Ernst & Young Eurozone Forecast Spain Spring 2010
Outlook for Spain Ernst & Young Eurozone Forecast Spring 2010 Finland Ireland Netherlands Belgium Germany Luxembourg Austria Slovakia France Slovenia Italy Spain Portugal Greece Malta Cyprus Please visit our dedicated Eurozone website for access to additional information on the Eurozone report, the 16 individual country reports and additional perspectives and interview content. The site contains the latest version of our reports, provides access to print ready files as well as an archive of previous releases. To find out more please visit www.ey.com/eef
Highlights Unwinding of imbalances, ongoing recession The Spanish economy will remain in recession in 2010, with GDP shrinking by 0.4%, as the fallout from the burst real estate bubble remains a heavy drag on the economy and the phasing out of the fiscal stimulus is not replaced by other domestic sources of growth. The crisis goes hand-in-hand with a rapid unwinding of the external and internal imbalances produced by a growth model based on a surge in credit: the strength of this correction will determine the speed of the recovery. On the eve of the crisis, the Spanish private sector s debt was one of the highest in the Eurozone. Deleveraging by households and firms pushed GDP down last year and will continue to cut growth for some time. The most dramatic feature of the slump in economic activity has been the unprecedented rise in unemployment. In September 2009, the unemployment rate reached 19% (a full 11 ppt increase since mid 2007) and has remained broadly stable thereafter. The collapse of the construction sector and the crisis of the tourism industry have led to layoffs of unskilled workers with temporary contracts. We expect the unemployment rate to remain at the current high level throughout the year and then to decline very slowly. While core inflation is currently close to zero, strong energy prices and the increase in VAT during the summer will bring inflation to around 1.5% this year. This will be an additional squeeze on households real incomes. In order to prevent the economy from going into tail spin, the Spanish government embarked in one of the biggest stimulus plans in Europe, which led to an estimated 11.4% deficit to GDP ratio for 2009. This has raised concern about the sustainability of public finances, leading the government to announce a sizable fiscal retrenchment plan starting this year, aiming at reducing deficit to 3% of GDP by 2013. We expect a slower consolidation and this target should be reached by 2015 at the earliest. The contraction in import following the plunge in domestic demand enabled net trade to provide a positive contribution to growth. This is expected to continue this year and in 2011: weak import growth will be complemented by a rebound in exports, as the expected wage restraint will provide some of the real exchange rate depreciation needed to undo the large deterioration in price competitiveness seen over the last 10 years. Ernst & Young Eurozone Forecast Spring 2010 Spain 1
Unwinding of imbalances, ongoing recession Domestic and external shocks battered the Spanish economy Spanish GDP is expected to fall again by 0.3% in 2010 after the 3.6% contraction recorded in 2009. The Spanish economy is expected then to experience a deeper and longer contraction than the Eurozone average, as domestic demand is set to prove a drag on the economy going forward. This is the result of the necessary unwinding of imbalances, such as high levels of private sector debt, that the Spanish economy inherited from the period of high growth which characterised the 1998-2007 decade. The contraction of residential investment, started at the end of 2007 turned into a collapse around the beginning of 2008. Between the peak of the construction cycle and the last quarter of 2009, residential investment contracted by nearly 20%. The fallout on the labor market was immediate and dramatic as the collapse of the construction sector was accompanied by the crisis of other cyclical and labor intensive sectors, such as tourism and manufacturing and thanks to the record high proportion (nearly 30%, before the crisis erupted) of temporary jobs in the economy. As a consequence the unemployment rate skyrocketed. In February 2010 it was 18.8%, a full 11 percentage points (ppt) increase with respect to the minimum reached in mid 2007. The collapse of the construction sector has left mainly unskilled workers without a job. Moreover, their return to the labor market is going to be slow. As a result, unemployment will remain stubbornly