## 1. Household Deleveraging and Growth

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---

### Context and Outlook
- Economic performance and drivers
  - Economy expanded at 1.4 percent in 2014; growth accelerated significantly in the first half of 2015.
  - Real GDP growth is expected at 3.1 percent in 2015 and 2½ percent in 2016.
  - Employment increased with the rebound in demand and moderate wage growth; employment growth reached over 3 percent by end-2014.
  - New credit is being extended to firms (especially those with strong financial positions) and to households; deleveraging is slowing.
  - Housing prices started to increase moderately in the second half of 2014—albeit unevenly across regions—and investment and employment in construction have started to recover.
- External and financial conditions
  - Sovereign bond yields are about 5¼ percentage points below their 2012 peak.
  - The external current account registered a 0.8 percent of GDP surplus in 2014.
  - Spain’s negative net international investment position (NIIP) was 93 percent of GDP in 2014.
  - The cyclically adjusted current account remained ½ to 2½ percent of GDP weaker than what would be consistent with medium-term fundamentals and desirable policy settings.
  - The real effective exchange rate (REER) is assessed to be about 5–10 percent overvalued.
- Structural constraints on medium-term growth
  - Potential growth is still very low, of less than 1½ percent.
  - Absent further reforms, unemployment would remain at an estimated structural level of about 16½ percent as the output gap closes.
  - Private and public debt levels remain high, at 235 and 98 percent of GDP, respectively.
  - Household debt remains significantly above pre-crisis levels.

### Risks and Vulnerabilities
- Main downside risks (likelihood; impact)
  - Weak euro area demand and persistently low inflation. (Likelihood: High; Impact: Medium)
  - Sharp asset price adjustment and decompression of credit spreads. (Likelihood: High; Impact: Low/Medium)
  - Euro area bond market contagion. (Likelihood: Medium; Impact: Medium)
  - Reversal of past structural reforms that undermines confidence and growth. (Likelihood: Low/Medium; Impact: High)
- Amplifying factors
  - Contagion risks from developments in Greece could renew sovereign and financial sector stress in Spain.
  - A strong link between domestic demand and imports limits scope for current account improvement as growth strengthens.
- Authorities’ assessment
  - Authorities have higher forecasts for medium-term growth and attribute the rebound to reforms and progress in correcting imbalances, but agree that vulnerabilities and structural issues require attention.

### Labor Market: Status, Reforms, and Recommendations
- Key statistics and labor market snapshot
  - More than 5 million Spaniards, over 23 percent of the labor force, remain unemployed.
  - As of the first quarter of 2015:
    - More than 23 percent of the active labor force were looking for a job.
    - More than half of those under 24 years old were looking for a job.
    - About 60 percent of the unemployed have been jobless for over a year.
  - The share of temporary jobs in overall employment has remained fairly steady at around 25 percent.
- Impact of reforms and remaining challenges
  - Authorities broadly agreed that labor market reforms were a crucial driver of the recovery and the pickup in employment, but emphasized allowing time for social partners to adapt.
  - Duality remains a problem; solutions are complex.
- Policy agenda: main priorities (labor market focus)
  - Keep wage growth aligned with productivity and external competitiveness developments.
  - Ensure wages reflect differing business conditions across firms by increasing use of firm-level adjustment options and removing obstacles to firm-level wage bargaining and opt-out, particularly for small firms.
  - Reduce duality by closing the gap between dismissal costs for permanent and temporary workers, for example:
    - Introducing a single contract with tenure-based dismissal costs in sectors without high seasonal turnover; or
    - Uniformly financing dismissal costs through regular employer contributions to a common fund.
  - Reduce legal and administrative uncertainties in collective dismissals and streamline application of objective criteria for fair dismissals.
  - Strengthen active labor market policies: monitor, evaluate, and fine-tune programs to improve skills of the long-term unemployed and low-skill youth; increase effectiveness of public and private job-placement agencies.

### Boosting Small Firm Growth — findings and policy recommendations
- Findings
  - Productivity growth is fundamentally weak, partly reflecting the dominance of small firms.
  - Spanish firms tend to be more numerous, smaller, less productive, innovative, and export-oriented than those of most European peers.
  - Firms with fewer than 50 workers employ nearly two thirds of the labor force while generating only about half of the value added in the economy.
  - The productivity gap between small and large companies is wider than in many other European countries.
  - Staff analysis: lowering the share of small firms to match that of Germany and closing the productivity gap between small and large firms to German levels could raise aggregate TFP by as much as 9 percent, with most improvement coming from reallocation of employment between firms.
  - Obstacles to firm expansion include regional heterogeneity and market fragmentation, size-dependent regulatory thresholds, and limited financing access.
- Policy recommendations
  - Fostering competition:
    - Fast and effective implementation of the Market Unity Law.
    - Move ahead with long-delayed liberalization of professional services to facilitate market entry and resource allocation.
  - Lowering constraints:
    - Review and eliminate unwarranted size-related rules and regulations; recent corporate tax reform reduces fiscal disincentives to expand.
  - Supporting exports:
    - Government strategy should help SMEs enter export markets and remain competitive by reducing high fixed costs of exporting and fostering innovation.
  - Strengthening access to finance:
    - Increase market-based financing for SMEs (alternative exchanges, venture capital, securitization).
    - Increase accuracy of financial reporting and transparency (e.g., include consolidated financial information of SMEs in centralized database and register).
    - Continue ICO program providing guarantees and direct financing for new firms; complement with European efforts (including guarantees under the Juncker plan) ensuring support to all SMEs lacking market access.
- Authorities’ view
  - Agreed on need to help firms grow and noted ongoing implementation of the Market Unity Law and efforts to address differences in regulatory norms across Spain; emphasized link between firm size and export orientation.

### Further Strengthening Banks While Reducing Debt — indicators, challenges, and policies
- Recent improvements and indicators
  - Domestic non-performing loans (NPL) ratio fell to 12.1 percent at end-March 2015 from 13.4 percent one year earlier.
  - Provisions rose to 57 percent of NPLs—significantly above the euro area average.
  - Phased-in Basel III CET1 capital ratio of the system reached 11.8 percent (ranging between 9.7 and 12.7 in the case of the 10 largest banks).
  - Spanish banks on track to complete the fully-loaded Basel III capital schedule on schedule—or ahead of time for two SIFIs.
  - Funding conditions improved due to ECB TLTROs and lower market financing costs; resident deposits declined moderately due to shift to higher yielding instruments.
  - Spanish banks fully complying with phased-in liquidity coverage ratio (LCR) requirement of 60 percent.
  - Operating costs-to-income lowered by 1.5 percentage points (to 49 percent) at end-2014; number of commercial banks fell from 50 to 15 during 2012–14.
  - Overall credit still declining, but pace slowed from around -10 percent at end-2013 to -5 percent year-on-year in April 2015, and expected to turn positive by the end of this year.
  - New credit increasingly extended to non-financial corporations outside real estate and construction; new household credit also growing.
  - SSM now directly supervises Spain’s larger banks representing more than 90 percent of banking system assets; BRRD transposition approved in June 2015.
- Challenges
  - Upcoming international regulations on fully-loaded Basel III, TLAC, and MREL will likely demand additional loss-absorbing capacity.
  - Possible change in treatment of deferred tax assets (DTAs) might require additional capital buffers for some banks.
  - Prolonged low-interest rate environment could compress lending margins.
  - Some banks face significant costs from foreclosed assets and high levels of NPLs.
- Policy suggestions
  - Encourage banks to increase high-quality capital (e.g., through equity and restraint on dividends and bonuses).
  - Reduce carrying costs associated with high levels of NPLs (administration, capital, funding charges).
  - Ensure favorable credit conditions for financially-sound households and corporates and reduce likelihood that credit growth is supply-constrained as recovery matures.

