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Economic activity
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Growth continuing but imbalances fail to improve
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Spain’s economy maintaining high growth rate although it may have begun to reach ceiling.
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Spain’s economy continued full steam ahead in the third quarter of 2005, according to the main economic activity indicators. In the absence of confirming figures from National Accounting, available information so far would indicate stable growth in recent months. This may be seen in the following graph which shows the trend in the composite economic activity indicator prepared by the Ministry of Economy and Finance from a broad range of indicators.
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Is it possible to say then that growth of economic activity has hit a ceiling? With due caution, the answer is «Yes». Except in the case of an unexpected turn-around in current trends we could move into a more moderate path in coming months which, in its most positive aspect, could contribute to relieve the pressure on the major imbalances now being shown by Spain’s economy (the inflation rate has jumped above the level of 3.5% and the current account balance has beaten all records in the first seven months of the year).
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Good figure for industry in August fails to hide delicate situation in some sectors (textiles, electronics and motor vehicles, among others).
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In August industry showed the first positive sign in this direction seen in a long time. In fact, the industrial production index recorded year-to-year growth of 3.2% that month (keeping in mind calendar adjustments), thus breaking with the earlier regressive trend. Nevertheless, this figure should be taken with some caution because it refers to a month characterized by low seasonal activity. What has not changed at all is the delicate situation in some branches of industry, including textiles, clothing and furs, and the electronics industry with decreases of close to 10% year-to-year on average in all of these as of August. Because of its significance, we should mention the drop of nearly 6% in the index for motor vehicles over that 8-month period.
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The increase in utilization of production capacity, which went above 81% in the third quarter (an historically high value), is a figure which allows for no simple interpretation in current circumstances. In principle, it could indicate a prudent attitude on the part of companies with regard to expanding production capacity. For the moment, the most positive sign is the slight improvement in order books reported by the European Commission survey, although it is yet to be seen if this will be confirmed in coming months.
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Moderation in rise of housing prices and slowdown in foreign investment could mark beginning of less dynamic stage in real-estate sector.
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On the other hand, construction continues to show considerable strength, as seen in most indicators, including cement consumption, and the maintenance of high confidence indices in the sector. In any case, while housing construction continues to rise, some signs of wearing out of the boom seen in recent years are beginning to show up. If we look at the trend in prices, which is a sure sign of the state of the sector, we recently note more moderation in the growth rate, as may be observed in the accompanying graph. Another significant fact is the slowdown of foreign investment which is one of the factors which has fed into this boom in the past.
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With regard to services, the situation is generally positive with information technology and communications, company services and retail trade among the most dynamic sectors. Tourism, of major importance in Spain’s economy as a whole, is maintaining a somewhat more positive performance than was forecast at the beginning of the season. Domestic tourism continues to grow at a very notable rate and the inflow of foreign visitors has also risen considerably (growth of low-cost airlines has undoubtedly worked to foster this) but there is a trend to a reduction in spending and to shorter average stays.
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Increase in oil prices not for moment causing visible damage in Spain’s economic activity but, if situation continues, growth potential (along with prices) could finally be affected.
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In order to complete the present picture of Spain’s economy, from a demand perspective, we should add that both private consumption and investment continue to grow at a sustained rate and there is no reason for this to cut out over the short term. The only reason for concern is the persistence of high oil prices. For the moment, the impact on economic activity has been fairly moderate given that the factors driving Spain’s economy have been able to counteract the negative effects of the rise in crude oil prices. Nevertheless, if pressures on fuel prices fail to ease, growth potential and prices (the most stable components of the CPI) could be affected to a greater or lesser extent in coming months.
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Both consumption and investment growing at very stable rates in recent months with notably sharp rise in imports.
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With regard to consumption, the indices as a whole point to relatively stable overall growth although they show big differences between them. For example, passenger car registrations rose by 2.3% year-to-year in the third quarter, a rate lower than that for the previous quarter although, in absolute figures, levels recorded continue to be the highest in history. On the other hand, retail trade showed a good figure in August with a year-to-year increase in constant prices of close to 3% (above 4.5% in department stores) thus breaking the mediocre situation seen in previous months.
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Finally, with regard to capital goods investment, the rate of increase in nearly all indicators continues to be very high but there has been a halt to the earlier sharp rise. Under this heading, the strength of imports, which rose by more than 27% in the first eight months of the year, was in contrast to the stagnation in domestic production.
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Car production
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Spain’s motor vehicle industry at the crossroads
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The motor vehicle sector, until recently considered the flag-ship of Spanish industry, is not now going through one of its brightest moments. In fact, in the first nine months of the year, motor vehicle production in Spain showed a cumulative drop of nearly 10% compared with the same period last year. If we limit our view to passenger cars, the line of greatest volume (more than three-quarters of total production), the drop was even greater with a decrease of more than 12.5% (200,000 units less than in 2004).
