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Economic activity
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Uncertainty is affecting confidence
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Both consumption and investment make slow but steady progress.
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Since the Spanish economy started its recovery, quarter-on-quarter growth in gross domestic product (GDP) has remained relatively stable at around 0.2%. A rate clearly lower than the average of 0.9% posted between 1995 and 2007 but reasonable given the significant imbalances that have yet to be corrected.
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The economic recovery is partly being hindered by private consumption, whose improvement is steady but slow. Its average rate of growth over the last year and a half has been 0.9% year-on-year, although it is still being affected by the high unemployment rate and the deleveraging that needs to be carried out in the Spanish economy. Moreover, although the stabilization of fuel prices and the disappearance of the effect of the hike in value added tax (VAT) should encourage consumption, the savings rate is already close to its pre-crisis level, so that any boost provided by further falls will now be more limited.
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Investment is also unlikely to provide any wonderful news. Although gross fixed capital formation in capital equipment continues to make progress with an average growth of 0.7% over the last year and a half, investment in construction is immersed in a sharper and longer lasting readjustment that will probably not finish until next year.
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Demand and supply indicators reverse their positive trend.
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Moreover, any gradual recovery in these components has to offset the fiscal adjustment that needs to be carried out by the public sector over the coming quarters. Given this situation, GDP growth in the Spanish economy is likely to remain at a relatively weak rate over the next few quarters, albeit with an upward trend. However, the vast majority of supply and demand indicators have changed their positive trend over the last few months.
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Concerning demand, of note is the severe correction being undergone by consumer confidence. After its fall in August, in September this indicator remained stable at a relatively low level. The bad figures for trends in the labour market aren't helping confidence to recover either. In particular, after a somewhat promising start to the year with some stabilization in job losses and in rising unemployment, in September the number of unemployed rose by 95,817 people, the highest increase in this period since the Employment Ministry started producing this series. The trend in inflation isn't helping either as, although it's clearly downward, it has now remained above 2% for a year.
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The debt crisis is threatening to undermine the real economy.
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The figures aren't too encouraging on the supply side either. Electricity consumption, for example, fell to -1.3% in year-on-year terms in September, thereby maintaining a clearly downward trend. The confidence index for industry, which had remained relatively stable during the first half of the year, has fallen to the level of February 2010 in just one quarter. The economic sentiment index has seen a downward trend in the last few months and the purchasing managers' index (PMI) is also continuing to fall, now clearly below 50 points, the threshold as from which the economy is likely to shrink.
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Within this context, it's no surprise that the summary activity index produced by the Ministry of Finance has seen a significant decline in the last quarter, warning of a rise in the risk of recession in the short term.
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What lies behind this turnaround in the leading indicators? As has already been mentioned, there are no new fundamental elements to suggest that consumption or investment will halt their recovery. Quite the opposite, in fact. Their trend should be positive, albeit gradual.
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One of the possible reasons might be found in the deterioration in exports, one of the factors that, to date, have been key to recovering economic growth. For the moment, it's difficult to determine the extent of this factor's influence, as figures are only available up to August and, at present, no change in trend can be observed. In fact, in that month growth in exports rose to 17.4%, with a significant contribution by exports to European Union countries.
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The new measures will determine the confidence of agents and the course of the economy.
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Another, more plausible explanation is the delay in resolving the sovereign debt crisis in the euro area. In fact, the deterioration in the PMI over the last few months is a purely European occurrence. It's true that these indices also saw a significant drop in the United States and China in the first half of 2011 but there they have already started to pick up again while, in the countries of the European Union, they have speeded up their decline. Rising uncertainty, which led to higher stock market volatility in the summer, might be about to affect the real economy. The risk is increasing that both consumers and business people will, respectively, reduce their consumption and investment as a precaution and this might slow up the economic recovery.
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It is therefore very important to define credible, effective measures in order to tackle the sovereign debt crisis. The main European leaders seem to be aware of this and, at the summit held during the last week of October, will finally deal with the key points to address this crisis. Defining a new bailout plan for Greece and specifying the relief for Greek public debt for private investors, increasing the loan capacity of the European Financial Stability Fund and recapitalizing the banking sector are on the agenda. If they finally manage to achieve broad consensus on these issues, the confidence of agents might be significantly boosted over the coming months. The measures to be taken are unlikely to be defined down to the last detail because they are incredibly complex but it is very important both for the Spanish economy and for the euro area as a whole to get back on the right track.