### Insolvency Reforms — effects, estimates, and implementation issues
- Reforms enacted
  - Early 2015 introduction of a “fresh start” for individual entrepreneurs and consumers: conditional discharge of individuals’ residual debt after liquidation of assets in bankruptcy.
  - Amendments to out-of-court restructuring mechanism for SMEs and restructuring/liquidation procedures to facilitate restructuring of viable firms and sale of businesses as going concerns.
- Staff analysis of potential effects
  - “Fresh start” could potentially reduce stock of household debt by around 3–4 percent and level of corporate debt by about 1–2 percent relative to the baseline, contributing to higher private consumption and investment.
  - Negative effects on bank earnings estimated to be limited.
- Implementation challenges and recommendations
  - Provide greatest possible clarity regarding post-liquidation payment plan and conditions for revocation of the fresh start to reduce uncertainty and limit potential for abuse.
  - Fully involve public creditors; making at least those public claims considered ordinary (i.e., 50 percent of tax and social security claims) subject to discharge after liquidation would increase effectiveness and avoid incentives to prioritize payments to public creditors over private ones.
  - Staff estimates that possible immediate public sector impact likely small and could be positive longer term if formal-sector activity increases.
- Authorities’ view
  - Broad agreement on assessment of banks and general concurrence with staff’s views on insolvency reforms.
  - Agreed on need to clarify certain key elements in the “fresh start”; Parliament has approved amendments to do so.
  - Authorities did not consider exclusion of public creditors would limit reform’s effect and pointed to potential fiscal repercussions and harmful impact on current tax deferment policy.

### Ensuring a Coordinated and Credible Fiscal Consolidation
- Findings
  - Public debt is close to 100 percent of GDP and still increasing.
  - 2015 deficit target of 4.2 percent is being helped by higher than expected nominal growth and relatively low interest rates.
  - Bringing headline deficit below 3 percent to exit the Excessive Deficit Procedure (EDP) in 2016 and reaching structural balance in 2020 will be challenging; measures specified so far fall short of required structural adjustment.
  - Fiscal risks at the regional level are particularly high; regional targets systematically missed despite Budget Stability Law (BSL) and improved practices.
- Recommendations
  - Use windfalls from higher nominal growth and lower borrowing costs to bring the deficit down further.
  - Pace of structural adjustment of around ½ percent of GDP per year would ensure debt is put firmly on a downward path.
  - Raise excise duties and environmental levies, and gradually phase out VAT preferential treatments to align collection efforts with other European countries and support growth-friendly consolidation.
  - Protect vulnerable groups by strengthening transfer and tax system support; consider reducing or eliminating copayments for vulnerable groups via means testing for specific health services.
  - Improve regional fiscal framework: enhance monitoring and enforcement, rebalance risk sharing and discipline, consider strengthening conditionality of regional liquidity mechanisms, improve fiscal equalization and settlement procedures, and allow regions’ fiscal targets to differ in a rules-based and transparent fashion.

### Household Deleveraging: Baseline and Scenarios (Box 1)
- Current levels and context
  - Private consumption is still 11 percent below its 2007 peak and lagging GDP, which has recovered to about 7½ percent below the pre-crisis peak.
  - Household savings ratio declined to 9.7 percent in 2014; 2000–14 average was 10.6 percent.
  - Spanish household debt is 109 percent of disposable income.
  - Household debt-to-disposable income ratio dropped by 25 percentage points since 2007.
  - Household wealth-to-disposable income fell by nearly 30 percent, with house wealth losing about a third of its value since 2007.
- Simulation baseline and scenarios
  - Baseline: households reduce gross debt/GDI ratio to its 2004 level within 20 years while house prices are assumed to rise such that the gross asset/GDI ratio improves by 3¼ percent by 2020. With GDI growing at 3½ percent per annum over 2015–20, on average this requires an increase in household saving ratio from current levels to slightly below the long run historical average.
  - Scenario 1: achieve the same deleveraging target in 10 years — would require higher savings of ½ percentage point of GDI per year, on average, compared to the baseline.
  - Scenario 2: achieve the same deleveraging in 10 years and bring financial asset-to-GDI ratio back to its 2006 level in 6 years — would require higher savings of 1¼ percentage points of GDI per year, on average, compared to the baseline.
  - Insolvency reforms (“fresh start”) could lower savings by up to a ½ to a third of a percentage point of GDI per year, on average, over a 10 to 20 year period, respectively.
- Aggregate demand implications
  - Alternative deleveraging scenarios would imply lower household consumption than under the baseline; aggregate demand effects depend on the use of higher savings (e.g., higher net-exports, higher investment, or paying down external debt and lowering the very high negative NIIP).

### External Stability and Real Exchange Rate (Appendix I)
- NIIP and external debt
  - NIIP liabilities dropped from -34 percent of GDP in 2000 to -91 percent of GDP in 2009; NIIP remained elevated at -93 percent at end-2014.
  - High gross external debt stabilized around 160 percent of GDP.
- Current account
  - CA declined to a 0.8 percent of GDP surplus in 2014 (or -0.5 percent of GDP cyclically adjusted).
  - Staff gauges the 2014 cyclically-adjusted CA to have been 0.5-2.5 percent of GDP weaker than desirable.
  - Under staff’s forecast, a gradually improving current account will improve the IIP by about 3-4 percent of GDP annually in the medium term.
- Real exchange rate
  - CPI-based REER declined by 1 percent from its 2013 level and by 3 percent from its 2008 peak; ULC-based REER shows a larger reversal.
  - Two EBA REER regression model approaches estimate an overvaluation of 13.3 and 10.3 percent for 2014, respectively; on balance staff assesses a 2014 gap of around 5 to 10 percent above the level consistent with medium-term fundamentals and desirable policies.
- Policy responses
  - Continue gradual fiscal consolidation, further improve active labor market policies, foster corporate and household debt restructuring, and advance product market reforms.
  - A more ambitious fiscal adjustment would lead to faster improvement of the current account.
  - Continued monetary easing at the euro area level would support Spain’s adjustment efforts.

### Debt Sustainability Analysis — baseline and stress tests (Appendix III)
- Public debt evolution (gross nominal public debt, percent of GDP)
  - 2013: 92.2
  - 2014: 97.7
  - 2015: 98.5
  - 2016: 98.5
  - 2017: 98.1
  - 2018: 97.0
  - 2019: 95.6
  - 2020: 93.9
- Baseline projections and assumptions
  - Public debt is projected to peak at 98.5 percent of GDP in 2016 before declining to 93.9 percent by 2020.
  - Projections reflect WEO assumptions and assume average maturity remains 6½ years.
  - Beyond 2016, fiscal adjustment of ½ percent of GDP per year would be needed to ensure a firmly declining public debt path.
  - Gross financing needs expected to decline to 16.2 percent of GDP in the medium term.
- Selected stress-test outcomes (debt-to-GDP peaks)
  - Primary balance shock (2.5 percent of GDP in 2016–17): debt/GDP peaks at 103.1 percent in 2017, declines to 99.1 percent in 2020 (about 5.2 percentage points higher than baseline in 2020).
  - Growth shock (real GDP growth rates 2.7 percent lower in 2016–17): debt/GDP peaks at 108.5 in 2017, declines to 104.4 percent in 2020 (10.4 percentage points higher than baseline).
  - Interest rate shock (nominal rates +200 basis points during 2016–20): effective interest rate increases to 3.7 percent by 2020 vs. 2.8 percent baseline; debt/GDP peaks close to 99 percent in 2016, falls to 96.1 percent in 2020 (2.2 percentage points higher than baseline).
  - Combined shock (simultaneous combination of previous three): debt/GDP peaks at 110.1 percent in 2017, declines to 107.9 percent in 2020 (14 percentage points higher than baseline).
  - Contingent liability shock (one-time non-interest expenditure = 10 percent of banking sector assets in 2016 plus lower growth/inflation): debt/GDP peaks at 115.5 percent in 2017, declines to 111.7 percent in 2020 (17.8 percentage points higher than baseline).
- Baseline macro assumptions (selected)
  - Real GDP growth: 2015: 3.1; 2016: 2.5; 2017: 2.2; 2018: 2.0; 2019: 1.9; 2020: 1.8
  - Inflation (GDP deflator): 2015: 0.8; 2016: 0.6; 2017: 0.9; 2018: 1.1; 2019: 1.3; 2020: 1.6
  - Primary balance (percent of GDP): 2015: -1.8; 2016: -0.6; 2017: -0.1; 2018: 0.2; 2019: 0.7; 2020: 0.7
  - Effective interest rate: 2015: 3.2; 2016: 3.0; 2017: 2.9; 2018: 2.8; 2019: 2.8; 2020: 2.8