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Is this a passing phase or does it reflect a more deep-seated crisis? In fact, the causes are of various kinds – the weakness of foreign demand is one of the main reasons but, as a background to this, there is the excess capacity of the world motor vehicle industry within the current competitive framework characterized by supply pressure from the Asian block. As may be seen from the following table, the total production share of the European Union (EU-15), United States and Japan has dropped by nearly 10 percentage points in the past five years, mainly to the benefit of the emerging countries of Asia. Nor has Spain been able to escape this trend and has shown a loss of share amounting to nearly a half percentage point in the period under consideration.
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The drop in Spain’s exports of passenger cars (more than 12.5% as of September) was partly due to the stagnation in its main export markets but note should be taken that the drop is far greater than would have been brought about by containment of demand. It should be pointed out that, in the first nine months of 2005, the increase in passenger car registrations in the EU-15 was very limited (it did not reach 1% year-to-year) but still held to an increase in contrast to the decrease in Spanish sales abroad. No doubt the specialization of Spain’s motor vehicle industry in the medium and low-range segments means that it is more sensitive to market swings, as has been evident on previous occasions, but this time around this effect has turned out to be much sharper. In industry circles it is felt that the age of some models, now at the end of their market cycle, may also have contributed to these poor results.
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In the Spanish domestic market, demand remains buoyant but the tendency in recent years also points to a progressive loss of market share by the national industry (at present nearly 80% of passenger cars registered are imported, twice the figure at the beginning of the previous decade). All of this certainly makes up a very complex picture. If we limit ourselves to very recent events, in the United States (with a very flexible economy offering easy labour force adjustment processes) General Motors made an agreement with the unions for a 25% cut in non-wage benefits and announced the firing of 25,000 employees. Ford has gone into losses and is preparing a broad restructuring plan that includes significant plant closures and the wiping out of jobs. In Spain, SEAT is threatening to open a labour force regulation process (certainly less dramatic than simple firings) if the work-day and wages are not cut by 10%.
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Without becoming alarmist, we shall have to carefully follow trends in this sector on which, it should not be forgotten, one out of every ten jobs in Spain depends and which contributes nearly 6% to the GDP. While, according to widespread opinion, the 18 production plants operating in Spain enjoy a proper technological and competitive level, it will be necessary to reconsider certain aspects such as labour flexibility, taxation, professional training and investment in research, development and innovation in order to ensure a future without major setbacks.
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Labour market
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Employment maintaining positive note following summer
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Employment showing stable and sustained growth at end of third quarter.
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The labour market apparently continued to show a favourable state in the final stages of the third quarter, if we are to go by information available from registrations with Social Security. Nevertheless, the process of giving normal employment status to foreign workers significantly distorts this indicator which in itself showed spectacular growth (5.6%), higher than in previous months.
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Process of giving normal job status to foreign workers ending.
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In view of the information so far available, it is not possible for the moment to accurately isolate the effect of the process of giving such normal job status. Nevertheless, it may be estimated that the rate of increase in registrations with Social Security would stand between 2.8% and 3.5%, if we discount those registrations which are not for job creation but rather for giving legal status to existing jobs. In fact, once this process is completed it may end up giving rise to the registration of 474,477 foreign workers with Social Security, workers who previously were employed outside the system. Up until July 27, those applications given approval, that is to say, which ended up having registration with Social Security, totalled 352,522. With regard to other applications filed (somewhat more than 120,000) the effect on registrations in August and September, apparently quite high, is still unknown.
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A picture closer to the trend, although with a downward bias, is available from registrations by Spanish national workers. The rate of increase in registrations in this group held at 2.0% in September, somewhat lower than in the middle months of the year while showing notable stability compared with registrations throughout the year. As a result, the trend in employment in recent months may be regarded as positive.
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The favourable state of the labour market is also confirmed by hirings registered through offices of Public Employment Services. In the first nine months as a whole, hiring contracts registered were up by 3.4% with permanent contracts showing a more positive situation than temporary contracts, in spite of the fact that the latter were in the majority. Part-time work, in turn, continued to be the hiring formula enjoying the highest growth (6.9% year-to-year) coming to represent 22.7% of all job placements.
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Registered unemployment continues slightly downward trend
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Favourable trend in registered unemployment continues after summer.
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The favourable state of the labour market may also be seen in figures for registered unemployment. The number of those registered at Public Employment Services offices in September was down slightly, which meant a change over the normal increase during this period seen in recent years. As a result, registered unemployment (2,013,286 at the end of the month) stood 1.8% below the year before.
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In spite of this improvement, the cumulative balance for the year was somewhat less favourable than in the first nine months of 2004, the best for the present decade. The notable increase in farm unemployment and the performance in industrial unemployment, with a decrease well below that for last year, would account for most of the difference. In construction and services, the cumulative decrease in unemployment came somewhat closer to the previous year although still not reaching that figure.
