Research Dept. News
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Monthly Report, num 359 - July-August 2012
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International review
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United States
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The United States: diminishing growth
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The United States' expansion loses steam due to the weak recovery in employment.
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The US economy is leaving behind its vigorous start to the year and is on way to a weaker scenario than the consensus had expected at the end of April, after the publication of the gross domestic product (GDP) flash estimate for the first quarter. The main reason for this weaker tone lies in the loss of dynamism in the labour market's recovery. A weaker labour market inevitably leads to a standstill in household income, which therefore ends up affecting private spending on consumer goods, this being the driving force behind activity, especially considering its strong contribution to growth in the first quarter. However, our forecast for the GDP flash estimate for the whole of 2012 remains close to 2.0% as the improvement in the housing market and particularly the drop in oil prices could offset a large part of these weaknesses. The risk, nevertheless, is of worse figures as the euro area crisis continues to encumber the US recovery and oil prices are still subject to notable uncertainty.
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Low growth in household income and indebtedness affect the recovery.
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Private consumption is unlikely to maintain its rate in the first quarter. Household disposable income grew in real terms by 0.9% year-on-year in April, far below the rise of 2.1% occurring in private consumption. With income almost at a standstill, the other means of sustaining growth in consumption is through debt but this is limited by households' asset situation. Although it's true that families' financial wealth had been recovering over the last few months, their real estate wealth, which is the main tangible asset for households, is still below the secular trend. The main problem for households' asset balance is still the high level of debt, which has managed to get halfway back to normal. Household debt rose to 109.2% of disposable income in the first quarter of 2012. This represents a reduction of 19.9 percentage points from the peak of September 2007 but is still 17.8 points above the level of 91.4%, the average for 2000, one year before the start of the real estate bubble.
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Retail sales are still slowing up but lower petrol prices could boost consumer spending.
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Retail sales confirm this slowdown in consumption compared with the first quarter, aided by an abnormally mild winter. In May, retail trade, excluding the fluctuating cars and petrol, posted its second month of decline, taking year-on-year growth in real terms to 2.3% when this figure was 3.4% in March. Similarly, the Conference Board consumer confidence index fell by 6.8 points between February and May, standing at 29.4 points below its historical average. One support for consumption could come, however, from falling oil prices. A drop of 10 dollars in the price of a barrel of crude supposes, via savings in petrol, a larger budget for the rest of the shopping basket equivalent to around 0.3% of GDP. The average price of oil in the first four months of 2012 was 118.6 dollars per barrel, so that the level of 90 dollars per barrel when this report was being written, should it continue, would lead to savings equivalent to 0.8% of GDP in one year. Consequently, although the fluctuating nature of oil prices means we should remain cautious, the scenario has certainly changed.
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The labour market loses steam while the slowness of the recovery runs the risk of perpetuating lower participation in the labour market.
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The slowdown in the recovery of the labour market is the factor that best explains this slump in consumption. In May, 69,000 net jobs were created, a very modest figure that follows on from the bad figures for April. Similarly, the hours worked and weekly wages also fell. The recovery is too slow and the level of employment prior to the crisis is unlikely to be reached before the end of 2014. This lingering unemployment means that the proportion of long-term unemployed will remain at record levels. Hiring workers who have been unemployed for more than six months entails problems due to lack of suitability, as the market believes their skills are out of date. This leads to discouraged workers who end up leaving the labour market, reducing the labour force and helping to turn a cyclical phenomenon into a structural one.
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The 8.2% unemployment rate is partly due to a lower activity rate.
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The fall in the labour force means that weak growth accompanied by insufficient job creation can exist side by side with a drop in the unemployment rate. May's unemployment stood at 8.2%, 0.8 percentage points below the figure for the same period last year. However, excluding the workers who have left the market due to non-demographic reasons, the unemployment rate would easily exceed 10.0%. In addition to this unemployment there is also under-employment, the contingent of workers who are working part-time involuntarily, which has halted its improvement seen over the last few months.
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Investment remains moderately optimistic but entrepreneurs are still cautious in employment terms.
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Unlike this weak employment and the incipient slowdown in consumer spending, the investment sector is performing better. Although May's business climate index of the Institute for Supply Management (ISM) for manufacturing fell by 54.8 points to 53.5, this level still coincides with robust economic growth in the economy as a whole of more than 3.0%. With a somewhat less expansionary tone, the ISM services index, which rose minimally up to 53.7 points, points to growth of 2.0%. The other side of the coin was provided by the employment component, accounting for 86.4% of total private employment, which showed a marked decline.
