## 1espea2020001 - 2021. The recovery rests on a strong rebound in private consumption and a substantial increase in public investment financed mainly by a front-loaded utilization of funds under the EU Recovery and Resilience Facility (RRF). ## Source details **Canonical URL:** [1espea2020001 - 2021. The recovery rests on a strong rebound in private consumption and a substantial increase in public investment financed mainly by a front-loaded utilization of funds under the EU Recovery and Resilience Facility (RRF).](https://www.imf.org/-/media/files/publications/cr/2020/english/1espea2020001.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2020/english/1espea2020001.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2020/english/1espea2020001.pdf.json) --- ### Executive Board assessment and key messages - COVID-19 severely hit Spain’s economy and society: tragic loss of lives, higher unemployment, and sharp recession. - Recovery will be protracted and subject to significant downside risks; its path depends on: - containment of the second wave of infections; - size, timing, and composition of EU-funded additional spending; - success of policy measures to mitigate scarring. - Directors commended swift income and liquidity support and urged: - continued policy support until recovery is firmly underway, with flexibility to adapt; - shifting support toward targeted assistance to vulnerable groups and viable firms as the pandemic recedes to facilitate resource reallocation. - Urgent corporate vulnerabilities actions: - prioritize targeted equity support to viable firms with a well-designed exit strategy; - strengthen private debt resolution frameworks and expand commercial court capacity. - Financial system and supervision: - noted the strength of the financial system and need for continued supervision, relief measures, and prudent dividend policies; - welcomed efforts to strengthen the AML/CFT framework and enhance crisis management frameworks at national and European levels. - EU Recovery and Resilience Facility: - welcomed use of European funds to support near-term recovery and promote structural shift toward a more productive, greener, and digital economy; - stressed need for efficient coordination, implementation, and oversight. - Medium-term fiscal stance: - fiscal consolidation will be needed to rebuild buffers and put debt on a downward path; - welcomed efforts to enhance tax progressivity and revenue collection capacity, and encouraged further pension reforms. - Social inclusion and labor markets: - pandemic exacerbated socio-economic disparities; welcomed the Minimum Income Scheme (MIS); - encouraged retraining, reskilling, upgrading unemployment benefits, addressing labor market duality, and improving gender equality. ### Near-term outlook and policy priorities - Near-term outlook hinges on containment effectiveness and healthcare preparedness. - Recommended near-term policy actions: - continue income and liquidity support measures (short-time work schemes and public loan guarantees) in a targeted and flexible manner; - consider temporary enhancement of unemployment benefit and social assistance if needed; - address corporate vulnerabilities via private debt resolution and selective public equity support for viable firms; - ensure strong supervision and macroprudential relief measures to support banks’ lending capacity and resilience; - maintain prudent dividend policies for banks. ### Medium-term priorities and structural agenda - Use EU Recovery and Resilience Facility to combine demand stimulus with closing gaps in green infrastructure and human capital toward a low carbon emission economy. - EU funds can cover transition costs and ease difficult structural reforms. - Critical actions: - efficient coordination, implementation, and oversight of recovery plans; - enhance employability of dislocated workers through active labor market policies and training; - overcome segmentation of the labor market to improve social inclusion; - supervisors should ensure credible strategies to resolve NPLs and restore bank profitability; - implement a medium-term fiscal adjustment plan and pension reforms to preserve fiscal sustainability. ### Selected macroeconomic projections and key statistics - GDP growth (percent change): - 2019: 2.0 - 2020: -12.8 - 2021: 7.2 - 2022: 4.5 - Private consumption (percent change): - 2019: 1.1 - 2020: -14.8 - 2021: 9.1 - 2022: 4.8 - Gross fixed investment (percent change): - 2019: 1.8 - 2020: -16.2 - 2021: 10.3 - 2022: 4.9 - Exports/imports of goods and services (percent change): - Exports 2019: 2.6; 2020: -25.5; 2021: 10.1; 2022: 12.9 - Imports 2019: 1.2; 2020: -22.3; 2021: 10.6; 2022: 11.7 - Net exports (contribution to growth): 2019: 0.5; 2020: -1.7; 2021: 0.0; 2022: 0.5 - Household saving rate (percent of gross disposable income): 2019: 7.4; 2020: 13.1; 2021: 8.2; 2022: 6.4 - Private sector debt (percent of GDP): 2019: 189.8; 2020: 208.9; 2021: 195.8; 2022: 186.9 - Unemployment rate (percent): 2019: 14.1; 2020: 16.8; 2021: 16.8; 2022: 15.7 - Inflation and prices: - GDP deflator: 2019: 1.6; 2020: 0.5; 2021: 0.9; 2022: 1.4 - HICP (average): 2019: 0.7; 2020: -0.2; 2021: 0.8; 2022: 1.4 - External sector: - Current account balance (percent of GDP): 2019: 2.0; 2020: 0.5; 2021: 0.9; 2022: 1.3 - Net international investment position: 2019: -74.4; 2020: -84.0; 2021: -75.4; 2022: -68.6 Notes on projections: - Projections incorporate disbursements from the EU Recovery and Resilience Facility amounting to about 1.5 percent of GDP per year in 2021–24. - 2020 fiscal projections include discretionary COVID-19 measures, legislated pension and public wage increases, and the minimum vital income support. Fiscal projections from 2021 assume expiration of temporary COVID-19 measures and no further policy change; RRF disbursements in 2021–24 are reflected as receipts in other revenue (grants) and spending in public investment. ### Public finance, fiscal risks, and debt sustainability - Fiscal impact and projections: - General government balance (percent of GDP): 2019: -2.8; 2020: -14.1; 2021: -7.5; 2022: -5.8 - Primary balance: 2019: -0.8; 2020: -11.7; 2021: -5.1; 2022: -3.4 - General government debt (percent of GDP): 2019: 95.5; 2020: 123.0; 2021: 121.3; 2022: 120.4 - Drivers of the 2020 deficit: - Automatic stabilizers: 6.4 percent of GDP. - Temporary discretionary measures: 3 ½ percent of GDP. - Public debt scenarios: - Baseline: public debt expected to rise by about 25 percent of GDP in the next two years and, absent fiscal adjustment beyond 2021, stay largely unchanged in the medium term. - Adverse scenario: surge in public debt in next five years could reach over 40 percent of GDP. - Contributions to cumulative changes in public debt (Percent of GDP, selected entries): - Change in gross public sector debt (Baseline 2020-25): 23.3 - Structural primary deficit (Baseline 2020-25): 14.4 - Automatic debt dynamics (Baseline 2020-25): 10.4 - Real interest rate (Baseline 2020-25): 6.4 - Real GDP growth (Baseline 2020-25): -8.0 ### Fiscal measures and government support (selected figures) - Discretionary measures total: 40.5 billion Euros, 3.7 percent of GDP. - Healthcare sector additional allocation: 4.4 billion Euros, 0.4 percent of GDP. - Households (incl. unemployment benefits): 25.2 billion Euros, 2.3 percent of GDP (ERTE unemployment entitlement: 17.8 billion Euros, 1.6 percent of GDP). - Preserving employment linkages (ERTEs): 24.2 billion Euros, 2.2 percent of GDP (table reference). - Business support (excl. guarantees): 3.9 billion Euros, 0.4 percent of GDP. - Off-budget measures total: 170.1 billion Euros, 15.6 percent of GDP. - Loan guarantees for firms and self-employed: 100.0 billion Euros, 9.2 percent of GDP. - ICO guarantee line for investment (environmental sustainability and digitization): 40.0 billion Euros, 3.7 percent of GDP. - Creation of a state rescue fund (SEPI): 10.0 billion Euros, 0.9 percent of GDP. ### Financial sector resilience, supervision, and measures - Banking sector status: - Aggregate NPL ratio by 2020:Q2 close to the EU average. - Tier-1/CET1 improvements over the decade but average CET1 still among the lowest in the euro area. - Six largest banks provisioned €14bn in loan-loss provisions in 2020:H1 (more than double 2019:H1). - Frontloaded provisions and goodwill impairments contributed to eroded profits. - A merger of two major banks will create Spain’s largest domestic bank. - Policy measures to support banks and markets: - ECB and Bank of Spain enabled banks to use capital buffers and operate below minimum liquidity coverage ratio; request to refrain from paying dividends. - Enhanced access to ECB liquidity facilities: additional LTROs; TLTRO-III favorable terms; new liquidity facility (PELTRO). - Bank borrowing via LTROs reached €257 billion in July 2020. - Risks and recommendations: - Banks expected to draw down capital/liquidity buffers; regulatory flexibility should be followed by gradual rebuilding. - Supervisors should ensure credible NPL resolution strategies and resilient capital positions. - Follow prudent dividend policies, timely recognition of problem assets, and adjust provisioning on precautionary grounds. - Need to enhance crisis management frameworks at European and national levels; completing the banking union would strengthen resilience. ### Private sector, firms, insolvency, and targeted equity support - Private sector vulnerabilities: - Some SME segments and low-income households remain over-indebted despite prior deleveraging. - Before the pandemic less than 30 percent of firms were classified as vulnerable (interest coverage ratio below one); without policy support vulnerable firms share could rise to 57 percent; with policy measures share estimated at about 37 percent. - Insolvency framework concerns: - Insolvency mechanisms slow and generally lead to liquidation rather than restructuring. - Historical pattern: dissolved firms exceed insolvency cases by five times. - Recent temporary changes (Royal Decree Law 16/2020) welcome but insufficient. - Temporary equity support: - Fiscal cost of supporting all affected firms prohibitive; selective intervention justified for solvent strategic firms. - SEPI state-investment fund endowed with €10 billion (1 percent of GDP) targets firms meeting criteria (in line with EU State Aid rules). - Important implementation issues: develop exit strategy, transparently record and monitor fiscal risk. - Similar recapitalization options could extend to viable smaller firms; consider temporary injections creating public claims (e.g., future tax liabilities). ### Social inclusion, Minimum Income Scheme (MIS), labor market, and housing - Minimum Income Scheme (MIS): - Government estimates: MIS would benefit around 850,000 households with 2.3 million individuals. - Poverty reduction effects: - reduce population under extreme poverty (income < 2,950 euros a year) by about 75 percent; - reduce population under high poverty (income between 2,950 and 4,250 euros a year) by more than 50 percent. - Fiscal cost: estimated at about 3 billion euros a year or 0.3 percent of 2020 GDP; financed by the state budget via transfers to social security. - Administrative note: 2020 exception allows applicants to choose assessment based on current year or previous year income. - Recommendation: finance MIS within a medium-term budget plan and review/streamline overlapping benefits. - Labor market: - Temporary employment accounted for most job losses; construction and services accounted for about 90 percent of employment losses in March–September 2020. - ERTE take-up peak: nearly 3.4 million workers or 22 percent of total employees; ERTE workers stood at about 720,000 at end-September 2020. - At crisis height nearly 17 percent of labor force supported by unemployment benefits, almost four times pre-pandemic level. - Policy recommendations: - enhance active labor market policies, retraining, reskilling, and measures to reduce labor market segmentation; - consider a separation fund and simplify contract types while preserving incentives for permanent contracts; - consider Earned Income Tax Credit (EITC) as complement to MIS. - Housing: - New rental aid programs and state contribution to State Housing Plan; moratoria on mortgage and other loans accounted for nearly 8 percent of eligible domestic bank loans as of September 30. - Recommendation: maintain rent moratoria no longer than necessary and replace with transfers or guaranteed loans to the neediest. ### External sector, NIIP, and external debt sustainability - Tourism impact and external developments: - Tourism receipts plunged by more than 90 percent (y/y) over March–June 2020; tourism accounts for over 12 percent of Spain’s GDP. - Foreign-tourism activity slightly recovered in July but remained around 75 percent lower compared with previous year. - Net international investment position (NIIP): minus 78 percent of GDP in 2020:Q2; NIIP share held by public sector rose to almost 85 percent in 2019. - External DSA baseline and projections: - External debt (percent of GDP): 2019: 169.4; 2020: 198.2; 2021: 186.5; 2025: 163.9 - Gross external financing needs (percent of GDP): 2019: 73.7; 2020: 86.2; 2025: 71.0 - Deterministic/probabilistic NIIP analysis: - Deterministic 15-year results: small REER depreciations required to stabilize NIIP at various targets (e.g., about 2 percent REER depreciation to stabilize NIIP at -50 percent of GDP). - Probabilistic (Monte Carlo) results: probability that REER must depreciate to stabilize NIIP at -50 percent about 51–53 percent depending on CPI- or ULC-based REER; ULC-based average depreciations higher than CPI-based. - Policy implications: - Some additional relative-price adjustment may be needed; monitoring and policies supporting competitiveness and resilience warranted. ### Outlook, scenarios, and risks - Staff baseline: - 2020 projection: real GDP shrink by 12.8 percent. - Staff projects real GDP growth of 7.2 percent in 2021, helped by RRF utilization and confidence effects. - Baseline assumes additional spending of about 1¼ percent of GDP in 2021 out of a total grants package of about 7 percent of 2020 GDP. - Real GDP projected to reach end-2019 level only in 2023 while unemployment could stay elevated. - Baseline assumes some persistence in social distancing and limited targeted lockdowns. - Adverse (downside) scenario: - Assumes new economic disruptions and tightening of financial conditions due to concerns about firms’ balance sheets. - Fiscal policy assumed to provide similar but more extended support as baseline. - Under this scenario real GDP would be stagnant in 2021, i.e., 7.3 percentage points below the baseline outlook. - Economy would experience an additional 4½ percent cumulative output loss over the medium term. - Debt stress tests (selected results): - Combined negative growth, primary balance, and interest rate shocks push public debt-to-GDP to about 136 percent in 2025 (about 17 percentage points higher than baseline). - Contingent liability shock (one-time non-interest public expenditure equivalent to 6 percent of banking sector assets) raises debt-to-GDP to about 135 percent in 2021 and around 136 percent in the medium term. ### Governance, procurement, and green transition - Recovery strategy and climate compatibility: - Fiscal support should focus on green investment gaps with high social returns (e.g., insulation retrofits, clean energy infrastructure). - Public support for emission-intensive activities beyond lifelines should be conditioned on binding sustainability commitments. - Finalize adoption of green budgeting principles in public financial management. - Governance of fiscal and financial operations: - Strengthen public procurement practices, coordination with regions, and on-site supervision. - Improve corporate governance in banks and integrate ML/TF risk into prudential supervision. - Establishment of a European AML/CFT supervisor would further strengthen the framework (initiative supported by authorities). ### Key operational recommendations (concise) - Maintain targeted and flexible fiscal support until recovery is durable; shift to targeted assistance and policies that facilitate resource reallocation as conditions normalize. - Prioritize reforms to insolvency and private debt resolution frameworks; expand commercial court capacity and out-of-court restructuring options. - Use RRF funds to frontload green and digital public investment with strong implementation oversight. - Implement a medium-term fiscal adjustment plan once strong growth and falling unemployment are sustained (earliest under staff assumptions from 2022); example consolidation: annual reduction of structural primary deficit by about ½ percent of GDP could put debt on downward path from 2023. - Strengthen active labor market policies, retraining and reskilling, and measures to reduce labor market duality; protect vulnerable households while avoiding permanent unsustainable spending increases. - Ensure banking supervision remains strong; allow use of buffers with gradual rebuilding, and maintain prudent dividend and provisioning policies. *IMF staff report for the 2020 Article IV Consultation (October 26, 2020).