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By autonomous community, the improvement in the situation was especially notable in Madrid Community, the Basque Country and the Balearic Islands where the level of unemployment was substantially below that for the preceding year.
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The increasing drop in unemployment in Castile-Leon, Galicia and Catalonia, while somewhat less sharp was also appreciable. On the other hand, we note a decrease in unemployment in Extremadura, Andalusia, Aragon and Castile-La Mancha, regions where the farm sector has a relatively greater importance than in the rest of Spain’s economy.
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Prices
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Sharp rise in CPI in September
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Energy prices push CPI up to 3.7% in September.
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The consumer price index (CPI) showed a notable increase in September, well above the same month in 2004, which meant an increase in year-to-year inflation of four decimals putting it at 3.7%, the highest figure since the beginning of 2003. It was mainly energy, but also fresh foods, that muddied a picture marked by relative containment of core inflation, which excludes the more volatile elements of the index (energy and fresh foods).
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Core inflation fails to compensate for rise in prices of industrial goods and downward resistance in services.
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Core inflation, which rose by one decimal to stand at 2.5%, benefited from the stability in prices of services and processed foods, which continued to grow at the same rate as the month before, in the latter case in spite of the increase in indirect taxes on alcohol and tobacco. Nevertheless, this stability is not a specially hopeful sign to the extent that prices of services are continuing to grow at very high rates (3.7% year-to-year) due to increases in prices in certain controlled markets and public services (sanitation, transport, etc.) and the low level of competition in other sectors (personal and household services) where the fragmentation of the market makes it fairly easy to pass on cost increases, especially wage costs.
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Following several months of containment, the discordant note comes in prices of non-energy industrial goods, especially clothing, footwear and home goods, which showed some increase in spite of holding at the very modest growth of 0.9% year-to-year. The return of families to normal life following the summer holiday period ended up with price increases higher than last year, probably because of maintenance of a good level of private consumption.
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The performance in fresh food prices was clearly negative as, to some extent, these came to reflect certain pressures in prices at origin. In any case, growth figures held at relatively low levels although higher than in the two previous months. The biggest imbalance, however, came from a continuation of the rise in prices of oil and its by-products. The increase in fuels thus stood at 19.8% year-to-year and had a decisive effect on the rise in the general index.
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Prospects for year-end CPI come close to 4%.
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The rise in inflation in September meant a slight change from the situation in recent months. The impact of the increase in fuels in the past four months had been eased by the slight moderation in core inflation. In September, this trend toward a gradual drop in the more volatile core of the CPI was cut short precisely because of an upturn in prices of industrial goods, in keeping both with pressures seen in prices at origin, domestic and import, and with the strength of consumption aided by very easy monetary conditions. Altogether, forecasts for the year-end now stand very close to a year-to-year increase of 4%, a notable deviation from the official objective of 2%.
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In September, the upward trend in prices in Spain was somewhat higher than in the European Union as a whole, if we follow the harmonized consumer price index. In fact, the differential rose to 1.2 percentage points because of the heavier impact of prices for transport and education. The rise was not greater because of the relative containment of prices for alcoholic beverages and tobacco in Spain in spite of tax increases.
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Prices at origin show sustained increases
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Intermediate goods, food and energy push industrial prices to annual highs.
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Industrial prices heightened their upward trend in September with the continuation of certain increases in prices of food products and further pressure from energy prices and other intermediate goods. As a result, year-to-year growth of industrial prices reached an annual high to stand at 5.4%. Other components showed more stability and a more moderate performance.
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Inflation differential with euro area increases slightly.
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Import prices also continued to be affected by oil prices and cumulative year-to-year growth went up to stand at an average of 4.9% for the first seven months of the year, nearly five points more than in the same period in 2004. This boost did not come entirely from energy but was also fostered by increases in other industrial intermediate goods. The performance in consumer goods was less troubling although the average increase in prices (1.2%) was in contrast to the decrease shown in 2004.
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Situation worsens in import and farm prices.
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Farm prices showed an unfavourable performance in July although in year-to-year terms they continued to present a decrease. The worsening of the situation likely will continue until year-end as it will be difficult to improve on results seen in the second half of 2004. In any case, the average increase in farm prices as of July held at a modest 2.3%, a figure somewhat more favourable than that for the same period last year.
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Foreign sector
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Trade deficit continues to rise
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Weakness in exports on top of heavy imports widening trade deficit.
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The trade deficit continued to rise in August reaching 49.59 billion euros in the first eight months of the year, some 33.6% more than in 2004. The appreciable recovery of exports in August failed to prevent a worsening of the foreign balance because of the continuing sharp growth of imports.
