## 1. Real Sector and Inflation ## Source details **Canonical URL:** [1. Real Sector and Inflation](https://www.imf.org/-/media/files/publications/cr/2022/english/1espea2022001.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2022/english/1espea2022001.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2022/english/1espea2022001.pdf.json) --- ### Context and recent developments - Contraction and vulnerabilities - Spanish economy contracted by 10.8 percent in 2020, the largest among major advanced economies. - Structural vulnerabilities: prevalence of SMEs, high reliance on tourism and contact-intensive sectors, widespread use of temporary employment contracts. - Pandemic dynamics and recovery - Containment measures eased in 2021; more than 80 percent of the population is now vaccinated. - Growth resumed since 2021-Q2; at end-2021-Q3 output was 6 percent below its pre-crisis level. - Rebound driven by private consumption and some recovery in tourism; investment remained weak. - Labor market - Social security affiliation now above end-2019 level (even excluding workers in ERTE). - Total hours worked are 3.2 percent below pre-crisis levels. - Broader unemployment measures are 1.3 percentage points above end-2019 level. - Workers in ERTE and self-employed receiving COVID-related support fell to about 5 percent of their peak level in December, but remain at 1.2 percent of the labor force. - Inflation and external sector - Headline inflation reached 6.5 percent y-o-y in December (highest in thirty years). - Core inflation reached 2.1 percent y-o-y in December. - Current account surplus narrowed to 0.8 percent of GDP in 2020, mainly due to tourism receipts declining by about 80 percent. - Balance on goods trade deteriorated in 2021-Q3 owing to rising energy prices and underperformance of key export sectors. - Preliminary assessment: projected external position in 2021 is broadly consistent with medium-term fundamentals and desirable policies (Annex I). - Policy response - Cumulative fiscal response in 2020–21 estimated at about 23 percent of GDP, including: - nearly 8 percent of GDP in direct fiscal measures, - up to 14 percent of GDP in loan guarantees, - and 1 percent of GDP to help firms meet liquidity needs. - Headline fiscal balance was -11 percent of GDP in 2020; projected to improve to -7.8 percent in 2021. - ECB purchases under PEPP and PSPP covered all net issuance in 2020 and 2021. - Bank lending expanded in 2020 for the first time since 2008; in 2021 lending shifted from corporates to households. - Public support and recovery plans - ERTE and self-employed support covered about 25 percent of total employment at the peak. - State-backed loan guarantee program had the highest number of beneficiary firms in Europe. - Solvency support for the corporate sector introduced in 2021 with an envelope of about 1 percent of GDP (€11 billion). - Spain to receive €69.5 billion in grants under NGEU; about 1.5 percent of GDP (€19 billion) disbursed in 2021. - NGEU allocation: 40 percent for green transition; 30 percent for digitalization and upskilling. - Structural reforms - RTRP reforms cover climate and energy transition, innovation, housing, public administration modernization, justice system, business climate, education, labor markets, social inclusion, and pensions. - Labor market reform (end-2021) aims to reduce duality, enhance firms' adjustment to shocks, and change collective bargaining. - Pension reform initial phase concluded in 2021 prioritized social acceptability and sufficiency; sustainability concerns remain without additional measures. ### Outlook and projections - Baseline assumptions - Continued vaccine effectiveness against severe cases. - Global supply bottlenecks ease gradually in 2022. - GDP growth projections - Annual output growth projected at 4.9 percent in 2021 and 5.8 percent in 2022. - Output expected to recover to pre-crisis levels by end-2022. - NGEU impact and fiscal baseline - Cumulative impact on level of output estimated at 1½ to 2 percent by end-2022. - Baseline assumption of additional spending of 0.8 percent and 1.9 percent of GDP in 2021 and 2022, respectively. - Inflation outlook - Headline inflation expected to remain elevated in early 2022 due to energy prices and slow resolution of supply constraints. - Core inflation projected to average 1.8 percent in 2022 (compared to 2.1 percent y-o-y in December 2021). - Second-round inflation effects likely limited given modest wage inflation and remaining slack. - Medium-term - Potential growth expected to return to pre-pandemic levels; scarring likely limited. - Staff estimates loss of output relative to pre-crisis trend of between 2 and 3 percent of GDP in the medium term. ### Key projections and indicators (select figures as presented) - Real GDP growth (annual): -10.8 for 2020; 4.9 for 2021; 5.8 for 2022; 3.8 for 2023; 2.3 for 2024; 1.9 for 2025; 1.7 for 2026; 1.6 for 2027. - Headline inflation (average): 3.1 for 2021; 3.5 for 2022; 1.2 for 2023; 1.6 for 2024; 1.7 for 2025; 1.7 for 2026; 1.7 for 2027. - Core inflation (average): 0.8 for 2021; 1.8 for 2022; 1.5 for 2023; 1.6 for 2024; 1.7 for 2025; 1.7 for 2026; 1.7 for 2027. - Unemployment rate: 15.0 for 2021; 14.0 for 2022; 13.5 for 2023; 13.3 for 2024; 13.1 for 2025; 13.0 for 2026; 13.0 for 2027. - Current account (Percent of GDP): 0.4 for 2021; 1.3 for 2022; 1.6 for 2023; 1.7 for 2024 onward. ### Risks and uncertainties - Main risks - Evolution of the pandemic, vaccine effectiveness against new variants, and potential need for containment measures that could delay tourism recovery. - Pace and extent of normalization of household savings; much of the 2020 increase appears to be “forced” savings. - Path of oil, gas, and commodity prices and speed of resolution of global supply shocks; prolonged energy price increases could raise CPI persistently. - Persistent euro-area inflationary pressures could lead to faster withdrawal of monetary support, higher inflation risk premia, and higher sovereign bond yields. - Timing, composition, and effectiveness of EU-funded spending will affect recovery speed and scarring magnitude. - Longer-term success of reforms will determine efficient allocation of resources and higher potential output. - Risk assessment (Annex I highlights) - Staff-assessed appropriate CA norm given external risks from a large negative NIIP: 1.7 percent of GDP, with a range of 0.7 to 2.7 percent of GDP. - Staff gap reported as −0.5 percent of GDP for 2021. ### Fiscal policy: stance, risks, and recommended adjustment path - Near-term stance - Fiscal stance in 2021 was appropriately expansionary; support should remain until recovery is firmly established to minimize scarring. - Fiscal policy should remain accommodative while economic slack persists; activity expected to return to pre-crisis levels only at the end of 2022. - Fiscal consolidation in 2022 should be mainly driven by the economic recovery and automatic stabilizers, limiting discretionary adjustment to the unwinding of Covid-related emergency measures. - Pandemic fiscal toll and projections - Debt-to-GDP ratio increased by nearly 25 percentage points to about 120 percent of GDP in 2020. - Under the baseline scenario, deficit and debt ratios will fall in the near term as economic conditions improve and emergency spending measures wind down. - Staff’s baseline assumes no policy changes after 2022 beyond expiration of temporary support measures. - In absence of active consolidation, structural deficit will stabilize above pre-crisis levels and debt ratio will start increasing by 2024 once output growth rates slow down. - Recommended timing and pace of consolidation - Initiate sustained and gradual discretionary fiscal consolidation once the output gap is closed; under baseline, conditions met by 2023. - Pace and size: gradual reduction of structural primary deficit by an average of about ½ percent of GDP annually would reverse the rising trend in the debt ratio and achieve a close-to-balanced structural fiscal position within a decade. - Composition: mobilize additional revenues and enhance spending efficiency; preserve space for investment in climate mitigation and adaptation. - Quantified potential revenue measures (as presented) - Lowering the VAT policy gap to EU average: 1.5-2.0 (Percent of GDP) - Broadening the tax base by removing distortions in the tax system: 0.3-0.5 (Percent of GDP) - Harmonizing environmental taxes with EU average: 0.7-0.9 (Percent of GDP) - Medium-term credibility and pension costs - Pension reform (phase one) implications: indexing pensions to CPI and repealing sustainability factor would raise annual pension outlays by 3½ percent of GDP by 2050 compared to full implementation of previous legislation. - Additional efforts required to preserve fiscal sustainability. ### Stress tests, shock scenarios, and debt vulnerabilities - Growth shock - Real GDP grows by an average of 2.6 percent per year in 2022–23 versus 4.8 percent under baseline. - Primary balance weaker by about 1.8 percent of GDP per year in shock years. - Debt-to-GDP would rise to about 125 percent of GDP in the medium term (almost 10 percentage points higher than baseline). - Primary balance shock - Relaxation of fiscal policy by 1.6 percent of GDP per year in 2022–23; public debt-to-GDP would reach about 119 percent by 2026 (about 3.5 percentage points higher than baseline). - Interest rate shock - Assumes interest rates increase by 416 basis points from 2022 onwards; effective interest rate would increase to 3.6 percent by 2026 (baseline 1.7 percent). - Debt-to-GDP would rise to about 121 percent in 2026. - Combined shock - Public debt-to-GDP would increase to about 138 percent in 2026 (about 22 percentage points higher than baseline). - Contingent liability shock - One-time increase in non-interest public expenditures in 2021 equivalent to 6 percent of banking sector assets; primary deficit would rise to about 15 percent of GDP in 2022. - Debt-to-GDP would rise sharply to 135 percent by 2023 and stay around that level in the medium term. - Forecast accuracy indicators - Real GDP growth forecast error (Spain median, 2012–2020): 0.28 (in percent, actual-projection). - Primary balance forecast error (Spain median, 2012–2020): -0.95 (in percent of GDP). - Inflation (GDP deflator) forecast error (Spain median, 2012–2020): -0.42 (in percent). - Debt dynamics summary - Baseline and stress scenarios breach the debt burden benchmark of 85 percent of GDP. - Gross financing needs remain close to 20 percent of GDP over the forecast horizon in baseline and higher under most shocks. ### Labor market policies: challenges and recommendations - Structural challenges - High unemployment (particularly youth), overreliance on temporary contracts, vulnerable groups disproportionately affected. - Spain has the highest share of early leavers from primary and lower secondary education in the EU: 17.3 percent. - About 10 percent of students do not have access to internet or digital devices at home. - Scaling back and targeting support - ERTE scheme and benefits for the self-employed extended until February 2022; ERTE modified to increase incentives for returning to work and better target affected sectors. - Over time, unemployment benefits should become predominant safety net to encourage reallocation. - Active labor market policies (ALMPs) - Spain ranks low in ALMP spending per unemployed person compared to OECD peers. - Recommendation: allocate more ALMP resources to well-targeted training; strengthen public employment service; streamline hiring incentives. - Addressing duality - Reforms restrict temporary contracts by narrowing valid causes and strengthening enforcement. - Complement reforms with changes to severance payments (including possible employer-based separation fund) and reduce legal barriers to dissolving permanent contracts. - New Employment Law includes a national digital job market platform and individualized services to the unemployed. ### Labor market reform (December 2021): objectives and design - Objectives - Limit use of temporary contracts; enhance firms' adjustment to shocks; modify collective bargaining. - Contract and collective bargaining changes - Simplify and restrict temporary contracts; promote permanent-discontinuous contracts for seasonal activities; new training contracts. - Restore priority of sectoral agreements over firm agreements on wages; reinstate indefinite extensions of prior agreements on failure to reach new agreement. - Firms retain flexibility on working time, professional classification, and can negotiate opt-outs. - Short-time work schemes: ERTE and RED - ERTE: easier activation, dynamic worker inclusion, social security exemptions (20 percent for ERTE ETOP with training; 90 percent for force majeure), additional financing for training. - RED: new scheme financed by a special fund; cyclical RED (maximum 12 months; social security discounts 60/30/20 percent over three 4-month blocks); sectoral RED (initial 12 months, two 6-month extensions; 40 percent social security discount conditional on training; hiring firms receive 50 percent discount for six months). - Authorities expect RED to promote job stability and reskilling; operational details pending. ### Minimum wage and alternatives - Government target: increase minimum wage to 60 percent of average net monthly earnings by end of its term. - Staff caution: unintended adverse employment effects could