27 July 2012

IMF Executive Board concludes 2012 Article IV consultation with Spain

The IMF mission underlined the urgency of additional progress in boosting competitiveness and jobs, given the high level of unemployment in particular among the youth. It encouraged a rapid implementation of the government's structural reform agenda.

The economy has entered an unprecedented double-dip recession with unemployment already very high and public debt increasing rapidly. On the positive side, imbalances are improving, especially the current account deficit, inflation, and unit labour costs, and deleveraging is underway. But market confidence remains weak. Spain has suffered a sharp reversal of private external financing flows in the second half of 2011 and early 2012. After an LTRO-induced respite, market tensions re-emerged in the spring. Yields and spreads on Spanish government bonds remain high and banks unable to tap private unsecured financing.

Many major policy actions have been taken in recent months on several fronts. On banks, provisions and capital requirements have been raised, independent valuations commissioned, and a backstop provided with support from Spain’s European partners. The key policies incorporated to accompany this backstop are: (1) identifying individual bank capital needs based on a comprehensive asset quality review and an independent bank-by-bank stress test; (2) recapitalising, restructuring and/or resolving weak banks; (3) segregating legacy assets of weak banks into an asset management company; (4) burden sharing from hybrid/subordinated-debt holders in banks receiving public capital; (5) strengthening supervision and regulation. The financial assistance will cover estimated capital requirements with an additional safety margin, estimated as summing up to €100 billion in total, to be disbursed in several tranches over the 18-month duration of the program.

On fiscal policy, the 2011 fiscal slippage was about 3 per cent of GDP, much worse than expected, underlining the challenges of fiscal consolidation at all levels of government. The new government introduced a first package of measures in December, an ambitious 2012 budget was adopted in June, the fiscal framework was improved, and a scheme for clearing sub-national arrears was put in place. In July, the Council of the European Union recommended another year (until 2014) for Spain to reduce its deficit below 3 per cent of GDP and loosened the targets for 2012–14. To help achieve the new targets, the government recently announced a series of measures—including increases in VAT and reductions in civil service remuneration and unemployment benefits. Regarding regional governments, the government initiated the first step in the warning process for several regions at risk of missing targets, monthly reporting from October, and a new funding mechanism.

Directors commended the Spanish authorities for the measures taken to restructure the financial sector in a challenging environment. They welcomed the European financial assistance for the recapitalisation of Spanish financial institutions and the accompanying policies, as well as the envisaged role of the Fund in monitoring progress. Directors stressed the need to continue providing official support for weak but viable banks, resolve non-viable banks, and implement a comprehensive strategy to deal with legacy assets. Further efforts are also needed to upgrade supervision, crisis management, and the resolution framework. Directors considered that allowing direct recapitalisation for Spanish banks through the European Stability Mechanism would help break the adverse feedback loops between the sovereign and banks, and have positive spill over effects for the wider euro area. Faster progress toward establishing a common supervisory mechanism for euro area banks would also boost market confidence.

Directors welcomed the new fiscal package that supports a smoother path of consolidation in the context of weaker growth, although a few saw scope for a less front-loaded adjustment. Directors urged the authorities to adhere strictly to the agreed fiscal path, stressing the need for a credible medium-term budget strategy to reduce deficits and safeguard debt sustainability, while protecting the most vulnerable. In this context, they called on the authorities to take additional measures as necessary, especially on the revenue side, as well as use the available tools to enhance fiscal discipline, particularly at the sub-national level. Directors welcomed significant progress in strengthening the fiscal framework and looked forward to further improvements.

Full press release

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