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Eurozone Forecast
Spain
Spring edition, April 2011
Outlook for Spain
Ernst & Young Eurozone Forecast Spring 2011
• 17 Eurozone countries
Finland
Estonia
Ireland
Netherlands
Germany
Belgium
Luxembourg
Slovakia
Austria
France
Slovenia
Italy
Spain
Portugal Greece
Malta
Cyprus
• In the final three months of 2010, Spanish GDP increased by just 0.2%, only a marginal
improvement from the stagnation seen in Q3 2010. In 2010 as a whole, Spanish GDP shrank
by 0.1%: fiscal consolidation and private sector deleveraging severely constrained domestic
demand and the pull from foreign trade, which was instrumental in lifting growth in the
other large Eurozone countries, proved too weak an offset. Fiscal consolidation has
proceeded on schedule. Downside risks remain to the fore, related to a bleak outlook for
domestic demand and ongoing uncertainty about the future health of the banking sector.
• Spanish GDP is expected to grow by just 0.6% in 2011, markedly underperforming the
Eurozone average. In 2012, growth is unlikely to exceed 1.1%. Private consumption is
expected to remain depressed, as household income should remain under pressure from
stubbornly high unemployment, which is not expected to decline significantly from its
current levels, and from the adverse effect of the cut in public sector wages and
government transfers that are part of the fiscal consolidation process. Moreover,
deleveraging and uncertainty about employment are likely to keep the savings rate high.
• Investment should continue its fall this year, dropping by 2.8%. Non-residential investment is
expected to slide marginally, thanks to the improvement in foreign demand, but residential
capital expenditure should fall by another 12%, as the construction industry has to grapple
with a difficult financial situation and lack of demand.
• Export growth is expected to remain moderate, as unwinding the huge competitiveness gap
with the main trade partners, accumulated since the adoption of the euro, needs far-
reaching structural reforms to boost productivity that are only implemented gradually and
take time to bear fruit. However, weak import growth should lead net trade to provide a
significant contribution to growth.
• Since the beginning of 2011, the Government has taken new and important measures to
restructure the banking system and, in particular, to strengthen capitalization in the ailing
regional savings banking sector. A key concern is the amount of public money needed to
recapitalize the system, which could escalate to €100 billion, far above the resources made
available by the Government (€20 billion planned so far). In the meantime, banks are
regaining access to the interbank market but non-performing loans (NPLs) are increasing
and the large exposure to Portuguese debt could lead to a significant worsening in asset
quality in the event of a debt restructure there. Credit conditions remain tight and this is
going to affect domestic demand negatively going forward.
• Preliminary data for 2010 shows that the ambitious fiscal consolidation plan proceeds
according to schedule. The budget deficit for 2010 has been contained to an estimated 9.2%
of GDP. If fiscal discipline continues (especially at the regional level), the deficit is forecast
to shrink to 6.5% of GDP in 2011, not too far from the Government’s 6% target. However,
bond markets remain nervous as the Government has to roll over nearly 25% of total debt in
2011. At over 200 basis points (bp) by the end of February, spreads over German Bunds
have fallen by less than 50bp from the peak observed in the final months of 2010.
Muted growth at the end of 2010 … the cuts in public sector wages and government transfers that are
In the final three months of 2010, Spanish GDP increased by just part of the fiscal consolidation process. Growth in private sector
0.2%, only a marginal improvement from the stagnation seen in wages are going to be limited by unemployment and the cap
Q3 2010. The dynamic of the economy changed little through agreed in 2010. In addition, savings are expected to remain high at
2010, with domestic demand dragging down growth and net trade around 13% of disposable income, as uncertainty about
providing only a small contribution. In 2010 as a whole, Spanish employment should encourage precautionary savings. In addition,
GDP shrank by 0.1%, as the pull from foreign trade, which was deleveraging of the Spanish household sector has barely started.
instrumental in lifting growth in other Eurozone countries, proved Household debt has fallen only marginally from the pre-crisis peak
too weak to counter the plunge in domestic demand. and remains at 90% of GDP, around 20 percentage points (ppt)
above the Eurozone average. As a consequence, private
The first indications for 2011 do not point to a major turnaround. consumption is expected to increase by just 0.4% this year.
