Spain -- 2006 Article IV Consultation, Preliminary Conclusions of the IMF Mission
IMF News, March 21, 2006
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- Published: March 21, 2006
Macroeconomic performance and recent developments
- GDP growth in 2005 was 3.4 percent, marking a decade of uninterrupted expansion.
- Average income rose to 98 percent of the EU-25 over the decade.
- Spain generated more than 60 percent of all new jobs in the euro area in 2005; unemployment declined to historic lows.
- General government recorded a surplus of over 1 percent of GDP in 2005 and public debt was substantially reduced over the past decade.
- The year 2005 was marked by a widening external current account deficit to over 7½ percent of GDP—the second largest in absolute terms in the world.
Sources of growth and emerging imbalances
- Domestic demand dominated growth:
- Domestic demand contributed 5¼ percentage points to GDP growth in 2005.
- External sector depressed growth by almost 2 percentage points in 2005.
- Drivers of domestic demand: employment and income gains, real estate wealth effects, and rapid credit expansion.
- Sectoral concentration: growth concentrated in construction and sheltered distribution and services sectors rather than tradables.
- Construction accounts for 9 percent of output and 13 percent of employment.
- Competitiveness deterioration attributed to:
- Price pressures from advanced cyclical position.
- Lackluster productivity growth (as highlighted in the government's National Reform Program).
- Barriers to competition, restrictive regulations, and labor market rigidities.
Outlook and key risks
- Near-term projection:
- GDP growth expected to be 3¼ percent in 2006 under the central scenario.
- Consumption growth expected to moderate as housing wealth gains and credit demand slow and interest rates firm.
- Risks to the benign scenario:
- Continuation of unsustainable domestic spending and rising household indebtedness could require protracted balance-sheet adjustment.
- A correction of real estate prices could spill over to construction, depressing household demand, especially with monetary tightening.
- Continued competitiveness losses from persistent demand pressures and weak productivity could necessitate a protracted, costly internal adjustment within EMU.
- Timing: the mission did not view the housing-correction risk as imminent but judged medium-term outlook clouded by accumulated imbalances.
Fiscal policy: immediate stance and recommendations
- Assessment of 2005 fiscal stance:
- Despite the general government surplus, public spending grew rapidly.
- Non-interest expenditure at the general government level rose by 0.5 percentage points of GDP (after correcting for the RENFE operation in 2004), equivalent to a real growth rate of some 6 percent.
- Territorial Authorities posted a deficit of 0.4 percent of GDP in 2005; regional spending real growth rate was 7½ percent.
- Policy recommendation for 2006 and 2007:
- Greater expenditure-based fiscal restraint in 2006 and 2007 is called for.
- Fiscal policy should be explicitly directed toward improving the 2006 general government surplus by at least ½ percentage point of GDP (relative to 2005), based on expenditure control.
- At the State level: contain spending appreciably below the budget ceiling and safeguard the contingency fund for truly exceptional events.
- Autonomous Communities should at least aim to be in balance in 2006.
- For 2007: State should at least budget an unchanged surplus; Territorial governments should aim for a surplus in keeping with the new Ley de Estabilidad Presupuestaria (LEP) to enter into effect in 2007.
- Emphasis on the LEP's credibility through exemplary implementation in its first year.
Medium- and long-term fiscal framework
- Need for a robust budgetary framework given Spain's highly decentralized system.
- Positive aspects of draft LEP: greater cyclical sensitivity; pursuit of balance over the cycle; exclusion of the social security system and dedication of its surpluses to the Fondo de Reserva; strong wording barring state bail-outs for other levels of government.
- Concerns and suggested improvements to the draft LEP:
- Built-in asymmetry: deficit limit specified in low-growth scenarios but no commensurate surplus requirement in high-growth scenarios—risk of insufficiently ambitious targets in good times.
- Lack of specific surplus requirement leaves allocation between levels of government undetermined; recommendation that targeted surplus in high-growth situations be allocated predominantly to the regions.
- Ambiguity whether surplus requirement applies to Autonomous Communities as a whole or to each individual Community—risk of conflicting interpretations.
- Definition of excluded capital spending should be precise to close avenues for circumvention; off-budget capital spending is a current concern.
- Need for increased fiscal transparency of territorial governments: more extensive and timely publication of fiscal data, especially budget execution, quasi-fiscal activities, and contingent liabilities; improved State budget presentation.
- Recommendation to adhere to an agreed Code of Fiscal Transparency drawing from IMF and Eurostat guidelines.
- Consideration of creating an independent panel of experts to provide ex ante and ex post assessments of fiscal plans and outturns at the behest of Parliament.
Territorial financing and decentralization
- Ongoing review of territorial financing should aim to augment fiscal co-responsibility.
- Decentralization must be accompanied by mechanisms granting territorial governments significant taxing powers and creating incentives to use them to foster fiscal responsibility and accountability.
