18.05.2020
Pablo Hernández de Cos Appearance before the Parliamentary
Economic Affairs and Digital Transformation Committee
Governor
Ladies and gentlemen,
I appear before you today in particularly difficult circumstances. Our country, like many
others, is experiencing an enormously complex situation. My initial words are for all Spanish
citizens, whose behaviour is proving exemplary. And most particularly they are for all those
professionals who, putting their own health at risk, are working so resolutely to preserve the
health of others and keep essential services operating. Naturally, these initial words are also
to convey condolences to all those who have lost loved ones in this pandemic.
We are facing an unprecedented situation. From the standpoint of its economic impact, it
has three characteristics I wish to highlight, given that they condition the optimal economic
policy response.
First, the scale of the shock is immense. Unfortunately, we have seen how, in just a few
days, the pandemic stretched our health system to the limit, cutting short thousands of
human lives and leaving a deep scar on their families and on Spanish society as a whole.
The situation has led our authorities, like so many other governments worldwide, to adopt
drastic social distancing measures that severely limit people's movements and a practical
complete shutdown of activity in some productive processes.
The economic impact of these measures is most acute because of the reduction in the
supply and demand of goods and services. In parallel, the pandemic has heightened
uncertainty, causing a sharp downturn in agents' confidence and a heavy decline in the
price of many financial assets. As a result, this year will foreseeably witness the heaviest
declines in GDP since the Second World War in the advanced economies as a whole and
since the Civil War in Spain's case. Seeing the forceful impact on our economy through the
statistical evidence of the past weeks and the difficulties that we are beginning to discern
ahead of any future recovery mean, in fact, that the scenarios projected a month ago of
more moderate declines in GDP are now rather unrealistic, as I shall set out.
Second, at issue here is a crisis caused by a factor which, at least in principle, is temporary
in nature - though probably more lasting than initially expected - and unrelated to the
inherent workings of the economy. The duration of the shock is uncertain. However, it
should be limited and make way for a recovery once we have controlled the disease. Yet as
I shall go on to stress, it cannot be ruled out that, despite its temporariness, the wake of the
crisis will also see structural damages and/or changes. It is important we should identify
these promptly.
The third and final characteristic I wish to highlight is the global nature of this crisis, which
is going to land a most severe blow on the world economy. This means that the depth of
the recession in the Spanish economy and the subsequent recovery will also hinge on how
our main trading partners fare.
These three characteristics determine the particularities of the response the different
economic policies must provide. The severity, temporariness and global impact of the shock
require initially that economic policy actions should be forceful, time-limited (until
employment and economic activity regain momentum following their induced hibernation)
and internationally coordinated.
The aim of this shock therapy should be to extract the economy from this lockdown with
the least possible damage and thus prevent a temporary shock causing persistent effects
over time. This calls for resolute action during the current phase of restrictions on activity in
order to mitigate the loss of income for households and firms affected by the crisis and to
prevent the temporary shutdown in corporate activity becoming permanent. This action
should be tailored to the duration of the restrictions on activity, bearing in mind that these
will foreseeably affect the various productive sectors and firms unevenly.
In the current phase of containing the economic impact of the crisis, fiscal policy is the most
suitable tool as a first line of defence. Preventing the temporary shutdown in activity from
leading to a permanent destruction of the productive system calls for the loss of income by
the households and firms affected to be alleviated. Also, from the standpoint of fairness, it
seems reasonable to have society as a whole share the burden of the costs that some
citizens are already bearing most directly. In this respect, only fiscal policy has the
instruments suited to attain these objectives with measures that are immediate, focused
and tailored to an uncertain and uneven duration.
Monetary policy should also operate vigorously to ensure appropriate financing and liquidity
conditions for the various economic agents. In the case of the euro area, this means
eliminating the possibility of bouts of financial fragmentation among its different members.
This is particularly important in a setting in which economies' financing needs will increase
most significantly as a result of the crisis.
In parallel, the micro- and macroprudential policies of the financial system should operate
to ensure a suitable flow of credit to the economy and, in turn, to preserve financial stability.
The aim is that financial institutions should continue ensuring the flow of credit to crisis-hit
households and firms. For example, they should be allowed to use the capital buffers built
up in recent years precisely to this end. A parallel objective is to prevent the increase in
credit, market and operational risk arising from the strong downturn in activity from
ultimately generating financial stability problems.