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Labour market
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The lack of growth starts to have consequences
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A rise of almost 96 thousand people in September takes registered unemployment to 4.2 million.
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The job drought continues at the start of autumn. The latest figures provided by the State Employment Service (formerly INEM) indicate to what extent the slowdown in the economy is now affecting a labour market that never managed to fully recover. In the second quarter the economy hardly grew, just 0.2% compared with the first three months of the year, while the forecasts for the year-on-year change in gross domestic product for 2011 and 2012 are 0.8% and 1.1% respectively. These latest growth figures seem optimistic given the number of people unemployed and the number of registered employed published in September.
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Unemployment increased by 95,817 people compared with August, its biggest rise in this period since the Ministry of Labour has been producing this series. Moreover, the data don't improve much when we take the seasonal component into account as the rise is still 77,010 people from this perspective. In total, 4,226,744 people are unemployed in Spain.
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Why this sudden increase? The services sector saw very severe job losses, losing 74,590 employees. After an exceptionally good summer season in the tourism sector, the end of the summer has meant that, of all jobs lost, 78% occurred in this sector. This figure reveals the marked seasonal nature of our labour market.
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Only 7.5% of new contracts are permanent.
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The other major cause of higher unemployment is the rise in the number of first-time job seekers. This group grew by 5.23% compared with the previous month and, together with the services sector, accounts for 98% of the rise in unemployment.
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On the other hand, job losses also led to a reduction of 64,956 people in the number of people registered as employed with Social Security in September. This figure falls to almost half when seasonally adjusted. Consequently, the cumulative figure for the last year shows a loss of 235,918 registered employed. Similar to the unemployment figures, the services sector, with hotels and restaurants and retail at the head, lead the fall in registered employed. In fact, the self-employed have been the hardest hit by September's adjustment, as they account for almost half the reduction.
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One glimmer of hope comes from the number of contracts registered in September, up by 3,445 compared with the same month in 2010. However, only 7.51% of these new contracts were permanent, once again highlighting the dual nature and the importance of temporary workers in our labour market.
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Spain posts a record unemployment rate at an international level.
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If we look at Europe, Spain's face must surely either go pale or redden with shame. Spain contributes 31% of the euro area's 15.7 million unemployed; i.e. one in three unemployed people in Europe is Spanish, whereas Spain only accounts for 14% of the total population of the euro area. Our 21.2% unemployment rate puts us way down at the bottom of Europe's league, followed at a distance by Greece (16.7%) and Ireland (14.6%). The euro area, for its part, has 10% unemployment and this figure has remained more or less flat since the third quarter of 2009. Comparisons are even worse if we look at the 20 most powerful economies in the world as, together with South Africa, we are the only G-20 economy with a double digit unemployment rate.
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During this crisis, Spain has demonstrated a spectacular capacity to destroy jobs, thanks to our dual-nature market and the end of the property boom, as it was capable of going from 8% to 18% unemployment in just two years. As of today, youth unemployment stands at 45%, more than double that of our European peers. Young people are the hardest hit by the crisis, as their unemployment rate doubles that of the economy as a whole, both in Spain and in the euro area.
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Given the current outlook for our economy and the economic slowdown in the euro area, these figures aren't going to improve in the short term. The labour force survey (LFS), published at the end of October, will provide revealing figures on our labour market that will help to confirm this negative outlook, although we are not expected to go above 5 million unemployed for the time being.
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The labour force survey will clarify to what extent the labour market has deteriorated.
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Positive data might come from the publication of labour costs for the third quarter. The pace of growth in total labour costs has moderated to date and, even more importantly, is below that of the euro area. Providing this continues, and thanks to wage containment, the Spanish economy looks like regaining its competitiveness.
