Transcript

With Mr. Alessandro Leipold, Deputy Director in the European Department and Mission Chief for Spain; and Mr. Julio Escolano, Deputy Division Chief in the European Department
Washington, DC, May 18, 2007

MS. GAVIRIA: Good morning and good afternoon to those of you who are dialing in from Spain. I'm Ángela Gaviria and I'm with the IMF External Relations Department. I'm happy to welcome you to this conference call on the Public Information Notice on the 2007 Article IV Consultation with Spain. The document, as you know, was posted at 8:00 a.m. today in the Online Media Briefing Center. I hope that you had a chance to look at it. The contents of this conference call and the document are embargoed until 10:00 a.m. today, Washington time. Here, with me, are Alessandro Leipold, Mission Chief for Spain, and Julio Escolano, Deputy Division Chief in the European Department of the IMF. They will make some brief remarks, and then they will be happy to take your questions. (Welcoming remarks in Spanish.)

MR. LEIPOLD: Thank you very much. On Wednesday, the Executive Board of the IMF concluded the 2007 Article IV Consultation with Spain. As some of you may recall, we were on mission in Spain in March, and we also at that time gave the authorities our preliminary conclusions, which are posted on our web site. The discussion at the Board was an interesting one. The Directors on the whole agreed with the conclusions, and allow me to summarize them briefly. You will find them in the Public Information Notice.

What was welcomed generally was that Spain has enjoyed again another year of remarkable growth in 2006 and it is now 13, 14 years of expansion with strong job creation, increases in female participation, integration of immigrants, and—recently—inflation has been coming down appreciably as well. More importantly, Directors noted, there are also some signs of rebalancing of growth away from consumption and construction and toward corporate investment and exports. At the same time, revenue buoyancy has lifted the general government balance to a record surplus of 1.8 percent of GDP. However, private sector indebtedness reached new highs, and the current account deficit widened, as you know, to close to 9 percent of GDP.

Against this background, the Board saw the rebalancing of growth as underpinning the central scenario of a smooth landing, a gradual deceleration of growth; to this around 3.6 percent for this year. But there are downside risks that this scenario may not unfold. The main risk is that agents who are heavily indebted may adjust their balance sheets more rapidly than we anticipate and that, given the rigidities that there are in the Spanish economy, it will be difficult to shift resources quickly to exports and to regain competitiveness within EMU, and therefore you could possibly have a prolonged period of slow growth.

To forestall such a scenario, which, of course, is difficult to know if and how it may take place, but it's important for policies to forestall such risks, we and the Board saw three policy priorities: To safeguard budgetary stability while tempering demand, to raise the supply capacity and improve competitiveness of the economy, and to keep the financial sector strong.

As regards the first priority, we see a need to base fiscal adjustment more on expenditures. Revenue buoyancy certainly has strengthened the public finances, but at the same time primary spending is rising steadily, and it can be difficult to reverse such spending to preserve fiscal sustainability when one needs to. So we're looking for the central government in the 2008 budget to set the expenditure ceiling at a level which would keep primary spending constant in relation to GDP, and we would have liked a more ambitious surplus to be set for the regional governments than the 0.25 percent of GDP recently agreed. Pension reform also remains necessary and that's something that the next legislature should take up.

On the structural reforms to increase productivity and competitiveness, we support the authorities' National Reform Program. We and the Board would like to see greater emphasis on competition-enhancing efforts, which should be stepped up and backed by a strong political commitment to contestable markets and a greater independence of sector regulators. Also, after the upcoming elections, the Board noted that further labor reforms will be needed to increase labor market flexibility.

Finally, on the financial sector, this is certainly one of the more dynamic aspects of the Spanish economy. It's shown remarkable vibrancy and profitability, but continued vigilance by the Bank of Spain in the face of strong credit growth and banks' exposure to the real estate sector is warranted.

I'll be happy to take your questions now.

QUESTIONER: I have a question on the nature of the independence of the regulators. As you know, there have been allegations in Spain of government involvement in the actions of the stock sales agency, passing documents to investigators, bankers, and so forth. There have been allegations like that in the past of government interference with the agency. I wonder if that something that you're asking, for the independence of regulators, if that's what you're referring to, and whether those kinds of things are something that is worrying the IMF.