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The recovery in exports in August did not change the cumulative balance for the year. In fact, growth of sales abroad in the first eight months of 2005 stood at 3.9%, somewhat more than two points below the same period last year. Furthermore, this growth was entirely due to price factors given that the volume of exports was 0.5% lower than last year. The drop in exports was centred in the European Union (EU) in contrast to third country markets which grew by 3.1% real in overall terms, aided by the strength of countries like China and some Eastern countries because of the improvement in relative income levels of oil producers.
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EU market offsets good progress in exports to third countries.
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The poor situation in foreign sales was clearly seen in cars and motorcycles, appliances and consumer manufactures, mainly footwear and toys. In addition, there were weaknesses in the area of capital goods in some sectors, such as office equipment, where there were general price decreases. Foreign sales of foods, traditionally one of the main backbones of exports, also showed a slight contraction in volume.
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Imports in August recovered some of the strength lost in the two previous months putting nominal cumulative growth up to 12.2%, equivalent to 6.8% by volume. The notable increase in import prices (5.1%) came mainly from the rise in oil and oil by-products given that non-energy purchases abroad presented a price increase of 2.1%. The recovery of imports in August, which must be viewed with care because this is a holiday month, was mainly in oil and oil by-products, consumer electronics, clothing and ships.
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Poor situation in industry, some moderation in consumption and strength of investment behind performance in imports.
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So far in 2005, the main features of purchases abroad indicate, first of all, a notable weakness in purchases of non-energy intermediate goods, in keeping with the poor state of industry. Secondly, we note weaker growth in imports of consumer goods (strong growth at 7.4% by volume but half the figure for the January-August period in 2004). Finally, there was an increase in capital goods that was practically three times the figure for last year, which underlines the high level of this component of domestic demand. Foreign purchases of transportation equipment, particularly aircraft and railway equipment, contributed to this increase.
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Current account deficit showing no limit
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Balance of payments continues to show drops going further and further into red.
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The current account balance continued along a worsening path in July with a deficit going above that for the same period last year although the rate of increase in the foreign imbalance moderated slightly. In any case, the cumulative deficit for the past 12 months in July amounted to 59.6 billion euros. The poorer situation was due to the general worsening under the various headings. The trade balance rose by 40% in the first seven months of the year, reflecting the impact of the boost in oil and the unstoppable increase in imports in a context of export difficulties.
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Secondly, the services balance was down by 5% because of the poor results shown in the tourist balance which reflects the increased trend of Spaniards to travel abroad and the low level of spending by foreign tourists. Tourist revenue inflows rose well below the number of foreign tourists (1.3% as against 6.0%) whereas payments grew by close to 25%.
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The surplus in the transfers balance, in turn, showed a major drop from the decrease in the balance with the European Union and, on the other hand, remittances abroad by immigrants were up sharply. Finally, under the incomes heading, the increase in the deficit may be attributed to the drop in inflows and the increase in payments. Capital account, in turn, showed a notable surplus in July although this was lower than in the same period last year because of inflows from the European Union. The cumulative balance as of July was also below the figure seen in the same period in 2004 and was not sufficient to cover the current deficit. This meant that the deficit resulting from the current account balance and the capital balance rose to 33.28 billion euros in the January-July period, some 85.9% more than in 2004.
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Foreign real estate sector attractive to Spanish capital.
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In the financial sphere, direct foreign investment in Spain was down sharply both in the corporate field and in real estate. In the latter case, the drop in the first half-year stood at 17%, a substantial figure if we take into account the rise in prices in the sector. Only foreign portfolio investment moved ahead strongly. Spanish direct investment abroad, on the other hand, was up notably, thanks to investment in real-estate and especially in portfolio investment.
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Foreign competitiveness
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Spanish exports losing competitiveness
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In recent times, the trade deficit has become the most troubling imbalance in Spain’s economy. It is not without reason. In the early months of 2005 it went above 7% of the GDP, thus in percentage terms exceeding that of the United States which has caused so much comment in the press. This may be due to the fact that we are importing a lot and probably saving very little or that we are exporting little, possibly because we are not competitive. Strong domestic demand is driving the rash of imports while exports are failing to compensate for the gap created by purchases abroad.
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The point is that Spain has a serious and growing problem of competitiveness in world terms. Since 1998, in terms of unit labour costs in the manufacturing sector, Spain’s main customers have lowered the cost of their products by 8.1% compared with Spanish costs. Before the adoption of the euro, this loss of competitiveness could be supplemented through currency devaluations but this in no longer possible. Spain’s competitiveness in terms of Portugal and Italy has been maintained but with regard to Germany it has dropped by 11.5% and against France (where 19.4% of the country’s exports go) it has slipped by a dramatic 17.4%. The worsening situation is especially significant in terms of one new EU member state, namely Poland, which has cut its costs by 38.4% in terms of Spanish costs.