Further, the fact the crisis is global calls for a coordinated response by countries. The
temptation to resort to protectionist policies should be avoided. That can only hamstring the
fight against the pandemic, and delay and weaken the awaited economic recovery for all.
On the contrary, we should reinforce the multilateral economic policy coordination
mechanisms already in place internationally.
This need is particularly evident as regards the euro area members, since they share the
same currency. For each and every member, joint action - beyond the common monetary
policy response - is the most effective means to ensure that the economic effects of the
pandemic are vanquished in a shorter time and at a lower cost. This coordinated action is
also needed to shore up the solidarity of the European project: although the shock has been
a common one, the effects across countries have not been even, and the starting position
of each country in facing its effects also differed.
The elements needed for an appropriate European response to this crisis largely coincide
with those already deemed vital before COVID-19 to complete the institutional architecture
of the euro area: the creation of a powerful, pooled budgetary resources mechanism that,
in the context of the current crisis, smooths the financing of government spending that has
arisen as a result of the pandemic and of those other needs that may arise during the
recovery; the completion of the banking union, with the launch of a European deposit
guarantee scheme; and the full roll-out of the project to achieve a genuine European market
for capital.
In this specific field of joint European action there is clearly room to boost the response so
far to the crisis. In other economic policy areas, namely fiscal, monetary and prudential
policies, the degree, composition and duration of the response should be tailored to those
of the pandemic itself and its economic effects.
That said, how this crisis will unfold is shrouded in unusually high uncertainty. As matters
currently stand, from the point of view of public health there are many unknowns as to how
the illness will evolve in the coming months. This will determine at what rate normality returns
to our daily lives and, therefore, to economic activity. In this connection, irrespective of the
suitability of the containment measures, the longer the duration of the economic shutdown,
the greater the damage to activity. We must thus be mindful that anything we do now may
not be enough to rescue the economy without considerable damage being caused.
Further, it cannot be ruled out that, beyond its effects in the short and medium term, the
pandemic may also cause certain structural changes in supply and demand in our
economies. While these are currently difficult to anticipate, it is crucial to identify them
promptly to ensure the appropriate economic response. Timely identification of these
structural damages or transformations is important, since the economic policy response
should not be directed solely at temporarily sustaining the incomes of the companies and
employees affected but also at assisting reconstruction and cross-sectoral and
crosscompany reallocation.
However, the current shock therapy is not exempt from adverse side-effects. These are
particularly visible in the strong increase in public debt. Accordingly, just as a resolute
shortterm fiscal response will help lessen future damage to our economy, we should accept that
a greater budgetary impulse at present should be part of a clear strategy to redress public
finances. This is particularly necessary in countries, such as Spain, that face this crisis from
a vulnerable public finances starting position, owing to high public debt and structural deficit
levels.
This strategy should rest on a medium-term budgetary consolidation programme which,
through a spending and tax structure and capacity review, will help restore health to public
finances. It should also be underpinned by a structural reform programme that raises the
economy's growth capacity and, therefore, broadens the tax bases needed to fund the
desired level of expenditure.
This fiscal consolidation and structural reform strategy should be implemented once this
episode and its economic effects are behind us. But its design and communication should
not be delayed. In the short run, there is no place for a premature withdrawal of the
emergency fiscal measures, since that would increase the risk of more lasting damage to
economic growth. However, the necessary counterpart to this fiscal activism is the early
announcement of a strategy to reduce fiscal imbalances, with a view to its subsequent
implementation, which should perforce be gradual.
An early definition of this strategy would significantly benefit the credibility of our economic
policy and help boost the expansionary effects of the current fiscal measures.
The full implementation of this phase will require a political agreement that is up to the scale
of the challenge we face and that will foreseeably run for several legislatures.
The rest of my address today is structured in three major sections. In the first, I shall provide
some details on the scale of the economic shock we are undergoing, including its effect on
financial stability. Next, I shall review the role the different economic policies are playing in
this shutdown phase of our economy. Finally, I will offer some thoughts on the function that,
in my opinion, economic policies should perform once we are over the worst of the crisis.