partially offset gains for low wage earners. - Suggested alternative: introduce an Earned Income Tax Credit program to complement the Minimum Income Scheme. - Authorities intend to further increase statutory minimum wage toward the 60 percent target. ### Financial sector and corporate solvency support - Corporate stress and support - Share of companies with negative profits increased to about 40 percent (from about 30 percent in 2019). - Non-financial corporate leverage increased by about 15 percentage points, reaching 107 percent of GDP in 2020. - Corporate solvency support package (2021): envelope of about 1 percent of GDP (€11 billion); direct aid component accounted for 60 percent and was administered by regional authorities under national guidelines. - Simulation findings - Direct aid package helped reduce debt overhang; initial design estimated to close about 30 percent of total SME equity gap after disbursement. - Alternative, broader designs could offset more than half the SME equity gap but risk deadweight losses. - About 85 percent of loans under moratoria expired in first half of 2021; remaining loans under moratoria amount to less than one percent of total bank loans. - Financial stability recommendations - Banks frontloaded provisioning in 2020; forward-looking provisions should not be reversed until pandemic impact clearer. - Supervisors should ensure loss recognition is forward-looking and provisioning appropriate; address heterogeneity across banks. - Further cost rationalization and digitalization to improve profitability; some consolidation may be warranted. - Monitor willingness to use capital buffers; prudential relief should not be withdrawn prematurely. - Stress tests show system broadly resilient under severe stress, with heterogeneity across banks. - Insolvency framework amendments aim to facilitate early restructuring, speed up processes for microenterprises, and simplify discharge of debts for individuals and entrepreneurs. ### Housing affordability and climate policy - Housing affordability - Limited rental supply and inefficient building regulations contributed to surge in rental prices and constrained labor mobility. - Draft housing law introduces rent caps on large landlords and tax incentives for small landlords; targeted rent support programs envisaged. - RTRP envisages €1 billion for construction of new public social rental dwellings in 2022–23. - Additional supply measures recommended: simplify land use regulations and accelerate licensing at regional level. - Climate change mitigation - Law on Climate Change and the Energy Transition (2021) sets carbon neutrality by 2050 and intermediate target to reduce emissions by 23 percent relative to 1990 levels by 2030 (about a one third reduction compared to 2018 levels). - Carbon pricing coverage extensive but effective rates low relative to estimated emission damages. - About 40 percent of announced NGEU investments allocated to green projects. - Sector-specific recommendations - Cross-cutting: gradual and predictable carbon price increases; distributive policies for vulnerable households; support for workers affected by transition. - Road transport: strengthen vehicle acquisition taxation; consider feebates; implement low emission zones and tolls. - Residential: fiscal feebates, differentiated property taxes, phase in tighter energy performance standards, favorable financing for renovations. - Power sector: auction framework supports renewable investment; public investment to address market failures (grid, charging infrastructure, rail freight). ### Staff appraisal: consolidated policy recommendations - Near-term - Maintain supportive fiscal policy until recovery firmly entrenched; become more targeted over time. - Save any upside fiscal surprises to rebuild buffers. - Medium-term fiscal strategy - Start gradual, sustained, growth-friendly consolidation once output gap closed (staff baseline indicates 2023). - Early formulation of credible medium-term consolidation plans to support investor confidence. - Identify additional measures to offset pension spending increase from 2021 reform. - Financial sector - Maintain sizable safety buffers, be forward-looking in loan quality assessment, and maintain adequate provisions. - Enhance private resolution frameworks to address debt overhangs and facilitate resource reallocation. - NGEU and structural reform - Use NGEU funds for strategic investment and reforms; ensure efficient coordination across government levels and robust evaluation frameworks. - Labor market - Enforce temporary-contract restrictions effectively; make open-ended contracts more attractive by reducing dismissal cost differentials; consider employer-based separation funds. - Regular ex-post evaluation and private sector collaboration for RED/ERTE implementation. _Italic source attribution: IMF staff report (excerpt)._ ### 1. Real Sector and Inflation ______________________________________________________________________ 29 ### 1. Real Sector and Inflation ### Context and recent developments - The Spanish economy experienced a contraction of 10.8 percent in 2020, the largest among major advanced economies. - Structural vulnerabilities amplified the shock: prevalence of small and medium-sized enterprises (SMEs), high reliance on tourism and other contact-intensive sectors, and widespread use of temporary employment contracts. - Containment measures eased in 2021 and mobility levels recovered; more than 80 percent of the population is now vaccinated. - Growth resumed since 2021-Q2 but output remained below pre-pandemic levels: at the end of 2021-Q3 output was 6 percent below its pre-crisis level. - Drivers and constraints: - Rebound driven by private consumption and some recovery in tourism. - Investment remained weak due to elevated uncertainty, manufacturing supply bottlenecks, and rising costs of energy and materials. - High inflation and a resurgence of infections dampened consumption and slowed recovery in contact-intensive sectors. - Labor market: - Social security affiliation is now above end-2019 level (even excluding workers in ERTE). - Total hours worked are 3.2 percent below pre-crisis levels. - Broader measures of unemployment (including inactive people available for work but not seeking, and involuntary part-time workers) are 1.3 percentage points above the end-2019 level. - Workers in ERTE and self-employed receiving COVID-related support have fallen to about 5 percent of their peak level in December, but remain at 1.2 percent of the labor force. - Inflation: - Headline inflation reached 6.5 percent y-o-y in December, the highest level in thirty years. - Core inflation reached 2.1 percent y-o-y in December. - External sector: - Current account surplus narrowed to 0.8 percent of GDP in 2020, mainly due to tourism receipts declining by about 80 percent. - Balance on goods trade deteriorated in 2021-Q3 owing to rising energy prices and underperformance of key export sectors. - Preliminary assessment: projected external position in 2021 is broadly consistent with medium-term fundamentals and desirable policies (Annex I). - Macroeconomic policy stance: - Cumulative fiscal response in 2020–21 estimated at about 23 percent of GDP, including: - nearly 8 percent of GDP in direct fiscal measures, - up to 14 percent of GDP in loan guarantees, - and 1 percent of GDP to help firms meet liquidity needs. - Headline fiscal balance was -11 percent of GDP in 2020; projected to improve to -7.8 percent in 2021. - ECB purchases under PEPP and PSPP covered all net issuance in 2020 and 2021, helping keep long-term yields at historically low levels. - Bank lending expanded in 2020 for the first time since 2008; in 2021 lending shifted from corporates to households. - Public support and recovery plans: - ERTE and self-employed support covered about 25 percent of total employment at the peak of the crisis. - State-backed loan guarantee program had the highest number of beneficiary firms in Europe. - Solvency support for the corporate sector introduced in 2021 with an envelope of about 1 percent of GDP (€11 billion). - Spain to receive €69.5 billion in grants under NGEU; about 1.5 percent of GDP (€19 billion) disbursed in 2021. - NGEU allocation: 40 percent for green transition; 30 percent for digitalization and upskilling. - Structural reforms: - Reforms under the RTRP cover climate and energy transition, innovation, housing, public administration modernization, justice system, business climate, education, labor markets, social inclusion, and pensions. - Labor market reform (end-2021) aims to reduce duality, enhance firms' adjustment to shocks, and change collective bargaining. - Pension reform initial phase concluded in 2021 prioritized social acceptability and sufficiency; sustainability concerns remain without additional measures. ### Outlook and projections - Baseline forecast assumptions: - Continued vaccine effectiveness against severe cases. - Global supply bottlenecks ease gradually in 2022. - GDP growth projections: - Annual output growth projected at 4.9 percent in 2021 and 5.8 percent in 2022. - Output expected to recover to pre-crisis levels by end-2022. - NGEU impact: - Cumulative impact on level of output estimated at 1½ to 2 percent by end-2022. - Baseline assumption of additional spending of 0.8 percent and 1.9 percent of GDP in 2021 and 2022, respectively. - Inflation outlook: - Headline inflation expected to remain elevated in early 2022 due to energy prices and slow resolution of supply constraints. - Core inflation projected to average 1.8 percent in 2022 (compared to 2.1 percent y-o-y in December 2021). - Second-round inflation effects likely limited given modest wage inflation and remaining slack. - Medium-term: - Potential growth expected to return to pre-pandemic levels; scarring likely limited. - Staff estimates loss of output relative to pre-crisis trend of between 2 and 3 percent of GDP in the medium term. ### Risks and uncertainties - Main risks: - Evolution of the pandemic, vaccine effectiveness against new variants, and potential need for containment measures that could delay tourism recovery. - Pace and extent of normalization of household savings; much of the 2020 increase appears to be “forced” savings. - Path of oil, gas, and commodity prices and speed of resolution of global supply shocks; prolonged energy price increases could raise CPI persistently, weighing on consumption and growth. - Persistent euro-area inflationary pressures could lead to faster withdrawal of monetary support, higher inflation risk premia, and higher sovereign bond yields, increasing vulnerabilities and constraining fiscal space. - Timing, composition, and effectiveness of EU-funded spending will affect recovery speed and scarring magnitude. - Longer-term success of reforms (labor market and others) will determine efficient allocation of resources and higher potential output. *Source: 1espea2022001 - 1. Real Sector and Inflation (Spain), IMF PDF chapter* ### 14. The authorities broadly agreed with staff’s assessment of the economic outlook and ### 14. The authorities broadly agreed with staff’s assessment of the economic outlook and the main risks ### Outlook and risks - Authorities broadly agreed with staff’s assessment of the economic outlook and the main risks; Bank of Spain’s recent economic projections are similar to staff’s. - The government projects somewhat higher output growth for 2022 and highlighted an inconsistency between output, employment, and fiscal revenue growth given the fast recovery of employment and the increase in fiscal revenues. - Forecasts are marked by a high degree of uncertainty in a context of high volatility of economic indicators. - Authorities and staff share the view that the balance of risks has improved compared to expectations during the first year of the pandemic. - Despite the rise in headline inflation, authorities do not expect significant second-round effects because the share of wage contracts with automatic indexation clauses is relatively low and contracts renewed in 2021 resulted in moderate wage increases. - Spain’s external position is assessed as broadly in line with fundamentals. *Source: IMF staff text.