THE REAL ESTATE SECTOR AND THE FINANCIAL CRISIS: THE SPANISH EXPERIENCE Eloísa Ortega Director, Economic Analysis and Forecasting Department CONFERENCE ON EUROPEAN ECONOMIC INTEGRATION CEEI 2013 Vienna November 18, 2013 Directorate General Economics, Statistics and Research
THE SPANISH ECONOMY IS OVERCOMING THE SECOND RECESSION IN THIS CRISIS BUT CHALLENGES ARE STILL CONSIDERABLE To ensure a path of sustainable growth, domestic demand needs to pick up, the reallocation of productive and financial resources needs to be speeded up and the deleveraging of public and private sector needs to be completed GDP LEVELS: SPAIN AND THE EURO AREA 102 2008 Q1 = 100 100 98 96 94 92 90 2008 2009 2010 2011 2012 2013 2014 EA SPAIN 2
THE OUTLINE OF THIS PRESENTATION 1. A brief review of macroeconomic imbalances before the outbreak of the financial crisis 2. Adjustment and rebalancing after 2007 1. Excessive investment in the real sector 2. Rapid expansion of credit and leverage in the private sector 3. High current account deficits and high dependence on external savings 3. Some lessons to be learnt 1. Contribution of housing and indebtedness to the crisis 2. Economic policy within EMU 4. Looking ahead 3
THE OUTLINE OF THIS PRESENTATION 1. Macroeconomic imbalances before the outbreak of the financial crisis 2. Adjustment and rebalancing after 2007 3. Some lessons to be learnt 4. Looking ahead 4
IMBALANCES BEFORE THE OUTBREAK OF THE FINANCIAL CRISIS The Spanish economy expanded strongly in EMU: GDP growth averaged 3.6% after 1998, considerably above the euro area average Favourable financial conditions were key to explaining the surge in demand Supply reacted swiftly: population increased by 6 million people from 1999 to 2008 and women and immigrants boosted the labour force BUT: Persistence of demand pressure in excess of supply capacity saw a number of macroeconomic and financial imbalances emerge 5
IMBALANCES BEFORE THE OUTBREAK OF THE FINANCIAL CRISIS Strong expansion of the residential sector Private sector indebtedness expanded forcefully Persistent cost and inflation differentials with the euro area Sizeable real exchange rate appreciation and loss of competiveness Overall, this led to high dependence on external finance High current account deficit 6
THE OUTLINE OF THIS PRESENTATION 1. Macroeconomic imbalances before the outbreak of the financial crisis 2. Adjustment and rebalancing after 2007 3. Some lessons to be learnt 4. Looking ahead 7
RAPID DOWNSIZING OF THE RESIDENTIAL SECTOR AND MORE GRADUAL ADJUSTMENT IN HOUSING PRICES Residential investment has fallen 53% from its peak; House prices are down 37% in real terms. A more acute correction than in previous cycles. Sizeable stock of unsold homes and weak demand conditions, suggest correction could continue for a while. INVESTMENT IN HOUSING HOUSE PRICES (real terms) 220 1997 Q1 =100 240 1997 Q1 =100 200 220 180 160 200 180 160 140 140 120 120 100 100 80 97 99 01 03 05 07 09 11 13 80 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 8
WITH STRONG MACROECONOMIC IMPACT: SIGNIFICANT DIRECT AND INDIRECT EFFECTS ACROSS THE ECONOMY Housing is a very labour-intensive economic activity: strong effects of the sector s shrinkage via employment losses for the economy with repercussions in other sectors. Wealth effect not so relevant for consumption, except through increase in precautionary savings 8 % EMPLOYMENT IN THE MARKET ECONOMY (y- o- y growth and contributions) AGRICULTURE CONSTRUCTION TOTAL INDUSTRY MARKET SERVICES 20 15 10 % GDI HOUSEHOLD SAVING GROSS SAVING SAVING AFTER DEBT SERVICE 6 5 4 2 0 0-5 00 01 02 03 04 05 06 07 08 09 10 11 12 13-2 -4-6 1200 % GDI HOUSEHOLD NET WEALTH TOTAL REAL ESTATE -8 1000-10 00 01 02 03 04 05 06 07 08 09 10 11 12 13 800 600 400 00 01 02 03 04 05 06 07 08 09 10 11 12 13 9
DOMESTIC CREDIT GROWTH HAS FALLEN INTO NEGATIVE TERRITORY AND PROGRESS IS BEING MADE IN DELEVERAGING PRIVATE SECTOR Decline in credit is the result of demand (still high level of debt) and supply factors (worsening of borrowers credit quality and financial market fragmentation across the euro area). Deleveraging in a recessionary environment is a slow process CREDIT (y- o- y growth and contributions) 90 % GDP HOUSEHOLD DEBT 30 % HOUSEHOLDS NON-FINANCIAL CORPORATIONS TOTAL 80 70 60 25 20 15 10 50 40 30 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 Debt 5 0-5 -10-15 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 160 140 120 100 80 60 40 NON - FINANCIAL CORPORATIONS DEBT % GDP 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 Debt 10
