Research Dept. News
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Monthly Report, num 358 - June 2012
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Spain: overall analysis - Economic activity
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Confidence and credibility
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In the first quarter, GDP shrinks by 0.4% quarter-on-quarter.
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«Self-trust is the first secret of success». This quote, by Ralph W. Emerson, US poet and thinker, forces us to wonder whether Spain and Europe really believe in themselves and in each other. To date, the euro area has not been able to solve a problem affecting 2% of its economy, namely Greece, or to use all the mechanisms within its grasp, including the European Central Bank (ECB), to dispel doubts regarding the rest of the Member states. For its part Spain, after passing the fourth financial reform in less than three years, asked external consultants to evaluate the capital requirements of its banks and revised 2011's public deficit upwards. Both these facts led to a drop in confidence in Spain's public accounts and financial system.
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The nationalization of the country's fourth largest financial institution one week after its financial plan was approved by the Bank of Spain eroded the regulator's credibility and speeded up approval of a new financial decree. The new capital requirements maintain provisions for toxic assets and increase the general coverage for healthy ones. However, the reform did not manage to get investor confidence back and the risk premium rose to levels close to 500 basis points (forcing the central government to pay for increasingly expensive financing), as well as the Ibex 35 falling by 7.2% in seven days.
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The new financial reform does not resolve investor doubts.
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One week after this financial reform, the government approved the budgets for the autonomous communities except for Asturias, whose deadline was extended, to ensure the fiscal consolidation established for 2012. However, the upward revision of 4 tenths of a percentage point for 2011's deficit due to deviations from Madrid, Valencia and, to a lesser extent, Castile and Leon, means that an additional effort will have to be made to go from the current deficit of 8.9% to the promised figure of 5.3%. Although it's true that adjustments are more difficult to achieve in a recessionary context (the deficit is calculated as a ratio of gross domestic product), the adjustment plans already take into account the recessionary scenario.
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Confidence is crucial for growth. A credible economy leads to confidence in its payment obligations and it manages to finance itself at lower interest rates (lower risk premium). This less costly financing is passed on to the rest of the system and, under normal conditions, improves credit flows. Credit boosts consumption and investment and, in short, gross domestic product (GDP).
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The government revises 2011's deficit by 4 tenths of a percentage point up to 8.9%.
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However, uncertainty in the financial system stops banks from lending to each other and raises the cost of financing; uncertainty in the public accounts pushes up the risk premium and the remaining credit fails to flow due to increased requirements on banks. At the same time as this process, adjustment plans are produced that cut public spending. If consumption, investment and public spending decrease, only the foreign sector can stop GDP from falling. But as our trading partners are also suffering, to a greater or lesser extent, from this process of a lack of confidence and fiscal adjustment, foreign demand's contribution is less than in previous quarters.
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A breakdown of the National Accounts system confirms this and reveals that the decline in GDP in the first quarter of the year was 0.4% year-on-year. The drop in activity in the first quarter of the year was due to the deterioration in domestic demand, contributing -3.2 percentage points to growth, three tenths of a percentage point more negative than in the previous quarter. On the other hand, exports were the only motor of growth, adding 2.8 points to GDP. However, the foreign sector is showing signs of a slowdown with its contribution dropping by four tenths of a percentage point compared with the previous quarter.
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Lower investment affects the contribution made by domestic demand.
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This more negative contribution by domestic demand is entirely due to investment speeding up its rate of contraction as spending on end consumption has remained the same as the previous quarter. This is because households are offsetting the cuts in public consumption. In year-on-year terms, household consumption was down 0.6%, a slower rate than in the previous quarter. The cause lies mainly in the loss of confidence and purchasing power. With regard to the first point, consumer confidence worsened in the first quarter of the year and stands at 11 points away from its historic average and 5 points lower than last year. The latest figures, corresponding to April, show hardly any improvement over the previous month.
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On the other hand, wages rose by 0.9% year-on-year while inflation increased by 2.0% in the same period. This meant that most households saw their potential to consume fall. Moreover, in the last year 655,500 full-time equivalent jobs were lost, helping to reduce the wages of employees in general. The positive note is that unit labour costs are falling at a rate of -2.5% year-on-year and worker productivity is increasing (although this is because jobs are being lost faster than the decline in GDP).
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The foreign sector is showing signs of less dynamism.
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In the last year, austerity plans have cut public spending by 5.2%. According to the 2012 budget and the stability plan announced by the government, this trend will get worse over the year and will remain in negative terrain until 2015.
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However, the aspect of demand most sorely affected by the crisis is investment, which has seen negative figures for the last four years. In the first quarter of 2012, this fell by 8.2% year-on-year, pushed by the drop in material assets and investment in construction. Investment is crucial to stimulate future growth but, for the moment, this is contracting at a faster pace than in the previous quarter. Tensions in the financial sector and a lack of public investment and short-term expectations are ensuring this continues to be the case. April's decline in the industrial confidence indicator seems to confirm that this trend will continue over the coming quarter.
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Lastly, the foreign sector started to show signs of running out of steam. Exports shrank compared with December and the year-on-year rate of change fell by 3 points to 2.2%. Europe's slowdown led to lower demand, especially for services, and more moderate tourism. For their part, imports fell by 7.2%, a figure in line with the lower level of activity, but they are slowing up their rate of decrease.
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Europe can help Spain to restructure its economy.
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The government's stability plan acknowledges that the reforms will have an effect in the medium term. Consequently, in the short term Europe is the only one that can help to restructure Spain's economy. The proposals range from a renegotiation of the fiscal adjustment schedule, mobilizing European funds to encourage investment or providing mechanisms to reduce the cost of debt (a more active role by the European Central Bank or some kind of debt mutualization such as Euro bonds). Whatever the initiatives taken, Europe must prove that it believes in itself and, therefore, in Spain.
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