* ### Fiscal policy: stance, risks, and recommended adjustment path - Fiscal stance in 2021 was appropriately expansionary; support should remain until recovery is firmly established to minimize scarring. - Economic slack persists and activity is expected to return to pre-crisis levels only at the end of 2022; fiscal policy should remain accommodative. - Fiscal consolidation in 2022 should be mainly driven by the economic recovery and automatic stabilizers, limiting discretionary adjustment to the unwinding of Covid-related emergency measures. - The 2022 budget is consistent with these recommendations; the high share of investment in government spending in 2022, facilitated by EU funds, is welcome. - Use of fiscal space should be judicious if downside risks materialize; some support measures may need flexible extension but should become increasingly targeted to vulnerable groups and viable firms. - NGEU funds: - Provide an exceptional opportunity to support recovery and promote a structural shift to a more inclusive, greener, and digital economy. - The European Commission has approved Spain’s first disbursement request; implementation of projects is expected to gain pace in 2022. - Spain’s RTRP envisions a frontloaded use of funds during 2021–2023, but expeditious and effective absorption could be challenging given decentralized implementation. - Staff’s baseline scenario assumes that the use of funds is spread over four years. - Pandemic fiscal toll and near-term projections: - Debt-to-GDP ratio increased by nearly 25 percentage points to about 120 percent of GDP in 2020. - Under the baseline scenario, deficit and debt ratios will fall in the near term as economic conditions improve, tax revenues recover, and emergency spending measures wind down. - Staff’s baseline scenario assumes no policy changes after 2022 beyond the expiration of temporary support measures. - In the absence of active consolidation, the structural deficit will stabilize above pre-crisis levels and the debt ratio will start increasing by 2024 once output growth rates slow down. - Long-term spending pressures related to population aging will pose a significant challenge to public finances. ### Recommended fiscal consolidation: timing, pace, composition - Timing: - Initiate a sustained and gradual discretionary fiscal consolidation process once the output gap is closed and the economy is on a sustained growth path. - Under the baseline scenario, these conditions would be met by 2023. - Timing may be adjusted if downside risks materialize; upside fiscal surprises should be saved. - Pace and size: - A gradual reduction of the structural primary deficit by an average of about ½ percent of GDP annually would reverse the rising trend in the debt ratio and achieve a close-to-balanced structural fiscal position within a decade. - This pace and cumulative size align with a model balancing trade-offs between economic stability and debt sustainability (Annex IV). - If growth is higher-than-expected, adjustment could be more front-loaded to restore fiscal buffers. - Composition: - Measures should include mobilizing additional revenues and enhancing spending efficiency, building on recent expenditure reviews. - Preserve space for investment in climate mitigation and adaptation. - Spain’s tax-to-GDP ratio is relatively low compared with regional peers. - Revenue measures could include strengthening VAT collection, raising environmental taxes, and reducing tax system inefficiencies. - Major tax reforms should be accompanied by targeted social transfers to protect vulnerable households. - Expenditure rationalization should emphasize efficiency improvements; Spain spends less than peers on public investment and education, and more on social protection (pensions and unemployment benefits). - The recent creation of a permanent division within the fiscal responsibility authority (Airef) to provide continuity to spending reviews is welcome. ### Medium-term credibility and pension costs - Early formulation of credible medium-term consolidation plans would support investor confidence. - Low-interest environment has kept total interest payments lower despite the significant increase in debt; interest spending will remain low in the medium term due to relatively long debt maturity. - A sudden or sustained increase in interest rates would further reduce limited fiscal space. - Findings of the ongoing expert review of Spain’s tax system (to be completed in early 2022) should inform medium-term adjustment planning. - Fiscal adjustment should be growth-friendly, preserving space for public investment and education, and accompanied by growth-enhancing structural reforms. - Pension reform fiscal impact: - Under the recently adopted pension reform, pension payments will be permanently indexed to CPI inflation and the sustainability factor was repealed in 2021. - This would raise annual pension outlays by 3½ percent of GDP by 2050, compared to full implementation of the previous legislation. - Only part of the increase is expected to be offset by other measures in the reform (incentives to increase effective retirement age and temporary increase in social security contributions). - Preserving fiscal sustainability requires additional efforts to counterbalance pension spending pressures. - Annex V discusses alternative reform options, including expenditure restraint (e.g., further extending work lives) and raising revenues (e.g., increasing the maximum earnings subject to contributions). ### Quantified potential revenue measures (as presented) - Lowering the VAT policy gap to EU average: 1.5-2.0 (Percent of GDP) - Broadening the tax base by removing distortions in the tax system: 0.3-0.5 (Percent of GDP) - Harmonizing environmental taxes with EU average: 0.7-0.9 (Percent of GDP) ### Authorities’ views on fiscal policy - Authorities reiterated commitment to fiscal discipline and supportive policies until recovery is entrenched. - Key support measures have been extended to 2022, including the short-time work scheme and the state-backed loan guarantee program. - Authorities project headline fiscal deficit would significantly decline in 2021 and decrease to about 3.2 percent by 2024 from 11 percent in 2020 (based on no discretionary measures other than the expiration of COVID-related support). - Authorities intend to bring revenue levels closer to peer countries over time as the economy recovers. - Authorities commit to comply with EU and national fiscal frameworks and seek prompt reform to the EU framework. - On pension reform: elements of the 2021 reform (such as CPI indexation) have broad consensus; further measures are expected in the second phase of the reform in 2022 as committed in Spain’s recovery plan. - The contingent mechanism in the intergenerational equity mechanism foresees complementary measures if needed beyond 2032. ### Labor market policies: challenges and recommendations - Structural weaknesses exacerbated by the pandemic: - Spain’s unemployment rate, particularly among the young population, has historically been one of the highest in the EU. - Overreliance on temporary contracts reduces incentives for training and accumulation of human capital. - Vulnerable groups (women, young, less educated, low skilled, immigrants) were disproportionately affected, many working in tourism and hospitality and more likely to have temporary contracts. - The pandemic likely had an adverse impact on income inequality, as these groups are overrepresented in the lower deciles of the income distribution. - Employment recovery in 2021 shows significant heterogeneity across sectors: - Strong employment growth in ICT, health services, public administration; subdued employment in contact-intensive sectors. - Among the remaining 125,000 ERTE participants in December 2021, more than half were concentrated in accommodation, food, travel agencies/operators and wholesale/retail trade. - Further labor reallocation is expected due to structural changes including accelerated technology adoption and automation; labor market policies should facilitate this reallocation. - Scaling back and targeting pandemic support: - ERTE scheme and benefits for the self-employed have been recently extended until February 2022. - ERTE has been modified to increase incentives for returning to work and better target sectors and companies most affected. - Support for the self-employed has become more targeted and benefits have been gradually reduced. - Over time, unemployment benefits should become the predominant safety net to encourage reallocation toward expanding sectors. - Strengthening active labor market policies (ALMPs): - Spain ranks low in ALMP spending per unemployed person compared to other OECD countries. - Existing resources have been directed mostly to job creation programs and start-up incentives. - More ALMP resources should be allocated to well-targeted training. - Strengthen the public employment service and reduce heterogeneity of service provision at the regional level. - Streamline hiring incentives to target the most vulnerable groups. - Planned ALMP-related reforms and investments in the RTRP are consistent with these recommendations. - Addressing labor market duality: - Recent reforms restrict the use of temporary contracts and promote open-ended contracts for construction and seasonal activities; effective enforcement will be needed. - These reforms do not address the fundamental driver of duality—the large difference in dismissal costs of permanent versus temporary workers. - Complement reforms with changes to the severance payments system (including possible employer-based separation fund) and address legal issues that increase costs of dissolving permanent contracts. - The new Employment Law includes proposals such as a national digital job market platform to facilitate labor matching and individualized services to the unemployed. - Effective implementation, regular ex-post evaluation, and close collaboration with the private sector will be critical for success. *Italic source attribution: IMF staff report (excerpt).* ### 26. The recently agreed labor market reforms aim to limit the use of temporary contracts, ### 26. The recently agreed labor market reforms aim to limit the use of temporary contracts, ### Labor market reforms: objectives and design - Objectives: - Limit the use of temporary contracts. - Enhance the ability of firms to adjust to shocks. - Modify collective bargaining to provide more protection to workers. - Short-time work schemes: - Existing ERTE scheme: envisaged easing of administrative procedures. - New RED scheme: a new and more generous short-time work scheme created to support firms dealing with cyclical macroeconomic fluctuations or sectoral shocks. - Workers in the RED scheme will undergo training and get support to find new jobs. - Operational details (specific conditions for use) have not yet been defined. - The new scheme will be financed by the government. - Potential risks: could put a significant burden on public finances and limit work opportunities for unemployed and first-time job seekers by encouraging hiring from the pool of RED participants. - Potential benefit: sectoral RED may help enhance mobility of employed workers; authorities expect RED to promote job stability and support reskilling of workers transitioning to new sectors. - Collective bargaining changes: - Restores the priority of sectoral agreements over firm agreements on wages. - Reinstates indefinite extensions of prior agreements in case of failure to reach a new agreement. - Firms retain flexibility to set other working conditions and can negotiate with unions an opt-out from sectoral agreements. - Concern: option to extend indefinitely expired agreements is not in line with practices in peer countries and entails a reduction in flexibility for firms. ### Findings and risks related to temporary employment and adjustment - Reforms aim to restrict temporary contracts by: - Narrowing the definition of valid causes. - Strengthening enforcement. - Widening the scope of open-ended seasonal contracts. - Authorities expect that short-time work schemes and incentives to in-company training would offset any potential reduction in firm-level flexibility stemming from a lower share of temporary workers. - Authorities do not plan changes in the gap in dismissal costs or the adoption of an employer-based separation fund. ### Minimum wage policy and alternatives - Government target: increase of the minimum wage to 60 percent of average net monthly earnings by the end of its term. - This target would leave Spain with one of the highest minimum wages as percent of median earnings in the EU. - Staff analysis: unintended adverse consequences on employment could partially offset gains for low wage earners (see 2020 Selected Issues). - Recommendation: future minimum wage increases should be aligned with labor market conditions and productivity growth. - Alternative policies suggested: - Introduction of an Earned Income Tax Credit program, which would complement the Minimum Income Scheme. ### Authorities’ views on labor policy - Authorities concurred with staff on need to address high incidence of temporary employment and youth unemployment. - Authorities expect net cost of RED scheme would be low or even negative because: - Intended use only for severe shocks. - Expected to reduce flows into unemployment. - Authorities reiterated intention to further increase the minimum statutory wage to achieve the 60 percent of average net monthly earnings target. - Authorities acknowledged importance of revamping ALMPs and reforming vocational training to reduce structural unemployment and facilitate sectoral reallocation; recovery plan foresees important reforms and investments in this area. ### Key labor-market related statistics and indicators (as reported) - Spain has the highest share of early leavers from primary and lower secondary education in the EU: 17.3 percent. - Qualification/access gaps: about 10 percent of students do not have access to internet or digital devices at home. ### Financial sector and corporate implications linked to labor measures and crisis support - Corporate sector stress and public support: - Share of companies with negative profits increased to about 40 percent (from about 30 percent in 2019). - Non-financial corporate leverage increased by about 15 percentage points, reaching 107 percent of GDP in 2020 (compared to about 140 percent in the aftermath of the GFC). - Corporate solvency support package (2021): - Envelope of about one percent of GDP (11 billion euro). - Direct aid component accounted for 60 percent of the package and was administered by regional