Miguel Fernández Ordóñez: Overview of the Spanish economy in 2008
Address by Mr Miguel Fernández Ordóñez, Governor of the Bank of Spain, to the Governing
Council of the Bank of Spain on the occasion of the presentation of the Annual Report 2008,
Madrid, 16 June 2009.
* * *
Ladies and gentlemen,
The year 2008, the subject of the Annual Report I submit today to the Council, saw strains on
international financial markets heighten and turn into a global financial crisis which ultimately
triggered a widespread loss of confidence and an unprecedented worldwide economic
recession.
The financial tensions pushed a large number of banks from a broad range of countries to
the brink. And they have caused losses in the global financial system which, with all the due
caution any estimate calls for, amount to trillions of euro. The crisis affected all financial
markets, with some such as the asset-backed securities and interbank deposits markets
brought to a grinding halt. The habitual stress indicators surged to all-time highs around
October and remain at high levels despite the improvement in recent months. Clearly, the
globalisation conducive to the growth of finance in recent years has also been instrumental in
the swift and simultaneous spread of tensions, seeing them extend further.
Testifying to the real impact of the financial crisis in all its harshness was the contraction of
over 6% in the world economy at end-2008, and the decline in world trade of more than 20%,
both in terms of annualised rates, with most of the more advanced countries in full-blown
recession and with growth in the emerging economies dwindling substantially. The picture
worsened further in the first quarter of 2009, marking what currently appears to have been
the crisis at its height. The improvement in the latest indicators suggest contractionary forces
are abating, and the danger of a continuous deepening of the recessionary spiral appears to
have been allayed.
A real and financial crisis on the scale currently attained reveals deep-seated weaknesses
that affect the structural interlinkages of economic systems. In principle, the severity of the
crisis depends on the magnitude of the shock that triggers it and on the strength of the
economies on which it bears down. Evidently, from this perspective, the increase in US
subprime mortgage defaults, the bankruptcy of Lehman Brothers and any episode that may
now be singled out could not alone have triggered a situation of the seriousness and on the
scale that we have seen. Rather, such episodes preyed on economic and market structures
that were fragile and that had incubated unsustainable trends which could not be detected or
corrected in time.
With hindsight, it was clearly a mistake to assume that financial markets had virtually
unfettered capacity to improve risk management, and to have given excessive leeway to
selfregulation. Further, the continuous expansion of spending in some advanced economies on
the basis of growing private debt was a key component of the so-called "global imbalances",
about whose dangers many reports warned. But the detection of the problem did not suffice
either to properly diagnose its potential scope or to act accordingly. Indeed, economic
policies - and monetary and financial policies in particular - were, broadly speaking, clearly
excessively lax during the upturn.
Economic authorities now face the challenge of designing appropriate mechanisms to
strengthen institutions in their economies and, once the crisis is behind us, to prevent such
trends from recurring.
This challenge firstly involves a far-reaching review of some of the basic principles
underpinning financial market regulatory and supervisory policies in recent years. A new
balance must be struck between regulation and self-regulation, providing both financial
institutions and other investors with appropriate incentives to curb the natural tendency of
financial systems to accentuate business cycles. It will also be necessary to extend the
purview of regulators and supervisors, avoiding the presence of "blind spots" in financial
systems, and seeking a suitable response to the fact that markets and many market players
are increasingly more global, both in terms of the geographical scope of their actions and of
the products they trade. The crisis has also highlighted the advisability of designing and
setting in place a macro-prudential supervisory framework concerned with overall stability
and which thus complements individual bank-focused microprudential supervisory conduct.
Macroeconomic strategies should likewise be reviewed in light of the shortcomings they have
evidenced, in order to detect and correct in time the imbalances I referred to earlier. In the
case of fiscal policies, greater emphasis on the sustainability of public finances in the
medium and long term would have provided a more powerful countercyclical component to
offset excessive private-sector spending. As regards monetary policy strategy, careful
analysis should be made of the role to be played by the identification and appropriate
coverage of risks to stability that originate, develop and, in the worst-case scenario,
materialise in financial markets.
