RECOVERY DYNAMICS STILL INCOMPLETE

While Spain was severely affected by the COVID-19 pandemic due to its dependence on the tourism sector (12% of GDP and 13% of employment), its recovery dynamic has deteriorated sharply following the outbreak of war in Ukraine. With the unfavorable environment in 2023, GDP will still need to return to its pre-crisis level. Despite a rebound in 2022, tourism was still 15% below pre-pandemic levels, with 15% fewer foreign visitors than in 2019. Nevertheless, unlike other European countries, Spain is not very dependent on Russian gas and obtains its supplies mainly from the United States and Algeria. Moreover, its geographical isolation and low level of gas connection with the rest of the continent mean that it is less exposed to the risk of supply disruption. This is all the more true as the country has numerous infrastructures (6 terminals) for importing liquefied natural gas. This isolation also allows the country, in the current context, to benefit from more attractive prices via the MIBGAS market (with Portugal). In addition, an “Iberian derogation” granted by the European Commission has allowed the country to cap the price of gas used in electricity generation since mid-2022 and until May 2023. Inflation, driven down by the moderation of gas and electricity prices at the end of 2022, should continue its downward trend. Nevertheless, as the rise in energy prices has spread to all products and services - core inflation reached 7% in December 2022 - inflation will remain at levels well above those recorded before the crisis. With wages growing slower, households will see their purchasing power shrink. As this period of uncertainty is conducive to precautionary savings, families will reduce their consumption. At the same time, companies will continue to suffer from higher input costs and wage increases while facing much higher financing costs as the ECB tightens monetary policy early this year. In a context of high economic uncertainty, the consequent reduction in margins will hamper business investment. In this gloomy panorama, activity will still be supported by European funds, with EUR 69.5 billion in subsidies (6% of GDP) for 2021-2026. In terms of foreign trade, exports will be limited by the sluggish regional economy since 62% of its exports are destined for the rest of the European Union (68%, including the United Kingdom).

PUBLIC FINANCES ARE STILL IN DEFICIT DUE TO THE EXTENSION OF SUPPORT MEASURES

The public accounts will remain mainly in deficit in 2023 due to the extension of numerous support measures. The government will thus continue the efforts to limit the impact of the rise in energy prices on households (reduction in fuel price, VAT on essential goods, and taxes on the cost of electricity) and some measures introduced during the pandemic (partial activity, guaranteed loans). Social spending will reach a record level (60% of the total budget). The government will finance part of these measures through temporary taxes on windfall profits of banks and energy companies (estimated revenue of EUR 7 billion or 0.6% of GDP over two years). As the ECB has announced that it will start reducing its asset portfolio in March 2023 by not reinvesting part of the maturing bonds, the cost of funding will increase further. In this context, the sustainability of the very high public debt will be one of the challenges in the medium term.

On the other hand, since 2013, the country has consistently posted a current account surplus, which has narrowed significantly in 2020 due to the fall in tourism revenues. The large surplus in the balance of services (5% of GDP before the pandemic, 2% since) offsets the structural deficits in the proportion of goods, primarily due to the country’s energy dependence, and in the balance of income (remittances from the Latin American and Moroccan diasporas to their countries of origin). Despite the confirmation of the return of foreign tourists, the current account surplus will remain stable in 2023 due to a still high energy bill and sluggish external demand. Despite a downward trend in recent years, the country’s net external debt remains among the highest in the European Union (69% of GDP by mid-2022).

HIGHLY UNCERTAIN 2023 GENERAL ELECTION, WHICH COULD SEE THE RETURN OF THE MAIN OPPOSITION PARTY PP

At the head of a heterogeneous coalition government since January 2020, supported by Unidas Podemos (UP, far-left, 33 seats) and a multitude of minor parties, including regionalist parties, Prime Minister Pedro Sánchez of the Socialist Party (PSOE, 120 seats out of 350) will see his term of office ended in 2023. The general elections, which will take place by December at the latest, look particularly uncertain. In early 2023, polls gave the main opposition party, Alberto Núñez Feijóo’s center-right Popular Party (PP), 31% of the vote vs. 25% for the PSOE. However, as the political landscape is particularly polarized and fragmented, the PP would likely be forced to form a coalition with the far-right Vox party (15% of voting intentions). While such an agreement was already reached in the region of Castilla y León in March 2022, the negotiation of such an alliance at the national level is more uncertain, especially given Feijóo’s more centrist position. Regardless of the outcome of these elections, the many small regionalist parties are once again likely to play a significant role in building a majority. Thus, the negotiations for the future governing coalition could be long and uncertain. Although Pedro Sánchez has granted pardons to nine separatist leaders sentenced in 2019 for organizing the referendum, the issue of Catalan independence remains topical, as the current executive is still calling for a referendum on self-determination in the context of negotiations on the region’s status.