authorities under national guidelines. - Simulation analysis suggests package should have mitigated solvency risks, particularly for the SME segment. - Moratoria and borrower support: - About 85 percent of loans under moratoria already expired in the first half of 2021. - Remaining loans under moratoria amount to less than one percent of total bank loans. - Emerging asset-quality signs: - NPLs have increased for consumer credit and in the hostelry sector, and for loans subject to expired moratoria and public guarantees. - Stage 2 loans increased in the last quarter of 2020 as banks reclassified the most vulnerable loans. ### Financial sector policy recommendations and monitoring - Provisioning and supervision: - Banks frontloaded provisioning in 2020; forward-looking provisions should not be reversed until the ultimate impact of the pandemic becomes more certain. - Supervisors should ensure loss recognition is sufficiently forward-looking and provisioning levels appropriate; address heterogeneity across banks. - Profitability and consolidation: - Further progress in cost rationalization and digitalization needed to improve profitability in a low interest rate environment and with potentially large provisioning needs. - Some additional consolidation may be warranted; Spanish banking system has become more concentrated (market share of top five banks) than EU average. - Capital buffers and prudential relief: - Monitor willingness of banks to use capital buffers; may be limited by stigma or expected pace of rebuilding buffers. - Prudential relief measures should not be withdrawn prematurely; if risk scenarios materialize, capital buffers should be allowed to be built back only gradually. - Stress tests: - Stress-testing by Bank of Spain, EBA/ECB, and IMF suggest the Spanish banking system is broadly resilient under a severe stress scenario, with heterogeneity across banks. - Dividend payouts and share buybacks should be assessed case-by-case given uncertainty and lower CET1 capitalization relative to European peers. - Insolvency and restructuring framework: - Proposed amendments aim to: - Facilitate early restructuring for distressed enterprises. - Speed up restructuring and liquidation for microenterprises. - Simplify discharge of debts for individuals and entrepreneurs. - Reduce burden on court system to increase capacity to handle insolvency cases. - Inclusion of public creditors in restructuring and a “second chance” procedure for individuals are highlighted as commendable. - Policy choice to extend moratorium until end-June 2022 allows time for system to adjust to insolvency reforms; continued extensions risk creating a cliff of insolvency filings and an increase in “zombie” companies. ### Structural reforms to raise productivity and inclusiveness - Productivity context: - Productivity levels in Spain are lower than in most peer economies; productivity growth has been below the EU average in recent years. - Pandemic has exacerbated these trends. - Policy pillars and recommendations: - Human capital: - Spain’s RTRP includes ambitious education reforms: investments in digital skills, expansion of vocational training, modernization of education system, adaptation of university courses to market needs, and stronger collaboration with firms. - Importance of timely implementation and evaluation of new programs. - Digitalization: - Spain is above EU average overall in digitalization but with significant heterogeneity across firms and regions. - Low adoption rates of e-business and cloud computing among SMEs; low broadband usage in rural areas. - RTRP emphasis on digitalization of SMEs and public administration; plan to achieve universal broadband and 5G coverage is critical. - Additional policies: promote benchmarking of firms and sharing best practices to foster technology adoption. - Innovation: - Spain ranks relatively low on R&D spending, SME innovation, and technology-intensive exports. - Despite generous R&D incentives, take-up has been limited historically. - Recommendation: conduct a review of existing incentives to assess effectiveness prior to planned expansion under the RTRP; strengthen public-private collaboration, particularly among SMEs and research institutes. *Source: IMF staff analysis and authorities’ views as presented in the source document.* ### 37. Continued efforts to address housing affordability challenges would support growth, ### Continued efforts to address housing affordability challenges would support growth, facilitate labor mobility and reduce inequality ### Housing affordability: findings - Prior to the pandemic, limited rental housing supply hampered by relatively inefficient building regulations contributed to a surge in rental prices, creating affordability problems and limiting labor mobility (especially for young people and other vulnerable groups). - The draft housing law and the national housing plan aim to address existing challenges. - The law introduces rent caps on large landlords and tax incentives for small landlords to keep rents low. - The envisaged targeted rent support programs for vulnerable groups are welcome but should be combined with effective supply measures to avoid further pressures on rent prices. - The increase of taxes on empty properties and the expansion of the social housing stock are contemplated in the proposed reform and should help increase rent supply. - The RTRP envisages €1 billion for the construction of new public social rental dwellings in 2022–23. - Additional supply policies could include simplifying land use regulations and accelerating licensing processes at the regional government level. - Authorities do not expect a negative effect from the introduction of rent caps as they would be temporary and only restricted to very specific stressed areas. - Rent caps could introduce inefficiencies and restrict the availability of properties for future tenants; further evaluation of these measures would be useful to gauge their impact. ### Key statistics and benchmarks (as presented) - RTRP envisages €1 billion for construction of new public social rental dwellings in 2022–23. - Size of the Social Rental Housing Stock (Percent of total housing stock; 2020 or latest available) — comparative charts presented (Spain among peers). - Housing Cost Overburden Rate (Percent; 2019 or latest available) — charts presented showing Spain’s indicators relative to peers. ### Climate change mitigation: findings - Spain’s Law on Climate Change and the Energy Transition, passed in 2021, establishes the goal of carbon neutrality by 2050, together with an intermediate requirement to reduce emissions by 23 percent relative to 1990 levels by 2030 (about a one third reduction compared to 2018 levels). - In contrast to most other EU countries, greenhouse gas (GHG) emissions in Spain remain above 1990 levels (despite a material reduction since the global financial crisis). - Carbon pricing coverage is extensive in Spain, but effective rates are low relative to estimates of emission damages, and tend to be lower than in peer economies. - Carbon pricing for the power sector is expected to increase further within the EU ETS framework. - Predictability and gradual increases in carbon prices are important to provide certainty to investors and avoid political backlash associated with sudden large increases. - The authorities’ 2030 strategic plans identify priorities, but implementation details are yet to be defined in certain areas, especially on the role of carbon pricing in driving decarbonization. ### Climate change: sector-specific recommendations - Cross-cutting - Gradual and predictable carbon price increases, complemented with distributive policies to protect vulnerable households. - Support for low-income households and workers affected by the green transition to ensure social acceptability and mitigate regressive effects. - Road transport sector - Strengthen vehicle acquisition taxation (current schedule described as coarse, flat within each bracket, and less ambitious compared to peer countries). - Consider "feebates" combining a tax on high-emissions vehicles with subsidies for low-emission ones. - Implement and closely monitor low emission zones; consider toll systems as complementary policy to raise revenues to mitigate distributional concerns. - Residential sector - Use fiscal measures such as feebates and differentiated property tax rates to complement carbon pricing. - Phase in tighter mandatory energy performance standards for existing buildings to accelerate renovations. - Provide favorable financing terms to reduce upfront costs of residential energy efficiency improvements. - Power sector - Spain's auction framework is assessed as adequately supporting investments in renewable energy. - Cross-sector public investment - Public investment and financial support are vital where market failures constrain private investment (e.g., transport charging infrastructure deployment, rail freight infrastructure upgrades, grid coverage and interconnection expansion). - Leverage NGEU funds: about 40 percent of announced investments have been allocated to green projects, with initial investments prioritizing clean energy, sustainable mobility and building efficiency renovations. ### Staff appraisal: macroeconomic and policy recommendations - Near-term outlook - The Spanish economy is emerging from a deep recession; growth resumed in Q2 2021 supported by vaccination; employment recovered strongly but output remains significantly below pre-pandemic levels due to slow recovery in contact-intensive sectors. - Recovery should continue in 2022 with normalization of households’ savings rate and faster deployment of NGEU funds, though Covid-19 resurgence and high inflation pose headwinds. - Fiscal policy - Fiscal policy should remain supportive until the recovery is firmly entrenched, while becoming more targeted and focused on supporting the most vulnerable. - With economic slack persisting and activity projected to return to pre-crisis levels only in late 2022, fiscal policy should remain broadly supportive, in line with authorities’ FY2022 budgetary plans. - Any positive surprises to the fiscal balance from faster-than-expected recovery should be saved; the policy response should remain agile and targeted. - Over time, Spain should gradually bring public debt down via a sustained gradual fiscal consolidation once the output gap is closed and growth is sustained; credible medium-term plans for growth-friendly consolidation are recommended. - Additional measures will need to be identified to offset the increase in future pension spending resulting from the 2021 reform. - Financial sector - Banks should maintain sizable safety buffers, be forward-looking in loan quality assessment, and maintain adequate provisions. - Enhance private resolution frameworks to address debt overhangs and facilitate resource reallocation. - Increased activity in the residential real estate market does not point to elevated risks at this stage, but close vigilance is warranted. - NGEU funds and structural reform - Use NGEU funds to support strategic investment and structural reforms; select projects with high social return, ensure efficient coordination among government levels, close public-private collaboration, and focus on transparency and accountability. - Establish a framework for regular data-based evaluation of reform effectiveness. - Labor market - Recent labor market reforms broadly move in the right direction; restricting temporary contracts may reduce duality if effectively enforced. - Make open-ended contracts more attractive by reducing costs and legal uncertainty associated with dismissal and consider employer-based separation funds. - Reinstatement of “ultra-activity” is viewed as a step backwards. - Explore alternative financing mechanisms for short-time work schemes to share risk among parties; regular ex-post evaluation and private sector collaboration needed for effective implementation. *Source: IMF staff report excerpt (provided content).