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Economic activity
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Severe adjustment in growth prospects
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Early figures for 2012 seem to confirm the recession.
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2012 has not got off to a good start. The latest indicators for economic activity confirm that the recession is underway and no analyst doubts this now. The only significant doubts that remain are the duration of the recession and its extent. In January, the consensus of economists once again revised downwards their growth forecasts for Spain's gross domestic product (GDP) in 2012 and, on average, now expects a reduction of 0.3% for the whole of the year. However, the economy is expected to get back on the path of growth next year and advance by 0.9% year-on-year.
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The divergence between the forecasts from the main research centres is very big, highlighting the great uncertainty surrounding the performance of economic activity at present. Among these, of note is the severe revision carried out by the International Monetary Fund (IMF), going from predicting 1.2% growth for this year to a decline of 1.7%. The IMF doesn't hold out much hope for the coming year either as, according to its latest forecasts, GDP will also record a slight drop for 2013 as a whole, specifically 0.3%.
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To a large extent, the size and duration of the fall in GDP will be determined by three factors: the resolution of the sovereign debt crisis, the extent and manner of the adjustment for Spain's fiscal deficit and the trend in oil prices. These three factors will largely depend on political rather than strictly economic factors. Hence the great uncertainty surrounding the current economic slowdown.
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Oil prices have picked up again slightly as a result of tensions in the Strait of Hormuz. A further rise in crude would make recovery even more difficult, as it would push up general inflation and reduce the level of activity. In the European area, negotiations for the new fiscal pact are progressing as expected; i.e. slowly. A positive note is provided by the growing credibility afforded the negotiation process by the strength of the French-German tandem made up of President Nicolas Sarkozy and the German chancellor, Angela Merkel.
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The consensus estimates a 0.3% fall in GDP year-on-year.
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Looking to Spain, the new government has confirmed that the actual public deficit for 2011 will deviate notably from the target set by the previous government. Specifically, the new government's forecasts place the deficit at around 8% of GDP, while the target was 6.0%. Should this figure be confirmed, it would mean that a greater effort would have to be made in 2012 in order to meet the 4.4% target set by Brussels. The new government has affirmed that it is totally committed to the fiscal stability pact and has therefore already presented a battery of reforms, including an increase in income tax and house rates (for a more detailed explanation, see the section on the public sector).
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More than 40 billion euros will need to be saved to cut the deficit to 4.4% of GDP.
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The measures announced represent a saving of 15 billion euros but savings this year will have to exceed 40 billion in order to reduce the deficit from 8.0% of GDP to 4.4%. New, far-reaching measures will therefore be announced over the coming weeks and particularly when the 2012 budget is approved, which will take place in March. In any case, the impact this will have on growth in the short term will be clearly negative, partly explaining the reduction in forecasts. However, it is very important to note that, in the medium and long term, these measures might have a positive effect on growth, not only because a healthier economy is better able to undertake substantial projects but also due to the improved credibility this would entail in international markets.
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Both supply and demand indicators warn of a decline.
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For the moment, the macroeconomic indicators are not at all encouraging. We shall look more closely at two of these: retail sales and industrial production. The former recorded a sharp contraction in November of 7.1% in year-on-year terms. This indicator reflects the situation affecting demand, which has fallen back again as it did in 2009, threatened by rising uncertainty. The consumer confidence index, which fell again in December, and electricity consumption, down by 4.9% in the same month, are further signs of rising uncertainty.
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The situation is similar for supply. The industrial production index fell by 7.0% in November in year-on-year terms and the trend is not at all reassuring. The purchasing managers' index or PMI, still at very low levels indicative of a recession, and the industrial confidence index both reinforce the downward outlook of economic activity in Spain.
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The nature of this second recession is particularly political.
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The job market's weak development, the tendency of prices to moderate and the timid pace of imports, all commented on in their respective sections, have led us to also considerably revise our scenario of forecasts for the year as a whole. In line with the evolution of these indicators, we expect GDP to shrink by 1.0%. For the coming year we expect growth of 0.6%. For this to happen, it will be fundamental for the course set by the new government to continue without delay, for the sovereign debt crisis to gradually be resolved over the first half of the year and, ultimately, for the vacillation of oil prices to remain just that; vacillation.