### Box 3 — Public Stakes in the Financial Sector
- FROB divestment progress and remaining stakes
  - Since 2009, FROB provided €53.5 billion of public support to banks in the form of equity stakes.
  - In 2014, sales (NCG Banco, Catalunya Banc, and 7.5 percent stake in Bankia) resulted in about €3.5 billion of revenue over a number of years as payments are being received in installments.
  - Two remaining stakes (in Bankia and BMN), worth about €11 billion, are scheduled for divestment ahead of end-2017 and early-2018 deadlines but could be more difficult to sell in the near term.
  - FROB maintains a 45 percent equity stake in SAREB, amounting to approximately €½ billion, expected to be divested by 2027.
- SAREB performance and adjustments
  - SAREB reported losses of €0.3 billion in 2013 and €0.6 billion in 2014.
  - The original portfolio (€50.7 billion) has been reduced by almost 15 percent, broadly in line with the targeted 15-year unwinding schedule.
  - SAREB has hired 4 investment companies, including distressed debt funds, as servicing companies.
- Near-term challenges
  - Selling remaining public stakes worth about €11 billion faces valuation and market-demand constraints.
  - Market concerns about DTAs in capital can depress share price valuations relative to target sale prices.
  - Continued management of SAREB losses requires realistic valuation assumptions, active servicing arrangements, and adherence to the 15-year unwinding timetable.

*Source: _cr15232 (IMF staff report excerpts and annexes for Spain, 2015 Article IV Consultation).*

### 1. Household Deleveraging and Growth _________________________________________________________ 19

### 1. Household Deleveraging and Growth

### Context and Outlook
- Economic performance and drivers
  - Economy expanded at 1.4 percent in 2014; growth accelerated significantly in the first half of 2015.
  - Real GDP growth is expected at 3.1 percent in 2015 and 2½ percent in 2016.
  - Employment increased with the rebound in demand and moderate wage growth; employment growth reached over 3 percent by end-2014.
  - New credit is being extended to firms (especially those with strong financial positions) and to households; deleveraging is slowing.
  - Housing prices started to increase moderately in the second half of 2014—albeit unevenly across regions—and investment and employment in construction have started to recover.
- External and financial conditions
  - Sovereign bond yields are about 5¼ percentage points below their 2012 peak.
  - The external current account registered a 0.8 percent of GDP surplus in 2014.
  - Spain’s negative net international investment position (NIIP) was 93 percent of GDP in 2014.
  - The cyclically adjusted current account remained ½ to 2½ percent of GDP weaker than what would be consistent with medium-term fundamentals and desirable policy settings.
  - The real effective exchange rate (REER) is assessed to be about 5–10 percent overvalued.
- Structural constraints on medium-term growth
  - Potential growth is still very low, of less than 1½ percent.
  - Absent further reforms, unemployment would remain at an estimated structural level of about 16½ percent as the output gap closes.
  - Private and public debt levels remain high, at 235 and 98 percent of GDP, respectively.
  - Household debt remains significantly above pre-crisis levels.

### Risks and Vulnerabilities
- Main downside risks
  - Weak euro area demand and persistently low inflation. (Likelihood: High; Impact: Medium)
  - Sharp asset price adjustment and decompression of credit spreads. (Likelihood: High; Impact: Low/Medium)
  - Euro area bond market contagion. (Likelihood: Medium; Impact: Medium)
  - Reversal of past structural reforms that undermines confidence and growth. (Likelihood: Low/Medium; Impact: High)
- Amplifying factors
  - Contagion risks from developments in Greece could renew sovereign and financial sector stress in Spain.
  - A strong link between domestic demand and imports limits scope for current account improvement as growth strengthens.
- Authorities’ assessment
  - Authorities have higher forecasts for medium-term growth and attribute the rebound to reforms and progress in correcting imbalances, but agree that vulnerabilities and structural issues require attention.

### Key Statistics and Labor Market Snapshot
- More than 5 million Spaniards, over 23 percent of the labor force, remain unemployed.
- As of the first quarter of 2015:
  - More than 23 percent of the active labor force were looking for a job.
  - More than half of those under 24 years old were looking for a job.
  - About 60 percent of the unemployed have been jobless for over a year.
- Labor market features
  - The share of temporary jobs in overall employment has remained fairly steady at around 25 percent.
  - Not enough firms are using flexibility clauses introduced by reforms to deviate from sector-level wage agreements.
  - Wage dynamics do not adequately reflect differences in business conditions across firms.

### Policy Agenda: Main Priorities
- Overarching goals
  - Sustain job-rich, inclusive growth and transition to a more balanced and export-oriented growth model.
  - Further reduce public and private indebtedness and maintain confidence through gradual but sustained fiscal consolidation.
- Priority areas
  - Improving labor market performance:
    - Keep wage growth aligned with productivity and external competitiveness developments.
    - Ensure wages reflect differing business conditions across firms.
    - Strengthen the skills of the long-term unemployed.
  - Enhancing small firm growth:
    - Remove obstacles that prevent small firms from scaling up domestically and externally to raise productivity.
  - Facilitating private debt reduction:
    - Further reduce firm and household debt; continue strengthening banks so they support growth as credit demand recovers.
  - Anchoring confidence:
    - Continue gradual and growth-friendly fiscal consolidation, well coordinated across all levels of government.

### A. Further Strengthening Labor Market Performance — Specific Measures
- Set the right labor market conditions
  - Keep wage growth in line with productivity and external competitiveness to promote strong and sustainable employment growth.
- Promote firm-level adjustment
  - Ensure wage dynamics reflect firm- and sector-specific conditions by increasing use of existing options for firm-level adjustment and removing obstacles to firm-level wage bargaining and opt-out, particularly for small firms.
- Lower duality
  - Close the gap between dismissal costs for permanent and temporary workers, for example by:
    - Introducing a single contract with tenure-based dismissal costs in sectors without high seasonal turnover; or
    - Uniformly financing dismissal costs through regular employer contributions to a common fund.
  - Reduce legal and administrative uncertainties in collective dismissals and streamline application of objective criteria for fair dismissals.
- Make Active Labor Market Policies count
  - Monitor, evaluate, and fine-tune programs to improve skills of the long-term unemployed and low-skill youth, starting with more transparent use of regional coverage and enforcement data.
  - Increase the effectiveness of public and private job-placement agencies.

*Source: _cr15232 - 1. Household Deleveraging and Growth*

### 15.      The authorities broadly agreed with the assessment of the impact of labor market

### _cr15232 - 15.      The authorities broadly agreed with the assessment of the impact of labor market

### Impact of labor market reforms and remaining challenges
- Authorities broadly agreed with staff assessment that labor market reforms have been a crucial driver of the Spanish recovery and the pickup in employment.
- Authorities view:
  - Reforms should be given more time for social partners to adapt before additional measures are considered.
  - Duality remains a problem; solutions are complex.

### B. Boosting Small Firm Growth — findings
- Productivity growth is fundamentally weak, partly reflecting the dominance of small firms.
- Structural characteristics:
  - Spanish firms tend to be more numerous, smaller, less productive, innovative, and export-oriented than those of most European peers.
  - Firms with fewer than 50 workers employ nearly two thirds of the labor force while generating only about half of the value added in the economy.
  - The productivity gap between small and large companies is wider than in many other European countries.
- Staff analysis:
  - Lowering the share of small firms to match that of Germany and closing the productivity gap between small and large firms to German levels could raise the level of aggregate total factor productivity (TFP) by as much as 9 percent, with most improvement coming from reallocation of employment between firms.
- Obstacles to firm expansion:
  - Substantial variation of TFP across firms’ size, sector, and region.
  - Regional heterogeneity pointing to market fragmentation from proliferation of regulatory requirements and practices at regional and local level (permits, standards).
  - Size-dependent thresholds in regulation (reporting, auditing, labor-related regulation) and taxation.
  - Limited financing access.

