29.03.2021
The Spanish economy and the COVID-19 crisis: assessment, outlook
and challenges
Europa Press informative breakfast
Pablo Hernández de Cos
Governor
*English translation of the original speech in Spanish
Good morning, ladies and gentlemen.
I would like to thank the organisers of this event for their kind invitation. I shall begin with a
brief assessment of the period since the COVID-19 crisis broke. I shall then set out the
Banco de España's view on the outlook for the Spanish economy. Finally, I shall describe
the medium-term economic policy challenges at the national and European level.
Taking stock of a year of pandemic: an unprecedented, persistent and uneven impact
COVID-19 has caused a global economic recession of an intensity which, in most
geographical areas, is unprecedented.
The crisis is, moreover, proving very persistent: as of today the pre-pandemic levels of
activity have not yet resumed in most countries. Indeed, the successive waves of the
pandemic have checked the recovery, particularly in the sectors most exposed to the
restrictions.
In Spain, this impact is particularly marked. GDP declined by 10.8% in 2020 as a whole, a
slump appreciably greater than that in the euro area (-6.8%). At end-2020, Spanish GDP
was still 8.9% below its pre-pandemic level, while this gap was 4.9 percentage points (pp)
in the euro area.
Several reasons account for this more pronounced impact in our country. One was the
greater intensity of the pandemic initially, which led to harsher containment measures in
spring last year. Another was the greater weight of the sectors most affected by these
measures. But the impact is also the outcome of the smaller size, on average, of our firms.
SMEs are less adaptable to this shock, given that they usually face greater obstacles in
gaining access to external financing; their fixed costs are, in proportion to their turnover,
higher; and their levels of digitalisation are generally lower, which hampers their access to
remote working. The first two editions of the Banco de España's Survey on Business Activity
confirm these circumstances.
The impact of the crisis has been very uneven, as the sectoral outlook evidences. Thus,
while effective social security registrations1 were, in February, 6.8% down on their
prepandemic level, the figures were significantly worse in the sectors whose activity has most
been restricted, such as hospitality, retail trade, artistic and recreational activities, and some
other services. For example, in the hospitality industry, the level of effective registrations
was almost 50% down, whereas in health care and in general government it was 4% higher.
Moreover, the sectors most affected by the crisis employ, on average, workers with lower
educational levels. In fact, the decline in employment among the lower qualified amounted
to 15.1% in 2020 Q4, compared with the slight increase among those with higher studies
(0.4%). Also of note was the fall in employment among young adults (aged 16-29), at 10.4%,
compared with the 1.4% increase among the over-45s.
And the economic vulnerability of those working in these sectors is greater. Their income is
not only on average lower, but also they have a less sound financial position: they form part
of households with less accumulated saving2 and their median net wealth is 17% lower.
This heterogeneity is also patent in the business sector, in particular regarding financial
vulnerability. Thus, somewhat less than 15% of firms were in a vulnerable position before
this crisis.3 This proportion did not vary significantly on the basis of firm size and sector of
activity. Conversely, the proportion of vulnerable firms increased by an estimated 20% in
2020, with the rise more pronounced at small firms; and by sector, in hospitality, the figure
would have stood at 40%.
The banking sector, for its part, has shown notable resilience. Underpinning this have been
the improvements both in its balance sheet quality and solvency in the past decade, and
the forcefulness of the economic policies applied since the onset of the crisis.4 The CET1
capital ratio increased by 71 bp and the NPL ratio fell by 0.4 pp in 2020. But the sector's
profitability declined significantly as a result, above all, of the increase in provisions for
impairment losses, more than 50% up on those in 2019. Also, in this case, the effects have
been uneven across banks, given what were diverging starting positions and the differing
degree of exposure to the regions, sectors, firms and population groups most affected by
the crisis.
One area where the impact of the crisis is most visible is public finances, which have seen
a deterioration with few precedents in peacetime. The budget deficit was up almost 7 pp to
over 10% of GDP. And the rise in the public debt ratio exceeded 20 pp, to around 120%.
In short, a little over a year later, the consequences of the pandemic remain very much
apparent in the economy. Output and employment are still some distance off their
preCOVID levels, markedly so in certain services sectors, and the general government sector
as a whole and some households and firms segments have seen their financial position
worsen significantly. Further, financial institutions, whose profitability has fallen, will
foreseeably witness a progressive worsening of their credit portfolio.
The medium-term outlook: uncertainty remains high
But what is the outlook ahead?
As stated, the successive waves of the pandemic have checked the recovery after the
summer. Indeed, quarterly GDP growth in Spain was zero in 2020 Q4 and, for 2021 Q1, our
projections under the baseline scenario point to slightly negative growth of -0.4%.
