Spain: IMF Staff Concluding Statement of the 2018 Article IV Mission

IMF News, October 3, 2018

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Real GDP growth is projected to moderate to about 2.7 percent in 2018 and 2.2 percent in 2019, still above the euro area average.
Beyond 2019, economic expansion is set to converge to its potential rate, estimated at about 1¾ percent.
Important structural challenges: notably high public debt, high structural unemployment and sluggish productivity growth weigh on potential GDP growth.
Downside risks:
- External: sudden changes in investors’ risk appetite; escalating global protectionism; weakening conditions in emerging economies.
- Domestic: pressures to reverse reforms; continued procyclical fiscal policy.

Findings

Fiscal buffers depleted during the crisis need rebuilding to create fiscal space for future shocks.
The decline in headline deficits over the past three years has reflected entirely the strong economic cycle.
The structural balance deteriorated to about 2.5 percent of GDP.
For 2018, additional structural loosening of 0.2 percent of GDP is projected.
Debt levels have only come down marginally while the economy has grown strongly.

Policy recommendations

Restart structural fiscal adjustment and take full advantage of still-strong conditions to bring down high public debt.
Government’s announced deficit target of 1.8 percent of GDP for 2019 is critical and appropriate; it implies a structural effort of about 0.5 percent of GDP.
Maintain this pace of adjustment per year until fiscal structural balance is achieved and debt is on a clear downward path.
2019 budget must include a credible package of measures; prudently project yields from revenue measures and plan contingency actions to promptly compensate any revenue shortfalls.
Raise additional revenues beyond deficit reduction to finance spending protecting the vulnerable, support youth and long-term unemployed, foster innovation and environmental protection, and achieve distributional objectives—while carefully designing tax measures to limit distortions.

Findings

The pension system shielded the older generation during the crisis but faces future challenges from population ageing.
The social acceptability of the 2011/13 pension reforms has been put into question.
Linking pension increases permanently to inflation is estimated to add about 3-4 percent of GDP in pension outlays by 2050 under current demographic and macroeconomic projections.

Policy recommendations

A sustainable and comprehensive pension package is needed; Toledo Pact recommendations should not be translated into legislation without a comprehensive package.
Structural spending hikes require structural offsets (examples: increases in the minimum contribution for self-employed; increases in the maximum earnings subject to contributions; linking the statutory retirement age directly to life expectancy).
Consider distributional consequences of measures and ensure full transparency about the effect of pension changes so future pensioners can make informed decisions.

Findings

Unemployment rate dropped to 15 percent in the second quarter of 2018, below its long-term average.
Long-term unemployed accounted for more than half of the total unemployed who found a job in the past 18 months.
Some regions still have unemployment over 20 percent.
Spain’s youth joblessness remains among the highest in the EU; the young remain at highest risk of poverty despite declines since 2015.
Labor market duality persists and constrains productivity, regional mobility, and contributes to persistent regional unemployment gaps.

Policy recommendations

Preserve the thrust of labor market reforms, in particular the prevalence of firm-level over sectoral agreements.
Ensure future wage increases follow productivity growth; the July guidelines by social partners on general wage increase are welcome.
Caution that steep increases in the statutory minimum wage could risk employment opportunities for the low-skilled and the young.
Make open-ended contracts more attractive to reduce duality and high structural unemployment.
Enhance active labor market policies: improve training programs and education outcomes; increase labor-market relevance of tertiary education; expand vocational training and life-long learning; reduce school drop-out rates.
Consider incentives for regional mobility (for example, subsidies for moving expenses and temporary and targeted housing assistance).

Findings

Productivity has improved but remains notably below European peers, especially among small and micro firms.
Labor productivity varies widely across regions, with a gap of nearly 50 percent.
Regions with lower skills mismatch, higher foreign direct investment and greater reliance on R&D tend to use resources more efficiently.

Policy recommendations

Reduce regulatory fragmentation across the three levels of government.
Improve market access and competition, particularly for professional services.
Lower barriers for firms to grow.
Better coordinate research and innovation policies across government levels; tackle factors holding back the uptake of R&D incentives and business-science cooperation.
Promote systematic exchanges of best practices in education and peer reviews among regions.
Continue enhanced focus on gender policies to reduce inequality and raise long-term growth.

Findings

Banking system health continues to improve; nonperforming loans and foreclosed real estate assets have notably declined, though some banks still need to follow suit.
No clear evidence so far of a generalized house price overvaluation, but housing-related new loans and consumer lending are picking up.
Spanish banks still lag European peers in capital ratios despite generally being less leveraged.
Financial oversight lacks an integrated approach to focus on risk transmission and amplification across sectors.

Policy recommendations

Swiftly expand Bank of Spain’s macroprudential toolkit to include borrower-based tools such as limits on loan-to-value and debt service-to-income ratios.
Rigorously manage liquidity and interest rate risks, especially ahead of ECB policy normalization and against market volatility and sudden changes in risk appetite.
Accelerate build-up of high-quality capital buffers for banks.
Expedite plans to modernize the institutional framework for financial oversight; prioritize creation of a national macroprudential authority comprising the Bank of Spain, Treasury and other financial oversight agencies to bolster systemic risk surveillance, enhance macroprudential decision-making and promote coordination.
Promptly complete creation of an independent insurance and pension supervisor, a financial consumer protection authority, and increase transparency of appointment processes for senior positions at financial oversight agencies.

IMF mission team concluding statement, October 3, 2018.