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Spain: Staff Concluding Statement of the 2016 Article IV Mission
December 13, 2016
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IMF Communications Department
MEDIA RELATIONS
PRESS OFFICER: Andreas Adriano
Phone: +1 202 623-7100Email: MEDIA@IMF.org
The Spanish economy has continued its impressive recovery and strong job creation. Earlier reforms and confidence-enhancing measures have paid off, and combined with external tailwinds and fiscal loosening fueled the strong economic rebound of the past two years. Preserving the reform achievements is therefore of utmost importance but Spain needs to go farther if it is to sustain the dynamic economic performance. It is critical to reduce the remaining vulnerabilities and structural weaknesses. Immediate attention should focus on restarting gradual fiscal consolidation to put the elevated public debt firmly on a downward path, reducing the high long-term and structural unemployment, and raising the low productivity growth of Spain’s many small and medium-size enterprises.
Economic outlook and risks
The recovery is strong and imbalances are falling. The rebound in private consumption, exports, and investment, aided by past reforms, has remained the main driver of growth. Tailwinds such as the European Central Bank’s accommodative monetary policy, and fiscal relaxation have also provided support. Real GDP and employment growth remain well above the euro area average, despite a prolonged period of domestic political uncertainty. The current account is projected to record its fourth consecutive annual surplus, thus supporting the ongoing rebalancing of the economy. Private sector balance sheets—including those in the banking system—have continued to strengthen, access to credit has improved, and real estate prices have edged up.
Despite considerable progress, adjustment is still incomplete and structural weaknesses persist. In particular, unemployment, especially long-term and youth joblessness, is still very high, while the use of temporary contracts for new jobs remains wide-spread. At the same time, elevated public debt, lingering debt overhang in parts of the private sector, and the large negative net international investment position continue to leave the economy vulnerable to shocks.
Spain’s earlier reforms continue to pay off but need to be expanded to sustain strong growth and employment prospects over the medium term. In particular, wage moderation and greater labor market flexibility have helped the Spanish economy regain competitiveness and contributed to the swift creation of new jobs. In combination with several tailwinds, this has allowed the economy to expand at a vigorous 3.2 percent rate in 2015 with the same growth rate expected for 2016. However, as impulses to the economy from lower oil prices, the weaker euro, and fiscal stimulus are set to dissipate, real GDP growth is projected to moderate to 2.3 percent next year. Over the medium term, growth prospects are expected to slow further as Spain will continue to confront particularly the challenges of feeble productivity growth and high structural unemployment. Past reforms have mitigated this trend and demonstrated that additional structural measures can upgrade the medium-term outlook.
Fiscal policy: Resuming growth-friendly and inclusive consolidation
Resumption of gradual but steady structural fiscal consolidation would ensure that debt is firmly on a downward path. While headline fiscal deficits have continued to narrow, for the second consecutive year the deficit will likely be higher than originally planned despite strong economic growth and lower interest costs. This implies a structural loosening of the fiscal stance in 2015–16. Building on the large fiscal measures adopted over 2010-13, adjustment going forward can take a more measured pace but should be steady and be underpinned by well-defined policy actions. An annual fiscal adjustment of the structural primary balance of about 0.5 percent of GDP would strike an appropriate balance between preserving the economic recovery and ensuring the long-term sustainability of public finances. In that respect, the fiscal measures adopted for 2017 are an important step toward reaching the deficit target and public debt reduction.
A carefully designed adjustment can be growth- and job-friendly. In particular, Spain has room to raise revenues. Gradually reducing the value-added tax exemptions would bring its collection more in line with other EU countries. Similarly, there is scope to raise excise duties and environmental levies—especially in the current environment of low energy prices—and tackle inefficiencies and special treatments in the tax system. In combination with the earlier reduction in corporate and personal income tax rates, such revenue measures would support the growth-friendly shift from direct to indirect taxation. On the expenditure side, room for further efficiency gains could be best gauged by conducting thorough expenditure reviews—in particular in the areas of health and education. At the same time, it will be important to properly shield vulnerable groups and enhance the efficiency of expenditure programs that directly support employment and growth, such as active labor market policies (ALMP) and public research and development spending.
