with excessive reliance on ECB’s liquidity support; place premium on effective liquidity risk management by banks (SSM, BdE)
  - Status: Liquidity monitoring reinforced. New EU-level financial statement "maturity ladder" introduced in March 2018; information already collected by BdE.
  - BdE included for first time a liquidity stress test exercise for entire banking sector (SIs and LSIs) in November 2017 Financial Stability Review.

- Recommendation 6: Initiate supervisory and prudential steps to reduce mismatching of assets/liabilities in insurer balance sheets (DGSyFP)
  - Status: New procedure based on quantitative reporting templates implemented.

- Recommendation 7: Foster development of market-based financing and supply of nonbank financial services for corporates and households (MoE, BdE, CNMV, DGSyFP)
  - Status: CNMV identified promotion of confidence in securities markets as strategic area for 2017–18; held outreach events to encourage SME listings.
  - CNMV improved efficiency of actions, strengthened culture of service, promoted measures to foster financial business, followed crowdfunding development, and launched “CNMV Innovates” with an innovation hub for fintech proposals.

- Recommendation 8: Enhance capacity to monitor and analyze macro financial linkages, intra-system connectedness, and cross-border spillovers; close data gaps (BdE with CNMV and DGSyFP)
  - Status: BdE plans to include a section on intra-system interconnectedness in Financial Stability Report; initial stock-taking of information sources and data quality performed.
  - CNMV concluding analysis of “shadow banking” (renamed “market-based credit intermediation”), to be published in 2018, followed by regular “shadow banking monitor” twice a year. CNMV published study on redemption of mutual funds under stressed conditions, will begin study on market infrastructures’ participants, and plans research on interconnectedness starting in 2018.

- Recommendation 9: Review, as a priority, SAREB’s medium-term financial outlook based on adverse scenarios; set up tripartite committee (BdE, MoE, FROB) for mid-course corrections (MoE, BdE, FROB)
  - Status: SAREB’s business plan updated annually and includes simulations under different scenarios; latest update approved March 2017 built on more conservative expectations.
  - BdE’s supervisory approach includes analysis of SAREB’s assumptions and ability to request alternative plans; so far BdE has not used this tool.
  - SAREB’s current business plan envisages complete repayment of senior debt and no need for additional capital-raising actions. SAREB carried out sensitivity analyses and combined worst scenarios to perform a stress test.
  - A tripartite group not set up; authorities consider SAREB's Monitoring Commission already carries out these functions.

### To strengthen systemic and prudential oversight
- Recommendation 10: Set up a ‘Systemic Risk Council’ for inter-agency coordination on systemic risk factors, surveillance, and system wide financial sector policies (MoE with BdE, CNMV, DGSyFP)
  - Status: Treasury drafting proposal for a National Systemic Risk Council.
  - Financial Stability Committee (CESFI) reconvened on July 24, 2018 for first time since 2013 and set goal of establishing a national macroprudential authority as soon as possible.

- Recommendation 11: Expand the macroprudential toolkit to include borrower-based tools (All authorities)
  - Status: BdE started initial analysis of potential additional measures; additions would require legislative changes.
  - CNMV proposed developing borrower-based tools and measurements using data from Household Survey and Financial Competences.

- Recommendation 12: Increase supervisory focus on corporate governance practices across all credit intermediaries, and the nonbank sector (SSM, BdE, DGSyFP, CNMV)
  - Status: For banks, corporate governance supervision part of annual SREP, based on SSM’s 2015 thematic review.
  - Corporate governance included as supervisory priority for LSIs in 2017 and 2018; focus area for on-site inspections. Seven requirements/recommendations on governance (including internal audit) sent to LSIs during on-site inspections in 2017 (no 2018 on-site inspections finalized as of May 2018).
  - 2017 SREP review of internal governance and risk management element performed applying SREP methodology for LSIs approved by Supervisory Board; methodology to be applied in 2018.
  - CNMV focused supervisory activities on quality of audit committees and compliance of independent board directors’ criteria.

- Recommendation 13: Assign BdE full regulatory powers in matters not harmonized at the European level including authorizing mergers (BdE, MoE)
  - Status: No specific action taken.

### To bolster crisis management, resolution, and safety nets
- Recommendation 14: Develop a credible resolution strategy for credit cooperatives and other LSIs; prepare recovery and resolution plans for significant insurance companies (BdE, FROB, DGSyFP)
  - Status: BdE drafted and adopted resolution plans for 25 out of 55 LSIs during 2017, 12 under simplified obligations. For 2018 BdE plans to develop resolution plans for 30 LSIs, subject to resource availability.
  - Resolution plans for LSIs account for specificities; sale of business is default preferred resolution tool.
  - BdE conducts annual risk assessment system (part of SREP) for all LSIs to keep recovery plans updated.
  - Cooperative sector: creation of platform to mutualize losses among 29 credit cooperatives and a bank (Banco Cooperativo Español) would facilitate resolution.
  - No specific action taken regarding preparation of recovery and resolution plans for significant insurance companies since no Spanish insurance company qualifies as a significant institution.

- Recommendation 15: Strengthen and upgrade the deposit guarantee scheme; create a protection scheme for insurance policyholders (FGD, MoE, DGSyFP)
  - Status: No specific action taken.

*Appendix V. Implementation Status FSAP Recommendations — IMF staff report content (as provided).*

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_Source: https://www.imf.org/-/media/files/publications/cr/2018/cr18330.pdf_