SPAIN

Country report Group A-11

Page 1 of 15

Contents
Country Overview ....................................................................................................................................... 3 Politics ....................................................................................................................................................... 3 Economic Indicators ................................................................................................................................ 3 Other Indicators ....................................................................................................................................... 4 Recent Economic Trends & Analysis......................................................................................................... 4 Gross Domestic Product .......................................................................................................................... 5 Inflation ..................................................................................................................................................... 6 Balance of Payment .................................................................................................................................. 6 Foreign Trade ........................................................................................................................................... 7 Foreign Direct Investment (FDI) ........................................................................................................ 7 Exchange Rate .......................................................................................................................................... 8 Employment and Labour Market .......................................................................................................... 9 Productivity ............................................................................................................................................ 10 Sovereign Euro Zone Debt Crisis ............................................................................................................. 10 Mortgages ............................................................................................................................................... 11 Spanish banking system......................................................................................................................... 11 Government debt and budget deficit.................................................................................................... 11 Unemployment ....................................................................................................................................... 12 Inflation ................................................................................................................................................... 12 Decline in investor confidence............................................................................................................... 12 Measures to tackle the economic crisis .................................................................................................... 13 Labour market reforms ......................................................................................................................... 13 Austerity measures to reduce government deficit............................................................................... 13 Reforms in the banking sector .............................................................................................................. 14 Conclusion .................................................................................................................................................. 14 Bibliography ............................................................................................................................................... 15

Page 2 of 15

Country Overview

Official Name Capital Population

Kingdom of Spain Madrid 46,754,784

Politics Government Type Chief of State Head of Government Parliamentary Democracy and Constitutional Monarchy King Juan Carlos I Jose Luis Rodriguez Zapatero

There are more than 20 political parties in Spain. Some of these parties contest elections on a national level whereas some contest on a regional level. The last two elections have witnessed a hung parliament forcing the formation of a coalition government. The group Basque Fatherland and Liberty (ETA) have used guerrilla warfare to oppose the government. Al- Qaeda, a terrorist group, has also opposed the government and has carried out a bombing in Spain.

Page 3 of 15

Economic Indicators GDP GDP by Sector Labour Force Literacy Unemployment Rate Public Debt Consumer Price Inflation Total Export Total Imports Currency Credit rating 1,062 billion Agriculture-2.9%, Industry 25.5%, Services-71.6% 21.58 million[1] 97.9% of Total Population 20.1% (2010) 60.1% of GDP [2] 1.8% (2010)[1] 171.6 billion[1] 280.2 billion[1] Euro (1 = 100 cents) AA (S&P), Aa2 (Moodys)

Other Indicators Religion Education Urban Population Life expectancy at births 76% Roman Catholic, 22% No religion, 2% Others Free and compulsory from age 6 to 16 77% (2010) Males 78.16 years, Females 84.37 years

Page 4 of 15

Recent Economic Trends & Analysis

Gross Domestic Product The real estate boom, which began in 1997, was one of the major determinants of the growth of the Spanish economy at the beginning of the decade. This period of economic boom lasted till about late 2007 when the real estate bubble began to burst around the world. This was followed by the global credit crunch crisis in 2008 and the subsequent euro zone sovereign debt crisis in 2009 2010. The following graph traces the decline in the growth of the gross domestic product (GDP) over the past five years and compares it against the GDP growth rate in the European Union (including Spain) during the same period.
GDP growth rate
10.00% 5.00% 0.00% 2006 -5.00% -10.00% Source: GDP figures for Spain - Instituto Nacional de Estadistica (INE) GDP figures for European Union OECD 2007 2008 2009 2010 European Union (27 countries including Spain) Germany United Kingdom Spain

The services industry, including the tourism, financial services and insurance and real estate industry are significant contributors to the Spanish economy and form around 46.2% of the economy in 2010. The industrial sector, which includes the manufacturing industry, including chemical, textile, food processing, automotive and iron and steel industry, constituted around 14.6% to the GDP in 2010. The construction sector also forms a sizeable part of the GDP at around 9.5%. The agricultural and energy sector together comprise around 2.6% of the GDP and this makes Spain heavily reliant on imports to meet its energy needs.
Income distribution 2010
1.3% 1.3% 14.6% Agriculture and fishing Energy 27.0% 46.2% Construction Source: INE 9.5% Industry