* ### 2021. The recovery rests on a strong rebound in private consumption and a substantial ### 1espea2020001 - 2021. The recovery rests on a strong rebound in private consumption and a substantial increase in public investment financed mainly by a front-loaded utilization of funds under the EU Recovery and Resilience Facility (RRF). ### Executive Board Assessment and Key Messages - COVID-19 has severely hit Spain’s economy and society, causing a tragic loss of lives, higher unemployment, and a sharp economic recession. - The recovery will be protracted and is subject to significant downside risks; its path will crucially depend on: - containment of the second wave of infections; - size, timing, and composition of EU-funded additional spending; - success of policy measures to mitigate scarring. - Directors commended swift and forceful income and liquidity support measures and urged: - continued policy support until recovery is firmly underway, with flexibility to adapt to developments; - as the pandemic recedes, fiscal support should shift toward targeted assistance to vulnerable groups and viable firms, facilitating resource reallocation toward expanding sectors. - Urgency to address corporate vulnerabilities: - prioritize targeted equity support to viable firms with a well-designed exit strategy; - strengthen private debt resolution frameworks and expand commercial court capacity. - Financial system and supervision: - noted the strength of the financial system and need for continued strong supervision, relief measures, and prudent dividend policies; - welcomed efforts to strengthen the AML/CFT framework and to enhance crisis management frameworks at national and European levels. - EU Recovery and Resilience Facility: - welcomed use of European funds to support near-term recovery and promote a structural shift toward a more productive, greener, and digital economy; - stressed need for efficient coordination, implementation, and oversight of plans. - Medium-term fiscal stance: - fiscal consolidation will be needed to rebuild buffers and put debt on a downward path; - welcomed efforts to enhance tax progressivity and revenue collection capacity, and encouraged further pension reforms. - Social inclusion and labor markets: - pandemic exacerbated high socio-economic disparities; welcomed the Minimum Income Scheme; - encouraged retraining and reskilling, upgrading unemployment benefits, addressing labor market duality, and improving gender equality. ### Near-term outlook and policy priorities - Near-term outlook depends on effectiveness of new containment measures and healthcare preparedness. - Near-term priorities (policy actions recommended): - continue income and liquidity support measures, notably short-time work schemes and public loan guarantees, in a targeted and flexible manner; - consider temporary enhancement of unemployment benefit and social assistance if needed; - address corporate vulnerabilities via private debt resolution and selective public equity support for viable firms; - ensure strong supervision and macroprudential relief measures to support banks’ lending capacity and resilience; - maintain prudent dividend policies for banks. ### Medium-term priorities and structural agenda - Use EU Recovery and Resilience Facility to combine demand stimulus with closing gaps in green infrastructure and human capital toward a low carbon emission economy. - EU funds can cover transition costs and ease difficult structural reforms. - Critical actions: - efficient coordination, implementation, and oversight of recovery plans; - enhance employability of dislocated workers through active labor market policies and training; - overcome segmentation of the labor market to improve social inclusion; - supervisors should ensure credible strategies to resolve NPLs and restore bank profitability; - implement a medium-term fiscal adjustment plan and pension reforms to preserve fiscal sustainability. ### Selected macroeconomic projections and key statistics (from October 2019 WEO table) - GDP growth (percent change): - 2019: 2.0 - 2020: -12.8 - 2021: 7.2 - 2022: 4.5 - Private consumption (percent change): - 2019: 1.1 - 2020: -14.8 - 2021: 9.1 - 2022: 4.8 - Public consumption (percent change): - 2019: 2.3 - 2020: 3.7 - 2021: 0.2 - 2022: 1.0 - Gross fixed investment (percent change): - 2019: 1.8 - 2020: -16.2 - 2021: 10.3 - 2022: 4.9 - Exports of goods and services (percent change): - 2019: 2.6 - 2020: -25.5 - 2021: 10.1 - 2022: 12.9 - Imports of goods and services (percent change): - 2019: 1.2 - 2020: -22.3 - 2021: 10.6 - 2022: 11.7 - Net exports (contribution to growth): - 2019: 0.5 - 2020: -1.7 - 2021: 0.0 - 2022: 0.5 - Savings-Investment Balance (percent of GDP): - Gross domestic investment: 2019: 20.8; 2020: 20.3; 2021: 20.8; 2022: 20.9 - National savings: 2019: 22.8; 2020: 20.8; 2021: 21.7; 2022: 22.1 - Foreign savings: 2019: -2.0; 2020: -0.5; 2021: -0.9; 2022: -1.3 - Household saving rate (percent of gross disposable income): - 2019: 7.4 - 2020: 13.1 - 2021: 8.2 - 2022: 6.4 - Private sector debt (percent of GDP): - 2019: 189.8 - 2020: 208.9 - 2021: 195.8 - 2022: 186.9 - Corporate debt (percent of GDP): - 2019: 127.6 - 2020: 136.9 - 2021: 126.1 - 2022: 118.8 - Household debt (percent of GDP): - 2019: 62.2 - 2020: 72.0 - 2021: 69.7 - 2022: 68.1 - Credit to private sector (percent change): - 2019: -1.5 - 2020: 2.5 - 2021: 1.4 - 2022: 1.5 - Potential output growth: - 2019: 1.5 - 2020: -2.5 - 2021: 1.8 - 2022: 1.5 - Output gap (percent of potential): - 2019: 0.6 - 2020: -10.0 - 2021: -5.3 - 2022: -2.5 - Inflation and prices: - GDP deflator: 2019: 1.6; 2020: 0.5; 2021: 0.9; 2022: 1.4 - HICP (average): 2019: 0.7; 2020: -0.2; 2021: 0.8; 2022: 1.4 - HICP (end of period): 2019: 0.8; 2020: -0.3; 2021: 0.8; 2022: 1.6 - Core inflation (average): 2019: 0.9; 2020: 0.8; 2021: 0.6; 2022: 1.4 - Core inflation (end of period): 2019: 1.0; 2020: 0.8; 2021: 0.6; 2022: 1.4 - Labor market: - Unemployment rate (percent): 2019: 14.1; 2020: 16.8; 2021: 16.8; 2022: 15.7 - Labor productivity (output per worker): 2019: -0.3; 2020: -3.6; 2021: 3.4; 2022: 2.3 - Labor costs, private sector: 2019: 2.3; 2020: 0.6; 2021: 0.8; 2022: 1.4 - Employment growth: 2019: 2.3; 2020: -4.9; 2021: 1.0; 2022: 2.1 - External sector: - Current account balance (percent of GDP): 2019: 2.0; 2020: 0.5; 2021: 0.9; 2022: 1.3 - Net international investment position: 2019: -74.4; 2020: -84.0; 2021: -75.4; 2022: -68.6 ### Public finance projections (percent of GDP) - General government balance: - 2019: -2.8 - 2020: -14.1 - 2021: -7.5 - 2022: -5.8 - Primary balance: - 2019: -0.8 - 2020: -11.7 - 2021: -5.1 - 2022: -3.4 - Structural balance: - 2019: -3.1 - 2020: -8.1 - 2021: -4.4 - 2022: -4.3 - General government debt: - 2019: 95.5 - 2020: 123.0 - 2021: 121.3 - 2022: 120.4 Notes on projections: - The projections incorporate disbursements from the EU Recovery and Resilience Facility amounting to about 1.5 percent of GDP per year in 2021–24. - The 2020 fiscal projections include discretionary measures adopted in response to COVID-19, legislated pension and public wage increases, and the minimum vital income support. Fiscal projections from 2021 assume an expiration of temporary COVID-19 measures and no further policy change. Disbursements under the EU Recovery and Resilience Facility in 2021–24 are reflected as receipts in other revenue in the form of grants and spending in public investment. - The headline balance includes financial sector support equal to 0.2 percent of GDP for 2016, and 0.1 percent of GDP for 2017. ### Context and structural considerations - Spain was among the hardest hit countries by the pandemic, with nearly 28,000 deaths during the first wave and a larger second wave since mid-July; government declared a state of emergency from March 14 to June 21 and launched a new state of emergency on October 26. - Prior to the pandemic, Spain experienced five years of strong, job-rich growth with GDP outpacing the euro area average by nearly 1 percentage point annually and unemployment falling nearly 10 percentage points, but fiscal buffers were not fully rebuilt. - Structural challenges highlighted: - large service sector dominated by SMEs, importance of tourism, and widespread temporary employment raise vulnerability; - high share of temporary employment concentrates burden on fixed-term workers in tourism and hospitality; - high income inequality and socio-economic disparities remain above European peers. - Government intentions: - orient recovery toward medium-term social inclusion and climate-friendly agenda; - pursue digitalization and climate change priorities supported by EU Recovery and Resilience Facility resources. ### Staff appraisal and mission context - Staff mission: exchanges between IMF staff and Spanish authorities continued virtually with comprehensive meetings during September 11–29, 2020; staff team led by Andrea Schaechter. - Key assessment: pandemic will take several years for the economy to recover; outlook subject to strong downside risks; policy response must remain agile and be upscaled if the outlook deteriorates. *IMF staff report for the 2020 Article IV Consultation (October 26, 2020).* ### 5. After a massive fall in GDP, the gradual relaxation of confinement measures breathed ### 5. After a massive fall in GDP, the gradual relaxation of confinement measures breathed ### Economic activity and inflation - Real GDP declined by 12.8 percent (y-o-y) in the first six months. - Domestic demand was the main culprit for the plunge in activity. - Net exports declined, shaving about 1.6 percentage points off the annual growth in the first half of 2020. - Since mid-May several high frequency indicators displayed upward trends from very depressed levels, but many activity improvements stalled or reversed in August and September with the second wave of infections. - Core inflation, after remaining broadly stable around 1 percent (y-o-y) until June, declined to 0.3 percent during July–August. - The sharp fall in oil prices pushed headline inflation into negative territory. ### Labor market and social protections - Following significant job losses in March-April, the labor market partially recovered. - Social security affiliated employment regained in June-September, though it was still more than 2 percent below the level in September 2019. - Temporary employment accounted for most of the job losses. - Construction and service sectors together accounted for about 90 percent of the employment losses in March-September. - At the height of the crisis, nearly 17 percent of the labor force was supported by unemployment benefits, almost four times higher than the pre-pandemic level. - At the peak of ERTE take-up, nearly 3.4 million workers or 22 percent of the total employees (excluding the self-employed) had temporarily suspended contracts or worked reduced hours. - The number of ERTE workers stood at about 720,000 at end-September. - Note on unemployment benefit coverage: Spain’s contributory unemployment benefit has a minimum contribution requirement of 360 days during the six years prior to becoming unemployed. The duration of the benefits varies between 120 and 720 days, depending on the length of the contribution time. ### External sector and tourism - The current account remained in surplus in 2019, about 2 percent of GDP. - During March-June 2020, total exports and imports dropped by 34 and 29 percent, respectively (y/y). - Tourism receipts plunged by more than 90 percent (y/y) over March-June; tourism accounts for over 12 percent of Spain’s GDP. - Foreign-tourism activity slightly recovered in July, when the number of tourist arrivals was around 75 percent lower compared with the previous year, but the resurgence of the virus is hurting this recovery. - The net international investment position (NIIP) amounted to minus 78 percent of GDP in 2020:Q2. - The share of the NIIP accounted for by the public sector increased from nearly 16 percent in 2006 to almost 85 percent in 2019. - Staff’s assessment of the external position in 2019 improved to broadly consistent with medium-term fundamentals; the 2019 current account gap was assessed at -0.8 to 1.2 percent of GDP and the REER gap was estimated at -4.9 to 3.1 percent. - On a preliminary basis and adjusting for transitory factors, recent developments suggest a moderately weaker overall external position in 2020 compared to 2019; assessment is highly uncertain pending full-year data for 2020. ### Private sector and banks - Households and corporates have significantly deleveraged in recent years, though some groups (segments of SMEs and low-income households) remained over-indebted. - By 2020:Q2 the aggregate NPL ratio was very close to the EU average. - The Tier-1 capital ratio has clearly strengthened over the past decade; the average CET1 ratio is still among the lowest in the euro area. - Profitability challenges persist amid low-for-long interest rates. - In 2020:H1 the six largest Spanish banks unveiled €14bn in loan-loss provisions, more than double the level in 2019:H1. - Frontloaded provisions, together with some goodwill impairments, have contributed to erode profits. - A recently announced merger by two major banks will create Spain’s largest domestic bank. - Supported by public loan guarantees, new loans to firms strongly increased in the wake of the coronavirus shock and bank lending to the private sector recorded positive annual growth rates for the first time in many years. ### Financial conditions, markets, and sovereign financing - Spanish equity market indices experienced historic declines of around 40 percent in February and March 2020; bank equity prices corrected around 47 percent. - Bank equity prices have since broadly stabilized, and the increase in banks’ bond funding costs has been partly reversed. - Corporate credit risk premia in Spain and the euro area remain high; as of June 2020, around half of Spanish companies’ ratings had a negative outlook or were being reviewed for downgrades, according to Moody’s. - Residential activity and house price growth decelerated further in 2020:Q2; commercial real estate prices in nonprime areas declined. - The 10-year sovereign bond yield reached a one-year peak in mid-March, with the spread over the German benchmark widening by more than 80 basis points from the average in February. - The spread narrowed subsequently and dropped in September/October below the 2019 average. - The government issued €165 billion of public debt during March to July; more than 11 percent of this was bought by the Eurosystem through the PSPP. ### Outlook and risks — Overview - 2020 projection: real GDP for the year could shrink by 12.8 percent. - The unemployment rate could rise to around 17 percent on average in 2020 despite the strong employment support program. - Headline and core inflation are projected to decline to -0.2 and 0.8 percent respectively in 2020 before gradually recovering in 2021. - Staff projects real GDP to grow by 7.2 percent in 2021, helped by the utilization of the EU Recovery and Resilience Facility (RRF) and its confidence effects. - Staff baseline projections assume additional spending of about 1¼ percent of GDP in 2021 out of a total grants package of about 7 percent of 2020 GDP. - Real GDP is projected to reach its end-2019 level only in 2023 while unemployment could stay elevated. - The baseline assumes some persistence in social distancing, consistent with limited and targeted lockdown restrictions (by sector and region). - The outlook is highly uncertain and risks are strongly tilted to the downside. ### Downside (adverse) scenario - The illustrative adverse scenario assumes new economic disruptions and a tightening of financial conditions associated with heightened concerns about firms’ balance sheets. - Fiscal policy is assumed to provide similar but more extended support as in the baseline under broadly unchanged financing conditions. - Under such circumstances real GDP would be stagnant in 2021, i.e., 7.3 percentage points below the baseline outlook. - The economy would experience an additional 4½ percent cumulative output loss over the medium term. ### Sector-specific outlook and risks - Current account: forecast to remain in surplus, but faces considerable uncertainty; tourism receipts are weak even beyond 2020 and significantly contribute to the expected decline in the current account surplus. - Factors offsetting tourism losses: subdued imports (reflecting domestic demand and low oil prices) and relatively resilient exports of goods as global trade gradually recovers. - Risks to the current-account baseline are tilted to the downside, compounded by trade tensions and possibly a disorderly Brexit. - Nonfinancial corporations: before the pandemic less than 30 percent of firms were classified as vulnerable (interest coverage ratio below one) with median leverage ratio close to one. - Simulations: without policy support the share of vulnerable firms could rise to 57 percent; accounting for policy measures the share of vulnerable firms is estimated to rise to about 37 percent (an increase of 7 percentage points from pre-pandemic). - Insolvency cases could increase significantly; shortcomings in insolvency frameworks, if not addressed, will weaken capacity to deal with a potential wave of insolvencies and to repair balance sheets and address debt overhangs. - Banking sector resilience: banks’ profitability and lending capacity may deteriorate as loan defaults materialize; NPLs likely to rise disproportionately in the non-financial corporate segment upon expiration of borrower-support measures. - Compared to some EU peers, the impact on Spanish banks could be amplified by the severity of the downturn, a possible broad rise in insolvencies, the lower initial CET1 ratio, and moderately higher exposure to vulnerable sectors such as accommodation and food. - Banks are expected to draw down on capital and liquidity buffers to absorb potential losses and continue supporting lending; regulatory flexibility and broader policy support in Europe and Spain should also help banks withstand the shock, albeit temporarily. - ECB analysis (July 2020): euro area banks’ average CET1 ratio could deteriorate by nearly 6 percentage points under a severe scenario. - Banks face additional risks from reduced gains of geographic diversification; Spanish banks have significant subsidiary operations abroad and largely operate with a subsidiary model under which there is virtually no intragroup funding. - Spanish banks hold about 7 percent of assets in domestic government bonds, exposing them to potential adverse feedback effects from a reemergence of the sovereign-bank nexus. - Legal risks related to mortgage contracts exist, but the European Court of Justice’s March 2020 ruling on the IRPH was perceived as mostly favorable for banks. *International Monetary Fund staff summary based on the provided chapter content.