Luis M Linde: The current macroeconomic setting and outlook for the
Spanish economy
Testimony by Mr Luis M Linde, Governor of the Bank of Spain, before the Parliamentary
Budget Committee in relation to the draft State Budget for 2016, Madrid, 18 August 2015.
* * *
Ladies and gentlemen,
I appear before this Committee at the start of the discussion and approval process for the
State Budget for 2016, the draft legislation for which was approved by the Government on 31
July. Let me begin by referring to the current macroeconomic setting and outlook for the
Spanish economy, after which I will move on to the core content of the draft Budget and to
the relationship between fiscal policy and recovery in our economy.
The external setting of the Spanish economy
The international financial setting is marked by a degree of volatility. The ups and downs of
the negotiations between the Greek authorities and European institutions and the IMF,
doubts over the economic situation in China and expectations about the normalisation of US
monetary policy have given rise to uncertainty in the principal markets, leading to movements
in share prices, long-term interest rates and exchange rates.
The agreement reached by the euro area Heads of State and of Government on 13 July
paved the way for a third financial assistance programme for Greece. This agreement has
reaffirmed the commitment to monetary union, patent both in the supportive efforts of its
members and in the observance of the common stability rules governing the functioning of
the Monetary Union.
The negotiations for the Third Bailout Programme for Greece unfolded as scheduled, and
there is every indication the Programme will be launched immediately and that the day after
tomorrow, on 20 August, the Greek authorities will be able to meet their ECB payments,
thereby avoiding a default with dire consequences.
This third bailout is, perhaps, the most complex and demanding of those so far agreed
between Greece and the European authorities and the IMF. This is so, among other things,
because it will include measures to reinforce the Greek banking system, which has been
greatly affected by events in recent months. Evidently, it is in the interest of all euro area
members that the new Programme should be properly adhered to, and follow schedule, so
that assessments of its implementation before year-end may be positive and provide for its
full effectiveness and continuity. Needless to say, the fulfilment of this third programme will
boost the growth of the Greek economy - the central and fundamental objective of this third
assistance programme - and will strengthen the euro area and its stability as a whole.
Recent developments on the international economic front are positive in terms of growth.
While growth in both the Asian and Latin American emerging economies remains below par,
the latest indicators show that the United States and the United Kingdom appear to have
picked up speed, following the weak first-quarter results this year.
Economic recovery is also holding up in the euro area. GDP grew by 0.4% in the first quarter
of this year and, on the latest preliminary estimate released last Friday, by 0.3% in the
second quarter. For the year as a whole, projections envisage figures of around 1.5%,
considerably up on end-2014 estimates. Private consumption continues to be the driving
force here, while the contribution of private investment remains moderate.
Turning to inflation, both actual and projected euro area rates have now turned around from
the declining trajectory marking their path throughout 2014, but inflation is still some way off
the ECB's reference level of 2% for the euro area.
The favourable performance of euro area economic activity and prices is underpinned by
certain external factors, such as the pick-up in the global economy and lower oil prices, but
also by other factors whose origin lies in the economic policy decisions adopted by the
national governments and the European authorities. These include most notably the reforms
undertaken in different countries and the more neutral stance of fiscal policies.
In any event, mention should be made of the contribution of monetary policy and the
significance of the decision adopted in January this year to enlarge the securities purchase
programme with the inclusion of government debt securities. Since then, we have witnessed
not only further monetary easing and the depreciation of the euro, but also a more uniform
transmission of expansionary impulses to the various countries in the area and, in particular,
to those such as Spain which were comparatively more affected by the fragmentation of
European financial markets.
The latest monetary policy measures have translated into a significant improvement in the
Spanish economy's financing conditions. This improvement is visible not only in the lower
cost of new funds, but also in a progressive - but slow - normalisation of credit in Spain.
Aggregate balances continue to post negative rates of change, reflecting the headway in the
deleveraging of our households and firms; however, these rates are increasingly less
negative and are compatible with the growth of new financing flows.
Performance of and outlook for the Spanish economy
On preliminary estimates in late July, the Spanish economy is expected to have grown by 1%
in the second quarter of this year. This growth rate highlights the dynamism of the current
recovery phase, now under way for two years.
Recent indicators suggest this expansionary trajectory will hold in the second half of the year.
On the latest Banco de España estimates, GDP growth should be slightly over 3% this year
and somewhat below that figure in 2016, meaning that growth in our economy will continue
to outpace the euro area average.
In terms of composition, national demand has continued to expand strongly. After several
years of containment in household spending plans, the favourable course of their disposable
income coupled with brighter job prospects and readier access to credit have been
conducive to the growth of consumption. Real estate market indicators show a recovery in
the sector which, while moderate and uneven across market segments and regions, is also
contributing to rekindling household spending. The buoyancy of final demand and the
progressive normalisation of financial conditions have continued exerting a positive effect on
business investment.