Page 5 of 15

Inflation The financial crisis and the fall in private and public consumer spending, compounded by rising unemployment, resulted in deflationary conditions. Most businesses cut down significantly on prices in order to encourage consumers to spend more and contributed to a deflation rate of 0.2% in 2009.
Consumer Price Inflation
7 6 5 4 3 2 1 0 -1 -2 Source: INE 2006 2007 2008 2009 -0.3 2010 Furnishings, household equipment and routine maintenance of the house 4.1 3.5 2.8 1.8 Restaurants, cafs and hotels Food and non-alcoholic beverages Overall CPI

While low level of inflation is not good news for Spain during the financial crisis, the economy saw inflation rise to 3.5% inflation rate in May 2011, which is higher than the rest of the Euro-zone. This is attributable to Spains energy-intensive economy, which has faced the brunt of rising fuel prices more than other EU nations.

Balance of Payment The current account deficit was significantly high in the pre-recession period, primarily due to the construction and real estate sector. The boom in these sectors was financed through significant borrowing by the private sector in the overseas market to finance the construction boom. Also, Spains dependence on imports also led to a large balance of trade deficit contributing to a significant increase in the current account deficit.
Current Account as a % of GDP
0.00% -2.00% -4.00% -6.00% -8.00% -10.00% -12.00% Source: INE 2003 2004 2005 2006 2007 2008 2009

Page 6 of 15

The improvement in the current account deficit in 2009 is primarily due to a reduction in both imports and exports rather than an actual improvement in the economy. The global financial crisis of 2008-09 resulted in a reduction in aggregate demand throughout the world. Exports reduced by around 20.4% in 2009 while imports reduced more significantly by around 27.5% during the same time. Foreign Trade Level of foreign trade has been more stable except for a significant decline in 2009. Exports have increased to 171.6 billion in 2010 from 148.6 billion in 2006. Comparatively, imports reduced to 261.2 billion in 2010 from 281.2 billion in 2006.
Foreign Trade 400,000 350,000 300,000 250,000 200,000 150,000 100,000 50,000 -

Total exports Total imports

2006

2007

2008

2009

2010

Source: Economists Intelligence Unit [5]

France, Germany, Portugal, Italy and the United Kingdom are Spains main trading partners. Besides these countries, China and the Netherlands contribute around 10% of the total imports in to Spain. Foreign Direct Investment (FDI) There has been a significant fall in foreign direct investment both within and outside the country compared to the pre-2008 real estate boom era. More significantly, inward investment fell to 14.7 billion in 2010 from 21.7 billion in 2006 with a sharp dip to 6 billion in 2008.

Page 7 of 15

Foreign Direct Investment 120,000 100,000 80,000 60,000 40,000 20,000 -

Inward direct investment Outward direct investment

2006 2007 2008 2009 2010

Source: Economists Intelligence Unit[5]

The Netherlands was the largest investor followed by France and United Kingdom, accounting for around 56% of the total FDI in 2010. Italy, Luxembourg and the United States were the other significant investors who invested in Spain in 201 Transport and storage, real estate, manufacturing, 2010. ransport financial activities, insurance and electrical energy supply were some of the industries which received ce FDI in 2010.

Exchange Rate Spain adopted the on 1 January 1999 and euro notes and coins were introduced on 1 January 2002. The Spanish peseta was converted to euro at an exchange rate of 166.386 ESP for one euro. The Spanish peseta remains exchangeable indefinitely at any branch of the Central bank of Spain. The Bank of Central Spain suggests that around 1.7 billion worth of the old currency were never converted to Euros. The graph below shows the movement of the exchange rate of the euro versus the American dollar since it was introduced in the euro zone. Currently the exchange rate between the euro and the dollar is around 0.69 per dollar.
Exchange rate ( per $US)
1.2000 1.0000 0.8000 0.6000 0.4000 0.2000 2002 2003 2004 2005 2006 2007 2008 2009 2010 Source: Economists Intelligence Unit