* ### 19. The scarring effects of the pandemic will severely strain Spain’s public finance, ### 19. The scarring effects of the pandemic will severely strain Spain’s public finance, ### Fiscal impact and projections - General government deficit, excluding local governments, reached 6.7 percent of GDP in the first seven months of the year, nearly 5 percentage points higher than the same period last year. - For the year as a whole, staff projects the fiscal deficit to widen to around 14 percent of GDP, more than 11 percentage points above the pre-pandemic level. - Deterioration drivers: - Automatic stabilizers: 6.4 percent of GDP. - Temporary discretionary measures adopted in response to the crisis: 3 ½ percent of GDP. - Public debt projections: - In the baseline scenario, public debt is expected to rise by about 25 percent of GDP in the next two years and, in the absence of fiscal adjustment beyond 2021, would stay largely unchanged in the medium term. - In an adverse scenario with a more protracted European crisis and additional fiscal support, the surge in Spain’s public debt in the next five years could reach over 40 percent of GDP. - Under the adverse scenario, continued downward pressure on inflation, continued pressure from high global savings, low investment, and accommodative monetary policy would be key to keep borrowing costs low. - Contribution components to cumulative changes in public debt (Percent of GDP) as presented: - Change in gross public sector debt: 61.0 (2009-14), 23.3 (Baseline 2020-25), 43.2 (Adverse 2020-25). - Identified debt-creating flows: 60.9, 24.8, 44.6. - Structural primary deficit: 15.7, 14.4, 18.5. - Automatic debt dynamics: 40.5, 10.4, 21.1. - Automatic stabilizers (Cyclical primary deficit) 2/: 20.6, 11.9, 18.5. - Interest rate/growth differential 3/: 19.9, -1.5, 2.6. - Real interest rate: 15.9, 6.4, 7.7. - Real GDP growth: 4.0, -8.0, -5.1. - Financial sector support and other one-offs: 4.7, 0.0, 5.0. - Residual, including asset changes: 0.1, -1.5, -1.5. - 2/ Excluding interest income. - 3/ Derived as [r - π(1+g) - g]/(1+g+π+gπ)) times previous period debt ratio, with r = average nominal interest rate; π = growth rate of GDP deflator; g = real GDP growth rate. - Source caption associated with the chart: "Spain: Contribution to Cumulative Changes in Public Debt (Percent of GDP) Source: Ministry of Finance and IMF staff calculations and projections." ### Authorities’ views - Overall alignment: - Authorities broadly shared staff’s view on the economic outlook and balance of risks. - Government has somewhat higher growth projections for 2021 compared with staff. - Bank of Spain projects a slightly weaker recovery due to more scarring. - On policy impact and EU support: - Authorities underscored that the downturn would have been significantly sharper without the policy support package. - Government expects the implementation of the EU Recovery and Resilience Facility to lift real GDP by 2–3 percent in 2021 and raise potential growth by about ½ percent annually over the medium term. - Banking sector concerns: - Authorities stressed profitability challenges for banks as a key risk and the need to ensure viability and address overcapacity. - Anticipated loan delinquencies will start rising in the first half of 2021—the end date of the grace period (usually of one year) for loans made under the public loan guarantee scheme. - Firms’ increased bank deposits will play a mitigating role, but cliff effects are seen as a material risk that will predominantly affect SMEs. - Authorities expect NPL ratios to rise but judge banks’ solvency positions should be largely resilient under the baseline scenario, helped by support measures in Spain and Europe. - Noted that Spain’s international banks may not benefit from geographical diversification as much as in the past. - Emphasized that while a large fraction of sovereign holdings is held to maturity, risks related to the bank-sovereign nexus warrant close monitoring. ### Policy agenda — near-term priorities and fiscal stance - Near-term priorities: - Combatting the health crisis and mitigating the economic impact remain the near-term priorities. - Control the second wave of infections and ensure preparedness of the healthcare system for future outbreaks, including purchasing and widely distributing vaccines and treatments when available. - Fiscal support guidance: - Fiscal support should remain in place until the recovery is firmly under way to avoid the recession morphing into financial sector stress. - Calls for extending and flexibly calibrating fiscal income and liquidity measures as needed. - Once the economy can remain open, policies should gradually shift from lifelines toward fostering activity pick-up with a focus on inclusiveness, greener, and more digital economy. - Efforts needed to preserve sustainability of public and private debt levels to ensure they do not impede the recovery. - Specific near-term health and social measures (examples and data): - Healthcare sector additional allocation: 4.4 billion Euros, 0.4 percent of GDP (from fiscal discretionary response table). - Households (incl. unemployment benefits): 7.6 billion Euros, 0.7 percent of GDP. - Preserving employment linkages: 24.2 billion Euros, 2.2 percent of GDP. - Business (excl. guarantees): 3.9 billion Euros, 0.4 percent of GDP. - Of which: SME and self-employed: 2.9 billion Euros, 0.3 percent of GDP. - Residual or undefined: 0.5 billion Euros, 0.0 percent of GDP. - Total discretionary measures: 40.5 billion Euros, 3.7 percent of GDP. - Support for households: - Short-time work schemes streamlined and expanded. - Special subsidy for self-employed workers whose business activities were severely interrupted. - Increased sick pay for workers infected with COVID-19 or quarantined. - Measures extended multiple times, through end-January, with modifications. - Income support package estimated to have benefited nearly 7 million workers or 30 percent of the working population, with a fiscal cost at about 2 percent of GDP. - New rental aid program for vulnerable renters; subsidies for basic water and energy access; additional resources to sub-national governments for social services. - Moratoria on mortgage and other loans: as of September 30, these moratoria accounted for nearly 8 percent of the eligible domestic bank loans (including voluntary moratoria offered by banks). - Launch of a Minimum Income Scheme in late May, a permanent social security benefit. - Support for firms: - Public loan guarantees worth over 13 percent of GDP with focus on SMEs and the self-employed. - Instituto de Crédito Oficial credit lines: tourism sector (€400 million) and automotive industry (€500 million). - Tax payment deferrals for SMEs and the self-employed; deferments of social security and tax debts; flexibility in tax filing. - A €4.2 billion support package for the tourism sector, including €2.5 billion in loans. - Exemptions of social contributions for companies that maintain employment under the ERTE program. - Loan guarantee take-up: Of the €100 billion public loan guarantees available, about €76 billion had been contracted as of September 15, corresponding to 800,000 bank loans; 98 percent of the loans were granted to SMEs and the self-employed. The implied liquidity injection stands at €100 billion. - Additional €40 billion public loan guarantees available to finance working capital and investment. - Financial sector support: - ECB and Bank of Spain enabled banks to use capital buffers and operate below minimum liquidity coverage ratio; request to refrain from paying dividends. - Flexibility in accounting and prudential regulations to avoid excessive procyclicality. - Enhanced access to ECB liquidity facilities: additional LTROs, more favorable TLTRO-III terms, and a new liquidity facility (PELTRO). - Spanish banks’ borrowing via LTROs increased and reached €257 billion in July (a six-year high prior to stabilizing in August), below historical maximum of €338 billion (August 2012). - CNMV monitoring liquidity at investment funds; short-selling ban in stock market between March and May. - National Financial Stability Authority (AMCESFI) scrutinizing bank–non-bank linkages. - Authorities’ operational stance: - Authorities emphasized readiness to manage new outbreaks, noted second wave had fewer deaths and lower hospital admission rates, and highlighted improved protection and testing capacities. - Wider roll-out of a contact tracing app and newly agreed criteria for regional containment measures (from October) expected to ensure greater consistency and quicker control. - Government not considering another wide-spread lockdown. - Authorities judged policy actions have effectively supported banks so far and are analyzing cliff effects as measures expire. ### Transitioning to recovery and medium-term priorities - Continued support until recovery is durable: - Fiscal support should remain in place as long as the pandemic is not under control and operating conditions remain highly uncertain. - Government agreement to extend ERTEs through January 2021 with incentives for job reactivation is welcome; further extensions should be considered depending on health and economic outlook. - Government should be ready to flexibly calibrate and scale up other measures if downside risks materialize. - New EU instruments (including the €21.3 billion that Spain will receive through SURE) and globally high saving/low investment together with supportive ECB monetary policy are providing critical assistance in keeping borrowing cost low. - Commitments to permanently raise current spending ratios (e.g., wage bill and pensions) should be avoided given high structural fiscal deficit and long-term spending pressures from population aging. - Gradual policy shift to support reallocation: - Shift from rescue to recovery packages, given Spain’s limited fiscal space; the shift should be gradual to avoid disrupting the recovery. - Given diminishing net benefits from job retention schemes over time, unemployment benefits should gradually become the predominant safety net in the recovery phase; a careful review and potential temporary upgrade of unemployment benefits is recommended (eligibility, benefits, duration). - Temporary increases in social assistance, including rent support for those who benefited from moratoria, to alleviate hardships during transitions. - Use of EU Recovery and Resilience Facility to upgrade physical infrastructure toward a more digital and resilient economy, while enhancing human capital especially of those impacted by the crisis. *Source: Ministry of Finance and IMF staff calculations and projections.* ### 35. Some companies require temporary equity support. As fiscal cost of supporting all ### 35. Some companies require temporary equity support. As fiscal cost of supporting all ### Temporary equity support for firms - Fiscal cost of supporting all affected firms would be prohibitive and hinder needed resource reallocation. - A case can be made for the government to intervene selectively to rescue or help solvent strategic firms facing pandemic-related difficulties. - In line with EU State Aid rules, the newly created state-investment fund (under the umbrella of the Spanish state-owned industrial holding company SEPI) endowed with €10 billion (1 percent of GDP) targets firms that meet these criteria. - Important implementation issues: - Develop an exit strategy for the public sector from the “bailed out” companies. - Transparently record and monitor the fiscal risk. - Similar recapitalization options could be extended to certain segments of viable smaller firms facing financial strains due to the pandemic. - Consideration could be given to providing temporary injections that create public claims, for example in the form of future tax liabilities. ### Insolvency and private debt resolution - Spain’s private debt resolution system remains relatively inefficient despite recent reforms (see IMF Country Report No.17/340). - Insolvency mechanisms are deemed slow and generally lead to liquidation rather than restructuring. - The role of public creditors in these processes remains a key problem. - Commercial courts will face bottlenecks as personal and business insolvency cases increase. - Historical concern: the number of dissolved firms in Spain has tended to exceed by five times the number of insolvency cases. - Recent temporary changes to corporate resolution frameworks (Royal Decree Law 16/2020) are welcome but likely insufficient to prevent rising insolvencies and liquidations. - Recommended additional measures: - Improve out-of-court restructuring frameworks. - Enhance incentives and penalties to encourage debt restructuring, including for SMEs. - Swift and adequate transposition of the EU Directive on restructuring and insolvency to help address debt-overhang problems. - See IMF’s note on “Private Debt Resolution Measures in the Wake of the Pandemic” (May 2020). ### Banking sector supervision, provisioning, and resolution - Supervisors need to continue monitoring and carefully review banks’ forward-looking plans for resolving NPLs and ensuring resilient capital positions. - Regulatory relief measures should help facilitate the use of capital and liquidity buffers, followed by their gradual rebuilding. - Banks should: - Continue recognizing problem assets in a timely manner. - Adjust provisioning decisions on precautionary grounds. - Follow prudent dividend policies. - Pursue cost rationalization and invest in technology. - Some additional consolidation in the banking system is an adequate response to profitability challenges. - Need to enhance crisis management frameworks at the European and national levels by tackling shortcomings in resolution and liquidation regimes. - Completing the banking union would strengthen resilience. ### Recovery strategy and climate policy compatibility - Recovery strategy will shape future structure and carbon intensity of the economy and is critical for meeting the climate objective of achieving carbon neutrality by 2050. - Three guiding principles: 1. Fiscal support should focus on addressing green investment gaps with high social returns (see IMF Departmental Paper No. 20/13, “EU Climate Mitigation Policy”). - The EU Recovery and Resilience Fund could finance labor-intensive, large-multiplier, climate-compatible public investment, such as insulation retrofits and clean energy infrastructure. - Building sector: accounts for around 16 percent of Spain’s non-EU ETS emissions; difficult to decarbonize; one of the most energy inefficient in Europe. 2. Public support for emission-intensive activities and sectors—beyond initial lifelines—should be conditioned on binding sustainability commitments to avoid locking in future emissions. - SEPI’s operations should ensure strategic public investment is aligned with climate objectives. 