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With this drop in competitiveness, it is not surprising that Spain has stopped making gains in its share of international trade. At least, however, the country has managed to not lose ground which, given the circumstances, is of some merit. Spain’s exports in nominal terms have maintained their share of the world total, a share which had been increasing continually from 1.3% in 1985 and 1.7% in 1994 to 2.0% at the end of 1998, the date when the euro came into use. From that time on there was a decline which ended up with a drop to 1.7% at the beginning of 2001, followed by a strong recovery since then, in spite of ups and downs over the past years which have put it at 1.9%. In this respect, Spain contrasts favourably with countries like France, United Kingdom, United States and even Japan. All of those countries saw their share of nominal world exports drop appreciably. Among the large countries, only China shows a better export balance. Things are not so bad.
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In terms of market penetration by geographical area, the result is identical. The share of Spanish exports in total imports of the euro area went from 4.1% from 1994 to 4.5% in 2004. In areas of growing importance, such as between the new member states of the European Union, including Poland, Spain went from 1.1% to 1.8% and, among the rest of Eastern Europe, from 0.9% to 1.9%. This good situation is not restricted to Europe. Market share is increasing in Africa and Oceania and is holding up in Latin America and Asia, excluding the Far East. In two key areas, such as the Far East and the United States, which are engines of the world economy, the decrease in recent years has switched to an advance, especially in the case of China where, since the beginning of the year, Spain’s exports have doubled their share of total imports. It may be assumed that, in areas of major growth, Spain’s share would be lower but, if this bias were so marked and such a determinant, its share of world exports would drop, something which is not happening.
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Also having an effect on these events, and to a considerable extent, has been the trend in exchange rates. The sharp devaluations of the peseta in the Nineties raised Spain’s foreign competitiveness, a situation which was consolidated by the move into the euro. At the beginning of 1999, Spain was a cheap country compared with its partners in the Monetary Union and in terms of its main trading partners. This represented a considerable boost for Spain’s exports, giving them an extension of time which has served to mask the problem of competitiveness and has delayed the consequences.
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These consequences are now beginning to be felt. In spite of a generally favourable trend, Spain’s exports are showing some dark spots. Exports by such relevant sectors as furniture, textiles, toys, footwear and motor vehicles are dropping or are stagnant. What is happening in imports is even worse. The penetration of foreign products in the Spanish market is making the country’s lack of competitiveness even more evident. What is troubling is that at this time Spain’s economy is not greatly specialized in high value added and growth sectors but quite the opposite. The exchange rate gave Spain a breathing space but the challenge now lies in taking advantage of this in order to improve our competitiveness before it is too late.
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Public sector
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Central government budget for 2006
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As its priority economic policy objective, the 2006 central government budget presents a growth model that is balanced, sustainable and competitive. According to the budget, this economic policy is based on a decided improvement in productivity, on budget stability and the strengthening of the social fabric.
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Central government, Social Security and other central government bodies to spend 300 billion euros in 2006.
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In order to achieve its objectives the 2006 budget presents consolidated spending by the central government, Social Security, autonomous bodies and public corporations amounting to 301.3 billion euros. This figure represents an increase of 7.7% compared with the year before, that is to say, one point above the nominal growth forecast for the economy. This consolidated spending does not include that carried out by other levels of government (autonomous communities and municipalities) nor operations of the corporate public sector or public foundations or other public bodies, such as Spanish Radio and Television.
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The two largest headings of consolidated government spending are pensions, which make up 31.4% of the total and transfers to other levels of government, which involve 20.8%. Following far behind comes servicing the public debt at 6.5% of the total and unemployment measures with 5.0% which make up the next largest headings. In fact, four major headings take up 60% of all spending.
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Main government spending headings show little margin for manoeuvre.
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In addition, it should be pointed out that the greater part of spending programmes enjoy allocations which are growing above the nominal rate of the economy, thanks to the contraction in interest payments. The only allocations showing less growth than the nominal gross domestic product (6.6%) are for agriculture and fishing, financial and tax administration, programmes to foster employment and defence services.
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Most spending programmes are expansionist and benefit from margin created by lower interest payments on public debt.
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At the other end of the scale, that is to say, among those showing very expansionist trends we should point out the economic measures in the area of retail trade, tourism and small and medium-sized business (38% increase), research, development and innovation (29.7%), foreign policy (23.2%), access to housing (20.0%), transportation subsidies (19.0%) and education (16.6%) although in the latter case the allocation in absolute terms is relatively small if we take into account the administrative decentralization of the system. Programmes related to infrastructures, in turn, are up by 12.4% to reach 12.69 billion euros. This figure does not include certain measures falling outside the budget as a result of which real investment in infrastructures will be substantially higher going to 16.12 billion euros, that is to say, 1.69% of the GDP estimated for 2006. Priority is given to railways and the continuation of investment in waterworks.
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Investment in infrastructures amounts to 1.7% of GDP while funds going into R&D&i stand at 0.7%.