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The recession the Spanish economy is entering is particularly the result of high political uncertainty and not of structural problems in the economy, although these do exist and measures will have to be taken to revive growth in the medium term. The nature of the recession therefore means that short-term risks are high. A new upswing in financial tension due to negotiations breaking down between holders of Greek debt and the Greek government on how to restructure its debt, or doubts regarding Portugal and Ireland's capacity to comply with their respective fiscal adjustment programmes might delay the Spanish economy's recovery. At the same time, if all this is resolved favourably, confidence might return faster than expected. 2012 has not started well but this does not mean it is going to end badly.
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Labour market
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In search of an aegis
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In 2011, the number of unemployed increases by 322,286 people compared with 2010.
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In Greek mythology, the aegis is Athena's shield, used by Perseus to help him decapitate Medusa, whose head is then incorporated into the goddess's shield. The task faced by the current government is no less titanic than that of Perseus: decapitating the monster of unemployment, without comparison in Europe, and protecting the labour market so that, in future crises, the unemployment rate will not go above 20% again.
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This will be the umpteenth reform of the job market since democracy began in Spain, the last one taking place just eight months ago. The expected reform has been preceded by an announcement by the President of the government, Mariano Rajoy, anticipating that the next labour force survey (LFS) will provide an unemployment figure of 5.4 million people. This takes the unemployment rate to 23.3% so that, given the current situation, the historical maximum of 24.6% could be exceeded, reached at the start of 1994.
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For 2011 as a whole, the State Employment Service recorded an increase of 322,286 people in the number of unemployed; i.e. 7.9% more than in 2010. This annual figure hides the extensive decline suffered by the labour market in the second half of the year, when the number of unemployed rose by more than 300,558 people, more than double the figure for the same period in 2010. According to the latest figures published, in December the number of unemployed increased by 1,897 people, while the number of workers registered with Social Security fell by 18,608, a drop of 2.0% compared with the figure for the previous December.
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Various organisations, both national and supranational in scope, have recommended that the new government carry out labour reform to improve the high unemployment figures. In this respect, the government indicated that it would start to take measures early in January. However, the conversations and subsequent agreement between social agents, employers and trade unions have, for the time being, postponed the government's initiative until February.
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The main issues around which conversations revolve and on which the reform might be based are: collective bargaining, internal flexibility, conditions for hiring and firing workers, wage moderation and a last block made up of a combination of training, public employment policies and absenteeism control.
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The discussions on the current collective bargaining procedure focus on how to synchronize wage rises and activity throughout the economic cycle. Agreements lasting over several years and ultra-activity (the automatic extension of an agreement when a new one can't be reached), together with the prevalence of many different areas of negotiation, including at a sector and province level, are slowing up the process of adjusting the labour framework to the situation of the company. One example of how collective bargaining can be out of synch occurred in 2009, when the economy declined by 3.7% and the country was on the brink of deflation but real wages grew by 2.5%. That's why employers and trade unions have declared that they want to help separate company agreements from sector ones at the same time as encouraging the former.
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94% of new contracts in December are temporary.
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Another agreement reached by social agents is the increase in the minimum hours of irregular distribution from 5% to 10%. The aim is to make companies more flexible and to help labour market adjustments be carried out more readily via prices (wages) instead of quantities (dismissals).
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Simplifying the amalgam of contracts established by legislation is also on the government's agenda. The current labour framework is defined by its dual nature, with a large proportion of workers enjoying permanent contract conditions that are very different from those of temporary workers. Of note is the prevalence of temporary contracts in December, accounting for 94% of all new contracts given.
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With regard to wage moderation, employers and trade unions seem to have reached an agreement regarding wage trends over the coming years. This agreement contains a maximum wage increase of 0.5% in 2012 and 0.6% in 2013 and 2014, with a specific clause for this last year. If the rise in GDP for 2013 is between 1% and 2%, the maximum wage increase in 2014 will be 1%; if the rise in GDP in 2013 is greater than 2%, wage increases will be 1.5%. This agreement also modifies the year-end wage revision clause and establishes the following: if inflation is above 2%, wages will only be increased by the difference to this 2%; if inflation in the euro area is less than in Spain, the former will be used as a reference; if the rise in fuel and oil prices is greater than 10%, this component will be removed from the inflation calculation.
