Spain: Risk Assessment
Country Risk Rating
Business Climate Rating
- Corruption retrenching amid a renewal of political class, stronger fiscal frameworks
- Important post-crisis reforms (labor market, banking sector, bankruptcy law, etc.)
- Renewed competitiveness and strengthened export sectors
- Improvement of the financial situation of companies and banks
- Strong comparative advantage in tourism
- High private and public debt, very negative international investment position
- Dual labor market, high structural unemployment
- Large quota number of small, low-productivity companies
- Construction and consumption have high sensitivity to financial conditions
- Fragmented and polarized political landscape, territorial unity threatened by the Catalan independentist movement
The economy will cool down further amid weaker demand and global headwinds
Domestic demand started to lose momentum in mid-2019, meaning that the impulse of the 2018 minimum wage hike has probably been depleted. In addition, the prolonged political instability is by now weighing down on consumer and business confidence. Consumption of durable goods has been particularly hit. Furthermore, the pace of job creation will slow down, with unemployment stabilizing in the 13-14% range. Finally, households are using rising incomes to reconstitute their net wealth, with the savings rate projected to rise to 8.5% in 2019 and 10% in 2020. Because of this improvement to net wealth, private consumption is expected to recover slightly. This will bring the contribution of private consumption on par with investment as the two pillars of growth in 2020. Investment will remain robust, with both construction and industrial equipment supported by monetary easing. The transport equipment industry (including automobiles), which accounts for a fifth of Spanish exports, is facing significant pressures from protectionism and environmental regulations. More broadly, the manufacturing and agri-food industries will feel the effects of global trade tensions and the European slowdown. The tourism sector (15% of GDP) will again break records, with 84 million visitors in 2019, and continue to be a pillar of growth in 2020. Net exports, which carried growth in 2019, will again yield a positive contribution, albeit a smaller one due to an acceleration of import growth.
A fragile coalition, a rising far-right and a crisis in Catalonia
After negotiations to form a government with hard-left Unidas Podemos (UP) broke down during the summer, caretaker PM Pedro Sánchez of the center-left Socialist Party (PSOE) decided to call fresh elections, the second of 2019 and the fourth in as many years. The November poll again yielded a fractured parliament. PSOE and UP both performed slightly worse, going from 123 to 120 seats and from 42 to 35 seats, respectively. The sentencing of independentist leaders just before the election reinvigorated secessionist fervor in Catalonia, prompting massive and sometimes violent protests. At the same time, public opinion in broader Spain galvanized in favor of a more aggressive response to the Catalan crisis. This prompted the ascendance of the far-right party VOX, which doubled its presence in Parliament (from 24 to 52 seats) and became the third strongest political force. Liberal Ciudadanos, on the other hand, lost 47 of their 57 seats after going back and forth on supporting the investiture. ERC, the left-leaning Catalan independentist party, emerged as king-maker and allowed for the formation of a coalition government with an ultra-narrow margin of two votes. Even in government, the left-wing coalition led by PSOE and UP still faces the challenge of passing a budget. For this, it will again need the support of ERC, who is in line with the expansionist program but will try to extract significant concessions on the Catalan issue. The survival of the coalition is anything but guaranteed, and fresh elections are not impossible.
An expansionist budget on the horizon (if the coalition survives)
In a successful budget vote, the deficit should increase and Spain will stray further away from the targets demanded by the EU. The PSOE-UP program aims to index pensions on inflation, raise the minimum wage, increase welfare measures and energy subsidies, among other measures which will increase expenditure. The corporate tax rate will increase for large corporations and decrease for SMEs, with particular taxes for banks and tech platforms, as well as income tax hikes for high-income households. Spain could find itself at odds with Brussels only a year after exiting the excessive deficit procedure. While growth will not erode the public debt burden as much as it has in recent years, this effect will be more than compensated by cheaper debt service, with the ECB engaging in further monetary easing and sovereign spreads at record lows. Despite wage appreciation, a slowdown of productivity growth and a weaker external environment, the current account surplus will stay relatively stable thanks to the moderation of import demand. The structural difficulties of the manufacturing sector are offset by the robust tourism surplus, as well as the growing pharmaceutical and mining sectors. However, energy dependence translates into a goods balance structurally in deficit, and outflows of remittances and debt service payments ensure a negative income balance. With a large negative external position (70% of GDP) and external debt (150% of GDP), Spain is exposed to a reversal in global financial conditions, though this is mitigated by the large share of TARGET 2 flows (30% of GDP).
