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Economic activity
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Back in recession
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In the first quarter, GDP shrinks by 0.4% quarter-on-quarter.
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The Bank of Spain has just confirmed the second recession of the Spanish economy in a little over two years. According to the banking authority's announcement, gross domestic product (GDP) fell in the first quarter of 2012 by 0.4% quarter-on-quarter, placing its year-on-year rate of change in negative terrain with a drop of 0.5%. The good performance by the foreign sector was not enough to offset weak domestic demand and the lack of investment. This recessionary tone in activity could intensify over the coming months as the presentation of the central government's budget, which largely determines the pace of activity for the rest of the year, in addition to being the most austere since the start of the crisis does not seem to have dispelled, for the time being, the uncertainty surrounding the country's fiscal consolidation or to have boosted confidence.
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Household final consumption accounts for almost 60% of our economy so that investigating the reasons why this contracted year-on-year by 1.1% in the fourth quarter of 2011 will provide us with valuable lessons for the future. The savings rate of households and non-profit institutions stood at 11.6% of their disposable income in 2011, 2.3 points less than the previous year. Given that there has not been a rise in savings as a precaution against the financial disruption, this drop in household consumption in the fourth quarter was due to the fall in households' gross disposable income. In fact, this fell by 1.5% year-on-year, mainly because of the 2.1% drop in workers' wages.
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The household savings rate falls by 11.6% in 2011.
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If the fall in consumption in the fourth quarter had been due to an increase in the savings rate, consumption would have been able to recover relatively quickly, as soon as confidence improved. However, as it is due to a loss of disposable income, the recovery in consumption will probably be slower. According to the Bank of Spain's initial estimates, household consumption was still considerably weak in the first quarter of 2012 and posted a quarter-on-quarter decline of 0.4%.
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The poor evolution of the labour market, the drop in gross disposable income and the loss of purchasing power (wages are increasing less than inflation and the rates for personal income tax have risen) are in addition to the uncertain climate and are wearing away consumer confidence. In the month of March, in particular, the consumer confidence index fell to the levels of spring 2009 and, over the last three months, has accumulated a drop of more than 13 points. Such a rapid fall in consumer confidence had only occurred prior to 2008. Other demand indicators such as vehicle registrations were a little more promising, posting a decrease of 4.5% in March compared with the same month last year, far from the year-on-year fall of 21% experienced by industrial vehicle registrations in the same period.
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Supply and demand indicators are not encouraging.
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On the supply side, indicators for the first three months of the year aren't at all encouraging either. In February, the industrial production index, adjusted for calendar effects, posted a drop of 5.1% with regard to the same month last year, eight tenths of a percentage point less than in January. Retail sales also declined in February, down 6.2% year-on-year. Confidence indicators for industry and construction, for which we have March's figures, remain negative, as do the figures for electricity and passenger air traffic.
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On the other hand, the contribution by the foreign sector is still vital to attenuate the decrease in gross domestic product. However, the slowdown in activity which is also being experienced by our trading partners, mainly European, is slowing up the growth of exports and therefore their contribution to GDP.
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The data for the month of February show that, in real terms, the volume of exports fell for the first time since 2009, by 0.2%. This figure confirms the slowdown in foreign trade due to weak aggregate demand. Imports are following a similar trend and their volume in real terms has also fallen. Whereas, in the last quarter of 2011, the euro area shrank by 0.3% quarter-on-quarter, the consensus of economic studies predicts growth of -0.4% year-on-year for 2012. A situation that, should it come about, will limit the foreign sector's contribution to the growth of activity in Spain.
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The foreign sector is starting to show signs of weakness.
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Within this context of worsening prospects, the government presented its Budget plan, which defines the fiscal consolidation process to be followed by the central government. In spite of this being a highly austere budget (for an in-depth analysis, see the public sector section), the week following the budget announcement Spain's risk premium was still above 400 points and the Ibex lost 2.9% of its value. Doubts remain regarding the country's capacity to adjust its public accounts and are in addition to uncertainty regarding the bank restructuring process. That's why the government announced further cuts of 10 billion euros to education and healthcare.
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The new Budget does not manage to restore confidence.