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The reform must put a stop to job losses.
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The aim of this agreement is for firms to improve their competitiveness abroad and for workers not to lose so much purchasing power. The clauses serve to separate wages from inflation in the case of sudden increases in oil prices or indirect tax hikes (hence the use of Europe's inflation rate as a reference). Apart from these agreements, and in an attempt to contain wages, the government has also frozen the official minimum wage used to establish payment concepts in many agreements, setting this at 641 euros.
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Lastly, making greater use of the available resources is also being studied for labour reform, in terms of redefining training and public employment policies to ensure these focus on those groups hardest hit by unemployment, namely the long-term unemployed, who account for 42.5% of all unemployed, and also young people, who double the unemployment rate with a rate of 45.8%.
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Other measures being considered are a greater control of absenteeism and moving public holidays to Mondays to reduce costs.
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These five areas are interrelated and form part of a whole. Like the sides of a shield, they must be perfectly balanced to achieve a legal framework that protects the rights of all workers at the same time as helping firms become more competitive.
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The monster of unemployment is rising up and it has more than five million heads. To put a stop to the constant job losses, a labour reform is required that lays the foundations to create employment that are rooted in productivity. At the same time, this reform must also protect workers to ensure that, come the next economic dilemma, we do not return to the same high levels of unemployment.
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Prices
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Inflation falls and the outlook darkens
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Inflation falls by 5 tenths of a percentage point to 2.4%.
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December served up what had been promised. The year-on-year rate for the consumer price index (CPI) fell by 5 tenths of a percentage point compared with November, placing its year-on-year change at 2.4%. This increase masks the change in trend undergone by prices in April after reaching a peak with a 3.8% year-on-year change and their practically unabated drop since then. The extent of this fall will be determined both by the severity of aggregate demand's lethargy and also the performance of energy products.
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In spite of the squeeze in activity in the fourth quarter, indicated by the Bank of Spain, the explanation for December's fall in inflation does not lie so much in the recessionary tone of consumption but rather in the disappearance of last year's base effects. In December 2010, inflation rose by 7 tenths of a percentage point due essentially to rises in the price of tobacco and fuels and oils. On the other hand, this year tobacco has remained stable over the last three months and fuels and oils even decreased slightly in December. These effects have caused the year-on-year rate of change for tobacco and fuels and oils to alternate from 13.6% and 14.0% in November to 4.9% and 8.6% in December.
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International tensions push up oil prices.
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In fact, the performance of fuels and oils is precisely one of the unknown factors for this year. The geopolitical tensions generated regarding the Strait of Hormuz, a marine corridor of just 60 kilometres at its narrowest point through which approximately 40% of the world's crude travels, has helped to momentarily push up oil prices in January. Oil products constitute 54% of final energy consumption and Spain imports 98% of these so, in this case, our country is totally dependent on others. Any distortion in the trade of fuels and oils will have an immediate effect on prices and therefore on the CPI, of which it accounts for 7.7%.
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In fact, this dispute is already having an impact on energy supply policy via European sanctions, which will force a reorientation regarding Iranian crude imports. This country is the largest supplier for Spain, contributing 15% of the total. It is unknown whether this lower supply will push up fuel prices.
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The euro's depreciation makes imports more expensive.
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Another factor increasing the risk of higher oil prices is the appreciation of the dollar. Given that barrels of Brent quality oil are traded in dollars, the more the euro depreciates against the dollar, the more expensive it is to buy. A rise in price in this commodity is then passed on to the economy as a whole, pushing up inflation. This is a common phenomenon throughout all euro area countries.
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If we compare the price of fuels in Spain, not including taxation, with our largest trading partner, namely the euro area, they are above the average, according to the latest report on this area by the Ministry of Industry. However, if we include taxation, petrol and diesel are 14% and 7% below the average for the 17 countries that share the euro. Even so, Spain's taxes add more than 40% to the final price.
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This high level duty can be explained by the difficulty in replacing oil with another kind of input. This phenomenon makes fuel prices inelastic and means that, when they rise, there is less variation in the amount consumed. As a result, autonomous communities have used fuels to impose the so-called «health cent». This duty on the price of petrol and diesel is passed on almost entirely to consumers. That's why a large proportion of the differences between prices in the different autonomous communities were in the region of 3.7 and 4.2 cents per litre, respectively, in November.