high well into 2011 and will then start decline very slowly. The rapid deterioration of the labor market affected consumption heavily through the fall in disposable income which was only marginally offset by the beneficial effects of past wage increases, low inflation and low interest rates. Overall, household consumption fell by 4.9% in 2009, one of the largest slumps seen in the Eurozone. The collapse in foreign trade led exports to fall by 11.5% (with a large improvement during the last part of the year thanks to the effect of the car scrappage schemes). However, the massive correction in domestic demand lowered import by nearly 18% so that net trade contributed positively to growth. The unwinding of domestic imbalances was a key factor accounting for developments in domestic demand last year and will be an important determinant of the speed of the recovery going forward. The rapid growth of the Spanish economy since the introduction of the euro was driven to a large extent by domestic demand, as low real interest rates triggered a credit boom. As a consequence the Spanish private sector, both households and businesses, became one of the most leveraged in the Eurozone. Between 2000-08, household debt grew from 45% to over 80% of GDP. Most of this credit boom went into house purchases, creating the property price bubble which burst at the end of 2008. The perceived large wealth losses related to tumbling house prices and heightened uncertainty about the labor market translated into a Table 1 Spain (annual percentage changes unless specified) Source: Oxford Economics 2009 2010 2011 2012 2013 2014 GDP -3.6-0.4 0.8 1.4 1.6 1.9 Private consumption -4.9-0.5 0.3 1.0 1.2 1.5 Fixed investment -15.3-5.0 0.0 1.8 2.5 2.5 Stockbuilding (% of GDP) 0.4-0.3-0.6-0.5-0.6-0.7 Government consumption 3.8 1.5 0.6 0.5 1.6 1.5 Exports of goods and services -11.5 5.5 4.6 5.3 5.4 5.7 Imports of goods and services -17.9 0.1 1.6 4.1 4.5 4.7 Consumer prices -0.3 1.5 1.4 1.5 1.8 1.7 Unemployment rate (level) 18.0 19.2 19.5 19.0 17.8 16.3 Current balance (% of GDP) -5.4-4.3-3.7-3.4-3.1-2.8 Government budget (% of GDP) -11.4-10.3-8.3-6.5-5.3-3.5 Government debt (% of GDP) 53.0 64.3 71.8 76.6 79.4 80.6 ECB main refinancing rate (%) 1.1 1.0 1.6 3.3 4.3 4.3 Euro effective exchange rate (1995=100) 129.7 124.8 122.0 119.7 117.7 116.3 Euro-US dollar exchange rate ($ per ) 1.39 1.34 1.32 1.30 1.29 1.27 2 Ernst & Young Eurozone Forecast Spring 2010 Spain
Figure 1 Consumption and investment Figure 2 Government balance and debt % year 16 12 Investment Forecast % of GDP 4 2 Forecast % of GDP 90 80 8 0 70 4 0-4 -8-12 Consumption -2-4 -6-8 Government budget balance (LHS) Government debt (RHS) 60 50 40 30 20-16 -10 10-20 1985 1989 1993 1997 2001 2005 2009 2013 Source: Oxford Economics -12 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 Source: Oxford Economics 0 quick adjustment in households balance sheet. The households saving ratio shot up from 10% in 2007 to over 15% of disposable income in 2009, prompting the large fall in consumption seen last year. The still relatively high level of household debt, the prospects of further downward corrections in house prices and the dire outlook for the labor market will force further deleveraging. This and the prospect of very weak real wage dynamics (due to both nominal wage restraint and the pick up of inflation) will lead consumption to contract again by 0.5% in 2010. Non financial corporations too are deleveraging fast. During 1997-2007, corporate borrowing grew at double digit rates, peaking at a staggering 31.2% in 2006. Non-financial sector liabilities amounted to around 190% of GDP in 2008. The credit expansion turned into reverse quickly: in 2009 the outstanding amount of loans decreased (by 3.7%) for the first time since records began in the early 1960s. Balance sheet adjustment will be just one the drivers of the plunge in capital formation (-5%) we expect for this year. The large spare capacity will impinge further on capital expenditure. Burdened with a high stock of unsold homes, the construction sector (which still accounts for around 10% of Spanish GDP) will cut capital spending. Therefore, residential investment is likely to fall by over 16% this year, as it did in 2009. The rest of the industrial sectors will continue to struggle as foreign and domestic demand will remain sluggish in the industries where the Spanish economy is specialized, such as the automotive sector, which will suffer from the end of the car scrappage schemes in most European countries in 2010 compressing inflation The dramatic fall in demand