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The announcement of a credible fiscal consolidation plan in the medium term is absolutely vital to regain confidence. An improvement would not only help to lower the interest rates paid for government financing but would also help investment flows to return and to get the country back on the road to growth. Spain will soon have to present its stability programme to the European Union, detailing the series of economic measures for the next three years. A clear definition of how the deficit will be reduced to 3% by 2013 would be a highly significant step forward in regaining credibility.
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Labour market
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Unemployment in the public accounts
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Headings related to the labour market account for 11% of the Budget.
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The almost constant rise in the number of unemployed since the start of 2007 is not only a reflection of the deterioration in economic activity but also entails a number of additional costs for Spain. The headings allocated to unemployment benefit and to stimulating employment account for 9% and 2%, respectively, of the consolidated budget expenditure for 2012. Another cost of unemployment also results from the fall in Social Security contributions due to the decrease in the number of people registered as employed, which reduces revenue and, together with growing pension expenditure, puts the Social Security accounts under great pressure.
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In March, the number of registered unemployed increased by 38,769 and reached a total of 4,750,867 people unemployed. Unemployment has risen steadily since July last year but, if we take seasonal factors into account, the last time unemployment fell was in December 2010. In the last twelve months, the State Employment Service (SEPE) recorded a 9.6% rise in the number of unemployed.
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36% of those unemployed are not receiving any kind of benefit.
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According to the latest data available, of the 4,750,867 registered unemployed in February, only 3,023,142 were receiving some kind of benefit; i.e. the coverage rate for February stood at 64%. Since March 2010, just over two years after the crisis began, social assistance benefits and the minimum insertion income (non-contributory benefits) have exceeded the number of contributory benefits. This is due to the fact that contributory benefits, to which only those who have previously paid Social Security contributions are entitled, are given for a maximum period of two years. The amount paid in contributory benefit, whose average in February rose to 866 euros, is generally higher than non-contributory.
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Unemployment is still rising but the coverage rate has fallen.
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Another way of looking at these figures is to note the 1,689,000 registered unemployed in February that were not receiving any kind of benefit. In December, the labour force survey (LFS) calculated that 5,274,000 people were unemployed so, if we use this estimate, considered as the best indicator of the state of the labour market, the number of unemployed people not receiving benefit totals 2,346,500. The coverage rate in December falls from 66% to 56%, depending on whether the unemployment figures are calculated by the SEPE or using the LFS estimate.
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With regard to the unemployed who do receive benefit, in 2011 their total number fell by 2.9%. This fall has been particularly sharp in social assistance benefits, down 8.8%, in clear contrast with the 44.5% rise in the number of people receiving the minimum insertion income, designed to complement the income of those with minimal economic resources.
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In general, entitlement to unemployment benefit is temporary in nature so that, as the crisis continues, the number of people receiving benefit will tend to fall. That's why the coverage rate has fallen by 11 points since the 75% recorded in 2010. The government has therefore estimated, in its 2012 Budget, that the number of people receiving contributory benefit will remain the same as in December 2011, although this year 631,100 jobs will be lost, according to the government's own forecasts. For the moment, in the first two months of the year the number of people receiving contributory benefit has risen by 1.4% compared with the same period in 2011.
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5.5% decrease in the Budget aimed at unemployment.
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These estimates, together with a slight fall in the number of people receiving non-contributory benefit, have led to a 5.5% decrease in the heading allocated to unemployment compared with the 2011 Budget, totalling 28.8 billion euros. The Budget also contains a 21.3% reduction in headings allocated to stimulating employment.
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On the other hand, the deterioration in the job market is not only reflected in rising unemployment but also in the fall in Social Security contributions. Although the average number of people registered as employed with Social Security increased by 5,419 people in March, totalling 16,902,530 workers, when seasonally adjusted this figure fell by 56,021 people. This drop in registrations results in less revenue from Social Security contributions. Workers' contributions are used to finance pensions, so that the lower level of revenue is putting more pressure on the Social Security accounts (for a more detailed analysis, see the section on the public sector).
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Spain is the European country that dedicates most resources to employment policies.