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Inflation will fall towards 1.4% but there are risks that might push it up.
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In spite of the aforementioned risk of prices rising, the slump in activity will become a decisive factor in pushing inflation down. The measures adopted to reduce the deficit will have a notable effect on aggregate demand and, according to our forecasts, will reduce growth prospects for 2012, placing the fall in GDP at 0.5% year-on-year. For this reason, our inflation forecast for 2012 is around 1.4%. The extension of the extra low VAT rate and a return to tax deductions for a primary residence will hardly have any effect on the CPI.
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This core scenario assumes an average price of Brent quality oil for the whole of the year at around 104 dollars; i.e. reflecting a context where the problems in the Persian Gulf are contained. These forecasts also assume a dollar-euro exchange rate above 1.30 for the year as a whole. Any deviation from these two assumptions will push up inflation in 2012. Moreover, our forecasts do not include any modifications in indirect taxation that might occur, which would also increase the inflation forecast. In short, the downward slide will continue in 2012, although the euro's devaluation and oil prices might lessen its fall.
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Foreign sector
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Exports boost the correction in the trade balance
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The foreign sector's good performance will soften the economic squeeze in 2012.
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Since 2008, the foreign sector has become the main source of growth for the Spanish economy. This good performance is due to the sharp shrinkage in imports at first and then the good pace of exports and particularly to tourism picking up in 2011. As a consequence, the foreign component's contribution to gross domestic product (GDP) was slightly lower than the annual average of 2 percentage points during these four years. With regard to 2012, we expect the foreign sector to continue contributing positively. However, there are several factors that might affect the intensity of the latter. These are: the evolution of Europe's economy, the euro's exchange rate and oil prices.
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In fact, the data available for the fourth quarter of 2011 show clear signs of weakness in the country's domestic demand. Within this context, the pace of growth of imports fell sharply. In November, the consumption of foreign goods grew by 5.3% year-on-year compared with the average 11.2% rise during the first nine months of last year. This contrasts with the faster pace of growth in exports that, in November, stood at 13.4% year-on-year.
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The fall in the volume of imports reflects the slowing up of domestic demand.
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This disparate trend is accentuated if we analyze the real evolution of trade flows; i.e. net of the price effect. Of note is the fall in real imports in the month of November, 4.9% year-on-year, compared with the 8.7% rise in the volume of exports over the same period.
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The trade deficit reduces by 31.1% year-on-year in November.
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As a result, the trade deficit fell by 31.1% year-on-year in November and the cumulative imbalance for the last twelve months stood at 47.2 billion euros. This improvement is mainly due to the evolution in the non-energy component, with a surplus of 192 million euros. The surplus with the European Union lies behind this good performance.
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Looking to the future, we expect the recession in Europe's economy in 2012 to reduce the rate of growth of Spanish exports. However, this effect will be partly offset by the slight depreciation expected in the euro over the first half of this year, which will boost exports to the rest of the world. At the same time, weak domestic demand will also affect the consumption of foreign goods, which will more than likely lead to a fall in Spain's imports in 2012.
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We expect the trade balance to continue adjusting in 2012.
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In short, Spain's trade balance will maintain its path of adjustment throughout this year thanks mainly to the reduction in the non-energy deficit. All this in a context where oil prices will gradually converge towards levels slightly lower than the present, reducing the pressure of the energy balance on the total deficit.
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The current balance records its first surplus since 1998
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The transfer and services balances permit a current surplus in October.
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If we widen our analysis to the whole of the current balance we can see that, in October 2011, this totalled 456 million euros. This figure, the first surplus recorded since August 1998, represents an improvement in the current balance of 3.1 billion euros compared with the same month last year. However, a breakdown shows that close to two thirds of this adjustment correspond to the good performance by the transfer balance, reflecting a transfer from the European Union to the public administrations.
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Another component that played an important part in this improvement was the services balance, boosted by the good performance of tourism revenue, in October growing by 7.9% year-on-year. However, the slowdown in the growth of tourist visits to Spain over the last two months of the year suggests that revenue will have less room for improvement in the remainder of 2011. In our opinion, the weakness of the European economy in 2012 will ensure this trend continues in 2012.
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The trade deficit will fall below 3% of GDP in 2012.