Page 8 of 15

Employment and Labour Market Unemployment rate increased to 20.1% in 2010 from 8.30% in 2007 and rose to an all time euro zone high of 21.3% in the first quarter of 2011. The labour market in Spain is characterised by a high degree of rigidity and this has resulted in the prevalence of temporary contracts. The government has set a minimum wage rate equal to 641.40 per month effective 1 January 2011 and collective bargaining is prevalent in both private and public sector making it difficult to reduce wages, even during a downturn. The cost of dismissal in Spain is around 56 weeks of wages and is one of the highest among the OECD countries. High levels of unemployment are therefore compounded by the unwillingness by firms to provide employment. The following table shows the rate of change in employment among the participating workforce.
Change in employment among the participating work force 2007 2008 2009 3.1% -0.5% -6.8% 1.7% -17.0% -38.0% 3.1% -0.1% -6.3% -1.9% -12.4% -5.3%

Total 16 to 19 years 20 to 69 years 70 and over

Source: INE

2010 -2.3% -26.0% -2.0% 3.0%

Workers in the age group 16 to 19 years were the hardest hit since most of the workers in this age group drop out of school early and work on temporary contracts. If the government does not equip this group with the relevant technical skills the lack of knowledge and education can be a problem for them in the future. Among the younger workers, 20 29 year olds, the situation is slightly better off however most of them are working in jobs for which they are over qualified. The following graph lists down the change in employment rate among the labour force in some of sectors of the Spanish economy.
Change in employment rate
5.00% 0.00% -5.00% -10.00% -15.00% -20.00% -25.00% Source: INE Data available for only three years -2.40% 2010 -2.24% -5.93% -7.42% -12.58% 2009 -4.01% -6.62% Manufacturing industry -13.23% -14.65% Construction -23.03% -23.21% 0.88% Agriculture, cattle breeding, forestry and fishing Extractive industries

Page 9 of 15

Productivity The growth in an economy can roughly be attributed to three main factors Productivity of labour Capital injection Increase in total factor productivity (TFP)

The following graph shows the change in gross domestic product (GDP) along with the change in labour productivity, TFP and capital formation.
Total Factor Productivity 10.00% 5.00% 0.00% -5.00% -10.00% -15.00% -20.00% -25.00% Source: INE 2007 2008 2009 2010

Gross domestic product at market prices Labour productivity Total factor Productivity Gross capital formation

The productivity of labour calculated as the rate of change of GDP by the rate of change of employed workers has been fairly constant, seeing a marginal dip in 2009. With the onset of the economic crisis capital investment declined significantly by 3.04% in 2008 and 18.69% in 2009 with a lower decline of 5.08% in 2010. The decline in the level of investment can be directly attributed to a significant reduction in capital investment in the real estate and construction business. These two sectors were the main catalysts of the economic growth in Spain before the economic crisis and have seen a significant decline in activity over the past three years. The growth in the Spanish economy seems to be supported by capital investment rather than by an increase in efficiency. The productivity of labour has been relatively constant over the past four years. The TFP had increased by 8.03% in 2009, in light of significant decline in capital investment and rising unemployment, which supports the view, that GDP growth in Spain is driven by capital formation. The Spanish economy needs to go ahead with labour reforms and create jobs in the market to work towards a more sustainable GDP growth in the future.

Sovereign Euro Zone Debt Crisis

Spain was one of the fastest growing economies in the Euro zone and had outperformed even the United Kingdom and Germany. The collapse of the real estate prices world over and the sub-prime mortgage crisis created pressures on the Spanish economy at the start of 2008. Spains economic