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Construction confirms its improvement but it starts from a low level.
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There are some signs of improvement in investment in construction. On the supply side, new houses started in May maintained part of April's upswing and were 28.5% higher than the same period a year ago. Similarly, the rise in building permits, which are its leading indicator, suggest this progress will continue. For its part, the Case-Shiller index for second-hand homes for the twenty main cities was still rising slightly in March, while sales of second-hand housing continued to liven up in May. All this points to the sector contributing to growth throughout 2012 although its influence will initially be limited due to the low starting levels. The weaknesses of housing are far from being averted, nevertheless, with 12 million households facing negative equity, although the latest figures point to a timid reduction in mortgage default.
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To boost the mortgage market and create jobs, in May the Federal Reserve started up its long-term debt purchase programme again, financed by selling short-term debt. And inflation is giving the Fed even more room for additional expansionary measures, should they be deemed necessary. The consumer price index (CPI) has slowed up, rising by 1.7% year-on-year in May and 2.3% in April, due to the base effects of oil prices. Core CPI, which excludes energy and food prices, repeated its rise of 2.3% year-on-year but the trend is one of moderation as price increases centred on components that do not reflect the underlying trend, such as clothing.
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The trade balance will benefit from cheaper oil in the second quarter.
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With regard to the external sector, April's trade deficit decreased by 8.0% to 50 billion dollars. Lower oil prices, which account for 55.9% of the total trade imbalance, lie behind just under half this improvement but will continue to reduce the deficit over the next three months. On the other hand, exports maintained part of their upswing in March and point to the sector's positive contribution to growth in GDP in the second and third quarter.
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Japan
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Japan: bad times for exports and investment
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Japan grows by 2.7% thanks to private consumption.
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The upward revision of GDP figures for the first quarter, which left growth at 1.2% quarter-on-quarter and 2.7% year-on-year, has increased doubts as to whether expansion will continue in the rest of the year. The economy bases its growth on the accumulation of stock, fluctuating by nature, and particularly on private consumption encouraged by expansionary policies that will not continue, with a government that is looking to increase the tax on consumption. However, the two traditional pillars of Japanese growth are looking weak. Capital goods investment is falling and its leading indicator in April, machinery orders, continue to show declines. For their part, exports were still submerged in lethargy in May.
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Private consumption offsets industry's bottlenecks.
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May's trade balance showed a deficit again, for the fifteenth month, due to higher energy costs resulting from the nuclear stoppage and bottlenecks in production that are harming the competitiveness of exports. In this respect, industrial production, which has a greater influence on GDP in Japan than in other advanced economies, fell in April. The recovery of the second half last year has faded, with cumulative growth at a meagre 0.4% in the four first months of 2012, leaving the index 3.1% below the level prior to the catastrophe of March 2011.
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But growth will not improve. Industrial production is falling and exports will suffer from the global weakness.
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However, April's retail sales and May's vehicle registrations point to the rise in consumption continuing for the moment. Similarly, the consumer confidence index rose in May to 40.7 points, now close to the levels of February 2011. This strength being shown by private consumption will not be able to dispel the threat of deflation however. In April the CPI rose by 0.5% year-on-year thanks to the effects of expensive oil that, more recently, has changed direction and whose downward effects will be seen in the coming months. The core CPI, the general index without energy or food, continued at a standstill, accumulating a drop of 0.3% year-on-year while prices in Tokyo, which fell again in May, also point to a return to deflation.
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China
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China: moderation in the economic slowdown
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Oil, the reason for price rises at the beginning of the year, might help a return to deflation.
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Inflation has fallen within a context of a slowdown in activity. May's CPI slowed up from 3.4% year-on-year to 3.0%, helped both by the food component, which accounts for more than one third of the general price index and continued to moderate its advance from 7% to 6.5%, and also by the non-food component, which went from the 1.7% in April to 1.4%.
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The rise of prices below the government's target of 4% has created further room for expansionary policies. Hence the government cut the official interest rate by 25 basis points, down to 6.31%, at the beginning of June, and reduced the cash reserve ratio by 50 basis points in mid-May. For the remainder of the year, we predict further reductions in the cash reserve ratio of between 100 and 150 basis points, as well as a further cut in the interest rate at the beginning of the third quarter.
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China's low inflation, 3% in May, helps cut the official interest rate by 25 basis points.