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Employment needs economic growth, like plants need water, to be able to flourish. The present situation seems to confirm the theory that it is very difficult to create jobs in any sustained way with the current growth rates. The further the economy moves away from the rains of growth, the more likely we are to hear bleak employment figures. If it doesn't rain, the tree doesn't produce fruit and society suffers from a lack of provisions. Manna from Europe looks like it's dwindling so, meanwhile, the Spanish economy is attempting to generate its own drizzle through gains in competitiveness.
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Prices
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Inflation picks up temporarily
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The CPI rises by one tenth of a percentage point and stands at 3.1% in September.
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The year-on-year rate of change in the general consumer price index (CPI) increased by one tenth of a percentage point in September and stood at 3.1%. After four consecutive months of falls, starting in April from a level of 3.8%, this figure represents a temporary break in inflation's downward trend.
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The origin of this upswing can be found in the somewhat anomalous behaviour of certain components. The group of alcoholic beverages and tobacco increased by 9.2%, almost four tenths of a percentage point more than in the previous month. This increase can be explained by the change in tobacco prices, up by 12%, and this rise seems to confirm the end of the tobacco war that started at the end of spring. The oligopolistic nature of the tobacco industry helps to explain the great volatility of its components and the unexpected hikes in its prices.
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Tobacco and fuels are responsible for the upswing in inflation.
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The other component responsible for the rise in inflation is the group of fuels and oils, posting a year-on-year increase of 16.4%. Unlike the rest of the components, and within the context of an economic slowdown, energy refuses to take a downward path and has remained at a practically flat rate of inflation for the last five months, fluctuating slightly around 15.6% in terms of its year-on-year change.
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Economic indicators continue to point to a slowdown.
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Although unprocessed food and energy products are not included in the calculation for core inflation, the role played by tobacco explains why its annual rate rose to 1.7%. However, and as in the case of general inflation, this upswing has been interpreted as temporary, given that the rest of the indicators continue to point to weak economic growth.
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The bitterest aspect of this slowdown is the labour market, which never managed to recover. In September, registered unemployment increased by 95,817 people compared with the previous month and the rest of the indicators are not exactly encouraging either. Both consumer confidence and the indicator for economic sentiment were worse than the previous month, while retail sales and industrial production fell by 4.8% and 1.5% compared with August last year.
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This is why we believe the upswing in inflation to be temporary. Weak economic growth is still the key decisive factor for inflation, pushing it to a rate of almost 2.4% for the end of the year and below 2% for 2012, according to our forecasts.
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We should remember that the behaviour of energy products might still provide the odd surprise in the form of small hikes. In spite of the Ministry for Industry freezing electricity prices, at some time in the coming months we will see a price adjustment that is more in line with production costs. On the other hand, the prices of some commodities, such as gas, might pick up slightly.
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In fact energy, with a 12.4% year-on-year rise, has been partly responsible for inflation in the euro area shooting up to 3.0% in the month of September. The other key decisive factor is the methodological change introduced by Eurostat to estimate seasonal prices.
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Although inflation in the euro area saw a rise in September of 5 tenths of a percentage point compared with the previous month, inflation forecasts remain below 2% for 2012. Give that the medium-term aim of the European Central Bank (ECB) is precisely to keep inflation below this figure of 2%, pressure continues to lower interest rates.
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Inflation in the euro area is up by 5 tenths of a percentage point compared with the previous month.
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However, this scenario might take some time to arrive due to the fact that the new ECB president, Mario Draghi, will want to make sure that the upswing in inflation is actually temporary, as well as certifying the slowdown in the euro area. However, other types of liquidity measures might be implemented sooner.
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Spain narrows its inflation differential with the euro area in September.
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A comparison between the harmonized index of consumer prices (HICP) in the euro area and Spain helps us to gauge the competitiveness of the Spanish economy, given that the former is our main trading partner. In this case, the year-on-year change both for Spain and the euro area stood at 3.0%. These two rates had not coincided since August 2010 and this latest figure seems to confirm that Spain is indeed regaining some of its competitiveness. Nonetheless, we must be very cautious until we can confirm the significance of Eurostat's methodological change in closing the inflation gap with the euro area.