Page 10 of 15

growth, which had been spurred by the real estate and construction business, began to contract and rising oil prices further exacerbated the GDP decline. Mortgages Around 80% of Spanish citizens own the houses in which they live and the desire to own a house is very strong among Spanish. The tax system gave a 15% allowance on mortgage payments on personal income tax calculation. Domestic banks were more than willing to offer loans to finance this desire and offered 100% financing for a 40 year mortgage. Along with borrowings by the private sector to buy houses, the construction business had also borrowed heavily to finance building activities. As a result, when the housing prices started cooling, the Spanish banking system was burdened with a significant amount of toxic loans. Spanish banking system The Spanish banking system was relatively stable compared to the crisis in many other countries. This can be attributed to conservative regulatory rules which require banks to have high capital provisions and adequate guarantees and securities need to be provided by borrowers. The major banks were therefore able to survive the financial crisis. However, the banking system also includes regional savings banks, known as Cajas, lent heavily to finance the growth the in the construction and real estate business. With the onset of the decline in real estate prices and decline in construction activity, these cajas were left with large amounts of loans on which a large number of borrowers could default on. Government debt and budget deficit As in Iceland, a similar story was played out in Spain during the financial crisis wherein the crisis was a result of heavy borrowing by the private sector more so than the public sector. Government debt in Spain is quite low compared to the European Union, Germany and UK.
Government debt as % of GDP
90.0% 80.0% 70.0% 60.0% 50.0% 40.0% 30.0% 20.0% 10.0% 0.0% 2006 Source: Eurostat 2007 2008 2009 2010 European Union (27 countries) Spain Germany (including former GDR from 1991) United Kingdom

However, over the past three years the government has seen a significant increase in the budget deficit. During the boom years, tax revenues were high and the government managed to run a budgetary
Page 11 of 15

surplus. With the onset of the financial crisis, economic activity declined and so did government revenues. A long life expectancy, an ageing population and the fall in market values of asset classes resulted in an increase in burden on the governments pension liabilities and other social welfare measures.

Unemployment The onset of the financial crisis put a halt to activities in the construction business. Labour market rigidities, prevalence of temporary contracts and high cost of dismissal has fuelled a significant increase in unemployment, which peaked to around 20.1% in 2010. The reduction in employment and output caused a significant reduction in GDP growth and added further pressure on the economy. Inflation The Spanish economy was criticised for high levels of i inflation in the euro zone. The financial crisis tion led to a decrease in demand and the subsequent credit crunch reduced economic activity further. This has led to deflationary conditions, which has been aided by rising unemployment over the past two years. Decline in investor confidence In March 2009, the Bank of Spain bailed out Caja Castilla la Mancha by providing around 0.9 billion in liquidity. An increasing budget deficit and the bailout of a caja created panic among investors and resulted in decline in the value of bank shares. Further bailouts and low investor confidence resulted in an increase in yields on Spanish government bonds, making it increasingly difficult to raise finance from the external debt market. In March 2011, Moodys downgraded Spains sovereign credit rating to Aa2 from a pre-crisis AAA rating. This has led to an increase in Spanish government bond spreads, crisis wherein the debt market now demands a higher yield on these bonds. A vicious cycle has been icious perpetuated wherein it has become even more difficult for the Spanish government to issue more government bonds to tackle the budget deficit crisis. T government, therefore, was forced to udget The implement a series of austerity measures aimed at reducing the budget deficit.

Page 12 of 15

Interest Rates
6.00 5.00 4.00 3.00 2.00 1.00 0.00 2006 Source: INE 2007 2008 2009 2010 Inter-bank market/ EURIBOR / 1 year Treasury bills/ 1 year Bonds 3 years Bonds 10 years

Measures to tackle the economic crisis

Labour market reforms The Spanish economy is still reeling from the impact of the economic crisis of 2008 and the current euro zone sovereign debt crisis a decline in retail sales, low domestic consumption and high inflation. As a result unemployment rate has steadily increased and touched a high of 20.1% in early 2011 and seems to be the most important challenge that the government is faced with. In June 2010, the Spanish government had initiated labour reforms aimed at encouraging employment. These measures were implemented mainly to eliminate the labour market rigidities, which Spain is criticised for. Since there is a high cost of dismissal associated with firing workers, one of the highest in the Euro zone, most firms are hesitant towards hiring workers and favour hiring workers on temporary contracts. Therefore, the cost of dismissal was reduced to 33 days from 45 days of salary per year worked. The labour reforms also proposed reducing the term of fixed contracts to two years and would also allow firms to reduce work hours instead of firing workers during periods of low demand. The government also proposed setting up a government sponsored employee severance fund which could be used by business houses to pay a portion of the employees severance on dismissal. The fund is intended to be set up in 2012. In early June this year, the government had introduced a further set of reforms aimed at reforming the collective bargaining system. These initiatives were met with widespread strikes and protests. However the government seems determined to go ahead with these reforms.