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The increase in spending in the area of retail trade, tourism and small and medium-sized business may largely be explained by international promotion measures and the relatively small allocations to those programmes. In the area of R&D&i, the main effort shows up in various programmes and projects among which of special note is the Avanz@ programme for developing the information society with an allocation of 634 million euros. As a whole, budget allocations of all types amount to 6.5 billion euros, that is to say, 0.7% of the GDP.
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In housing, the greater part of spending is to go into subsidies, supports and amelioration of interest for an amount close to 900 million euros. In addition, measures are set out for fostering construction and rental housing development within the framework of the 2005-2008 housing programme which, among other measures, involves intervention in 277,900 housing acquisition transactions, 164,600 rental operations and 159,500 renovations.
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The ample figures shown by the 2006 central government budget in its various spending measures is largely based on favourable revenue forecasts. In consolidated terms, revenues from non-financial operations will amount to 253.1 billion euros, an increase of 8.4% over the initial 2005 budget. This increase would be lower if it were to be calculated on effective collections in 2005 which will be higher than initially forecast.
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Tax load from direct taxes, indirect taxes and Social Security contributions to rise to 24% of GDP.
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The tax load (direct taxes, indirect taxes and Social Security contributions) in terms of the initial budget will reach 24.0% of the GDP in 2006, a half-point more than in the initial budget for 2005.
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The increase in tax collections will be due mainly to the increase in direct taxes, both personal income tax (in spite of the reduction in rate) and in corporate income tax. Compared with the initial budget, the increase in direct taxes stands at 12.6% (9.7% if this is calculated on forecast tax collections). Indirect taxes will grow by 5.2% (5.1% in the second case), a surprisingly lower percentage than the increase in domestic demand and rather unlikely in view of the increase in special taxes on alcohol and tobacco. The increase in collections for Social Security contributions stands at 7.7% and may be explained by the updating of contribution bases and an increase in registrations.
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Seeing that spending will exceed revenues, the result of the economic measures planned by the central government will be a net deficit of 14.08 billion euros, equivalent to 1.5% of the GDP.
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Budget presents consolidated surplus of 0.3% of GDP.
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Formally, the 2006 central government budget shows a consolidated surplus of 2.87 billion euros in terms of National Accounting, that is to say, 0.3% of the GDP. This surplus arises from the surplus in the Social Security accounts (0.7% of the GDP) which compensates for the central government deficit (0.3%) and that of other central government bodies (0.1%). If we add to these figures the deficit forecast for other levels of government (0.1%), the final balance for general government as a whole in 2006 would be positive at 0.2% of the GDP.
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Deficit or surplus?
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Central government to borrow in spite of budget surplus
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In consolidated terms, the 2005 central government budget shows a surplus of 0.3% of the GDP. This positive balance arises from the compensation between the surplus in Social Security and the respective deficits of the central government, autonomous bodies and other public bodies, such as the Nuclear Safety Council, the Economic and Social Council, the Central Government Taxation Agency, the Cervantes Institute, the Spanish Agency for Protection of Information, the Foreign Trade Institute, the National Intelligence Centre and the Prado Museum.
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In spite of this positive balance, the budget shows a net borrowing requirement, that is to say, a financial imbalance of 14.08 billion euros, equivalent to 1.5% of the GDP. This situation is not something new this year but rather is a normal recourse in the presentation of the public accounts. Year after year the central government net financial requirement has exceeded total revenues.
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Why does this discrepancy take place? Accounting regulations make possible, for example, that certain opening amounts are registered as financial investments which, because of their nature, would come closer to real investment spending. An example would be the provision of funds by the central government to the Railway Infrastructures Administrator which is more like a non-repayable investment (as are public investments in infrastructures) than a financially recoverable investment.
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Remaining recourse to an increase in financial assets is oriented along similar lines. In general, this involves the granting of loans or property allocations to companies forming part of the corporate public sector, to those institutions belonging to the public foundations sector and to a series of entities operating under public law which do not have their own legal entity, such as the Development Aid Fund, the Foreign Investment Fund, Micro-Credit Fund (social development programmes abroad), Tourist Infrastructure Modernization Fund and the Fund for Foreign Investment by Small and Medium-sized Businesses.
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Specifically, the most notable allocations in the 2006 budget, among other purposes, go into programmes of research and development under the Ministry of Industry (2.77 billion euros) and the Ministry of Education and Science (860 million euros), Railway Infrastructures Administrator (1.85 billion euros), Development Aid Fund (850 million euros), loans to highway infrastructures promoters (679 million euros), to RENFE operating company (404 million euros), the new central government corporation for Land Transport Infrastructures (400 million euros), to programmes for reindustrialization of depressed areas (215 million euros) and the Tourist Infrastructure Modernization Fund (70 million euros). These transactions would appear to be closer to spending than to financial investment.
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Apart from measures undertaken through financial accounts, the budget also contains authorization of guarantees which involve further government spending to the extent that they cover the losses of Spanish Radio and Television and government corporations showing losses. These guarantees, which show up as deficits in the figures for National Accounting, do not, however, appear in the financial accounts shown in the budget.