Sluggish economic growth in 2019
Spanish growth was already showing signs of slowing in 2018. Growth is expected to moderate further in 2019. The labor market will remain on a positive trend, with a continued decline in the unemployment rate, but job creation is projected to be less dynamic. The slight acceleration in wages, driven by the minimum wage hike and the increase in public sector pensions, should lead to a rise in disposable income. However, this gain will mainly benefit savings. Household consumption is set to decline further, especially in durable consumer goods. Conversely, accommodative financing conditions should continue to support growth in residential construction. The vigorous real estate market will likely continue to fuel the surge in investment, hampered by a slight slowdown in the corporate sector. Despite an external environment characterized by a high level of uncertainty over increased protectionism and a gloomy outlook in the eurozone, net exports are once again expected to make a positive contribution. As the effects of euro appreciation dissipate, exports are set to strengthen as they continue to capitalize on competitiveness gains.
The budget deficit is gradually narrowing, but by less than required under the stability program
The strong economic recovery since 2015 combined with fiscal consolidation under the European Excessive Deficit Mechanism have contributed to a gradual readjustment in the country’s public finances. Spain, the last eurozone country still subject to the corrective arm of the Stability and Growth Pact, emerged from the mechanism in 2018 with a government deficit of less than 3%. In 2019, the deficit is expected to continue to shrink, but it is difficult to determine to what extent. Pedro Sanchez’s socialist government presented its budget proposals to the Commission in October 2018, but has yet to have them approved by both chambers of the Spanish Parliament. Despite the support of the radical left-wing Podémos party, the government has only a slender majority and will struggle to get its budgetary policy ratified. The finance law presented by the government proposes to cut the government deficit to 1.8% of GDP. Expenditure is expected to decrease only slightly and to finance new social measures such as the increase in social security contributions due to the hike in the minimum wage, the indexing of pensions to inflation and the increase in social transfers (child protection, long-term care and paternity leave). These measures will be financed by increasing the taxation of dividends from large companies (domestic and foreign), as well as high-income households, and by introducing new taxes, including environmental, digital services and financial transaction taxes. If the budget is not passed, the 2018 budget will be repeated, leading, on a constant policy basis, to a smaller reduction in the government deficit (2.2% of GDP) and an unchanged structural balance. Presented as part of the European semester, the Spanish budget was rejected by the Commission, which considers that even if Pedro Sanchez were to implement these measures, the government and structural deficits would still exceed those set by the government, breaking the commitments made under the Stability Programme. Public debt is expected to decline only slightly, at a slower pace than that set by the stability program. However, this decline is mainly due to cyclical factors such as lower interest rates and higher inflation.
With a fragile government, snap elections could be on the way in 2019
In May 2018, Pedro Sanchez, the leader of the Spanish Socialist Party (PSOE), won, for the first time in the history of Spanish democracy, a non-confidence motion against former Prime Minister Mariano Rajoy after the verdict in the Gurtel case found that Popular Party members were involved in a corruption scandal. The socialist government, which is supported by the radical left-wing Podemos Party and the Catalan and Basque independence parties, remains on a fragile footing since it has a tiny majority with only 80 deputies. It is therefore at the mercy of the independence vote, particularly that of the Catalan party, making it dependent on relations between the State and the region. Accordingly, Mr. Sanchez’s government may have great difficulty passing its budget, which is the cornerstone of its social policy, especially since the PSOE does not hold a majority in the Senate. Parliamentary elections could thus be called. Since it is well ahead in the polls, the PSOE has not ruled out calling elections, but the party will have to choose the best time to do so. Various elections are already scheduled to take place in 2019, with municipal, regional and European elections all being held on May 26, 2019. In the regional elections held in December 2018 in Andalusia, the bastion of the Spanish left, the PSOE, which has run the region since 1982, failed to obtain a majority.