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An analysis at a European level provides a perspective of the effort being made by Spain with regard to the labour market. The latest data available from Eurostat, corresponding to 2010, reveal that Spain is the country with the most resources dedicated to employment policies, namely 3.9% of GDP, one and a half points more than the second country, France. Given its high number of unemployed, Spain uses 80% of these resources for unemployment benefits, a similar percentage to Italy but more than 20 points above the percentage used by France or Germany.
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Per beneficiary, Spain invests a quarter of France's investment in stimulating employment.
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Regarding expenditure per beneficiary, in 2010 Spain dedicated 904 euros in unemployment benefit per beneficiary and month, close to the average for the countries shown in the above graph but far from the 1,258 euros dedicated by Italy. In terms of expenditure per beneficiary on policies to stimulate employment, Spain invested 200 euros per beneficiary and month, less than half of the countries in the sample and very far from the 820 euros invested by France.
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In short, the cost to the public treasury is merely one of the many different impacts unemployment has on society. Although the expenditure on employment policies at an aggregate level may seem high, an analysis at a European level of expenditure on benefits and on stimulating employment per beneficiary helps to fine-tune these findings.
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Does labour regulation allow company growth?
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Labour market regulation is in the firing line. Most European countries have changed or are about to change some key aspects of their legislation. The fear of an economic standstill has placed issues firmly on the table that had, until very recently, been taboo, such as dismissal costs and collective bargaining. The reforms being discussed appear to be broad and far-reaching. However, almost nothing has been said about the different labour legislation conditions for companies depending on their size. According to several studies, this aspect could be vastly limiting the growth of the production fabric of the main countries in Europe.
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As has been mentioned in the box «Companies and productivity: a matter of size» generally speaking company size is crucial in being able to improve productivity and gain export share. Labour market regulation is also related to all this. There is a clear correlation between the degree of flexibility of the labour market and company size. As can be seen in the graph below, those countries with a more flexible labour market have a higher percentage of people employed in large firms.
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This relationship, however, cannot be interpreted causally. It might be the case, for example, that countries with a more rigid labour market specialize in industries where the optimum company size is smaller. A study published by the Organization for Economic Cooperation and Development (OECD) uses more sophisticated statistical techniques that precisely take this kind of consideration into account.(1) Its conclusion is categorical: excessively restrictive labour market legislation makes it difficult for many companies to grow. This means that companies that are very productive and that can potentially employ a large number of people limit their size; and vice versa, firms that should disappear or be very small take advantage of this and, although they are not very productive, are considerably large.
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(1) See «Product and labour markets interactions in OECD countries» (2001). G. Nicoletti, A. Bassanini, E. Ernst, S. Jean, P. Santiago and P. Swaim. WP 312.
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This connection could be particularly worrying in Spain. As can be seen in the graph above, Spain appears as one of the countries with the most rigid labour market regulations and, at the same time, is one of the countries with the smallest share of large firms. The aforementioned study tells us little about which aspects of labour legislation might be key. However, analyses have been carried out of specific cases and these can provide us with clues as to the potentially decisive aspects.
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In France, for example, the percentage of large firms is significantly smaller than in the United States or the United Kingdom. Some studies have related this to labour costs being significantly higher for firms with more than fifty workers. These firms, for example, if they want to dismiss 10 or more workers, have to offer them a social plan that must be approved by the Ministry of Labour; or they must set up a health and safety committee of their workers, whose members must be appropriately trained by the company. A study by L. Garicano et al. concludes that a large number of companies decide to remain just below the threshold of 50 workers in order to avoid this regulation and this therefore has huge consequences for the growth capacity of France's productive fabric.(2) In fact, they estimate that the cost generated by this legislation is equivalent to a wage rise of between 5% and 10%.
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The proportion of small firms in Italy is also very large and, in part, this is also due to discriminatory treatment in labour regulation depending on company size. For example, in a dismissal declared wrongful by a court, companies with more than 15 workers must readmit the worker or pay compensation equivalent to 15 months' salary. Firms with fewer than 15 workers do not have to readmit the worker and the compensation that must be paid ranges from 2.5 to 6 months' salary. Redundancy costs also increase considerably as from 15 employees. These are just two examples of the higher labour costs for Italian firms with more than 15 workers. According to a study by Borgarello et al., the impact on the distribution of company size is significant.(3)
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Portugal is another country where labour market regulation varies considerably depending on the size of the company. In fact, some studies state that this aspect is one of the key factors underlying the country's low productivity in the last decade.(4) Among the different distortions, of note are, on the one hand, the subsidies offered to firms with fewer than 50 workers for hiring young people and for investment and, on the other, the reduced red tape for companies with fewer than 20 workers in dismissals on objective grounds.