* ### 52. It is recommended that Spain remain on the standard 12-month Article IV cycle. ### It is recommended that Spain remain on the standard 12-month Article IV cycle. ### Overview - Recommendation: Spain remain on the standard 12-month Article IV cycle. - Context: Spain experienced the largest contraction in the region in 2020 and a significant rebound is expected. ### Real Sector and Inflation - Real GDP growth: historical series shown; notable entry: "Real GDP Growth (Annualized qoq percent change)" with Spain inside EA 25th-75th percentile and euro area comparisons. - Industrial production and retail trade: indices (SWDA, Index: 2015=100) show recovery toward and above 2015=100 levels. - PMIs: "PMI (SA, 50+=Expansion)" — PMIs have remained in expansionary territory since April 2021. - Business and consumer confidence: "back to pre-crisis levels." - Services and tourism: - Service activities recovering; tourism sector still lagging. - Tourist Overnight Stays and Service Sector Turnover show weaker year-on-year percent change through late 2021. - Inflation: - Headline inflation: "has reached the highest level in the last three decades." - Core inflation: "remains contained." - Table 1 headline inflation (average): 3.1 for 2021; 3.5 for 2022; 1.2 for 2023; 1.6 for 2024; 1.7 for 2025; 1.7 for 2026; 1.7 for 2027. - Table 1 core inflation (average): 0.8 for 2021; 1.8 for 2022; 1.5 for 2023; 1.6 for 2024; 1.7 for 2025; 1.7 for 2026; 1.7 for 2027. ### Covid-19 High-Frequency Indicators and Mobility - Containment measures: eased after end of state of emergency in May; omicron wave had lower hospitalizations and deaths given wide vaccination coverage. - Mobility: - Mobility recovered significantly in 2021 but declined recently amid infections. - Mobility indicators (Transit Stations, Workplaces) show percent deviation from baseline with medians and percentiles plotted. - Electricity consumption and air pollution: "have come back to 2019 levels." ### Labor Market - Employment growth: "picked up, driven by services and construction." - Contributions to Employment Growth (Percent, yoy) show services as primary positive contributor in 2021Q3. - Unemployment: "progressively going down for all age groups." - Unemployment rate levels in Table 1: 15.0 for 2021; 14.0 for 2022; 13.5 for 2023; 13.3 for 2024; 13.1 for 2025; 13.0 for 2026; 13.0 for 2027. - Labor market tightness: vacancy-posting picks up; "Market Tightness (Ratio of Vacancies over Unemployment, Seasonally Adjusted)" increased in 2021. - Wages and hours: - Wage inflation remains modest; "Growth of Wages & Salaries (Percent, yoy; national accounts definition)" shows moderate recovery. - Hours worked still lagging; "Hours Worked (Index: 2019=100, Seasonally Adjusted)" below 2019 levels. - Pandemic support: considerable number of workers still receiving pandemic-related support (ERTE and self-employed benefits), expressed as percent of labor force. ### External Sector - Current account and tourism: - Deterioration of current account in 2020 persisted into 2021. - Trade balance, primary and secondary income components shown; Current account (Percent of GDP) in Table 4: 0.4 for 2021; 1.3 for 2022; 1.6 for 2023; 1.7 for 2024; 1.7 for 2025; 1.7 for 2026; 1.7 for 2027. - Tourist spending and arrivals: partial recovery since summer 2021 but "foreign tourism remains weak." - Imports: imports picked up with recovery of domestic demand and rise of energy prices. - Table 1 imports of goods and services growth: 12.0 for 2021; 5.9 for 2022; 3.6 for 2023; 3.4 for 2024; 3.5 for 2025; 3.4 for 2026; 3.4 for 2027. - Capital and financial flows: - Net outflows in portfolio and other investment (excl. Bank of Spain) rose in 2020 but reverted in 2021. - Net international investment position: deteriorated in 2020, gradually recovered in 2021. - Real effective exchange rate: "ULC-based REER continued to depreciate in 2020 and 2021." ### Credit, Corporate Sector, and Real Estate - Credit and financial cycle: - Household balance sheets "relatively stable." - Corporate leverage increased but remains below GFC levels. - Bank lending to private sector expanded for first time in about a decade in 2021. - Change in lending standards and demand: initially tilted toward corporates, later toward households. - Corporate sector (Table and Figure highlights): - Corporate turnover: improved in first three quarters of 2021. - Return on assets: recovered from low 2020 levels. - Debt-to-asset ratio: increased but low vs GFC. - Debt financing cost: continued to decline. - Share of firms with negative profits: started to decline in 2021. - Real estate: - Residential price growth accelerated recently; residential transactions uptick. - Starting point "not one with significant misalignments in residential prices." - Supply expected to catch up with demand. - Commercial real estate: impacted more severely in 2020; pre-pandemic CRE prices broadly in line with fundamentals. ### Banking System and Financial Soundness - Nonperforming loans (NPLs): aggregate NPLs remained subdued; loans benefitting from public support appear riskier. - Table 3 NPL ratios (consolidated): Nonperforming loans to total loans 3.0 for 2021; specific provisions to NPLs 64.6 for 2021. - Domestic operations NPL to total loans: 4.3 for 2021. - Provisioning: Spanish banks increased provisioning during 2020. - Stage 2 classifications: increased, more moderately than peers. - Profitability: recovered from 2020 lows but remains below pre-pandemic levels. - Return on assets (consolidated): -0.2 for 2020; 1.0 for 2021 (annual); 0.7 for 2021Q2. - Return on equity (consolidated): -3.2 for 2020; 14.8 for 2021 (annual); 10.9 for 2021Q2. - Capitalization: - CET1 ratio: 17.0 for 2020; 17.0 for 2021; 17.2 for 2021Q2 (regulatory capital to risk-weighted assets). - Leverage ratios in line with peers on a leverage basis but below peers on risk-weighted basis. - Liquidity: bank liquidity ratios remain strong (LCR and loan-to-deposit metrics). ### Public Finances, Debt, and Scenarios - Fiscal toll of pandemic: - General government balance (Percent of GDP) in Table 1: -11.0 for 2020; -7.8 for 2021; -5.3 for 2022; -4.3 for 2023; -4.0 for 2024 onward. - Primary balance: -8.9 for 2020; -5.8 for 2021; -3.5 for 2022; -2.5 for 2023; -2.3 for 2024 onward. - General government debt (Percent of GDP): 120.0 for 2020; 120.4 for 2021; 117.0 for 2022; 115.8 for 2023; 115.4 for 2024; 115.5 for 2025; 115.6 for 2026; 115.9 for 2027. - Debt dynamics and risks: - Debt to GDP increased by about 25 percentage points (pandemic impact noted). - Spain among highest gross financing needs in euro area: "Gross Financing Needs, 2021 (Percent of GDP)" chart lists Spain high among peers. - Debt scenarios (Figure): - Public debt: baseline and shock scenarios plotted for 2019–2026 with scenarios for "Real growth shock", "Real interest rate shock", "Contingent liability shock." - Revenue and tax structure: - Importance of improving revenue performance when rebuilding fiscal buffers. - Need to bring environmental taxation more in line with peer economies. - VAT revenue ratio (2018): Spain at level shown in chart relative to peers (exact values presented in figure). ### Projections (Table 1 and Tables 2a/2b) - GDP and demand projections (Table 1): - Real GDP growth: -10.8 for 2020; 4.9 for 2021; 5.8 for 2022; 3.8 for 2023; 2.3 for 2024; 1.9 for 2025; 1.7 for 2026; 1.6 for 2027. - Private consumption: -12.0 for 2020; 5.1 for 2021; 4.7 for 2022; 3.3 for 2023; 2.4 for 2024; 3.0 for 2025; 2.6 for 2026; 2.2 for 2027. - Gross fixed investment: -9.5 for 2020; 3.3 for 2021; 7.0 for 2022; 7.1 for 2023; 3.3 for 2024; 0.5 for 2025; 0.6 for 2026; 1.3 for 2027. - Exports of goods and services: -20.2 for 2020; 12.4 for 2021; 9.9 for 2022; 4.6 for 2023; 3.7 for 2024; 3.3 for 2025; 3.2 for 2026; 3.3 for 2027. - Public finance projections (Table 2a/2b): - Revenue (billions of euro): 465.4 for 2020; 511.5 for 2021; 542.4 for 2022; 560.9 for 2023; 575.1 for 2024; 575.4 for 2025; 594.8 for 2026; 614.6 for 2027. - Expenditure (billions of euro): 588.3 for 2020; 605.2 for 2021; 610.9 for 2022; 619.1 for 2023; 631.5 for 2024; 634.0 for 2025; 655.4 for 2026; 677.2 for 2027. - Net lending/borrowing (percent of GDP): -11.0 for 2020; -7.8 for 2021; -5.3 for 2022; -4.3 for 2023; -4.0 for 2024 onward. - Projections assume expiration of temporary COVID-19 measures and no further policy change; incorporate EU Recovery and Resilience Facility allocations amounting to about 0.8 percent, 1.9 percent, 1.6 percent, and 1.3 percent of GDP from 2021 to 2024. ### Social Indicators and Demographics - Income inequality: "high relative to peers" (Gini index ranking chart; Spain near top of EA-19 group). - At-risk-of-poverty: elevated share among young, low-skilled, and temporary contract workers. - Youth disengagement and early school leaving: - Spain "third country in the euro area with the highest share of young people who neither work nor study." - Highest share of early leavers from education and training among peers. - Gender gaps: sizeable gaps remain in economic and political empowerment despite progress. - Demographics: over next 30 years, Spanish population projected to age quicker than rest of euro area; projected change in old-age dependency ratio 2021-2050 shown (percentage points). ### Key Risks and Considerations - Near-term risks: - Pandemic developments impacting tourism and mobility. - Energy price increases and import dynamics affecting current account and inflation. - Financial sector risks: - Loans benefiting from public support appear riskier; stage 2 ratios increased. - Bank capitalization lower on a risk-weighted basis; continued monitoring advised. - Fiscal risks: - High gross financing needs and elevated general government debt leave Spain vulnerable to shocks. - Scenario analysis highlights sensitivity to growth, interest rate, and contingent liability shocks. ### Policy Implications and Recommendations (as reflected in the content) - Maintain regular Article IV engagement: "remain on the standard 12-month Article IV cycle." - Fiscal strategy: - Rebuild fiscal buffers as pandemic measures expire. - Improve revenue performance when time comes to rebuild buffers. - Align environmental taxation more with peer economies. - Financial stability: - Monitor bank asset quality, especially supported loans and stage 2 increases. - Maintain strong liquidity positions and address capitalization on a risk-weighted basis as appropriate. - Labor and social policies: - Address high in-work risk-of-poverty, youth disengagement, early school leaving, and sizeable gender gaps to support inclusive recovery. - Structural policies: - Support measures that sustain recovery in services and tourism while addressing supply constraints in housing to prevent misalignments. *International Monetary Fund — Spain: selected figures, analyses, projections, and policy considerations drawn from the IMF staff report and supporting tables and figures.* ### Annex I. External Sector Assessment ### Annex I. External Sector Assessment ### Overall assessment and potential policy responses - Overall Assessment: The external position in 2021 is broadly in line with the level implied by medium-term fundamentals and desirable policies. Further strengthening the NIIP will require sustaining a relatively high CA surplus over the coming years. This assessment is preliminary given the absence of full-year data for 2021 and uncertainty surrounding the economy’s recovery; a complete analysis will be provided in the 2022 External Sector Report. - Potential Policy Responses: - Foster competitiveness to facilitate recovery of the export sector (including tourism), while carefully managing the public debt load. - Boost competitiveness through productivity gains via continued wage flexibility, implementation of reforms to address labor market duality, actions to enhance education outcomes, and measures to encourage innovation. - Implement recovery-plan investments and reforms, and specific measures to diversify and improve the quality of tourism services. ### Foreign asset and liability position and trajectory - Background: - NIIP declined in 2020 to −86 percent of GDP, mainly due to the contraction in GDP. - In 2021, the NIIP recovered and is expected to reach −78.7 percent by end-2021, supported by a net increase in financial assets and positive valuation effects. - Gross liabilities—of which 70 percent correspond to external debt—are projected to decline by about 8 percentage points of GDP, reaching 283.1 percent of GDP in end-2021. - With continued deleveraging of the private sector, the NIIP accounted for by the general government and the central bank increased to a share of 96 percent in 2021:Q3 (including TARGET2 liabilities, which amounted 41 percent of GDP in September 2021). - Assessment: - Despite its projected decline, the still large negative NIIP comes with external vulnerabilities, including large gross financing needs and potentially adverse valuation effects. - Mitigating factors: favorable maturity structure of outstanding sovereign debt (averaging almost eight years), limited share of debt denominated in foreign currency, and current ECB measures keeping cost of debt low. - 2021 (% GDP) key statistics: - NIIP: −78.7 - Gross Assets: 204.3 - Debt Assets: 92.2 - Gross Liab.: 283.1 - Debt Liab.: 166.0 ### Current account - Background: - COVID-19 led to a stronger decline in exports than imports due to the sharp contraction in travel services receipts. - CA surplus declined from 2.1 percent of GDP in 2019 to 0.8 percent of GDP in 2020. - In 2021 the CA surplus is projected to further deteriorate as foreign tourism remains weak and imports pick up with domestic demand recovery; thereafter CA is projected to gradually recover as foreign tourism resumes and global supply bottlenecks resolve, offsetting import increases driven by stronger domestic demand including NGEU-funded investments. - Assessment and adjustments: - 2021 cyclically adjusted CA balance: −1.0 percent of GDP, yielding an EBA CA gap of −1.3 percent of GDP. - Pandemic-related transitory shocks not captured by the EBA model amount to: 1.9 percent (tourism), 0.3 percent (medical goods), and 0.0 percent (global shift of household consumption from services to consumer goods). - Adjusting for these effects, the 2021 cyclically adjusted CA balance is 1.2 percent of GDP. - EBA CA model norm for 2021: 0.3 percent of GDP (standard error of 0.8 percent of GDP noted in footnote). - IMF staff-assessed appropriate CA norm given external risks from a large negative NIIP: 1.7 percent of GDP, with a range of 0.7 to 2.7 percent of GDP. - This yields a CA gap of −1.5 to 0.5 percent of GDP (staff gap reported as −0.5). - With a sustained CA surplus of about 1.7 percent of GDP, the NIIP is projected to reach −50 percent of GDP over the medium-to-long term