### B. Boosting Small Firm Growth — policy recommendations
- Fostering competition:
  - Fast and effective implementation of the Market Unity Law.
  - Move ahead with long-delayed liberalization of professional services to facilitate market entry and resource allocation.
- Lowering constraints:
  - Recent corporate tax reform reduces fiscal disincentives to expand, but a careful review of all size-related rules and regulations is needed to identify and eliminate unwarranted obstacles to growth.
- Supporting exports:
  - Government strategy for boosting internationalization could do more to help SMEs enter export markets and remain competitive by reducing high fixed costs of exporting (market penetration and other trade costs) and fostering innovation.
- Strengthening access to finance:
  - Continue efforts to increase market-based financing for SMEs (alternative exchanges, venture capital, securitization).
  - Increase accuracy of financial reporting and transparency (e.g., include consolidated financial information of SMEs in centralized database and register).
  - Continue ICO program providing guarantees and direct financing for new firms; complement with European efforts (including guarantees under the Juncker plan) ensuring support to all SMEs lacking market access.

- Authorities’ view:
  - Agreed on need to help firms grow and noted ongoing implementation of the Market Unity Law and efforts to address differences in regulatory norms across Spain.
  - Emphasized link between firm size and export orientation, and the need for additional efforts to support SME internationalization.

### C. Further Strengthening Banks While Reducing Debt — recent improvements and indicators
- Asset quality and provisioning:
  - Domestic non-performing loans (NPL) ratio fell to 12.1 percent at end-March 2015 from 13.4 percent one year earlier.
  - Provisions rose to 57 percent of NPLs—significantly above the euro area average.
- Capital and solvency:
  - Phased-in Basel III CET1 capital ratio of the system reached 11.8 percent (ranging between 9.7 and 12.7 in the case of the 10 largest banks).
  - Spain’s large banks on track to complete the fully-loaded Basel III capital schedule on schedule—or ahead of time for two SIFIs.
- Funding, liquidity, and profitability:
  - Funding conditions more favorable due to ECB TLTROs and lower market financing costs; resident deposits declined moderately due to shift to higher yielding instruments.
  - Liquidity: Spanish banks fully complying with phased-in liquidity coverage ratio (LCR) requirement of 60 percent.
  - Profitability increased reflecting lower provisioning costs, stronger net interest margins, and mark-to-market gains on government bonds linked to ECB purchase program.
- Efficiency and consolidation:
  - Operating costs-to-income lowered by 1.5 percentage points (to 49 percent) at end-2014.
  - Number of commercial banks fell from 50 to 15 during 2012–14.
- Credit trends:
  - Overall credit still declining, but pace slowed from around -10 percent at end-2013 to -5 percent year-on-year in April 2015, and expected to turn positive by the end of this year.
  - New credit increasingly extended to non-financial corporations outside real estate and construction with healthy financial positions; new household credit also growing.
- Progress towards banking union:
  - SSM now directly supervises Spain’s larger banks representing more than 90 percent of banking system assets.
  - Transposition of BRRD in Spain (approved in June 2015) established two-tier setup: Bank of Spain responsible for pre-resolution tasks and national bank resolution fund (FROB) responsible for execution-phase resolution functions.
  - ESRB noted further progress needed to bring macroprudential framework in line with recommendations.

### C. Further Strengthening Banks While Reducing Debt — challenges and policy recommendations
- Challenges:
  - Upcoming international regulations on fully-loaded Basel III, TLAC, and MREL will likely demand additional loss-absorbing capacity.
  - Possible change in treatment of deferred tax assets (DTAs) might require additional capital buffers for some banks.
  - Prolonged low-interest rate environment could compress lending margins.
  - Some banks face significant costs from foreclosed assets and high levels of NPLs.
  - Pressures to cut operational costs likely to persist.
- Policy suggestions:
  - Encourage banks to increase high-quality capital (e.g., through equity and restraint on dividends and bonuses).
  - Reduce carrying costs associated with high levels of NPLs (administration, capital, funding charges).
  - These measures will help ensure favorable credit conditions for financially-sound households and corporates and reduce likelihood that credit growth is supply-constrained as recovery matures.

### Insolvency reforms — effects, estimates, and implementation issues
- Reforms:
  - Early 2015 introduction of a “fresh start” for individual entrepreneurs and consumers: conditional discharge of individuals’ residual debt after liquidation of assets in bankruptcy.
  - Amendments to out-of-court restructuring mechanism for SMEs and restructuring/liquidation procedures to facilitate restructuring of viable firms and sale of businesses as going concerns.
- Staff analysis of potential effects:
  - “Fresh start” could potentially reduce stock of household debt by around 3–4 percent and level of corporate debt by about 1–2 percent relative to the baseline, contributing to higher private consumption and investment.
  - Negative effects on bank earnings estimated to be limited; banks unlikely to face significant impact on ability to extend credit.
- Implementation challenges highlighted:
  - Need for greatest possible clarity regarding post-liquidation payment plan and conditions that would lead to revocation of the fresh start to reduce uncertainty and limit potential for abuse.
  - Inclusion of public creditors: fully involving them in restructuring and making at least those public claims considered ordinary (i.e., 50 percent of tax and social security claims) subject to discharge after liquidation would increase effectiveness and avoid incentives to prioritize payments to public creditors over private ones.
  - Staff estimates that possible immediate public sector impact likely small and could be positive longer term if formal-sector activity increases.
- Authorities’ view:
  - Broad agreement on assessment of banks and general concurrence with staff’s views on insolvency reforms.
  - Agreed on need to clarify certain key elements in the “fresh start”; Parliament has approved amendments to do so.
  - While noting staff concerns regarding exclusion of public creditors, authorities did not consider this would limit reform’s effect and pointed to potential fiscal repercussions and harmful impact on current tax deferment policy.
  - Agreed that short-term impact on banks’ earnings likely limited, and that effects on Spain’s strong payment culture deserve careful monitoring.

### D. Ensuring a Coordinated and Credible Fiscal Consolidation — findings
- Public finances:
  - Public debt is close to 100 percent of GDP and still increasing.
  - 2015 deficit target of 4.2 percent is being helped by higher than expected nominal growth and relatively low interest rates.
  - Bringing headline deficit below 3 percent to exit the Excessive Deficit Procedure (EDP) in 2016 and reaching structural balance in 2020 will be challenging; measures specified so far fall short of required structural adjustment.
- Regional fiscal risks:
  - Fiscal risks at the regional level are particularly high.
  - Regional governments contributed significantly to post-crisis consolidation aided by Budget Stability Law (BSL) and improved practices, but efforts uneven and overall regional target systematically missed.
  - Regional liquidity mechanisms (conditional loans from central government) have helped but raised moral hazard risks.

### D. Ensuring a Coordinated and Credible Fiscal Consolidation — recommendations
- Use windfalls:
  - Any windfalls from higher nominal growth and lower borrowing costs should be used to bring the deficit down further.
  - A pace of structural adjustment of around ½ percent of GDP per year would ensure debt is put firmly on a downward path.
- Revenue and tax policy:
  - Raise excise duties and environmental levies, and gradually phase out VAT preferential treatments to bring Spain’s collection efforts more in line with other European countries and support growth-friendly consolidation (completing tax shift from direct to indirect taxes).
  - Protect vulnerable groups by strengthening support provided by transfer and tax system; consider reducing or eliminating copayments for vulnerable groups via means testing for specific health services (chronic diseases, preventive care, immunization).
- Regional fiscal framework improvements:
  - Enhance monitoring and enforcement of regional fiscal targets, rules, and access to regional liquidity mechanisms under the BSL (e.g., pre-agreed intra-year targets and corrective measures; stress best budgeting practices; improve responsiveness to independent fiscal council recommendations).
  - Rebalance risk sharing and discipline; consider strengthening conditionality of regional liquidity mechanisms (access conditional on approval of adjustment plan and compliance with intra-year fiscal targets) or adding new conditional credit facilities (e.g., tax-based rainy day funds).
  - Improve fiscal equalization and settlement procedures to increase regions’ capacity to reach fiscal targets; review rules determining how intergovernmental transfers are advanced and settled.
  - Consider allowing regions’ fiscal targets to differ in a rules-based and transparent fashion, taking into account structural differences in adjustment needs and capacity.