Fiscal and monetary authorities also share the substantial challenge of designing "exit
strategies". These allow, once the crisis has been overcome, for the winding down of the
various measures that central banks and governments have adopted in the face of the risk
that this crisis might bring the world economy to the verge of a depressive spiral with grave
consequences.
The raft of measures adopted has been wide-ranging, and many are based on common
principles jointly agreed upon in different international fora. Multilateral cooperation is crucial
for successfully tackling a global crisis. Further headway must thus be made along these
lines, harnessing opportunities such as that provided by the G20 meeting in London last
April. Not in vain, one of the lessons to be drawn from past experience is that economic
redeployment behind national borders and protectionism are sure-fire recipes for
exacerbating and prolonging global crises such as the present one.
Among the measures adopted, central banks in the advanced economies reacted decisively
by providing abundant liquidity to financial systems and substantially cutting their key interest
rates. These standard monetary policy measures were later complemented by other,
nonconventional measures. The European Central Bank began very early to increase liquidity
assistance and, from October, banks' applications for liquidity began to be met in full, while
the range of financial assets accepted as collateral for these operations was widened. The
main refinancing rate has been cut by 325 basis points to an all-time low of 1% following the
May meeting. And, as regards extraordinary measures, the term over which liquidity is
injected has been extended to 12 months, and funds are provided in currencies other than
the euro, thanks to cooperation agreements with other central banks; the European
Investment Bank has been granted the status of eligible counterparty, in order to smooth the
course of the loans this institution makes to European SMEs; and the decision has been
taken to purchase covered bonds and other similar types of asset-backed bonds. At the
same time, an expansionary monetary impulse of unprecedented proportions was set in train
in Europe, commensurate with the seriousness of the contractionary trends experienced in
the real and financial domain.
At government level, measures were aimed, first, at supporting financial systems and,
further, at stimulating demand. Among the former, selective bail-outs of banks of systemic
importance in the opening months of 2008 were followed, after the heightening of tensions in
markets as from the summer, by the raising of deposit guarantee scheme limits,
governmentbacked bank issues, public injections of capital and the purchase or the safeguarding of the
value of troubled assets held by banks. All these measures were under the umbrella of the
common principles for concerted action, at the level of the Heads of State and of
Government in Europe, and at the G20 meetings more globally.
Among the demand-stimulus measures, and aside from the operation of the automatic
stabilisers, which are pivotal in economies such as Spain, measures based on increased
public spending and aimed, on many occasions, at the groups and sectors most adversely
affected by the crisis, tended to predominate. The European Economic Recovery Plan
approved in December provides the reference point here for the coordination of measures in
Europe.
The Spanish authorities have also adopted a broad set of similarly geared measures. These
include the raising of the limit on deposit guarantees, the creation of the Fund for the
Acquisition of Financial Assets to purchase high-quality assets from Spanish banks,
guarantees for bank bond issues, various special financing facilities instrumented through the
ICO (Official Credit Institute), and the introduction of new personal income tax deductions
and the launching of the State Fund for Local Investment and of the Special State Fund for
revitalising the economy.
In Spain, the international crisis has impacted the economy at a particularly delicate time.
Already under way was a process of adjustment of the imbalances that had built up over a
long growth phase in which Spain had shared some of the above-mentioned factors of
fragility of the world economy, though not all of them and not to the same degree of intensity.
Certain components were undoubtedly particular to Spain.
Starting with the shared elements, the expansion of Spanish household and corporate
spending was based excessively on debt. True, the private sector was starting from relatively
low debt levels. Admittedly, too, euro area membership provided a particularly valuable
framework of stability and broadened financing possibilities. No less true, however, was the
fact that the single monetary policy stance proved overly lax during all these years for
Spanish domestic conditions and that fiscal policy, even though substantial budgetary
consolidation was undertaken, was not enough to offset the excessive monetary looseness.
A greater containment of current spending in the upturn would have helped curb the
imbalances and would have strengthened the underlying budgetary position.
Other features of our expansionary phase were, however, more specific. In Spain, productive
factors and financial resources were overly concentrated in the real estate sector. Further,
some of the structural constraints of our economy, such as productivity and the functioning of
the labour market, did not show sufficient improvement.
