## 1. Real Sector and Inflation

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### Context
- Spain’s economic resilience to adverse shocks has improved; revamped short-time work scheme (ERTE) helped prevent significant job destruction during the pandemic.
- Labor market reform in 2021 sharply reduced prevalence of temporary contracts from 25.6 percent in 2021Q4 to 15.7 in 2024Q1.
- Structural unemployment rate is estimated at about 11 percent and is projected to remain the highest in the euro area.
- The income-per-capita gap between Spain and the highest-income euro area countries was about 32 percent in 2022, about 8 percentage points wider compared to 20 years ago.
- Strong tax revenues and sustained inflation contributed to a decline in public debt to 107.7 percent of GDP in 2023.

### Recent developments — growth, labor market, inflation, and financial conditions
- Real GDP and demand:
  - Real GDP grew by 2.5 percent in 2023, 1.8 percentage points higher than the euro area.
  - Services exports and public consumption were key drivers; private investment remained weak overall despite a recent pickup.
  - Household disposable income grew by 11 percent in 2023; consumption has just recovered its pre-pandemic level; households’ excess savings remain high.
- Labor market:
  - Social-security-affiliated workers increased by over ¾ million between December 2022 and April 2024.
  - Unemployment rate broadly stabilized below 12 percent; vacancy-to-unemployment ratio at historical highs.
  - Employment absorbed increases in labor force participation, including older workers due to pension reforms.
  - Skill and geographical mismatches and limited housing supply hinder vacancy filling.
- Inflation and wages:
  - Headline inflation fell below the ECB’s 2-percent target in June 2023, then rebounded to above 3 percent as base effects dissipated.
  - Core inflation has declined steadily; collectively bargained wage growth contained below 4 percent under the May 2023 national wage agreement.
  - Actual wage growth per employee slowed from 5.7 percent in Q1 2023 to 5.0 percent in Q4 2023; unit labor costs decelerated similarly.
- Financial conditions and housing:
  - Financial conditions started easing after peaking in H1 2023; 10-year sovereign and corporate yields and spreads fell from fall 2023 peaks.
  - Spanish banks stopped tightening credit standards by late 2023; repayment of TLTRO funding was 92 percent completed by February 2024.
  - Tight conditions strengthened banks’ net interest margins; stage 2 and non-performing loans remained broadly stable.
  - House prices continued to increase y/y despite double-digit y/y declines in transaction volumes in 2023.
- Public finances:
  - Overall fiscal deficit fell from 4.7 percent of GDP in 2022 to 3.6 percent of GDP in 2023.
  - Temporary levies on bank and energy profits and the solidarity tax on large fortunes contributed 0.2 percent of GDP to revenues.
  - Support measures for energy and food prices cost approximately 1 percent of GDP in 2023; some measures extended part of 2024 at an estimated cost of 0.2 of GDP.
  - Debt-to-GDP declined to 107.7 percent in 2023 from 111.6 percent in 2022.
  - The 2024 budget law failed to pass the parliamentary vote in March 2024.
- External sector:
  - Trade balance surplus rose by 3 percentage points of GDP in 2023, driven by services exports and a lower energy import bill.
  - Current account surplus increased to 2.6 percent of GDP in 2023 despite deterioration in the primary income account.
  - Net international investment position improved to -52.8 percent of GDP by end-2023.

### Outlook and key baseline assumptions
- Growth and labor market:
  - Sequential growth expected to average 2.4 percent in 2024 and 2.1 percent in 2025.
  - Potential growth projected to temporarily surpass its medium-term equilibrium of 1.6 percent.
  - Output expected to stay close to potential in 2024; unemployment projected to fall further towards slightly above 11 percent.
- Inflation and wages:
  - Inflation expected to decline throughout 2024–25; headline and core inflation expected to return close to the ECB’s target before mid-2025.
  - Full withdrawal of VAT reductions on basic foods and electricity will cause one-off price increases in 2024.
  - Under the national wage agreement, projection implies 3-percent wage increases for both 2024 and 2025.
  - Actual wages projected to grow 0.3-0.5 percentage points faster than the national agreement amid a tight labor market.
- Policy and financial assumptions:
  - Assumes ECB monetary policy rates decline by 0.6 and 0.7 percentage points in 2024 and 2025, respectively.
  - General government structural primary deficit assumed to fall by 0.7 percentage points in 2024 as energy support measures are withdrawn.
  - NGEU grants disbursements followed by NGEU loans (authorities plan to request the loan component in full starting second half of 2024) and easing financial conditions should support investment.
- External balance:
  - Current account surplus expected to remain high in 2024 before gradually declining to 1.8 percent of GDP in 2029 (from 2.6 percent of GDP in 2024).

*Source: IMF — 1. Real Sector and Inflation (extracted content).*

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### Risks to the Outlook and Authorities’ Views

### Risks to the outlook
- Overall: Risks have become more balanced but downside risks to growth and upside risks to inflation predominate.
- Political/fiscal fragmentation:
  - Protracted domestic political fragmentation could undermine fiscal commitments and structural reforms, weakening confidence, investment and growth.
  - Fiscal risks could increase if financing of autonomous communities alongside broad-based debt forgiveness weakens incentives for fiscal discipline.
- Labor-cost/inflation dynamics:
  - Greater second-round effects on unit labor costs could lead to more persistent inflation and deteriorate confidence and external competitiveness if sustained.
- NGEU and external risks:
  - Weaker or less-effective-than-expected use of NGEU funds could weigh on investment and potential growth.
  - Deepening geo-economic fragmentation or abrupt euro area/global slowdown would weigh on growth.
- Energy/commodity shocks:
  - Higher energy prices from conflicts or commodity price volatility would deteriorate terms of trade, lower real incomes and raise inflation.
- Monetary policy upside:
  - Faster-than-expected monetary policy easing would raise near-term growth but persistent inflation could lower medium-term domestic demand.

### Authorities’ views
- Authorities broadly share staff’s view that growth will hover around 2 percent in 2024-25 and concur that inflation will continue to fall close to the ECB’s 2-percent target.
- Authorities note pickup in real wage growth would help households recover purchasing power but stress monitoring second-round effects from higher labor costs.
- Policy priorities: reduce vulnerabilities and raise living standards; sustain discretionary fiscal consolidation to rebuild fiscal buffers; enhance macroprudential policies and structural reforms to reduce structural unemployment, support low-income workers, and boost productivity.

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### Fiscal Outlook, Risks, and Recommended Consolidation

### Near-term fiscal stance and projections
- No budget law will be passed by parliament in 2024; “rollover” of the 2023 budget entails a fiscal deficit target of 3 percent of GDP for 2024, to be reduced to 2.5 percent in 2025.
- 2023 outturn: deficit of 3.6 instead of 3.9 percent of GDP.
- Energy and food price support policies amounted to approximately 1 percent of GDP in 2023 and are being gradually phased out throughout 2024.
- After expedited lapsing of reduced electricity VAT rate by Q1 2024, staff estimates the cost of measures at about 0.2 percent of GDP for the year.
- Staff project the deficit to remain at or above 3 percent of GDP, and the public debt ratio to stabilize at a high level in the years ahead.

### Debt dynamics, baseline numbers, and risks
- Debt-to-GDP projected path (percent of GDP):
  - 2023: 107.7
  - 2024: 105.6
  - 2025: 104.4
  - 2026: 104.3
  - 2027: 104.2
  - 2028: 103.7
  - 2029: 103.2
  - 2030: 102.8
  - 2031: 102.3
  - 2032: 101.7
  - 2033: 101.1
- Gross financing needs projected to remain around 16 percent of GDP (e.g., 2024: 17.1; 2025: 16.2; 2026: 16.4; 2027: 16.5).
- Staff assess overall risk of sovereign stress as moderate in the medium term; long-term risk assessed as high in a no-further-policy-action scenario due to ageing-related expenditures.

### Recommended consolidation path and fiscal plan
- Staff recommend reducing the primary structural fiscal deficit by about 0.6 percentage point of GDP each year over 2024-28 to achieve a cumulative fiscal adjustment of about 3 percentage points of GDP.
- Expected impact: bring debt down to just over 100 percent of GDP and reduce gross financing needs by some 3 percentage points of GDP by 2028 relative to baseline.
- Institutional measures: publish an explicit medium-term fiscal plan; AIReF to review medium-term projections and evaluate quantitative impacts.

### Growth-friendly revenue and spending measures
- Revenue options:
  - Eliminating VAT exemptions and harmonizing VAT rates could yield up to 1.5 percent of GDP.
  - Increasing taxation of environmental externalities to average EU levels (uprating fuel duties, strengthening vehicle acquisition fees and carbon pricing in residential heating) and improving coordination could mobilize a further 0.7–0.9 percent of GDP.
  - Together with withdrawal of emergency anti-inflationary measures (about 1 percent of GDP), VAT harmonization and enhanced environmental taxation could deliver the recommended medium-term consolidation of 3 percentage points of GDP.
- Use of proceeds and distributional measures:
  - Address potential income-distribution impacts via an in-work tax credit, scaled-up ALMPs, and enhanced affordable housing supply.
- Windfall levies:
  - Windfall levies provided 0.2 percent of GDP in 2023 to finance anti-inflation support measures.
  - Turning temporary levies into permanent taxes would be distortionary; if maintained, align bases with clear definition of exceptional profits and consider redesigns (e.g., tax credits proportional to a positive neutral CCyB).

### Spending pressures and pension sustainability
- Pension reform and risks:
  - 2021–23 reforms permanently indexed pensions to inflation and repealed planned entitlement adjustments to life expectancy.
  - Authorities expect revenue measures to more than offset higher pension expenditures over 2024–50, but projections rely on favorable long-term assumptions.
  - AIReF and others estimate a substantial financing gap in the pension system; further measures might be required at the first mandatory review in 2025.
- Automatic safeguard mechanism risks:
  - If activated and a future reform relies only on contribution increases, Spain’s average labor tax wedge could rise by up to 1.9 percentage points, 6.8 percentage points above the OECD average.
  - Such an increase could reduce employment by about 1 percent, equivalent to around 230,000 jobs.
- Reform options:
  - Reduce replacement rates by extending benefit computation period; raise effective labor market withdrawal age (currently 64); broaden measures across health, flexible work, unemployment assistance for those aged 52 and above, and ALMPs.
  - Share of delayed retirements among new pensioners increased from 4 percent in 2022 to 8 percent in 2023, and to 10 percent in the first two months of 2024.

### Subnational fiscal discipline and institutional reform
- Compliance with national fiscal rule historically limited.
- FLA entails weak conditionality; partial forgiveness discussions present opportunity to strengthen national fiscal rule.
- Recommendations:
  - Enhance incentives for autonomous communities to pursue sound fiscal policies, strengthen corrective mechanisms, enhance regions’ revenue-raising capacity, and place greater weight on net primary expenditure targets.
  - Return autonomous communities to market-based debt issuance as primary financing means, with FLA as last-resort under stricter conditionality.

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### Fiscal Policy Guidance and Contingency Rules

- Consolidation should be more decisive and frontloaded if adverse inflationary shocks or financing difficulties occur.
- In adverse disinflationary shocks, automatic stabilizers should be allowed to operate.
- Discretionary stimulus only for major and temporary negative shocks and only while government funding costs remain low.
- Authorities reiterated commitment to sustained fiscal consolidation, starting with a 3 percent of GDP deficit target for 2024; medium-term plan being prepared under revamped EU governance.
- Consolidation strategy planned to center on revenue measures aligning taxation closer to EU peers; temporary levies could be converted to permanent taxes with revamped designs to support policy goals (e.g., green investment).

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### Financial Sector Resilience, Macroprudential, and Supervisory Recommendations

### System-wide assessment and stress tests
- Banking system weathered tighter monetary policy with no signs of significant systemic risks; SIs maintained stable capital and ample liquidity buffers; CET1 ratios above regulatory requirements but below euro area peers.
- Pockets of vulnerability: loans guaranteed by ICO under pandemic-relief; volume of stage 2 loans and NPLs reached € 20.5 billion   (1.   4 percent of GDP) by end-2023.
- 2024 FSAP solvency stress tests:
  - Baseline: aggregate CET1 ratio of 10 Spanish SIs would rise by 1.8 percent points, from 12.6 percent in 2023Q3 to 14.4 percent by end-2025 (assuming moderate dividend distributions and current bank levy form until 2025).
  - Adverse: aggregate CET1 ratio would decline by 3 percentage points to 9.6 percent by end-2025; would remain above regulatory minima but imply substantial credit contraction and heterogeneity.
- Liquidity tests: SIs can cope with market valuation shocks but could face cash-flow challenges under large retail deposit withdrawals.

### Profitability, funding, and household/corporate vulnerabilities
- Banking profitability solid, driven by higher net interest income; net income as percent of total assets at post-GFC highs; ROE aligned with EU peers and increasing.
- Pass-through of ECB rates significant for loan and new term deposit rates but lagged for overnight deposit rates.
- Households continued deleveraging in 2023; indebtedness low vs European peers; vulnerabilities concentrate among low-income households.
- Corporate sector among least indebted in Europe; liquidity and profitability improved; firms’ interest coverage rebounded to pre-pandemic levels by end-2022.