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In Spain, the relationship between company size and labour market regulation has yet to be studied in depth but the aforementioned examples for France, Italy and Portugal are quite similar to Spanish legislation. For example, dismissal costs are not the same for all firms. For those with fewer than 25 workers, and in the case of objective dismissal, out of the compensation package of 20 days' pay per year worked, 8 are provided by the Wage Guarantee Fund. The entrepreneur support contract offers significant fiscal benefits to companies with fewer than 50 workers and union representation costs increase as a firm gets larger.
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(2) See «Firm Size Distortions and the Productivity Distribution: Evidence from France» (2012). L. Garicano, C. Lelarge and J. V. Reenen.
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(3) See «Identifying the effects of firing restrictions through size-contingent differences in regulation», F. Schivardi and R. Torrini, Labour Economics, 2008. Also «Employment Protection Legislation and the Size of Firms», A. Borgarello, P. Garibaldi and L. Pacelli, IZA Discussion Papers, 2003.
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(4) See «The incredible shrinking Portuguese firm», S. Braguinsky, L. G. Branstetter and A. Regateiro, NBER WP 17265, 2011.
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The growth prospects of the Spanish economy are not at all encouraging. In 2012, activity is more than likely to fall sharply again and, in the medium term, any recovery will be hindered by a domestic demand that is still completing its deleveraging process. The great challenge facing the Spanish economy is therefore to improve its productivity and set its sights on export markets. Many firms are already doing this and are world leaders in their sector. The obstacles for those companies that can and want to follow this path must be minimal. Spain must be sure that labour market regulation does not penalize them but actually supports them.
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This box was prepared by Oriol Aspachs Bracons
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European Unit, Research Department, "la Caixa"
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Prices
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The weight of regulation and taxes
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The CPI falls by one tenth of a percentage point and stands at 1.9%.
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In the last month, the government has taken several decisions that will affect price trends in the coming year. The rise in the regulated tariff for electricity, gas and tobacco products, together with the high price of oil, will push up inflation as from April.
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After two months of stability, in March the year-on-year rate of change in the consumer price index (CPI) fell by one tenth of a percentage point compared with the previous month, down to 1.9%. Inflation has stabilized over the last few months at close to 2.0%, in contrast with the sharp drop seen towards the end of 2011.
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The relative weight of food and non-alcoholic beverages lies behind this drop.
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The main reason for this fall was the group of food and non-alcoholic beverages, down 0.3 percentage points on February and standing at 2.3% in March. Other goods and services, boosted by the price stability of the insurance, also recorded 0.3 percentage points less than in the previous month. Car insurance provides the best example of the base effect that lies behind this fall as, whereas the price of car insurance rose by 2.0% in the first three months of last year, this year prices have remained constant. The drop in vehicle registrations at an ever faster rate since 2012 began might be helping to contain prices. Medical and house insurance also rose less than in the first quarter of last year. The base effect could also be seen in the heading for housing, down 2 tenths of a percentage point compared with February due to the lower increase in heating fuel.
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Transportation and housing exercise the greatest inflationary pressure.
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Food and non-alcoholic beverages, other goods and services, housing, and hotels, cafeterias and restaurants, which also recorded a slight fall, make up little more than half the whole shopping basket and, together, exercise a downward pressure of just over one tenth of a percentage point. On the other hand, in March leisure and culture posted moderate inflation of 0.7%, but this was 0.3 percentage points higher than the rate of the previous month and, together with the rise in clothing and footwear, explains why the final fall in inflation was one tenth of a percentage point. For its part, core inflation, as it excludes fresh foods and energy, remained constant at 1.2%.
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With a view to the future, the items that will continue to pressurize inflation the most will be transportation and housing, as their current year-on-year change in price is 5.2% and 3.1% respectively and both include energy products in their calculation.