The Purchasing Managers’ Index (PMI) for March suggested that
output only increased on account of foreign orders, while spare Investment to continue its slide as the construction
capacity remained large. Meanwhile, the services PMI pointed to sector remains weak
only a tiny increase in activity. Both sectors reported a contraction Investment is expected continue its fall and, in 2011, being 2.8%
in labor force. As a result, the unemployment rate has continued to lower than the year before. The recovery in exports seen in 2010
increase this year, to 20.4% in January (on the International Labor has restored profitability in the manufacturing sector somewhat;
Organization measure). together with relatively better prospects for demand, this should
help limit the slide in non-residential investment.
… and GDP to increase by just 0.6% in 2011
Spanish GDP is forecast to grow by just 0.6%, markedly lower than By contrast, residential investment is expected decrease by more
the Eurozone average. In 2012, growth is unlikely to exceed 1.1%. than 12% this year. And we do not expect it to start rising before
Subdued domestic demand and a positive contribution from net 2013. Saddled with strained balance sheets, the construction
trade should continue. industry faces quite bleak prospects.
Household income is expected remain under pressure from The fall in house prices is likely to continue, as price-to-rent ratios
stubbornly high unemployment, which is not likely to decline suggest that housing is still overvalued. Tax incentives for house
significantly from its current levels, and from the adverse effects of purchases in place until the end of 2010 and low interest rates are
Table 1
Spain (annual percentage changes unless specified) Source: Oxford Economics
20
0
Industrial
-5 production
15
-10
-15
10
-20
-25 5
1980 1984 1988 1992 1996 2000 2004 2008 2012 1980 1984 1988 1992 1996 2000 2004 2008 2012
likely to have prevented a steeper fall in prices so far. As these All in all, in the medium term, the Spanish economy is expected see
factors no longer support the housing markets, very large declines growth rates much lower than those enjoyed in the boom years,
in prices seem likely. Moreover, despite the pickup in sales seen in and we forecast GDP growth below 2% per year until 2015.
Q3 2010 (due to the anticipation of the end of tax incentives), the
backlog of unsold homes remains large. According to Bank of Inflation expected to come back down
Spain’s estimates, there are between 700,000 and over a million Subdued domestic demand should put a lid on inflation in the
unsold homes, corresponding to over three years’ worth of sales. medium term. The rise in inflation since the end of 2010, which
has seen consumer prices increase by 3% year on year in January
Moreover, credit conditions remain tight. According to the latest (harmonized measure), has been mostly accounted for by the spike
Bank of Spain’s Bank Lending Survey for Q1 2011, the significant in energy prices and last July’s increase in VAT. Inflation should
tightening seen in the first part of 2010 has not been relaxed, and remain above 3% during H1, but it is expected to come back down
the majority of banks continue to report an increase in interest later this year in line with the forecast moderation in energy prices
margins. Tighter and more costly credit is expected to act as an and as the impact of the VAT increase drops out of the
additional drag on domestic demand and, in turn, threaten the calculations, averaging 2.9% for the year as a whole. In the medium
relative stability of the banking sector. term, inflation is projected to remain below the Eurozone average,
at around 1.5%, as Spain tries to regain competitiveness.