Short-term developments and reference macroeconomic scenarios
Globally, the expansion of the pandemic and the necessary containment measures have
sharply disrupted the world economy. The evidence coming to light in recent months reveals
a marked slump in activity and employment, acutely so in the services sectors and in those
countries which, affected by a more severe outbreak of the epidemic, have pursued more
stringent containment measures.
In China, the first economy to be hit by the illness, the first quarter of the year saw a fall-off
in GDP close to 10% quarter-on-quarter. In the United States, the decline was smaller,
around 1.2% quarter-on-quarter. Admittedly, though, the spread of the disease was
belated. The US monthly unemployment rate posted in April its biggest increase (over 10
pp) in the related time series to 14.7%, the highest level since the Great Depression in the
1930s. Preliminary estimates in the euro area point to a 3.8% decline in GDP in Q1.
As you know, Spain has been one of the countries hardest hit by the health crisis and,
subsequently, by the impact of the containment measures on economic activity. More than
two months after the state of alert was decreed, we now have significant statistical
information on the scale of the shock to the Spanish economy. Specifically, a preliminary
estimate by INE (National Statistics Institute) indicates that GDP fell by 5.2% in 2020 Q1,
despite the fact the lockdown only affected the last fortnight of this period. Should this be
confirmed, this quarterly decline in GDP in 2020 Q1 will be double that observed in the
related quarter in 2009, at the height of the global financial crisis. As is to be expected, there
has been a particularly acute reduction in the value added of certain services sectors, and
construction has also been severely affected.
In the labour market, the pandemic and the measures adopted to contain it are also leaving
a deep imprint. The figures on Social Security registrations reveal a reduction of almost
950,000 in numbers employed between mid-March and 30 April. Job destruction was mainly
concentrated in the second fortnight of March (almost doubling the loss of jobs between
end-November 2008 and end-January 2009). This figure was in contrast to the rise of almost
160,000 in Social Security registrations in the same period in 2019.
In any event, the Social Security figures provide a partial view of the consequences of the
current crisis on the labour market. An even larger contingent of employees, some 3.4
million, have availed themselves of temporary lay-off arrangements (known as ERTE by their
Spanish name). As you are aware, ERTEs entail the formal maintenance of the contractual
relationship, pending the resumption of activity, although there is no actual employment
benefit. Moreover, 1.3 million self-employed workers have applied for the benefit for the
cessation of activity.
No indicators (other than some qualitative ones) are available yet for Q2, meaning it would
be premature to project the decline in GDP in this quarter. In any event, given that the
number of weeks affected by the lockdown is much greater than in Q1, a significant
acceleration in the fall in GDP is to be expected.1
Beyond the short term, estimates of the duration and depth of the effects of the shock on
the economy are still subject to much uncertainty. In principle, if these uncertainties clear
over the coming months, a rebound in activity into the second half of the year might be
expected. But that will depend broadly on two types of factors. The first relates to the future
course of the illness. In particular, we cannot rule out the possibility of further waves of the
epidemic making it necessary to re-introduce or discretely reinforce the limitations on
various types of productive activity. Ultimately, this source of uncertainty will not be fully
dispelled until an effective vaccine or anti-viral treatment is available.
The second factor concerns the effectiveness of the measures, both in Spain and in the rest
of the world, that the economic authorities have pursued in an attempt to prevent the
shutdown in activity at the height of the pandemic from leading to permanent job losses and
company closures. Evidently, the second of these factors (the effectiveness of the economic
measures in minimising the damages of the lockdown) depends, in turn, on the first (how
the pandemic evolves).
It should in any case be stressed that certain characteristics of our economy make it more
vulnerable than others to the shock we face. These include the sectoral specialisation of our
productive system, the small average size of companies and the high proportion of
temporary as opposed to permanent employment.
Firstly, in Spain, tourism-related activities have a very high weight in terms both of value
added and employment. And, as we know, the social distancing measures have affected
the sectors related to hotels, restaurants and leisure most acutely. It is uncertain how long
the return to normality will take in these sectors. But scenarios in which the persistence of
the shock is greater than anticipated and, thereby, the damage inflicted on the sectoral
productive system is more severe, cannot be ruled out.