The firming of the recovery in the euro area economy has helped compensate for the recent
loss of momentum in some non-Community markets, meaning that exports maintain high
growth rates. Ongoing contributing factors are the gains in competitiveness in our economy,
which reflect the containment of costs in recent years by Spanish firms and, more recently,
the depreciation of the euro. Nonetheless, imports have responded forcefully to the pick-up in
domestic spending (we should remember that gains and losses in competitiveness are felt
abroad but also at home, in respect of imports), which has led, in net terms, to external
demand generally not contributing to the increase in activity.
The recovery in output has come in step with a more expansionary behaviour of employment
than might have been foreseen on past patterns. According to official Spanish labour force
data, from the second quarter of 2014 to the same period this year numbers employed are
estimated to have increased by more than half a million, making for an appreciable reduction
in the unemployment rate.
The greater flexibility enjoyed by firms, following the reforms approved in 2012, in adjusting
their working conditions to the macroeconomic and competitive setting has no doubt
provided for the creation of new jobs and, therefore, for the expansion of economic activity. If
the dynamics of the past 18 months hold, the increase in employment might place the
unemployment rate at around 20% in the fourth quarter of 2016.
As to prices, the increases in activity and employment have been accompanied by very low
inflation rates. The fall in oil prices has prompted declines in the general level of prices over
much of the past year. Yet core inflation, the indicator that excludes energy and fresh food
prices, has moved on a rising course over the year. And while still at moderate levels, this
indicator's recent trajectory suggests the risks of entering an overly prolonged period of very
low inflation have progressively been dispelled.
While in July the overall price index posted growth of 0.1%, influenced by fuel prices, inflation
at the end of the year is expected to be around 1%. In any event, the still-high spare capacity
in the economy presages a gradual recovery in inflation over the next two years.
The factors underpinning the recovery
The path of recovery of growth and employment has essentially been underpinned by the
restoring of macroeconomic and financial equilibria, which were severely eroded in the crisis.
Progress has been visible in the correction of the external imbalance, the deleveraging of
households and firms, the redressing of fiscal balances towards levels more compatible with
the sustainability of public finances and the restructuring and consolidation of the banking
sector. Unemployment, too, is showing clear signs of a correction.
The reforms undertaken within Spain, along with the headway in economic and monetary
union and the application of the highly expansionary monetary policy by the ECB, have
proven key to restoring confidence and providing for the progressive absorption of the
imbalances. By way of illustration, the proportion of Spanish public debt held by
nonresidents has risen from 30% in 2012 to 44% at present, an increase indicative of the
improved confidence in our economy, but also of its dependence on the perception abroad of
the soundness and continuity of our recovery. Despite what has been achieved in growth,
employment and restoring equilibria, we are far from having overcome all the factors of
vulnerability. Doubts over the continuity of the macroeconomic, fiscal and financial
rebalancing drive might curtail and lead to backtracking from these achievements.
We must not forget that the legacy of the crisis is still burdensome. Our unemployment rate
remains above 22%; households and firms are speedily reducing their high debt, but public
debt as a proportion of GDP has increased by over 60 pp since 2007; and the economy's
financial dependence on the external sector remains high, with a net debtor position of close
to 100% of GDP, far higher than in the other major euro area economies. Admittedly, though,
a portion of the recent increase in this latter ratio is due to the recovery in the relative value
of Spanish assets.
It is thus essential to persevere with the policies that strengthen confidence in our economy.
In particular, a swifter reduction in unemployment and ensuring that the correction of the
external imbalance continues calls for maintaining and, where possible, deepening gains in
competitiveness. Budgetary policy, for its part, should provide for the stabilisation, first, and
the reduction, subsequently, of the public debt/GDP ratio. I shall now turn to budgetary
policy.
Budgetary policy in 2016
The macroeconomic forecasts accompanying the draft State and Social Security Budget for
2016 entail the prolongation of the current expansionary phase. They estimate a 3.0%
increase in GDP in 2016, after a projected 3.3% increase for this year, rates that are slightly
up on the latest Banco de España forecast but that are of course feasible in the current
setting. Based on these forecasts, growth will be accompanied by a mild pick-up in inflation,
whose rate could average close to 1.1%, measured by the private consumption deflator. As a
result, the increase in nominal GDP would be around 4%.
At end-2015 the overall general government deficit target (4.2% of GDP) is expected to be
met. For 2016, a deficit of 2.8% of GDP is targeted, which would involve attaining - for the
first time since 2007 - a figure close to the 3% ceiling established in the Stability and Growth
Pact. In turn, the public debt/GDP ratio would stand at 98.2% in 2016, having posted a figure
of 98.7% at end-2015, which would mean a decline in this ratio for the first time since 2007.