Another singular factor has been the position of relative strength from which the Spanish
financial system has faced the crisis. Spanish banks continued to pursue a "traditional"
business model during the entire upturn, focusing on retail financial intermediation. This is
certainly the main reason why, as is widely known, the role of Spanish intermediaries in the
generation, acquisition and financing of toxic assets has proven negligible. As the system's
supervisor, the Banco de España also contributed to entrenching this relative strength,
through a policy that focused on the cyclical pattern of building up provisions and on the
rigorous definition of the scope of consolidation of financial groups.
The Spanish financial system was thus able to ride the first wave of the crisis - the nature
and origin of which, let me remind you, were strictly financial - and readapted its sources of
funding to the new market situation. Loan securitisation therefore left centre stage to
deposits, short-term commercial paper issues and bank resort to the new abundant liquidity
provision policy implemented by the ECB for the whole of the Eurosystem.
Nonetheless, the transformation of the financial crisis into a real recession has given rise to a
second wave of risks to financial stability, whose nature is this time eminently
macroeconomic. The Spanish financial system is facing this second wave with the relative
advantage of having been less damaged by the first. But that is no guarantee of immunity
since the deterioration of the Spanish economy exerts pressure, through various channels,
on banks' and savings banks' income statements. I shall discuss this when I turn to the
financial system, after having analysed the situation of and outlook for the Spanish economy.
The Spanish economy did not escape unscathed from the global contractionary trends, and
in 2008 it underwent a far-reaching adjustment. Declines in GDP were evident from the third
quarter, leading the economy to post a 0.7% fall in output at year-end in terms of its
year-onyear rate. This recessionary pattern became more visible in the first quarter of 2009, when
GDP decreased at a year-on-year rate of 3%, while employment was down 6% on its level a
year earlier. As at world level, the improvement since in the latest indicators appears to point
to some easing of the contractionary trends.
The adjustment of the Spanish economy is impacting particularly those domestic spending
components which showed the greatest excesses during the long upturn. The origin of this
behaviour lies in the overlapping of a series of differing shocks. Firstly, the correction of the
real estate sector and of the high level of private-sector debt, which had started prior to the
crisis, already entailed significant elements of spending containment. Further, however, the
forceful effects of the international financial crisis and of the global recessionary trends
compounded this situation, amplifying the contraction of domestic demand, eliminating any
possible external support and exacerbating the loss of confidence. This latter factor was,
moreover, particularly affected by the impact of the far-reaching deterioration of the labour
market on income expectations, an important matter which I shall return to later.
As a result of these factors, there was a marked decline in Spanish household spending,
both on consumption and on residential investment. In 2008, both items accounted jointly for
80% of the decline in the contribution of national demand to output, which stood at slightly
more than 4 pp for the year on average. Naturally, the heightening of the financial crisis in
the final stretch of the year, and the subsequent deterioration in macroeconomic
expectations, saw the contractionary impulses spread to the other components of domestic
spending, meaning that business investment ultimately collapsed in the second half of the
year. Indeed, the sole prop of spending in 2008 was net external demand, which showed a
marked increase with a contribution of 1 pp to GDP growth for the year as a whole and of 2.3
pp in the final quarter. Set against the progressive weakening of the world economy, this
improvement in the external contribution was due to the notable slowdown in imports,
whereby the fall in GDP is proving more moderate than in other countries.
The decline in residential investment, along with the sharp pick-up in the household saving
rate to 13% of disposable income, entailed an abrupt reduction in household net borrowing,
insofar as households generated a net lending capacity for an amount equivalent to 0.6% of
GDP over the year as a whole. The slowdown in household debt intensified to the extent that
the debt/GDP ratio began to fall in the closing months of the year. In the case of businesses,
the decline in productive investment also led to a sharp reduction in net borrowing, which
was ultimately manifest in a slowdown in the rate of increase of the debt ratio, although the
interest burden still continued to increase.
As a result of the change in the sign and intensity of foreign trade, there has been a
reduction in the nation's high net borrowing, which stepped up in the opening months of
2009, as shown by the 25% decline in the first quarter when compared with the same period
a year earlier. Foreseeably, the decrease in the external deficit will continue apace in the
coming months, and it may have halved within two years, evidencing the speed of the
adjustment induced by the depth of the contraction in domestic demand.