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The announcement of the reduction in interest rates just before the monthly activity indicators are released suggested a bad May. However, the slower rate of decline in some of these indicators and the improvement in others surprised a large number of analysts. May's figures are consistent with a soft landing, in line with our growth forecast close to 8% in 2012. Industrial production grew by 9.6% year-on-year, 0.3 percentage points above April's figure although still far from its potential of 15%. Regarding demand, retail sales pushed forward with 13.8% growth year-on-year, slightly below the 14.1% of the previous month, while cumulative fixed capital investment from January to May grew by 20.1% year-on-year, 0.1 points below the cumulative figure up to April.
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Although still weak, May's business indicators are better than expected.
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On the external front, both exports and imports surprised on the upside, unlike in April and in spite of the fragility of advanced economies. In particular, exports grew by 15.3% year-on-year in current terms, far above April's figure of 4.9%, and did so throughout all destinations. And imports grew by 12.7% year-on-year, compared with 0.3% in the previous month, placing the trade surplus at 18.7 billion dollars. Part of this strength in imports was due to the upswing in foreign demand, as indicated by the growth in exports for processed and assembled products, although imports of final goods also rose considerably. Nonetheless, we must be cautious in our interpretation of the foreign trade figures as they are highly volatile from month to month.
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Exports and imports pick up in May relative to a weak April.
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Once again, May's figures are still symptomatic of a slowdown in the Chinese economy. However, May's figures, the expansionary monetary measures and the government's capacity and willingness to support growth are dispelling fears of a hard landing for the country.
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Brazil
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Brazil: more disappointment
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Brazil's economy continues to slow down more than expected.
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Although macroeconomic indicators were already pointing to a slowdown in Brazil's economy, the growth figures for the first quarter were a disappointment for both Brazilians and foreigners alike. GDP grew by a mere 0.2% compared with the previous quarter, which represents a meagre advance of 0.8% in year-on-year terms. Moreover, if we take into account the fact that, in the fourth quarter of 2011, quarter-on-quarter growth was already 0.2% and 0.3% in the third, it is evident that Latin America's leading economy has run aground among pyrrhic growth without there being any sign of the upswing it so desires.
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Stimuli are yet to have an effect.
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By component and in year-on-year terms, of note is the debacle of investment, down 2.0%, and the 3.2% upswing in public expenditure. Regarding consumption, this picked up slightly compared with the previous quarter, boosted by the good tone in credit and employment. Exports also improved their figures compared with the fourth quarter of 2011 but this was not enough to offset the advance of imports (see the graph below). On the whole, we can observe both a marked decline in private domestic expenditure as well as an increasing lethargy in net exports, in line with the world's failing appetite for commodities.
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The real continues to depreciate.
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Brazil has therefore joined the widespread deterioration of global economic prospects and the latest activity figures merely increase doubts concerning the immediate future of the Amazonian giant. Although the confidence of Brazilian consumers and employment are holding firm, industrial production is still in negative terrain and the index produced by Brazil's central bank as an approximation of GDP posted a minimal increase of 0.22% compared with the previous month, in year-on-year terms representing a drop of 0.02% and its worst figure since the end of 2009. It's true that this indicator is not precise and usually differs from the definitive GDP growth figure but, even so, it is indicative of the significant downward risk for growth in the second quarter.
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This, together with the disappointing growth figures for the first quarter and the expectation that the slowdown in world economic growth will continue for a few months yet, has led us to revise downwards our growth forecasts for Brazil's economy both in 2012 and in 2013. Although we still think that economic activity will pick up in the second half of the year, when we expect the stimuli applied almost a year ago to start to have an effect, we have reduced our growth forecast from 2.5% to 1.6% for this year and from 4.1% to 3.8% for 2013.
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Given this evidence, the reaction of the Brazilian authorities was not slow in coming, quickly announcing further measures to boost their economy. These measures include greater credit facilities, barriers to imports and a new line of credit available to the states totalling 20 billion reais (around 7.7 billion euros) to be invested in projects related to highways, transport and infrastructure in general. The moderation in inflation will also help stimuli in the area of monetary policy (we expect a further reduction in interest rates in July), although the real's continuing weakness, hit by the rise in global risk aversion, will stop prices from correcting, keeping the increase at around 5% in 2012.
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Mexico
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Mexico: changing times?
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The strength of domestic expenditure protects the Mexican economy from the global slowdown.