Investment is forecast to increase by only 1.5% in 2012 and may
accelerate to 3.4% the following year. Health of the banking sector key uncertainty
Our baseline forecast assumes a gradual but effective resolution of
Only net exports to provide a positive contribution the problems affecting the banking sector. Some important policy
to growth measures have been taken and, on the whole, the situation has
Given bleak prospects for domestic demand, only exports could improved since the final months of 2010, but the possibility of a
provide some pull to the economy, but Spanish exporters have to marked deterioration, leading possibly to a state bailout, cannot be
grapple with structural competitiveness problems. Between 1999 ruled out. The health of the banking sector constitutes a key risk to
and 2010, Spain’s real exchange rate has appreciated by 22%, as our forecast.
opposed to the 2% appreciation of the Eurozone average and the
over 10% depreciation experienced in Germany. Wage moderation The most important policy initiatives taken are aimed at
is expected to bring about some small competitiveness gains going overhauling the regional savings banking sector (cajas), in order to
forward, but undoing the losses accumulated in the past decade tackle its low capitalization and large dependence on wholesale
requires substantial improvements in productivity resulting from funding. At the beginning of 2010, the Government implemented a
structural reforms, which take time to implement and bear fruit series of reforms aimed at strengthening the sector, by merging
only slowly. the cajas and improving their governance. The number of banks
has dropped from 45 to 17, and average total assets per institution
have more than doubled, which should improve efficiency.
Figure 3 Figure 4
Contributions to GDP growth Government balance and debt
% year % of GDP % of GDP
8 Forecast 4 Forecast 80
Domestic
demand
6 2 70
GDP
4 0 60
2 -2 50
0 -4 Government debt 40
(right-hand side)
-2 -6 30
-6 -10 10
-8 -12 0
1985 1988 1991 1994 1997 2000 2003 2006 2009 2012 2015 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014
Moreover, in February 2011, new measures were put in place to Fiscal consolidation appears on track
strengthen capitalization. Banks will have to raise the capital needed Better news is coming from public finances. Preliminary data for
on the market, sell assets or tap temporarily into a government- 2010 shows that the ambitious fiscal consolidation plan is
sponsored fund that would amount to a partial nationalization. proceeding according to schedule. The budget deficit for 2010 has
been contained to an estimated 9.2% of GDP. If fiscal discipline
According to central bank estimates, the capital shortfall to be filled continues to be enforced, budget deficit will shrink to 6.5% of GDP
by public money will not exceed a manageable €20 billion, but in 2011, not too far from the Government’s 6% target.
other analyses put the amount of resources needed as high as
€100 billion, given the uncertainty surrounding the quality of assets However, most of the improvement has come so far from the
linked to the construction sector. Such a sum would far exceed the better-than-expected performance of the central government.
amount of resources set aside by the Government to restructure According to the Ministry of Finance, more than half of the regions
the banking sector and would jeopardize fiscal restructuring. (including the biggest one, Catalunya) have missed their deficit
reduction targets and will be obliged to step up the fiscal
Meanwhile, Spanish banks have succeeded in regaining access to retrenchment measures in 2011.
the interbank market and have greatly reduced their dependence
on the European Central Bank (ECB). In January 2011, loans from Yet, the improvement in fiscal balances has so far failed to impress
the ECB have dropped to €53 billion, less than half the amount bond markets, which remain nervous, as the Government has to
borrowed at the peak last June. However, the weak economic roll over nearly 25% of total debt this year. At over 200bp by the
situation is continuing to erode the quality of banks’ assets. In beginning of March, spreads over German Bunds have fallen by
December 2010, the ratio of NPLs to total credit climbed to a less than 50bp from the peak observed in the final months of last
15-year high of 5.8%. Bad loans may continue to increase as they year. While they remain low in comparison to those on Portuguese
normally lag economic activity. and Irish bonds, the burden of interest payments on government
finances remains substantial. These latent tensions in the Spanish
An additional source of risk stems from the large exposure of the government bond markets imply that any slippage in fiscal
Spanish banking sector to Portugal. According to analysts’ consolidation, for instance from regional governments, could have
estimates, Spanish banks own roughly a third of Portugal’s foreign a significant impact on the cost of borrowing and the sustainability
debt (which is 60% of total debt). Any loss triggered by a of public finances.
Portuguese debt restructuring would inevitably have a sharp
adverse impact on Spanish banks’ balance sheets.
The views of third parties set out in this publication are not necessarily the views of the
global Ernst & Young organization or its member firms. Moreover, they should be seen in
the context of the time they were made.