With a view to the future, the development of various vaccines and the start of their roll-out
to the population has allowed us to discern a horizon in which this crisis is resolved. Yet
uncertainty remains high, especially that arising from the course of the pandemic and the
vaccination process, and the consequences of the crisis on the productive system and on
agents' behaviour.
Against this background, the projections presented last Tuesday by the Banco de España
continue to complement the baseline scenario with another two alternatives, with different
assumptions about how the main areas of uncertainty will evolve.5
The first point of uncertainty evidently pertains to the epidemiological situation. Our baseline
scenario assumes that the course of the pandemic in the coming months will require similar
restrictions to those in the early months of the year, but that the gradual administration of
vaccinations will enable these restrictions to be lifted during the second half of the year.
One key aspect is the forecast path of tourism. Under the baseline scenario, it is assumed
that the incompleteness of the vaccination process in the coming quarters will give rise to
tourist flows that do not reach a high degree of normalisation until 2022.
As to the damage to the productive system,6 until last February the number of active firms
had fallen by 3.6% relative to February 2020. This figure was lower than that of the first two
years of the previous crisis - 2008 and 2009 - and comparable to 2012, despite the fact that
the decline in activity was much greater last year. Behind this reduction is the fall in business
start-ups, but not a rise in business deaths, which might be attributable to the support
measures adopted, including the moratoria on insolvency procedures. In any event, the
future is uncertain, in particular once this support should disappear. The baseline scenario
of the projections assumes only moderate destruction of the productive system.
There are likewise doubts about the behaviour of household saving,7 which increased
significantly last year and has built up largely in bank deposits. This increase is the outcome
both of more precautionary behaviour and of the restrictions on some expenditure caused
by the lockdown measures. The Banco de España's models suggest that the reservoir of
forced saving might be significant and have climbed to 2.5% of GDP in 2020 Q3.
Foreseeably then, as uncertainty abates, this accumulated saving will gradually be released,
infusing consumption with greater momentum. However, the scale and the distribution over
time of this effect is subject to high uncertainty and some factors might restrict it. In
particular, a portion of pent-up consumption is attributable to spending on services, which
generally cannot be deferred; and saving has concentrated in higher incomes, whose
marginal propensity to consume is lower. Also, households might decide to retain a high
level of saving for precautionary reasons or indeed because they expect tax rises in
response to mounting public debt. The baseline scenario of the projections assumes that
the saving rate will fall to 2023 but, even then, will still hold above its pre-pandemic level.
Uncertainty about the distribution over time and the use of the NGEU programme's funds
also conditions the projections. In this case, as regards our December forecast, a delay in
the investment expenditure financed by the programme in 2021 is assumed. Accordingly,
the impact on GDP is expected to fall from 1.3 pp in December to 1 pp in the latest
projections, with the estimated contribution for 2022 rising at the same time, as a result of
the assumptions that funds not invested this year will be applied the following year.
Based on these assumptions, GDP would grow by 6% in 2021 under the baseline scenario,
dipping to 3.2% under the severe scenario and increasing to 7.5% under the mild scenario.
Following a sluggish first half of the year, activity would quicken in the second half under
the baseline scenario. Greater dynamism as from the summer would give rise to a powerful
carryover effect in 2022, added to by the greater estimated impact of the European funds
for next year, whereby GDP would post high growth in 2022 of 5.3%, before easing to 1.7%
in 2023.
These figures represent a downward revision of 0.8 pp in GDP growth for this year compared
with those projected in December. The lesser momentum of activity in the short term and,
to a lesser extent, the revised distribution of spending under the European funds largely
account for this revision.
Compared with the ECB's projections for the euro area, which expect growth of around 4%
both in 2021 and in 2022, growth in the Spanish economy would be higher. That said, the
euro area would attain its pre-crisis level of GDP in 2022 whereas this would be delayed
until 2023 in Spain's case, reflecting the bigger decline in our economy last year.
After slowing significantly last year, inflation has rebounded in early 2021. This rise is due to
dearer commodities, associated with the improved global economic outlook and, in the case
of crude oil, with some supply-side factors. Certain temporary factors have also affected
services and non-industrial energy goods prices. These factors will give rise to high inflation
volatility in the coming months.
There has been much discussion in recent weeks on whether these developments might be
a prelude to a period of higher inflation. In my opinion this is unlikely, given the weakness of
demand and the high degree of cyclical slack. In the ECB projections, euro area inflation
would, at end-2023, still be some distance off the medium-term monetary policy objective
of 2%. In Spain's case, inflation would average 1.2% for 2023 under the baseline scenario.
The risks surrounding these projections remain tilted to the downside in the short term under
the baseline scenario. Such risks would be essentially linked to more acute episodes of
contagion or slower progress in immunisation.