The macroeconomic scenario used to devise the Draft Budget is, as I earlier stated, and with
slight upward differences, similar in terms of rates and composition to that I described when
referring to the Banco de España forecasts and, more generally, to the consensus of
analysts.
It is reasonable to expect the improved cyclical position and the reduction in public debt
yields to have a positive direct effect on public finances. In this respect, the upward revision
of the Spanish economy's growth prospects means that the budgetary drive required to
further the fiscal consolidation process, measured by the change in the primary structural
balance, will be very limited, in line with the latest Updated Stability Programme, which
anticipated that the fiscal policy stance would be essentially neutral in the 2015-2018 period.
Naturally, any slippage in growth or rise in financing costs would hamper fiscal consolidation,
making the process more demanding.
In 2016, according to the draft State Budget, the planned reduction in the deficit will stem
firstly from lower public spending, whose ceiling for the year as a whole, excluding that
derived from local and regional government financing arrangements, will entail a reduction of
4.4% in relation to that set for 2015.
The key expenditure-side measures are the 1% increase in the remuneration of public sector
employees and the refund in 2016 of the remaining 50% of the extra salary payment
eliminated in 2012. With regard to public employment, a standard 50% replacement rate has
been established for public-sector vacancies, rising to 100% in priority sectors. Overall, these
measures would lead to growth of 2.7% in wage expenses in the State Budget relative to the
2015 Budget outturn projection. The restrictions on current expenditure on goods and
services are maintained, with a 14% reduction.
Notable with regard to the Social Security system is the 0.25% revaluation of pensions, in
keeping with the provisions of the 2013 reform. The projected growth in spending on
contributory pensions in relation to the initial 2015 budget is rather higher, at 2.8%. This is as
a result of the foreseeable increase in the number of pensions and of the substitution effect
in terms of new pension claimants as opposed to deregistered pensioners, meaning that the
weight of pensions spending relative to total consolidated spending of the State and Social
Security system rises to 38.5% (37.8% in 2015). Mention should also be made of the
reduction in spending on unemployment benefits, by 21.9% relative to the initial 2015
Budget. This is due to the fall in unemployment and in the coverage rate of the contributory
benefit, which is partly offset by a shift in beneficiaries to non-contributory benefits, such as
reinsertion scheme income and economic assistance under the activation programme for the
unemployed.
Finally, a further decline in the interest burden on government debt is foreseen as a result of
the reduction in interest rates.
On the revenue side, the main measures include the application of the second phase of the
corporate income tax reform, and the impact over a full year of the related personal income
tax reform. It is estimated the budgetary cost of these measures will be offset by the increase
in revenue attributable to greater economic activity. Specifically, tax revenue before
assignment to local and regional governments is expected to increase by 6.2% relative to the
2015 budget outturn projection, and Social Security contributions by 6.6% compared with the
initial budget for 2015, which, given the macroeconomic forecast and the impact of the
aforementioned tax reforms, would signify a greater response by revenue to the pattern of
economic activity than that historically observed.
The uncertainty habitually surrounding estimates of the impact of tax changes, which peaks
at times of marked cyclical swings, will call over the rest of 2015 and in 2016 for a monitoring
of revenue that enables risks of slippage to be identified and pre-emptive action to prevent
such risks materialising.
Notably, in a country as decentralised as Spain where more than 40% of public spending is
by local and regional government, the Budget affecting central government and the Social
Security system offers a partial view of the budgetary policy for next year. We must wait until
October for the 2016 budgetary plan for the overall general government sector, including the
regional and local governments. It is that document which will allow a full analysis of the
budgetary forecasts for next year and which is, indeed, the draft on which basis the
European Commission will deliver judgement in autumn, under the new European
governance arrangements.
Meeting our fiscal consolidation commitments remains the best anchor for preserving
credibility and for ensuring, first, the stabilisation of the level of public debt and,
subsequently, its reduction. In this respect, the different tiers of government (central, regional
and local) must fulfil these commitments to the same degree of stringency. The Budgetary
Stability Law has instruments at its disposal to achieve this aim.
Conclusions
I shall now sum up. Compared with past experience in Spain, we are currently in a fairly
exceptional situation: GDP and employment are growing at over 3%, and the economy is
maintaining its gains in competitiveness vis-à-vis the external sector, whereby our exports
continue to increase their market share and we continue to run a substantial external surplus.
This combination, which has arisen solely over very short periods in Spain's economic
history in recent decades, obviously does not in itself guarantee any continuation, nor does it
mean that Spain has managed to sufficiently overcome the consequences of the crisis that
broke in 2007, as indeed the unemployment and foreign debt figures, among others, testify.
Continuing to pursue fiscal consolidation policies - the only means of containing the increase
in public debt relative to GDP and bringing about its subsequent reduction - and the policies
that have brought about our gains in competitiveness will prove pivotal to controlling our
financing costs, our balance of payments and, of course, the capacity of our economy to
generate employment.
Thank you.