3. Finalize adoption of green budgeting principles in the public financial management system to make fiscal policy more responsive to climate change. - Government’s holistic approach to climate and energy policy strategy is welcome. ### Governance of fiscal and financial operations - With large additional public spending planned, strengthen public procurement practices and build on progress to enhance digitalization (Annex VII). - Address coordination challenges with regions related to procurement. - Strengthen on-site supervision to ensure efficient and transparent use of public finances. - In the financial system, some significant institutions have faced idiosyncratic reputational risk events—ensure banks’ corporate governance aligns with best practices. - COVID-19 increases pressure on the AML/CFT supervisory framework. - Continue efforts to integrate ML/TF risk into prudential supervisory considerations. - Establishment of a European AML/CFT supervisor would further strengthen the framework (initiative supported by the authorities). ### Authorities’ views on near-term support and supervision - Authorities aim to continue policy support in a more targeted and flexible manner in the near term. - Last extension of the ERTEs prioritized support to the most affected sectors and firms while allowing flexibility for new containment measures. - Authorities emphasize promoting professional transitioning through training; introduction of special training opportunities to workers under the ERTEs noted as important. - Commitment to protect the most vulnerable through extensions of some time-bounded support packages. - Acknowledge larger and more persistent pandemic impact could raise corporate sector vulnerability and require solvency support for SMEs. - Emphasize ambitious, comprehensive and cross-cutting climate and energy policy strategy. - On debt restructuring and bank supervision: - Noted that a new Insolvency Law came into force in September and work is under way to prepare the transposition of the EU Directive on restructuring and insolvency. - Initiatives to increase the efficiency of insolvency procedures and strengthen capacity of commercial courts. - Authorities are closely monitoring lending standards and credit portfolios and ask banks to be well prepared to deal with rising NPLs. - Welcome further cost cutting by banks and merger initiatives involving synergies. - Strongly advocate actions to enhance resolution frameworks in Europe, noting that completing the banking union with a common deposit insurance scheme is critical. ### Medium-term fiscal position and adjustment - Spain’s fiscal space was at risk before the pandemic; current crisis expected to further raise fiscal vulnerability. - Projected position would leave little fiscal room to cope with future adverse shocks, especially in an environment of higher interest rates (Annex IV), putting public debt sustainability at substantial risk. - Staff recommends resuming a gradual consolidation once the economy is on a sustained strong growth path with falling unemployment. - Under current assumptions, such conditions could be in place at the earliest from 2022. - Example: staff estimates that an annual consolidation of the structural primary deficit by about ½ percent of GDP could revert the rising trend, put the debt ratio on a downward path from 2023 and achieve a close-to-balance structural fiscal position within a decade under current estimates. - An advanced announcement of a credible adjustment plan could send a strong signal to the market and promote policy transparency. - Recommendation anchored at growth and unemployment outcomes rather than traditional output gap trigger; output gap information should still be considered. ### Rebuilding fiscal buffers: revenues, spending efficiency, and pension sustainability - Fiscal policy should focus on mobilizing additional revenues and enhancing spending efficiency, building on recent expenditure reviews. - Spain’s tax-to-GDP ratio is relatively low compared with regional peers, indicating room for structural improvement. - Possible revenue measures: strengthen VAT collection, raise excise duties and environmental levies, reduce tax system inefficiencies (see IMF Country Reports No. 18/330 and No. 17/319 for details). - Design of adjustment package should be contingent on economic and social conditions: - Measures transferring savings from private to public sector (e.g., increases in tax contribution from more affluent/less-affected groups) could be considered in 2021. - Measures with disproportionate effects on low-income populations (e.g., expanding VAT collection or increasing environmental taxes) should wait until recovery is on firm footing and be accompanied by targeted spending to protect the most vulnerable. - Pension system: sustainable reform package needed to contain pressure from population ageing. - Specific measures could include: (i) incentivizing longer work lives; (ii) raising revenues without raising already high contribution rates; (iii) encouraging supplementary savings. ### Social inclusion, labor markets, and structural transformation - Spain had a subpar record of income equality pre-pandemic. - Technological progress and global integration reduced labor share since mid-1990s, with negative implications for income distribution. - Destruction of 4 million jobs during the global financial crisis worsened social outcomes and was not fully reversed. - 2012 labor reforms catalyzed a job-rich recovery but may have reduced average hours worked and contributed to more in-work poverty. - Relatively weak redistributive effects of social spending fell short of protecting vulnerable groups adequately and equally. - Limited rental housing supply and inefficient building regulations contributed to rental price surges and affordability problems. - Sizeable gender inequality remains in employment and wages; representation of women in top management positions is low by European standards. - Pandemic likely to widen social inclusion gaps: - Impact particularly harsh for low-skilled temporary workers in tourism and hospitality. - Low-educated workers have less teleworking options, aggravating pandemic impact. - Income losses could aggravate rental overburden if rental prices do not adjust. ### Policy priorities to mitigate social impacts and promote structural change - Use EU funds to buffer social costs and accelerate technological upgrades and reforms. - Labor market reforms: - EU funds can facilitate introduction of a separation fund while making open-ended contracts more attractive. - Simplifying the menu of contracts while introducing a separation fund could increase share of permanent jobs without necessarily raising dismissal costs. - Mitigate legal and administrative costs of permanent contracts; reduce improper use of temporary contracts, including by reinforcing use of big data. - Social protection: - Recent Minimum Income Scheme addresses coverage gaps; integration into regional support tools and embedding financing in a medium-term plan needed. - Consider an Earned Income Tax Credit (EITC) as a complement to the Minimum Income Scheme to target low-income workers and stimulate labor force participation. - Housing: - Additional EU funds could support expansion of public housing and temporary upgrades in housing assistance. - Maintain rent moratoria no longer than necessary; gradually replace with transfers or guaranteed loans to the neediest. - Gender and childcare: - Boost family and childcare support and promote flexible working arrangements to enhance gender equality. - Digital transition and skills: - Recovery plans should catalyze digital transition; planned digitalization of public administration is critical. - Step up active labor market policies to support acquisition of new skills and facilitate worker transitions. - Measures to assist regional labor mobility could help reallocation. - R&D and innovation: - Rethink existing R&D incentives and establish periodic evaluations before expanding them under EU recovery plans. - Past R&D incentives had limited take up and constrained private-public collaborations. - Eliminating or modifying size-contingent regulations could enhance innovation. *Source: IMF staff analysis from the cited Spain report (content unit 1espea2020001).* ### 49. The authorities reiterated their commitment to fiscal prudence in the medium term ### 1espea2020001 - 49. The authorities reiterated their commitment to fiscal prudence in the medium term ### Fiscal stance and 2021 draft budgetary plan - 2021 draft budgetary plan will combine short-term priorities of supporting economic recovery with medium-term objectives of maintaining fiscal sustainability and reducing inequality. - The budget will include a recovery plan outlining the use of about €27 billion grants under the EU Recovery and Resilience Facility and the REACT-EU funds (the decision about the use of loans is still pending). - To support medium-term adjustment needs, the government is contemplating several revenue measures: - introducing a digital and financial transactions tax, - boosting environmental taxation, - fighting against tax fraud and evasion. - Policies planned to improve public service efficiency, particularly through digitalization of public and judicial administration. - On pension reforms: preserve the purchasing power of pension benefits while safeguarding financial sustainability; a key policy area is to narrow the gap between the effective and the legal retirement age. ### EU Recovery and Resilience Facility (RRF) and structural transformation priorities - Authorities view the RRF as an opportunity to frontload and upscale reform plans and aim to establish a special unit in the Prime Minister’s office to oversee implementation of RRF programs. - Government priority areas: - Ecological transition: - undertake projects that create short-term employment while fostering decarbonization and longer term environmental sustainability, - examples: retrofitting of buildings, creating charging stations for electric vehicles, upgrading water infrastructure. - Digital transformation: - digitalization seen as integral to solutions for structural economic challenges, - National Digital Strategy (NDS) focuses on the data economy, digital skills, digitalization of public administration, healthcare, and agriculture, - aim to capitalize on leading position in open data policies and network visualization that attracts startups, - National Action Plan for Digital Skills aims to promote digital skills at all levels of education. - Social cohesion: - address job precariousness and high structural unemployment, - revamp vocational training system and upgrade curricula to reskill workers, - improve efficiency of Active Labor Market Policies (ALMPs), particularly functioning and coordination of regional Public Employment Services, - streamline number of contract types and fight abuse of sub-contracting, - refine the ERTE program to promote its future use as an employment adjustment tool, - plans to increase stock of social rental housing, including mobilizing public land and collaborating with private investors. - Gender equality: - recognize disproportional impact of COVID-19 on women, - short-term focus on promoting work-life balance and teleworking, - proposals to revamp public childcare system, strengthen regulations to narrow the gender pay gap, and finalize ongoing full equalization of maternity and paternity leave. ### Near-term priorities: containment, support, and targeted fiscal measures - Containing the new wave of contagions and continued policy support remain critical in the near term. - Government’s swift provision of income and liquidity support has played a major role in limiting the economic fallout. - Policy measures such as the short-term work scheme and public loan guarantees should be flexibly extended and scaled. - Fiscal support should remain in place but become increasingly targeted as the pandemic recedes, focusing on vulnerable groups and viable firms. - Over time, unemployment benefits should gradually become the predominant safety net, facilitating resource reallocation toward expanding sectors. ### Financial sector risks and needed measures - Policies need to mitigate risk of recession morphing into financial sector stress; corporate sector vulnerabilities must continue to be addressed. - Private debt resolution frameworks should be enhanced promptly to address debt overhangs; possible role for public equity support in certain corporate segments. - Continued strong supervision together with carefully calibrated macroprudential relief measures are needed to underpin banking sector resilience. - In severe scenarios, solvency may be materially affected; need to enhance crisis management frameworks at European and national levels by tackling shortcomings in resolution and liquidation regimes. - Completing the banking union with a common deposit insurance scheme would strengthen resilience. ### Role and implementation of EU funds - Funds under the EU Recovery and Resilience Facility provide an exceptional opportunity to underpin near-term recovery and promote structural shift to a more productive, greener, and digital economy. - Efficient coordination, implementation, and oversight of plans will be key. - Authorities committed to a front-loaded use of EU funds as a catalyst for structural transformation. - Speed of implementation uncertain: education policy changes may be difficult given fragmented political landscape; green investment and digitalizing public administration may be more readily available. ### Medium-term fiscal consolidation and public debt outlook - Need to ensure a sustainable downward path for public deficits and debt to rebuild fiscal buffers once recovery is underway. - Requires a substantial reduction in the structural deficit. - Spain entered the pandemic with an already challenging fiscal position due to limited adjustment during the previous upswing. - Since the onset of the crisis, government intervention has mitigated impacts on private sector balance sheets but has deeply affected government finances. - Public debt ratio is expected to increase by nearly 30 percentage points from the pre-pandemic level to over 120 percent of GDP. - Authorities remain committed to medium-term fiscal adjustment but have yet to provide details about future fiscal plans. - Fiscal adjustment should start only once the economy is on a sustainable growth path with falling unemployment; early formulation of credible plans (contingent on the state of the economy) could support investor confidence. - To protect critical social spending, most space to lower the deficit lies on the revenue side. ### Inclusion, labor market, and social protection recommendations - Recovery and consolidation policies should be inclusive and seek to address growing inequalities. - Support for displaced workers should include retraining and reskilling, with income support during transitions. - New Minimum Income Scheme is a welcome step to expand the safety net. - Unemployment benefits and other social assistance may need temporary upgrades. - Further inclusion measures should address labor market precariousness, support rental affordability, and enhance gender equality. - Eventual medium-term fiscal consolidation must be consistent with social inclusion and resilient growth. *Source: IMF staff report excerpts.