under current policies, assuming zero valuation effects and acknowledging high uncertainty. - 2021 (% GDP) reported figures: - CA: 0.4 - Cycl. Adj. CA: −1.0 - EBA Norm: 0.3 - EBA Gap: −1.3 - COVID-19 Adj.: 2.2 - Other Adj.: −1.4 - Staff Gap: −0.5 ### Real exchange rate (REER) - Background: - 2020: CPI-based REER appreciated by 0.5 percent; ULC-based REER depreciated by 4.1 percent relative to 2019. - CPI-based REER is only moderately lower than its 2008 peak, partially reversing the significant appreciation from euro entry in 1999–2009. - ULC-based REER shows a depreciation of 21 percent in 2008–20, largely reversing the 1999–2008 appreciation. - 2021: CPI-based REER appreciated by 0.8 percent and ULC-based REER depreciated by 1.3 percent relative to 2020. - Assessment: - EBA REER models estimate an overvaluation of 5.8 (level) to 8.3 (index) percent for 2021. - Based on IMF staff CA gap and an elasticity of 0.29, IMF staff assesses the REER gap to be in the range of −1.8 to 5.2 percent, with a midpoint of 1.7 percent. ### Capital and financial accounts: flows and policy measures - Background: - 2020: net inflows by the Bank of Spain partially offset net outflows by other resident sectors. - Bank of Spain’s negative financial account balance was driven by increased liquidity creation by the Eurosystem via expansion of asset purchase programs, leading to accumulation of TARGET2 liabilities. - Other resident sectors had a positive balance due to purchase of investment fund shares/units, net increase in deposits abroad and loans to non-residents, and a decrease in net purchases of Spanish long-term government bonds by international investors. - Up to September 2021, financial account balance remained positive, but composition changed: net outflows by the Bank of Spain partially offset net inflows by other resident sectors, particularly FDI and portfolio investment. - Assessment: - Large external financing needs leave Spain vulnerable to sustained market volatility, though ECB policies maintaining favorable liquidity conditions and monetary accommodation mitigate risks. ### FX intervention and reserves level - Background and assessment: - The euro has the status of a global reserve currency. - Reserves held by the euro area are typically low relative to standard metrics, but the currency is free floating. ### Risk Assessment Matrix — selected risks, likelihoods, impacts, and policy responses - Global risks: - Global resurgence of the Covid-19 pandemic - Relative likelihood: Medium - Impact if realized: High — containment measures could negatively affect activity; external demand and contact-intensive services could remain low. - Policy response: - Maintain targeted public health measures. - Stand ready to extend pandemic-related support measures. - Disorderly transformations (impeded resource reallocation) - Relative likelihood: Medium - Impact if realized: High/Medium — higher unemployment, misallocation, lower growth. - Policy response: - Realign support to incentivize resource reallocation while supporting affected workers. - Accelerate structural reforms including labor market and insolvency framework. - Rising commodity prices amid volatility - Relative likelihood: Medium - Impact if realized: Medium — higher oil prices raise CPI inflation, weigh on consumer spending and growth. - Policy response: - Use windfall revenues to reduce public debt. - Allow automatic stabilizers to operate and formulate credible medium-term fiscal consolidation. - Intensified geopolitical tensions and security risks - Relative likelihood: High - Impact if realized: Medium — potential disorderly migration, higher commodity prices, lower confidence. - Policy response: - Accelerate structural reforms and enhance labor market integration. - Let automatic stabilizers operate and formulate credible medium-term fiscal path. - Domestic risks: - Unexpected pace of run-down of excess savings - Relative likelihood: Medium - Impact if realized: High — pace of normalization critical to near-term growth. - Policy response: - Allow automatic stabilizers to operate. - If rapid unwinding, withdraw fiscal support faster to prevent overheating and rebuild fiscal space; monitor real estate and consider macroprudential tightening. - Implementation of EU-funded projects - Relative likelihood: Medium - Impact if realized: High — investment under EU-funded projects is an important driver of near-term recovery. - Policy response: - Ensure efficient coordination, implementation, and oversight of the Recovery, Transformation and Resilience Plan. - Higher and persistent inflation - Relative likelihood: Medium - Impact if realized: Medium — could slow recovery and raise sovereign yields if euro-area inflation persists. - Policy response: - Wage-setting negotiations should internalize transitory nature of current drivers of inflation. - If persistently high domestic inflation leads to higher wages, recalibrate policy stance. - Formulate credible medium-term fiscal consolidation to support investor confidence. - Prolonged political uncertainty related to Catalonia - Relative likelihood: Medium - Impact if realized: Medium — could weaken business confidence and investment. - Policy response: - Accelerate structural reforms and enhance labor market performance. - Formulate credible medium-term fiscal consolidation to support investor confidence. - Weak implementation or reversal of fiscal commitments and structural reforms - Relative likelihood: Medium - Impact if realized: High — could weaken confidence, investment, employment, and public debt dynamics. - Policy response: - Accelerate structural reforms and improve labor market performance. - Return to gradual, steady, and growth-friendly fiscal consolidation. - Reform the regional financing framework to reduce fiscal risks. *Source: Annex I. External Sector Assessment (Spain), IMF staff.* ### 0.28 percent, suggesting a moderate downward bias in the staff projections. In contrast, the median ### 1espea2022001 - 0.28 percent, suggesting a moderate downward bias in the staff projections. In contrast, the median ### Stress-test scenarios and quantitative outcomes - Growth shock (real GDP growth shock): - Assumes growth lower than baseline by one (computed from 2010 to 2019) standard deviation for two consecutive years in 2022–23. - Implies real GDP would grow by an average of 2.6 percent per year in 2022–23 versus annual average growth of 4.8 percent under the baseline. - Inflation lower by an average of 0.5 percentage points per year in the shock years. - Primary balance weaker by about 1.8 percent of GDP per year (on average) in the shock years. - Debt-to-GDP would rise to about 125 percent of GDP in the medium term (almost 10 percentage points higher than the baseline). - Gross financing needs would stay above the 20 percent benchmark level through the forecast horizon. - If no fiscal tightening (primary expenditure remains at same nominal level as baseline), public debt would reach about 132 percent of GDP by the end of the forecast horizon. - Primary balance shock: - Assumes relaxation of fiscal policy in 2022–23 with an average deterioration of the primary balance of 1.6 percent of GDP per year. - Public debt-to-GDP ratio would reach about 119 percent of GDP by 2026 (about 3.5 percentage points higher than in the baseline). - Gross financing requirements larger than in the baseline. - Interest rate shock: - Assumes interest rates increase by 416 basis points from 2022 onwards. - Effective interest rate would increase to 3.6 percent by 2026 compared to 1.7 percent in the baseline. - Debt-to-GDP ratio would rise to about 121 percent in 2026. - A sizeable and sustained increase in interest rates would reduce the (already limited) fiscal space. - Combined shock (growth + primary balance + interest rate): - Public debt-to-GDP ratio would increase to about 138 percent in 2026 (about 22 percentage points higher than under the baseline). - Gross financing needs would be significantly higher, above 25 percent most years over the forecast horizon. - Contingent liability shock (negative financial sector shock): - Assumes 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 estimated over 2010–2019). - Primary deficit would rise to about 15 percent of GDP in 2022. - Gross financing needs would be brought close to 35 percent of GDP. - Debt-to-GDP ratio would rise sharply to 135 percent by 2023 and stay around that level in the medium term (around 19 percentage points higher than the baseline). ### Key statistics on forecast accuracy and realism of baseline assumptions - Real GDP growth forecast error (Spain median, 2012–2020): 0.28 (in percent, actual-projection). - Spain has a percentile rank of 85% in the distribution of forecast errors (versus all countries). - Primary balance forecast error (Spain median, 2012–2020): -0.95 (in percent of GDP, actual-projection). - Spain has a percentile rank of 33%. - Inflation (GDP deflator) forecast error (Spain median, 2012–2020): -0.42 (in percent, actual-projection). - Spain has a percentile rank of 54%. - Realism of projected fiscal adjustment: - Comparison with high-debt country experience indicates projected levels of the cyclically adjusted primary balance (CAPB) in Spain are below thresholds that would question feasibility. - Spain 3-year average CAPB percentile rank: 86% (3-year average CAPB level, percent of GDP). - Spain 3-year CAPB adjustment percentile rank: 37% (3-year adjustment in CAPB, percent of GDP). ### Vulnerabilities and risk assessment - Baseline and stress scenarios breach the debt burden benchmark of 85 percent of GDP. - Gross financing needs remain close to 20 percent of GDP over the forecast horizon in baseline and are higher under most shocks. - Debt profile risks: - High level of external financing needs is a key vulnerability. - Share of public debt held by non-residents is an additional, though lesser, risk. - Heat-map and risk thresholds: - Benchmark of 85 percent of GDP breached under baseline and each shock scenario. - External financing requirement, bond spreads, and public debt held by non-residents are key indicators underpinning the risk assessment. ### Policy implications and recommendations - Fiscal consolidation will need to play a role in the medium term to create space for responding to fiscal shocks. - Fiscal adjustment should be growth-friendly: - Preserve space for public investment and education spending. - Accompany consolidation with growth-enhancing structural reforms. - Early formulation of specific plans to rebuild fiscal buffers would reinforce investor confidence and reduce the risk of sharp increases in financing costs. - Recognize that debt maturities imply higher interest rates would have a backloaded impact; sustained rate increases would further reduce limited fiscal space. ### Withdrawing fiscal stimulus: timing and pace - Staff’s model-based analysis (Fournier, 2019 calibration) suggests: - Fiscal stance should remain broadly supportive in the near term. - Deficit reduction in 2022 should be mainly driven by the economic recovery and automatic stabilizers. - A multi-year consolidation should start once the output gap has closed (in 2023 under the baseline forecast). - Model calibration and assumptions: - Long-run r-g calibrated to about the 1990–2020 average. - Potential growth rate from the WEO baseline. - Shock persistence and a probabilistic debt limit at which market access is lost with 50-percent probability inform the debt limit. - Fiscal multiplier set above the short-run multiplier used in the baseline WEO projections. - Baseline keeps Fournier’s calibration for interest-rate sensitivity to debt levels and the degree of hysteresis. *Source: IMF staff.