### Real estate and market valuation
- No evidence of significant residential or commercial real estate overvaluation.
- Housing transaction volumes fell by over 10 percent in 2023; prices registered small increases; price-to-income and price-to-rent ratios below pre-GFC levels.
- New dwellings saw average price appreciation exceeding 8 percent in 2023; close monitoring warranted.
- Commercial real estate prices still below pre-pandemic levels; banks’ exposure to sector low.

### Macroprudential and supervisory recommendations
- Introduce as soon as feasible a positive neutral counter-cyclical capital buffer (CCyB); current neutral rate of 0 prevents CCyB serving as main releasable buffer.
  - System projected voluntary buffers: 2.3 percent of risk-weighted assets as of 2023Q3, increasing by 1.8 percentage points over 2024-2025 under staff baseline.
- Strengthen supervision and oversight, maintain financial integrity, and enhance operational capacity of financial safety net.
  - Align supervisory resources to complex risks (e.g., cyber security); strengthen LSI risk management supervision; increase transparency and autonomy of macroprudential authority; grant full autonomy to CNMV recruitment.
  - Improve AML/CFT risk-based supervision and enhance resolution regime operational capacity.

### Insolvency law implementation
- New insolvency law (Sept 2022) shows encouraging early evidence: comprehensive restructuring framework uptake; increased insolvency filings due to improved “fresh start” conditions; special procedure for micro-enterprises underused.
- Recommendations: continue monitoring implementation, enhance data collection, ensure procedural safeguards, and ensure adequate court resources to enable restructuring of viable firms.

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### Labor Market Policies and Active Labor Market Policies (ALMPs)

### Key findings and priorities
- Boosting ALMPs is key to cutting structural unemployment.
- 2023 Employment Law sets right approach, but decisive progress requires:
  - strengthening activation requirements (comparatively weak in Spain);
  - better integrating active and passive policies via a “one-stop shop” model (single caseload worker administering benefits, activation support, sanctions).
- Increase effectiveness of regional PES by tightening link between central transfers and job placement performance; measure performance via reduction in unemployment duration or contractual stability.
- Scope to raise share of PES resources on job placement, increase PES expenditures share in total ALMP spending, and raise overall ALMP expenditures as fiscal space is rebuilt.
- Bringing PES spending per unemployed to euro area average would entail a direct cost of about 0.15 percent of GDP.
- A one percentage point decline in unemployment rate reduces unemployment benefit spending by about 0.2 percent of GDP.

### Unemployment assistance (UA) reform and in-work incentives
- Government’s subsidio por desempleo proposal would:
  - raise benefit levels and broaden coverage;
  - improve work incentives by reducing benefit amount over time;
  - make benefit receipt temporarily compatible with work;
  - establish personalized activation itineraries.
- Strengthen job search support and activation requirements for recipients aged 52 and over (indefinite benefit duration) to increase effectiveness.
- Convert the existing labor earnings tax allowance into a refundable in-work tax credit to support low-skilled incomes and employment and mitigate disincentives from PIT withholding schedule.
- Keeping UA payments after starting a new job would incentivize job take-up, especially among low-wage workers.

### Working time and minimum wage considerations
- Ministry of Labor proposed reducing legal working hours from 40 to 37.5 hours per week.
  - Affects nearly 9 million salaried workers currently working longer than 37.5 hours.
  - May entail decline in income per capita if productivity gains do not offset reduced labor input.
  - Mitigation: wage moderation, sectoral collective bargaining, flexibility (annualization), and careful interplay with minimum wage.
- Minimum wage:
  - After a rise of nearly 55 percent since 2018, further increases need careful calibration.
  - Government target: net minimum wage level of 60 percent of average net monthly earnings.
  - 2023: average net monthly earnings estimated at €1,681; monthly minimum wage set at €1,008 in net terms (14 payments) and had already reached the target.
  - Minimum wage increases less well-targeted than in-work tax credit for poverty reduction; Minimum Wage Commission should guide future increases and be granted more autonomy.

### Authorities’ position
- Authorities agree on boosting ALMPs and emphasize individualized itineraries, professionalization of PES staff, linking PES transfers to performance, and enhancing program evaluation.
- Government aims to bring unemployment rate down to 8 percent in medium term and is confident about passing revised UA reform.
- Ministry intends to tailor severance pay for unfair dismissals and reduce maximum legal working time with unchanged wages via gradual negotiation with social partners.

---

### Macroeconomic Outlook, Indicators, and Key Tables (Selected Projections)

- Real GDP growth (percent change):
  - 2023: 2.5
  - 2024: 2.4
  - 2025: 2.1
  - 2026: 1.8
  - 2027: 1.6
  - 2028: 1.6
  - 2029: 1.6
- Headline inflation (average, percent):
  - 2023: 3.4; 2024: 2.9; 2025: 2.3; 2026: 1.9; 2027: 1.8; 2028: 1.8; 2029: 1.8
- Core inflation (average, percent):
  - 2023: 5.8; 2024: 3.0; 2025: 2.1; 2026: 1.8; 2027: 1.8; 2028: 1.8; 2029: 1.8
- Employment growth (percent):
  - 2023: 3.1; 2024: 1.3; 2025: 0.9; 2026: 0.8; 2027: 0.4; 2028: 0.3; 2029: 0.2
- Unemployment rate (percent of total labor force):
  - 2023: 12.2; 2024: 11.8; 2025: 11.5; 2026: 11.2; 2027: 11.2; 2028: 11.2; 2029: 11.2
- Current account (percent of GDP):
  - 2023: 2.6; 2024: 2.6; 2025: 2.3; 2026: 2.0; 2027: 1.9; 2028: 1.8; 2029: 1.8
- NIIP (percent of GDP):
  - 2023: -52.8; 2024: -46.5; 2025: -41.4; 2026: -37.1; 2027: -33.8; 2028: -30.7; 2029: -27.7
- Key fiscal numbers (selected):
  - General government balance (percent of GDP): 2023: -3.6; 2024: -3.0; 2025: -2.9; 2026: -3.1; 2027: -3.1; 2028: -2.9; 2029: -3.0
  - Primary balance (percent of GDP): 2023: -1.8; 2024: -0.6; 2025: -0.3; 2026: -0.4; 2027: -0.4; 2028: -0.3; 2029: -0.3
  - General government gross debt (Maastricht, percent of GDP): see debt path above.
  - Revenue level (billions of euros): 2023: 625.7; 2024: 659.8; 2025: 688.2; 2026: 709.3; 2027: 719.1; 2028: 743.9; 2029: 770.2
  - Expenditure (billions of euros): 2023: 737.8; 2024: 705.7; 2025: 734.7; 2026: 760.3; 2027: 772.7; 2028: 796.3; 2029: 824.9

---

### External Sector Assessment (Annex I) — Key Findings and Policy Responses

### Overall assessment and NIIP trajectory
- External position in 2023 assessed preliminarily as moderately stronger than level implied by fundamentals and policies.
- NIIP improved to -52.8 percent of GDP by end-2023.
- Gross liabilities declined to 248.3 percent of GDP by end-2023; nearly 70 percent of gross liabilities correspond to external debt.
- NIIP projected to continue improving supported by sustained CA surpluses and temporary NGEU capital-account impact.

### Current account and REER assessment
- CA surplus rose from 0.6 percent of GDP in 2022 to 2.6 percent of GDP in 2023; cyclically-adjusted CA balance is 2.8 percent of GDP in 2023.
- IMF staff CA norm estimated between 0.1 and 1.7 percent of GDP, midpoint 0.9 percent; CA gap midpoint 1.9 percent of GDP.
- Staff assess the REER to be moderately undervalued with a midpoint of 6.6 percent and range ±2.8 percent; CPI- and ULC-based REER changes in 2023 were 0.3 and -0.45 percent, respectively.

### Capital and financial account and vulnerabilities
- Financial account balance improved to 4.1 percent of GDP in 2023 (from 1.9 percent in 2022), driven largely by Bank of Spain balance sheet changes.
- Large external financing needs leave Spain vulnerable to sustained market volatility and tighter global conditions.
- Mitigating factors: long average sovereign debt maturity (almost eight years) and limited share of debt in foreign currency (11.9 percent of total external debt).

### Key 2023 (% GDP) levels (external assets/liabilities)
- NIIP: −52.8
- Gross Assets: 195.5
- Debt Assets: 95.0
- Gross Liab.: 248.3
- Debt Liab.: 149.0

---

### Debt Dynamics, Stress Assessment, and Long-Term Risks

### Recent financing conditions and debt structure
- Nominal yields on Spanish government bonds peaked at 3.95 percent in October 2023; spread over German bund averaged 100bps in 2023.
- Average maturity of public debt: 7.9 years.
- Share of total debt held by Bank of Spain: rose from 18 percent in 2019 to more than 28.5 percent in mid-2022, fell to 26.7 percent by late 2023.
- Share held by non-residents fell from close to 48 percent in 2019 to 42 percent in late 2023.

### Baseline scenario and assumptions for debt projections
- Baseline projection: public debt declines to 105.6 percent of GDP in 2024 and stabilizes around 103 percent of GDP over forecast horizon.
- Assumptions include full winding down of anti-inflationary support by end-2024; expiration of temporary windfall levies in Dec 2025; phased higher social security contributions; disbursement of EU RRF grants (~5.5 percent of GDP over 2021–26) and loans (~€26. billion assumed drawn over 2024–28; loan component raises debt-to-GDP by 1.5 percentage points by 2028).

### Risk assessment and indices
- Overall risk of debt distress: moderate (medium term); long-term risk: high without further policy action due to ageing-related expenditure.
- Debt fan chart signals high medium-term distress risk; probability of debt non-stabilization: 52.3 percent (fanchart module).
- Gross Financing Needs (GFN) module: Average baseline GFN: 16.5 percent of GDP.
- Final assessment: Probability of missed crisis, 2024-2029, if stress not predicted: 27.3 pct; Prob. of false alarms: 15.9 pct.

### Long-term amortization risk (Annex III)
- Long-term amortization risk signal not triggered; medium-term extrapolations show GFN stabilizing around 16 percent of GDP and total public debt around 100 percent of GDP.
- Historical-average scenario flagged as implying high amortization risk (influenced by COVID-19 period).

---

### Temporary Levies, Windfall Taxation, and Design Considerations

### Key messages
- Temporary levies and solidarity tax provided important revenue contribution but should remain limited and temporary.
- If extended permanently in current form, the levies could be distortionary and deter investment.
- Redesign recommendations: align tax base with clear definition of “excess” profits; for solidarity tax encourage autonomous communities to establish commonly agreed minimum rate to avoid distortions.

### Bank levy (4.8 percent on NII and fees; threshold €800 million in 2019)
- 2023 outturn: €1.2 billion (≈10 percent of banks' profits connected to activities in Spain in 2023).
- Limitations: base on NII and fees rather than profits; may discourage higher-risk lending; smaller institutions exempt by threshold.
- If permanent: align base to excess profits; consider interaction with macroprudential policy and CCyB; consider tax credit tied to capital set aside for CCyB.

### Energy company levy (1.2 percent on net turnover for 2023–24)
- 2023 outturn: €1.6 billion.
- Limitations: base does not capture profits; not calibrated as environmental tax; criticism from energy firms; deduction for green investment announced but not implemented.
- If permanent: align base to excess profits, consider interactions with existing energy/environmental taxes, and restrict base to non-competitive profits.

### Solidarity tax on large fortunes
- Marginal rates 1.7–3.5 percent on net wealth €3 million+; allowance €700 thousand plus €300 thousand for primary residence.
- 2023 revenue: €623 million (€555 million from residents of Community of Madrid).
- Regional dynamics: Community of Madrid challenged tax (Constitutional Court 149/2023 ruled in favor); regional actions may substantially reduce central government revenue from tax in 2024–25.
- Policy trade-offs: preserve regional fiscal autonomy while avoiding excessive heterogeneity; cooperation across communities to set a minimum rate preferred to national top-up.

---

### Working-Time Reduction: Lessons and Policy Implications (Annex VIII / France experience)

### Empirical regularities and fiscal cost
- France 35-hour reform: mandated reduction from 39 to 35 hours with phased implementation (Aubry I and II).
- Official reduction 10 percent; actual reduction averaged 4–6 percent due to flexibilities.
- Direct fiscal cost if fully implemented could have reached about 1 percent of GDP (Askenazy, 2013).
- Employment impact mixed and ambiguous; some studies show positive effects, others null or negative.
- Wage and labor-cost dynamics: reform increased hourly wages for some (minimum-wage workers protected), but persistent wage moderation and reductions in social security contributions and productivity gains kept labor income share broadly unchanged.

### Scenario and implementation guidance
- If proposed reform closed 50 percent of working hours gap, effective hours fall by 3 percent; with productivity gains 0–1/3, income per capita could decline by 2 to 3 percent.
- Recommendations for Spain:
  - Negotiate implementation with social partners to accommodate cross-sector heterogeneity.
  - Manage interplay with minimum wage to avoid large fiscal cost or employment effects.
  - Public-sector implementation should reflect small existing gap in effective working time; consider delivery and service quality impacts.

---

*Source: IMF staff report excerpts contained in content unit 1espea2024001.*

### 1. Real Sector and Inflation _____________________________________________________________________ 32

### 1. Real Sector and Inflation

### Context
- Spain’s economic resilience to adverse shocks has improved; revamped short-time work scheme (ERTE) helped prevent significant job destruction during the pandemic.
- Labor market reform in 2021 sharply reduced prevalence of temporary contracts from 25.6 percent in 2021Q4 to 15.7 in 2024Q1.
- Structural unemployment rate is estimated at about 11 percent and is projected to remain the highest in the euro area.
- The income-per-capita gap between Spain and the highest-income euro area countries was about 32 percent in 2022, about 8 percentage points wider compared to 20 years ago.
- Strong tax revenues and sustained inflation contributed to a decline in public debt to 107.7 percent of GDP in 2023.