*Source: _cr15232 - 15.      The authorities broadly agreed with the assessment of the impact of labor market (IMF staff report content).*

### 35.      The authorities are confident that they can achieve the deficit targets. The planned

### _cr15232 - 35.      The authorities are confident that they can achieve the deficit targets. The planned

### Fiscal targets, regional framework, and authorities' view
- Authorities are confident they can achieve the deficit targets, supported by:
  - strong economic recovery,
  - lower interest rates,
  - measures envisaged under the Stability Program.
- The BSL and, in particular, the expenditure rule should help ensure regional fiscal targets are met.
- Authorities see public debt on a clear downward path and argued that historical sustainability scenarios based on an extraordinary difficult period including the recent crisis period could be misleading.
- Authorities broadly agree on the need to strengthen the regional financing system, noting:
  - merit in a review of the financing system of the regions,
  - complexity of the issue.
- They felt monitoring and enforcement rules under the BSL have supported achieving general government deficit targets and that the conditionality requirements under existing regional financing mechanisms are sufficient to mitigate moral hazard risks.
- Recommendation: Spain remain on the standard 12-month Article IV consultation cycle.

### Recent macroeconomic performance and recovery drivers
- Spain’s recovery has accelerated.
- Stronger confidence is supporting the rebound of domestic demand, aided by:
  - the ECB’s expansionary policies,
  - external tailwinds.
- Employment is growing, even though, at more than 5 million people, unemployment remains painfully high.
- Past reforms and strong policy implementation contributing to the recovery include:
  - Labor market reforms and moderate wage growth,
  - the Market Unity Law,
  - financial sector reform,
  - continued fiscal consolidation.

### Constraints on sustaining growth and medium-term outlook
- Medium-term expansion constrained by:
  - sizable public and private debt overhangs weighing on consumption and investment,
  - deep structural problems, including high structural unemployment and low productivity of many small firms.
- Without additional reforms, staff estimates place potential growth at well under 1½ percent per year on average 2015–20.
- To put debt on a firmly declining path, a pace of structural adjustment of around ½ percent of GDP per year should be ensured.
- Any windfalls from lower interest rates and higher-than-expected growth should be saved.
- Additional measures will be required at all government levels to achieve EDP and Medium-Term Budgetary Objective (MTO) targets; these should be implemented to protect the vulnerable.

### Labor market: issues and policy directions
- Significant room for improving labor market performance:
  - Keep aggregate wage increases in line with productivity and competitiveness while allowing firm-level wages to better reflect business conditions.
  - Reduce duality and implement more effective active labor market policies to improve skills and help the long-term unemployed find work.

### Small firms, productivity, and structural reform recommendations
- Reducing obstacles for small firms to grow can unlock productivity:
  - Accelerate implementation of the Market Unity Law and open up professional services to foster market entry and competition.
  - Review size-related rules and regulations, support SME internationalization, and further develop access to finance to allow firms to scale up.
- Staff analysis: a counterfactual reform lowering the share of small firms to match Germany and closing the productivity gap between small and large firms to German levels could possibly raise TFP (and the corresponding level of potential output) by as much as 7 and 2 percent above the baseline, respectively.
- Tackling duality, addressing skills deficiencies, and other reforms lowering structural unemployment to about 10 percent would lift potential output by an estimated additional 4 percent.
- Joint implementation within a 10 year time frame would result in potential annual growth of about 2½ percent.

### Banking sector, NPLs, and deleveraging
- Further strengthening banks will support growth as credit demand recovers.
- ECB’s comprehensive assessment confirmed the much stronger position of the banking system, but operating conditions remain challenging.
- Policy priorities: continue to build high-quality capital and reduce the carrying costs of high NPLs.
- The “fresh start” reform facilitates private sector deleveraging; implemented effectively, it can boost demand and future entrepreneurial activity while protecting Spain’s strong payment culture.
  - Fully involving public creditors would add to the impact of the reform.

### Household deleveraging and implications for savings and consumption (Box 1)
- Current levels and context:
  - Private consumption is still 11 percent below its 2007 peak and lagging GDP, which has recovered to about 7½ percent below the pre-crisis peak.
  - Household savings ratio declined to 9.7 percent in 2014 and could, in principle, fall further.
  - The savings rate is well below its 2000–14 average of 10.6 percent.
  - Spanish household debt is 109 percent of disposable income.
  - Household debt-to-disposable income ratio dropped by 25 percentage points since 2007.
  - Household wealth-to-disposable income fell by nearly 30 percent, with house wealth losing about a third of its value since 2007.
- Simulation baseline and scenarios:
  - Baseline: households reduce gross debt/GDI ratio to its 2004 level within 20 years while house prices are assumed to rise such that the gross asset/GDI ratio improves by 3¼ percent by 2020.
    - With GDI growing at 3½ percent per annum over 2015–20, on average, this would require an increase in household saving ratio from current levels to slightly below the long run historical average.
  - Scenario 1: achieve the same deleveraging target in 10 years — would require higher savings of ½ percentage point of GDI per year, on average, compared to the baseline.
  - Scenario 2: achieve the same deleveraging in 10 years and bring financial asset-to-GDI ratio back to its 2006 level in 6 years — would require higher savings of 1¼ percentage points of GDI per year, on average, compared to the baseline.
  - Insolvency reforms (“fresh start”) could lower savings by up to a ½ to a third of a percentage point of GDI per year, on average, over a 10 to 20 year period, respectively, partially offsetting hypothetical increases in the savings ratio under deleveraging scenarios.
- Aggregate demand implications:
  - Alternative scenarios would imply lower household consumption than under the baseline, but aggregate demand effects depend on the use of higher savings (e.g., higher net-exports, higher investment, or paying down external debt and lowering the very high negative NIIP).

### Potential output and scope for improvement (Box 2)
- Potential growth trends:
  - Multivariate filter-based estimates suggest potential growth dropped from about 3 percent in 1995–2007 to around ¾ percent since 2008.
  - The crisis led to a sharp fall in investment and a rise in unemployment, increasing long-term and structural unemployment.
  - Empirical measures of TFP have shown some improvement relative to very low past levels, linked mostly to the exit of low-productivity firms and drastic labor shedding.
- Staff baseline: potential growth expected to remain low without additional reforms — well under 1½ percent per year on average 2015–20.
  - This reflects subdued capital accumulation, adverse population dynamics, persistent structural unemployment at around 16 percent, and low TFP growth due to dominance of small firms and labor market duality.
- Reform potential:
  - A package addressing small-firm structure, duality, and skills could raise potential output materially, with joint reforms over 10 years raising potential annual growth to about 2½ percent.

*Source: IMF staff appraisal content provided in the supplied document excerpt.*

### Box 3. Public Stakes in the Financial Sector

### Box 3. Public Stakes in the Financial Sector

### FROB divestment progress and remaining stakes
- Since 2009, FROB provided €53.5 billion of public support to banks in the form of equity stakes.
- In 2014, the fund sold its holdings in NCG Banco and Catalunya Banc, as well as a 7.5 percent stake in Bankia, resulting in about €3.5 billion of revenue over a number of years as payments are being received in installments.
- Buyers of banking stakes have been mainly domestic banks; portfolios have been acquired by private equity funds.
- Two remaining stakes (in Bankia and BMN), worth about €11 billion, are scheduled for divestment ahead of end-2017 and early-2018 deadlines but could be more difficult to sell in the near term.
- Although these banks’ earnings have increased, their share price valuations remain below target sale prices, in part due to potential concerns about a large share of deferred tax assets (DTAs) in capital.
- The FROB also maintains a 45 percent equity stake in SAREB, Spain’s Asset Management Company, amounting to approximately €½ billion, which is expected to be divested by 2027.