MR. LEIPOLD: We've been calling for a greater independence of regulators for some time, well before the episodes you mention. It's not determined by these episodes, which are under investigation, and I have no idea as to their veracity. Already last year, if you look at our staff report and our conclusions, we were calling for this. We mainly had in mind the sectoral regulators, i.e., in energy and other key sectors. In our concluding statement this year, we call for a greater arms-length relationship between the regulators and the relevant sectoral ministries. So it's a longstanding issue that predates recent events, and we've been calling for greater independencet for some time.

QUESTIONER: I wondered if you could just say what you mean by a prolonged or a protracted period of slow growth. Are you referring to a growth between 2 and 3 percent or lower than that, and when might that period begin and end?

MR. LEIPOLD: You're asking me to speculate on a risk scenario. Our central scenario is different. What we are worried about is really uncharted territory: it is a situation in which households and enterprises, having accumulated considerable debt, suddenly decide, or over time decide, to retrench and restore the health of their balance sheets. How that unfolds, frankly, is very difficult to say, whether it's a sudden retrenchment or a slow, prolonged one. There are examples in Japan, of course, in Portugal right now, that one can think of.

We don't have a precise scenario, and I don't think it would be possible to say exactly how a "risk" unfolds, but we have language, in the staff report or in our concluding statement, that says clearly that, even though it's uncertain as to how this might happen, the risk is there and it's the task of policies to try to avert that risk, however uncertain it may be in its timing and intensity. So I'm not able to answer your question about timing and intensity: that's uncertain, but what's certain is that there is a risk that needs to be addressed.

QUESTIONER: I just wanted to know what, in your central scenario, happens to house prices and if you could say a bit about the probability of deviations to the upside or the downside from that.

MR. LEIPOLD: House price increases have been coming down nicely in the recent period. House price inflation was 17.2 percent in the fourth quarter of 2004, and it's at 7.2 percent in the first quarter of this year. So there has been a deceleration in line with our underlying scenario of a smooth landing.

There were scenarios, and I would have to direct you more specifically to work that was done in last year's FSAP, the Financial Sector Assessment, in which we did some stress scenarios for the banking sector that looked at possibilities of a 30 percent decline in real estate prices over two years, which would be a pretty sharp decline, and its impact on GDP growth. Those scenarios estimated that the impact on growth would be in the order of 0.4 and 0.7 percentage points, i.e., slower GDP growth in years one and two respectively with respect to the baseline. But the details are in last year's FSAP documents that I don't have in front of me right now.

QUESTIONER: Can you comment on what the expected price developments are within the central scenario you've talked about?

MR. LEIPOLD: Well, it's not that we project housing prices per se. We normally don't try to project asset prices; it's far too difficult. But the path is one of continued slow deceleration. Mr. Escolano may have something to add.

MR. ESCOLANO: We do expect a deceleration. Our projection is very similar to that of the Bank of Spain and the authorities in that sense. We would say that in one or one year and a half, it could go down to a historical trend, which could be considered similar to the increase in incomes. That is the central scenario.

QUESTIONER: You say in the report that you're worried about a sharp unexpected balance sheet consolidation in corporate Spain. Can you elaborate on what you mean by that phrase? Is this all due to high liquidity of Spanish companies?

MR. LEIPOLD: Let me just say that you all seem to be concentrating on the risk scenario, and to repeat that that's not our central scenario. But as to the risks, we're a little bit more worried about households retrenching and pulling in their oars and affecting consumption. It is households that are particularly highly indebted. Corporate debt has also been rising, but their balance sheet situation is still very strong in a number of respects, and constitutes, to our minds, a lesser risk. Julio might want to add something. There is a chart in the staff report which I hope you'll have shortly, if not yet, to which he can point you.

MR. ESCOLANO: Yes, we show a rather sharp increase in indebtedness of corporations in Spain since, say, 2005. That's parallel to a commensurate increase in investment and mergers and acquisitions. So we are concerned that the indebtedness could reach a point in which corporations may decide to retrench and to consolidate their balance sheets. However, it has to be said that the debt service coverage is still pretty high—corporations thus still have some room for further indebtedness although interest rates are increasing in Europe, and that could be a factor over the next year in terms of retrenching investment.

QUESTIONER: I have two questions, one for Mr. Escolano. You mentioned that house prices could go to an historical trend. I wonder if you could tell us around what percentage that would be of an increase of prices or inflation. The other issue is, you mentioned that you have seen already that there's a slowdown of the price increases in the sector. Do you know what kind of impact they have had on the Spanish economy?