On the supply side, the weakness in activity passed through to all productive branches, but
with particular force to construction and industry. Employment was rapidly eroded following
fourteen years of uninterrupted job creation. In late 2008 and early 2009, job destruction was
most intense and, since the labour supply remained notably strong, the unemployment rate
surged to 17.4% in the first quarter of the year, bearing down most on the young and the
lesser skilled.
Regrettably, this high unemployment figure shows that one of the risks I referred to when
presenting the Annual Report for 2007 has materialised. I insisted then on the need to
prevent the adjustment of the Spanish economy from falling predominantly on employment,
as in previous recessions, since that would have significant adverse multiplier effects on
demand and activity, via disposable income and future income expectations. And as stated,
this is proving precisely to be one of the most powerful channels for the propagation of
contractionary trends. One of the traditional behavioural patterns of the Spanish economy is
thus recurring, revealing the persistent weaknesses in its institutional framework and
arrangements that must be corrected.
The high increases in labour costs witnessed last year, reflecting the rise in inflation in the
first half of the year, were not favourable to employment. Wage cost pressures have only
begun to abate in 2009, in line with improved inflation expectations, following the declines in
the rate of change of the CPI in recent months.
Indeed, after inflation had moved on a markedly rising trend in the first half of 2008, prices
slowed sharply in the closing months of the year as a result of the abrupt turnaround in oil
and food prices and of the marked sluggishness of demand. This deceleration has become
more pronounced in 2009 to date, with the annual rate of change of the CPI falling in March,
April and May (-0.9% in this latter month). While the CPI trajectory reflects the correction of
some price rises in the most volatile components in the opening months of 2008, the ongoing
recession, which is severely affecting consumption, is prompting an adjustment in prices and
margins that is beginning to impact services and the other less volatile components. And this
means that the price growth differential with the euro area has turned negative, and will
foreseeably remain so in the coming months.
The CPI is expected to continue to temporarily post negative rates of change in the coming
months and, once the statistical effect linked to higher oil prices in the first half of 2008 is
stripped out, inflation should resume positive although very moderate rates of change. This
price behaviour is in line with the improvements in competitiveness required to lessen the
scope and costs of the recession, to prompt the necessary adjustments and to embark on a
sound recovery.
The outlook for the Spanish economy points to declines in GDP over the rest of the year that
should lead to a significant fall in 2009, albeit slightly lower than is forecast for other
European countries. It is highly likely that the worst of the contraction has already passed,
and that the intensity of the restrictive impulses will begin to diminish in the second half of the
year as the broad range of measures implemented progressively deploy their effects. As a
result, the fall in activity in 2010 is expected to be less pronounced. The course of
employment in this scenario, in any event, is a cause for concern; despite the somewhat
more positive signals given by some recent indicators, linked in part to seasonal factors, job
destruction may run for some time and the unemployment rate may continue further on its
rising trend.
The imbalances built up during the long expansionary phase, in the form of the inflation
differential and the resort to external financing, are being swiftly reabsorbed, providing an
unquestionable source of relief in the global outlook described. Yet this rapid correction is
occurring on the back of an excessive brake on activity, entailing major costs in terms of job
destruction, higher unemployment and the deterioration of the productive fabric. If the
institutional features behind these developments are not reformed, there is a risk that, even
after the most acute phase of the crisis is over, they will continue to hold back the Spanish
economy's possibilities of recovery and become a drag on further progress in real
convergence with Europe.
To rebuild sound foundations for growth, economic policy should contribute to setting in
place the appropriate conditions to revive confidence, to return financing flows to normal and
to reinvigorate spending plans. That will require headway in restoring health to the financial
position of the private sector and the banking system, the completion of the adjustment in the
real estate sector and, above all, improvements in productivity, competitiveness and job
creation incentives.
The correction in the construction sector is proving most intense. And although there is still a
sizeable stock of unsold housing, the reduction in interest rates and in house prices will no
doubt make the residential market more accessible. Cheaper borrowing terms and the
easing of credit restrictions will also help breathe new life into spending. But it will be the
recovery in external demand, as we move out of the international crisis, that will act as the
main support. And the more competitive national production is, the more powerful this effect
will be. To this end, and as frequently indicated by the Banco de España, sustained
increases in productivity must be attained and the pertinent cost, margin and price
adjustments made.