### SAREB performance and adjustments
- SAREB reported losses of €0.3 billion in 2013 and €0.6 billion in 2014, mainly owing to optimistic valuations of the assets transferred—even though the real estate market has now stabilized after a roughly 40 percent decline.
- The original portfolio (€50.7 billion) has been reduced by almost 15 percent, broadly in line with the targeted 15-year unwinding schedule.
- The business plan has been recently updated to reflect more realistic assumptions.
- SAREB has hired 4 investment companies, including distressed debt funds, as servicing companies to manage the cash flow and sales of the bulk of its portfolio assets.

### Near-term challenges and policy-relevant considerations
- Selling remaining public stakes (Bankia and BMN) worth about €11 billion faces valuation and market-demand constraints despite improved bank earnings.
- Market concerns about DTAs in capital can depress share price valuations relative to target sale prices, complicating divestment.
- Continued management of SAREB losses and portfolio run-down requires realistic valuation assumptions, active servicing arrangements, and adherence to the 15-year unwinding timetable.
- The FROB’s 45 percent stake in SAREB (approximately €½ billion) remains a medium-term divestment objective to be completed by 2027.

*Source: Box 3. Public Stakes in the Financial Sector (from the supplied IMF content).*

### Appendix I. Spain: External Stability Report (ESR)

### Appendix I. Spain: External Stability Report (ESR)

### Overall Assessment: Foreign asset and liability position and trajectory
- Background findings:
  - NIIP liabilities dropped from -34 percent of GDP in 2000 to -91 percent of GDP in 2009, driven mainly by substantial current account (CA) deficits but also reflecting valuation effects.
  - The current account improved subsequently, but the NIIP remains elevated at -93 percent at end-2014.
  - High gross external debt has stabilized around 160 percent of GDP.
- Assessment:
  - The large negative NIIP comes with external vulnerabilities, including from valuation changes and the large gross financing needs from external debt.
  - Mitigating factors include a favorable maturity structure of Spain’s outstanding sovereign debt with an average of 6 ½ years and current ECB measures such as QE.
  - Overall assessment: The external position in 2014 was substantially weaker than that consistent with medium-term fundamentals and desirable policy settings.
  - As of May 2015, the impact of lower oil import prices and REER depreciation is broadly offset by strong domestic demand growth; these recent developments do not change the overall assessment.
  - Achieving both a sufficiently declining IIP and much lower unemployment would require a substantially weaker real effective exchange rate.

- Potential policy responses:
  - Continue recent reforms and policy plans to deliver gradual fiscal consolidation, further improve active labor market policies, foster corporate and household debt restructuring, and advance product market reforms.
  - A more ambitious fiscal adjustment would lead to a faster improvement of the current account.
  - In the medium term, further structural reforms of the labor market and accelerated implementation of product market reforms would be required to speed the adjustment.
  - Continued monetary easing at the euro area level would support Spain’s adjustment efforts.

### Current account
- Background:
  - CA declined to a 0.8 percent of GDP surplus in 2014 (or -0.5 percent of GDP cyclically adjusted) after a 1.4 percent surplus in 2013 and a peak deficit in 2007 of 10 percent of GDP.
  - Since 2014, sharply lower oil price helped reduce overall import costs, partly offsetting higher import growth following the surge in domestic demand.
  - Depreciation of the euro positively contributed to Spain’s exports outside the Euro zone; ECB measures have helped to drive down interest rates on external debt.
- Assessment:
  - EBA model-based estimates suggest a balanced CA for 2014 (0 percent of GDP); staff assessment considers the overriding need to sharply improve the NIIP and gauges the 2014 cyclically-adjusted CA to have been 0.5-2.5 percent of GDP weaker than desirable.
  - Surpluses of this magnitude will need to be maintained until the NIIP is at safer and sustainable levels.
  - Under staff’s current forecast, a gradually improving current account will improve the IIP by about 3-4 percent of GDP annually in the medium term.
  - If the output gap is larger (for example, reflecting a structural level of unemployment closer to international peers), the cyclically-adjusted current account would be lower and thus the gap with respect to the desirable level larger.

### Real exchange rate
- Background:
  - By 2014, the CPI-based real effective exchange rate (REER) had declined by 1 percent from its 2013 level, and by 3 percent from its 2008 peak, only a limited reversal of the almost 12 percent appreciation since euro entry.
  - The ULC-based REER shows the appreciation has been substantially reversed since that time, largely reflecting substantial labor shedding.
  - Export market shares have been resilient.
  - As of May 2015, the REER has depreciated by 5 percent from its 2014 average.
- Assessment:
  - The two EBA REER regression model approaches, the “index” and “level” REER tools, estimate an overvaluation of 13.3 and 10.3 percent for 2014, respectively (with reference to the CPI-based REER).
  - Historical REER (CPI and ULC based) and other model-based analysis, including taking into consideration IIP sustainability, suggest the overvaluation may be smaller.
  - On balance, staff assesses a 2014 gap of around 5 to 10 percent above the level consistent with medium-term fundamentals and desirable policies.
  - Achieving significantly lower unemployment rates closer to international peers in the medium term would likely imply a larger gap.

### Capital and financial accounts: flows and policy measures
- Background:
  - Since mid-2012, financing conditions have greatly eased, with sovereign bond yields near historical lows, non-resident portfolio inflows have resumed, and ECB borrowing has fallen significantly.
- Assessment:
  - The ECB’s actions as well as domestic reform progress have greatly helped improve investor sentiment.
  - However, large external financing needs both in the public and private sector leave Spain vulnerable to sudden changes in market sentiment and spillovers from Europe.

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

### Risk Assessment Matrix — Key risks, likelihoods, impacts, and policy responses
- Euro area: Weak demand and persistently low inflation
  - Relative Likelihood: High
  - Impact if Realized:
    - Protracted weak demand, lack of structural reforms and persistently low inflation in core EA countries.
    - Slowing exports would lower growth and worsen private and public debt dynamics.
    - Persistently low EA inflation would make Spain’s adjustment more difficult.
  - Policy response:
    - Deepen and accelerate labor and product market reforms.
    - Further strengthen framework for facilitating private debt restructuring.
    - Adjust fiscal targets.
    - Further loosening monetary policy by the ECB.
- Sharp asset price adjustment and decompression of credit spreads
  - Relative Likelihood: High
  - Impact if Realized:
    - A bumpy UMP exit could lead to real and financial spillovers to Spain, including from economic and financial stress in EMs.
    - Risky asset prices could drop abruptly, with a rise in volatility.
  - Policy response:
    - ECB’s QE and TLTRO provide a credible backstop against excessive financial volatility.
    - Accelerate fiscal and structural reforms that support investor confidence (e.g., credible medium-term fiscal plans).
    - Further ECB policy actions could help reduce financial market volatility.
- Euro area bond market contagion
  - Relative Likelihood: Medium
  - Impact if Realized:
    - A Greece tail event could lead to a re-assessment of investor’s risk appetite to euro area exposures.
    - Bank failures and the bail-in of debt holders could have spillovers across European banking system.
    - Higher risk premia leads to a deterioration of Spain’s external vulnerabilities.
  - Policy response:
    - Market tension mitigated by the ECB QE and TLTRO.
    - Banks should continue to build capital buffers.
    - The ECB should maintain loose monetary conditions and liquidity provisions.
    - Strengthen the banking union.
- Rolling back of past reforms
  - Relative Likelihood: Low/Medium
  - Impact if Realized: High
    - A reform reversal would impact confidence and slow down demand and employment gains, undermining the recovery.
    - Given the high fiscal deficit, sustainability may be questioned.
  - Policy response:
    - Complete ongoing structural reforms.
    - Reduce politicization of reform by fostering independent agencies, such as the Fiscal Council.
    - Enhance communication on the important role of reforms for growth, and reducing unemployment.