Beyond the short term, uncertainty has tended to abate as the effectiveness of the vaccines
has been confirmed. And that has lessened the likelihood of more unfavourable scenarios
materialising. Uncertainty is also lower as a result of the fiscal package approved in the
United States and the agreement for the United Kingdom's withdrawal from the European
Union. Overall, risks are more balanced in the medium term than they were some months
back.
Economic policy support should be maintained in the short term...
What is the role of economic policy in the setting described?
In my view, maintaining the exceptional support measures for the economy is warranted.
This support is crucial for preventing the crisis from adding a financial component that would
make it deeper and more lasting.
This is the course of action monetary policy has followed. In December, we extended our
pandemic purchases programme to at least March 2022 to ensure that financing conditions
remain favourable. More recently, to counter the rise in long-term interest rates observed in
recent months, in a setting in which our inflation forecast is far off our objective and below
that expected before the crisis, we have stressed we will use the flexibility of our pandemic
programme to increase purchases in the coming months.
These decisions lead me to emphasise the importance of maintaining a high degree of
monetary accommodation so that fiscal policy may, in turn, retain a very high degree of
support to the economy until a firm recovery is in place.
In banking, and given the crucial role this sector has still to play, we supervisory authorities
have continued to stress that the use of capital buffers by banks is appropriate for
recognising credit impairment and to continue providing solvent credit to households and
firms. Banks will have sufficient time to comply once more with their capital requirements,
and the start of the process will never be before the main effects of the pandemic have
dissipated.
In parallel, given the uncertainty still in place, and the fact that the impact of the pandemic
has not been fully manifest on bank balance sheets and that they continue to benefit from
various public support measures, we have recommended that banks act with extreme
prudence in dividend distribution policies. In tandem, banks must pursue a policy of early
recognition of impairment losses, ensuring that this is appropriate and timely, as stipulated
in supervisory guidelines.
Fiscal policy support in this phase should focus on the firms and population groups most
affected. One particularly important aspect is the support to viable firms which, in light of
the scale and duration of the crisis, have seen their solvency worsen. Should such solvency
problems materialise, they would not only prompt destruction of the productive system and
employment, in firms that could be viable in the post-pandemic scenario; they might also
ultimately affect the financial position of the banking sector, which might respond with
lending restrictions that would feed back negatively into the prospect of recovery and
economic growth in the medium term.
Recently, a raft of measures has been approved to help the business sector and the
selfemployed, which may prove a useful tool precisely for reducing this risk. In this connection,
its swift and consistent implementation is crucial. And the distribution mechanisms must
selectively target the assistance on firms that are viable but have solvency problems.
Flexibility is also needed in the volume and use of committed funds, so as to adapt to the
course the pandemic takes and to the potential materialisation of risks.
In parallel, we must promptly identify the structural transformations caused by the
pandemic. There may be firms that have ceased to be viable and it would be
counterproductive for them to be sustained indefinitely by budgetary policy. For these firms, it would
be desirable to make insolvency procedures more flexible. The proper functioning of the
flexibility mechanisms available to firms must also be ensured. Their role is crucial for
allowing potential structural adjustments derived from the crisis. And, of course, there
should be an emphasis on active employment and training policies to smooth the
reallocation of workers to sectors with a future.
All these actions would help, jointly and complementarily, to prevent the crisis from taking
on an additional financial component. The banking sector could thus continue to be part of
the solution to the crisis by granting credit to households and firms, and contributing to the
recovery of the economy. That will require the sound functioning of the credit channel, which
is so important in the European economies and, of course, in Spain.
... and immediately tackle structural problems and challenges
Beyond the short-term reaction, it is time for economic policy to focus on tackling structural
challenges. Allow me to summarise some of these, both at the national and European levels,
including those relating to monetary policy and the banking sector.
As regards national economic policy, one of the major challenges is undoubtedly to restore
health to public finances. I have already pointed out that one of the most adverse
consequences of this crisis will be the strong growth of public debt. And high public debt
increases the economy's vulnerability. Hence, the necessary counterpoint to the current
fiscal activism is the announcement of a multi-year strategy to correct budgetary
imbalances, to be implemented once the health crisis is behind us.
The scale of the challenge is substantial. Even before the crisis the structural budget deficit
exceeded 3% of GDP. We must now add to that figure the increase in the interest burden
owing to the greater volume of debt. Also, there are expenditure increases derived from the
introduction of the minimum living income and, in the case of pension spending, from
population ageing pressure and the decision to link pensions to the CPI, along with the
potential structural increase in certain expenditure items, such as healthcare.
