Closing the gaps

Rafael Pampillón. Professor. IE Business School

2 January 2013

Although the Spanish economy will continue to shrink this year, some imbalances are already starting to even out.

In 2013 the Spanish economy will continue to contract. This forecast is based on the further deterioration of the labor market, the continued effort of the private sector to reduce debt, fiscal consolidation, demanding credit conditions, all this against a backdrop of continuing crisis in the Eurozone. Thus the OECD foresees a) a substantial drop in spending on consumer goods by households (-2,3%), greater, therefore, than that registered in 2012 (-1,9%), which reflects the high level of unemployment; b) that the collapse of the gross fixed capital formation will follow, which having fallen by 9% this year will once again fall by the same amount in 2013 (due to the lack of expectations among entrepreneurs and credit restrictions); and c) that the only positive contribution to economic growth will come from external demand. As a result, the OECD says that the Spanish economy will contract by 1.4% in 2013 (The Economist calculates that it will shrink by 1.7%).

Given this depressing scenario, unemployment will reach catastrophic levels in 2013 – 6.2 million people will be out of work. That is why it is not surprising that the majority of Spaniards believe that the economic situation is currently bad, or very bad. The state and supranational powers have the responsibility to minimize the impact the crisis has on the well-being of citizens. In order to achieve this they will need to lay the foundations on which to build a solid recovery through the necessary correction of imbalances resulting from the expansive phase of the cycle. Fortunately, as we will now see, some of these imbalances are already being reduced and this trend will continue in 2013.

Hence, in 2012 the government maintained its commitment to reduce the public deficit (not quite reaching its objective but certainly moving in the right direction), which required the government to step up austerity budget measures (reduction in public spending and a rise in rates of personal income tax and VAT). They applied these measures last year, and will also apply them next year, with all the negative consequences on consumer levels, investment and the labor market that this implies. The positive side is that the public deficit, which reached over 11% of GDP in 2009, stood at around 7% for 2012. In 2013 the deficit will drop below 6%, with will require another “turn of the screw” to further reduce unproductive public spending by autonomous regions, privatization or closure of many public companies, and a pension freeze.

The restructuring of the banking sector

Moreover banks are now undergoing rationalization processes. As a result the gap between the accounting value of many assets (particularly those associated with construction) and the market value is slowly closing. Throughout 2012 a raft of measures was put in place designed to reduce the imbalance (by providing support for banks’ liquidity, fostering the restructuring of banks in particularly delicate positions and raising levels of capital and provisions, especially those aimed at covering construction-based risks).

Consequently banks are becoming more solvent and transparent and are regaining their credibility. In 2013 the aim should be to have a definitive solution to the banking system problem, and to break the perverse link between the banking system and public debt, which would help credit to flow into the economy and promote economic growth.
The foreign deficit disappears.

Throughout 2012 companies continued to cut costs and improve their levels of competitiveness. This permitted an increase of 4% in the export of goods and services. The balance in terms of Spain’s current account, which in 2007 and 2008 produced GDP deficits of 10%, is that it reached the end of 2012 with a GDP deficit of just 2%. According to the OECD, exports are set to grow in 2013 by 6.4%, a very acceptable figure if we consider that our main client, the Eurozone, will still be in recession. Effectively, the Central European Bank has estimated that the Eurozone’s GDP will fall by 0.3% in 2013, although it forecasts growth of 1.2% for 2014. The evolution of Spain’s foreign trade sector looks very promising, which could suggest that the current account deficit will drop in 2013 to below 1% of GDP.

In short, in 2013 Spain will manage to redress some imbalances, namely those pertaining to foreign trade and the finance system.  Fiscal policy will have to continue to be restrictive in order to further reduce the deficit.  There are two imbalances, however, that will not be redressed in 2013. One is the labor market, and the other is housing. But there are still reasons to be optimistic, given that as Spain lifts itself out of the crisis on the back of increasing external demand, the economy will begin to grow and so will the demand for labor. Also, but in the longer term, the gap between supply and demand for housing will begin to close and the real estate sector will eventually climb out of the doldrums and start heading for recovery.

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