27 April 2012

Miguel Fernández Ordóñez: Recent developments in the Spanish economy

The duality of the problems, with one purely national component and another genuinely European one, coupled with the growing interrelatedness of euro area economies as a whole, created a breeding ground in which the tensions took on a systemic nature. Moreover, it is widely known that to correct the weaknesses detected in the initial design of the euro project, the Member State governments have embarked on a thorough revision of the mechanisms for European governance. This process has already yielded some results, including the legislative initiatives adopted in what is known as the “six plus two package”; the Treaty establishing the European Stability Mechanism, the new permanent European crisis-management mechanism; or the Treaty on Stability, Coordination and Governance in the euro area. But the flip-side is that this process has moved forward in fits and starts, it has not enjoyed a broad degree of consensus and it has sometimes failed to be as rigorous and ambitious as the gravity of the situation required.

A frequently-voiced criticism of the ECB’s three-year LTROs is that such an extremely generous provision of liquidity will tend to mask the underlying problems of the most vulnerable financial systems, thereby weakening the thrust of governments’ reforms in this area. This has not, of course, been Spain’s experience. A glance at the measures adopted in Spain shows that the process to clean up, restructure and recapitalise the Spanish credit system has lost no momentum whatsoever. Rather, the opposite is true. Throughout last year and in the opening months of 2012, the process has been stepped up to adapt it to changing circumstances, marked by a growing deterioration in economic and funding conditions. After resolving the governance and ownership-structure problems affecting the system in the initial stages of the tensions, efforts have focused recently on further strengthening banks’ capital and provisions, thereby keeping up the pressure for the necessary restructuring of the sector.

Allow me to refer briefly to the delicate cyclical situation that frames the context of the State budget for 2012. The intensification of the sovereign debt crisis from the summer of last year interrupted the mild recovery that the Spanish economy had begun a year earlier, with a decline in GDP of 0.3 per cent in the final quarter of 2011. This pattern ran into the first quarter of this year, so that the Spanish economy is, once again, in recession. As in the case of the 2008–09 recession, national demand is displaying the greatest weakness. All domestic demand components declined in the fourth quarter of 2011 and have continued to do so during the first few months of this year.

In these conditions, the outlook for 2012 is not favourable and remains subject to a high degree of uncertainty. Broadly, the Banco de España’s view does not differ greatly from that of the Government implicit in the macro-economic table accompanying the Budget. The process of adjustment of national demand will continue. Private consumption will be affected by the decline in employment and by the lower support that general government will be giving to household income. However, the impact of these two factors will be partly offset by more moderate price increases and, probably, by a continuation of the decline in the saving rate, although the margin available for this to smooth the pattern of private consumption is increasingly limited.

The 2012 Budget envisages an increase in revenue from tax measures falling basically on household and corporate income. Also, a special charge is imposed for the regularisation of hidden assets. The revenue-raising potential of these measures is expected to offset the fall in revenue due to the unfavourable trend in tax bases deduced from the macroe-conomic scenario accompanying the Budget. Last year’s experience, when the bulk of the budget deviation stemmed from the adverse performance of government revenue, showed that it is essential to budget prudently for this variable. In this respect, the projected course of overall budget revenue is subject to downside risks.

The reasons for this are various. First, because both the expected corporate income tax receipts and any other tax revenue will depend on the ultimate effectiveness of the numerous legislative changes, which is particularly uncertain in the case of the special charge on undeclared income. It should also be emphasised that the Spanish economy is in the midst of a process of macro-economic adjustment and, as noted above, its growth prospects depend on the external sector, which tends to yield only moderate increases in tax revenue in the short and medium term, particularly if this is accompanied, as in the Spanish case, by an adjustment in the real estate sector.

On the expenditure side, the draft Budget proposes highly significant reductions concentrated in capital expenditure and also in current transfers and goods and services purchases. In the case of transfers to government-owned corporations, it is important for the planned reduction to be accompanied by adjustments of similar size in the effective expenditure of these entities, so as to achieve a lasting reduction of the imbalances. Here, too, the Budget projections are generally not free from risk. First, because it is often difficult to restrain the high inertia of certain items, frequently resulting in the past in overshooting with respect to the initially budgeted figure, particularly in the case of goods and services purchases. Nor can we rule out further unfavourable changes in those items, such as unemployment or pension benefits, whose size depends on external factors, such as the unemployment rate, population or inflation. This is related to the fact that the risk of deviating from the budget is higher in social contributions.

Simultaneously, it is important that the process of budgetary consolidation be accompanied by a strengthening of the national budgetary framework, so as to allow governments at all levels to meet their commitments. In this respect, the reform of the Constitution in September 2011 so as to include the deficit and debt ceilings set at European level, which was subsequently implemented in the draft budgetary stability law, was designed to meet this need and is fully consistent with the recent EU governance reforms.

Finally, the draft stability law retains the clause stipulating “no bailout” between governments which was introduced in the previous law. I consider that, as at European level, this clause is crucial to prevent the cost of a government’s inadequate fiscal conduct from being passed on to others and to ensure that the capital market exercises disciplinary effects. At the same time this draft law allows regional and local governments to request extraordinary liquidity support measures from the State. In this case a plan to ensure that the fiscal targets will be fulfilled must be submitted and the payment of each tranche of financial aid must be dependent on such fulfilment. In this respect, in the opening months of this year, the Government set in train various regional and local government support mechanisms in order to smooth the refinancing of their existing debts or payment to trade creditors. The financing mechanisms agreed also require fulfilment of adjustment plans. It is now crucial to insist on strict compliance so that this type of aid does not provide inappropriate incentives.

In short, the current budgetary imbalance has become one of the main obstacles to growth of the Spanish economy. Correcting it is urgent and unavoidable. What is thus needed is a fiscal adjustment strategy based on commitments made at European level. This strategy has to be accompanied by a strengthening of the national budgetary framework, as reflected in the constitutional reform, and by the application of the medium- and long-term reforms that enable the challenge of population ageing to be addressed. The credibility of this strategy, which calls for absolute rigorous compliance with the short-term objectives set in the 2012 draft Budget law, will determine whether economic agents regain their confidence in our economy, which is the key to a sustained recovery of activity.

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