### Appendix III. Debt Sustainability Analysis — public debt outlook and stress tests
- Background:
  - Public debt increased from 35.5 percent of GDP in 2007 to 97.7 percent in 2014, driven by large fiscal deficits.
  - Composition of public debt is tilted towards long-term debt (81 percent of the total) in a similar proportion to the one that existed before the crisis.
  - The fraction of public debt in hands of domestic residents increased from 52.2 percent in 2007 to 58.8 in 2014.
- Baseline projections:
  - Public debt is projected to peak at 98.5 percent of GDP in 2016 before declining to 93.9 percent by 2020.
  - Projections reflect WEO forecast assumptions: (i) gradual fiscal consolidation in 2015–16 to reduce the deficit to 3 percent of GDP and exit the EDP in 2016, followed by a slowdown in fiscal efforts beyond 2016; (ii) stronger growth for this and next year, but somewhat slower medium term growth; and (iii) effective interest rate estimates factor in lower marginal interest rates for this year and next due to the ECB’s QE, with a gradual increase thereafter.
  - The average maturity is assumed to remain fairly long (6½ years, on average).
  - Beyond 2016, fiscal adjustment to the tune of ½ percent of GDP per year would be needed to ensure a firmly declining public debt path and reduce sovereign vulnerabilities.
  - Gross financing needs are expected to decline to 16.2 percent of GDP in the medium term.
- Stress tests:
  - Primary balance shock:
    - Shock: Primary balance in 2016-17 is hit by a shock equal to 2.5 percent of GDP (50 percent of the 10-year historical standard deviation of the primary balance-to-GDP ratio).
    - Outcome: Debt/GDP ratio peaks at 103.1 percent of GDP in 2017 and then gradually declines to 99.1 percent in 2020, about 5.2 percentage points higher compared to baseline debt in 2020.
  - Growth shock:
    - Shock: Real GDP growth rates are 2.7 percent lower in 2016–17 (100 percent of the 10-year historical standard deviation of real GDP growth rates).
    - Outcome: Debt-to-GDP ratio peaks at 108.5 in 2017 and then declines gradually to 104.4 percent in 2020 (10.4 percentage points higher than the baseline).
  - Interest rate shock:
    - Shock: Nominal interest rates increase by about 200 basis points during 2016–20.
    - Outcome: The effective interest rate increases to 3.7 percent by 2020 compared to 2.8 percent in the baseline. The debt-to-GDP ratio peaks at close to 99 percent in 2016 and then gradually falls to 96.1 percent in 2020 (2.2 percentage points higher than the baseline).
  - Combined shock:
    - Shock: Simultaneous combination of the previous three shocks.
    - Outcome: Debt-to-GDP ratio peaks at 110.1 percent in 2017 and then declines gradually to 107.9 percent in 2020 (14 percentage points higher than the baseline).
  - Contingent liability shock:
    - Shock: A one-time increase in non-interest expenditures equivalent in 2016 to 10 percent of banking sector assets combined with lower growth and lower inflation in 2016–17 (i.e., growth is reduced by 1 standard deviation).
    - Outcome: results in debt-to-GDP ratio peaking at

*Source: Appendix I. Spain: External Stability Report (ESR) — content unit _cr15232*

### 115.5 percent in 2017, followed by a gradual decline to 111.7 percent in 2020 (17.8 percentage

### _cr15232 - 115.5 percent in 2017, followed by a gradual decline to 111.7 percent in 2020 (17.8 percentage

### Debt projections and evolution
- Gross nominal public debt:
  - 2013: 92.2
  - 2014: 97.7
  - 2015: 98.5
  - 2016: 98.5
  - 2017: 98.1
  - 2018: 97.0
  - 2019: 95.6
  - 2020: 93.9
- Evolution of predictive densities of gross nominal public debt (in percent of GDP): baseline shows debt rising to 115.5 percent in 2017, followed by a gradual decline to 111.7 percent in 2020 (17.8 percentage points higher than the baseline).
- Change in gross public sector debt (cumulative):
  - 2004-2012 actual: 4.1
  - 2013: 7.6
  - 2014: 5.6
  - 2015: 0.8
  - 2016: 0.1
  - 2017: -0.5
  - 2018: -1.0
  - 2019: -1.5
  - 2020: -1.6
- Identified debt-creating flows (2013–2020 projections total shown as annual contributions):
  - Primary deficit (in percent of GDP): 2013: 2.8; 2014: 4.0; 2015: 2.9; 2016: 1.8; 2017: 0.6; 2018: 0.1; 2019: -0.2; 2020: -0.7; cumulative: 0.9
  - Primary (noninterest) revenue: 37.4, 37.1, 37.4, 37.1, 37.1, 37.1, 37.1, 37.0, 36.9, 22.3 (years as in table)
  - Primary (noninterest) expenditure: 40.2, 41.0, 40.3, 38.9, 37.7, 37.2, 36.8, 36.3, 36.2, 23.1
- Automatic debt dynamics (derived contributions, in percent):
  - 2013: 0.7
  - 2014: 3.7
  - 2015: 2.5
  - 2016: -0.6
  - 2017: -0.1
  - 2018: -0.2
  - 2019: -0.4
  - 2020: -0.4
  - longer-run cumulative: -2.2
- Residual, including asset changes (2013–2020):
  - 2013: 0.6
  - 2014: -0.1
  - 2015: 0.2
  - 2016: -0.4
  - 2017: -0.4
  - 2018: -0.4
  - 2019: -0.4
  - 2020: -0.4
  - cumulative: -2.4

### Sovereign spreads, market perception, and financing needs
- Bond spread (Long-term bond spread over German bonds, average over last 3 months, 24-Mar-15 through 22-Jun-15): 122 bp (noted elsewhere EMBIG (bp) 118).
- Y CDS (bp): 98
- Public gross financing needs (in percent of GDP): 2013: 11.8; 2014: 20.3; 2015: 20.3; 2016: 18.9; 2017: 17.3; 2018: 17.4; 2019: 16.9; 2020: 16.3; projection example: 16.25
- External financing requirement benchmarks used in heat-map stress tests: 17 and 25 percent of GDP.
- Benchmarks for bond spreads in stress tests: 400 and 600 basis points.
- Other risk-assessment thresholds and inputs:
  - Change in the share of short-term debt: 1 and 1.5 percent
  - Public debt held by non-residents: 30 and 45 percent
  - Highlighting scheme: cell green if debt burden benchmark of 85% not exceeded under specific shock or baseline; yellow if exceeded under specific shock but not baseline; red if benchmark exceeded under baseline.

### Baseline macroeconomic assumptions and projections
- Real GDP growth (baseline projections):
  - 2015: 3.1
  - 2016: 2.5
  - 2017: 2.2
  - 2018: 2.0
  - 2019: 1.9
  - 2020: 1.8
- Inflation (GDP deflator, in percent):
  - 2015: 0.8
  - 2016: 0.6
  - 2017: 0.9
  - 2018: 1.1
  - 2019: 1.3
  - 2020: 1.6
- Primary balance (baseline, in percent of GDP):
  - 2015: -1.8
  - 2016: -0.6
  - 2017: -0.1
  - 2018: 0.2
  - 2019: 0.7
  - 2020: 0.7
- Effective interest rate (in percent, defined as interest payments divided by debt stock at end of previous year):
  - 2015: 3.2
  - 2016: 3.0
  - 2017: 2.9
  - 2018: 2.8
  - 2019: 2.8
  - 2020: 2.8
- Constant Primary Balance scenario:
  - Primary Balance held at -1.8 for 2015–2020 in that scenario (other variables as baseline).