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In summary, the upswing seen by inflation in September is merely an interruption in the downward trend taken by prices both in Spain and in the euro area. The refusal of energy products to join this descent might hold back a process that seems inevitable given the sharp slowdown in the European economy, including Spain.
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Foreign sector
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The trade deficit, caused by oil and the European economy
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Trade deficit up 10.4% year-on-year in August.
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August's trade deficit increased by 10.4% year-on-year, putting an end to four consecutive months of correction. This large imbalance results from the upswing in imports, up by 17.5% year-on-year, after their moderate fall in July. In spite of this temporary decline, the bulk of the evidence available suggests that the foreign sector will continue to be the main engine of the economy during the second half of the year. Weak domestic demand, which is reducing the pace of growth of imports, will play in its favour. However, there are two factors that will determine the future trend of the trade balance: the pace of growth of Europe's economy and trends in oil prices.
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In fact, close to two thirds of the Spanish goods exported during 2011 went to a country in the European Union. The good performance of exports to these countries, up 19.3% year-on-year in August, has resulted in a favourable trade balance for Spain with the European Union as a whole. This situation has not occurred since 1986. Of particular note is the case of France and Portugal, where the cumulative surplus for the last twelve months reached 9.3 and 7.8 billion euros respectively.
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The slowdown in Europe's economy jeopardizes exports.
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Given these data, there's no doubt that the decline in economic vigour expected in Europe for the coming quarters will lead to a slowdown in Spanish exports. However, the rate of exports to countries with less trading tradition with Spain might absorb part of this drop. One clear example of this is China. As can be seen in the graph above, the volume of exports to the Asian giant has gradually increased in relative weight over the last few years.
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Energy imports grow by 27.7% year-on-year in August, boosted by the high price of crude.
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On the other hand, the trend in oil prices will also play an important role in determining the future trade imbalance. In fact, the cumulative energy trade deficit between September 2010 and August 2011 reached almost 40 billion euros, accounting for more than 80% of the total trade deficit in this period. The sharp rise in the price of crude since September 2010, easily exceeding 100 dollars per barrel, explains this imbalance. The breakdown of energy imports for this period confirms this. Although these grew by 27.7% year-on-year in August, their increase in real terms was just 2.7% in the same period.
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Future stagnation in the price of crude, not discounting slight falls, could ease the pressure on the trade deficit for the coming quarters.
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The current deficit falls in spite of higher interest costs
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The current deficit accelerates its rate of decline in July.
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Within this context, the cumulative current deficit for the last twelve months speeded up its rate of decline in July with a fall of 16.3% year-on-year. This correction was largely due to the good performance by the balance of goods, revived by the fall in imports. However, the foreign trade figures point to less adjustment in August. In addition to this current balance component, also of note are the items of services and income due to their opposing trends.
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In the case of the former, the cumulative service balance surplus for the last twelve months reached 31.5 billion euros, 20.9% more than the figure for the same period a year ago. The rise in tourism was the main reason. This can be seen in the trend of tourism revenue, almost reaching 2008's record high in July. Europe's relatively healthy economy and the armed conflict in North Africa boosted visits by foreign tourists.
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The income deficit rises due to the higher financing cost for Spanish debt.
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However, there are risks of a slowdown in tourism's rate of growth as from 2012. At the same time, we also expect the income balance deficit to go on increasing. Between August 2010 and July 2011, this reached 26.8 billion euros, up 14.8% year-on-year. The rise in payments due to the higher financing cost of Spain's public and private debt is one of the main reasons. Tension in the financing markets is expected to continue over the coming quarters, moderating the adjustment in the current deficit in the medium term.
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Public sector
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The deficit target looks difficult to achieve
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The increase in the write-down of Greek public debt, up to 50%, affects European sovereign debt markets.
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The European public debt markets continue to be the focus of international attention and the main question is still the situation of the Greek economy and its ability to stabilize its public debt. In this respect, discussions on the need to raise the write-down of Greek debt above the 21% initially planned are keeping the European financial sector on edge. However, it seems that the main European leaders have finally decided to take far-reaching measures. The summit at the end of October is expected to define the conditions for recapitalizing Europe's banks and the mechanism to allow the EFSF to increase its lending capacity to avoid contagion.