* ### 3. The baseline specification suggests that fiscal policy should remain supportive ### 3. The baseline specification suggests that fiscal policy should remain supportive through 2022, with a sustained steady consolidation starting in 2023 ### Baseline fiscal path and model prescription - Fiscal policy: supportive through 2022; sustained steady consolidation starting in 2023. - Pace of consolidation: should average about 0.5 percentage points per year until the end of the decade. - Model prescription: a front-loaded consolidation path, instead of the constant pace of adjustment recommended by staff. - Consistency: results are consistent with previous staff advice (IMF Country Report No. 20/298). ### Robustness and alternative calibrations (model results) - Alternative calibrations considered: lower r-g; different multipliers; a higher potential growth; no hysteresis; larger hysteresis; higher sensitivity of interest rates to debt levels; lower probabilistic debt limit; lower shock persistence (temporary or permanent). - Near-term (2022) prescription: - Consolidation should begin in case of no hysteresis. - A more stimulative stance would be appropriate in case of a permanently lower r-g, higher hysteresis, or a low fiscal multiplier. - From 2023 onward: - All specifications suggest a sustained and front-loaded consolidation. - Prescribed cumulative consolidation in the next 15 years: about 4 percent of potential GDP in most specifications. - Exceptions: the cases of no hysteresis (calls for a higher total consolidation) and of a lower r-g (calls for a lower total consolidation). - Model parameters table (selected values from baseline and alternatives as presented): - Long run r-g: 10.5 - Fiscal multiplier (m1): 0.95 0.8 - Potential growth (g*): 1.55 1.75 - Hysteresis: 0.10 0.2 - Hysteresis threshold: -0.1 -0.15 -0.2 - Rate sensitivity (alpha): 1.5 2 - Debt Prob. Limit: 150 140 - Shock persistence (rho): 0.7 4.7 4; lower in SR - Change in Primary Structural Balance (figures and labels shown in source): - 2022: Change in Primary Structural Balance: 2022 (in percent of potential output) - 2023 onwards: Change in Primary Structural Balance: 2023 onwards (in percent of potential output) - Conclusion: changes in model parameters affect the desirable pace of adjustment, but less so the cumulative size of the adjustment. ### Policy flexibility, uncertainty, and scenarios - Uncertainty: extent to which the economy is operating below potential and how fast the gap will close. - WEO baseline output gap projection: activity expected to remain 1.6 percent below potential in 2022. - Authorities’ projection: authorities anticipate a broadly closed gap in 2022 (-0.3 percent). - Scenario implications: - Faster-than-projected growth calls for a more frontloaded pace of consolidation relative to the baseline model prescription. - Structural reforms that spur growth potential would allow rebuilding fiscal buffers faster. - Scenario construction note: The faster (slower) pace scenario is computed by changing the WEO baseline output gap projection by 3/4 pp over the forecast horizon. ### Annex V — Aging pressures and pension reform: headline findings - Demographics: - Spain will undergo a dramatic demographic transformation; old-age dependency ratio is expected to nearly double by 2050 (from about 30 percent at present). - The old-age dependency ratio is projected to recede moderately after 2050, while remaining significantly above current levels. - Past pension reforms: - 2011 reform: increased statutory retirement age from 65 to 67 by 2027; extended contributory period for calculating the pension regulatory base (from the last 15 years to the last 25). - 2013 reform: introduced an index (IRP) linking pension increases to the structural balance of the social security system and a sustainability factor adjusting initial pension benefits according to life expectancy changes. - Reversals and fiscal impact: - IRP implementation suspended; pensions indexed to CPI since 2018. - Sustainability factor postponed to 2023, then permanently eliminated starting in 2021. - Policy reversals expected to increase the pension spending-to-GDP ratio by 3.2 to 3.5 percentage points by 2050 (on top of nearly 1 percentage point increase due to aging projected under the 2011–13 reforms). ### Phase one reform measures and quantified effects - Measures introduced to narrow the gap between effective retirement age and legal retirement age: - Currently about 40 percent of pensioners retire before age 65; less than 25 percent delay retirement beyond age 65. - Airef estimate: increasing the effective age of retirement to the statutory age could result in about a 1½ percentage point reduction in expenditures as a share of GDP by 2050 (likely an upper bound). - Intergenerational equity mechanism (phase one): - Temporary increase for a decade in social security contributions of about 0.6 percentage points to be accumulated in a reserve fund. - A maximum of 0.2 percent of GDP per year could be withdrawn from the fund to cover pension expenses, starting in 2032 and for as long as the reserves last (estimated under 15 years). - A contingent mechanism requiring further measures to be implemented if needed, starting in about a decade; measures not specified and would need negotiation with social partners. - Annex V. Table 1 (selected figures and effects on public pension spending to GDP ratio by 2050): - Full Implementation of 2011&13 reforms: 10.7 - Elimination of sustainability factor: 0.9 0.8 - CPI indexation instead of IRP: 2.3 2.7 - Increase in effective retirement age to 67*: -1.6 - Policy linking retirement age to life expectancy: -1.1 - Extending period for computing base from 25 to 35 years: -0.6 - Note: The intergenerational equity mechanism is not reflected in this table, as accumulated reserves are likely to be exhausted by 2050, and specific measures under the contingent mechanism are yet to be determined. - Note: * Compared to 62.1 in 2019, and 64.1 projected from 2027 onwards under the central scenario. ### Funding constraints and limits on revenue measures - Options and constraints: - Raising social security statutory rates or eliminating ceilings on contributions could in principle fund increases, but constrained by already relatively high contribution rates and potential negative effects on employment and productivity. - The complete elimination of the ceiling on contributions could yield additional resources between 0.4 and 0.8 percent of GDP (Hernandez de Cos, 2021). - Increasing general taxes is an alternative, but room may be limited: Spain’s tax-to-GDP ratio is currently relatively low compared with regional peers, yet the tax burden would likely have to rise to reduce Spain’s sizable structural deficit. - Additional age-related non-pension spending: Ageing Report 2021 estimates that age-related non-pension spending will increase by 1.5 percent of GDP by 2050. - Sustainability risk: Pension contributions would need to increase by about one third by 2050 to match the projected increase in public pension spending (Ageing Report 2021). - Historical risk example: Pensions can be cut by 20 to 30 percent in a short period if debt sustainability concerns intensify (examples: Greece and Portugal). ### Expenditure restraint, system design, and protection of vulnerable groups - Need for an expenditure restraint mechanism: gradual, transparent, and predictable implementation of restraint measures to give workers time to adapt. - System generosity: - Benefit ratio in Spain is one of the highest among European countries due mainly to a relatively high replacement rate. - Under the repealed 2013 reform, replacement rates would have gradually declined due to indexation below CPI and the sustainability factor. - Extending the contributory years from 25 to 35 is estimated by Airef (2020) to reduce pension spending-to-GDP ratio by 0.6 percentage points. - Notional account systems and sustainability factors are used in multiple European countries to adjust benefits to life expectancy and/or system sustainability. - Retirement duration and statutory age: - Statutory retirement will gradually increase to 67 years by 2027, but individuals with at least 38.5 years of contributions will still be able to retire at age 65 with a full pension. - From 2030 to 2050, life expectancy is projected to increase by about two years (Airef 2020, Ageing Report 2021). - Protecting vulnerable groups: - Expenditure restraint measures should seek to protect the most vulnerable (long unemployment spells, low replacement rates for the self-employed). - Minimum pensions should be sufficient to cover basic needs. - Ensuring fiscal sustainability should not rely solely on increases in the statutory retirement age because increases may disproportionately affect vulnerable groups with lower-than-average life expectancy. ### Complementary policies to support sustainability - Policies to promote higher employment and productivity would support pension sustainability. - Incentives for longer working lives: promote flexible working hours, part-time arrangements (while drawing partially on pension), and telework. - Access to lifetime learning opportunities to mitigate human capital depreciation over longer careers. - Promote private saving as a supplement to the public pension system: participation in private voluntary pension schemes is low in Spain compared to the OECD average. *Source: IMF staff calculations and Annexes V–VI of the provided content.* ### 8.2 percent, and the increase in the total share of employment in those firms is even more ### 1espea2022001 - 8.2 percent, and the increase in the total share of employment in those firms is even more ### Corporate solvency support measures rolled out in 2021 - Measures included: - A €7 billon fund providing direct aid to severely affected companies. - A recapitalization fund of €1 billon for pandemic-affected companies, with a focus on medium-sized enterprises. - A €3 billon fund for bank restructuring of loans with a public guarantee. - A range of other tools. - The overall envelope of the programs is about one percentage point of GDP, broadly in line with staff’s estimates of the increase in the equity gap. - Effectiveness depends on how well support is targeted to viable firms. ### Simulation design and eligibility scenarios for the direct aid package - Initial design (official criteria): - Eligibility: firms that experienced more than 30 percent turnover loss in 2020 in certain sectors. - Compensation: 20 to 40 percent of the lost income for each eligible firm, depending on firm size. - Maximum limits: €3,000 for sole proprietors and €20,000 for others. - Regional authorities had flexibility to modify some criteria. - Alternative design (simulated): - Eligibility: firms with a turnover loss of more than 15 percent in 2020. - Compensation: 40 percent to 90 percent of lost income depending on firm size. - Assumes broader eligibility and higher compensation rates. ### Simulation results and impacts on solvency - Overall effects: - The direct aid package helped reduce debt overhang and the share of firms with negative equity falls significantly. - Based on the initial design, about 30 percent of the total SME equity gap is estimated to be closed after disbursement of funds. - With strict application of the eligibility requirements, only 50 percent of the available funds would have been allocated. - The assumed alternative design offsets more than half of the increase in the SME equity gap while exhausting all available funds, but may increase deadweight losses without significantly improving corporate solvency. - Distributional and database caveats: - The Orbis BvD database does not include the self-employed, who would take up about 20 percent of the direct aid fund according to the government’s simulation. - The simulation assumes percent turnover loss for each firm equals sectoral level turnover loss; actual firm-level turnover data available to authorities could allow more efficient distribution. - Role of other supports in scenarios: - Both end-2020 and end-2021 scenarios include support in the form of ERTEs and publicly guaranteed loans. - All scenarios assume wage subsidies under ERTE are in place. ### Jobs at risk and sectoral observations - The simulation indicates a significant fall in the share of firms with negative equity, which would alleviate potential pressures on the commercial court system. - Large companies, though not the main target of the direct aid facility, account for about 30 percent of the worsening in the equity gap. - Use of solvency support for large firms has been limited so far, possibly because they can raise private equity as an alternative to public support. ### Targeting and policy recommendations - If further support to the NFC sector is needed, use indicators of firms’ financial health (for example, the leverage ratio) to better target funds. - Authorities should leverage the expertise of financial institutions to select viable firms. - Consider targeting rules that exclude firms not expected to end up with negative equity to reduce deadweight losses. *Source: IMF staff calculations using Orbis BvD database and government simulations as presented in the supplied content.