Overall, the sectors most affected by the pandemic account in Spain's case for around 25%
of GDP. These include hotels and restaurants, transport and retail trade, owing to the
restrictions on people's movements and the suspension of their activity, and others such as
the car industry, owing to the halt in demand and the interruption of global supply chains.
Secondly, as regards corporate structure, Spain has a comparatively higher weight of SMEs
than most euro area economies. Specifically, in 2019, 90% of firms had fewer than 10
employees (compared with 75% in Germany). The small average size of non-financial
corporations places the Spanish productive system in a position of greater vulnerability to
the loss of income as a result of the COVID-19 crisis, since generally SMEs have less access
to external financing and higher overheads relative to turnover.
Lastly, this crisis has once again highlighted sharply the fact that, as occurred in previous
recessions, when there is an adverse shock, job destruction falls disproportionately on
temporary employees. Specifically, the weight of these employees in the decline in Social
Security registrations between March and April is estimated to have been approximately
three-quarters of the total, a similar proportion to that in the financial crisis. This is, primarily,
profoundly unfair; it means that, unlike permanent employees, temporary workers can
scarcely count on any protection once their contract expires, unless exceptional measures
are deployed that are tantamount to such protection. Beyond considerations of fairness, the
high proportion of temporary employment in our labour market makes for a high
procyclicality of employment, which tends to exacerbate the depth of recessions, in addition
to generating negative effects on productivity, which I shall refer to later.
Higher labour turnover and the high rate of part-time employment chiefly affect the young.
This group is particularly vulnerable in these circumstances, since it has fewer buffers to
withstand unexpected declines in income, and the public insurance mechanisms available
to them are limited compared with other groups. Moreover, the young had still not recouped
their levels of income and wealth prior to the financial crisis.
Set against the high uncertainty mentioned, preparing macroeconomic projections with the
usual methodologies is an enormously difficult task. This is why the Banco de España opted,
in its publication on 20 April, to prepare several alternative scenarios using different
analytical tools.2
In any of the scenarios considered, confinement would translate into a very severe
contraction in Spanish GDP in 2020, all the greater the longer the period during which it is
necessary to retain the restrictions on economic activity, and with greater risks that the
liquidity problems many economic agents are currently facing will lead to situations of
insolvency. Looking ahead to next year, these scenarios outline a recovery in activity and
employment which, nonetheless, would be insufficient for GDP to attain its pre-COVID-19
trend level.
Specifically, in the two scenarios recently published by the Banco de España that seem
most realistic at present, having ruled out the third which projected a shorter and more
moderate recession, GDP is expected to fall by 9.5% and 12.4%, respectively, in 2020 (and
post subsequent increases of 6.1% and 8.5% in 2021).3 The figures in the first of these
scenarios do not differ significantly from those reported by other national and supranational
institutions, public and private alike. Thus, for example, the Spanish Government, the
International Monetary Fund (IMF) and the European Commission have recently projected
declines in our economy of 9.2%, 8% and 9.4% for 2020, respectively. For the euro area as
a whole, the fall in GDP projected by the IMF and the European Commission for 2020 is,
respectively, 7.5% and 7.7% (and the related whole-world decline would be 3% and 3.5%).
These scenarios incorporate the effect of the measures approved in the fiscal, monetary
and prudential areas, to which I shall later refer, such that the declines in activity would be
significantly greater in the absence of these measures.
In any event, what has been confirmed in recent weeks is that the recovery will not be free
from difficulties, and that scenarios more unfavourable than those currently considered
cannot be ruled out.
These macroeconomic scenarios also offer an estimate that the budgetary cost of the crisis
will be very high, owing to the dual effect of the alleviating measures adopted and, above
all, of the operation of the automatic stabilisers. That will lead to a very high budget deficit
this year, with its subsequent pass-through to overall general government debt. Under the
scenario of a more moderate fall in GDP, the public debt/GDP ratio would rise to around
115%, a similar figure to that projected by the Spanish Government, the European
Commission, the IMF and the AIReF. Under the harshest Banco de España scenario, the
debt ratio would in fact stand at over 120% of GDP (some 25 pp higher than at end-2019).4
Under the assumption of economic recovery projected for 2021, the public debt/GDP ratio
would stabilise around its 2020 levels or fall slightly.