The scale of the global recession called for the implementation of demand-side expansionary
fiscal and monetary policies. And it is in this context that the substantial cuts in central bank
intervention rates seen over the past year should be understood, cuts that have been
conducive to a significant decline in the cost of financing and to a sharp expansionary
stimulus. In Spain, the potential effects of this pass-through are particularly powerful as a
result of the prevalence of floating interest rate loans.
Spain, too, has moved to adopt demand-stimulating discretionary fiscal measures in order to
bolster the expansionary impact of the substantial transfers of income to the private sector,
especially to households, arising from the operation of the automatic stabilisers. The fiscal
drive by the Spanish authorities is of a considerable scale and generally exceeds that of
other developed countries. Its budgetary impact has been accentuated, moreover, by the
sharp fall in tax revenue as a consequence of the economic recession and of the magnitude
of the real estate adjustment; accordingly, the fiscal situation has deteriorated rapidly.
It should be recalled that the Spanish economy started from a healthy budgetary position,
with a surplus of somewhat over 2 pp of GDP and a very low public debt ratio compared with
our European counterparts. Indeed, at last year's presentation of the Annual Report to the
Council, I referred to budgetary policy as one of the main underpinnings of the Spanish
economy in this phase of the cycle and I pointed out that the favourable fiscal position would
allow the automatic stabilisers to operate to their full extent without jeopardising budgetary
stability.
One year on, the fiscal results for 2008 and the projections available - which point to a
budget deficit approaching 10% of GDP in 2010 and to a public debt ratio that might exceed
the threshold of 60% of GDP - augur a drastic change in outlook, with the possibilities of
fiscal policy boosting spending having been exhausted.
Fiscal measures that call into question the commitment to budgetary stability in the medium
term should be categorically avoided, since that would adversely affect the cost of raising
funds and confidence in the Spanish economy, and it could also generate expectations of
future tax rises that might ultimately sterilise the expansionary effects of the measures
adopted. Public-sector debt must be prevented from becoming an obstacle once the Spanish
economy is better placed to grow. Accordingly, priority must be given to promptly defining a
credible strategy to reduce the deficit to levels compatible with budgetary stability, once the
exceptional circumstances that led to the rise in the deficit have disappeared.
The demand-side expansionary fiscal and monetary impulses are proving very powerful and
are contributing to the alleviation of the contractionary forces at play. Evidently, though, the
possibilities of further using these types of policies have become notably constrained, both at
home and abroad. It should also be borne in mind that, once the economic and financial
fragility beleaguering the world economy has been resolved, demand-side policies should
adopt a more neutral stance.
All these considerations on the diagnosis of the Spanish economy in the current international
crisis and on the limited leeway available to demand-side policies mean, rather, that
economic policy has a central role to play in implementing the reforms that help improve
productivity and the behaviour of the factor and product markets. It is in this area that the
authorities undoubtedly have effective room for manoeuvre, and also considerable
responsibility.
Let me begin with the labour market, which is where the most pressing problems are to be
found. The scale of job destruction has once more highlighted the existence of distortions
that emerge with force in recessions and compound contractionary trends. And there is a risk
that, as in the past, the surge and change in level in unemployment may stick and that this
will delay subsequent recovery. Labour market dysfunctions are also closely linked to the
discouraging behaviour of the economy in respect of gains in economic efficiency and in
productivity, hampering the possibility of attaining genuine improvements in competitiveness
and of raising growth potential. Economic recovery in Spain requires structural changes that
will encourage technologically dynamic productive sectors with high growth potential to take
up the baton from construction. For this to occur, the labour market must function so as
reallocate resources, increase and adapt workers' skills to new demands, and make
productive processes within companies more efficient.
Reform should focus on ensuring that labour conditions adjust to the economy's different
cyclical junctures and, in particular, to the specific circumstances companies or productive
sectors face. That should prevent the adjustment coming about through pushing large
numbers of workers out of the market. Changes are also needed in hiring arrangements.