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These measures aim to restore investor confidence in the public debt markets; something that has already happened in Ireland, for example. The extensive correction in fiscal imbalances and the good performance of the Irish economy have reduced pressure on its public debt over the last three months. For Spain, on the other hand, rating agencies once again downgraded its public debt rating in October due to increased doubts regarding the solidity of its economic recovery. This increased pressure on the risk premium for Spanish debt, with this rising above 350 basis points during the second half of October.
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Public sector borrowing remains at 9.2% of GDP in June.
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Moreover, there is the risk that the public deficit will not achieve the target set by the government for 2011. Data for the quarterly non-financial accounts of public administrations show that borrowing stagnated in the second quarter of 2011. As can be seen in the graph above, cumulative public borrowing over the last year accounted for 9.2% of the gross domestic product (GDP) in June. This represents a correction of just one tenth of a percentage point compared with the level at the end of 2010. In fact, if we compare the figures from the first half of this year with the previous year, we can see that borrowing increased slightly, up to 41.4 billion euros.
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Lower public investment and wage cuts reduce public spending by 5.3 billion euros during the first six months.
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This stagnation is partly due to the inertia shown by some items of public spending. One clear example is social benefits, including unemployment benefit and retirement pensions, as well as social transfers in kind, principally education and health. In both items we can see that, in spite of halting its upward trend of previous periods, spending has hardly fallen during the first half of the year. This contrasts with the fall in spending on gross capital formation (investment) and payroll, a result of fiscal adjustment measures. This improvement, of 5.3 billion euros compared with the first half of 2010, was nevertheless neutralized by the higher interest paid on public debt and the lower revenue from taxes on production.
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The public deficit seems unlikely to achieve the target of 6.0% of GDP set by the stability programme for 2011. Available figures to date present the fiscal imbalances of the autonomous communities as one of the main reasons for not achieving this target. The trend in the central government's accounts in the third quarter is not very encouraging either. The cumulative cash deficit between January and August fell by 9.1% year-on-year to 33.7 billion euros. Should this rate of shrinkage continue up to the end of the year, the imbalance would exceed the target set by the government by three tenths of a percentage point of GDP, the main reasons for this being the weak growth in taxes and the rise in financial costs.
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We have revised our deficit forecast for 2011 upwards to 7.5% of GDP.
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As a consequence, our public deficit forecasts for 2011 have been revised upwards to 7.5% of GDP, 1.5 percentage points above the fiscal consolidation target. Consequently, and given the postponement of the privatization of the state lottery and the airports of Barcelona and Madrid, we expect Spain's public debt to reach 69.7% of GDP in the same period. However, in spite of Spain's public deficit perhaps not achieving its target for this year, the level of debt will remain at a relatively low level compared with the main countries in Europe.
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Savings and financing
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The private sector continues to reduce its indebtedness
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The new capital ratio requirement for the main European banks is raised to 9%.
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Europe's banks have to recapitalize. Finally, tensions in the sovereign debt markets, particularly for the peripheral countries, have meant that measures must be taken to reinforce the solvency of the main holders of public debt, namely banks. The aim of this measure is to restore confidence in wholesale financing markets regarding the health of financial institutions and thereby help to channel credit towards different sectors of the economy. However, the requirement for banks to have more fixed capital might make it harder for credit to be granted in the short term. In Spain's case this situation would occur within a context of stalling economic growth and private sector deleveraging. All these factors auger further falls in credit for the remainder of 2011 and 2012.
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It's certainly quite surprising that the decision to recapitalize the main European banks has come just three months after they passed the stress tests. The reason is that the scenarios simulated by the European Banking Authority did not include the possibility of a write-down of the public debt held by the banks. This scenario now seems more likely after the events of the last few months. That's why the new capital requirements have been raised by four percentage points to 9.0% of risk-weighted assets. Moreover, the value of peripheral sovereign debt has been reduced. These reductions range from 50% in the case of Greek bonds to 2% for Spanish. These measures will only affect those banks that are large enough for their failure to jeopardize Europe's financial system as a whole, also known as systemic banks.