* ### 57. It is recommended that Spain remain on the standard 12-month Article IV cycle. ### 1espea2020001 - 57. It is recommended that Spain remain on the standard 12-month Article IV cycle. ### Real sector and inflation - The COVID-19 pandemic "severely disrupted economic activity in the first half of 2020." - Industrial production and retail trade "plunged" in 2020Q2 (charts indicate steep negative quarterly annualized changes). - Since reopening in June, PMIs recovered but "recently receded again"; services—particularly accommodation—are "lagging." - Core inflation: "After remaining stable until June, core inflation fell notably." - Sources cited: Bank of Spain, Eurostat, Haver Analytics, and IMF staff calculations. - Note: "Ireland is excluded for 2015Q1 due to methodological change and a growth rate of 119 percent." ### High-frequency indicators of real activity - Electricity consumption and air pollution picked up from lockdown lows but "still remain below 2019 levels." - Mobility related to workplace, retail and recreation "has remained below European peers" reflecting strict movement restrictions. - Hotel room occupancy rates and number of flights show "a very slow recovery of Spain’s tourism sector." - Sources cited: ENTSOE, European Environment Agency, Flight Radar 24, Google Mobility Report, Smith Travel Research, and IMF staff calculations. ### Labor market developments - "Total employment plummeted following the lockdown, but recovered gradually in subsequent months." - "Young workers suffered the highest job loss rate." - Construction and services sectors were hardest hit; temporary employees "shouldered most of the adjustment." - Short-time work scheme (ERTE) expansion increased takeup significantly and "contained the immediate impact on unemployment," but average hours worked "has declined substantially." - Charts show large negative year-on-year employment changes in 2020 and cumulative ERTE flows in 2020. ### External sector - The current account "remained in surplus in 2019." - After COVID-19 the trade balance "has started to deteriorate," with an "acute impact from depressed international tourism." - Recent net outflows in "other and portfolio investment were offset by inflows accounted for by the Bank of Spain." - The net international investment position "remains large and negative" though cost-competitiveness gains have helped improve the external position. - Sources cited: Bank of Spain, Eurostat, Haver Analytics, INE, WEO, and IMF staff calculations. - Note on financial flows: "Portfolio Investment and Other Investment exclude the Bank of Spain, which is shown separately." "Positive (negative) values indicate net financial outflows (inflows)." ### Tourism indicators - Tourism contributes "well over a tenth of Spain’s employment" and "above 15 percent of its total exports." - Domestic tourists represent "about half of Spain’s arrivals" and provide some cushion. - Outbound tourism expenditure has "limited potential to offset the drop in inbound tourism." - Urban tourism accounts for "over one-third of overnight stays in Spain" and is expected to be badly hit by COVID-19. - The hotel business accounts for "almost three-quarters of total overnight stays in Spain." - Sources: Eurostat; Haver Analytics, UNWTO, WTTC, and IMF staff calculations. ### Credit development and financial cycle - Credit supply to firms "has eased, supported by public loan guarantees." - Credit demand "rose among firms but declined among households." - Lending rates remained "relatively stable at low levels" from January to August 2020. - Bank lending recorded "positive annual growth rates for the first time in several years" and a broader measure of credit to the private sector increased in 2020Q2. - By mid-2020, house prices "had not been much affected by the crisis, and remained below their pre-GFC peak." - Sources: Bank of Spain, Haver Analytics, INE, and IMF staff calculations. ### Banking system performance - Prior to COVID-19, decline in impaired assets (mainly via portfolio sales) "had likely helped reduce impairment costs." - Profitability for banks in Spain "has started to deteriorate in 2020" amid already low pre-crisis profitability. - In 2019 Spain’s return on assets "was above the European average." - Spain exhibits "the lowest CET1 ratio in the euro area," despite a declining trend in risk-weighted assets and improvements in the Tier-1 capital ratio. - Sources: Bank of Spain; EBA Risk Dashboard; ECB Supervisory Banking Statistics; IMF Financial Soundness Indicators database; and IMF staff calculations. ### Public finances - Fiscal consolidation "has come to a standstill since 2015," with expenditure expanding structurally over the past five years. - Public debt "remained elevated before the pandemic." - The recession and policy responses are expected to "widen the fiscal deficit substantially." - Spain's gross financing needs remain "among the highest in euro area" and leave the country "vulnerable to shocks." - Sources: Bank of Spain; Fiscal Monitor (October 2020); Spain Ministry of Finance; and IMF staff estimates. - Reference: "For more details, see Debt Sustainability Analysis in Annex IV." ### Social outcomes - Spain’s labor share "declined considerably over the past two decades"—a change associated with higher income inequality. - Spain’s income inequality is "high" and the "share of population at risk of poverty elevated relative to European peers." - Tenants in Spain are "more overburdened than European peers" (overburden defined as housing costs > 40 percent of disposable income). - Despite progress, "sizeable gender gaps remain in economic and political empowerment." - Sources: Eurostat, Eurostat based on EU-SILC, Haver Analytics, World Economic Outlook, and IMF staff calculations. ### Key projections and macro indicators (Table 1 highlights, 2016–2025) - Real GDP growth: 2016: 3.0; 2017: 2.9; 2018: 2.4; 2019: 2.0; 2020: -12.8; 2021: 7.2; 2022: 4.5; 2023: 3.4; 2024: 2.8; 2025: 1.5. - Private consumption: 2016: 2.7; 2017: 3.0; 2018: 1.8; 2019: 1.1; 2020: -14.8; 2021: 9.1; 2022: 4.8; 2023: 2.2; 2024: 1.5; 2025: 1.2. - Gross fixed investment: 2016: 2.4; 2017: 5.9; 2018: 5.3; 2019: 1.8; 2020: -16.2; 2021: 10.3; 2022: 4.9; 2023: 4.7; 2024: 5.3; 2025: 0.8. - Exports of goods and services: 2019: 2.6; 2020: -25.5; 2021: 10.1; 2022: 12.9; 2023: 7.2; 2024: 4.5; 2025: 3.9. - Unemployment rate: 2016: 19.6; 2017: 17.2; 2018: 15.3; 2019: 14.1; 2020: 16.8; 2021: 16.8; 2022: 15.7; 2023: 14.9; 2024: 14.4; 2025: 14.2. - General government balance (percent of GDP): 2019: -2.8; 2020: -14.1; 2021: -7.5; 2022: -5.8; 2023: -4.7; 2024: -3.9; 2025: -4.4. - General government debt (percent of GDP): 2016: 99.3; 2017: 98.6; 2018: 97.6; 2019: 95.5; 2020: 123.0; 2021: 121.3; 2022: 120.4; 2023: 119.3; 2024: 118.1; 2025: 118.8. - Memo: Nominal GDP (Millions of euros): 2019: 1,091.2; 2020: 1,179.8; 2021: 1,249.7; 2022: 1,312.9; 2023: 1,371.7; 2024: 1,415.8. - Note: Projections "incorporate disbursements from the EU Recovery and Resilience Facility amounting to about 1.5 percent of GDP per year in 2021-24." ### General government operations (highlights from Tables 2a / 2b) - Revenue (billions of euro): 2019: 421.6; 2020: 478.1; 2021: 505.5; 2022: 528.9; 2023: 550.5; 2024: 545.4. - Taxes (billions of euro): 2019: 279.1; 2020: 323.6; 2021: 260.0; 2022: 276.5; 2023: 290.4; 2024: 303.9. - o.w. VAT (billions of euro): 2019: 80.9; 2020: 66.7; 2021: 76.0; 2022: 81.2; 2023: 85.4; 2024: 89.6; 2025: 92.4. - Expenditure (billions of euro): 2019: 521.9; 2020: 575.4; 2021: 566.8; 2022: 578.5; 2023: 591.0; 2024: 604.4; 2025: 607.3. - Social benefits (billions of euro): 2019: 264.1; 2020: 243.3; 2021: 247.5; 2022: 252.5; 2023: 257.9; 2024: 264.0. - Gross operating balance (billions of euro): 2019: -34.9; 2020: -153.4; 2021: -88.3; 2022: -72.7; 2023: -61.8; 2024: -53.6; 2025: -61.6. - Net lending / borrowing (billions of euro): 2019: -35.2; 2020: -153.8; 2021: -88.6; 2022: -73.0; 2023: -62.1; 2024: -53.9; 2025: -61.9. - Memorandum: Nominal GDP (billions of euro) repeated: 2019: 1,091.2; 2020: 1,179.8; projections shown through 2025. *Source: IMF staff summary of the Spain country chapter and supporting figures and tables.* ### Annex I. Main Recommendations of the 2018 Article IV ### Annex I. Main Recommendations of the 2018 Article IV ### Fiscal Policy - Recommendation: Resume fiscal adjustment with an annual reduction in the structural primary deficit by about 0.5 percent of GDP until structural balance is reached. - Finding: After a small structural improvement in 2018, the structural primary balance worsened by 0.9 percent of GDP in 2019. - Projection: As a result of the Covid-19 crisis, the structural balance is projected to widen to about 4¾ percent over the medium-term absent adjustment measures. - Recommendation: Identify growth-friendly adjustment measures by gradually expanding VAT collection, raising excise duties and environmental levies, and lowering inefficiencies in the tax system. - Implementation: Under the budget extensions for 2019-20, no major measures were introduced. Beyond 2021, the authorities plan to introduce a package of revenue measures. The first phase of the expenditure review was concluded with proposals to improve spending efficiencies. The second phase is ongoing. - Recommendation: Continue the implementation of the 2011/13 pension reforms and identify refinement options to balance pension sustainability and social acceptability. - Finding/Actions: Non-contributory pensions were increased by 3 percent in 2019 and 2020 deviating from the 0.25 percent implied by the pension formula. On the revenue side, maximum contribution bases were raised by 7 percent and the minimum contribution rate for professional contingencies (accidents at work) was increased to 1.5 percent. The government plans to permanently relink pension increases to inflation and eliminate the sustainability factor. New reforms consultations under the Toledo Pact are envisaged. ### Structural Reforms - Labor market reforms — Recommendations: - Improve the efficiency, coordination, and design of active labor market policies (ALMPs), implement a multi-year strategy on employment activation, and consolidate the vast amount of ALMPs from the programs with low participations to the most promising programs, such as those involving the support by a personal tutor. - 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. Creating an employer-based separation fund (“Austrian backpack”). - Provide incentives for people to move, such as subsidies for moving expense and temporary and targeted housing assistance. - Implementation/Findings: - 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. The government’s coalition agreement foresees additional measures. - 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. In this context, they have intensified inspections and increased sanctions to reduce the abuse of temporary and permanent contracts. - No specific measure to enhance incentives for labor mobility have been taken. - Productivity growth — Recommendations: - Advance the implementation of the Market Unity Law and liberalization of professional services; tackle remaining size-related regulations; improve coordination between different levels of government on research and innovation policies; clarify and simplify the eligibility criteria for firms to qualify for government’s R&D incentives; increase labor market relevance of tertiary education; and reduce regional differences in education outcomes through exchanges of best practices. - Implementation/Findings: - 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 authorities started to use the regional conferences to facilitate the implementation of the Market Unity Law, though with limited impact so far. ### Financial Sector Policies - Recommendation: Keep reducing impaired assets by implementing ECB guidance on NPLs, while closely monitoring NPLs in consumer credit. - Finding: Partly driven by supervisory pressure, NPLs and foreclosed assets continued to decline as several banks continued to sell impaired asset portfolios. According to the SSM, progress is broadly in line with banks’ NPLs reduction plans. The BdE has analyzed developments in consumer credit and concluded that greater vigilance on credit standards and on the most active institutions in consumer credit is necessary. - Recommendation: Encourage banks to build up high-quality capital and to pursue further cost-cutting and branch consolidation, as well as continue exploring the scope for further banking consolidation. - Finding: The BdE has emphasized that the subdued performance of CET1 capital in recent years differs from that of dividends distributed by Spanish banks, and that higher CET1 ratios should help reduce banks’ debt issuance costs. Several banks are rationalizing costs, in line with BdE’s advice. A merger of two significant banks is underway. - Recommendation: Ensure rigorous monitoring and management of liquidity and interest rate risks. - Finding: The Bank of Spain conducted a new round of liquidity stress tests in 2019. The National Securities Market Commission has started to monitor more closely liquidity risks at investment funds. - Recommendation: Strengthen areas of prudential oversight and resolution. - Finding: The BdE has asked banks to estimate their exposure to legal risk from new potential lawsuits. A new real estate credit law came into force in June 2019, transposing the EU mortgage directive into national law. The creation of an independent insurance and pension supervisor as well as a financial consumer protection authority are still under active consideration. - Recommendation: Modernize the institutional framework for financial oversight and enhance BdE’s macroprudential toolkit. - Finding: A new macroprudential authority (AMCESFI) was created in early 2019. The sectoral supervisors have been empowered with new macroprudential tools since December 2018, including borrower-based tools for the BdE. ### External Sector Assessment — Overall - Assessment: The external position in 2019 was broadly in line with the level implied by medium-term fundamentals and desirable policies. On a preliminary basis, recent developments suggest a moderately weaker overall external position in 2020 compared to 2019. This assessment is highly uncertain given the lack of full-year data for 2020 and the COVID-19 crisis. - Finding: In 2019, the CA remained in surplus for the eighth consecutive year. Achieving a sufficiently strong NIIP will continue to require a relatively high CA surplus for a sustained period. ### Foreign Asset and Liability Position (NIIP and Trajectory) - Background: The NIIP dropped significantly during 2000–09, driven mostly by high CA deficits but also by valuation effects. - Finding: The NIIP was –74 percent of GDP in 2019, but has risen by 15 percentage points since 2015, partly due to sustained CA surpluses and despite some negative valuation effects. - Finding: Gross liabilities stood at 250 percent of GDP in 2019, with about two-thirds in the form of external debt. - Finding: The NIIP accounted for by the general government and the central bank increased, raising its share to more than four-fifths in 2019. Part of that increase is due to TARGET2 liabilities, which had reached 30 percent of GDP by end-2019. - Assessment: The large negative NIIP comes with external vulnerabilities, including from large gross financing needs and potentially adverse valuation effects. Mitigating factors are a favorable maturity structure of outstanding sovereign debt (averaging almost eight years) and current ECB measures, such as QE, that lower the cost of debt. - Key 2019 (% GDP) figures: - NIIP: –73.5 - Gross Assets: 176.1 - Debt Assets: 80.9 - Gross Liab.: 249.6 - Debt Liab.: 151.7 ### Current Account - Background: After a peak CA deficit in 2007, regained competitiveness from wage moderation and greater internationalization efforts contributed to strong export growth, leading to CA surpluses in 2012–19. - Revision: Historical data revisions, including upward changes in tourism receipts, show that recent CA surpluses were higher than reported earlier—the annual average surplus during 2013–18 was revised from 1.5 to 2.3 percent of GDP. - Finding: The CA surplus was close to 2.0 percent of GDP in 2019. - Projection: With high uncertainty, the 2020 CA is projected to remain in surplus, with imports declining more strongly than exports partly because of low oil prices. Weaker-than-expected exports—particularly tourism receipts—are a key downside risk. - Assessment: The EBA CA model suggests a norm of 1.1 percent of GDP for 2019, which is below the cyclically adjusted CA balance (2.2 percent of GDP). Given external risks from a large and negative NIIP, the IMF staff’s assessment puts more weight on external sustainability and is guided by the objective of raising the NIIP to at least –50 percent over the medium to long term. - Projection: The NIIP is projected to reach –52 percent of GDP over the medium term under current policies, though with high uncertainty as zero valuation effects are assumed. - Staff-assessed CA norm: about 2 percent of GDP, with a range of 1 to 3 percent of GDP. - This yields a CA gap of –0.8 to 1.2 percent of GDP. - Key 2019 (% GDP) figures: - Actual CA: 2.0 - Cycl. Adj. CA: 2.2 - EBA CA Norm: 1.1 - EBA CA Gap: 1.1 - Staff Adj.: –0.9 - Staff CA Gap: 0.2 ### Real Exchange Rate (REER) - Background: In 2019, the CPI-based REER and the ULC-based REER depreciated from their average 2018 levels by 1.9 and 1.4 percent, respectively. - Finding: The CPI-based REER is still moderately lower than its 2009 peak, partially reversing the significant appreciation from euro entry in 1999 until 2009. The ULC-based REER shows that the appreciation between 1999 and 2008 has been substantially reversed, initially because of labor shedding and thereafter due to wage moderation and strong output growth until 2019. After reaching its peak in 2008, the ULC-based REER depreciated by 19 percent. - Finding: As of August 2020, the CPI-based REER had appreciated by 1.7 percent and the ULC-based REER had appreciated by 0.8 percent relative to their 2019 averages. - Assessment: The EBA REER models estimate an overvaluation of 4.9 to 5.2 percent for 2019, whereas the IMF staff CA gap implies an undervaluation of 0.9 percent. Taking into account also the need for preserving competitiveness, and the risks from NIIP sustainability, on balance, the IMF staff assesses the 2019 REER gap to be in the range of –4.9 to 3.1 percent, with a midpoint of –0.9 percent. ### Capital and Financial Accounts: Flows and Policy Measures - Background: Financing conditions have continued to be favorable, despite some increase in sovereign bond yields in the wake of the COVID-19 crisis. By 2019:Q4 the private sector had continued its deleveraging against the rest of