Miguel Fernández Ordóñez: Developments in Spain
Testimony of Mr Miguel Fernández Ordóñez, Governor of the Bank of Spain, before the
Senate Budget Committee in relation to the draft State Budget for 2012, Madrid,
30 May 2012.
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Ladies and gentlemen,
I appear before this Committee at a vitally important juncture for our country. A severe crisis
continues to assail the Spanish economy, making it a centre of attention not only for the euro
area countries, but probably for the world economy. Against this background, the 2012
Budget is a key instrument for shoring up the credibility of our public finances and our
economic policy in general, and for restoring confidence in our economy.
The seriousness of the current situation is inextricably linked to the European sovereign debt
crisis, which worsened last year, spreading to countries with sounder economic
fundamentals than those initially affected. The depth of the crisis and the difficulties in
overcoming it can be attributed to the macroeconomic imbalances built up by various
economies, imbalances that reached an excessive scale owing, perhaps, to the apparent
protection afforded by the Monetary Union. But the current critical situation may not be
understood without considering a European element relating to the absence of suitable
mechanisms within the Union to tackle problems on this scale and to the difficulties of
shaping a strategy enabling them to be corrected in an orderly manner.
The depth of Spain's problems, along with the lack of a suitable European response, has led
moreover to the crisis becoming systemic, acutely affecting countries with problems of a
different nature and magnitude.
True, there has been some progress in European governance in recent years, with the
strengthening of procedures already in place, the design of new macroeconomic surveillance
procedures and the implementation of new Treaties. These treaties include that establishing
the European Stability Mechanism, and the Treaty on Stability, Coordination and
Governance in the euro area, which makes provision for the so-called Fiscal Compact. But
this progress has not been sufficient to stabilise the situation, partly due to the lack of broad
consensus that is apparent in the stance and statements of different European authorities.
In these circumstances, action by the European Central Bank has been key to easing the
moments of greatest tension and extending the time available to adopt the necessary
measures in other economic policy areas. Evidently, the ECB cannot resolve the serious
underlying problems of this crisis, be they national or related to the European architecture. It
can only address some of the manifestations of these problems, in particular those reflected
in financial markets, with a view to smoothing the way so that governments can take the
corresponding measures.
Spain is a clear example of an economy in which Eurosystem action has overcome critical
situations and has provided the time needed to set in train ambitious reforms in various
areas. Significantly, this reforming drive has in no way been slowed by the fact that the
Eurosystem has taken specific measures, such as the three-year long-term refinancing
operations. In the specific case of the ongoing clean-up, restructuring and recapitalisation of
the Spanish credit system, this process has intensified, to adapt to a new set of increasingly
worse economic and financing conditions, by imposing stricter capital and real estate
provisioning requirements on banks.
Of the recently adopted structural reforms, I would underline the importance of the labour
market reform. This is an area where Spain had built up evident inefficiencies that have now
been tackled to some extent by the new legislation. The essential role of employment in any
scenario for exiting the crisis should also be highlighted, since only with a recovery in jobs
can a stable path of public finances, a reduction in private debt and bank restructuring
become entrenched.
The labour market reform is intended to provide companies with various means to achieve
greater internal flexibility, so that they may adapt working conditions more rapidly and
effectively to their position in the cycle. In this respect, it allows the decentralisation of
collective bargaining and shapes an environment more conducive to job creation and job
stability, once the current difficult circumstances have been overcome. Overall, these
changes should in time bring about a recovery in the competitiveness of Spanish companies.
It is very important that the reform should be accompanied by measures that improve the
competitive environment in which companies take decisions, promoting the liberalisation of
activities where there are still obstacles to competition.
But let me move on to the main part of my testimony: the examination of Spanish budgetary
policy. I said at the outset that Spain is the centre of attention for the international economic
community. This is because we face a particularly complex situation, where there is an
overlap between various adjustment processes and imbalances, generated following a long
upturn. Possibly, Spanish fiscal policy was not the source of the current difficulties. But
clearly, overcoming these problems will require us to swiftly move public finances towards a
path of stability, as this is crucial for restoring agents' confidence and reducing uncertainty
about the economic outlook.
As you know, following the recent revision, the budget deficit ended 2011 at 8.9% of GDP, a
long way off the 6% target set in the previous Stability Programme. The public debt/GDP
ratio stood at end-2011 at 68.5%, more than 30 pp above the 2007 figure. The deficit targets
have been set at 5.3% of GDP for 2012 and at 3% for 2013. If these targets are met, the
public debt/GDP ratio would stabilise in 2014, albeit at a level somewhat higher than 80%.