VERY SUBSTANTIAL CORRECTION OF EXTERNAL DEFICIT SINCE 2007 Progress in correcting the external imbalance has been significant thanks to competitiveness improvements (plus weak internal demand, increasing export base and geographical diversification). 10 8 % of GDP NET LENDING/ BORROWING Energy Non-energy goods Services Income Transfers Net lending/net borrowing 120 RELATIVE ULC: Spain versus Euro area Index 1998=100 ULC, whole economy Compensation per employee Productivity, whole economy 6 4 115 2 110 0-2 105-4 100-6 -8 95-10 -12 90 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13-14 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 11
STABILITATION OF THE NET INVESTMENT INTERNATIONAL POSITION Improvement in the external position due to net lending of households and non-financial corporations. Large increase in public deficit has emerged. Sustained surpluses on the current account balance are needed to bring down the NIIP on a sustainable basis NET LENDING / NET BORROWING NET INTERNATIONAL INVESTMENT POSITION 12 %GDP HOUSEHOLDS NON - FINANCIAL CORPORATIONS FINANCIAL INSTITUTIONS PUBLIC SECTOR TOTAL ECONOMY -20-30 % GDP NET IIP 9 6 3 0-3 - 6-9 - 12-40 -50-60 -70-80 -90-100 97 99 01 03 05 07 09 11 13-15 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 12
THE OUTLINE OF THIS PRESENTATION 1. Macroeconomic imbalances before the outbreak of the financial crisis 2. The process of adjustment and rebalancing 3. Some lessons to be learnt 4. Looking ahead 13
CONTRIBUTION OF HOUSING AND CREDIT TO THE SPANISH CRISIS Housing investment played a key role in generating macroeconomic and financial imbalances during the upswing Collapse in residential sector is key to the depth and dynamics of the crisis in Spain Why residential investment generates sharp cyclical fluctuations Highly sensitive to changes in market expectations (interest rates, asset prices) Highly employment-intensive sector with the risk of large quantity of labour flooding the labour market in a housing crisis Important spillovers on other industrial and services branches 14
CONTRIBUTION OF HOUSING AND CREDIT TO THE SPANISH CRISIS Carry-over effects on activity and employment might increase if labour and product market inflexibility fails to provide for cross-sector reallocation of resources Adjustment in the residential sector could have adverse financial consequences: Following the build-up in debt, deleveraging of the private sector is needed, which compounds the already contractionary environment. Damaging effects on bank balance sheets in that risk of real estate companies and households defaulting increases. General tightening of financial conditions Rapid rise in private and external debt increased Spanish vulnerability in the context of the euro area crisis. 15
SOME REFLECTIONS ON ECONOMIC POLICY To reduce the role of the real estate market in creating macroeconomic imbalances Additional macroprudential instruments Structural and labour market policies conducive to price and relative cost adjustment and reallocation of resources To ensure sustainability of the external deficit Need for early diagnosis and to implement economic policies to prevent an external imbalance build-up A more restrictive fiscal policy during the upturn Greater liberalisation of the goods and factor markets 16
THE OUTLINE OF THIS PRESENTATION 1. Macroeconomic imbalances before the outbreak of the financial crisis 2. Adjustment and rebalancing after 2007 3. Some lessons to be learnt 4. Looking ahead 17
CHALLENGES AHEAD Remarkable effort has been made to adjust and rebalance the economy Fiscal consolidation Structural reforms Restructuring the financial system Correction of Spain s main imbalances are under way but major issues pending : Continue the internal devaluation process and speed up the absorption of unemployment Reduce the high level of indebtedness Speed up reallocation of resources across sectors Economic policies can improve the resilience of the economy: Complete the established roadmap for restructuring the financial sector Maintaining a sustained path of deficit reduction Deepening the structural reforms in goods and factor markets 18
ELOÍSA ORTEGA THANK YOU FOR YOUR ATTENTION