### Recent Developments — Growth, Labor Market, Inflation, and Financial Conditions
- Real GDP and demand:
  - Real GDP grew by 2.5 percent in 2023, 1.8 percentage points higher than the euro area.
  - Services exports and public consumption were key drivers of the recovery; private investment remained weak overall despite a recent pickup.
  - Household disposable income grew by 11 percent in 2023; consumption has just recovered its pre-pandemic level, and households’ excess savings remain high.
- Labor market:
  - Social-security-affiliated workers increased by over ¾ million between December 2022 and April 2024.
  - The unemployment rate has broadly stabilized below 12 percent, but the labor market remains tight with vacancy-to-unemployment ratio at historical highs.
  - Employment has absorbed increases in labor force participation, including from older workers due to pension reforms.
  - Skill and geographical mismatches and limited housing supply hinder firms’ ability to fill vacancies.
- Inflation and wages:
  - Headline inflation fell below the ECB’s 2-percent target in June 2023, then rebounded to above 3 percent as base effects dissipated.
  - Core inflation has declined steadily, supported by energy disinflation and continued wage moderation.
  - Collectively bargained wage growth was contained below 4 percent under the May 2023 national wage agreement.
  - Actual wage growth per employee slowed from 5.7 percent in Q1 2023 to 5.0 percent in Q4 2023.
  - Unit labor costs displayed a similar deceleration.
- Financial conditions and housing:
  - Indicators of financial conditions started easing after peaking in the first half of 2023; 10-year sovereign and corporate yields and spreads fell from fall 2023 peaks.
  - Spanish banks stopped tightening credit standards by late 2023; repayment of TLTRO funding was 92 percent completed by February 2024.
  - Tight financial conditions strengthened banks’ net interest margins; stage 2 and non-performing loans remained broadly stable.
  - House prices continued to increase year-on-year despite double-digit year-on-year declines in transaction volumes in 2023.
- Public finances:
  - Overall fiscal deficit fell from 4.7 percent of GDP in 2022 to 3.6 percent of GDP in 2023.
  - Temporary levies on bank and energy profits and the solidarity tax on large fortunes contributed 0.2 percent of GDP to revenues.
  - Support measures for energy and food prices cost approximately 1 percent of GDP in 2023; some measures were extended part of 2024 at an estimated cost of 0.2 of GDP.
  - Debt-to-GDP declined to 107.7 percent in 2023 from 111.6 percent in 2022.
  - The 2024 budget law failed to pass the parliamentary vote in March 2024, signaling a challenging political environment.
- External sector:
  - Trade balance surplus rose by 3 percentage points of GDP in 2023, driven by services exports and a lower energy import bill.
  - Current account surplus increased to 2.6 percent of GDP in 2023 despite deterioration in the primary income account.
  - Net international investment position improved to -52.8 percent of GDP by end-2023.

### Outlook and Risks
- Growth projections:
  - Sequential growth expected to average 2.4 percent in 2024 and 2.1 percent in 2025.
  - Forecast assumptions include a rebound of trading partners’ import growth starting 2024 and gradual normalization of global energy prices.
  - Potential growth is projected to temporarily surpass its medium-term equilibrium of 1.6 percent.
  - Output is expected to stay close to potential in 2024; unemployment rate projected to fall further towards its medium-term structural level, slightly above 11 percent.
- Inflation and wages:
  - Inflation is expected to further decline throughout 2024–25; headline and core inflation are expected to return close to the ECB’s target before mid-2025.
  - Full withdrawal of VAT reductions on basic foods and electricity will cause one-off price increases in 2024, with inflation resuming its downward trend thereafter.
  - Under the national wage agreement, projection implies 3-percent wage increases for both 2024 and 2025.
  - Actual wages are projected to grow 0.3-0.5 percentage points faster than implied by the national agreement amid a still tight labor market.
- Policy and financial assumptions:
  - It is assumed the ECB’s monetary policy rates will decline by 0.6 and 0.7 percentage points in 2024 and 2025, respectively.
  - The general government structural primary deficit is assumed to fall by 0.7 percentage points in 2024 as energy support measures are withdrawn.
  - Disbursements of NGEU grants followed by NGEU loans (authorities plan to request the loan component in full starting second half of 2024) and easing financial conditions should support investment.
- External balance projection:
  - Current account surplus expected to remain high in 2024 before gradually declining to 1.8 percent of GDP in 2029 (from 2.6 percent of GDP in 2024), as tourism normalizes and non-energy imports regain strength with a shift toward domestically driven growth that has a high import content.
- Risks and structural challenges:
  - Structural unemployment expected to remain high; productivity growth likely to lag peers, calling for continued reform efforts.
  - Aging and normalization of immigration may slow employment growth; the drop in trend productivity growth following large recent employment gains is a concern for medium-term incomes and fiscal consolidation.

*Source: IMF — 1. Real Sector and Inflation (extracted content).*

### 12.      Risks to the outlook have become more balanced but downside risks to growth and

### 1espea2024001 - 12.      Risks to the outlook have become more balanced but downside risks to growth and

### Risks to the outlook
- Overall: Risks have become more balanced but downside risks to growth and upside risks to inflation predominate.
- Political/fiscal fragmentation:
  - Protracted domestic political fragmentation could undermine implementation of fiscal commitments and structural reforms, weakening business confidence, investment and growth, particularly if domestic financial conditions were to tighten.
  - Fiscal risks could be further increased if changes in the financing of autonomous communities alongside broad-based debt forgiveness were to weaken their incentives to maintain strong fiscal discipline.
- Labor-cost/inflation dynamics:
  - Greater second-round effects on increases in unit labor costs, alongside limited room for margins to absorb them, could lead to more persistent inflation and deteriorate confidence and external competitiveness if sustained over the medium term—although they would also support consumption in the near term.
- NGEU and external risks:
  - Weaker or less-effective-than-expected use of NGEU funds could weigh on investment and potential growth.
  - Deepening geo-economic fragmentation or an abrupt euro area or global slowdown would also weigh on growth.
- Energy/commodity shocks:
  - Higher energy prices from intensified regional conflicts or heightened commodity price volatility would deteriorate terms of trade, lower real incomes and raise inflation.
- Monetary policy upside:
  - Faster-than-expected monetary policy easing by the ECB and other major central banks would raise growth in the near term, but persistent inflation could lead to weaker confidence and lower domestic demand over the medium term.

### Authorities’ views
- Growth and inflation:
  - Authorities broadly share staff’s view that growth will hover around 2 percent in 2024-25, supported mainly by domestic demand.
  - They concurred with staff’s projection that inflation will continue to fall close to the ECB’s 2-percent target.
- Other perspectives:
  - Authorities note that a pickup in real wage growth would help households recover purchasing power and stimulate domestic consumption, while stressing the importance of monitoring risks of second-round effects from higher labor costs.
  - They expect the current account balance to stay at around 2 percent of GDP in the medium term, in line with staff’s projections.
- Policy priorities:
  - Two overarching objectives: reduce vulnerabilities and raise living standards towards those in the highest-income European countries.
  - Need for sustained discretionary fiscal consolidation to rebuild fiscal buffers and bring down high public debt.
  - Enhanced macroprudential policies and additional structural reforms to reduce structural unemployment, support low-income workers, and boost productivity.

### Fiscal outlook and near-term policies
- 2024–25 budgeting and support measures:
  - No budget law will be passed by parliament in 2024; the “rollover” of the 2023 budget entails a fiscal deficit target of 3 percent of GDP for 2024, to be reduced to 2.5 percent in 2025.
  - 2023 outturn: deficit of 3.6 instead of 3.9 percent of GDP.
  - Energy and food price support policies amounted to approximately 1 percent of GDP in 2023 and are being gradually phased out throughout 2024.
  - After factoring in expedited lapsing of the reduced electricity VAT rate by the first quarter of 2024, staff estimates the cost of the measures at about 0.2 percent of GDP for the year.
- Baseline projections and risks:
  - Staff project the deficit to remain at or above 3 percent of GDP, and the public debt ratio to stabilize at a high level in the years ahead.
  - Part of the tax revenue boom of 2020–23 is expected to wane, leaving only a permanent revenue rise in personal income taxes (PIT) and social security contributions.
  - Debt-to-GDP ratio projected to decline to 105.6 percent of GDP by end 2024 and stabilize around 103 percent from 2025 onwards, 5 percentage points above its 2019 level.
  - Refinancing of maturing debt at higher interest rates will raise the debt-service burden to 2.5-3 percent of GDP over 2024–29.
  - Staff’s baseline fiscal balance would most likely fall short of the expected adjustment path set out by the revamped EU economic governance framework.

### Sovereign stress assessment and fiscal space
- Risk levels:
  - Spain’s overall risk of sovereign stress is assessed as moderate in the medium term.
  - Debt and gross financing needs ratios projected to stabilize at 103 percent and 16 percent of GDP, respectively, making debt dynamics and rollover risk very sensitive to lower growth, higher financing costs, and/or a weaker fiscal balance.
  - Absent sustained consolidation or additional pension reforms, population ageing will sharply increase health and pensions expenditures starting from the mid-2030s; staff assess the risk of sovereign debt stress over the long term to be high in a no-further-policy-action scenario.
  - Staff assess fiscal space to be “at risk” under the baseline and in the context of the reinstated EU-wide fiscal rules.

### Recommended consolidation path and fiscal plan
- Recommended consolidation:
  - Staff recommend a reduction in the primary structural fiscal deficit of about 0.6 percentage point of GDP each year over 2024-28 to achieve a cumulative fiscal adjustment of about 3 percentage points of GDP.
  - This adjustment would bring debt down to just over 100 percent of GDP and reduce gross financing needs by some 3 percentage points of GDP by 2028 relative to the baseline projection.
  - The recommended cumulative consolidation is broadly in line with staff’s projection for 2024 but repeated each of the four subsequent years.
- Rationale and institutional measures:
  - The adjustment would build fiscal space to respond to future shocks and align with a buffer-stock model of optimal fiscal policy.
  - An explicit medium-term fiscal plan would signal commitment, anchor expectations, and increase the likelihood of successful consolidation.
  - AIReF could play an important role in reviewing medium-term projections and evaluating quantitative impacts; publication of the plan would foster public debate about medium-term taxation and spending priorities.

### Growth-friendly revenue and spending measures
- Revenue options:
  - Eliminating VAT exemptions and harmonizing VAT rates could yield an increment in revenues of up to 1.5 percent of GDP.
  - Increasing taxation of environmental externalities to average EU levels—e.g., uprating fuel duties, strengthening vehicle acquisition fees and carbon pricing in residential heating—and improving coordination across levels of government could mobilize a further 0.7–0.9 percent of GDP of revenues.
  - Together with withdrawal of emergency anti-inflationary measures (about 1 percent of GDP), VAT harmonization and enhanced environmental taxation could deliver the recommended medium-term consolidation of 3 percentage points of GDP.
- Use of proceeds and distributional considerations:
  - Potential income-distribution impacts could be addressed through an in-work tax credit, scaled-up active labor market policies, and enhanced affordable housing supply.
- Windfall levies:
  - Windfall levies provided 0.2 percent of GDP in 2023 to finance anti-inflation support measures.
  - Turning temporary levies into permanent taxes would be distortionary; if maintained, their bases should be aligned with a clear definition of exceptional profits and could be redesigned to achieve policy objectives (e.g., tax credits proportional to a positive neutral counter-cyclical capital buffer if introduced).

### Spending pressures and pension system sustainability
- Pension system concerns:
  - The 2021–23 reforms permanently indexed pensions to inflation and repealed planned entitlement adjustments to life expectancy; authorities expect revenue measures to more than offset higher pension expenditures over 2024–50, but projections rely on favorable long-term assumptions.
  - AIReF, rating agencies, and think tanks estimate a substantial financing gap in the pension system and suggest further measures might be required already at the first mandatory review in 2025.
- Automatic safeguard mechanism risks:
  - If the mechanism is activated and a future reform relies only on contribution increases, Spain’s average labor tax wedge could rise by up to 1.9 percentage points, 6.8 percentage points above the OECD average.
  - An increase of such magnitude could reduce employment by about 1 percent, equivalent to around 230,000 jobs.
- Reform options:
  - Future pension reforms should consider a balanced set of options: reduce replacement rates by extending the benefit computation period toward full careers; raise the effective labor market withdrawal age (currently 64, 3 years below the standard pensionable age of 67) by incentivizing older workers’ participation; broaden measures across health, flexible work arrangements, unemployment assistance for those aged 52 and above, and active labor market policies.
  - The share of delayed retirements among new pensioners increased from 4 percent in 2022 to 8 percent in 2023, and to 10 percent in the first two months of 2024—early evidence on effectiveness of recent reforms.
  - Consider making the automatic adjustment mechanism simpler and more forward-looking and granting AIReF greater autonomy to use its own projections for activation assessment.
- Long-run spending management:
  - Improving public spending efficiency, informed by AIReF reviews, could curb spending growth while better targeting support to vulnerable households.
  - There is scope for containing pension outlays; relying predominantly on revenue measures to balance the pension system would hurt employment and workers’ incomes.