- Avoid heavy reliance on higher shares of taxes and transfers from the central government which leave incentives unchanged.
- Given health spending importance in regional budgets, financing changes should be accompanied by healthcare reform:
- International experience suggests healthcare costs are difficult to contain without private participation and cost-sharing (e.g., user co-payments).
- Careful costing and tight targeting of commitments under the new Ley de Dependencia to avoid spending pressure.
Tax reform and pensions
- Recent tax reform: limited in size but welcomed for simplification and reduction of distortions.
- Uniform tax on savings enhances transparency and competition among financial instruments.
- Corporate income tax simplifications align with best practices though the rate remains comparatively high.
- Reduction in tax-exempt contributions to private pension plans may deter private pension development and create uncertainty about future tax treatment.
- Pension reform urgency:
- Rising costs of aging will onset in ten years; delays increase the size of required measures.
- Government submitted proposals last November; discussions should proceed expeditiously.
- Reform measures should be broad-ranging, including extension of the base period used to compute pensions.
Labor market and product market reforms to restore competitiveness
- Labor market:
- Previous measures produced rising employment rates among female and older workers and declines in structural and long-term unemployment, but indicators still lag Lisbon objectives.
- Employment protection legislation remains among the most restrictive in the OECD; wage formation insufficiently responsive to productivity differentials.
- July 2004 diálogo social has not yielded results; urgent need for meaningful labor market reform during this legislature.
- Recommendations:
- Reduce rigidity and high dismissal costs of regular contracts to address high temporary employment.
- Social partners should pursue modifications to the collective wage bargaining framework to reflect relative productivity, encourage regional mobility, and avoid amplifying inflationary effects.
- Product and services markets:
- Emphasize competition-enhancing measures and incentives rather than sole reliance on government provision.
- Focus on deregulating sheltered sectors that majorly contribute to widening cost and price differentials with trading partners:
- Further liberalization of energy, telecommunications, and transport sectors.
- Lifting barriers in the retail distribution sector (address double licensing, zoning restrictions, opening-time regulations).
- Liberalizing professional services is a key priority.
- Support planned strengthening of competition authorities under a single, independent Comisión Nacional de Defensa de la Competencia.
- Firm implementation of announced restructuring of national television company (RTVE).
- Openness and regulatory independence:
- Welcome government's liberal stance on EU Services Directive and waiver of barriers to immigration from new member states.
- Concern about potential EU moves confining the internal market in sensitive areas.
- Recent changes to the Comisión Nacional de Energía competencies give regulator discretion that risks discriminatory exercise—urge close cooperation with EU Commission and adherence to single market requirements.
- Recommend reviewing appointment procedures to sectoral regulatory agencies to fully guarantee independence.
Financial sector assessment and recommendations
- FSAP findings:
- Financial sector is vibrant, highly competitive, and well supervised and regulated.
- Strengths: high degree of financial intermediation; low intermediation margins; well-capitalized and professionally managed institutions; robust prudential framework.
- Stress tests: banks and insurance companies would be able to withstand large adverse shocks without systemic distress.
- Main FSAP risk:
- Potential downturn in the housing market, especially if combined with an adverse macroeconomic scenario as described in the mission's central risk (paragraph 3).
- High priority on moderating housing-related credit expansion and mitigating credit risk.
- Concerns about non-traditional mortgage products and the maintenance of adequate lending standards; BdE vigilance in monitoring credit quality recommended.
- Observance of international standards:
- High degree of observance, but need for improvement in supervisory independence and coordination:
- Bolster independence of the three financial sector supervisors by delegating authority to issue norms and to sanction violations more broadly from the Ministry of Economy and the Council of Ministers to the respective agencies.
- Increase formal independence of the insurance regulator currently directly part of the Ministry; recommend alternative institutional arrangements.
- Clarify ambiguities about role of Autonomous Communities in prudential oversight; state-level supervisors should be unambiguously recognized as maintaining sole responsibility and powers regarding prudential supervision and regulation.
- Encourage more regular and continuous collaboration among financial sector regulators; welcome establishment of the Committee for Financial Stability and recommend early start to its work.
- Savings banks and credit institution governance:
- Recommendations for savings banks:
- Reduce further the public sector representation ceiling in governing bodies.
- Promote means to raise high-quality capital (e.g., issuance of cuotas participativas) to enhance market discipline.
- Remove restrictions to savings banks' mergers.
- Nonfinancial equity investments of credit institutions are sizeable and returns are risky and volatile:
- Support consideration by the BdE of adopting the most conservative approaches to the treatment of industrial participations under Basel II.
- Introduce regulations to prevent a credit institution representative serving on the board of a nonfinancial company from taking part in the institution's operations with that company to mitigate conflicts of interest and informational asymmetries.
International Monetary Fund, Mission Concluding Statement, March 21, 2006.