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The breakdown by GDP component for the first quarter of 2012 confirms that the recent dynamism of Mexico's economy comes from renewed strength in domestic expenditure. Private consumption was the area that contributed the most to economic growth (2.9 percentage points), with year-on-year growth of 4.3%, followed by gross fixed capital formation, which contributed 1.9 percentage points to the growth in GDP and increased by 8.6% compared with the first quarter of 2011. Public expenditure advanced by 2.9%. Exports recorded growth of 5.1% while imports rose by 8.1%. In net terms, exports deducted 0.6 percentage points from growth.
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The peso, however, is at the mercy of the turbulences.
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In spite of the good rate of economic growth, prices continue to rise moderately. Although the weak peso, resulting from the problems in Europe, is expected to introduce some inflationary pressure, it is also predicted that the world slowdown in economy and particularly in the United States will end up affecting the domestic economy, pushing down this pressure. This has been endorsed by the decision taken by the Monetary Policy Committee to keep official interest rates at the same rate for another month, albeit explicitly changing the tone of their position from pro-expansion to neutral.
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More than just changes in posture are expected from the government. At the time of writing this report, just a few days before the presidential elections, Enrique Peña Nieto (PRI) looked like being the new President of Mexico. The polls also suggest that he more than likely won't be able to govern alone, so he will have to secure the opposition's support to promote the reforms required by the Mexican economy in order to gain in solidity and guarantees for the future.
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Commodities
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Oil prices in free fall
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Oil falls to 90 dollars per barrel, the lowest since December 2010.
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Oil is intensifying its descent. Between 18 May and 22 June, the price of crude fell by 15.8% to 90.49 dollars per barrel (Brent quality, for one-month deliveries), its lowest level since December 2010. Oil price is therefore 15.5% below its level at the start of 2012 and 16.4% lower than its level one year ago, which will pull down the CPI for May and June for most economies.
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Oil prices are falling due to a combination of three factors: the euro area crisis, the slowdown in China and other emerging economies and the increased production by Saudi Arabia, which remains at the record level of 10 million barrels a day, one third of the total production of all OPEC countries. As from 2013, should there be a recovery in world growth, there should also be a change in the trend for oil prices with moderate rises.
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Metals most affected by China's slowdown.
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The rest of commodities continued to join the downward slide of crude, albeit not so sharply. The CRB index fell by 1.2% between 18 May and 22 June. Among metals, of note was the 10.0% drop in aluminium, particularly affected by energy prices given its energy-intensive production process. Copper, nickel and steel saw minimal drops after their falls in May. Among precious metals, silver was down 5.9% while gold lost 2.1%, standing at 1,562 dollars per ounce. Falls were also prevalent among foods, with wheat losing 5.2%, sugar 3.8% and coffee 14.0%.
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Target surplus: reality or mirage?
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During the economic boom before the crisis, Spain multiplied its current account deficit by four, from 25 billion euros (4% of GDP) in the year 2000 to 105 billion (10% of GDP) in 2007, the world's second largest current account deficit after the United States. Then the crisis came and brought with it an abrupt, substantial correction of this deficit, pushing it back down to 3.5% of GDP (38 billion euros) by 2011. Undoubtedly, this correction makes a significant contribution to the Spanish economy's cherished external sustainability but will it be maintained or will we return to the previous trend once growth picks up again? Above all else, in order to answer this question we need to know what has brought about this correction and this is precisely the aim of this box.
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In this respect, the graph below is revealing in itself: if we break down the current account balance into its different components, we can readily see that the adjustment in the external balance between 2007-2011 was particularly due to a sharp drop in the balance of trade in goods deficit and, to a lesser extent, to an increase in the positive balance in services. The current transfers and income balances also helped but to a much smaller extent and, in fact, the latter has deteriorated again due to the continued financial tensions in the euro area and their repercussions on the cost of financing Spain's debt.
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Entering into more detail, the improvement in the trade balance of goods and services, which went from a deficit of 6.5% of GDP to one of 3.5% of GDP, was essentially due to the improved trend in the trade in goods: out of the 6 percentage points corrected, 5 correspond to the adjustment in the goods deficit and 1 percentage point to the improvement in the services surplus. Given this situation, the question arises as to whether the adjustment in the goods trade deficit reflects a better performance by exports or a sharp drop in imports, in line with the trend in domestic spending.