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In addition to less dynamism in the services balance is the increase in the income balance deficit, resulting from the rising cost of financing Spanish debt. Nevertheless, we expect that the improvement in the balance of goods will help to reduce the current deficit to below 3% of Spanish GDP in 2012, compared with the 4.0% we estimate for 2011.
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Public sector
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Fiscal consolidation: a long road to travel
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Spain's deficit exceeds 8% of GDP in 2011 according to a government announcement.
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«The beginning of the beginning». The government's Vice-President used these words to introduce the new package of fiscal measures to redirect Spain's public deficit. The message is clear: the consolidation process promises to be laborious. Particularly after announcing that 2011's public deficit would be around 8.0% of the country's gross domestic product (GDP). A figure that is varies significantly from the 6.0% target contained in the stability programme.
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In fact, the figures for public administration net borrowing in the third quarter of 2011 have confirmed suspicions that last year's fiscal adjustments were not enough. As shown in the graph below, the cumulative deficit between October 2010 and September 2011 represented 8.8% of GDP for the same period. This means a reduction of just 5 tenths of a percentage point compared with the 2010 balance.
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In fact, during the first three quarters of 2011, the general government only adjusted its deficit by 4.4 billion euros, far from the 34 billion required to meet the target set for the whole of the year. An analysis of budget flows during this period shows a fall in primary spending of 11 billion euros; i.e. expenditure without taking into account interest payments. But the deteriorating macroeconomic situation wiped out part of this improvement as interest payments rose and revenue fell.
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Higher financing costs and falling revenue hinder the correction of expenditure in 2011.
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With regard to the fourth quarter, we expect that the economic squeeze won't favour fiscal adjustment either. Available cash accounting figures confirm this. Tax revenue for the central government and autonomous communities in November 2011 was down by 11.3% compared with the same period a year ago. In the case of the central government, it achieved its deficit target for 2011 as a whole, namely 4.8% of GDP, one month before the end of the year, so that it probably exceeded this figure by year-end.
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But the central government wasn't the only one not to meet its targets. According to the government, the Social Security accounts had a deficit in 2011 compared with the target surplus of 0.4% of GDP. Similarly, the autonomous communities reached an imbalance of close to 2.5% of Spanish GDP, far from the figure of 1.3% set at the beginning of year. As a consequence, we estimate that public sector net borrowing stood at 8.2% of GDP in 2011, more than 2 percentage points higher than the target.
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Undoubtedly, this deviation makes it more difficult to consolidate Spain's public finances in 2012. An adjustment of approximately 40 billion euros is required in order to meet the target set for this year of 4.4% of GDP. Given this situation, the new government announced another adjustment plan that includes measures both to cut spending and increase public revenue. Among the former, of note are the freezing of civil service wages and of the filling of vacancies for most staff, a 20% reduction in grants to political parties and unions, as well as cuts in research and development, in loans to motorway licensees and the budgets for RENFE (railways) and RTVE (broadcasting). Public spending is expected to fall by 8.9 billion euros with these measures.
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The deficit needs to be adjusted by around 40 billion euros in 2012.
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We must also add to this figure the 6.3 billion euro rise in revenue the government hopes to achieve. This will be done via tax hikes in 2012 and 2013 that affect housing rates (IBI in Spanish), taxes on savings and also income tax (IRPF in Spanish). The latter will see an increase of between 0.75 percentage points for the lowest incomes to 7 percentage points for the highest.
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In addition to these measures, throughout January the new executive also announced further advances regarding the drafting of the Budget Stability Act. As well as introducing a new fiscal rule that limits Spain's deficit, this also aims to establish measures to increase control of the public accounts of autonomous communities. It was also agreed to close 400 public corporations at the end of the year. In exchange, the government is providing a new line of credit through the Official Credit Institute (ICO in Spanish) to resolve any liquidity problems encountered by the communities.
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According to the government, its new measures will reduce the deficit by 15 billion.
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All these measures have been welcomed by the financing markets. This, together with the European Central Bank's injection of liquidity into the banking sector, meant that new debt issuances could be placed at lower interest rates than those recorded in the preceding months. However, an additional adjustment in the order of 25 billion euros is still required to achieve the deficit target set for 2012. This means the introduction of further measures that won't help to boost Spain's economy in a year of recession.