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The amounts guaranteed, on the other hand, are very large: 226.59 billion euros to cover losses attributed to Spanish Radio and Television (apart from an operating subsidy for an amount of 578.58 million euros) or 180.3 million for RENFE operating company. Of more significance is the amount of guarantees which may be applied by SEPI (Sociedad Estatal de Participaciones Industriales) for the benefit of companies in which it has holdings for certain credit or guarantee transactions. The maximum amount to be guaranteed is 1.21 billion euros, a figure higher than estimated net losses of the public corporate sector (1.02 billion euros).
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In spite of these high deficits, the fact is that in terms of the GDP they have lost relative importance, given that nominal growth of the economy has exceeded the volume of these public deficits. This explains the downward trend shown by the public debt in relation to the GDP, a trend which is indicative of the health of the government accounts in recent years which in 2006 are expected to drop to 43.0% as against 46.6% in 2004.
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Savings and financing
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Sharp increase in loans to households
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Reduced prospects of cut in European Central Bank official rate brings rise in interest rates.
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Interest rates on bank loans and credits generally rose slightly in August. As a result, the composite reference rate at banks and savings banks rose by 9 basis points to 3.84%, somewhat below that twelve months earlier. The rise in bank rates came following disappearance of prospects of a cut in the European Central Bank official rate.
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Housing loan rate also moves up slightly.
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In addition, the interest rate on mortgage loans held at 3.2% in September 2005.
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As a result, it stood 17 basis points below the same month in 2004.
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Funding of private sector growing at twice rate seen in euro area.
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Funding of the private sector continued to rise at a strong rate. In August, loans to companies and households showed growth of 18.6% compared with the same month last year, some 2.5 points more than the annual rate recorded in December. Demand for finance was boosted by the good economic climate and easy borrowing conditions. As a result, funding going to companies and households, including loans from the financial system, both domestic and foreign, securitizations and bond issues (but not share issues) grew at the highest rate since September 2000, doubling the rate for the euro area as a whole. The biggest year-to-year increase came in loans to households (20.3%), slightly higher than that recorded in previous months. Mortgage loans continued to boost financing to households.
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With regard to funds obtained by non-financial companies, this figure rose by 17.1% compared with the same month in 2004. Of total funding, credit granted to non-financial companies by resident credit institutions and securitization funds rose by 22.0% in the past year.
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Bank deposits continue to grow at high rate
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Funding of private sector growing at twice rate seen in euro area.
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Total deposits of companies and households continued to rise at a sharp rate in August compared with the same month last year and much more rapidly that in the euro area. Nevertheless, the increase in absolute terms in the past 12 months was notably lower than in the case of loans. In order to compensate this difference in balances, the credit institutions issued bonds or had recourse to foreign markets.
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Private sector deposits grow more than in euro area but less than loans.
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On the other hand, the new accounting regulations for credit institutions came into force in June as a result of adoption by the European Union of the International Financial Information Regulations relating to application of the International Accounting Standards. As a result, the balance of time deposits, mainly long-term deposits, was increased as a cross-entry for the return to the balance sheet of some securitized assets which had been removed when the previous regulations were in force. As a result, the year-to-year increase in time deposits and in the total appear to be overvalued. Nevertheless, there is no doubt that the biggest annual increase came in time deposits for more than two years which enjoy a tax benefit of 40% on interest. Deposits in currencies other than the euro also showed a big increase. In addition, on-demand and savings accounts showed a considerable rise of 11.7%.
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With regard to bank deposit interest rates for the private sector, these scarcely rose in August holding at very low levels. The composite interest rate for non-financial companies rose by 7 hundredths to 1.23%, some 4 basis points above one year earlier. The composite rate for households rose by 3 basis points to 1.14% to stand at the same level as 12 months earlier.
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Assets of securities mutual funds rose by 3.5 billion euros in September going to 242.07 billion euros, showing growth of 13.8% over the same month last year, according to Inverco, the sector organization. This increase in assets may be attributed to major capital gains due to the good performance on the stock markets during the month and also to net subscriptions to shares (after deducting sales) of 1.08 billion euros. The biggest inflows of new money in September went into global funds, guaranteed bond-based funds and European share-based funds. On the other hand, the funds to mark up the biggest withdrawals were money-market funds, guaranteed share-based funds and short-term bond-based funds. However, in the January-September period net subscriptions were concentrated on short-term bond-based funds (for an amount of 6.08 billion euros), some 43% of the total, thus reflecting the risk aversion stand among many savers.
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On-demand and savings accounts up 12% in past 12 months.
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The total number of participants in securities mutual funds rose to 8,341,634 at the end of September. As a result, there was an increase of 4.7% in the past 12 months. In this period, the types of fund to show most growth in number of participants were guaranteed bond-based funds and national share-based funds, with year-to-year increases of 20.6% and 14.2% respectively.