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Oil has risen by 15% for the year, leading to a year-on-year increase in the price of fuels and oils in the order of 9.0% for March. Fuel forms part of the heading of transportation, which is the second most important group with 15% of the shopping basket. Another factor which will contribute, albeit to a lesser extent, to pushing up transportation prices will be the hike in urban transport tariffs in several autonomous communities and the hike in aviation duties.
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The price hikes in electricity and gas are in addition to high oil prices.
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For its part, the heading of housing includes not only rental but also the costs resulting from maintenance. Consequently, costs for electricity, gas and other fuels make up a large part of housing-related consumption. In this respect, the government's decision to increase the last resort tariff (TUR in Spanish) by 7% for domestic consumption is in addition to the decision, also by the government, to raise the regulated gas rate by 5%. The aim of these measures is to comply with the Supreme Court's order to limit the electricity tariff deficit in 2012 to 1.5 billion euros and other measures were also taken regarding the payments for distribution, capacity and transport received by the firms involved. Similarly, the hike in gas prices, which is also accompanied by a reorganization of the industry, aims to halt the growing deficit in the gas sector.
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Tobacco prices are on the up due to the hike in special taxes.
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The increase in the TUR for households was complemented by a rise in the regulated part for other groups, so that electricity has gone up by 4.1% for small and medium-sized firms, 2.8% for industry on average and 0.9% for large firms. The latest data available, from the last six months of 2011, reveal that the cost of electricity per kilowatt-hour for Spanish consumers is the highest in Europe. In fact, at the end of 2011, the price of electricity in Spain was 21% higher than in Germany and 66% higher than in France.
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Another of the measures taken by the government that will affect inflation in the coming months is the hike in the special taxes on tobacco. In addition to value added tax (VAT), the government also charges duty on alcohol and alcoholic beverages, beer, electricity, hydrocarbons, tobacco and other intermediate products via an additional indirect tax. These goods share the characteristic of being inelastic; i.e. demand falls to a lesser extent when their price increases. The higher tax on tobacco products aims to produce additional revenue totalling 150 million euros, according to Spain's Budget. In 2011, 18.98 billion euros were collected from special taxes with hydrocarbons accounting for half this figure, 40% tobacco and 7% electricity. Last year, special taxes accounted for 40% of the total revenue generated by VAT.
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In short, the government's decisions affect price levels as well as revenue. Over the coming months, the rise in energy products will produce inflationary pressures on some groups of items in the shopping basket, although weak demand will prevent this rise from causing any widespread increase in the prices of all the CPI items.
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Foreign sector
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The growth in exports is showing signs of wearing thin
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According to the International Monetary Fund, world trade will slow up its rate of growth in 2012.
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Exports of goods and services had demonstrated significant dynamism over the last two years. As a consequence, forecasts suggested that the foreign sector would offset weak domestic demand in 2012, subsequently becoming the main engine of the economic recovery. However, February's figures confirmed the slowdown in goods exports revealed a month earlier. This trend is in line with the lower growth in world trade forecast by the International Monetary Fund (IMF) for this year. In particular, it expects exports by advanced countries to rise by just 2.3% year-on-year, 3 percentage points lower than last year's growth. Given this scenario, it seems advisable to slightly revise the forecasts for the foreign sector in 2012.
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The trend in real exports, i.e. adjusted for the price effect, posted a 0.2% fall year-on-year in February. This is the first time they have shrunk since October 2009. As can be seen in the graph below, this drop in real exports maintained the downward trend shown since January 2011. It is highly likely that weak external demand is the reason for this slump in growth.
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In fact, the trend in nominal goods exports reflects the weakness of demand in the euro area, the destination for more than half the products exported by Spain in 2011. In the first two months of this year, exports to single currency countries were down 1.3% year-on-year, compared with the 9.2% year-on-year growth recorded for last year as a whole. During these first two months of 2012, of note were the falls in exports to Italy and Portugal, down 8.0% and 9.2% year-on-year respectively.
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Exports to the euro area fall by 1.3% year-on-year during the first two months of 2012.
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However, trade with members of the common market was not the only one to record a significant slowdown. During the first two months of the year, year-on-year growth in exports was 13.1% in Asia, 5.2% in Latin America and 1.8% in North America. Respectively, these figures are 8, 14 and 19 percentage points below the increases recorded in 2011.