The consolidation involved in meeting these fiscal targets will be tremendously hard to
achieve. Events in 2011 show the difficulties of reducing the budget deficit at times of
economic weakness. And they highlight the need to improve budgetary monitoring, early
warning and control procedures, especially in a country such as Spain with highly
decentralised public finances.
A realistic macroeconomic scenario is the starting point for achieving budgetary targets.
Here, as you know, the Spanish economy has double-dipped, with GDP declining by 0.3% in
both the final quarter of 2011 and the first quarter of 2012. And the outlook for the coming
months is not favourable either.
In terms of composition, the pattern of economic activity observed in recent quarters does
not differ from that seen at the start of the crisis in 2008, when national demand was
considerably weak and its impact on output was softened by the positive contribution of
external demand to growth. In any event, Spain has not been immune to the slowdown in
world trade and, in particular, to the greater sluggishness of some of our main trading
partners, such as Italy and Portugal, meaning that exports have recently been seen to be
less buoyant.
Foreseeably, then, in 2012 we will once again see a substantial decline in GDP. In this
respect, the Government's macroeconomic forecast of a 1.7% fall seems realistic and
prudent. But it should be stressed that the uncertainty permeating the current
macroeconomic climate is very high. In terms of the composition of the macroeconomic
figures, the view of the Banco de España does not differ greatly from that of the Government;
the adjustment of national demand is projected to continue further, while net demand will
remain the linchpin of the Spanish economy, although its considerable contribution to growth
will not suffice to prevent a contraction in activity and employment.
As earlier stated, it is vital here that companies should harness the flexibility afforded by the
new labour legislation to respond to the changes in demand without having to shed staff. If
used appropriately, not only will this prevent the demise of certain companies, but production
will also be much more competitive and Spanish products more attractive, both domestically
and abroad. Evidently, in a situation like the present, the recovery in Spain should be
export-led. Accordingly, all measures and reforms that enhance competitiveness should be
considered a priority.
In this connection, the State Budget for 2012 is part of a broader, medium-term consolidation
strategy that requires the participation of the different levels of government. The Stability and
Growth Programme unveiled in late April to the European authorities details these objectives
up to 2015, with a breakdown of the efforts required by each level of government.
From my standpoint, the fiscal consolidation process is one of the cornerstones of the
recovery of the Spanish economy, although the adjustments needed to meet the fiscal
targets may in the short term exert adverse effects on demand and activity. As for the
financial tensions that have shaken the Spanish economy in recent weeks, holding resolutely
on a course towards fiscal consolidation is a pre-requisite for dispelling the mistrust stifling
the economy. Therefore, the potential short-term costs will be amply offset once it becomes
apparent that the efforts made are yielding results.
The State and Social Security budgets for 2012 are pivotal to this strategy. Fortunately, while
they have not yet been approved, many of the measures they envisage have already been
implemented, thereby preventing precious time from being lost in adjusting the fiscal
imbalance. In this respect, it should be stressed that cutting the budget deficit requires an
unprecedented structural effort. The measures that have to be adopted must reduce debt in
an environment in which the interest burden will be growing and where the double-dip in
economic activity will affect tax revenue and some cyclical expenditure. In light of these
conditioning factors, the consolidation strategy must obviously use all the instruments
available, on both the expenditure and revenue sides.
As regards revenue, various measures have been adopted affecting, above all, the direct
taxes households and firms pay. A reduced rate has also been introduced to bring
undeclared assets out into the open. Here, although the macroeconomic forecast for 2012
may be realistic, there are risks of slippage in projected revenue. This is in light of the
composition activity is likely to evidence, given the sizeable weight of exports and the
weakness of private consumption and the real estate market, which may lead to lower
revenue than the course of output might suggest, as was the case in 2011. The foreseeable
decline in employment also appears to suggest Social Security contributions will be more
modest than budgeted. Finally, there is substantial uncertainty surrounding projected
revenue takings in respect of the special treatment accorded to undisclosed income.