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The average annual weighted yield obtained by securities mutual funds was 6.1%, substantially above inflation. While all types of securities mutual fund recorded positive annual yields there was a wide range. Whereas international share-based funds in emerging markets reported an extraordinary annual yield of 55.5% and national share-based funds showed 35.6%, money-market funds earned only 1.2%.
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Biggest inflows of new money into securities mutual funds in September go into global funds, guaranteed bond-based funds and European share-based funds.
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Total assets of securities mutual funds (SICAV and SIM) amounted to 26.9 billion euros at the end of July 2005. The number of shareholders on June 30, 2005 was 395,412.
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Securities mutual funds mark up average annual yield of 6.1%, substantially above inflation.
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In turn, as a result of the real-estate boom, real-estate mutual funds have shown major growth. The assets of this type of investment fund at the end of September amounted to 6.02 billion euros, an increase of 37.6% over December. The number of participants was 126,566, an increase of 19.1% so far this year. The annual average weighted yield for the past year was 5.7%.
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Financial requirements
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Foreign deficit from the inside, or where savings we import are going
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When a country presents a deficit in its current account balance, this is because it is living beyond its means. It is spending more than it produces, and, as happens in a household or a company, it must resort to borrowing in order to maintain its rate of spending. At times, this is good if it happens to be a developing country which presents a broad growth potential and concentrates its spending on investments that will pay off in the future and increase its growth capacity. It is not usually so good if the imbalance arises from mere consumer spending so that there is an increasing debt (which must be paid back in the future) in order to pay for current spending. It may be a case of «eat today and starve tomorrow».
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Spain’s economy is suffering from a run-away trade deficit which is bringing about a growing gap in the current account balance. We are spending more than we earn. In order to maintain this imbalance, we must borrow more and more from abroad. That is to say, as the balance of payments has to be settled, the figures in the red arising from current transactions must be compensated by capital inflows. It should be pointed out that Spain has no problems in obtaining finance. Being within the euro area has radically changed the traditional picture of Spain’s economy which formerly found getting foreign financing to be an insuperable bottleneck. In spite of everything, however, we should be asking if it is sustainable to have increasing recourse to the surplus savings of other countries.
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In order to help clarify this key problem, we must break down this borrowing into the different segments of the national economy. This breakdown of net borrowing of the private and public sectors comes from the financial accounts of the Bank of Spain. In 2004, this net borrowing amounted to more than 30 billion euros to stand at 4.2% of the gross domestic product, a figure which coincides with the current account deficit plus capital transfers in the balance of payments. Up until a few years ago, the usual scheme of things was, on the one hand, households, which used to provide a very substantial surplus to the rest of the economy thanks to the fact that home acquisition (the only investment spending by households) was well below gross savings, that is to say, lower than whatever income was left over after paying consumption costs. In addition, there were the non-financial corporations whose position with regard to the rest of the economy changed according to the current economic situation. Finally, there was the public sector with continuing deficits which involved huge borrowing requirements. The sum of these three factors, plus the position of the financial institutions, meant a positive or negative foreign balance depending on the then current situation.
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In recent years, this pattern has changed. As may be seen in the accompanying graph, the public sector has corrected its deficit and now does not need to borrow. On the other hand, companies have moved into the negative area with net borrowing close to 5% of the GDP. The most notable change, however, is that households have followed a similar path so that in 2004 all of that sector’s surplus had practically disappeared. That is to say, correction of the government imbalance has not been sufficient to compensate for the major worsening of the private sector’s financial position. What then brought about this trend in the private sector?
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The answer is investment. The figure for gross household savings has dropped but the main change is that households have swung heavily into buying homes, stretching their capacity to the hilt. Something similar is taking place in the case of companies. They have slightly reduced their savings while at the same time increasing investment, within which investment in construction is very substantial. The drop in interest rates and the spiralling rise in land and housing prices are among the reasons for this trend.
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If the foreign deficit were due to an increase in investment, this deficit could be seen with good eyes. But to the extent that it is exclusively because of the construction component, the verdict must change. In 1995, the specific weight of capital goods in the GDP was 6.0% and went up to 6.7% in 2004. On the other hand, in the same period construction went from 12.3% to 16.2%. In today’s globalized world, investment in information technology and communications is said to have the greatest future. On the other hand, investment in housing would not seem to be raising the future growth potential of Spain’s economy.
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With regard to companies, a good part of investment is also going into activities linked to construction. But now it would be most relevant to ask questions about the low capacity of non-financial companies to generate savings. Compared with what is happening in the United States, for example, where corporate savings is quite positive, we could point to the insufficient ability to boost productivity as an explanation of this discrepancy. Finally, the increasing need for funding arises from the growth model followed in recent years, a model characterized by a low capacity to improve productivity in the case of industry and excessive investment in the construction sector.
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