Spain’s economic resurgence has exceeded even the most optimistic expectations. But how sustainable is it, given structural inefficiencies, stubbornly high unemployment and the threat of external shocks?

Author: Vanessa Drucker

TROIKA’S STAR PUPIL UNDERTAKES REFORMS

Gual, CaixaBank: Unemployment remains high, but the rhythm of the decline gives confidence to the population.
Gual, CaixaBank: Unemployment remains high, but the rhythm of the decline gives confidence to the population.

Spain has undertaken a slate of reforms unmatched among neighboring periphery nations in the eurozone. Key regulations have been enacted pertaining to the labor market, pension system, fiscal framework and financial sector. First, new labor market regulation addresses collective bargaining at the firm level. That adjustment has provided greater flexibility for adjusting wages, which are now either static or weakening.  Labor demand rose in 2014, after having fallen continuously since mid-2008, resulting in a decline
in unemployment, which dipped to 23.7% versus 25.7% at the end of 2013. “Unemployment remains high, but the rhythm of the decline gives confidence to the population,” Gual comments.

Meanwhile, the Spanish government faces accusations that it has fostered a duality between those inside the protected economy, who have fixed-term contracts, and a growing segment working under part-time or temporary contracts. “The type of service sector and temporary jobs which were created have helped in the short term but are not enough to sustain a recovery in consumer spending,” Badiani explains. 

Jobs that offer no security also do little to build credit for mortgages, which accounts for a leveling off in the languid real estate revival. Badiani estimates a glut of around half a million unsold properties remains, especially in the suburbs. Who will buy them? Young people cannot get mortgages to join the property ladder, and many 30-somethings still live with their parents.  Although coastal areas are attractive to purchasers, much construction remains unfinished. “It’s hard to know whether investors will make their money back on those,” McKeown observes. “Incomplete buildings lose value, so projects may need to be restarted.”

The banking industry, which has seen its share of restructuring, takes its cue from the real estate and construction sectors. Meanwhile, the transmission channel has finally been repaired, conveying the benefits of ECB monetary loosening to the Spanish credit market. “Banking union and consolidation, comprehensive assessments and recapitalization have brought back confidence to lending,” says Navarrete. 

Although Spain did perform relatively well in ECB stress tests, the overhang of bad debts casts a shadow, and business is still barely profitable. “A gradual reduction of provisions and losses associated with real estate will help the recovery,” Gual anticipates. That process began last year, with the ratio of nonperforming loans drifting downward since late 2014, and should gain momentum, leading to normalization in 2016. Gual says the current return on equity of the average Spanish bank stands at 4%, but that number could double in a couple of years.

Barroso, Teneo Intelligence: Consumption and tourism alone won’t save the day, while Spain needs higher value-added products to export across the world.
Barroso, Teneo Intelligence: Consumption and tourism alone won’t save the day, while Spain needs higher value-added products to export across the world.
McKeown, Capital Economics: Risks of both internal economic imbalances and possible external shocks may not be fully appreciated, and it’s too soon to sound the all-clear.
McKeown, Capital Economics: Risks of both internal economic imbalances and possible external shocks may not be fully appreciated, and it’s too soon to sound the all-clear.
Navarrete, Instituto de Crédito Oficial: Banking union and consolidation, compre- hensive assessments and recapitalization have brought back confidence to lending.
Navarrete, Instituto de Crédito Oficial: Banking union and consolidation, compre- hensive assessments and recapitalization have brought back confidence to lending.

A SUSTAINED REVIVAL

Just as consumer confidence has jump-started the economic rebound, the reverse dynamic could have the opposite effect. For now, shoppers judge that the brunt of the crisis is over and that it is safe to release pent up demand with renewed purchasing power. What will transpire, however, if either inflation or deflation sets in? McKeown, who perceives a significant risk of deflation, acknowledges that falling prices have had a benign impact. Yet she cautions that consumers may begin to put off purchases. So far this year the consumer price index has already fallen by 0.2%, and is expected to rise by only 1.2% next year. Spenders have reacted positively to take advantage of discounts, but they might become more hesitant if prices keep sliding.

By contrast, inflation could prove problematic if energy or food prices rally. Income would be rapidly scaled down or even neutralised. Although the recent uptick has in part been funded by reduced household saving, at some point rising real income must take over the stress of higher consumer spending. That can only be accomplished through continued employment growth, longer-term contracts, higher wages and rising profit margins for firms. “Benefits need to trickle down, so that firms don’t need to squeeze workers,” says Badiani.

Spain’s revival is partly owing to internal devaluation and cost control. It is critical that the process of wage and cost formation between unions and employees maintain that discipline to avoid resuming excessive cost increases that might undermine competitiveness. Oil prices in particular, which have provided a bonanza, could reverse course at any time. Last, the danger of an external shock is always unpredictable. Countries in the periphery appear to have built in protection with internal reforms and ECB policies, “but a shock would lead us into unknown territory,” Gual notes. Likewise, a US interest rate rise could create turmoil in emerging markets with global consequences. Assuming no unforeseen stumble, Spain’s resurgence will have exceeded even optimistic expectations. The next chapter will demonstrate whether the country can move beyond a test of textbook theory and emerge as a sustainable success.

GFmag.com Data Summary: Spain

Central Bank: Bank of Spain

International Reserves                 

$50.2 billion

Gross Domestic Product (GDP)

$ 1,406.9 billion

Real GDP Growth

2012
-2.1%

2013
-1.2%

2014
1.4%

GDP Per Capita—Current Prices

$30,278

GDP—Composition By Sector*  

agriculture:
3.2%

industry:
25.4%

services:
71.4%

Inflation

2012
2.4%

2013
1.5%

2014
-0.2%

Public Debt (general government
gross debt as a % of GDP)

2012
84.4%

2013
92.1%

2014
97.7%

Government Bond Ratings
(foreign currency)

Standard & Poor’s
BBB

Moody’s
Baa2

Moody’s Outlook
POS

FDI Inflows

2011
$28,379  million

2012
$25,696 million

2013
$39,167 million

* Estimates                                                                                                                   
Source: GFMag.com Country Economic Reports

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