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Our forecast for the foreign sector's contribution to economic growth is revised downwards.
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This trend, and the euro area's poor economic prospects, have led us to reduce slightly our growth forecast for exports in 2012. This revision will undoubtedly reduce exports' contribution to the growth in gross domestic product (GDP) although the effect will be partly offset by a greater fall in imports. This can be put down to weakening demand, both domestic and external, and therefore the fall in imports to meet this demand. In short, the ultimate contribution of the foreign sector will shrink slightly in 2012.
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With regard to the value of imports in February, this picked up by 6.6% year-on-year, boosted by the energy component, which grew by 31.2% in the same period. This figure is much higher than those posted over the last few months due to the large increase in the volume of energy imports after several months almost at a standstill. A greater demand for energy goods, caused by the low temperatures recorded in February, could lie behind part of this rise. As a consequence, the trade deficit increased by 15.7% compared with February 2011 in spite of the improvement in the non-energy balance, reaching a new surplus of 547 million euros in February. Looking to the future, however, we expect the trade deficit to start correcting again.
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The rise in the risk premium damages the income balance deficit for 2012.
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If we broaden our analysis to the balance of payments as a whole, we can see a further correction in the current deficit in January of 7.2% year-on-year. However, the slowdown in the process of adjusting the external deficit reveals two main obstacles to lowering the deficit.
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Firstly, the continual rise in the surplus of the services balance is starting to show signs of exhaustion. In particular, the number of tourist visits in the first quarter of 2012 rose by 2.6% compared with the same period a year ago and this figure represents a fall of 4.8 percentage points compared with the growth recorded in 2011. A second aspect to take into account is the deterioration in the income balance deficit, particularly after the sharp rise in financing costs for Spain's debt in April. Both factors have led us to increase our forecast for the current deficit for 2012 as a whole to 2.4% of GDP, 0.3 percentage points above the previous figure.
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Public sector
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Spain's Budget fails to dispel doubts in the debt markets
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Spain's Budget includes significant adjustment measures, both in revenue and expenditure...
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The Spanish government is facing a huge challenge. On the one hand, it must take the necessary measures to achieve the fiscal adjustment agreed with the European Union, namely 3.2 percentage points, the largest since the start of democracy. On the other hand, this consolidation process must affect the economy as little as possible, whose deterioration is estimated at 1.7% year-on-year for 2012. Spain's Budget shows the strategy to be followed by the government. According to this, the central government's account imbalance will be corrected by means of severe spending cuts and tax hikes. This has not dispelled the doubts in the debt markets, however.
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The weakness of the economy in 2011, in particular during the second half of the year, was one of the reasons why the public deficit did not achieve its target. By way of example, revenue from tax on production and Social Security contributions fell by a total of 4.03 billion euros compared with 2010. At the same time, the decline in the labour market and higher financing costs for Spain's debt raised the payments of welfare benefits and interest by 7.26 billion euros in the same period. This counteracted the efforts made to contain spending. The 10.5 billion euro fall in gross capital formation in one year is a clear example.
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...and totalling 27.3 billion euros in 2012.
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Spain's accounts were not immune to this effect and recorded a deficit equivalent to 5.1% of gross domestic product (GDP), 0.3 percentage points higher than the stability programme's target. With a view to 2012, the central government must reduce its net borrowing by 1.6 percentage points, down to 3.5% of GDP. However, according to the Budget, the effect of the economy's deterioration on the public accounts pushes up the value of the adjustment measures required to 27.3 billion euros, affecting both revenue and expenditure.
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With regard to the former, the government presented a battery of tax measures, calculated at 12.3 billion euros. These include a temporary increase in the personal income tax rate, approved in December 2011, which will provide 4.1 billion euros. To this figure we should also add the 5.35 billion euros that the government estimates will come from modifying corporation tax. Particularly of note is the limit to large deductions, as well as the introduction, in 2012, of a tax on dividends that come from abroad and a change in the system for calculating split payments. On the other hand, the approval of an extraordinary programme to expose hidden incomes will provide a further 2.5 billion euros. The hike in special taxes on tobacco and legal duties will contribute the remaining 264 million euros.