This projected path is not specific to Spain: in its latest World Economic Outlook, the IMF
estimated that the increases in the deficit and debt ratios, as a percentage of GDP, might
rise in 2020 to a comparable scale across the advanced economies. Likewise, on the
European Commission's latest forecasts, public debt in the euro area as a whole will stand
this year at 102.7%, and exceed the 100% threshold in another six countries, as well as
Spain.
The impact of the crisis on the financial system
The severe impact of the pandemic on economic activity has significant consequences on
many fronts. One such front is financial stability.
In this connection, as highlighted in the Banco de España's latest Financial Stability Report,5
published on 4 May, the economic impact of the crisis has substantially increased the risks
to financial stability. That said, the national, European and international economic policy
measures adopted should help mitigate these risks. In the specific case of banks, the
disruption of activity is increasing credit, market and operational risks.
Indeed, the pandemic has meant that credit risk has increased substantially. This is
particularly the case of credit exposures to non-financial corporations, which have seen how
their revenue has fallen, initially as a result of the shutdown in productive activities and
subsequently further to the lower demand for their products. In this respect, it should be
borne in mind that, although this crisis affects all sectors of activity, it does so
asymmetrically. This is why the effects on each bank's credit portfolio depend on its sectoral
composition and, therefore, also on its presence in different regions.
The pandemic also entails an increase in households' credit risk, mainly as a result of job
destruction. Past experience shows that, in the face of declines in household income, the
non-performance of consumer loans tends to increase at some speed. This is a type of loan,
moreover, that has been growing at very high rates in recent years. From the standpoint of
overall credit to households, this factor of risk is partly mitigated by the mortgage
component, for which the evidence available suggests that defaults tend to occur some
time after the initial shock when its effects persist over time. Accordingly, if it does in fact
hold that the crisis is temporary in nature, this latter credit component will foreseeably post
more moderate default rates.
But the risks to financial stability arising from the current crisis do not end at credit risks.
First, COVID-19 has increased market risk, as a result of the fall in the price of the financial
assets that banks hold on their balance sheets. Further, operational risks have also risen
insofar as the adaptation to restricted movements and remote working has had to occur in
a very short space of time, which may give rise in some cases to vulnerabilities in
technological infrastructures. So far, banks have managed to adapt effectively to the
situation and financial markets have carried on working properly. But further contingency
plans are needed ahead of any potentially extreme operational events that this crisis may
cause.
It should in any event be stressed that the Spanish non-financial private sector is facing this
situation in a more favourable financial position than it was in before the global financial
crisis. The financial situation of the household sector as a whole has improved significantly
in the wake of the global financial crisis. Specifically, its debt ratio has fallen by almost 30
pp of GDP since 2010.
In the case of non-financial corporations, the sector's net debt level has fallen by more than
45 pp of GDP since 2010 and, in fact, it stands below the euro area average. Moreover, the
sector now has a bigger volume of liquid assets.
In parallel, the Spanish banking sector has also significantly enhanced the quality of its
balance sheet over the past decade, which leaves it better placed to absorb this crisis and
to continue providing the financing the economy needs. With regard to balance sheet
quality, the NPL ratio has fallen by more than 9 pp to 4.8% in 2020 Q1 since peaking in
2013. Over this same period, moreover, the weight of refinanced exposures on the asset
side has fallen by 9 pp. Finally, the weight of credit to construction and real estate promotion
activities, which at one point accounted for 27% of total credit to the non-financial private
sector, now stands at around 10%.
Turning to solvency levels, Spanish banks increased their ordinary - or Tier 1 - capital. This
rose from €158 billion in 2007 to €215 billion at present, entailing an increase of slightly more
than 35%. In terms of total assets, the increase was of the order of 1 pp between these
dates, to 5.8%. The increase in capital has meant a notable extension of absorption capacity
for the losses that will emerge as a result of the growth of bad debts that the crisis will
cause.
Almost half this total amount of capital is in the form of buffers above the regulatory
minimum level. These may be released, as I will explain later, as part of the prudential
response to the crisis should it prove necessary. The amount involved - some €90 billion -
could cover a volume of losses equivalent to almost twice the current volume of doubtful
loans in the system, i.e. approximately 8.2% of the total credit to the resident private sector.
