Research Dept. News
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Monthly Report, num 357 - May 2012
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Spain: overall analysis - 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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