### Subnational fiscal discipline and institutional reform
- Autonomous communities and fiscal incentives:
  - Compliance with the national fiscal rule has historically been limited.
  - The Fondo de Liquidez Autonómico (FLA) entails weak conditionality; ongoing discussions on partial forgiveness of some autonomous communities’ debt to the FLA present an opportunity to strengthen the national fiscal rule.
  - Any reform should enhance incentives for autonomous communities to pursue sound fiscal policies, strengthen corrective mechanisms, and enhance regions’ revenue-raising capacity to align accountability with expenditure autonomy.
  - A reformed rule should place greater weight on net primary expenditure targets to support overall consolidation objectives.
  - Returning autonomous communities to market-based debt issuance as the primary financing means, with the FLA as a last-resort instrument under stricter conditionality, would enhance fiscal discipline.

*Source: IMF staff text (chapter 12) contained in 1espea2024001*

### 25.      The fiscal policy adjustment path should respond flexibly to possible adverse shocks,

### 25.      The fiscal policy adjustment path should respond flexibly to possible adverse shocks,

### Fiscal policy guidance and contingency rules
- More decisive and frontloaded consolidation would be needed in the event of adverse inflationary shocks or financing difficulties.
- In the event of adverse disinflationary shocks (for example, weaker investment or exports), automatic stabilizers should be allowed to operate.
- Given the already limited fiscal space, discretionary stimulus should be considered only in case of major and temporary negative shocks and insofar as government funding costs remain low enough to allow for such support.

### Authorities’ views on fiscal consolidation
- The authorities reiterated their commitment to sustained fiscal consolidation, starting with a 3 percent of GDP deficit target for 2024.
- A medium-term plan is being prepared in light of the revamped EU economic governance framework.
- Consolidation strategy planned to center on revenue measures to align taxation levels closer to those of EU peers, building on recent efforts to increase overall progressivity and bolster environmental taxation.
- Temporary levies on banks and energy companies and the solidarity tax on wealth could be converted into permanent taxes with revamped designs, including to support other policy goals—such as green investment.
- Authorities are confident that recent pension-related reforms will not require additional measures to preserve sustainability while protecting older households’ living standards.
- Plans to reform the financing system of autonomous communities aim to strengthen regional fiscal autonomy, foster greater accountability, and ensure a fair provision of essential public services.

### Financial sector resilience — system-wide assessment
- Spain’s banking system has weathered tighter monetary policy and financial conditions with no signs of build-up of significant systemic risks.
- Spanish significant institutions (SIs) have maintained stable capital and ample liquidity buffers; CET1 ratios are above regulatory requirements but remain below euro area peers.
- System-wide NPL ratios stayed unchanged and the share of stage 2 loans increased modestly in 2023.
- The bulk of variable-rate loans for both households and NFCs had been repriced by end-2023; a moderate deterioration in asset quality is expected going forward.
- Pockets of vulnerability include loans guaranteed by the Official Credit Institute (ICO) under pandemic-relief measures: overall volume of stage 2 loans and NPLs reached € 20.5 billion   (1.   4 percent of GDP) by end-2023.

### Banking sector profitability and funding structure
- Banking sector profitability has been solid, primarily driven by higher net interest income in the domestic market.
- Banks’ net income as a percentage of total assets has reached post-GFC highs; return-on-equity ratio aligned with EU peers and steadily increasing since after the pandemic.
- Pass-through of ECB monetary rates has been significant for loan rates and new term deposit rates, but has lagged for overnight deposit rates—potentially reflecting a combination of ample liquidity, high banking sector concentration, and consumer inertia.
- Migration from sight to term deposits has started for both households and NFCs, but overnight deposits still take up most of the deposit base.

### Household and corporate balance-sheet vulnerabilities
- Households continued deleveraging in 2023 and indebtedness remains low compared to European peers.
- Simulations based on the Bank of Spain’s 2020 Survey of Household Finances suggest household vulnerability peaked in 2022 and would further decline under staff’s baseline projections, supported by a resilient labor market, robust real income growth, and excess savings accumulated since the pandemic; vulnerabilities concentrate among low-income households.
- Corporate balance sheet strength has improved; the Spanish corporate sector is now among the least indebted in Europe. Corporate liquidity and profitability have continued to increase.
- Firms’ interest coverage ratio rebounded to pre-pandemic levels by end-2022.

### Real estate and market valuation
- No evidence of significant residential or commercial real estate overvaluation.
- Housing transaction volumes fell by over 10 percent in 2023, but prices continued to register small increases; price-to-income and price-to-rent ratios remain below pre-GFC levels.
- Empirical model suggests house prices were broadly in line with fundamentals in 2023Q4.
- Close monitoring warranted in the new dwellings segment, where average price appreciation exceeded 8 percent in 2023.
- Commercial real estate prices are still below pre-pandemic levels and banks’ exposure to the sector remains low.

### 2024 FSAP stress tests — solvency and liquidity findings
- Solvency stress tests indicate Spanish SIs as a whole would be resilient to severe and persistent global shocks, but with substantial credit deleveraging and heterogeneity across banks; this calls for stronger capital buffers ex ante.
- Under the baseline (assuming moderate dividend distributions and the bank levy keeping its current form until 2025), the aggregate CET1 capital ratio of the 10 Spanish SIs would rise by 1.8 percent points, from 12.6 percent in 2023Q3 to 14.4 percent by end-2025.
- Under the adverse scenario, the aggregate CET1 ratio of the ten SIs would decline sharply by 3 percentage points to 9.6 percent by end-2025; this would remain above regulatory minima but imply substantial credit contraction and heterogeneity across banks.
- Staff recommend that authorities deploy policies to ensure banks capitalize on current high profitability to accumulate more buffers.
- Liquidity stress tests show SIs can cope comfortably with market valuation shocks but could face cash flow challenges under large withdrawals of retail deposits.
- Systemic risks from interconnectedness among banks and from the nonbank financial intermediation (NBFI) sector appear low.

### Macroprudential and supervisory recommendations
- Introduce as soon as feasible a positive neutral counter-cyclical capital buffer (CCyB). Rationale and details:
  - Current neutral rate of 0 prevents the CCyB from serving as the main releasable macroprudential capital buffer to mitigate severe adverse exogenous shocks.
  - Staff welcome that the Bank of Spain may consider introducing a positive neutral CCyB rate and recommend a decision be made as soon as feasible.
  - Banks could withstand comfortably a moderate positive neutral CCyB given the system’s projected voluntary buffers: 2.3 percent of risk-weighted assets as of 2023Q3, increasing by a further 1.8 percentage points over 2024-2025 under staff’s baseline.
- Further strengthen financial system supervision and oversight, maintain financial integrity, and enhance the operational capacity of the financial safety net.
  - Align supervisory authorities’ resources to complex risks and emerging challenges (for example, cyber security risks).
  - Strengthen supervision of less significant institutions’ (LSIs) risk management, including liquidity, interest rate, and concentration risks.
  - Increase transparency, impact and accountability of the national macroprudential authority.
  - Grant full autonomy to the National Securities Market Commission over its recruitment process.
  - Continue efforts to improve AML/CFT risk-based supervision and oversight through comprehensive data collection and risk analysis.
  - Enhance the operational capacity of the resolution regime and clarify arrangements for funding in resolution.

### Insolvency law implementation
- The new insolvency law (adopted September 2022) shows generally encouraging early evidence:
  - Use of the comprehensive restructuring framework for corporates has taken off.
  - New incentives for individual debtors with more attractive “fresh start” conditions have increased insolvency filings.
  - The special procedure for micro-enterprises has not yet gained speed.
- Recommendations:
  - Continue monitoring implementation, including through enhanced data collection as planned.
  - Ensure strong procedural safeguards for all parties.
  - Ensure appropriate institutional capacity, including adequate court resources, to enable restructuring of viable firms rather than liquidation.

### Authorities’ views on financial sector recommendations
- Authorities concurred with staff’s risk assessment and recommendations, noting absence of elevated cyclical systemic risks and signs of easing financial conditions.
- Bank of Spain found provisioning, credit risk identification, liquidity and solvency buffers adequate but agreed that higher solvency buffers could further dampen the macroeconomic cost of severe shocks.
- Bank of Spain recognizes benefits of a positive neutral CCyB and agrees with staff on the need to make a decision soon.
- Authorities view the insolvency law’s initial impact positively and attribute underuse of the special procedure by micro-firms to market unfamiliarity.

### Labor market policy findings and recommendations
- The 2021 labor market reform lowered the share of temporary employment by almost 10 percentage points to average EU levels, with concentrated gains in the private sector and increased shares of regular permanent and fixed-discontinuous (FD) contracts.
- Key disadvantaged groups, including youth and migrants, benefited disproportionately from improved contractual stability.
- The reform has not materially changed aggregate transitions from employment to unemployment; some reduction in employment stability among FD and permanent workers observed.
- Policy options to further reduce dualism:
  - Provide additional incentives for employers to create regular permanent contracts by reducing length and cost of dismissal procedures while increasing notice periods to enable early public employment service support to laid-off workers.
  - Caution: The government’s plan to tailor severance pay to individual circumstances could raise uncertainty around dismissal costs and disincentivize offering permanent contracts.
  - Introduce higher unemployment insurance contributions for employers with higher turnover to discourage excessive shifts under FD contracts; monitor with additional statistical information.
  - Any reform to ease employment protection legislation (EPL) should be carefully communicated and subject to broad public debate given large political economy obstacles.
  - Curb use of temporary contracts in the public sector for jobs that are permanent in nature, as planned, to help reduce overall temporary employment share.

*Source: IMF staff report (excerpts provided).*

### 38.      Boosting active labor market policies

### 38.      Boosting active labor market policies

### Key findings on ALMPs and PES performance
- Boosting active labor market policies (ALMPs) is key to cutting structural unemployment.
- The 2023 Employment Law sets the right approach, but decisive progress requires:
  - strengthening activation requirements, which are comparatively weak in Spain;
  - better integrating active and passive policies through convergence towards a “one-stop shop” model where a single caseload worker administers benefits, provides activation support, enforces activation requirements, and decides on sanctions for a given unemployed worker.
- Increasing the effectiveness of regional Public Employment Service (PES) agencies could be achieved by tightening the link between central government transfers and their job placement performance. Job placement performance should be measured through simple indicators such as the achieved reduction in unemployment duration or contractual stability upon finding a job.
- There is scope to raise:
  - the share of PES resources spent on job placement;
  - the share of PES expenditures in total ALMP spending;
  - overall ALMP expenditures over time as fiscal space is rebuilt.
- Bringing PES spending per unemployed to the euro area average (as percent of GDP per capita) would entail a direct cost of about 0.15 percent of GDP.
- A one percentage point decline in the unemployment rate reduces spending on unemployment benefits by about 0.2 percent of GDP.

### Unemployment assistance (UA) reform and activation for recipients
- Strengthening the rights and obligations of UA recipients could broaden income security and speed return to work.
- The government’s reform proposal for the subsidio por desempleo would:
  - make the scheme more generous by raising benefit levels and broadening coverage;
  - improve somewhat beneficiaries’ work incentives by reducing benefit amount over time;
  - make benefit receipt temporarily compatible with work;
  - establish personalized activation itineraries.
- Greater job search support and stronger activation requirements for recipients—particularly those aged 52 and over, whose benefit duration is indefinite and who are less likely to find a job—could increase the reform’s effectiveness.

### In-work incentives and tax design
- Making UA compatible with work, coupled with a well-designed in-work tax credit, would strengthen employment incentives and support low-income workers.
- Keeping UA payments for a while after starting a new job—possibly for longer than envisaged in the government’s initial reform proposal—would incentivize job take-up, especially among low-wage workers.
- Converting the existing labor earnings tax allowance into a refundable in-work tax credit would support incomes and employment of the low-skilled and mitigate a current interaction with the PIT withholding schedule that discourages minimum-wage earners from working more hours.
- Together, compatibility of UA with labor earnings and an in-work tax credit would promote employment formalization, enhancing economic security, participation in the social security system, and tax revenue.

### Working time and minimum wage considerations
- The Ministry of Labor proposed reducing legal working hours in the private sector from 40 hours per week to 37.5 hours per week.
  - This would affect nearly 9 million salaried workers who currently have effective working weeks longer than 37.5 hours, most in the private sector.
  - The reform may entail a decline in income per capita in the medium term if productivity gains do not offset the reduction in labor input.
  - To mitigate adverse effects, international experience suggests accompanying hour reductions with wage moderation, sectoral collective bargaining to accommodate cross-sector heterogeneity, flexibility such as annualization of hours, and consideration of interplay with the minimum wage.
- After a rise of nearly 55 percent since 2018, any further increases in the minimum wage need careful calibration.
  - The government targets a net minimum wage level of 60 percent of average net monthly earnings of a full-time worker.
  - In 2023, with average net monthly earnings of a full-time worker estimated at €1,681, the monthly minimum wage was set at €1,008 in net terms (14 payments) and had already reached the target.
  - Based on the ratio of minimum wage to median gross monthly earnings, Spain now ranks close to the euro area average.
  - Minimum wage increases are not a well-targeted anti-poverty tool compared with an in-work tax credit; micro simulations suggest minimum wage increases can be less effective in reducing overall household poverty than in-work poverty.
  - Future increases should be guided by the Minimum Wage Commission, which should pursue joint employment, poverty and inequality objectives, be granted more autonomy and greater institutional weight, and assess feasibility of differentiating the minimum wage by age or region.