Austerity measures to reduce government deficit In May 2010 last year, the government had proposed reducing the average pay of a public sector employee by 5%. These were accompanied by measures to scrap payouts that the government offered
Page 13 of 15

to parents on the birth of a child along with the suspension of automatic inflation adjustments for pension schemes. Following these set of measures, in Dec 2010 the government proposed further measures which suggested selling of a 30% stake in national lottery, reduction in unemployment benefits, tax deductions for small businesses and an increase in tobacco tax. In January 2011, the Spanish government proposed a bill which was aimed at increasing the retirement age from 67 to 65. This bill was proposed with a view to simplify the social security system and reduce the budget deficit, though the impact of this reform is expected to be more gradual. These measures, though important for the economy, have been met with mass protests by the Spanish people, who feel they are being unjustly burdened whereas the responsibility for the crisis rests with banks and real estate developers.

Reforms in the banking sector The banking system has seen consolidation activities. The number of cajas has reduced to 17 banks compared to 45 before the crisis. The Spanish government is trying to persuade cajas to attract private capital to refinance their debts. However, with a reduction in investor confidence it is becoming increasingly difficult for Spanish banks to pursue this strategy. The Bank of Spain has suggested a new law whereby all banks will have to have enough equity to back around 8% - 10% of a banks risk weighted assets. The banks have been given time till September 2011 to achieve this target. The government had also set up a Fund for Orderly Bank Restructuring (FROB) in June 2009. This was intended to provide capital to banks which needed to restructure their debts and the fund has the capacity to disburse around 99 billion. However, banks need to comply with certain regulations to be applicable to apply for aid and the bank is also expected to repay these loans. The cajas have not been very enthusiastic about accessing the FROB to restructure their debt and the fund has disbursed 12 billion till date.

Conclusion
Spain is an important part of the Euro zone and further worsening of the economic crisis will result in a significant dent in investor confidence and will also pose a serious threat to the future of the euro and the European economic area. Among the affected countries, Spain is such dire situations because of the over dependence of the economy on the real estate and construction business and the activities of the cajas despite a well regulated banking sector. The government is taking significant steps to tackle the current crisis. The labour market and banking sector reforms will go a long way in creating long term benefits for the economy. However, these measures will be slow to implement and the impact of these may not be felt for a very long time. The government is faced with widespread opposition but will have to be careful to not buckle under political compulsions and backtrack on its commitments to reduce public debt.

Page 14 of 15

Bibliography

1.

Instituto Nacional de Estadistica (INE) http://www.ine.es/ Eurostat http://epp.eurostat.ec.europa.eu/portal/page/portal/eurostat/home/ Bank of Spain http://www.bde.es Bank of Spain www.bde.es Economists Intelligence Unit (EIU) Library Resource Centre, ISB All figures from EIU have been converted to Euros using an exchange rate of $US 1 = 0.696330 CIA World fact book https://www.cia.gov/library/publications/the-world-factbook/ Wikipedia http://en.wikipedia.org/wiki/Spain Data monitor report In depth PESTLE analysis Country Report on Spain Library Resource Centre, ISB The University of Iowa Center for International Finance and Development The Spanish Financial Crisis

2.

3.

4.

5.

6.

7.

8.

9.

10. Spain Economy watch Blog by Edward Hugh 11. News articles and news reports from various sources available on the internet - some of these have been cited below Wall Street Journal - online.wsj.com Financial Times www.ft.com BBC - www.bbc.co.uk The Economist - www.economist.com Bloomberg www.bloomberg.com Huffington Post www.huffingtonpost.com New York Times www.nytimes.com 12. Total factor productivity has been estimated using the Cobb-Douglas Function wherein =0.37 as mentioned in the following paper Does TFP drive housing prices? A growth accounting exercise in four countries 23 October 2010 13. Various other online articles were also referred

Page 15 of 15