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Fiscal rules: tied to the mast?
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Homer told how, so as not to succumb to the Sirens' song, Ulysses decided to tie himself to the mast of his ship, ordering his crew to plug their ears with wax. Thanks to this decision, the Greek hero managed to avoid wrecking the ship against the reefs and was able to continue his long journey home. In a similar way, the Spanish government approved two new rules in 2011 that restrict fiscal policymaking by introducing limits to public spending and deficit. In exchange, they hope to be able to achieve fiscal consolidation and ensure the long-term sustainability of their public finances. Will these new fiscal rules help them to achieve this aim?
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In addition to exercising a redistributive function and ensuring the provision of public goods, fiscal policy might also be used to cushion the fluctuations inherent in economic cycles. For example, an increase in public spending can prevent a larger fall in economic activity during recessionary periods. This can be offset in boom times with reductions in spending that, in turn, slow up the pace of growth. However, there are some factors that push public spending too high in structural terms. This is the case, for example, of greater spending for electoral purposes or due to excessive optimism regarding how the economy will perform in the future. The adoption of fiscal rules is an attempt to correct these deviations to ensure the long-term sustainability of national accounts and give the fiscal policy decisions taken by public administrations more coherence over time and credibility.
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The economic literature points to Sweden, already in the 1930s, as the pioneer in designing a fiscal framework centred on achieving long-term sustainability for its national accounts without affecting the stabilizing nature of fiscal policy. Since then, numerous countries have adopted new rules. According to a report by the International Monetary Fund (IMF), in 2009 there were 57 countries with at least an explicit limit for their public deficit or debt and/or some budgetary items.(1) Among these we find member states of the European Union that, on signing the Stability and Growth Pact (SGP) in 1992, introduced a public deficit limit of 3% of the gross domestic product (GDP). But the credibility and effectiveness of this rule have been seriously damaged as it was not capable of boosting fiscal consolidation during the last expansionary cycle or of preventing the fast deterioration in national accounts after the crisis erupted. The laxness of the deficit rule in expansionary times and the practical absence of mechanisms to encourage the correction of imbalances when limits are exceeded explain its little success. Given this situation, euro area countries have started to design a new fiscal pact that can redirect public debt to more sustainable levels.
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According to the same IMF report, the empirical evidence available seems to confirm, in general, that fiscal rules are effective in achieving budgetary discipline and increase the chances of success for fiscal consolidation processes. However, the European case highlights the importance of the details in these rules in order for them to work well. A badly defined rule can divest fiscal policy of the necessary flexibility to dampen economic cycles, intensifying recessions (becoming procyclical) and reducing the public administration's capacity to react to the crisis. But as well as being flexible, an effective fiscal rule must also be precise, easy to implement and must be directly related to the desired final outcome, generally the sustainability of national accounts. It is also essential to define a corrective procedure in the case of non-compliance.
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In the case of Spain, the two reforms approved in 2011 regulate public spending and deficit. In the case of public spending, this cannot be higher than the medium-term rise in nominal GDP unless it is accompanied by discretional rises in public revenue. Excluded from this expenditure are interest payments on debt and non-discretional spending on unemployment benefit. With regard to the second rule, in September 2011 a reform of the Constitution was passed that limits the structural deficit of the public sector - i.e. the total deficit once corrected for the effect of the economic cycle. The structural deficit will not be able to exceed the margins defined by the European Union, in the case these are specified. Similarly, the limit to the structural deficit contained in the Constitution will be established in an organic law pending approval and that will probably be around 0.4% of GDP as from 2020. Of this figure, 0.26 points of GDP will correspond to the structural deficit of the central government and the remaining 0.14 percentage points will correspond to the autonomous communities.(2) These restrictions can only be exceeded in the case of economic recession or in exceptional situations.
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(1) See IMF (2009), Fiscal rules - Anchoring expectations for sustainable public finances.