### Authorities’ position and implementation priorities
- The authorities agree on boosting ALMPs and emphasize:
  - development of individualized itineraries for each unemployed person;
  - professionalization of PES staff;
  - linking regional PES transfers to quantifiable performance indicators;
  - enhancing evaluation of programs.
- The government aims to bring the unemployment rate down to 8 percent in the medium term and is confident about passing a revised UA reform proposal.
- If increased incentives for job take-up work as intended, the approach could be extended to other unemployment benefits.
- The Ministry of Labor intends to tailor severance pay for unfair dismissals to individual worker circumstances (design at an early stage).
- The government is committed to reducing maximum legal working time with unchanged wages and expects gradual, flexible implementation through social partner negotiations.

*Source: 1espea2024001 - 38.      Boosting active labor market policies (IMF).*

### 49.      Growth is projected to remain solid, inflation is expected to further decline, and risks

### Growth is projected to remain solid, inflation is expected to further decline, and risks have become more balanced albeit still tilted to the downside for growth and the upside for inflation.

### Macroeconomic outlook and risks
- Growth is expected to remain steady above 2 percent throughout 2024-2025, supported by:
  - private consumption benefiting from further solid real disposable income gains and a reduction in the household saving rate;
  - investment pickup as NGEU funds continue to be disbursed and financing conditions gradually improve as the ECB eases monetary policy.
- Inflation is projected to return close to the ECB target before mid-2025 as wage pressures remain contained on the back of the 2023 national agreement.
- Risk balance:
  - Risks have become more balanced in the past year.
  - Downside risks to growth: domestic (political fragmentation) and international (geopolitical) forces could derail the favorable growth outlook.
  - Upside risks to inflation: greater-than-foreseen wage growth and services inflation persistence could make inflation stickier than expected.

### Fiscal stance and recommendations
- Staff baseline projection implications:
  - Fiscal deficit and public debt ratios would stabilize at uncomfortably high levels in the medium term—around 3 and 103 percent of GDP, respectively.
- Recommended fiscal consolidation:
  - An improvement in the structural primary balance of about 3 percentage points of GDP overall over 2024-2028 is recommended.
  - Consolidation should be embedded in a strong medium-term fiscal plan and focused on addressing tax system inefficiencies.
  - If made permanent, levies on banks and energy companies should be redesigned to minimize distortionary effects, including by shifting their base to a clearer definition of exceptional profits.
  - Additional pension reforms will very likely be needed to cope with ageing pressures; reforms should go beyond raising social security contribution rates, which could reduce employment.

### Financial sector resilience and recommendations
- Current assessment:
  - Spain’s significant banking institutions have ample liquidity buffers and their capital ratios should continue to improve due to robust profitability.
  - 2024 FSAP stress tests indicate resilience to severe adverse shocks.
- Remaining vulnerabilities and policy advice:
  - Strengthening capital buffers would permit banks to better satisfy credit demand and limit economic costs if a downside tail risk materializes.
  - Authorities should deploy policies to ensure banks capitalize on current high profitability to accumulate more buffers, which are lower than their euro area peers.
  - Introducing as soon as feasible a positive neutral CCyB rate would further enhance banking system resilience.

### Labor market developments and reforms
- Progress and remaining issues:
  - The 2021 EPL reform reduced long-standing labor market dualism.
  - Structural unemployment remains elevated; further reforms could enhance employment stability.
- Policy recommendations to improve labor outcomes:
  - Reduce uncertainty around dismissal costs.
  - Introduce higher unemployment insurance contributions for employers with higher turnover.
  - Curb the use of temporary contracts in the public sector to increase prevalence of regular permanent contracts.
  - Strengthen activation requirements for the non-employed and better integrate active and passive labor market policies to lower the unemployment rate durably into single digits.
  - Design new labor market initiatives (planned reduction in the working week, future adjustments to the minimum wage, possible modifications of legislation regarding severance pay) carefully to avoid unintended effects on employment and growth.

### Productivity, NGEU use, and housing policy
- Productivity agenda:
  - A broad productivity-enhancing policy agenda is needed to rekindle income convergence.
  - Put more emphasis on productivity-enhancing NGEU-funded investments.
  - Revive the broader reform agenda including stronger government support to business R&D and regulatory reforms to help the most productive firms grow.
- Housing affordability and supply:
  - To address housing affordability while supporting investment and economic efficiency, prioritize raising housing supply by:
    - continuing to streamline urban planning; and
    - boosting social housing.

*Source: IMF staff summary (excerpt).*

### 54.      It  is recommended that the next Article IV  consultation take place on the standard 12-

### 1espea2024001 - 54. It is recommended that the next Article IV consultation take place on the standard 12-month cycle.

### Macroeconomic performance, real sector, and inflation
- Recommendation: next Article IV consultation on the standard 12-month cycle.
- Recent growth and demand:
  - Spain’s growth performance has been better than euro area peers in the past two years and growth momentum has been robust in recent quarters (figures and charts reported).
- PMIs and confidence:
  - PMIs rebounded in early 2024 with services above 50 (expansion) and manufacturing back into expansion territory.
  - Consumer and business confidence have started to recover recently.
- Capacity utilization and inflation:
  - Capacity utilization stabilized overall and improved for investment goods.
  - Core inflation continues to normalize; headline inflation rebounded from low levels last summer.
- Key projections and indicators (Table 1):
  - Real GDP growth projections: 2023: 2.5; 2024: 2.4; 2025: 2.1; 2026: 1.8; 2027: 1.6; 2028: 1.6; 2029: 1.6 (percent change).
  - Headline inflation (average): 2023: 3.4; 2024: 2.9; 2025: 2.3; 2026: 1.9; 2027: 1.8; 2028: 1.8; 2029: 1.8 (percent).
  - Core inflation (average): 2023: 5.8; 2024: 3.0; 2025: 2.1; 2026: 1.8; 2027: 1.8; 2028: 1.8; 2029: 1.8 (percent).

### Labor market and demographics
- Employment and participation:
  - Employment rate at highest level since mid-2000s; participation fully recovered from COVID-driven drop.
  - Labor force projected changes shown in charts; labor force growth and employment projections in Table 1: Employment: 2023: 3.1; 2024: 1.3; 2025: 0.9; 2026: 0.8; 2027: 0.4; 2028: 0.3; 2029: 0.2 (percent).
  - Labor force: 2023: 2.1; 2024: 0.8; 2025: 0.6; 2026: 0.5; 2027: 0.4; 2028: 0.3; 2029: 0.2 (percent).
- Unemployment:
  - Despite decline, unemployment remains highest in the euro area; Unemployment rate (Table 1): 2023: 12.2; 2024: 11.8; 2025: 11.5; 2026: 11.2; 2027: 11.2; 2028: 11.2; 2029: 11.2 (percent of total labor force).
- Migration and population:
  - Large net migration flows supporting working-age population growth (figures provided; migration data note detailing sources and proxies).

### External sector, tourism, and NIIP
- Goods, services, and current account:
  - Nominal goods imports growth decelerated as import prices fell on lower energy prices.
  - Services exports very strong in 2023; tourist arrivals and spending reached record highs.
  - Current account surplus increased significantly relative to 2022 despite a small decline in primary income.
- Financial account and NIIP:
  - 2023 increase in financial account surplus largely driven by Bank of Spain balance sheet; other components saw net outflows.
  - Net International Investment Position (NIIP) gradually improving, largely due to shrinking Bank of Spain liability position.
- Key external projections and levels (Table 4 and Table 1):
  - Current account (percent of GDP): 2023: 2.6; 2024: 2.6; 2025: 2.3; 2026: 2.0; 2027: 1.9; 2028: 1.8; 2029: 1.8.
  - Trade balance of goods and services (percent of GDP): 2023: 4.1; 2024: 4.0; 2025: 3.5; 2026: 3.2; 2027: 3.0; 2028: 3.0; 2029: 2.9.
  - Net international investment position (percent of GDP): 2023: -52.8; 2024: -46.5; 2025: -41.4; 2026: -37.1; 2027: -33.8; 2028: -30.7; 2029: -27.7.

### Credit, financial cycle, and interest rates
- Household and corporate deleveraging:
  - Households continued to deleverage; non-financial corporates also deleveraging.
- Bank lending and rates:
  - Contraction in bank lending to private sector moderating (Bank lending yoy changes and charts).
  - After rising sharply with ECB policy hikes, benchmark interest rates have started declining in recent months.
  - Credit demand rebounded but remains in negative territory; lending standards have stopped tightening lately.
- Key indicators (Table 1, Figures):
  - Credit to private sector (memo, Table 1): 2023: -3.2; 2024: 0.0; 2025: 0.5; 2026: 1.0; 2027: 2.0; 2028: 2.0; 2029: 1.9 (percent change).
  - Interest rates: Euribor 12m and new lending rates presented in charts (levels and trends shown).

### Household sector vulnerabilities
- Debt servicing and distributional risks:
  - Households’ debt servicing burden expected to ease for all income quintiles, though lowest-income quintile will continue to face high pressures.
  - DSTI and DSTI + Essential Exp. measures presented by income quintile for 2024 and 2026 (charts with percent shares).
  - Spain expected to remain more vulnerable than most European peers on household vulnerability metrics.
- Financial assets and arrears:
  - Low-income households have comparatively low financial assets; higher incidence of loan arrears coming out of the pandemic relative to peers (figures and cross-country chart).

### Non-financial corporate sector
- Turnover, profitability, and leverage:
  - Turnover continued to grow in 2023 at a more moderate pace; return on assets improved driven by rising profitability and deleveraging.
  - Profit margins heterogeneous across sectors but close to pre-pandemic levels overall.
  - Total debt-to-assets ratio resumed downward trend after pandemic uptick.
- Financing costs and liquidity:
  - Debt financing costs increased sharply after ECB tightening.
  - NFCs, particularly SMEs, generally maintained ample liquidity on balance sheets.
- Key indicators (figures and charts):
  - Return on Assets and Debt-to-Asset ratios shown in charts; debt financing cost trends presented.

### Real estate (residential and commercial)
- Residential:
  - House prices moderated lately after steady growth, especially for new dwellings.
  - Housing transaction volumes declined sharply in 2023; housing supply partly weak.
  - Mortgage lending standards remained prudent; average LTV and share of loans with LTV>80% shown in charts.
  - Price-to-income ratio broadly stable; price-to-rent ratio rising but far below pre-GFC peak.
- Commercial:
  - CRE prices varied across segments but remain generally below pre-pandemic levels.
  - Spain did not experience a recent CRE boom; CRE market relatively small as percent of GDP.
  - Banks’ exposure to CRE lower than most advanced economies; NPL ratios in CRE portfolio remain relatively high but have declined since 2021.
- Key metrics (figures):
  - House Prices index (2007=100) and regional y/y changes provided; CRE price indexes and market-size percent of GDP charts presented.

### Banking sector performance and financial soundness
- Asset quality and stages:
  - Stage 2 and 3 loans broadly stable; asset quality among state-guaranteed loans deteriorated mainly due to portfolio downsizing.
- Profitability, costs of risk, and capitalization:
  - Banking profitability increased, supported primarily by higher net interest income; cost of risk stabilized.
  - Bank capitalization below peers on a risk-weighted basis, but in line on leverage ratio.
  - Bank liquidity ratios declined but remain comfortable.
- Financial soundness indicators (Table 3 highlights):
  - Regulatory capital to risk-weighted assets: 2023: 17.1 (percent).
  - Tier 1 Capital to total assets: 2023: 5.7 (percent).
  - Nonperforming loans to total loans (consolidated): 2023: 3.1 (percent).
  - Return on assets (consolidated): 2023: 1.1 (percent).
  - Loans to deposits (2023): 80.9 (percent).
  - NPLs (domestic operations) nonperforming loans to total loans: 2023: 3.4 (percent).
  - Cost of risk trends and CET1 ratios shown in charts and tables.

### Public finances and fiscal outlook
- Debt and deficits:
  - Public debt declined steadily since 2020; holdings of foreign investors shrank most.
  - Fiscal balance improved significantly since pandemic low.
- Revenue composition and fiscal space:
  - Sharp rise in revenues from social security contributions and income taxes persists.
  - Revenues remain structurally lower than euro area peers with scope to mobilize further VAT revenues and strengthen environmental taxation (figures and policy notes).
- Key fiscal numbers (Table 1, Table 2a/2b):
  - General government balance (percent of GDP): 2023: -3.6; 2024: -3.0; 2025: -2.9; 2026: -3.1; 2027: -3.1; 2028: -2.9; 2029: -3.0.
  - Primary balance (percent of GDP): 2023: -1.8; 2024: -0.6; 2025: -0.3; 2026: -0.4; 2027: -0.4; 2028: -0.3; 2029: -0.3.
  - General government gross debt (Maastricht, percent of GDP): 2023: 107.7; 2024: 105.6; 2025: 104.4; 2026: 104.3; 2027: 104.2; 2028: 103.7; 2029: 103.2.
  - Revenue level (Table 2a, billions of euros): 2023: 625.7; projected 2024: 659.8; 2025: 688.2; 2026: 709.3; 2027: 719.1; 2028: 743.9; 2029: 770.2.
  - Expenditure (Table 2a, billions of euros): 2023: 737.8; 2024: 705.7; 2025: 734.7; 2026: 760.3; 2027: 772.7; 2028: 796.3; 2029: 824.9.
  - Net lending/borrowing (percent of GDP, Table 2b): 2023: -3.6; 2024: -3.0; 2025: -2.9; 2026: -3.1; 2027: -3.1; 2028: -2.9; 2029: -3.0.
- Fiscal projections incorporate EU Recovery and Resilience Facility funding: about 0.4, 0.9, 1.0, 1.0, 1.0, 0.9, and 0.2 percent of GDP from 2021 to 2027 (per Table 1 note and Tables 2a/2b).