has had large repercussions on inflation. During the decade of rapid growth, inflation remained well above 3%, peaking at 4.1% in 2008 thanks also to the surge in oil prices. In 2009 Spain experienced negative inflation, with consumer prices falling by 0.3%. The last months of 2009 saw a rise back to positive inflation, largely due to the strengthening of commodity prices. But core inflation has declined steadily and in January was just 0.1%. In 2010, consumer prices will increase by 1.5% thanks largely to the increase in VAT scheduled for July. This will be an additional squeeze on households real income. But once the effects of this artificial boost peter out, the risk of price deflation in Spain is higher that in most of the other Eurozone countries. Falling prices would increase the real burden of debt of the private sector, requiring an even higher adjustment with the risk of further depressing demand (and in turn prices). Ernst & Young Eurozone Forecast Spring 2010 Spain 3
Unwinding of imbalances, ongoing recession and despite the large fiscal stimulus The fall in demand as a result of private sector deleveraging forced the government to increase its debt. The government acted quickly with a plan of tax cuts, infrastructure spending and subsidized jobs worth over 3% of GDP in 2009, one of the biggest seen in Eurozone. The steady improvement of public finances during the high growth period made such a massive intervention possible, but the consequences on public finances have been sizeable. In 2009 government deficit soared to an estimated 11.1% of GDP. The prospects for public finances appear difficult: the deficit is set to remain above 10% of GDP this year and the government s aim to reduce it to 3% of GDP by 2013 looks fairly optimistic. Low growth will weaken tax revenue and the persistence of high employment will maintain social security disbursements at a high level. On a more structural level, the drastic contraction of the property sector has durably deprived the government of a sizeable source of revenues (which has been estimated at around 2%-3% of GDP) that will have to be replaced. Therefore we expect a slower correction of the fiscal deficit and the 3% target will be probably reached in 2015. Figure 3 Contributions to GDP growth % year 8 6 4 2 0-2 -4-6 -8 GDP Domestic demand Net exports Forecast 1985 1988 1991 1994 1997 2000 2003 2006 2009 2012 The rapid deterioration of public finances left Spanish sovereign debt more exposed to the jitters of the financial markets. Spreads over 10-year German bonds widened markedly in conjunction with the Greek bond crisis in January and peaked at 100 basis points (bp) before falling to around 70bp at the beginning of April. This has forced the Spanish Government to come up with a plan to reduce its deficit. The government has announced an austerity plan for 2010-12. Several stimulus measures, such as the car scrapping schemes will be ended and government current expenditure is going to be curbed by freezing wage increases and hirings. The austerity plan includes also the reversal of some of the tax cuts enacted in 2008 and, more controversially, a 2% increase in VAT effective from July, which is likely to further depress domestic demand. Given the persistent weakness of domestic demand, the withdrawal of the fiscal stimulus will have to be timed carefully as too quick a tightening might choke off the recovery, with adverse consequences on growth. The external sector to help growth (to some extent) The large domestic imbalances translated into a yawning external deficit. In 2008 current account deficit reached almost 10% of GDP. The huge contraction in demand accounted for its fall to 5% the following year. We forecast that the external imbalances will progressively narrow, due to much slower demand growth but also to improvements in cost competitiveness. Like the other Southern European countries, Spain s exports have seen their price competitiveness decline steadily since the inception of the euro, as large nominal wage increases were not met by equally large productivity employment. The wave of job destruction has led to a fall in wage costs and the expected wage growth restrain (trade unions and employers associations have agreed to cap wage increases to 2.5% per annum until 2012) will provide some of the real exchange rate depreciation needed. Therefore in the short run the export sector will provide a sizeably positive contribution to growth. Source: Oxford Economics 4 Ernst & Young Eurozone Forecast Spring 2010 Spain
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