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  Three years after Lehman Brothers went bust, advanced economies are generally undergoing a dubious recovery and some countries are at great risk of a double-dip recession. This weak tone can be put down essentially to two factors that are hindering economic growth: on the one hand, the need to carry out significant fiscal adjustments in order to stabilize and start to reduce the burden of public debt; and, on the other, the efforts that must be made by the private sector (households, firms and financial institutions) to reduce their high level of indebtedness. This Box focuses on the latter, namely private deleveraging, with the aim of clarifying, based on past experiences and the current circumstances, how this might be expected to develop, especially in the case of Spain.(1)

  Over the long term, private indebtedness (or leveraging) has tended to rise due to the effect, for example, of innovations in the financial sector, the fall in real interest rates and globalization, which has improved access to external financing and to deeper capital markets. However, like many other economic variables, such leveraging behaves cyclically around this trend: a typical indebtedness cycle lasts around six years on average, during which time the leveraging ratio rises by about 24 points of GDP. This is followed by a deleveraging cycle that lasts, on average, around five years and where the debt rate falls by about 19 points of GDP. Around these averages, the duration and intensity of deleveraging episodes have tended to vary, from less to more, depending on whether they have been associated simply with an economic recession, whether this has been combined with a real estate crisis or whether, in addition to all this, there has also been a banking crisis (see the graph below). In the presence of a banking crisis, deleveraging cycles have averaged an adjustment in the debt ratio of around 32 points of GDP and have lasted about seven years.

  (1) To a large extent, the content of this box is based on the "la Caixa" Documento de Economía in the upcoming publication entitled «Perspectivas de desapalancamiento» by Aspachs, Jódar and Gual.

  A typical deleveraging process also has different phases. Initially, both GDP and the volume of credit tend to contract, limiting the fall in the indebtedness ratio. After one year, and for approximately two years, nominal GDP growth recovers but credit continues to decrease, significantly reducing leveraging. For a further three years, in the last phase of the deleveraging cycle, growth in credit returns to positive figures, albeit lower than the growth in nominal GDP, thereby still allowing a reduction in the percentage ratio of debt to GDP.

  Like other advanced economies, Spain is fully immersed in a deleveraging cycle. The credit boom associated with the real estate bubble pushed the credit ratio up sharply to 172% of GDP in 2008, some 55 points of GDP higher than the long-term trend. Since then, this ratio has embarked on a downward slide, for the moment gentle, reaching 167% of GDP in September 2011. An extrapolation of the long-term trend observed would show that, by the middle of the decade, the ratio should be around 145% of GDP, which would mean that the current level of leveraging would have to fall by 22 points of GDP over a timescale of little more than four years.

  If this were the case, the size of the overall adjustment between 2008 and 2015 would be similar to the one observed in other economies which, in the past, were forced into deleveraging within a context of real estate and banking crises. This therefore seems to be a reasonable picture of what we might expect to happen. 17% cumulative growth in nominal GDP between the third quarter of 2011 and the end of 2015 (implying an average annual rate of 3.8%, for example resulting from real growth of 1.8% and 2.0% inflation), combined with very modest cumulative growth in credit over the same period, of less than 2%, would result in deleveraging of this intensity. In 2012, the outstanding balance of credit is likely to decrease by around 2.5% while nominal GDP will grow more than 2%, reducing the leveraging ratio to 155% of GDP by the end of year.

  Nevertheless, several factors could affect the deleveraging trend over the coming years. To begin with, if the liquidity tensions that are currently upsetting wholesale financing markets persist for long, the supply of credit would be limited, thereby intensifying the deleveraging process. A prompt resolution of Europe's sovereign debt crisis is therefore essential to avoid a vicious circle of accelerated deleveraging. Similarly, Spain's deleveraging process will also depend on other factors related to the financial system, such as how quickly losses from doubtful loans are recognized. In this respect, quickly writing off damaged bank assets could, in theory, help new credit to be provided. However, a strategy of this kind might be costly in fiscal terms, presenting a serious risk within the current context of doubts regarding public debt.

  Lastly, anything that helps towards greater GDP growth, fundamentally improved productivity, will make deleveraging more bearable as it will reduce the indebtedness ratio by increasing the denominator. When all is said and done, anything that reduces the role of the numerator in driving the evolution of the credit-to-GDP ratio, i.e. avoiding a sharp fall in demand or in the supply of credit, will alleviate the otherwise inevitable pain of deleveraging.

  This box was prepared by Enric Fernández

  International Unit, Research Department, "la Caixa"

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