### Social indicators, inequality, and demographics
- Inequality and poverty:
  - Income inequality declined slightly but remains high compared to most euro area peers (Gini index charts).
  - In-work at-risk-of-poverty rate remains above euro area average; youth and low-skilled highlighted.
- Education, NEETs, and gender gaps:
  - Share of young people neither in employment nor in education/training declined to recent historical lows but remains among highest in euro area.
  - Spain has highest share of early leavers from education and training in the euro area (chart, 2022 data).
  - Sizeable gender gaps remain in political empowerment and, to a lower extent, economic participation and opportunity (gender gap scores for 2006, 2013, 2023).
- Aging:
  - Spanish population projected to age rapidly 2023-2050; projected change in old-age dependency ratio presented relative to peers.

### External debt and external positions
- External debt levels and structure (Table 5 highlights):
  - Gross external debt (Q4 2023): 2,451.7 (billions of euro).
  - Short-term gross external debt (Q4 2023): 995.4 (billions of euro).
  - Long-term gross external debt (Q4 2023): 1,456.3 (billions of euro).
  - Net external debt (Q4 2023): 787.9 (billions of euro).
  - Gross external debt (percent of GDP, Q4 2023): 167.7 (percent).
  - Net external debt (percent of GDP, Q4 2023): 53.9 (percent).
- Notes: External debt data corresponds to Q4 of each year unless otherwise indicated; net external debt defined as gross external debt minus external assets in debt instruments.

*Source: IMF staff report content as presented in the provided PDF content unit.*

### Annex I. External Sector Assessment

### Annex I. External Sector Assessment

### Overall Assessment
- The external position in 2023 is assessed on a preliminary basis to be moderately stronger than the level implied by medium-term fundamentals and desirable policies.
- Even though the large negative NIIP was significantly reduced in 2023, strengthening it further will require sustaining relatively high CA surpluses in coming years.
- In 2023–24 the CA balance will exceed the norm, but this gap is projected to shrink in the medium term as:
  - tourism flows normalize,
  - non-energy imports regain strength—supported by the shift in the economy’s growth drivers towards domestic demand, particularly investment which has a high import content,
  - private saving slowly declines towards pre-COVID levels.
- A final assessment will be provided in the 2024 External Sector Report.

### Potential Policy Responses
- The projected CA surplus path will keep reducing the sizeable negative NIIP as needed.
- Policies that would divert the CA from such path, including those that would weaken competitiveness and the CA, should be avoided.
- A better policy mix could keep the savings-investment balance and the projected CA path broadly unchanged while supporting growth and preserving fiscal sustainability:
  - Sustained fiscal consolidation efforts would rebuild fiscal space and raise aggregate saving.
  - Structural reforms—together with investments in strategic areas—could boost growth and raise aggregate investment.
  - Industrial policies should be pursued cautiously, remain narrowly targeted to specific objectives where externalities or market failures prevent effective market solutions, and aim to minimize trade and investment distortions.
  - Spain should persist in efforts to enhance education outcomes, encourage innovation, and reduce energy dependence from abroad.
  - The Recovery, Transformation and Resilience Plan includes investments and reforms in these areas, as well as specific measures to diversify and improve the quality of tourism services, but adequate implementation and ex-post evaluation remain critical for success.

### Foreign Asset and Liability Position and Trajectory
- Background findings:
  - The NIIP continued to improve in 2023 and reached -52.8 percent of GDP by the end of the year.
  - This trajectory reflects a larger decrease in gross liabilities compared to that in assets (as a percentage of GDP).
  - Gross liabilities—of which nearly 70 percent correspond to external debt—declined to 248.3 percent of GDP by the end of 2023.
  - Most of the negative NIIP is attributed to the general government and the central bank, with T2 liabilities amounting to 26.2 percent of GDP by December 2023.
  - The NIIP is projected to continue improving in the medium term, supported by sustained CA surpluses and the positive—though temporary—impact of Next Generation EU funds disbursements on the capital account.
- Assessment and vulnerabilities:
  - Despite projected improvement, the still large negative NIIP comes with external vulnerabilities, including those from large gross financing needs and risks of adverse valuation effects, which could be affected by the evolution of global financial conditions and policy responses.
  - Mitigating factors include the rather long maturity of outstanding sovereign debt (averaging almost eight years) and the limited share of debt denominated in foreign currency (11.9 percent of total external debt).
- Key 2023 (% GDP) levels:
  - NIIP: −52.8
  - Gross Assets: 195.5
  - Debt Assets: 95.0
  - Gross Liab.: 248.3
  - Debt Liab.: 149.0

### Current Account
- Background findings:
  - The CA surplus rose from 0.6 percent of GDP in 2022 to 2.6 percent of GDP in 2023.
  - Drivers included a strong performance of services exports (both tourism and non-tourism) and weak imports (due to the decline in energy import prices and a low—relative to historical average—elasticity of imports to domestic demand).
  - Higher public saving and weaker private investment—including due to high uncertainty and tight financial conditions—more than offset the rise in public investment and a drawdown of excess private savings generated during the pandemic.
  - Continued strength of services exports and further improvements in the energy goods balance will keep the trade surplus high in 2024.
  - In the medium term, the CA surplus is projected to shrink gradually as tourism inflows normalize and non-energy imports regain strength—supported by the shift in the economy’s growth drivers towards domestic demand, particularly investment which has a high import content.
- Assessment:
  - The 2023 cyclically-adjusted CA balance is 2.8 percent of GDP.
  - IMF staff assess the CA norm to be between 0.1 and 1.7 percent of GDP, with a midpoint of 0.9 percent of GDP, in line with the EBA CA model.
  - The difference between the cyclically-adjusted CA and the CA norm yields a CA gap in the range of 1.1 to 2.7 percent of GDP, with a midpoint of 1.9 percent of GDP.
  - The overall estimated contribution of identified policy gaps is 0.3 percent of GDP, reflecting:
    - positive contributions from a more expansionary fiscal policy stance in the rest of the world relative to Spain (0.4 percent of GDP) and relatively low credit growth (0.2 percent of GDP),
    - partially offset by the negative contribution from strong social safety nets (-0.3 percent of GDP).
- Key 2023 (% GDP) levels:
  - CA: 2.6
  - Cycl. Adj. CA: 2.8
  - EBA Norm: 0.9
  - EBA Gap: 1.9
  - Staff Adj.: 0.0
  - Staff Gap: 1.9

### Real Exchange Rate
- Background findings:
  - In 2023, Spain’s CPI- and ULC-based REER remained broadly stable, with changes relative to 2022 average of 0.3 and -0.45 percent, respectively.
  - This followed a period of sustained REER depreciation since 2009, which almost fully reversed the large appreciation during 1999–2008.
  - As of April 2024, the CPI-based REER was 1.0 percent above the 2023 average.
- Assessment:
  - The IMF staff CA gap implies a REER gap of –6.6 percent in 2023 (with an estimated elasticity of 0.28 applied).
  - The EBA REER index and level models suggest instead an overvaluation of 3.7 percent and 18.4 percent for 2023, respectively, mostly driven by large unexplained residuals.
  - Consistent with the staff CA gap, the staff assesses the REER to be moderately undervalued, with a midpoint of 6.6 percent and a range of uncertainty of ±2.8 percent.

### Capital and Financial Accounts: Flows and Policy Measures
- Background findings:
  - The capital account surplus has remained high due to flows associated with Next Generation EU funds.
  - The financial account balance improved to 4.1 percent of GDP in 2023 (from 1.9 percent of GDP in 2022).
  - The increase in the financial account surplus was largely driven by changes in the Bank of Spain’s balance sheet, which were only partially offset by net outflows in the other components.
- Assessment:
  - Large external financing needs leave Spain vulnerable to sustained market volatility and tighter global financial conditions.

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

*Source: Annex I. External Sector Assessment (IMF).*

### 0.36 percent over the period. However, on the back of the ECB’s monetary tightening, nominal yields

### 1espea2024001 - 0.36 percent over the period. However, on the back of the ECB’s monetary tightening, nominal yields

### Debt dynamics and recent financing conditions
- Nominal yields on Spanish government bonds grew steadily during 2021–23, reaching a high of 3.95 percent in October 2023.
- The spread over the German bund averaged 100bps in 2023.
- Borrowing costs remained broadly stable in late 2023 as monetary tightening in the euro area stopped and investors’ confidence remained strong.
- The amortization profile of public debt is tilted towards the long term, with an average maturity of 7.9 years.
- The low share of short-term debt helped cushion the effect of higher borrowing costs on public finances since 2022.
- The share of total debt held by the Bank of Spain:
  - rose from 18 percent in 2019 to more than 28.5 percent in mid-2022,
  - subsequently fell to 26.7 percent by late 2023.
- The share held by non-residents:
  - fell from close to 48 percent in 2019 to 42 percent in late 2023.
- The share held by resident financial institutions and the non-financial sector:
  - fell from 34 percent to 31 percent between 2019 and late 2023.

### Baseline scenario and assumptions
- Baseline projection:
  - Public debt is projected to decline to 105.6 percent of GDP in 2024 and subsequently stabilize around 103 percent of GDP over the forecast horizon.
  - Gross financing needs are projected to remain stable at a high level of around 16 percent of GDP.
- Key baseline assumptions:
  - Full but gradual winding down of anti-inflationary support measures by the end of 2024.
  - Expiration of temporary windfall levies in December 2025.
  - Phasing in of higher social security contributions from the 2021–23 reforms.
  - Disbursement of grants and loans from the EU Recovery and Resilience Fund:
    - Grants amounting to about 5.5 percent of GDP are disbursed over 2021–26 and are fiscally neutral.
    - Approximately €26. billion of loans (31 percent of the total available amount) are assumed to be drawn over 2024–28, of which approximately €6 billion will be used for spending and the remaining sum destined to credit guarantee and lending programs.
    - The loan component entails an increase in the debt-to-GDP ratio of 1.5 percentage points by 2028, which will subsequently shrink gradually as loans are repaid.

### Risk assessment (summary)
- Overall assessment: Staff assess the overall risk of debt distress to be moderate.
- Medium term:
  - High levels of debt and gross financing needs increase sensitivity of debt dynamics and rollover risk to tightening credit conditions, lower GDP growth, and weakening of the fiscal position.
  - Fan chart exercise signals high medium-term distress risk (high probability of non-stabilization under baseline fiscal path).
  - Gross financing needs (GFN) exercise signals moderate medium-term risk.
- Long term:
  - Ageing-related expenditures (pensions, healthcare, long-term care) are the main source of long-term risk and are assessed as high.
  - AIReF projects public expenditures on pensions (net of recent revenue measures), healthcare, and long-term care to rise by approximately 4.5 p.p. of GDP between 2023 and 2050, partly offset by lower public education expenditures of approximately 0.6 p.p. of GDP.
  - If unaddressed, ageing-related costs could entail a sustained rise in the debt-to-GDP ratio starting from 2035.
- Pension reform features and risks:
  - 2021–23 reforms raised current workers’ contribution rate.
  - Intergenerational Equity Mechanism: portion of increased revenues destined to a reserve fund with disbursements allowed only after 2033 and with a yearly cap.
  - Reinstatement of pension benefits indexation to inflation increases future expenditures.
  - AIReF estimates benefit expenditures will grow faster than revenues over 2024–50, leading to a widening shortfall starting in 2030.
  - Safeguard clause: tri-annual review by AIReF starting in 2025; if average projected expenditures over 2022–50 (net of introduced revenue measures) exceed 13.3 percent of GDP, the review will recommend additional measures to increase contributions or reduce outlays; absent political agreement, a gradual increase in contribution rates serves as last-resort option.

### Debt coverage, structure, and mitigating factors
- Debt coverage: general government level.
- Commentary: Debt is predominantly issued in domestic currency, under domestic law, and is marketable.
- Domestic creditors and the central bank own more than half of all issued debt.
- The average residual maturity is close to 8 years.
- Mitigating factors for debt sustainability include the high share of debt held by the ECB and domestic investors, and the long average maturity.