### Stress tests and alternative scenarios
- Macro-fiscal stress tests considered:
  - Primary Balance Shock, Real GDP Growth Shock, Real Interest Rate Shock, Real Exchange Rate Shock, Combined Shock, Contingent Liability Shock.
- Selected scenario outcomes (gross nominal public debt, in percent of GDP):
  - Baseline and shocks plotted for 2015–2020 showing increases under shocks; example percentiles and bands displayed (10th-25th, 25th-75th, 75th-90th).
- External debt sustainability bound tests and shocks:
  - Individual shocks are permanent one-half standard deviation shocks; combined shock uses permanent 1/4 standard deviation shocks on real interest rate, growth rate, and current account balance.
  - One-time real depreciation of 30 percent occurs in 2015 in one scenario.
- Representative stress-test results (selected highlights):
  - Growth shock scenario box values referenced (e.g., growth shock 142 vs baseline 132 for an interest-rate shock chart).
  - CA shock and combined shock comparisons show baseline at 132 and scenario values reaching 141–144 in some charts.
- External debt under baseline projections (in percent of GDP):
  - 2010: 157.4
  - 2011: 162.0
  - 2012: 162.0
  - 2013: 154.7
  - 2014: 160.1
  - 2015: 154.1
  - 2016: 149.3
  - 2017: 145.0
  - 2018: 140.7
  - 2019: 136.5
  - 2020: 132.3
- Change in external debt (annual):
  - 2010: -3.8
  - 2011: 4.6
  - 2012: 0.0
  - 2013: -7.3
  - 2014: 5.4
  - 2015: -6.0
  - 2016: -4.8
  - 2017: -4.3
  - 2018: -4.3
  - 2019: -4.1
  - 2020: -4.2
- Identified external debt-creating flows (selected lines):
  - Current account deficit, excluding interest payments (in percent of GDP): 2010: 0.0; 2011: -1.2; 2012: -3.6; 2013: -4.9; 2014: -4.2; 2015: -4.1; 2016: -3.9; 2017: -4.4; 2018: -4.7; 2019: -5.1; 2020: -5.7
  - Exports (in percent of GDP): 2010: 25.6; 2011: 28.8; 2012: 30.3; 2013: 31.6; 2014: 32.1; 2015: 32.6; 2016: 34.0; 2017: 35.2; 2018: 36.5; 2019: 37.5; 2020: 38.4
  - Imports (in percent of GDP): 2010: 26.8; 2011: 29.0; 2012: 28.8; 2013: 28.1; 2014: 29.6; 2015: 29.9; 2016: 31.1; 2017: 32.3; 2018: 33.4; 2019: 34.2; 2020: 34.7
- External debt-to-exports ratio (in percent): 2010: 615.9; 2011: 562.1; 2012: 534.4; 2013: 490.3; 2014: 498.2; 2015: 472.1; 2016: 439.7; 2017: 411.6; 2018: 385.9; 2019: 363.8; 2020: 344.4
- Gross external financing need (in billions of US dollars and percent of GDP):
  - US$ values: 2010: 1,104.7; 2011: 1,092.5; 2012: 1,131.2; 2013: 1,053.8; 2014: 961.8; 2015: 955.9; 2016: 842.1; 2017: 844.8; 2018: 854.8; 2019: 863.9; 2020: 871.6
  - In percent of GDP: 2010: 77.0; 2011: 73.0; 2012: 83.4; 2013: 75.6; 2014: 68.4; later years shown as projections with example long-run 10-Year values: 77.9, 66.2, 63.7, 61.7, 59.8, 57.5.

### Key macroeconomic averages and historical comparisons
- Historical averages and standard deviations for key macro variables used in baseline:
  - Real GDP growth (historical average and deviations shown across tables): baseline path 2015–2020 listed above.
  - GDP deflator in US dollars (change in percent): sample values include -4.6, 5.0, -7.4, 4.0, -0.4, 2.3, 6.6, -15.4, 1.1, 2.1, 2.3, 2.4, 3.2
  - Nominal external interest rate (in percent): series includes 2.3, 2.9, 2.2, 2.2, 2.2, 3.2, 1.0, 1.7, 2.0, 2.3, 2.5, 2.9, 3.2
  - Growth of exports/imports (US dollar terms, in percent): samples show strong volatility, with export growth including 7.6, 17.6, -4.6, 6.9, 2.8, 5.8, 11.0, -11.5, 7.8, etc.; import growth similar pattern.

### Fund relations, data, and institutional context (as of mid-2015)
- Fund/financial holdings and quota (SDR Million and percent of quota):
  - Quota: 4,023.40 (100.00)
  - Fund holdings of currency: 3,457.18 (85.93)
  - Reserve position in Fund: 566.22 (14.07)
  - New Arrangements to Borrow: 640.10
- SDR Department:
  - Net cumulative allocation: 2,827.56 (100.00)
  - Holdings: 2,729.36 (96.53)
- Outstanding Purchases and Loans: None
- Latest financial arrangements: None
- Projected payments to Fund (Charges/Interest): 2015: 0.03; 2016: 0.10; 2017: 0.10; 2018: 0.10; 2019: 0.10
- Data adequacy and dissemination:
  - General: Data provision is adequate for surveillance.
  - Subscriber to SDDS since September 1996; in 2015 Spain subscribed to SDDS Plus.
  - Table 1 (Common Indicators Required for Surveillance) lists latest observation dates and frequencies (examples: Exchange Rates July 2015; International Reserve Assets May 2015; Consumer Price Index June 2015; GDP/GNP Q1 2015).
  - Data quality assessments shown for methodological soundness and accuracy/reliability with O and LO ratings in several series.

### Authorities’ assessment and policy context (Statement by Mr. Jimenez Latorre and colleagues, July 27, 2015)
- Key highlights from authorities’ statement:
  - Spain has emerged from an unprecedented deep recession and is now among the fastest growing advanced economies with strong employment creation in the Euro area.
  - Output growing at an annualized rate of around 4 percent; employment creation significant (example: Q1 2015 around 500,000 new jobs created over last year, reducing unemployment by more than 2 percentage points on seasonally adjusted basis).
  - Exports account for 32 percent of GDP vs. 23 percent in 2009.
  - Current account: Spain has been running a current account surplus since 2013 and 2015 will be the third consecutive year with a current account surplus.
  - Private debt has fallen by 38.2 percentage points from its peak; household debt as a share of net assets stands at 69.9 percent of GDP.
- Fiscal strategy and reforms:
  - Fiscal deficit reduction: from its peak, fiscal deficit expected to be reduced by 6.6 percentage points of GDP in nominal terms in 2015.
  - Authorities committed to bringing the fiscal deficit below 3 percent in 2016 and reaching the MTO of a balanced budgetary position in structural terms by 2019.
  - Structural fiscal reforms: Budget Stability Law, new independent fiscal institution, clearing of commercial arrears, public sector efficiency measures, pension reforms.
- Structural reforms and financial sector measures:
  - 2012 labor market reform credited with preventing large-scale labor shedding and supporting job creation.
  - Market Unity Law, insolvency overhaul, measures to improve SMEs’ financing, corporate governance, and competition.
  - Financial sector reforms: strengthened provisioning, transparency, asset quality reviews, stress tests, recapitalization, asset management company for impaired real estate assets, corporate governance overhaul, savings banks regime reforms, investor protection and prudential tightening.
  - Banking system outcomes: best result in the asset quality review and second best in the 2014 ECB Comprehensive Assessment stress test.
- External sector and NIIP:
  - NIIP worsened substantially since 2000 driven by boom-era deficits and valuation effects; NIIP has a large FDI component (20 percent of GDP) and large gross equity liabilities and assets (60 percent of GDP).
  - Debt is net domestic-currency denominated and predominantly long-term; assets are diversified.
  - Authorities and staff expect NIIP to improve substantially over coming years.
- Authorities’ caution:
  - No room for complacency: stock imbalances remain significant and correction will take time; fiscal consolidation and reform momentum should continue.

*Source: IMF staff report excerpts and annexes for Spain (2015 Article IV Consultation), as provided in the content unit.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr15232.pdf_