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Measures to achieve a significant rise in tax revenue in spite of the economy's decline.
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However, lower economic activity during 2012 will partly offset the effect of these measures. This is the case of the revenue from value added tax (VAT) which, according to the Budget, will fall by 1.6 billion euros this year, down 3.3% year-on-year. As a consequence, the improvement in tax revenue will be just below 7 billion euros. Taking into account the effects of the settlement of the financing system in 2010 and other accounting adjustments, the rise in revenue will be equivalent to 0.8 percentage points of GDP.
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Ministerial spending decreases by 13.4 billion euros compared with the 2011 Budget.
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Regarding Budget payments, ministerial spending is expected to drop by 13.4 billion euros. Of note are the adjustments made to investment. If we compare the 2011 Budget, the total of real investment and capital transfers will decrease by around 7 billion euros, representing year-on-year cuts of 23.4% and 51.5% respectively. On the other hand, interest payments are expected to rise significantly, by 6.7 billion euros. To a lesser extent, current transfers, which include payments for pensions and contributions to the State Employment Service, will also rise. On the whole, and after applying the necessary accounting adjustments, central government spending will contribute the remaining 8 tenths of a percentage point to the deficit's correction.
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Judging by the markets' reaction, the Budget announcement has not helped to dispel doubts regarding the process of fiscal consolidation. This can be seen in the sharp rise in the risk premium, measured as the spread between the yield on Spanish ten-year bonds and their German equivalent, which went above 420 basis points at the end of April. The reasons for this climb centre on two aspects.
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The risk premium rises sharply in April to 420 basis points.
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Firstly, there is some uncertainty as to whether the targets set in the central government's Budget will be achieved. Specifically, the effect of the economic recession on some items of revenue and expenditure might have been underestimated. This is the case of expenditure on unemployment benefit which, according to the Budget, will decrease within a context of job losses. Similarly, the drop in revenue from some taxes, such as VAT, might be slightly optimistic. In all likelihood, the Budget spending figures for February did nothing to calm these tensions. In fact, on a national accounts basis, the deficit accumulated during the first two months of the year reached 1.9% of GDP, 0.6 percentage points above the figure recorded a year ago. However, part of this increase is due to transfers to the autonomous communities and Social Security being brought forward.
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The government reacts quickly and approves spending cuts worth 10 billion euros in healthcare and education.
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A second reason comes from the doubts regarding the consolidation process in the autonomous communities. In this respect, the Spanish cabinet approved a 10 billion cut in healthcare and education. 7 billion euros come from healthcare by increasing the co-payment for medicines and from limiting access to health services for non-resident foreigners. Education will provide the remaining 3 billion by raising university fees and increasing class sizes. With this reform, the government has demonstrated that it prioritizes the achievement of the ambitious deficit targets. However, this strategy does not coincide with the recommendations of the International Monetary Fund, which favours easing back on the correction of the public deficit so as not to excessively damage the economy.
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Savings and financing
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The increase in the external debt is covered via Eurosystem financing
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The private sector deleverages in 2011 while public debt continues to grow.
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Public sector and private debt revealed opposing trends in 2011. While indebtedness continued to grow at a fast pace in the first case, the deleveraging started two years ago continued in the second. There's no sign of a change in trend in the figures for 2012. Eurosystem liquidity injections have played an important part in the rise in public debt. With a view to 2012, it's of the utmost importance to dispel the uncertainty that has blocked traditional financing channels. In this respect, this year's reorganisation of the banking system will be crucial.
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The net lending of firms reaches 2.8% of GDP.
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In the case of the private sector, non-financial firms and households were net lenders in 2011, with a net lending equivalent to 5.1% of the gross domestic product (GDP). Although this figure is only 0.3 percentage points lower than the one recorded a year ago, significant differences can be observed in the breakdown of both sectors' net lending. In the case of households, this fell by 1.5 percentage points, reaching 2.3% of GDP. On the other hand, the net lending of firms increased to 2.8% of GDP last year, achieving the highest figure for the last decade. However, net lending in the private sector was not enough to offset the public administration deficit of 8.5% of GDP.
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The relative weight of ECB financing for external debt increases to 9.9% in 2011.