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A priori, both rules comply with most of the conditions indicated previously as propitious for them to function correctly. Both the use of the structural deficit and medium-term growth in GDP to calculate public spending allow the series' cyclical component to be adjusted, making the rules more flexible. In boom periods, the effort to comply with these rules is greater than if both variables were not cycle-adjusted. Similarly, the deterioration in budget flows associated with economic contractions, due for example to greater spending on unemployment benefit, does not affect the deficit's structural component and reduces the need to adjust the budget. Moreover, elevating the deficit limit to a constitutional level might improve the rule's effectiveness as it makes it difficult to modify. However, the correct design of both measures will have to be evaluated after the European fiscal pact and the state budget stability law have been concluded. The details of their wording will determine their efficacy, as that is where the corrective mechanisms will be established that will be followed in the case of non-compliance of the rules. On the other hand, lack of specificity when defining the exceptions that allow the structural deficit limit to be exceeded and delaying its commencement until 2020 hint at some unknown factors regarding its good functioning.
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(2) This means that the accounts of local corporations and of the Social Security Administration must be in equilibrium. However, in the case of the latter, the implementing organic law might detail a budget stability target according to the medium and long-term demographic and economic evolution forecasts.
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An interesting exercise that attempts to analyze the effectiveness of the new fiscal rules consists of estimating their effect if they had been in force during the last expansionary cycle. In the graph on the left we can see the evolution of Spain's fiscal balance between 1998 and 2007. As can be seen, this did not exceed the limit of 3% of GDP contained in the SGP and large surpluses were recorded during the last three years. In contrast, the new rule defined for the structural deficit would have only been complied with between 2005 and 2007, which would have forced the public administrations to make a greater effort so as not to exceed the structural deficit of 0.4% of GDP. Similarly, as shown by the graph on the right, the spending limit introduced in the budget framework would have been exceeded throughout these years. According to the Bank of Spain, during that period the average growth in public spending was 7.0% year-on-year compared with the 4.6% that would have been permitted by this fiscal rule.(3)
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The use of both rules would have brought about less public spending between 1998 and 2007 and would have forced public administrations to take advantage of expansionary periods to sort out their accounts. The table shows the annual budget balance required to comply with the new fiscal rules during the period analyzed. As can be seen, the structural deficit limit would have been the more restrictive rule during the first few years. In 2001, this rule would have demanded a structural surplus of 0.7% of GDP compared with the deficit of 0.5% observed. From that time on, the spending rule would have been the one that would have forced greater budget containment. The effect that the implementation of these rules would have had on public debt cannot be underestimated. This would have been close to 25% of GDP at the start of the economic crisis. A figure, by 9.1 percentage points, lower than the minimum of 2007, which would have given public administrations much more leeway to tackle the sovereign debt crisis.
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(3) See Banco de España (2011), «La reforma del marco fiscal en España: los límites constitucionales y la nueva regla de crecimiento del gasto público». Boletín Económico. September 2011.
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In short, both from the theoretical point of view and via a hypothetical exercise, it seems that the design of Spain's new fiscal rules is on the right course in its aim to ensure the long-term sustainability of national accounts without losing the stabilizing nature of fiscal policy. To this end, it is of the utmost importance that both the European fiscal pact and Spain's budget stability law to be approved in the next few months end up defining the aspects that are important for them to function correctly. This would strengthen the ties to the mast of fiscal coherence and would allow the journey to continue towards the consolidation of Spain's national accounts.
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This box was prepared by Joan Daniel Pina
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European Unit, Research Department, "la Caixa"
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Savings and financing
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Deleveraging continues in the private sector
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The non-financial private sector reduces its debt by 50 billion euros.
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In Spain, resident private sector financing fell in 2011. This decline was largely due to the weakness of economic activity and the far-reaching restructuring process carried out by Spain's banking system. All this in a context of huge tension in Europe's financing markets. 2012 started with these turbulences easing thanks basically to the injection of liquidity by the European Central Bank (ECB) last December. However, forecasts for 2012 do not augur any recovery in credit.
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In fact, during the first three quarters of 2011, the non-financial private sector accelerated its deleveraging that had started in mid-2010, reducing its debt by more than 50 billion euros. Nevertheless, the ratio of private debt to gross domestic product (GDP) was still at a very high level, namely 217.3%. As a consequence, this imbalance is expected to continue to adjust over the coming years. This is quite the opposite to what will happen with public sector debt which, due to its net borrowing, will continue to gradually rise.
