Puerta del Sol in Madrid. Spain’s economy has stabilized but further reforms are needed (photo: Peter & Georgina Bowater/Newscom)
ECONOMIC HEALTH CHECK
But as recent developments in the sovereign debt markets have made clear, Spain is not out of the danger zone yet. The government will have to persevere with reforms to further build market confidence and to create a new growth model that can generate jobs for the country’s millions of unemployed.
As the IMF wraps up its annual health check of the Spanish economy, IMF mission chief James Daniel discusses what is needed for Spain to firmly put the crisis behind it.
IMF Survey online: What is the outlook for Spain’s economy?
Daniel: A modest recovery is currently under way in Spain, led by an encouragingly strong rebound in exports. But the outlook remains difficult. The country has built up imbalances over many years, and it will take years for these to be unwound. The problems are compounded by the lingering effects of the global financial crisis―which resulted in a large fiscal deficit―and the current sovereign debt crisis in Europe, which has increased borrowing costs for Spanish banks and for the government.
Spain’s policymakers are well aware of the challenges, and have mounted a strong and wide-ranging policy response. Measures adopted since mid-2010 include a front-loaded plan to reduce the fiscal deficit, a pension reform that increased the official retirement age from 65 to 67 years, and steps to make permanent hires more attractive.
The government has also implemented strong reforms in the banking sector, reshaping the savings banks―the cajas, as they are known―by strengthening capital standards, transferring their operations to commercial banks, and making it easier to assess each bank through improved access to information.
But Spain is not yet out of the danger zone, as recent events have demonstrated. More determined policy choices will be needed to further enhance market confidence and move Spain to a new growth model.
IMF Survey online: A significant fiscal consolidation is already underway. Is this enough, or is more needed?
Daniel: This year the deficit will be about 6 percent of GDP. This is already a big achievement, given that it stood at 11 percent in 2009. But the goal is to achieve a deficit of 2 percent of GDP in 2014, so there is a long way to go.
The government should ensure that savings are achieved through careful planning that will deliver efficiency gains, and not just through across-the-board cuts. It will take considerable time to deliver on such reforms, just as it will take time for the benefits to become apparent.
Spain has devolved a lot of authority to the regional level, and many spending decisions are made at the local and regional levels, including for health and education. The challenge here is that these regional governments have never had to consolidate spending in the recent past, the decentralization model is fairly new, and the expenditure responsibilities they have are difficult to cut.
As a result, half the regions last year missed their deficit targets. Even though the net deficit was not a big number, we need all levels of government to play their part in the consolidation challenge that Spain faces.
IMF Survey online: Has progress been made in diversifying the sources of growth?
Daniel: One of the many positive aspects of the Spanish economy is the strong growth of exports. We have been surprised at how strong exports have been, and have had to rebalance our growth projections away from domestic sources of growth toward external sources.
We would like this to continue so that exports can become the motor for the Spanish economy going forward. Spain has seen big job losses in the construction sector. The next stage is to reemploy people in sectors that will produce sustainable and strong growth in the future.
IMF Survey online: You mention construction, at the heart of the bust suffered by the Spanish economy. Is further adjustment needed here?
The size of the construction sector has now returned to its historical average in terms of employment, in terms of value added, and in terms of activity. But the number of unsold units has not changed very much, and house prices probably also have further to fall. So far, prices have declined about a quarter from their peak, depending on which index is used.
So while we would not expect further declines in the size of the housing sector, households still have a lot of mortgage debt, and banks still have a lot of exposure to real estate. So the bottom line is that housing will continue to be a headwind for the economy in the foreseeable future.
IMF Survey online: Unemployment remains very high, especially for youth. When should Spain expect to see the impact of labor market reforms—and are additional reforms needed?
Unemployment, now at 21 percent of the workforce, is unacceptably high in Spain by anyone’s definition. This is a huge social problem. It is also a massive economic problem when you have a fifth of the workforce relying on social transfers.
Action has been taken and definitely in the right direction. Over the past year, the government has introduced a number of measures, including making permanent employment more attractive and making it easier to set wages at the company level. The government has also taken specific initiatives on employment training and activation.
That said, in our view these measures are not commensurate to the size and the urgency of the problem. We call for a bolder reform in Spain to address this unacceptably high level of unemployment, especially among the young and those who are more marginally attached to the labor market.
IMF Survey online: How do you assess the strength of Spanish banks? Would they be able to withstand a European downturn?
A lot has been done. In particular, the savings bank sector has been radically overhauled. The cajas have now opened themselves up to private capital and have become more standard in their governance structure so that investors can understand them better.
The banking sector as a whole has raised substantial amounts of capital and has recognized large amounts of losses. Banks have also published more information about their exposures to troubled real estate assets.
Spain has also set best practice in terms of the European stress tests by having almost the entire banking system participate compared to about half the banking sector elsewhere in Europe.
Nevertheless, the outlook for the Spanish banking sector is difficult. The cost of funding is high, profitability of assets will be modest, and the way forward for many banks will be through cost savings. This is already well underway but will need to continue. The restructuring of the savings banks should also be implemented promptly, weak banks will need to be decisively addressed, and progress on building capital and provisioning buffers will need to be maintained.