MR. LEIPOLD: Let me just start with the second one. The slowdown in housing prices, as we said, has been gradual. There's not really been a strong impact yet on the economy nor do we foresee one. I said earlier that the contribution of the construction sector, of residential construction has been a little less than in previous years, and that's good, and investment in equipment has been going up. Thanks to the strong fiscal position, should things get considerably weaker, there is also some space for public investment to take up the slack. So no significant effect on the economy so far, but some welcome rebalancing in the sources of growth. Your first question was directed to Julio and I'll leave it to him.

MR. ESCOLANO: In terms of the historical trend of house prices, we would say that it's between inflation and incomes. The increase in incomes in Spain, or wages, is between 3 and 4 percent at this point, and inflation, as you know, is about 2.5. So that's a range in which it's reasonable to expect the house prices to stay.

QUESTIONER: I was just wondering if you could comment in a little more detail on the national reform program, what aspects you think are positive, what aspects of that could be improved in the aim of improving productivity in Spain.

MR. LEIPOLD: The National Reform Program contains a wide, very large number of microeconomic measures. The organizations that oversee such policies more closely, the E.U. Commission as regards the Lisbon Agenda and the OECD because of its competencies in this area, are entrusted with the evaluation of the microeconomic measures envisaged in the Program. They have given the National Reform Program positive plaudit and we share their view.

What we have noted however is the Program has a fairly strong emphasis on the public provision or public promotion of certain activities, be it research and development, or other such measures. We would rather see a shift in emphasis on fostering competition in sheltered domestic markets whose rigidities we see as a major contributor to inflation and cost differentials with trading partners. So that's where we would place the emphasis.

At the same time, there are also a number of initiatives that are not in the National Reform Program as such, but that we certainly welcome strongly, and the Board did as well. Most notably, the new competition law that sets up a new competition authority with expanded powers and a number of new powers that we would encourage them to use proactively. And there is the transposition of the E.U. Services Directive which we think is also a very important tool to open up protected sectors throughout Spain.

QUESTIONER: You are asking the Central Bank of Spain to be vigilant on the evolution of the real estate sector, but at the same time you're saying that the correction is gradual. How can we match these two things?

MR. LEIPOLD: Yes, we say the correction is gradual. We also say there are risks, and that's where vigilance is needed. The Bank of Spain is indeed very vigilant, and we're not worried about that. Our call there, if you want, is a little rhetorical. But certainly there is very rapid credit growth. There is a heavy concentration of loans to the real estate sector. We really view the risks as relating to the outlook for continued strong growth rather than to any systemic risks in the financial sector: the level of non-performing loans is really very low, and the level of provisioning is really very high. The stress tests that we conducted in last year's financial sector assessment program, the FSAP, indicated that the financial system shows a robust resilience to a large range of adverse shocks.

We also highlighted, when we were in Madrid in March, that the parallels that are drawn by some analysts between the U.S. subprime mortgage market and Spain's mortgage market are unfounded. There's really no comparable phenomenon in Spain. But still, having said all that, continued Bank of Spain vigilance is well advised, and its very strong reporting and provisioning requirements are also well placed in the current environment.

QUESTIONER: What are the risks posed by the strength of the euro in the exports sector? I would like to know if the euro, against the dollar mainly, is going to pose any risk.

MR. LEIPOLD: I think the short answer is really no. In general, countries should cease to view their problems as coming from the outside. Certainly, the strength of the euro does pose some issues for weaker sectors that are less competitive to begin with, but fundamentally the problems of countries that have weak competitiveness within the euro area are homemade.

In the case of Spain, it has been low productivity. It has been an increase in unit labor costs that has outpaced that of its partner countries. So we tend to discourage policymakers from seeking external causes for the difficulties when really the causes are mainly internal.

MS. GAVIRIA: We don't have any more questions, so I would like to thank everybody at this time for participating.

MR. LEIPOLD: May I say one more thing? I believe the staff report was posted with some delay on our web site, but I would encourage you to look at it. It's quite short this year, and the main points that we tried to make are in the final pages that are entitled Staff Appraisal, and I think you will find a hopefully good summary of our points there.

MS. GAVIRIA: Thank you, Alessandro and Julio, and again to all participants. (Farewell in Spanish.)