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The data for November 2011 showed a trend in line with these predictions. Private sector financing was 2.1% below its level recorded a year ago. This reduction affected both households and non-financial firms in a similar way. On the other hand, if we look only at the change in the outstanding credit balance for other resident sectors, this shrank by 2.9% year-on-year in November.
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Credit to the non-financial private sector falls by 2.9% year-on-year in December.
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Albeit to a lesser extent, the weakness of credit over the last few months of 2011 could also be seen in the euro area as a whole, growing only slightly by 1.0% in November. Given this situation, the ECB decided to provide Europe's banking sector with enough liquidity to encourage credit to flow again to the different economic agents. In the case of Spain, and as can be seen in the graph below, this led to the banking system resorting more to the Eurosystem, up to nearly 119 billion euros and coming close to the peak reached in July 2010.
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Although this intervention by Europe's top monetary authority helped to ease tension in the financing markets, there are doubts as to whether it will boost Spain's credit balance in 2012. The reasons for this lie mainly in the weaker dynamism of the Spanish economy and the new reform of the banking sector which is very likely to be approved in February. With regard to the first factor, the squeeze in economic activity, and the consequent deterioration in Spain's job market, will reduce the solvent demand for credit this year. This will also push up the non-performing loan rate, which in November already accounted for 7.51% of the total credit portfolios in Spain, nine basis points above the previous month's ratio.
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The economic squeeze and the new reform of the financial sector will weaken credit's performance in 2012.
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As in previous months, real estate credit is the main culprit for this rise in non-performing loans. Given that this component accounts for 22.8% of the total credit in September, it is no surprise that real estate risk is considered to be the main threat to the solvency of Spain's banking system. Given this situation, the new government is preparing a new plan that aims to remove any doubt regarding the soundness of banks' balance sheets in Spain. The latest information rules out the creation of a «bad bank» to group together the financial sector's toxic real estate assets. In exchange, it seems that the government will toughen up the provisions that have to be made by financial institutions to cover any losses from their real estate portfolios, especially those related to foreclosed land. These provisions will reduce any profit made in 2011 and 2012.
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The government will force an increase in provisions to cover losses from real estate portfolios.
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In the long term, this measure might improve the solvency of Spain's banking sector without requiring any significant intervention by the public administration. However, excessively strict conditions might also affect their lending capacity. Moreover, those institutions with a larger proportion of real estate assets on their balance sheets might find it difficult to extend their provisions. This could result in further restructuring of Spain's banking sector.
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Bank deposits speed up their rate of descent
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The household savings rate falls again, to 12.0%.
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In the third quarter of 2011, the household savings rate maintained its downward slide started a year and a half ago, reaching 12.0% of disposable income in cumulative terms for four quarters. This figure is moving away from the peak of 2009, when households' precautionary savings rose by more than five percentage points, reaching 18.5%. In fact, this increase intensified the reduction in private consumption that year and, by extension, helped to shrink the economy further. Given the new deterioration in economic activity predicted for 2012, the performance of the savings rate has become one of the key questions to be answered.
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According to our forecasts, the savings rate will continue to fall over the coming quarters, albeit at a significantly slower rate. This will ease the fall in private consumption. The data for bank liabilities are in line with this forecast. Bank liabilities held by households and firms recorded a year-on-year decrease of 3.0% in November, driven by the fall in term deposits.
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The deposits of firms and households fall by 3% year-on-year in November.
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An analysis of the trend in deposits of households and firms shows a fast deterioration as from June 2011. There are three reasons for this decline: firstly, the stagnation and subsequent shrinkage of the Spanish economy as from the third quarter last year. Secondly, the introduction of a decree law that limited the return on deposits offered by financial institutions. As a consequence, these have used other financial instruments that are exempt from this limitation, such as commercial paper, to attract retail funds. And lastly, of note is the sharp rise in interest rates for sovereign debt which attracted a significant number of small investors during the last few months of 2011.
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The hike in duty levied on income from savings will not help deposits to recover.
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Looking to the future, the ECB's 3-year tenders are expected to meet the liquidity needs of Europe's banks and, in particular, of Spain's. This will reduce the need for finance via retail deposits and will avoid another period of sharp interest rate rises. Moreover, the hike in the duty levied on income from savings, of between 2 and 7 percentage points, which is introduced in the new plan to adjust Spain's public deficit, won't help deposits to recover in the coming quarters either.
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