Public Information Notice: IMF Concludes Article IV Consultation with Spain

July 30, 1999

Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.

On June 30, 1999, the Executive Board concluded the Article IV consultation with Spain.1


Economic activity has been buoyant in recent years. Spain's good performance reflects in part its strong competitive position, evidenced by rapid export growth. At the same time, the process of fiscal consolidation to meet the requirements for participation in Stage 3 of European Economic and Monetary Union provoked a sharp decline in domestic interest rates, spurring investment and private consumption. Real output grew by 4.0 percent in 1998, and despite slower export growth due to cyclically weak conditions abroad, strong domestic demand is expected to result in output growth of 3¼ to 3½ percent this year.

The recent economic recovery has been accompanied by a marked decline in inflation and robust employment creation. Inflation fell from about 5 percent in 1994 to 1.4 percent at end-1998, before rebounding to 2.2 percent in May 1999. Employment rose by 2-3 percent per year between 1995 and 1997, and by 3.4 percent in 1998, reflecting strong growth in labor-intensive sectors like construction and some increase in part-time employment. However, an inflation differential of about 1 percentage point exists between Spain and the euro-area average, which could affect competitiveness over the medium term. In addition, despite a steady drop in recent years, the unemployment rate-at 17 percent in the first quarter of 1999-remains the highest in the EU.

Since the mid-1990s, fiscal policy has largely been dedicated to meeting the Maastricht criteria for participation in monetary union. Substantial deficit reduction was achieved between 1995 and 1997, with the deficit falling by 4.7 percent of GDP. Deficit reduction relied largely on cuts in primary current expenditure, although lower interest expenditure and reduced capital outlays also contributed to the improved outcome. The pace of fiscal adjustment slowed in 1998, with reductions in the deficit arising from the cyclical upswing and declines in interest rates. The structural primary surplus, which excludes these factors, was broadly unchanged.

The 1999 budget provides for a further modest reduction in the deficit, which again implies a broadly unchanged structural primary surplus. The budget includes a reform of personal income taxes, which is projected to reduce revenues by about ½ percent of GDP, offset by increases in social security receipts resulting from continued employment growth, by further reductions in the civil service wage bill, and by higher collections on other taxes. The authorities target overall fiscal balance by 2002, with continued current expenditure reductions allowing a slight easing of the tax burden and a minor increase in capital expenditure.

In recent years, monetary policy has been governed largely by the need to attain convergence in inflation with the core ERM countries. Monetary conditions were tightened sharply in 1995, and remained relatively restrictive over the next three years as the Bank of Spain successfully sought to lower inflation and achieve a smooth transition to the single currency. As initial euro participation became increasingly likely, the scope for an independent monetary policy gradually eroded and the Bank of Spain influenced an ever-shorter portion of the yield curve. This process reached its conclusion with Spain's entry as a founding member of the euro on January 1, 1999.

Structural reforms have played a role in Spain's recent economic success. The weight of the public sector in the economy has been substantially reduced through the privatization of a large number of public enterprises. In addition, progress has been achieved in making the telecommunications and electrical utilities sectors more competitive. Labor market reforms introduced in May 1997 sought to stimulate the growth of permanent employment contracts by lowering dismissal costs and social security contributions for certain categories of workers. Although the reform has been followed by an increase in permanent contracts, it is still too early to ascertain its long-term impact. Despite recent initiatives, widespread rigidities in product and factor markets continue to contribute to unemployment and to constrain the potential growth of output.

Executive Board Assessment

Executive Directors praised the authorities for their sustained implementation, over a long period, of coordinated fiscal, monetary, and structural policies that had led to Spain's becoming a founding member of the European Monetary Union. These policies, and the attendant credibility gains, had created a virtuous circle of strong growth and fiscal consolidation, with inflation being reduced to historically low levels. Directors emphasized, however, that despite important gains in employment-reflecting favorable cyclical developments, and also the 1994 and 1997 labor market reforms-the unemployment rate was still at a worrisomely high level, and remains Spain's most pressing economic problem. Achieving further reductions in unemployment would, particularly in the context of monetary union, require accelerated efforts to reduce the rigidities and other inefficiencies that constrain the economy.

Directors noted that rapid economic growth is expected to continue in 1999, on the basis of strong domestic demand. While inflation remained low, a differential with respect to average inflation among other members of the common currency had emerged, which in the medium term could erode Spain's currently favorable competitive position. However, some Directors were more sanguine on this issue, pointing to the significant slack that still existed in the economy, Spain's record of moderate wage increases, and the Balassa-Samuelson effect.

Directors noted that monetary conditions were more accommodating than might be preferable from a purely Spanish perspective. They therefore welcomed the authorities' commitment to maintain the fiscal deficit target for 1999, despite a slight downward revision in the growth forecast owing to lower external demand. Several Directors considered that this fiscal stance should be regarded as a minimum effort, particularly given the ambitious objectives of Spain's Stability Plan. Directors also supported the authorities' intention to dedicate any revenue over performance to deficit reduction. Most Directors supported the authorities' intention to follow an asymmetric approach to the use of fiscal policy for smoothing the economic cycle, namely to tighten policy if growth and inflation were to exceed expectations, but maintain the deficit targets in the event of a moderate growth slowdown. This approach would be particularly appropriate at the present juncture. A few Directors, however, did not wish to rule out recourse to automatic stabilizers in the near term in the event of a further slowdown, but agreed that the scope for such action increased as fiscal consolidation progressed over time. More generally, Directors considered that the authorities should stand ready to tighten fiscal policy if inflationary pressures intensify.