### Baseline projections and key fiscal numbers (percent of GDP unless indicated otherwise)
- Public debt:
  - 2023: 107.7
  - 2024: 105.6
  - 2025: 104.4
  - 2026: 104.3
  - 2027: 104.2
  - 2028: 103.7
  - 2029: 103.2
  - 2030: 102.8
  - 2031: 102.3
  - 2032: 101.7
  - 2033: 101.1
- Change in public debt:
  - 2023: -4.0
  - 2024: -2.0
  - 2025: -1.2
  - 2026: -0.1
  - 2027: 0.0
  - 2028: -0.5
  - 2029: -0.5
  - 2030: -0.5
  - 2031: -0.5
  - 2032: -0.6
  - 2033: -0.6
- Contribution of identified flows (same values as "Change in public debt" for 2024–2033):
  - 2023: -7.3
  - 2024: -2.0
  - 2025: -1.2
  - 2026: -0.1
  - 2027: 0.0
  - 2028: -0.5
  - 2029: -0.5
  - 2030: -0.5
  - 2031: -0.5
  - 2032: -0.6
  - 2033: -0.6
- Primary deficit:
  - 2023: 1.8
  - 2024: 0.6
  - 2025: 0.3
  - 2026: 0.4
  - 2027: 0.4
  - 2028: 0.3
  - 2029: 0.3
  - 2030: 0.3
  - 2031: 0.3
  - 2032: 0.3
  - 2033: 0.3
- Noninterest revenues:
  - 2023: 42.2
  - 2024: 42.6
  - 2025: 42.6
  - 2026: 42.4
  - 2027: 41.6
  - 2028: 41.6
  - 2029: 41.6
  - 2030: 41.6
  - 2031: 41.6
  - 2032: 41.6
  - 2033: 41.6
- Noninterest expenditures:
  - 2023: 44.0
  - 2024: 43.3
  - 2025: 42.9
  - 2026: 42.8
  - 2027: 42.0
  - 2028: 41.8
  - 2029: 41.9
  - 2030: 41.9
  - 2031: 41.9
  - 2032: 41.9
  - 2033: 41.9
- Automatic debt dynamics (contribution):
  - 2023: -8.8
  - 2024: -2.7
  - 2025: -1.6
  - 2026: -0.6
  - 2027: -0.4
  - 2028: -0.5
  - 2029: -0.5
  - 2030: -0.4
  - 2031: -0.5
  - 2032: -0.5
  - 2033: -0.5
- Real interest rate and relative inflation:
  - Contribution: -6.1 (2023), -0.2 (2024), 0.5 (2025), 1.2 (2026), 1.2 (2027), 1.2 (2028), 1.2 (2029), 1.2 (2030), 1.1 (2031), 1.1 (2032), 1.1 (2033)
- Real growth rate (contribution):
  - 2023: -2.7
  - 2024: -2.5
  - 2025: -2.1
  - 2026: -1.8
  - 2027: -1.7
  - 2028: -1.7
  - 2029: -1.7a.
  - 2030: -1.6
  - 2031: -1.6
  - 2032: -1.6
  - 2033: -1.6
- Other identified flows:
  - 2023: -0.2
  - 2024: 0.1
  - 2025: 0.1
  - 2026: 0.0
  - 2027: 0.0
  - 2028: -0.3
  - 2029: -0.3
  - 2030: -0.3
  - 2031: -0.3
  - 2032: -0.3
  - 2033: -0.4
- (Minus) Interest Revenues:
  - 2023: -0.6
  - 2024: -0.3
  - 2025: -0.2
  - 2026: -0.3
  - 2027: -0.3
  - 2028: -0.3
  - 2029: -0.3
  - 2030: -0.3
  - 2031: -0.3
  - 2032: -0.3
  - 2033: -0.3
- Other transactions:
  - 2023: 0.4
  - 2024: 0.3
  - 2025: 0.3
  - 2026: 0.3
  - 2027: 0.3
  - 2028: 0.0
  - 2029: 0.0
  - 2030: 0.0
  - 2031: -0.1
  - 2032: -0.1
  - 2033: -0.1
- Contribution of residual:
  - 2023: 3.3
  - 2024–2033: 0.0 each year
- Gross financing needs:
  - 2023: 15.3
  - 2024: 17.1
  - 2025: 16.2
  - 2026: 16.4
  - 2027: 16.5
  - 2028: 16.3
  - 2029: 16.3
  - 2030: 16.3
  - 2031: 16.3
  - 2032: 16.3
  - 2033: 16.3
- Of which: debt service (same values as GFN for 2024–2033):
  - 2023: 14.1
  - 2024: 16.7
  - 2025: 16.2
  - 2026: 16.3
  - 2027: 16.3
  - 2028: 16.3
  - 2029: 16.3
  - 2030: 16.3
  - 2031: 16.3
  - 2032: 16.3
  - 2033: 16.3
- Local currency vs. foreign currency GFN:
  - Local currency: same values as GFN above.
  - Foreign currency: 0.0 for all years shown.
- Memo indicators:
  - Real GDP growth (percent):
    - 2023: 2.5
    - 2024: 2.4
    - 2025: 2.1
    - 2026: 1.8
    - 2027: 1.6
    - 2028: 1.6
    - 2029: 1.6
    - 2030: 1.6
    - 2031: 1.6
    - 2032: 1.6
    - 2033: 1.6
  - Inflation (GDP deflator; percent):
    - 2023: 5.9
    - 2024: 2.8
    - 2025: 2.3
    - 2026: 1.7
    - 2027: 1.7
    - 2028: 1.8
    - 2029: 1.8
    - 2030: 1.7
    - 2031: 1.7
    - 2032: 1.7
    - 2033: 1.7
  - Nominal GDP growth (percent):
    - 2023: 8.6
    - 2024: 5.2
    - 2025: 4.4
    - 2026: 3.5
    - 2027: 3.4
    - 2028: 3.4
    - 2029: 3.4
    - 2030: 3.4
    - 2031: 3.4
    - 2032: 3.4
    - 2033: 3.4
  - Effective interest rate (percent):
    - 2023: 0.0
    - 2024: 2.6
    - 2025: 2.8
    - 2026: 2.9
    - 2027: 2.9
    - 2028: 2.9
    - 2029: 3.0
    - 2030: 2.9
    - 2031: 2.9
    - 2032: 2.9
    - 2033: 2.9

### Medium-term risk analysis (indices and signals)
- Debt fanchart module:
  - Fanchart width: 84.8 1.2
  - Probability of debt non-stabilization (percent): 52.3 0.4
  - Terminal debt-to-GDP x: 37.4 0.8
  - Debt fanchart index (DFI): 2.5
  - Risk signal from fanchart: High
- Gross Financing Needs (GFN) module:
  - Average baseline GFN: 16.5 5.6 (percent of GDP)
  - Initial Banks' claims on the general government (pct bank assets): 10.7 3.5
  - Change in banks' claims in stress (pct banks' assets): 4.5 1.5
  - GFN financeability index (GFI): 10.6
  - Risk signal from GFN: Moderate
- Medium-term index and final assessment:
  - Medium-term index: Moderate
  - Final assessment: Prob. of missed crisis, 2024-2029, if stress not predicted: 27.3 pct.
  - Prob. of false alarms, 2024-2029, if stress predicted: 15.9 pct.

*Source: Fund staff.*

### Annex III. Figure 7. Spain: Long-Term Risk Analysis

### Annex III. Figure 7. Spain: Long-Term Risk Analysis

### Long-term amortization risk: headline findings
- The overall long-term amortization risk signal is not triggered.
- Medium-term extrapolations show a stabilization of GFN around 16 percent of GDP and total public debt around 100 percent of GDP.
- Medium-term extrapolations signal a high risk in terms of the amortization level because sustained GDP deflator growth mechanically implies a rise in the nominal value of debt; however, amortization relative to GDP remains stable and the amortization signal is not triggered.
- Extrapolation based on historical averages for key fiscal (e.g., primary balance, effective interest rates) and macroeconomic (e.g., real growth, inflation) variables implies a high amortization risk; this scenario is strongly influenced by the highly exceptional period of the COVID-19 pandemic and thus has limited informative content for the long-term horizon considered.

### Projection scenarios and indicators shown
- Projection variables referenced: GFN-to-GDP ratio; Amortization-to-GDP ratio; Amortization; Total public debt-to-GDP ratio.
- Scenarios/lines indicated in the projections:
  - Long run projection
  - Projection
  - Baseline with t+5
  - Baseline with t+5 and DSPB
  - Historical 10-year average
- Time span shown on figure axes includes year labels from 2016 through 2052.

### Key numeric levels explicitly reported
- GFN stabilizing around 16 percent of GDP (medium-term extrapolation).
- Total public debt stabilizing around 100 percent of GDP (medium-term extrapolation).
- Historical/historical-average scenario flagged as implying high amortization risk due to COVID-19 influence (no alternative numeric central estimate provided in the figure text).

### Data adequacy and related diagnostics (Annex IV)
- Staff assess the overall data quality as adequate for the Fund's surveillance.
- Suggested improvements include:
  - Reducing the magnitude of expenditure-based GDP components' revisions.
  - Improving GDP data granularity, including by publishing separately private and public investment or increasing the number of economic activities reported on the production side.
  - Enhancing consistency across different data sources (for example, trade data in the national accounts versus in BOP) in preliminary data releases.
- Data on execution of NGEU investments remains scarce and is published with significant delay; reporting is not done in national accounts terms.
- The data provided to the Fund is assessed along multiple domains (National Accounts, Prices, Government Finance Statistics, External Sector Statistics, Monetary and Financial Statistics, Inter-sectoral Consistency) with an overall Data Adequacy Assessment Rating of "A".

### Data Standards and metadata (Annex IV: Table of Common Indicators)
- Spain adheres to the Special Data Dissemination Standard (SDDS) Plus since February 2015 and publishes data on its National Summary Data Page.
- The Table of Common Indicators lists standard series such as Exchange Rates; International Reserve Assets and Reserve Liabilities of the Monetary Authorities; GDP/GNP; Reserve/Base Money; Broad Money; Central Bank Balance Sheet; Consolidated Balance Sheet of the Banking System; Interest Rates; Consumer Price Index; Revenue, Expenditure, Balance and Composition of Financing (General Government and Central Government); Stocks of Central Government and Central Government-Guaranteed Debt; External Current Account Balance; Exports and Imports of Goods and Services; Gross External Debt; International Investment Position.
- Footnotes clarify inclusion of reserve assets pledged or encumbered, market-based and officially determined interest rates, and scope definitions for government.

### Implementation status of 2022 AIV policy recommendations (Annex V): selected items
- Fiscal consolidation and medium-term planning:
  - Authorities signaled commitment to steady medium-term consolidation; no individual measures identified besides phasing out energy support measures and extension of temporary levies on banks and energy companies.
  - Authorities currently do not publish a medium-term fiscal plan; under revamped EU economic governance framework they will be required to submit a National Medium-Term Fiscal-Structural plan to the European Commission.
- Pensions:
  - The 2023 pension reform introduced revenue measures including: an increase in contribution rates under the intergenerational equality mechanism (MEI); an increase in the upper bound of the contribution base; a solidarity contribution over the portion of salaries that is above the contribution base; and fiscal incentives to encourage delayed retirement.
  - The reform established a safeguard mechanism with forward-looking review powers to prescribe corrective measures.
- Labor market and minimum wage:
  - Employment Law revamping ALMPs came into force on February 28, 2023 and is in implementation.
  - Minimum wage increases since 2022: February 2023 increase by 8 per cent and February 2024 increase by 5 percent; these increases were not set in line with productivity growth but aimed to bring the net minimum wage closer to the target of 60 percent of average net earnings.
- Housing and NGEU reporting:
  - Housing law approved in May 2023 and national housing plan include targeted rent support programs, increased taxes on empty properties, expansion of social housing stock, and reforms to streamline urban planning; authorities expect a draft law modifying the Law on Land and Urban Rehabilitation to be passed by the end of 2024.
  - Data on execution of NGEU investments has improved but reporting is still not done in national accounts terms.

### 2024 FSAP: Key Recommendations (Annex VI): selected priority actions and timing
- Systemic risk analysis and monitoring:
  - Enhance data collection and monitoring of foreign investments in the real estate market. (Addressees: BdE, CNMV, DGSFP; Timing: NT)
  - Create infrastructure for more granular cash-flow analysis and report regular stress testing results. (BdE; Timing: NT)
- Financial sector oversight and macroprudential:
  - Ensure alignment of supervisory resources to workload. (Government, BdE, CNMV, DGSFP; Timing: I)
  - Grant full autonomy to CNMV over recruitment and retention processes. (Government, CNMV; Timing: I)
  - Deploy policies to ensure banks raise capital buffers, including consideration of a positive neutral countercyclical buffer. (BdE, AMCESFI; Timing: I)
  - Increase frequency of AMCESFI Council meetings and raise transparency by publishing meeting minutes/summaries and timely Annual Reports. (AMCESFI; Timing: I)
- Supervision of LSIs and resolution:
  - Enhance BdE independence by removing MINECO appeal powers against BdE supervisory decisions and limiting government role in BdE Governing Council. (MINECO; Timing: NT)
  - Integrate preventative resolution authority functions and improve statutory resolution regime (various measures assigned to MINECO and BdE; Timing: I/NT).
- A broader set of 20+ numbered recommendations are listed with assigned addressees and timing categories: I = Immediate (within one year); NT = Near Term (within 1–3 years); MT = Medium Term (within 3–5 years).