Without reforms, the regional financing framework remains a risk for the achievement of fiscal targets. Reforms should aim to improve regions’ incentives to comply with fiscal targets while accounting for their different economic capacities. This calls for more automatic and stricter enforcement of targets and providing regions with greater power to mobilize their own revenues. And finally, the introduction of performance-based transfers could be considered to strengthen regions’ incentives to advance critical reform areas, such as the implementation of the Market Unity Law and ALMP.
Labor market: Tackling long-term unemployment and labor market rigidities
Reducing unemployment, in particular long term and youth joblessness, remains a key challenge. Employment has been growing at more than 3 percent annually, with almost 1.1 million jobs created over the past two years, supported by wage moderation and labor market reforms. The reforms have also made the labor market more resilient to shocks and promoted a moderate reduction in duality and structural unemployment. But temporary contracts still make up the largest share of the new jobs, with labor market duality particularly exacerbating employment volatility and inhibiting human capital investment and workers’ productivity. Unemployment has already come down about 8 percentage points from its peak but remains very high at around 19 percent, with almost 60 percent of the unemployed having been jobless for more than a year, a large share of them being low-skilled and previously occupied in construction.
Progress on a number of fronts could help more Spaniards benefit from the recovery and safeguard these gains going forward. An immediate priority is promoting job creation for the long-term unemployed and low-skilled youth. The impact of active labor market programs for these two groups has been limited, calling for urgent improvements, particularly though better coordination with regional governments, with some efforts already underway. At the same time, the range of hiring subsidies could be consolidated into better-targeted subsidy schemes. Moreover, addressing the longstanding issue of labor market duality requires making permanent contracts more attractive for employers. In the meantime, providing greater legal and administrative certainty over dismissals and allowing firms more control and flexibility over working conditions could enhance the effectiveness of recent labor market reforms.
Structural reforms: Boosting firm productivity and growth
Spain’s weak productivity remains a core medium-term challenge. The country’s corporate landscape is dominated by small firms, which tend to be less productive, innovative, and export-oriented than those in Spain’s European peers. Earlier labor and product market reforms helped companies increase competitiveness, and are estimated to boost productivity growth by about 0.5 percentage point annually over the next five years. While higher than in the pre-crisis period, productivity growth would need to be raised if Spain is to sustain real GDP growth above 2 percent over the medium term.
Boosting firm growth and productivity requires further progress in several areas: (i) adjusting public policies to foster good regulation and competition (in particular, expediting the implementation of the Market Unity Law and advancing the delayed liberalization of professional services); (ii) supporting innovation by enhancing private R&D investment, which is low compared to that in European peers, and increasing the efficiency of public R&D spending; (iii) revisiting remaining regulations that have created a “small business trap”; and (iv) further improving access to non-bank (typically equity) financing for frontier innovation. These types of reforms tend to have a particularly high pay-off when they are implemented during a cyclical recovery, as Spain is currently experiencing.
Financial sector: Continuing to strengthen the capacity to support growth
The banking system has gained further strength amid new challenges. Due to better asset quality, stronger capital and funding positions, and reduced debt overhangs, the system is closer to putting most of the crisis legacies behind it. However, banks have progressed at different speeds, and overall NPLs and foreclosed assets remain sizeable, although much lower than in some EU countries. At the same time, like other European banking systems, Spain’s banks face challenges arising from the low profitability environment and new regulatory initiatives.
Continuing to strengthen banks and improve the financial outlook of borrowers is a critical part of the economic recovery. Economic policies that sustain a job-rich economic recovery would help simultaneously strengthen domestic demand and private sector balance sheets. At the same time, continuing to ensure adequate provisioning, further improving efficiency gains—possibly through mergers—, boosting non-interest income, and further increasing high-quality capital would enhance the banking system’s ability to withstand shocks, and facilitate sufficient credit provision as demand picks up.
Toward a comprehensive medium-term strategy
Thanks to the impressive reforms undertaken during the crisis, the Spanish economy is now more resilient and has staged a strong recovery. The remaining challenges are mostly of a structural nature and call for a comprehensive medium-strategy. Focusing immediate attention on a few priority areas for which there appears to be broad-based political support could have a high pay-off: enhancing ALMP to lower long-term and youth unemployment, reforming regional public finances to safeguard public finances, and strengthening innovation and education policies to lift productivity. Going forward, additional labor and product market reforms would need to enhance such a strategy.
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The IMF mission team would like to thank the Spanish authorities and other counterparts for their warm hospitality and the open and constructive discussions.