Turning to expenditure, the draft Budget outlines highly significant cuts in public investment,
current transfers and goods and services purchases. These projections are not without risk,
given the substantial inertia some of these items show, which hinders any permanent change
in their trajectory. Precisely to reinforce this trajectory, the government added further
education and health-care measures following the presentation of the draft Budget, which
should contribute to attaining the targets set. That said, overspending on items such as
unemployment benefits or pensions cannot be ruled out, since they depend on factors
beyond the control of the authorities, such as the unemployment rate, demographics and
inflation.
Given these risks, the Budget must be rigorously implemented and mechanisms activated to
enable any emerging deviations to be detected sufficiently in advance, so that additional
countervailing measures may be taken. If this were necessary, measures to contain current
expenditure or to increase indirect taxes could be adopted, as already contemplated in the
Stability Programme ahead of 2013. Nor can it be ruled out that the temporary tax increases
approved this year may have to remain in place for longer or be replaced in time by other
permanent measures.
I believe that in a country as decentralised as Spain, and in light of the deviations that arose
in 2011, what was needed was to accompany budgetary consolidation with a significant
strengthening of the institutional framework, so that all tiers of government might be called on
to meet their commitments. Fortunately, the recently approved Organic Law on Budgetary
Stability is a substantial improvement here. Moreover, it is fully attuned to the recent EU
reforms on governance. Also, the agreement reached a few days back between the central
and regional governments under the aegis of the Fiscal and Financial Policy Council on the
deficit targets for 2012 and on the consolidation plans to attain these targets is excellent
news. This lays the foundations for avoiding overruns such as those witnessed last year.
What is crucial now is the swift and effective implementation of the instruments envisaged in
this Organic Law, in particular the monitoring and control mechanisms for public finances at
all levels of government, and those intended to enforce compliance with the targets set by all
of them.
The law proposes substantially improving general government transparency at the different
stages of the budgetary process. In particular, timely detection of budgetary deviations is
considered essential so as to adopt measures. Consequently, it would be advisable to begin
publication of the regional government monthly revenue and expenditure outturns as soon as
possible, as envisaged in the Organic Law (Article 27.3). The law further includes coercive
instruments to ensure compliance with budgetary targets by all levels of government. Such
instruments can be effective in ensuring discipline if rigorously applied and if the appropriate
procedures for overseeing the budget outturn throughout the year are set in place.
But the pressure of everyday events should not make us lose sight of the medium and long
term. Allow me to refer here to the major reform of the pensions system approved in July last
year. This checked a pension spending dynamic that was endangering the sustainability of
public finances over the medium and long-term horizon. But it should be recalled that this
reform did not cancel out all the risks arising from population ageing. It would thus be
desirable to properly define the so-called sustainability factor, so that the parameters of the
system may adapt automatically to future demographic developments.
Admittedly, the economic difficulties such as high unemployment and low growth that we
face are most serious. But the main problem currently confronting the Spanish economy is
the fall in all confidence indicators in recent months, exacerbated in recent weeks by the
management of the latest banking crisis. Restoring confidence is the imperative at present,
since without it, none of our problems will be resolved. All government measures and all
actions taken by economic policymakers and agents should be aimed at restoring the
confidence we have lost. And one of the pre-requisites for doing so and for dispelling all
uncertainty is that Spain should bring its public finances back on to a path of stability in line
with its European commitments.
I believe there is a sizeable consensus that Spain needs to redress its fiscal imbalance and
move towards a path of stability, in line with its European undertakings, and that this is a
pre-requisite for restoring confidence and dispelling uncertainty. Consolidation measures
have been tabled that are capable of bringing about this change of direction in budgetary
dynamics. And, above all, the national budgetary framework has been substantially
reinforced in order to allow the coordination, monitoring, surveillance and, where appropriate,
correction of deviations by the different tiers of government, which we were previously
lacking and which is vital to achieve the fiscal targets set.
The authorities at all levels of government have taken a significant first step in ratifying these
targets and agreeing on their contribution to the consolidation drive that must be undertaken
in the coming months. Now it is of the essence to restore credibility with a rigorous budgetary
outturn, transparent management and, when necessary, corrective measures that shore up
the fiscal targets set. That will attest to the strength of the commitment to the budgetary
stability enshrined in the new Organic Law. The State Budget for 2013, which will begin to be
drafted in the coming weeks, must uphold this commitment and give expression in specific
measures to some of the announcements made in the context of the latest Stability
Programme. It is no overstatement to say that much of Spain's future is at stake in complying
with these fiscal targets, and that failure in this process of consolidation would set back
considerably the possibility of an economic recovery in our country.