the world. - Finding: In 2019, the financial account balance was largely driven by net outflows of loans and other bank-related instruments (especially from sectors other than the central bank). - Finding: The accumulation of TARGET2 liabilities, reflecting liquidity creation within the framework of the Eurosystem’s asset purchase program, was negative for the first time since 2015 (–3 percent of GDP in 2019). - Assessment: Investor sentiment had continued to improve in 2019. However, amid the pandemic crisis, large external financing needs leave Spain vulnerable to sustained market volatility, although the ECB’s policies to maintain favorable liquidity conditions and monetary accommodation remain a mitigating factor. ### 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 — Conjunctural Risks - Unexpected shift in the Covid-19 pandemic - Relative Likelihood: High - Impact if Realized: - Downside: The disease proves harder to eradicate (e.g., due to difficulties in finding/distributing a vaccine) requiring more containment. Monetary and fiscal policy response is insufficient amid dwindling policy space and concerns about debt sustainability. Financial markets reassess real economy risks. Pandemic-prompted protectionist actions (e.g., export controls) reemerge. - Upside (Low likelihood): Recovery from the pandemic is faster than expected due to the discovery of an effective and widely available vaccine and/or a faster-than-expected behavioral adjustment to the virus. - Impact: High — The needed containment measures would negatively affect economic activity directly and through persistent behavioral changes (prompting costly reallocations of resources). Reassessing real economy risks would lead to a repricing of risk assets, unmasking of debt-related vulnerabilities, and weakening banks and nonbank financial intermediaries–forcing them to reduce credit. Protectionism actions will disrupt trade and global value chains. - Policy Response: - Scale up rescue measures already in place. - Realign policy support measures more towards incentivizing reallocation of resources while supporting affected workers during the transition. - Enhance private debt resolution system. - Regulatory forbearance and broader policy support from the ECB would help banks withstand this shock. - Accelerate structural reforms and formulate credible medium-term fiscal path to support investor confidence. - Continue strengthening the financial sector and its capacity to support growth. - In the case of faster-than-expected recovery, accelerate the unwinding of rescue measures, while ensuring that it does not disrupt the recovery process. - Intensification of geopolitical tensions and security risks - Relative Likelihood: High - Impact if Realized: Medium — Intensification of these risks in response to pandemic, cause socio-economic and political disruption. Intensification of conflicts in the Middle East and Africa could lead to disorderly migration into Europe further deepening political division within the EU, higher commodity prices (if supply is disrupted), and lower confidence. - Policy Response: - Accelerate structural reforms, enhance policies for swift labor market integration, and formulate credible medium-term fiscal path to support investor confidence. - Oversupply and volatility in the oil market - Relative Likelihood: Medium - Impact if Realized: Medium — Given relatively high oil intensity of the Spanish economy, higher oil prices would push up CPI inflation weighing on consumer spending and growth, while in a scenario of lower oil prices, the Spanish economy will benefit. - Policy Response: - Use any windfall revenues to reduce the high public debt. - Allow automatic stabilizers to operate and formulate credible medium-term fiscal path in support of public debt sustainability. ### Risk Assessment Matrix — Structural Risks - Accelerating de-globalization - Relative Likelihood: High - Impact if Realized: Medium — Geopolitical competition and fraying consensus about the benefits of globalization lead to further fragmentation, including to a no-deal Brexit. In the near term, escalating trade tensions, including a no-deal Brexit, could undermine growth both directly and through adverse confidence effects and financial market volatility. These policy shifts could reduce the cross-border flow of trade disrupting global supply chains and reducing FDI. In the medium-term, de-globalization would give rise to reshoring and less trade reducing potential growth. - Policy Response: - Accelerate structural reforms to strengthen competitiveness, in particular enhance labor market performance and lower duality. - Let automatic stabilizers play in case the output gap widens and formulate credible medium-term fiscal path in support of public debt sustainability. - Prolonged period of uncertainty related to political crisis in Catalonia - Relative Likelihood: Medium - Impact if Realized: Medium — Prolonged period of uncertainty could weaken business confidence weighing on investment. - Policy Response: - Accelerate 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 - Impact if Realized: High — Traction for structural reforms is low in a fragmented parliament. A credible medium-term fiscal plan has yet to be announced. Potential lack of or reversal of reforms and uncertainty about medium-term fiscal commitments could weaken confidence, investment, and employment, which would adversely impact public debt dynamics and could trigger adverse market reactions. - Policy Response: - Accelerate 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. *Source: Annex I. Main Recommendations of the 2018 Article IV* ### Annex IV. Debt Sustainability Analysis ### Annex IV. Debt Sustainability Analysis ### Public Debt Sustainability Analysis — key findings - Due to unprecedented output loss and fiscal response to the COVID-19 pandemic, Spain’s public debt sustainability risk has increased substantially. - Under the baseline scenario, the public debt ratio is projected to surge by nearly 30 percentage points in 2020 and drift slightly lower in the medium term. - Gross financing needs are projected to increase to 29 percent of GDP in 2020, raising rollover risks. - Continued ECB monetary policy support will mitigate the government’s funding risks. - Another adverse growth shock and/or the realization of contingent liabilities would put the public debt-to-GDP ratio on an upward trajectory. - Over the medium term, a gradual but persistent fiscal adjustment is crucial to put public debt on a downward path and reduce fiscal vulnerability. ### Background and definitions - Public debt comprises Excessive Deficit Procedure (EDP) debt in the hands of the General Government. - The 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 their nominal value. ### Public debt developments (historical) - Public debt peaked at 100.7 percent of GDP in 2014 and declined to 95.5 percent of GDP at end-2019. - The sharp increase between 2007 and 2014 (about 65 percentage points) was driven by: - Excessive fiscal deficits (about 8½ percent of GDP on average during 2008–14). - A largely unfavorable growth-interest rate differential (contributed an annual average of nearly 3 percent of GDP). - Support to the banking sector added about 4½ percent of GDP to the public debt stock. - Net public debt reached 81.3 percent of GDP at end-2019. ### Financing conditions and debt profile - Gross financing needs peaked at 22 percent in 2012 and continued to decline before the pandemic. - The 10-year benchmark bond yield fell from about 6¾ percent in mid-2012 to 0.4 percent at end-2019. - Interest payments on public debt fell to 2.3 percent of GDP in 2019. - Amortization profile: about 90 percent of total debt is medium and long term (residual maturity basis). - Average life of outstanding debt increased from 6.3 years in 2012 to 7½ years in 2019. - Average cost of outstanding debt reached an all-time low of about 2 percent in July 2020. - Holdings of marketable debt at end-2019: banking system about 15 percent; ECB 19 percent; almost half held by non-residents (nearly 20 percentage points higher than the lowest in 2012). - Composition shifts in 2020: small retreat from non-EU foreign investors offset by increases in non-resident EU investors and domestic investors (particularly banks). ### Baseline projections and assumptions - Baseline projection highlights: - Public debt projected to rise to 123 percent of GDP in 2020. - In absence of fiscal adjustment beyond 2021, debt-to-GDP is expected to stay around 120 percent in the medium term. - Gross financing needs rise to nearly 30 percent of GDP in 2020, gradually declining to just below the 20 percent benchmark in 2025. - Key baseline assumptions: - Real GDP: shrink by 12.8 percent in 2020, rebound with growth of 7.2 percent in 2021. - Medium-term growth converges toward potential of about 1½ percent. - Structural primary balance: deteriorates by 4½ percent of GDP in 2020, followed by a 3.8 percent of GDP improvement in 2021. - Inflation (GDP deflator): increases from 0.5 percent in 2020 to 1.7 percent in 2025. - Long-term sovereign spreads: 10-year bond yields rise moderately to 2.3 percent with gradual normalization of monetary policy. - Baseline assumes disbursements under the EU Recovery and Resilience Facility in 2021–24 and no other policy changes. ### Realism of projections - Forecast errors (median, 2011–19): - Real GDP growth median forecast error: 0.28 percent (moderate downward bias in staff projections). - Primary balance median forecast error: -0.73 percent (upward bias in staff projections). - Inflation (deflator) median forecast error: -0.31 percent (upward bias in staff projections). - Assessment of projected fiscal adjustment: - Projected levels of the cyclically adjusted primary balance (CAPB) are below thresholds that would question feasibility. - Near-term CAPB adjustment is large relative to historical and cross-country experience but reflects mostly temporary measures assumed to expire before end-2020. ### Stress tests — main scenarios and results - Main result summary: - Debt dynamics worsen significantly if contingent liabilities materialize: public debt could rise to around 135 percent of GDP in the medium term. - A combination of negative growth shocks plus deterioration in primary balance could push debt to 136 percent of GDP by 2025. - Growth shock: - Assumes real GDP growth lower than baseline by one (10-year historical) standard deviation in 2021–22. - Implies average real GDP growth of 3.6 percent per year in 2021–22 versus 5.8 percent under baseline. - Inflation lower by 0.6 percentage points per year on average; primary balance weaker by about 1.8 percent of GDP per year on average in shock years. - Debt-to-GDP would rise to about 128 percent in the medium term (almost 10 percentage points above baseline). - If no fiscal tightening in 2023–25 (primary expenditure held at baseline nominal level), debt could reach 135 percent of GDP in 2025. - Primary balance shock: - Assumes relaxation of fiscal policy in 2021–22 with deterioration of primary balance by 2.1 percent of GDP per year. - Public debt-to-GDP would be about 124 percent in 2021 and stay around that level in the medium term (about 5 percentage points higher than baseline). - Interest rate shock: - Real interest rate shock of about 335 basis points during 2021–25. - Effective interest rate increases to 3.7 percent by 2025 compared to 2.2 percent in baseline. - Debt-to-GDP would rise moderately to about 124 percent in 2025. - Combined shock: - Simultaneous negative growth, primary balance, and interest rate shocks. - Public debt-to-GDP increases to about 136 percent in 2025 (about 17 percentage points higher than baseline). - Gross financing needs peak at 30.5 percent in 2021 in this scenario. - Contingent liability shock: - One-time increase in non-interest public expenditures in 2021 equivalent to 6 percent of banking sector assets, combined with lower growth and lower inflation in 2021–22 (growth reduced by 1 standard deviation). - Primary deficit rises to about 10 percent of GDP in 2021. - Gross financing needs reach 37.6 percent of GDP. - Debt-to-GDP rises sharply to 135 percent in 2021 and stays around 136 percent in the medium term (around 17 percentage points higher than baseline). ### Heat map and risk assessment - The debt burden benchmark of 85 percent of GDP is breached under the baseline and in each shock scenario. - Gross financing needs would remain above 20 percent of GDP under the baseline until 2024, and in most shock scenarios. - Debt profile risks stem from: - High level of external financing needs. - The share of public debt held by non-residents (noted as a secondary source of risk). ### Baseline numerical snapshot (selected indicators, as presented) - Nominal gross public debt: 2018 84.8; 2019 97.6; 2020 95.5; 2020 (projection) 123.0; 2021 121.3; 2022 120.4; 2023 119.3; 2024 118.1; 2025 118.8 (in percent of GDP). - Public gross financing needs: 2018 19.7; 2019 17.0; 2020 16.7; 2020 (projection) 29.1; 2021 26.6; 2022 21.6; 2023 20.5; 2024 19.6; 2025 19.5 (in percent of GDP). - Real GDP growth: 2018 0.3; 2019 2.4; 2020 2.0; 2020 (projection) -12.8; 2021 7.2; 2022 4.5; 2023 3.4; 2024 2.8; 2025 1.5 (in percent). - Inflation (GDP deflator): 2018 0.3; 2019 1.1; 2020 1.6; 2020 (projection) 0.5; 2021 0.9; 2022 1.4; 2023 1.6; 2024 1.7; 2025 1.7 (in percent). - Effective interest rate (interest payments divided by debt stock): 2018 3.6; 2019 2.6; 2020 2.4; 2020 (projection) 2.3; 2021 2.3; 2022 2.3; 2023 2.2; 2024 2.2; 2025 2.2 (in percent). - Change in gross public sector debt (cumulative): 2018 6.5; 2019 -1.0; 2020 -2.1; 2020 (projection) 27.6; 2021 -1.7; 2022 -0.9; 2023 -1.1; 2024 -1.2; 2025 0.7; cumulative 23.4 (in percent of GDP). - Identified debt-creating flows (selected): - Primary deficit: 2018 5.1; 2019 0.3; 2020 0.8; 2020 (projection) 11.7; 2021 5.1; 2022 3.4; 2023 2.4; 2024 1.7; 2025 2.1; cumulative 26.3 (in percent of GDP). - Automatic debt dynamics (interest rate/growth differential): 2018 1.8; 2019 -0.9; 2020 -1.1; 2020 (projection) 16.1; 2021 -6.6; 2022 -4.1; 2023 -3.2; 2024 -2.6; 2025 -1.1; cumulative -1.5 (in percent of GDP). ### External Debt Sustainability Analysis — summary - Under the baseline, the external debt-to-GDP ratio is projected to reach a historical peak in 2020. - Over the medium term, external debt is projected to decline, supported in part by accumulation of trade surpluses, but would remain above 160 percent of GDP in 2025—only moderately below the pre-COVID ratio. - Mitigating factors for external vulnerability include: - Current low cost of debt. - Limited share of debt denominated in foreign currency. - Predominantly long-term maturity of debt. _Italic: Source — IMF staff (Annex IV. Debt Sustainability Analysis, Spain)._ ### 15. The External DSA provides a framework to examine a country’s external sustainability ### 15. The External DSA provides a framework to examine a country’s external sustainability ### External DSA: purpose and baseline - The External DSA complements the External Sector Assessment (Annex II) and estimates the external debt path under several scenarios using relatively mechanistic assumptions. - Baseline scenario: - Based on medium-term macroeconomic projections (Table 1). - Assumes real GDP growth plunges in 2020 and then recovers until reaching nearly 1.5 percent at the end of the forecast horizon. - Trade surplus (goods and services) declines in the near term and is forecast to gradually improve; the external current account balance remains in surplus. - External debt projected to slightly decline from about 169 percent of GDP in 2019 to 164 percent of GDP in 2025. - Compared with the previous External DSA (IMF Country Report No. 18/330), the external-debt ratio is expected to remain higher for longer (by almost 20 percentage points at the end of the forecast horizon), largely because of its surge in 2020. - External debt-to-exports ratio projected to decline during 2021–25, driven by gradual export recovery and low interest rates. - Gross external financing needs as a share of GDP would rise above pre-COVID levels in the near term and remain high thereafter (above 70 percent of GDP by 2025). ### Alternative scenarios and stress tests — key findings - Overall: Spain’s external debt will remain high but gradually decline over the medium term; level of external debt remains a vulnerability given risks. - Historical Shock Scenario: - Using 2010–19 historical properties for real GDP growth, external interest rate, GDP deflator in US dollars, and current account excluding interest payments, external debt would increase to 233 percent of GDP by 2025 (about 30 percentage points higher than in the pre-COVID historical shock scenario). - Driven in part by a real GDP growth path of 1 percent since 2020 and higher interest payments. - Interest Rate Shock: - A one-half standard deviation interest rate shock (increase from 1.2 percent in the baseline to 1.5 percent) raises end-2025 external debt by about 2 percentage points