### Temporary levies and taxes introduced since 2022: context and status (Annex VII)
- Context:
  - In response to the sharp rise in energy and food prices in 2021 and 2022, governments introduced fiscal support measures while central banks tightened monetary policy in 2022 and 2023; energy companies benefited from higher revenues and banks potentially from increased net interest margins.
- Spain's measures:
  - Temporary wealth tax and windfall levies were introduced to finance support measures, amounting to 1 percent of GDP in 2023.
  - In December 2022 the central government introduced levies (gravámenes) on energy companies and financial institutions and a “solidarity tax on large fortunes” of households.
  - In 2023, total revenue from the three measures amounted to € 3.5 billion, referring to business activities and households’ wealth in 2022.
  - The measures were initially set for 2023 and 2024; in December 2023 authorities extended the two levies through 2025 and signalled possible conversion into permanent taxes with revised designs.
  - Authorities signalled that the solidarity tax would remain in place until a broader review of wealth taxation is undertaken in the context of a reform of the financing system of autonomous communities (RDL 8/2023).
  - A deduction from the energy levy for investments in green energy projects was announced to be defined in the 2024 general budget; in the absence of a 2024 budget law, the deduction has not yet been introduced.

*Source: Annex III–VII excerpts from 1espea2024001 - Annex III. Figure 7. Spain: Long-Term Risk Analysis (PDF).*

### 3.      While the temporary levies and tax provided an important revenue contribution, the

### Temporary levies and tax; Bank levy; Energy company levy; Solidarity tax; Annex VIII — 35-hour working week reform (France)

### Temporary levies and windfall taxation — key messages
- Temporary levies and the solidarity tax provided an important revenue contribution but windfall taxation should remain limited and temporary.
- If extended permanently in their current form, the two levies and the solidarity tax could be particularly distortionary and create uncertainty, which could deter already subdued investment.
- They do not constitute a sound alternative to more structural revenue-raising tax policy measures.
- If kept as part of fiscal consolidation, a redesign should be considered, including:
  - Aligning the tax base of the two levies with a clear definition of “excess” profits in the respective sectors.
  - For the solidarity tax, encouraging autonomous communities to establish a commonly agreed minimum rate of the regional wealth tax instead of establishing an additional wealth tax at the national level — to balance minimizing distortions across regions and granting fiscal autonomy to regional governments.

### B. Bank Levy — description, outcomes, and design considerations
- Description and scope:
  - The levy imposes a 4.8 percent tax on the net interest income (NII) and fees of financial institutions operating in Spain.
  - It only applies to banks with revenues above the threshold of €800 million in 2019.
- 2023 outturn and significance:
  - In 2023 (referring to the financial year 2022), the levy’s outturn amounted to €1.2 billion.
  - Staff estimate that this sum represents approximately 10 percent of banks' profits connected to activities in Spain in 2023.
  - Conclusion: the levy is a rather small but non-trivial fraction of profits — not seen to have a significant negative effect on the financial sector so far, but sizable enough to factor into banks' future decisions if extended.
- Limitations of current design:
  - Base defined in terms of NII and fees rather than profits — so does not account for institutions having high interest margins but low overall profits, and vice versa.
  - Higher-risk lending could be discouraged because higher average returns would be taxed while larger loss provisions would not be deductible.
  - Defining banks’ fundamental profitability and identifying “exceptional” or excess profits is challenging.
  - On a consolidated basis, Spanish banks' return-on-equity did not experience large increases relative to European peers in 2022-2023, but domestic profitability rose to its highest level since the GFC.
  - The (€800 million) revenue threshold implies smaller institutions are exempt regardless of profitability increases in 2022.
- If converted to a permanent tax — recommended design improvements:
  - First, align the base to a clear definition of the excess component of profits, distinguishing profits due to market distortions from those due to conjunctural factors or normal returns to capital; only the former should be included.
  - If intended for financial stability or quantitatively large enough to affect operations, carefully consider interaction with macroprudential policies and counter-cyclical capital buffers.
  - Consider features to support policy objectives: for example, a tax credit reducing banks’ liability in proportion to capital set aside to comply with a positive neutral rate of the counter-cyclical capital buffer (CCyB), should the latter be introduced.
  - Design changes that minimize distortionary effects would likely decrease revenue potential because narrowing the base to well-identified excess profits reduces tax liabilities.
- Revenue prospects:
  - Conjunctural developments will likely reduce revenues from the levy in coming years.
  - As ECB monetary policy continues to pass through to domestic deposit rates and enters an easing phase, banks’ NII margins would narrow.

### C. Energy Company Levy — description, outcomes, and design considerations
- Description and scope:
  - A 1.2 percent levy on the net turnover of energy companies operating in Spanish territory for 2023 and 2024.
- 2023 outturn and reactions:
  - In 2023, the levy collected €1.6 billion in revenues relating to companies’ activities in 2022.
  - The measure faced significant criticism from energy companies; some large conglomerates threatened to shift business and new investment projects to other countries if the levy were extended.
  - In December 2023 the levy was extended until 2025, and a deduction for investment in renewable energy projects was announced; in the absence of a budget law for 2024, such deductions have yet to be implemented.
- Limitations of current design:
  - The base does not necessarily capture energy companies’ profits and lacks a clear definition of the excess component of profits.
  - The levy is not an environmental tax: it does not differentiate between energy sources based on carbon content, nor is it calibrated to address a well-identified negative environmental externality.
  - The proposed deduction for green energy projects may function as a valuable incentive for sustainable energy production.
- If converted to a permanent instrument — recommended considerations:
  - Align the base to a clear definition of the excess component of profits in the energy sector, distinguishing profits due to fluctuations in underlying energy prices from excess profits due to domestic competitive distortions.
  - Consider interactions with existing energy taxes and environmental taxes (e.g., preferential VAT rates, tax on the value of energy produced, excise tax on electricity) and the complex landscape across levels of government — with focus on economic efficiency and environmental objectives.
  - Restricting the base to non-competitive profits would reduce distortionary effects but inevitably reduce revenue potential.
- Revenue prospects:
  - With energy prices in Europe having mostly normalized since the 2021-2022 spike, expected revenue of the levy in the foreseeable future is expected to fall below the 2023 outturn, providing a smaller contribution to fiscal consolidation efforts.

### D. Solidarity Tax on Large Fortunes — features, incidence, and regional dynamics
- Design and rates:
  - Introduced in December 2022 as a temporary tax on household wealth targeted to large estates.
  - Imposes marginal tax rates ranging between 1.7 percent and 3.5 percent on net wealth portfolios of €3 million and higher.
  - Tax base defined as all household wealth (including real estate) with an allowance of €700 thousand plus an additional €300 thousand for primary residences.
  - In December 2023 the central government announced the extension of the tax.
- Interaction with regional wealth taxes:
  - The solidarity tax includes a full credit for taxpayers’ liability to the pre-existing wealth tax administered and collected by autonomous community governments.
  - As most communities enforce a wealth tax, only a small number of very high-net worth taxpayers in each community faced an outstanding liability to the solidarity tax in 2023.
  - Exception: the Community of Madrid historically has not enforced a wealth tax.
- 2023 revenue and regional concentration:
  - In 2023 the solidarity tax collected €623 million, of which €555 came from residents of the Community of Madrid.
  - The Community of Madrid challenged the tax in the Constitutional Court; the tribunal ruled in favor of the measure (Spanish Constitutional Court 149/2023, judgement of November 7).
- Regional policy actions and implications:
  - In December 2023 the Community of Madrid announced a temporary change redirecting the revenues of the solidarity tax to the regional government instead of the central government.
  - In practice, this would charge a regional wealth tax only to residents who would owe any amount of the solidarity tax, fully eliminating their ultimate liability to the central solidarity tax; all other taxpayers would remain unaffected.
  - This provision would imply a very substantial reduction in the revenue the central government would collect on the solidarity tax in 2024 and 2025.
  - The Community of Madrid also announced plans to introduce fiscal benefits targeted to high-net worth individuals (e.g., incentives to set up new firms, hire workers, investment deductions to the regional PIT) that could net out increased wealth-tax revenue at the general level.
- Policy trade-offs and recommendations:
  - Well-designed wealth taxes can be valuable for revenue mobilization and redistribution, but large heterogeneity in tax rates across regions could be particularly distortive.
  - In Spain, where the wealth tax is administered at the autonomous community level, it is important to preserve regional governments’ fiscal autonomy while avoiding excessive heterogeneity that could drive residential choices by tax concerns.
  - A national top-up to the regional tax would be at odds with leaving wealth taxation to autonomous communities; cooperation across communities to establish a commonly agreed minimum wealth tax rate is a more viable compromise.

### Annex VIII. Lessons From the 35-Hour Working Week Reform in France
A. Key elements
- Legislation and timing:
  - The law enacted in June 1998 (Aubry I) mandated a reduction of the workweek from 39 to 35 hours in large firms (more than 20 employees) by February 2000 and in small firms by January 2002.
  - A follow-up law enacted in January 2000 (Aubry II) introduced detailed legal provisions including definition of working time, overtime hours, working time of managers and minimum wage.
- Incentives and compensation:
  - Firms that lowered current employees' working hours by 10 percent and created 6 percent more jobs before January 2000 would receive deductions in their social security contributions.
  - Overtime beyond 35 hours treated as overtime, capped at 130 per year, with a wage premium of 25 percent (10 percent during the transition period and for small firms) for the first eight hours and of 50 percent for any additional hours.
  - Firms had to bargain with unions over hourly wage increases and other conditions; government offered social security contribution rebates to compensate firms for overtime costs.
  - Monthly salaries for minimum wage workers were guaranteed unchanged via a guaranteed monthly remuneration (lump-sum supplement).
- Scope and application:
  - Reform applied to the private sector only; public sector implemented reductions in some areas without creating new jobs (leading to staff shortages and accumulation of overtime debt in some public services).
- Flexibilities:
  - Law allowed annualization up to a maximum of 1,600 hours per year (i.e., 35 hours per week on average), distributing hours based on firms’ needs to respond to cyclical or seasonal fluctuations.

B. Economic effects — empirical regularities and findings
- Change in hours worked:
  - Official reduction was 10 percent, but actual working time reduction was on average 4–6 percent due to flexibilities, exceptions, and firms’ adjustments (e.g., excluding certain periods from effective hours calculations).
- Employment impact — mixed evidence:
  - Some studies show positive employment effects (Gubian et al, 2004; Crépon, Leclair and Roux, 2004).
  - Other studies find null or negative effects (Estevão and Sá, 2008; Chemin and Wasmer, 2009; Batut, Garnero, Tondini, 2022).
  - Assessment complicated by subsequent policy changes (Fillon relaxation measures in 2003 and other amendments) preventing long-run evaluation.
- Wages and labor costs:
  - The reform increased hourly wages for jobs whose annual/weekly wage was not reduced proportionally — notably minimum-wage workers whose monthly earnings were guaranteed.
  - For firms that reduced working hours to 35 hours, labor costs did not increase significantly due to reduced social security contributions and productivity increases.
  - Firms with minimum-wage workers that did not reduce working hours experienced cost increases because of revaluation of the hourly minimum wage, potentially affecting employment of the least qualified employees.
- Wage moderation and labor income share:
  - The reform generated persistent wage moderation for workers above the minimum wage (partial wage freeze for one to three years agreed with unions).
  - Wage moderation, reductions in social security contributions and productivity gains contributed to keep the labor income share in value added broadly unchanged after the reform.
- Flexibility and productivity:
  - Annualization and liberalization of working-time schedules provided firms with more flexibility, potentially yielding gains in hourly productivity while creating more irregular work schedules for employees.
- Social outcomes:
  - Despite some dissatisfaction due to schedule irregularity and wage moderation, increases in leisure and family time were noted as welcome by employees.

*Source: 1espea2024001 — excerpts from the provided IMF chapter content.*

### 12.      The working week reduction had a significant fiscal cost for the government. To dampen  the

### 12.      The working week reduction had a significant fiscal cost for the government. To dampen  the

### Fiscal cost and compensation mechanism
- The reform compensated companies for overtime costs via a reduction in social security contributions.
- Had the reform been fully implemented and effectively reduced the average working week to 35 hours, its direct fiscal cost could have reached about 1 percent of GDP (Askenazy, 2013).
- Unit labor costs are defined as the ratio of hourly labor costs to GDP per hour.

### Employment and distributional effects
- Employment gains are unclear and possibly small, especially if the working week is cut without reducing (weekly or annual) wages.
- Workers ultimately end up bearing at least some of the costs of the working week reduction—even if wages are not reduced initially, years of wage moderation may follow.
- As a result, the labor share may ultimately remain broadly unchanged despite an initial increase in hourly wages, as happened in France.

### Medium-term output and productivity scenarios
- Under the assumption that the proposed reform would close 50 percent of the working hours gap, effective hours worked would fall by 3 percent.
- Assuming a unitary elasticity between long-term output to long-term labor input, and productivity gains ranging between 0 and 1/3, income per capita would decline by 2 to 3 percent, all else equal.

### Implementation considerations and policy recommendations
- To minimize activity disruptions and enhance the likelihood of productivity gains, social partners should negotiate how to implement any working-time reduction to accommodate the existing wide cross-sector heterogeneity.
- The interplay between working week reduction and the minimum wage needs to be carefully managed, avoiding another sizeable increase in the hourly minimum wage or a large fiscal cost (if social security contributions are cut to mitigate the minimum labor cost shock).
- Implementation in the public sector should be commensurate to the very small gap that exists between the current effective working time and the new legal norm; implications for the delivery and quality of public services should be carefully considered.

*Source: SPAIN STAFF REPORT FOR THE 2024 ARTICLE IV CONSULTATION—INFORMATIONAL ANNEX, Prepared By European Department, May 15, 2024.*

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_Source: https://www.imf.org/-/media/files/publications/cr/2024/english/1espea2024001.pdf_