These must allow workers who have lost their jobs to return promptly to active working life,
so they do not spend long periods unemployed, the consequences of which were so adverse
in the past. Improvements in labour market intermediation systems and in mobility and
training for the unemployed are also very important.
Resolute action here would help check business closures and lessen the risk of
decapitalisation, which is admittedly very high at present. If, moreover, significant progress
were made in eliminating administrative formalities, the Spanish economy would be better
placed to resume a high growth rate once the world recovery began.
To bring about a new productive pattern enabling high rates of potential growth to be
regained, structural measures must span a wide range of fields. Improving the level of
educational attainment of the labour force is vital for raising the quality and productivity of
human capital. Decisive and effective action in boosting the knowledge economy should
contribute to substantially increasing technological capital and to bridge the gap blighting the
Spanish economy in this area. And improving the competitive environment in which
businesses take their decisions is crucial if all these steps are to result in overall gains in
efficiency and competitiveness. One key area for progress along these lines is liberalisation
in the services sector, which encompasses some of the most dynamic activities with the
greatest employment-generating capacity and where new forms of labour relations may be
more successful. Further, the growing interaction between industry and services has
increased the influence of the latter in determining international competitiveness. It is likewise
necessary to continue pushing through liberalisation and competition in the network
industries, so that the conditions in which inputs are provided to other productive activities
allow Spanish companies to compete on an equal footing with other developed countries.
The liberalising impulse must be regained, in particular, in the energy, telecommunications
and rail transport sectors.
I shall devote the final part of my address to analysing the situation of the Spanish banking
system in greater detail.
An economic environment marked by a real and financial global crisis poses a first-order
challenge to the normal pursuit of banking activity. As stated, the first wave of shocks,
confined essentially to the financial arena, did not have appreciable direct effects on our
banks, and the indirect effects were absorbed in an orderly fashion. However, as from last
autumn a second wave of shocks was unleashed, resulting in a real global crisis which,
naturally, is impacting Spanish banks.
The Spanish economy's entry into recession has consequences for banking and bad debts.
In particular, such repercussions include those arising from the high sensitivity of
employment - and, therefore, of households' ability to pay - to the deterioration in activity,
and those from the adjustment of the real estate sector, the relative weight of which in bank
balance sheets had become significant.
The deterioration in the economic situation reduces the demand for credit of bank customers,
whose spending plans and income expectations are normally revised downwards during
economic downturns. Likewise, banks become more cautious about granting loans as a
result of the subsequent upward revision of the risk profile of borrowers. In combination,
these two factors translate, as we have actually seen, into a substantial slowdown in bank
credit. Based on the past cyclical behaviour of this variable, the growth rate of bank credit will
tend to stand below that of GDP. This cyclical component of credit is currently being
reinforced by the difficulties still besetting wholesale funding markets and by the need both in
Spain and in the rest of the international financial system to redress the high levels of
leverage attained in the past.
The behaviour of banks' bad debts also follows certain cyclical patterns. Defaults increase
when, as now, the deterioration in activity weakens the financial position of bank customers,
particularly in the case of households whose members lose their job. Thus, following a long
economic boom that brought doubtful assets ratios to historically low levels, the year 2008
saw a sharp rise in such ratios, and the persistence of difficulties in the real sector of our
economy suggests that pressures have not yet dissipated. This is a risk that banks must be
mindful of and manage appropriately.
The diminished pace of activity and the increase in bad debts, which are general trends
across Spanish banks and savings banks, exerted pressure on their income statements
already in 2008. The recurring income inherent in a traditional banking model, which is
therefore less reliant on financial market developments, explains why, despite the difficult
economic circumstances, bank results were positive, in clear contrast to those reported by
many of the institutions in other developed countries' banking systems.
But Spanish banks' results will come under considerable pressure in the future. In the short
term, as a result of the foreseeable increase in bad debts. In the medium term, because
competition for funds will squeeze operating margins and this pressure will not be readily
offset as it was in the past by the generation of higher volumes of business. And I do not
believe that the ongoing deleveraging of the financial sector, and of the economy in general,
taking place both in Spain and globally, should be viewed