of GDP relative to baseline. - Growth Shock: - If real GDP growth averages 2.7 percent between 2020 and 2025 (vs. 3.8 percent in the baseline), external debt would reach 174 percent of GDP in 2025. - Non-Interest Current Account Shock: - If the current account surplus excluding interest payments averages 2.9 percent of GDP rather than 3.7 percent in the baseline, external debt stock would be 168 percent of GDP in 2025. - Combined Shock: - A combination of 1/4 standard deviation shocks to real GDP growth, the external interest rate, and the current account balance yields an external debt-to-GDP ratio of 172 percent in 2025. - Real Depreciation Shock: - A 30 percent real depreciation shock increases external debt to 173 percent of GDP in 2025; transmission in the DSA is via valuation effects, but Spain has a low share of debt denominated in foreign currency. ### Projections and key statistics (selected) - Baseline external debt series (external debt, percent of GDP): - 2015: 168.9; 2016: 167.7; 2017: 167.0; 2018: 168.3; 2019: 169.4; 2020: 198.2; 2021: 186.5; 2022: 178.9; 2023: 172.7; 2024: 167.2; 2025: 163.9. - Change in external debt (percent of GDP): - 2015: -0.3; 2016: -1.2; 2017: -0.7; 2018: 1.3; 2019: 1.1; 2020: 28.8; 2021: -11.7; 2022: -7.6; 2023: -6.2; 2024: -5.5; 2025: -3.3. - Identified external debt-creating flows (percent of GDP): - 2015: -6.2; 2016: -9.1; 2017: -9.7; 2018: -9.0; 2019: -9.5; 2020: 23.9; 2021: -13.7; 2022: -9.4; 2023: -8.0; 2024: -7.1; 2025: -4.4. - Current account deficit, excluding interest payments (percent of GDP): - 2015: -4.8; 2016: -5.6; 2017: -4.8; 2018: -4.0; 2019: -4.0; 2020: -2.9; 2021: -3.0; 2022: -3.3; 2023: -4.0; 2024: -4.3; 2025: -3.9. - Exports (percent of GDP): 2015: 33.6; 2016: 33.9; 2017: 35.2; 2018: 35.1; 2019: 34.9; 2020: 29.4; 2021: 30.3; 2022: 32.7; 2023: 33.8; 2024: 34.3; 2025: 35.2. - Imports (percent of GDP): 2015: -30.6; 2016: -29.9; 2017: -31.6; 2018: -32.4; 2019: -32.1; 2020: -28.0; 2021: -28.9; 2022: -30.9; 2023: -31.1; 2024: -31.1; 2025: -31.6. - Net non-debt creating capital inflows (percent of GDP): 2015: -1.8; 2016: -0.5; 2017: 0.3; 2018: -0.8; 2019: -2.5; 2020: -0.4; 2021: -0.3; 2022: -0.3; 2023: -0.3; 2024: -0.2; 2025: -0.2. - Automatic debt dynamics contribution (percent of GDP): 2015: 0.4; 2016: -3.0; 2017: -5.1; 2018: -4.2; 2019: -3.0; 2020: 27.1; 2021: -10.4; 2022: -5.8; 2023: -3.7; 2024: -2.5; 2025: -0.3. - Contribution from nominal interest rate (percent): 2015: 2.8; 2016: 2.4; 2017: 2.2; 2018: 2.0; 2019: 2.0; 2020: 2.3; 2021: 2.1; 2022: 2.0; 2023: 2.0; 2024: 2.0; 2025: 2.1. - Contribution from real GDP growth (percent): 2015: -7.4; 2016: -5.0; 2017: -4.6; 2018: -3.6; 2019: -3.4; 2020: 24.8; 2021: -12.5; 2022: -7.8; 2023: -5.7; 2024: -4.6; 2025: -2.4. - External debt-to-exports ratio (percent): 2015: 502.2; 2016: 494.8; 2017: 474.7; 2018: 479.2; 2019: 485.8; 2020: 673.8; 2021: 616.4; 2022: 547.8; 2023: 511.0; 2024: 487.0; 2025: 466.1. - Gross external financing need (in billions of US dollars): 2015: 964.3; 2016: 866.5; 2017: 898.3; 2018: 970.0; 2019: 1,028.1; 2020: 1,054.1; 2021: 1,091.7; 2022: 1,143.8; 2023: 1,156.6; 2024: 1,170.3; 2025: 1,190.6. - Gross external financing need (percent of GDP): 2015: 80.7; 2016: 70.3; 2017: 68.5; 2018: 68.3; 2019: 73.7; 2020: 86.2; 2021: 78.8; 2022: 77.4; 2023: 74.3; 2024: 71.9; 2025: 71.0. ### Key macroeconomic assumptions underlying the baseline (selected) - Real GDP growth (percent): 2015: 3.8; 2016: 3.0; 2017: 2.9; 2018: 2.4; 2019: 2.0; 2020: 1.0; 2021: 2.2; 2022: -12.8; 2023: 7.2; 2024: 4.5; 2025: 3.4; 2026: 2.8; 2027: 1.5. - GDP deflator in US dollars (change in percent): 2015: -16.0; 2016: 0.0; 2017: 3.5; 2018: 5.8; 2019: -3.7; 2020: -1.4; 2021: 6.8; 2022: 0.7; 2023: 5.7; 2024: 2.1; 2025: 1.9; 2026: 1.7; 2027: 1.7. - Nominal external interest rate (percent): 2015: 1.4; 2016: 1.5; 2017: 1.4; 2018: 1.3; 2019: 1.2; 2020: 1.9; 2021: 0.6; 2022: 1.2; 2023: 1.2; 2024: 1.2; 2025: 1.2; 2026: 1.3. - Growth of exports (US dollar terms, percent): 2015: -12.4; 2016: 3.9; 2017: 10.5; 2018: 8.1; 2019: -2.5; 2020: 3.9; 2021: 8.7; 2022: -26.0; 2023: 16.5; 2024: 15.1; 2025: 9.1; 2026: 6.2; 2027: 5.6. - Growth of imports (US dollar terms, percent): 2015: -12.2; 2016: 0.7; 2017: 12.5; 2018: 11.0; 2019: -2.8; 2020: 2.7; 2021: 9.0; 2022: -23.4; 2023: 16.9; 2024: 13.8; 2025: 6.3; 2026: 4.4; 2027: 4.7. - Current account balance, excluding interest payments (percent of GDP): 2015: 4.8; 2016: 5.6; 2017: 4.8; 2018: 4.0; 2019: 4.0; 2020: 4.1; 2021: 1.7; 2022: 2.9; 2023: 3.0; 2024: 3.3; 2025: 4.0; 2026: 4.3; 2027: 3.9. - Net non-debt creating capital inflows (percent of GDP): 2015: 1.8; 2016: 0.5; 2017: -0.3; 2018: 0.8; 2019: 2.5; 2020: 1.8; 2021: 1.5; 2022: 0.4; 2023: 0.3; 2024: 0.3; 2025: 0.3; 2026: 0.2; 2027: 0.2. ### Fiscal measures in response to COVID-19 (Annex V) — selected figures - Discretionary measures total: 40.5 billion euros, 3.7 percent of GDP. - Health sector support: 4.4 billion euros, 0.4 percent of GDP. - Advance transfer to the regions for the regional health services: 1.4 billion euros, 0.1 percent of GDP. - Budget support from the contingency fund to the Ministry of Health: 2.9 billion euros, 0.3 percent of GDP. - Other healthcare related spending including research: 0.1 billion euros, 0.0 percent of GDP. - Support for households: 25.2 billion euros, 2.3 percent of GDP. - Unemployment benefit entitlement for workers temporarily laid off under the ERTE: 17.8 billion euros, 1.6 percent of GDP. - Allowance for self-employed workers affected by economic activity suspension: 5.3 billion euros, 0.5 percent of GDP. - Increased sick pay for infected or quarantined workers: 1.4 billion euros, 0.1 percent of GDP. - New rental aids programs and state contribution to the State Housing Plan 2018-21: 0.5 billion euros, 0.0 percent of GDP. - Support for firms: 10.5 billion euros, 1.0 percent of GDP. - Exemptions of social contributions for impacted companies maintaining employment under ERTE: 6.3 billion euros, 0.6 percent of GDP. - Exemption from payment of contributions for self-employed affected: 2.7 billion euros, 0.2 percent of GDP. - Deferral of social security debts for companies and the self-employed: 0.5 billion euros, 0.0 percent of GDP. - Other support: 0.5 billion euros, 0.0 percent of GDP. - Off-budget measures total: 170.1 billion euros, 15.6 percent of GDP. - Loan guarantees for firms and self-employed (including commercial paper of medium-sized companies in MARF): 100.0 billion euros, 9.2 percent of GDP. - New ICO line of guarantees for investment (environmental sustainability and digitization): 40.0 billion euros, 3.7 percent of GDP. - Additional funding for ICO credit lines: 10.0 billion euros, 0.9 percent of GDP. - Creation of a state rescue fund to support strategic business: 10.0 billion euros, 0.9 percent of GDP. - Guarantees for financing operations via the Pan-European Guarantee Fund: 2.8 billion euros, 0.3 percent of GDP. - Endorsement of SURE Instrument: 2.3 billion euros, 0.2 percent of GDP. - Public guarantees for exporters through the Spanish Export Insurance Credit Company: 2.0 billion euros, 0.2 percent of GDP. - Line of guarantees for housing expenses for vulnerable households due to COVID-19: 1.2 billion euros, 0.1 percent of GDP. - Additional loan guarantees for SMEs and the self-employed through CERSA: 1.0 billion euros, 0.1 percent of GDP. ### Key income support programs (Annex VI) — ERTE and MIS summaries - Spain’s Job retention scheme (ERTE): - Introduced in 1980s; expanded in response to COVID-19. - Under expanded ERTE: - ERTEs caused by COVID-19 are considered force majeure. - Workers covered receive unemployment benefits equal to 70 percent of the regulatory base contribution, with no requirement for prior minimum contribution or reduction of accumulated entitlement. - Firms under ERTEs are exempted from employers’ contribution to social security contributions (100 percent for firms with less than 50 employees and 75 percent for the rest). - Initial duration covered period until the end of the state of emergency; later extended three times to end-January 2021. - Take-up: nearly 3.4 million workers or 22 percent of salaried workers benefited at the peak in April. - Fiscal cost of ERTE estimated at about 1 percent of GDP at end-August. - Minimum Income Scheme (MIS): - Introduced to address inequality and extreme poverty and to improve coverage and coordination across autonomous communities. - MIS is non-contributory and provides a monthly monetary benefit covering the difference between household disposable income (previous year) and a predetermined guaranteed income level. - Guaranteed income is differentiated by household type; for a single-person household it is set at 100 percent of the annual amount of non-contributory social security pensions in force at any given time, divided by 12. - Calculation of disposable income excludes regional minimum income benefits, making MIS a floor benefit while allowing autonomous communities flexibility. - MIS includes clauses to promote labor force participation (e.g., applicant must register as job seekers, temporary compatibility with labor earnings after finding a job) and provides incentives for employers to hire MIS recipients. - Administrative procedures simplified; applications can be submitted via multiple channels. *Source: 1espea2020001 - 15. The External DSA provides a framework to examine a country’s external sustainability* ### 6. The MIS is expected to significantly reduce extreme poverty in Spain, but its sizable fiscal ### 6. The MIS is expected to significantly reduce extreme poverty in Spain, but its sizable fiscal ### Minimum Income Scheme (MIS): coverage, impacts, and fiscal cost - The government estimated that the MIS would benefit around 850,000 households with 2.3 million individuals, of which about half currently earning less than 310 euros per month. - Poverty reduction effects: - Reducing the population under extreme poverty (income below 2,950 euros a year) by about 75 percent. - Reducing the population under high poverty (income between 2,950 and 4,250 euros a year) by more than 50 percent. - Single-parent households benefiting the most. - Adequacy relative to peers: - With the MIS benefit alone (i.e., without taking into account additional minimum income benefits granted by autonomous communities), the adequacy of Spain’s guaranteed minimum income system seems to be still low relative to European peers (text chart). - Fiscal cost and financing: - The fiscal cost of the MIS is estimated at about 3 billion euros a year or 0.3 percent of 2020 GDP. - Given its non-contributory nature, the program will be financed by the state budget through transfers to the social security budget. - Administrative/assessment note: - In light of the pandemic, an exception was made for 2020 during which the disposable income is assessed based on either the level in the current year or the previous year depending on the applicant’s choice. ### Fiscal and policy recommendations for MIS - The financing need of the MIS should be adequately considered in a medium-term budget plan to limit further widening of the structural fiscal balance. - Review and streamline existing benefit programs to avoid coverage overlapping or inconsistency. ### Financial sector risk management and public sector governance (Annex VII): recent steps and outstanding gaps - Institutional enhancements: - Creation of the National Financial Stability Authority (AMCESFI) in early 2019 to monitor financial sector risks, including from the COVID-19 crisis. - AMCESFI comprises officials from the Ministry of Economy and the sectoral supervisors: the Bank of Spain, the National Securities Market Commission (CNMV), and the Directorate General of Insurance and Pension Funds (DGSFP at the Ministry of Economy). - AMCESFI can analyze systemic risk and issue opinions, warnings and recommendations, including on macroprudential measures by sectoral supervisors. - The Bank of Spain provides the Secretariat for AMCESFI’s Technical Committee. - Macroprudential toolkit: - Since December 2018, sectoral supervisors have additional macroprudential tools. - For the Bank of Spain, these tools include sectoral countercyclical capital buffers (CCyBs), limits to sectoral concentration, and limits and conditions on bank lending and other operations. - CNMV and DGSFP were also granted additional tools to minimize leakages. - Remaining regulatory and institutional needs: - Finalize secondary regulations for some of the Bank of Spain’s tools—notably borrower-based instruments such as limits to loan-to-value and debt service-to-income ratios. - Consider creating a financial consumer protection authority and moving insurance and pension supervision outside the Ministry of Economy. - AML/CFT: - Advance additional enhancements to Spain’s AML/CFT regime; in particular, implement targeted financial sanctions (TFS) without delay. - A corresponding provision is included in the new draft amendment of the AML/CFT Law, which is expected to be approved in the last quarter of 2020. - Public procurement: - Continued efforts needed to address weaknesses in public procurement. - New institutional set-up being established following European Commission recommendations and the Procurement Law. - Good progress on digitalization via an electronic platform for contractual information and documentation. - Coordination challenges with regions remain; on-site supervision can be strengthened by ensuring appropriate funding of the newly established Office for Regulation and Supervision of Procurement. ### External adjustment and NIIP assessment (Annex VIII): background and objectives - Background: - Spain’s NIIP was around -30 percent of GDP in 1999 and peaked at roughly -100 percent of GDP in 2009. - The NIIP improved by about 22 percent of GDP over 2014–19 but remains deeply negative. - Objective of analysis: - Use a new method to determine additional relative price adjustment needed to bring the NIIP to a safer level. - Staff considers that a net external debtor position of at least -50 percent of GDP would be prudent. - Time horizon: - The analysis considers a horizon of 15 years for applying the Blanchard and Das (2017) framework. ### Methodology and assumptions - Approaches: - Deterministic approach based on present discounted value analysis (Blanchard and Das, 2017) to estimate REER depreciation required to lower the NIIP to target levels. - Probabilistic approach using historical shocks (VAR-based Monte Carlo simulations) to assess uncertainty and probability that a REER depreciation is required. - Key assumptions: - Semi-elasticity of net exports to the REER is assumed at -0.22 (constant over the forecast horizon for the deterministic approach). - For the probabilistic approach, a semi-elasticity of -0.15 is assumed in the case of the ULC-based REER. - Shares of external assets and liabilities denominated in foreign currency are assumed at about 40 percent for assets and close to 10 percent for liabilities. - For the present value analysis (deterministic approach), an ad-hoc discount factor of 0.95 is chosen. - Forecasting input: - Reflecting expected trade and capital account surpluses, and conservatively assuming zero valuation effects, the NIIP would improve to about -52 percent of GDP in 2025 under the baseline projection. ### Deterministic results: required REER depreciation for NIIP targets (15-year horizon) - Required REER depreciations: - To stabilize the NIIP at -50 percent of GDP: about 2 percent REER depreciation. - For a less ambitious target of -55 percent of GDP: 0.5 percent REER depreciation. - To stabilize the NIIP at -40 percent of GDP: 5 percent REER depreciation. - Interpretation: - More ambitious NIIP targets require larger REER depreciation to generate trade surpluses and offset net investment income drags. ### Probabilistic results: distributional assessment and probabilities - Monte Carlo setup: - For each target NIIP, 15,000 Monte Carlo simulations of the Blanchard and Das (2017) model are run using the joint distribution of VAR innovations. - Main findings: - Taking into account forecast uncertainty, the probability that the REER must depreciate to stabilize the NIIP at lower levels is estimated at between 51 and 53 percent. - CPI-based REER results (moments and probabilities): - Target NIIP -55%: Mean -11%, Std. Deviation 12%, Probability REER_CPI adjustment < 0 = 51% - Target NIIP -50%: Mean -11.8%, Std. Deviation 11%, Probability = 51% - Target NIIP -45%: Mean -12%, Std. Deviation 12%, Probability = 51% - Target NIIP -40%: Mean -13.0%, Std. Deviation 12%, Probability = 51% - ULC-based REER results: - Target NIIP -55%: Mean -13.4%, Std. Deviation 15%, Probability REER_ULC adjustment < 0 = 52% - Target NIIP -50%: Mean -14.5%, Std. Deviation 16%, Probability = 53% - Target NIIP -45%: Mean -15.5%, Std. Deviation 16%, Probability = 53% - Target NIIP -40%: Mean -16.7%, Std. Deviation 17%, Probability = 53% - Observations: - Average depreciations required are higher with the ULC-REER than with the CPI-REER for all analyzed NIIP targets. - For the CPI-REER, the probability the REER must depreciate (by about 12 percent) is around 51 percent when the NIIP target is -50 percent of GDP. - For the ULC-REER, the needed depreciation is higher (14.5 percent) with a probability around 53 percent. - Sensitivity to return assumptions: - When real yields including capital gains are used (unreported results), the probability that the REER must depreciate is generally higher, at about 59 percent, although average depreciations required to stabilize the NIIP in the range between -55 to -40 percent are around or below 5 percent. ### Synthesis and policy implications on external resilience - Both deterministic and probabilistic analyses point to the need for some additional relative-price adjustment, although the magnitude is fairly small in the deterministic case and probabilistic results show a substantial probability that the current exchange rate/relative prices may already yield a sustainable NIIP path. - The uncertainty of future real and financial shocks implies a non-trivial probability that depreciation will be required to ensure external sustainability; monitoring and policies that support competitiveness and resilience are warranted. *Source: IMF staff, Spain: Selected Issues (excerpted content).