Directors also welcomed the commitment of the authorities to eliminate the fiscal deficit by 2002 and their intention to achieve this through restraint in primary current expenditures. They were confident that Spain was well placed to achieve these medium-term fiscal objectives. They noted that determined action on expenditure, including further reforms in health and other areas, would create scope for reductions in the tax wedge on labor, and thereby provide a stimulus to employment. They cautioned, however, that reductions in social contributions would need to be accompanied by additional reforms to offset any negative impact on the long-term sustainability of the pension system.

Directors welcomed the constructive role that had been played by regional and local governments in recent years in fiscal adjustment, and noted that further modest reductions in the deficits of these entities would be required to achieve medium-term balance. They encouraged the authorities to continue working with regional and local governments to adopt measures-such as the renewed regional stability pact with explicit deficit targets, hard budget constraints, and timely publication of outturns-that would help ensure fiscal discipline at all levels of government.

Directors characterized the labor market reforms of 1994 and 1997 as positive developments, but noted that additional actions were required, as the unemployment rate remains very high and a large percentage of workers continued to be employed on temporary contracts. Attention would need to be paid to addressing differences in labor market performance across regions and between genders, and to promoting youth employment. Noting that dismissal costs are high, Directors called for a lowering of these costs. They also suggested a reduction in the duration of unemployment benefits to encourage earlier job search by unemployed workers. Directors noted that any of those savings could be used to extend benefits to those jobless that do not now qualify for them. Incentives on the supply side of the market could also be improved by pension reforms. These reforms are essential to improve the performance of the labor market, and ensure that all sectors of the economy derive benefits from Spain's impressive economic performance.

Directors welcomed the progress that had been achieved in liberalizing goods markets through privatization and regulatory reform. At the same time, they recognized that widespread rigidities continue to hamper Spain's growth potential and contribute to unemployment. They identified land, retail trade, and rental housing markets as priority areas for reform, and urged national, regional, and local governments to collaborate in the liberalization process. Part of this process could involve a diversification of revenue sources for regional and local governments to reduce their current reliance on revenues from urban development.

Directors recognized that monetary union presents new challenges for the banking system. They welcomed the prudent provisioning that banks had undertaken in recent years, which would help insulate them from the impact of adverse developments in Latin America. Some Directors encouraged the authorities to consider the need to enhance cross-border coordination of supervision. A few also suggested that the authorities consider further reforms to ensure the access of small- and medium-sized firms to equity markets.

Directors encouraged the authorities to complement their commendable support for the international community by increasing their funding for international development activities.

Spain: Selected Economic Indicators

  1995 1996 1997 1998 19991

Real economy (change in percent)          
GDP2 2.7 2.3 3.7 4.0 3.3
Domestic demand2 3.2 1.8 3.2 5.0 4.9
CPI (end-period) 4.3 3.2 2.0 1.4 2.1
Unemployment (in percent) 22.9 22.2 20.8 18.8 16.8
Investment3 22.3 21.9 22.2 23.3 24.4
Saving3 22.3 21.9 22.6 23.0 23.6
Public Finance (in percent of GDP)          
Central government balance -6.2 -3.5 -2.0 -1.4 -1.2
General government balance4 -7.1 -4.5 -2.6 -1.8 -1.6
Structural primary balance5 -0.5 1.7 2.6 2.5 2.4
Gross general government debt4 64.1 68.5 67.5 65.6 65.0
Interest Rates (annual average)          
Three-month interbank rate 9.4 7.5 5.4 4.2 2.6
10-year government bond rate 11.2 8.8 6.4 4.8 4.2
Balance of Payments (in percent of GDP)        
Current account balance 0.0 0.0 0.4 -0.2 -0.8
Trade balance -3.3 -2.6 -2.4 -3.2 -4.6
Fund position (SDR billions, April 30, 1999)        
Holdings of currency         1.6
Holdings of SDRs         0.2
Quota         3.0
Exchange rates          
Exchange rate regime Member of the European Economic and Monetary Union
Nominal effective rate (1990=100) 80.3 80.9 77.2 76.9 ...
Real effective rate 87.5 89.3 85.3 85.4 ...

Sources: Bank of Spain; IMF staff projections.

1IMF staff projections.
2Growth rates for 1995 are based on unrevised GDP series. Rates for other years are based on revised (SEC95) GDP series.
3In percent of GDP.          
4Maastricht basis.          
5Equal to the general government balance excluding interest expenditure and adjusted for short-run deviations from long-run output growth. Expressed as percent of potential GDP.

1 Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities. In this PIN, the main features of the Board's discussion are described.
2 This refers to the fact that countries that are experiencing rapid productivity growth in the tradables sector will tend to have higher inflation rates for nontraded goods, as nominal wage growth will exceed productivity growth in the slower-growing nontradables sector. As consumer price inflation is a weighted average of inflation in traded and nontraded goods, these countries will also tend to have higher consumer price inflation than countries where productivity is growing more slowly.


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