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In fact, the dive taken by imports in 2008 and 2009 and their moderate recovery since then have made a significant contribution to this improvement. In particular, total imports fell by almost 20 billion euros between 2007 and 2011, with capital goods, consumer durables, the automobile industry and that of semi-manufactured non-chemical products being the items shrinking the most. This undoubtedly reflects the weakness in spending by Spanish households and firms, undergoing a deleveraging process that is reducing their expenditure on investment and durables, as well as the lower activity in construction, the main destination for semi-manufactured non-chemical imports, and also the collapse in residential investment, a sector with a high import content and which went from representing 12.4% of GDP in 2007 to just 6.9% in 2011. Lower spending on imports has also been due, in part, to the gradual recovery in competitiveness of the domestic market: import penetration(1) has gone from 26.5% in 2007 to just over 23% in 2011.
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The decline in goods imports would have been even greater if oil prices hadn't risen sharply during the period analysed (from 72 dollars per Brent barrel in 2007 to 108 in 2011). This explains why energy imports went from almost 42 billion in 2007 (15% of all imports) to 56 billion in 2011 (22% of the total), making the energy deficit shoot up to 3.8% of GDP in spite of the slower pace of domestic activity (see the graph above). In this respect, the recent fall in oil prices is likely to correct this trend in the short term, particularly given the double-dip recession in Spain although, in the medium term, it is vital for industry to become less energy-intensive.
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And although the decline in imports (of goods) has made a significant contribution to correcting the trade deficit, the good performance by exports has also contributed as much, or more. In fact, the trend in exports of Spanish goods has been admirable since the beginning of the last decade. During the boom, Spanish goods managed to keep their worldwide share relatively stable in spite of facing sustained losses in price competitiveness and the overwhelming appearance of emerging economies in world trade (see the box «The external sector: driving the recovery» and «Gains in competitiveness to restart the external engine») and, once the crisis erupted, although they were not immune to the collapse of world trade in 2008-2009, Spanish exports, together with those of Germany, were the first to recover from this slump.
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(1) Measured as the ratio of imports to expenditure on private consumption, public consumption, investment and exports, as a percentage.
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This strength has been boosted by an export sector that is competitive not only in price terms, by the gradual recovery in external competitiveness (see the box «Gains in competitiveness to restart the external engine»), as well as a conscious effort to diversify towards more dynamic markets with great economic potential. In spite of the still broad export bias towards the euro area, the destination for 53% of all goods exports in 2011, its importance has waned in favour of, for example, China, India and Russia. This, together with the drop in imports and the correction in competitiveness terms is largely the reason for the change in direction of the trade balance with the euro area and also with the EU-27: while, in 2007, bilateral deficits were recorded with both zones of 3.7 billion and 3.8 billion respectively, in 2011 both achieved surpluses, of 1.6 billion with the euro area and 4.1 with the EU-27.
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Leaving the balance of goods to one side, it should be noted that the increase in the trade surplus in services, which went from 23 billion euros in 2007 to 34 billion in 2011, has also helped to improve the current account balance, albeit to a lesser extent. In this case, imports have fallen very slightly while exports, once again with the exception of 2009, have steadily improved. By sector, although tourism services continue to be the main item within this balance, the balance of non-tourism services has also improved considerably. This is a very positive figure as business services have great growth potential, both in terms of employment and also wealth.
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Lastly, the income balance and the current transfers balance have also made their own small contribution to the correction of the current account deficit but no more than this (5 billion euros between 2007 and 2011). With regard to the income balance, basically interest rates and dividends, its adjustment has been hindered by the sovereign debt crisis in Europe: the improvement that would have resulted from low official interest rates has been eroded by the rise in Spain's risk premium. Moreover, given the persistence of tensions, this balance is likely to continue to deteriorate in the short term. For its part the transfer balance, which includes funds sent by emigrants, donations and transfers from the European Union, has almost remained the same and the small correction observed can be attributed to a drop in payments related to the reduction in economic activity, from a deficit of 0.3% of GDP in 2007 to a little less than 0.15% of GDP in 2011.
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In short, the recent correction in the current account deficit can be mainly put down to the better performance by the balance of trade in goods and in services. In order to maintain this trend once economic activity picks up, the correction achieved, both in terms of imports and exports, will have to be based on gains in competiveness, as well as requiring greater commitment to diversifying exports towards more dynamic markets and progressing towards industries that have greater added value, a lower import content and are less energy-intensive.
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This box was prepared by Claudia Canals
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International Unit, Research Department, "la Caixa"
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