* ### 11. Over the medium term, structural reforms can be critical to preserve competitiveness ### 11. Over the medium term, structural reforms can be critical to preserve competitiveness ### Role of structural reforms - Structural reforms are critical to preserve competitiveness gains and boost productivity over the medium term. - If sources of external vulnerability that existed prior to the COVID-19 outbreak persist in the medium term, productivity improvements should further enhance Spain’s external sustainability. - Increasing TFP growth and moving up the value chain of export products would help ensure that competitiveness achieved in recent years through relative price adjustments is sustained. - Key reforms identified: - Tackling persistent labor market duality to enhance labor productivity. - Advancing product market reforms that support efficiency gains. - Upgrading education outcomes, labor skills, and innovation. - Supporting labor market institutions that allow firms to align wage evolution with productivity gains. ### Box 1. Medium-Term Forecasts and Extension to 15-Year Horizon — baseline and methodology - IMF staff medium-term projections cover 2020–25 and underpin the analysis. - Key baseline projection for present value analysis: the NIIP would significantly improve by 2025 to about -52 percent of GDP, driven by projected trade surpluses and supported by post-2020 GDP recovery, conservatively assuming zero valuation effects. - Projected grants under the EU Recovery and Resilience Facility in 2021-24 play a key role by impacting current transfers and the capital account. - Cumulative payments on investment income would negatively contribute to the NIIP improvement. - Caveat on valuation effects: due to data limitations, analysis is based either on capital gains which include exchange rate effects or on plain exclusion of capital gains. - Extension to 2034: forecasts are extrapolated assuming balanced growth in steady state — requiring growth rates of exports, imports, nominal output and components of the balance of payments to converge to the 2025 forecast growth rate of potential output. - Under this extrapolation, net exports plus current transfers and capital account balance in percent of GDP converge to a steady-state ratio of 2 percent. ### Medium-term projections of key variables (selected annual values as presented) - NIIP / GDP: - 2019: -74% - 2020: -84% - 2021: -75% - 2022: -69% - 2023: -62% - 2024: -56% - 2025: -52% - Assets / GDP: - 2019: 177% - 2020: 209% - 2021: 201% - 2022: 197% - 2023: 195% - 2024: 193% - 2025: 193% - Liabilities / GDP: - 2019: 252% - 2020: 293% - 2021: 276% - 2022: 265% - 2023: 257% - 2024: 249% - 2025: 245% - (Trade Balance + Current Transfers + Capital Account) / GDP: - 2019: 2.1% - 2020: 0.7% - 2021: 2.2% - 2022: 2.6% - 2023: 3.4% - 2024: 3.8% - 2025: 2.6% - Real GDP growth (year-on-year): - 2019: 2.0% - 2020: -13.7% - 2021: 6.9% - 2022: 4.4% - 2023: 3.3% - 2024: 2.7% - 2025: 1.4% - Real yield on assets (historical data 2019 calculated excluding capital gains) 1/: - 2019: 1.9% - 2020: 2.7% - 2021: 1.6% - 2022: 1.0% - 2023: 0.8% - 2024: 0.9% - 2025: 0.9% - Real yield on liabilities 1/: - 2019: 1.1% - 2020: 1.1% - 2021: 0.9% - 2022: 0.3% - 2023: 0.1% - 2024: 0.2% - 2025: 0.2% ### Statement by the Staff Representative — supplement highlights (post-report developments) - Q3 2020 rebound: - Growth in the third quarter was 16.7 percent relative to the previous quarter (preliminary data). - Despite the sharp rebound, the economy remains 8.7 percent below its level a year ago. - Recovery stronger for private consumption and investment; tourist services have held back exports. - Effective hours worked recovered substantially, increasing by about 25 percent relative to the previous quarter. - Unemployment rate rose to 16.3 percent (up from 15.3 percent in Q2) due to a sizable flow of workers moving from being inactive to actively seeking a job. - Given the strong Q3 outcome, the drop in GDP for 2020 could be less severe than the 12.8 percent decline projected by staff, absent a material tightening in containment measures. - Near-term risks from virus resurgence and authorities’ response: - Average daily new cases doubled to about twenty thousand by end-October/early-November compared to the first half of October. - Parliament extended the state of emergency through May 9, 2021 (with an interim assessment by March 9). - Restrictions announced so far are milder than the spring lockdown and include a nationwide curfew (with regional variation), limits on social gatherings, regional constraints to personal mobility, and limitations on hospitality and entertainment businesses (closing time and capacity), as well as localized closures. - No restrictions to most business activities including industry and trade, no home confinement restrictions, and schools and universities are to remain open. - Situation remains fluid and risks are tilted toward further tightening. - Macroeconomic outlook underpinning the government’s draft budget: - Government projects a recovery in activity of about 10 percent in 2021 compared to about 7 percent projected by staff. - Discrepancies mainly arise from the use of EU funds and the associated multiplier: authorities aim to absorb 2.2 percent of GDP and assume a multiplier impact of around 1.2. - Staff assumes slower absorption of EU funds, with additional spending of 1¼ percent in 2021 and an average short-term multiplier for investment of 0.8, based on past experience. - Staff assumptions were made prior to publication of the budget; further analysis will be needed once more detail on specific recovery plans is available. - A weaker-than-projected Q4 GDP outturn would make the projected 2021 real GDP growth difficult to achieve. *Source: IMF staff report content (1espea2020001 - section 11 and associated Box 1 and supplementary staff statement).* ### 4. The Draft Budgetary Plan and the draft budget law envisage a narrowing of the ### 4. The Draft Budgetary Plan and the draft budget law envisage a narrowing of the ### Fiscal outlook and Draft Budgetary Plan (DBP) - The DBP and the draft budget law envisage a narrowing of the fiscal deficit by 3.6 percent of GDP in 2021. - The government projects reducing the fiscal deficit by 3.6 pp down to -7.7 percent of GDP in 2021. - The authorities’ headline deficit for 2021 is broadly in line with staff projections, but rests on: - a stronger revenue forecast, including structural revenue measures of about 0.5 percent of GDP; and - a more expansionary spending plan, including using nearly €27 billion in grants under the EU Recovery and Resilience Facility for new government spending (about €21 billion envisaged for investment), thereby not changing the headline deficit in 2021. - The DBP envisages increases on contributive pensions and public wages by 0.9 percent (in line with projected inflation) and an increase in non-contributory pensions by 1.8 percent. ### Revenue measures and tax policy - The government plans structural revenue measures (about 0.5 percent of GDP) to improve progressivity, equity, and efficiency: - introduction of taxes on financial transactions and digital services; - increases in income taxation targeted at high-income earners and large companies; - measures to improve environmental taxation including new taxes on plastic bags and waste; - efforts to fight against tax fraud. - The DBP expects new measures to yield revenue increases over €6 billion, including: - an increase of the marginal rates of the personal income tax for highest earning taxpayers (wage earnings above €300.000 and capital gains above €200,000), affecting around 36,000 individuals, 0.17 percent of the total; - an increase of the marginal rate of the wealth tax (for wealth over €10 million); - for larger companies, a reduction from 100 to 95 percent in the tax credit applied to benefits from international subsidiaries (affects about 0.12 percent of the companies); - reinforced green taxation (new taxes on plastic packaging and waste); - new taxes on financial transactions and digital services; - an increase in the VAT rate for sugary drinks; - new measures to prevent tax evasion and reduced tax elusion. - Spain’s revenue-to-GDP ratio in 2019 was 41 percent of GDP, 6 points below the EU average. ### COVID-19 fiscal and liquidity response - Budgetary measures: 5.3 percent of GDP. - Liquidity measures: 15.3 percent of GDP. - Major policy actions and amounts: - Health: measures amounting more than €20 billion, including €16 billion in direct transfers to the regions through the Covid Fund (also covering education adaptation). - Minimum Income Schemes (MIS): will benefit 850,000 households and lift 1.6 million people out of poverty. - ERTEs (short-time work scheme): sustained 3.4 million jobs through the pandemic; unemployment increase of 3 pp (compared with 6.6 pp between 2008 and 2009). - Temporary ICO public guarantees program of €100 billion, supporting 550,500 companies with more than 842,000 operations granted, as of 15th October 2020. - Temporary moratoria and revisions of insolvency law; targeted tax and Social Security moratoria for SMEs and self-employed. - Recovery-phase targeted measures (temporary, contingent on pandemic evolution): - extension of ERTEs until January 2021 with sectoral focus; - additional ICO guarantee line of €40 billion for liquidity and investment ahead of recovery; - equity fund (SEPI Fund) equipped with €10 billion to support solvency of viable strategic companies. ### Recovery, Transformation and Resilience Plan and EU funding - Spain is eligible for €140bn to finance public investment, including €72 billion in transfers, expected to be deployed over six years and to mobilize up to €500 billion in private investment. - Plan structured around four axes: green transition, digitalization, gender equality and social and territorial cohesion; detailed in ten traction policies. - Allocation of resources: green and digital investment absorbing 37 and 33 percent of the resources, respectively. - The 2021 DBP includes €27 billion that can be financed with EU funds; React EU will finance in 2021 up to €8 billion of initiatives in regional operational programs. - Recovery Plan projected effects: - create 800,000 new jobs; - lift Spain’s growth potential above 2 percent; - reduce by two thirds the inequality gap with respect to the EU average. - Governance and accountability measures: new office in the Prime Minister’s cabinet for strategic review, commissions at ministerial, territorial and parliamentary levels, expert and consultation committees with private sector and social partners, and reinforced public procurement and supervision procedures. ### Economic outlook and scenarios - Authorities’ GDP projections: -11.2 percent in 2020 and +9.8 percent in 2021 (full implementation of Recovery and Resilience Plan), with recovery of pre-covid GDP levels by 2022. - Staff’s growth estimates: -12.8 percent in 2020 and +7.2 percent in 2021, with recovery of GDP levels by 2023. - 3Q20 outturn: GDP growth of 16.7 percent and employment growth of 3 percent, with 569.000 new jobs. - High uncertainty and downside risks mainly associated with pandemic evolution; potential upside risks if a medical solution is widely available. ### Public investment and expenditure priorities in DBP - DBP significantly boosts investment in health, education and social resilience, and R&D and infrastructure: - increase of over 70 percent on health, education and social spending, including an additional €3 billion on health expenditures (largely for primary care and vaccines); - infrastructures: 114 percent increase; - R&D and innovation: 80 percent increase; - support to SMEs: 150 percent increase; - consolidation of the MVI and additional social spending on dependency, child poverty and gender policies. - Digital Spain 2025: public investment of €20 billion in the 2020–22 period; aims for 100 percent connectivity and deployment of 5G by 2025 and digitalization of public administrations and companies, with special focus on SMEs and start-ups. ### Banking sector and financial stability - Initial financial impact cushioned by credit support programs, debt moratoria, and expansionary monetary policy. - Bank lending positive growth since end-March; corporate financial conditions normalized though slightly tighter than pre-COVID-19. - NPLs have increased only moderately so far. - Solvency improved slightly since 3Q19, supported by regulatory flexibility; significant capital buffers exist. - Extraordinary provisioning undertaken in anticipation of impairments, adversely affecting income statements. - Supervisory exercises (ECB and Banco de España) show high capacity to absorb losses under the central scenario; capital depletion could be significantly higher under severe macroeconomic scenarios. - Supervisory stance: banks will have sufficient time to replenish capital buffers; consolidation processes (including mergers) might be useful; completion of the Banking Union would improve resilience. - Recommendation supported: strengthen the European AML/CFT framework, currently coordinated by an ad hoc EBA Standing Committee. ### Medium-term challenges and structural reforms - COVID-19 heightens need to increase potential growth, ensure fiscal sustainability, lower unemployment, improve quality of jobs, enhance social and environmental sustainability, and foster gender equality. - Authorities committed to resume fiscal consolidation once recovery stabilizes; steps already taken include increased progressivity of personal income tax and new green, digital, and financial transactions taxes. - Planned reforms and policy actions: - complete review of the tax structure and public transfers to enhance progressivity and revenue capacity, data-driven and informed by independent fiscal authority reviews; - pension reform: convergence of contribution regimes, sustaining purchasing power, incentivizing older effective retirement age, encouraging compatibility of work with pension receipt, and improving complementary private pension system; - reordering non-contributory social benefits with MIS absorbing duplicative benefits; authorities prefer continuing to refine MIS over adopting an Earned Income Tax Credit now; - digitalization agenda and Digital Spain 2025 to raise productivity, reduce carbon footprint, ensure 100 percent connectivity and 5G by 2025, and digitalize public administration and firms; - labor market reforms: reform of active labor market policies, review of passive policies to boost active job search, fostering open-ended contracts as the ordinary form of employment, and redesign of ERTEs to reduce duality and incorporate training elements. ### Social and environmental sustainability - Draft bill on Climate Change and Energy Transition targets net zero GHG emissions by 2050. - Focus sectors: transport, housing and energy; institutional framework to exceed EU 2030 targets on renewables and energy efficiency. - Key provisions: almost all new vehicles zero carbon by 2040; establish low-emission areas in cities with more than 50,000 inhabitants by 2023; promote electric charging infrastructure nationwide. - Transition guided by “no one left behind” approach: transition agreements for affected areas, work-training programs for low-carbon jobs, climate change education in schools. - Government estimates: ecological transition could attract more than €200 billion in investments over the next decade and create up to 350,000 new jobs annually. *Statement by Pablo Moreno, Executive Director for Spain, Fernando Lopez and Rosa Moral Betere, Advisors to the Executive Director; November 11, 2020.* --- _Source: https://www.imf.org/-/media/files/publications/cr/2020/english/1espea2020001.pdf_