* ### Annex VII. 2021 Labor Market Reform ### Annex VII. 2021 Labor Market Reform ### Overview - A new labor reform was agreed in December 2021 following a difficult negotiation between the government, unions, and firms. - The reform aims to address duality and to adjust firms’ internal flexibility mechanisms and the collective bargaining process, while striking a balance between flexibility and worker protection. - It reverses some of the elements of the 2012 reform. - A royal decree law established the main elements of the reform, but some operational details have not been defined yet. ### Past reforms and remaining challenges - The 2012 labor reform included measures to enhance labor market efficiency such as: - reducing the gap in firing costs between permanent and temporary workers, - giving priority to firm-level over regional- or sector-level agreements, - limiting the automatic extension of expired collective agreements to a maximum of one year. - Despite successes, challenges remained: - The excessive use of temporary contracts continued due to a remaining significant gap in firing costs between temporary and permanent contracts. - Allegations that firms set wages too low without an economic justification. ### Reform components and specific measures - The reform includes changes in four areas: simplification of contracts, modernization of subcontracting regulations, changes in collective bargaining, and expansion of firms’ internal flexibility mechanisms. - Simplification of contracts - Aim: restrict the use of temporary contracts by limiting the set of circumstances which warrant their use, strengthening enforcement and imposing higher penalties on very short durations and fraudulent contracting. - Promotes use of seasonal open-ended contracts (“fixed-discontinuous”) for seasonal activities (e.g., agriculture or retail around holidays). - Creates a new permanent contract for the construction sector. - Introduces new training contracts, establishing a stronger link with the education and vocational training systems to facilitate insertion of the young population in the labor market. - Transition periods for companies to adapt existing contracts: three months (up to 6 months in some types of contracts). - Subcontracting - Subcontracting will now be subject to the sectoral agreements, with firm-level agreements applying only if they provide better conditions than the sectoral agreement. - Objective: provide more protection to subcontracted workers and improve their working conditions. - Collective bargaining - Reverts, at least partially, two flexibility elements introduced by the 2012 reform: - Restores the priority of sectoral agreements over firm agreements on wages. - Reinstates the indefinite extension of an expired collective agreement if a new agreement is not reached (“ultra-activity”); extensions had been limited to one year by the 2012 reform. - Applicability: These changes will only be applicable to new agreements. - Retained firm flexibility: - Firms retain flexibility on other aspects: firm-level agreements will prevail over sectoral agreements regarding working time, professional classification, type of contract, and measures to achieve work-life balance. - Firms will preserve their ability to unilaterally modify working conditions due to economic, technical, organizational, or productive causes. - Firms can negotiate with unions an opt-out from sectoral agreements. ### Internal flexibility mechanisms: ERTE and RED - Objective: Enhance firms’ internal flexibility and employment stability; authorities believe use of the two schemes will reduce the probability of entering unemployment. - ERTE (short-time work scheme) - Two modalities: ETOP (due to economic, technical, organizational, and productive causes) and force majeure. - Main innovations: - Easier activation, simplified and automated management. - Possibility of adding/removing workers from ERTE dynamically based on company’s level of activity. - Social security exemptions for firms: - 20 percent in the case of the ERTE ETOP, subject to the provision of training for ERTE workers; - 90 percent in the case of ERTE due to force majeure. - Additional financing for training activities, with the benefit varying with the size of the company. - The ERTE has been a key mechanism to protect employment and workers’ incomes during the pandemic; number of workers in ERTE decreased to around 100,000 (down from more than 900,000 at the end of 2020). - RED Mechanism (new short-time work scheme) - Activation must be authorized by the Council of Ministers. - Two modalities depending on the nature of the shock: cyclical or sectoral. - Cyclical RED: - Meant to respond to general economic fluctuations. - Maximum duration is 12 months. - Provides discounts to social security contributions for firms, which decline over time: - 60 percent in the first four months, - 30 percent in the next four months, - 20 percent in the last four months. - Sectoral RED: - Meant to support firm adjustment and reallocation of workers in sectors experiencing structural changes. - Initial duration set at 12 months; employers can request up to two extensions of 6 months each. - Firms receive discounts to social security contributions (40 percent), conditional on providing training for the workers under the scheme. - Government financing will cover training activities associated with the RED, which varies with company size. - Expectation: affected workers would eventually move to a different company/sector. - To facilitate moves, companies that hire workers on the sectoral RED would receive a 50 percent discount in social security contributions for six months. - Financing: - A special fund would be established to finance the RED mechanism (financed by social security contributions to unemployment, other budget allocations, and EU funds). ### Implementation context and link to EU recovery funds - The reform was one of the milestones of the recovery plan agreed with the European Commission. - Its approval will unlock the next tranche of NGEU funds to be disbursed in 2022. *Source: Annex VII. 2021 Labor Market Reform (1espea2022001) — Spain Staff Report materials* ### 5.2 percentage points down to 3.2 percent of GDP in 2024. The debt to GDP ratio is expected to ### 1espea2022001 - 5.2 percentage points down to 3.2 percent of GDP in 2024. The debt to GDP ratio is expected to ### Fiscal outlook and debt dynamics - Deficit reduced by "5.2 percentage points down to 3.2 percent of GDP in 2024." - The debt to GDP ratio is expected to continue its decline, reaching "112.1 percent of GDP in 2024." - Debt portfolio characteristics that support sustainability: - Average maturity of "8 years." - Record-low cost at issuance of "-0.04 percent for 2021." - Policy objective: reach a broad-based consensus at the European level on reform of the EU economic governance framework. - Fiscal strategy principles: strengthen public finances in the long-term with a realistic and pragmatic fiscal framework; adapt deficit and debt reduction paths to each country’s situation; support growth, good quality job creation, and necessary investment for green and digital transitions. ### Tax and public transfer reforms - Authorities undertaking a comprehensive review of the tax structure and the public transfers system to: - Enhance fiscal progressivity, efficiency, and revenue collection capacity. - Better target spending. - Process will be data-driven and informed by regular spending and revenue reviews by the independent fiscal authority. - Government commissioned a Group of Experts to report on tax system reform; the Group of Experts will publish its conclusions in "February 2022." - Authorities committed to implementation of the agreement on international taxation. ### Pension system reform - Broad reform underway with a first phase already adopted: - Indexation of pensions to "CPI inflation" to protect purchasing power. - Offsetting measures to reduce pension spending, including narrowing the gap between effective and legal retirement age, rationalization of financing structure of contributory and non-contributory pensions, and a new intergenerational equity mechanism. - The intergenerational equity mechanism includes an increase in contributions, starting in "2023," and foresees a contingent mechanism to correct potential deviations from the expected pension spending path beyond "2032," if needed. - Second phase of the reform to be approved during "2022," aims to ensure sustainability by: - Ensuring adequacy of social security contributions (adapting ceilings and expanding contributory period considered to calculate the regulatory base). - Promoting complementary workplace pension systems. - Discussions with social partners ongoing for the second phase. ### Financial sector resilience and regulatory measures - Banking sector assessment: - Despite the crisis, the banking sector remains sound and risks are balanced. - No significant increase in NPLs ratios has been recorded. - Latest stress-test exercises indicate Spanish banks are adequately capitalized, with provisions at comfortable levels. - Financial support measures to firms and households affect "13 percent" of banks’ credit exposures. - Banks have limited exposure to capital markets and a large share of mortgages in direct lending; "90 percent" of the banks’ mortgagees present LTV ratios below "80 percent." - No signs of overheating in the real estate sector; prices aligned with fundamentals and lending standards remain stable. - Preemptive regulatory measures introduced: - Extension of grace periods and maturity of loans, introduction of debt-to-equity swaps and partial write-offs under specific conditions in the public loan guarantees program (under a Code of Conduct with the banking sector). - Extension of the macroprudential toolkit: sectoral countercyclical capital buffer, introduction of relative concentration limits in specific portfolios or sectors, and new borrower-based measures in credit supply. - Revision of the insolvency and bankruptcy framework expected by "mid-2022" to make it more efficient and promote out-of-court procedures; draft Insolvency Law aligned with the EU framework and includes elements to facilitate early restructuring of viable companies, with possible debt restructuring and fast track processes especially for microenterprises. ### Structural reform program and NGEU funds - Reform momentum anchored in dialogue with social partners and supported by Next Generation EU (NGEU). - COVID-19 crisis reinforced objectives set in January 2020: increase potential growth, ensure fiscal sustainability, lower unemployment, improve quality of jobs, enhance social and environmental sustainability, and foster gender equality. - 2021 reforms approved include: Climate Change and Energy Transition Law, National Plan on R&D&I, labor market reform, and digitalization plans under Digital Spain 2025. - Recovery and Resilience Plan (RRP) objectives and resources: - Can mobilize up to "EUR 140 billion" in public investments and social development plans. - Complementary goal of catalyzing up to "EUR 500 billion" in private investments. - RRP structured around four axes: green, digital, social and territorial cohesion, and gender equality. - "85 percent" of the funds will be materialized in investment projects and capital transfers. - PERTE strategic recovery projects launched: - 2021 projects: Electric and Connected Vehicle, Vanguard Health, Renewable Hydrogen and Energy Storage. - 2022 PERTE on the agri-food sector; pipeline PERTEs on New Language Economy, the aerospace industry, and the New Care Economy. - NGEU disbursements and 2022 investment plans: - European Commission approved a first disbursement of "EUR 10 billion" in "December 2021." - Authorities planning to deploy up to "EUR 28 billion" of investments in "2022." - Governance for NGEU funds reinforced with a three-tier structure: General Comptroller of the State Administration, the Ministry of Finance, and the National Anti-Fraud Coordination Service. ### Labor market reform (2021) - Reform targets long-standing weaknesses: high incidence of temporary contracts, precariousness, and low productivity; moves labor market towards European flexi-security model. - Reform based on broad social dialogue with all social partners. - Four main areas and measures: (i) Simplification of contract types and incentives for open-ended contracts: - Limitation of circumstances for temporary contracts, reduction of maximum duration, promotion of permanent-discontinuous contracts for seasonal activities, and more flexible training contracts. (ii) New employment flexibility and stabilization mechanism (RED): - Simplification of the ERTE modality; introduction of a new permanent and closely monitored RED mechanism to reduce pro-cyclicality of employment. - Measures include temporary wage substitution payment, exemptions from social security contributions, and training and re-skilling to encourage cross-firm and cross-sector mobility. - Complementary measures to reinforce ALMPs, including the Spanish Employment Activation Strategy "2021-2024" approved in "December 2021," and a new Employment Law expected to be approved by the end of "2022." - Authorities estimate RED will have a positive impact on public finances by reducing costs of cyclical fluctuations and sectoral adjustments in terms of unemployment benefits and loss of employability. (iii) Reform of the collective bargaining framework: - Reintroduction of the ultra-activity clause (automatic extension of a collective agreement until a new one is reached) — a clause already included in "2/3" of existing agreements. - Prevalence of sectoral collective agreement on wage-related clauses while maintaining priority of company-level agreements for other labor conditions. (iv) Updating regulation on sub-contracting activities to address labor precariousness, including application of sectoral collective agreements unless outsourcing company has its own collective agreement. ### Climate change strategy and outcomes - Commitment: reach carbon neutrality by "2050." - Strategy instruments and focus: - Carbon pricing, promotion of green investments, incentives for economy-wide transformation, and addressing distributional consequences of decarbonization. - Governance framework with planning, budgetary, and reporting standards for public administrations and private sector. - Key elements: in-depth review of environmental taxation; focus on transport, building, and energy sectors; leverage NGEU funds with "40 percent" dedicated to climate change policies. - Implementation progress and measures: - Significant increase of prices within the EU Emissions Trading Scheme framework (ETS). - Closure of the coal industry. - Creation of a new auction scheme for new renewable capacity in the power market. - Measures to guarantee financial sustainability of the electric system. - Early results: - Spain per capita emissions "7.1 t CO2e" vs. EU27 "8.4 t CO2e" (according to Eurostat, "2019"). - Emissions have fallen "almost 40 percent compared to 2005," according to "2020 GHG inventory reported data." - Renewable capacity in the electricity sector reached a record share of "almost 50 percent in 2021." *Source: 1espea2022001 (PDF chapter content).* --- _Source: https://www.imf.org/-/media/files/publications/cr/2022/english/1espea2022001.pdf_