Spain: Risk Assessment
Country Risk Rating
Business Climate Rating
- Strong comparative advantage in renewable energy (solar, wind)
- Important reforms (labor market, banking sector, bankruptcy law, etc.)
- Increasing financial support from European institutions
- Important private-sector deleveraging (pre-pandemic)
- Manufacturing sector has shown reinvention capacity in recent times
- High private and public debt, very negative international investment position
- Dual labor market, high structural unemployment
- Large quota of small, low-productivity companies
- High exposure to pandemic-sensitive sectors
- Fragmented and polarized political landscape, territorial unity threatened by the Catalan independence movement
Comparative advantages in tourism and automotive become a double-edged sword
Spain’s productive apparatus is heavily reliant on pandemic-sensitive sectors. Tourism (14% of GDP and 15% of employment) ended 2020 with a 65-70% contraction and should keep severely underperforming at least until mid-2021. The automotive industry (11% of GDP, 18% of exports) has been recovering from the dramatic Q2 2020 contraction thanks to pent-up demand, but contracted by 20-30% nonetheless. Despite the robust government support (ERTE furlough scheme, loans and loan guarantees, specific support packages for tourism (EUR 4.2 billion) and automotive (EUR 3.7 billion)), some of the most vulnerable firms are unlikely to survive. The percentage of vulnerable firms (unprofitable and/or overleveraged) will rise from 20% to around 35%, reaching 65% in tourism, 55% in automotive and 40% in transport. Spanish firms have resorted more to loan guarantees (ES: 9% of GDP, IT: 7%, FR: 5%) than to furlough (at its peak, 15% of Spanish workers were in furlough, FR: 45%, IT: 28%). Thus, Spain is the only major European economy to register a noticeable rise in unemployment (from 13.7 to 16.2% by end 2020), as some of the cost adjustment has come through layoffs. All components of demand are in for a double-digit contraction in 2020 (consumption: -13%, investment: -18%, exports: -23%), before a rebound in 2021 (consumption: 5%, investment: 6%, exports: 13%). Only government spending will have a positive contribution in 2020-2021. A noticeable rise in bankruptcies is expected in 2021, but abnormally high household savings will cushion its effect on demand. With corporate debt set to increase from 127 to 136% of GDP in 2020, firm zombification will be a serious risk without insolvency reforms.
A “whatever it takes” European policy mix is a game-changer for fiscal sustainability
In order to sustain incomes while the economy is in hibernation, extraordinary deficit spending has been the order of the day. Automatic stabilizers (unemployment insurance and other social transfers, income tax, etc.) accounted for two-thirds of the deficit increase, with the rest coming from emergency discretionary measures (furlough, health spending, grants, and tax deferrals). Overall, expenditure rose by 10% and tax income fell by 13%, bringing the deficit to a record 14% of GDP. It will then decrease sharply as the economy recovers and emergency measures are phased out, but it will remain well above normal until at least 2022. Despite the record rise in debt, bond yields have reached record lows and appetite for Spanish bonds has never been higher. This comes from a radical shift in EU/ECB policy. Not only has the ECB fully embraced a “whatever it takes” philosophy by expanding QE by EUR 2.5 trillion, it is now purchasing the bonds of weaker member states in large quantities. Fiscal rules for 2020 and 2021 have been suspended and the European Stability Mechanism’s lending capacity has been boosted (EUR 240 billion), The EUR 750 billion Next Generation EU fund will be strongly geared towards the countries most affected by the crisis, with Spain set to receive EUR 140 billion over the next seven years. As long as this new consensus holds, Spanish debt can be seen as sustainable, not because of good economic fundamentals, but because European institutions will do whatever it takes to keep debt serviceable. A return of inflation would bring this consensus into question. The pandemic will have a broadly neutral effect on the current account, with both imports and exports of goods and services plunging. Banks are relatively fragile, although much stronger than on the eve of the 2008 crisis.
Urgency brings polarized parties to an uneasy equilibrium, but tensions escalate between regional and central governments
Prime Minister Pedro Sanchez of the centre-left socialist party (PSOE, 34% of seats) leads a fragile coalition government, supported by left-wing Unidas Podemos (UP, 10%) and smaller players including pro-independence parties. On the eve of the pandemic, the political landscape was becoming increasingly polarized and fragmented, with the historic two-party duopoly of the PSOE and center-right Popular Party losing votes to ideological radicals (UP on the left and Vox on the right) and regionalist parties. This resulted in a durable governance paralysis, manifested by recurrent snap elections (four in as many years) and an inability to pass a budget. Under the pressure of the pandemic, a new budget was passed with a wide majority, the first since 2018. Tensions between the central and regional governments arose over mobility restrictions, escalating into a standoff in Madrid. Catalan independentism remains relevant. It is thus hard to say whether the coalition government will fulfill its 4-year mandate. The country is also strongly exposed to European political developments, as European stimulus depends on continued German support.