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The data available for the first two months of 2012 show that this trend has continued. Private sector debt fell by 13.6 billion euros during the first two months of the year, a 0.6% decrease on December 2011. However, public administrations increased their debt by 29.0 billion euros in the same period. Consequently, the total liabilities of non-financial sectors grew further, reaching a new record high in February.
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As can be seen in the graph below, this greater indebtedness also involved an increase in the volume of Spain's debt in foreign hands, totalling 1.8 trillion euros in December 2011. This rise has made the reduction process started a year ago simply anecdotal. But in addition to this trend, an analysis of external debt also shows a gradual increase in the Spanish economy's dependence on Eurosystem financing. In fact, at December 2011, Europe's top monetary authority was financing 9.9% of Spain's total external debt. This proportion represents an increase of almost 7 percentage points compared with 2010. On the other hand, the input of capital via traditional financing channels has halted significantly. This reflects the deterioration in confidence inspired by the Spanish market in foreign investors.
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This injection of capital by the European Central Bank (ECB) was carried out via three-year loans granted to European banks in December 2011 and February 2012. The financing difficulties of Spain's banking system meant that banks increased their net debt with the Eurosystem by 130 billion euros during the five months prior to March 2012. The percentage of external debt financed by the Eurosystem is therefore expected to continue rising during the first quarter of this year.
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Banks increase their net position with the Eurosystem by 130 billion euros.
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This extensive use of the Eurosystem has helped, on the one hand, to relieve banks' liquidity tensions and, on the other, has also allowed the financial system to acquire Spanish public debt. However, the squeeze on private sector credit continued at the start of 2012. Specifically, the volume of credit granted in the first two months of the year fell by 11.2% year-on-year, causing the outstanding credit balance to shrink by 3.0% in February compared with the same month last year. For its part, the non-performing loan (NPL) ratio rose by 25 basis points that month, reaching 8.16% of total credit. We expect this upward trend to go on increasing over the coming months, given the expected weakness of the Spanish economy.
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Within this context of deteriorating credit portfolios, Spain's banking system will have to comply with the new hedging requirements for its real estate assets, approved by the royal decree-law to reorganise the financial system. It is estimated that these measures will entail an additional 50 billion euros for the sector, approximately. At the end of March, financial institutions presented their strategies to ensure compliance with these new requirements by the end of 2012. Among these measures, of note are charges to profit and capital surpluses, asset divestments and the attraction of private capital. Mergers between banks, in which case the deadline to comply with these requirements is extended to December 2013, have only been announced in two cases.
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The outstanding balance of credit to the private sector falls by 3.0% year-on-year in February.
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In short, this new reorganisation of the banking sector is expected to help dispel doubts regarding banks' solvency in the medium term. This will reopen the traditional financing channels for banks and help to ensure credit is channelled to the different sectors of the economy, once it starts to recover.
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Term deposits portend further drops in savings
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Given this growing economic weakness, the savings rate of Spanish households fell again in the fourth quarter of 2011, down to 11.6% of their gross disposable income for the year as a whole. This figure represents a fall of 2.3 percentage points compared with the level of a year ago. This decline is due to the fact that the 3.0% annual rise in final consumption costs was higher than the rise in gross disposable income, namely 0.4% in the same period.
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Household savings fall to 11.6% of their gross disposable income in 2011.
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Comparisons with the previous quarter show a certain slowdown in the growth of final consumption. However, gross disposable income already fell in the same period. This performance contrasts with the one recorded during the last recessionary cycle, when the drop in final consumption preceded the fall in gross income due to the effect of precautionary savings. In that case, the household savings rate reached 18.5%. We expect that, throughout 2012, savings will continue to decline albeit at a slightly slower pace.
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Short-term deposits fall during the first two months of the year.
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The figures for bank liabilities in the hands of households and firms are in line with this forecast, falling by 1.2% year-on-year during the first two months of 2012. Of note is the squeeze in short-term deposits, which include sight deposits and savings, down 2.9% and 3.3% respectively in the same period. This drop is highly significant if we take into account the fact that short-term deposits provide the best reflection of the trend in the savings rate. By way of example, in December 2009, when the savings rate reached its peak, short-term deposits rose by 10.4% year-on-year compared with the 1.3% fall year-on-year in long-term deposits.
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