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Spain's main banks will require more than 26 billion euros of additional capital.
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With regard to Spain, there are five banks that will have to meet these new capital ratios. However, the Spanish financial sector has little exposure to Greek public debt. This, and the slight discount carried out on Spanish bonds, places the sector's need for additional capital at 26.2 billion euros.
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All this will occur within a context where the private sector will continue to maintain its rate of deleveraging. As can be seen in the graph above, Spain's non-financial private sector was a net lender between July 2010 and June 2011, lending the equivalent of 4.9% of Spain's gross domestic product (GDP). This figure is four tenths of a percentage point higher than the figure recorded at the end of 2010 due to improvements in the accounts of non-financial firms. As a consequence, private debt fell slightly in the second quarter, maintaining the trend started a year ago. This, however, was not enough to meet all the capital required by public administrations. During the first half of the year, public administrations saw almost no reduction in their borrowing, this remaining at 9.2% of GDP, so their indebtedness continued to grow.
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The private non-financial sector's lending represents 4.9% of GDP in June 2011.
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The data available for the third quarter show that this trend has continued, with a clear drop in private sector financing, particularly in terms of bank loans. Debt in the hands of the private sector fell by 54.5 billion euros during the first eight months of the year, a drop of 2.5% year-on-year. This shrinkage affected both households and non-financial firms in equal measure. If we look only at bank credit to the other resident sectors we can see that, over the same period, the drop in the outstanding credit balance was 3.0%.
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Credit to other resident sectors falls by 3% between December and August.
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Further drops in credit are more than likely in the coming quarters. On the one hand, the closure of wholesale markets will not allow interest rates for new credit transactions to fall. In fact, during the first eight months of the year, the cost of financing increased by one percentage point for households. Firms also recorded a significant increase of seven tenths of a percentage point in the same period. On the other hand, the slowdown in economic recovery expected for the coming quarters will continue to weaken demand for credit.
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Both factors, the fall in the credit balance and weakening of Spain's economy, will push up the doubtful debt rate. In August, this rose to 7.15%, 22 basis points above the level recorded the previous month. The deterioration in property portfolios is seen as one of the main reasons. In this sector, the little dynamism in real estate activity and the adjustment of house prices represent a large part of the risks that will have to be faced by Spain's financial system in the future.
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Risks that, should they turn out to be losses, might partly be assumed by the financial institutions' Deposit Guarantee Funds, after the Decree Law of 14 October was passed. This regulation, which has unified the guarantee funds of banks, savings banks and cooperatives, aims to ensure that the banking sector itself can meet the net costs occurring due to its restructuring.
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Household savings continue to fall
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The Deposit Guarantee Fund will take on any losses resulting from restructuring.
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In the first quarter of 2011, the household savings rate continued its downward slide started a year ago, down to 12.8% of disposable income in cumulative terms for the four quarters. This figure is far from the maximum reached in 2009, when families' precautionary savings pushed it above 18%. We expect the savings rate to go on falling, reaching 11.4% by the end of 2011.
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The data for bank liabilities are in line with this forecast. Bank liabilities in the hands of households and firms recorded a year-on-year drop of 0.3%. As can be seen in the table above, this fall is due to the trend in short-term deposits, especially savings accounts. Term deposits, for their part, remained almost at a standstill during the same period. Part of the fall in deposits is due to lower interest rates for new deposit operations which, in the case of households, were down by 8 basis points. This lower return continues the trend started a month ago, after the decree came into force that limits the interest rates offered by bank deposits.
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The household savings rate falls further, down to 12.8%.
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The closure of wholesale financing markets since the end of August would have revived competition between financial institutions to attract retail deposits. As a consequence, September's figures might show a certain upswing both in interest rates and in the volume of deposits. However, there are two factors that might quickly slow up this increase. Firstly, October's injection of liquidity by the European Central Bank into the banking sector, with the reappearance of twelve-month auctions. This will reduce the financial institutions' borrowing in the short term. Secondly, the use of new instruments other than deposits to attract retail funds. As is the case of commercial paper, these do not require compliance of the aforementioned decree's conditions.
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