As I said, the risks to financial stability have been mitigated by the various economic policy
measures adopted. In particular, these measures should provide for more benign
developments in NPLs by directly supporting the financial position of households and firms
and through macroeconomic stimulus. Moreover, the aforementioned absorption capacity
for losses arising through NPLs is strengthened when the positive effect of credit moratoria
and of the Government-approved programme of guarantees for firms is taken into
consideration. In the case of temporary moratoria set in place both by the authorities and
by banks themselves, these should help enable those households most affected by the
crisis to face this critical period with greater peace of mind. At the same time, they provide
for containment of NPLs in the short run and, foreseeably, also in subsequent phases,
provided that a portion of these more vulnerable households can gradually regain their
habitual levels of income.
Three clarifications are, in any event, called for regarding the general situation of the financial
sector and the potential impact of the crisis on it.
First, the figures for the 2020 decline in GDP reflected in the macroeconomic scenarios I
have outlined would entail the biggest economic contraction in Spain for a single year in
recent history. They also exceed the assumptions of any stress test performed on the
banking sector in the past. This will give rise to an increase in the NPL ratio, albeit on what
is still an uncertain scale. On Banco de España estimates, a 1 pp decline in GDP has, on
historical averages, given rise to a 0.7 pp increase in the NPL ratio. That said, the scale of
the decline in output projected at present is very high, which might give rise to a
proportionately greater effect.
It is also true that, if the rebound in activity in 2021 projected in the scenarios published
both by the Banco de España and by other institutions were to materialise, that would
significantly mitigate the strong decline in GDP in 2020. This would provide for an
improvement in the credit quality of bank borrowers and for a more favourable path of the
prices of the assets that act as collateral to the loans. In turn, that would considerably limit
actual losses. In this respect, the results of the stress test performed to date show that, if
following a period of slowing economic activity the pace of recovery is swift, there is less
likely to be a pronounced deterioration in the aggregate solvency of the banking system.
In any event, the uncertainty over the duration of the pandemic and its effects is very high.
In this respect, the consequences of adverse economic scenarios that are prolonged over
time can indeed worsen aggregate solvency significantly. But even under these scenarios,
the loss absorption elements will mean that capital erosion is not immediate. This affords
some leeway which, where appropriate, should be used to set in place all the elements
allowing a forceful economic policy response with the aim of ensuring financial stability.
Second, the foregoing considerations on the aggregate situation of the system mask a high
degree of heterogeneity. This is mainly due to the fact that starting positions, in terms of
funds and credit quality, are per se divergent. In this same respect, in the case of households
and non-financial corporations there are still some segments in a position of high financial
fragility. For instance, in the case of companies, the smallest firms are more vulnerable to a
scenario of declining revenues. But, moreover, in a crisis such as that at present where - as
I have said - the pandemic is affecting different regions and sectors in differing ways, the
downturn in institutions' solvency will foreseeably depend on their degree of exposure to
such firms.
Third, the materialisation of losses in the credit portfolio as a result of the pandemic will
directly affect bank profitability, as the preliminary results of significant situations for 2020
Q1 suggest. Profitability was already low before the outbreak of the crisis: as in most
European economies, the profitability of Spanish financial institutions stood, on average,
below the cost of capital last year. The crisis has meant that this spread has tended to
widen.
The COVID-19 crisis will adversely impact banks' already modest profit-generating
capacity. As in the case of solvency, it will affect different institutions differently depending
on their business model and on the distribution of their exposures to the sectors and regions
most affected by the pandemic. Moreover, the crisis has bolstered the prospect of the
current scenario of low interest rates remaining in place. That will tend to bear down in the
future on Spanish banks' net interest income which, given the banks' type of business, is
the main component of their profit and loss account.6
In short, the financial situation of both the non-financial private sector and the financial
sector is, admittedly, significantly healthier than in the previous crisis; but the degree to
which the outlook for the Spanish economy has worsened, combined with uncertainty over
the duration of the downturn, obliges us as supervisors to monitor closely the risks to
financial stability.
I believe it is important that, both in this area and in others, we take as a starting point the
experience of the past crisis. And that experience should lead us to do everything possible
to prevent