In any event, if a strategy were deployed to correct the structural deficit by 0.5 pp of GDP
per annum (in line with the Stability and Growth Pact requirement), under plausible
macroeconomic scenarios, the public debt ratio would move onto a declining path that
would place it towards 2040 at slightly below pre-crisis levels.
The reduction would be greater if this strategy were supplemented by a structural reforms
programme that increased the economy's potential growth. One tool that may be
enormously useful to this end is the NGEU programme. In terms both of its volume and,
above all, the projects it is intended to finance, the programme has, a priori, the ability to
substantially raise the economy's productive capacity.
But it can be no substitute for the necessary structural reforms. Spain needs an increase in
its potential growth. It needed it before the pandemic and needs it even more now.
The Spanish economy's low potential growth over the past two decades has been
essentially due to poor productivity dynamics. Such dynamics have been constrained by
several structural problems, including most notably the small average size of our firms,
regulatory shortcomings in certain sectors and in the framework that determines business
dynamism, and major human capital and technological shortfalls. We must urgently correct
the causes behind these shortcomings.
Evident, too, are the flaws of the Spanish labour market. A telling fact here is that the
unemployment rate has been above that of other developed countries in recent decades.
We particularly need to strengthen active employment policies to provide the right guidance
and training to those who have lost their jobs, thus improving their employability.
Another differential characteristic of the Spanish labour market is the high proportion of
temporary employment, higher than in any other euro area country. This means that when
there is a recession, temporary employees are the first to lose their jobs, which is usually
exacerbated by the fact that these individuals belong to vulnerable groups. The harmful
effects of temporary employment extend to productivity growth. Resolving this problem
calls for changes to hiring mechanisms, so that firing costs differences may be reduced
between permanent and temporary contracts, without harming job creation capacity.
As well as correcting the structural shortcomings, we must tackle the medium-term
challenges, including most notably those stemming from population ageing, climate change
and inequality.
The rise in the demographic dependency ratio, which will foreseeably double in the coming
decades, will exert a significant impact on the economy and, in particular, rising pressure
on pension spending. The 2011 and 2013 reforms helped ease these pressures. But the
decision to link pensions once again to the CPI will mean additional compensatory
measures will have to be taken. There are three parameters within which action can be
taken: revenue, expenditure and retirement age. The scale of the problem advises
diversifying the measures with broad and stable agreements. Generally, it is appropriate to
increase the contributivity of the system and its transparency, ensuring a level of sufficiency
for those households with more limited resources. Also, establishing automatic adjustment
mechanisms would help stabilise the system, adapting it to demographic and economic
changes. Indeed, several EU countries (such as Germany, Sweden and Italy) have already
established a link between the level of benefits or retirement age and life expectancy.
Combating climate change and smoothing the transition to a more sustainable economy are
another of the fundamental challenges we face. Fiscal policy should take the lead in attaining
objectives in this field, both to deter the most environmentally harmful activities, through an
internationally harmonised tax system, and to foment the public and private investment
needed to develop cleaner technologies and alleviate the social costs of the transition.
As to inequality, we began the current crisis with a higher level than was the case at the end
of the previous upturn, and everything suggests that this crisis will entail a further increase.
The employment protection and income support measures approved should contribute to
lessening the vulnerability of the households most affected. Also, many of the reforms
intended to improve productivity or lower unemployment and job insecurity are vital for
reducing inequalities. The minimum life income scheme could, in coordination with regional
government arrangements, contribute to alleviating extreme poverty. In this connection it
will be important, as provided for in the scheme's founding legislation, to assess its
application on an ongoing basis. Also, and in particular, we must determine whether the
eligibility requirements are effective for supporting the most vulnerable groups, and whether
its design offers sufficient incentives for beneficiaries to join the labour market.
An additional matter is the problem of the affordability of rental housing. International
evidence shows that policies aimed at increasing supply are the most effective. Some
countries have opted to combine the introduction of public guarantees with tax incentives
for the private-sector development of rental housing. It is also crucial to ensure legal security
for owners.
Turning to European economic policies, despite the response during the crisis, there are
structural shortcomings in euro area governance that need resolving. From the standpoint
of crisis management, resolving these shortcomings would also be important, given that we
cannot rule out the fact that the impact of the pandemic on the economy, and its
persistence, may be greater than expected. We must persevere with a European response
to this crisis.
Completing the Banking Union with the approval of a fully mutualised European deposit
guarantee scheme would contribute decisively to ensuring financial stability in the euro area,
both in the coming months and in the medium term. Deepening the Capital Markets Union
project would likewise be crucial. And a further priority is to analyse the suitability of
European bank resolution and winding-up regulations to a hypothetical systemic crisis, and
to set in place a common procedure for the administrative winding-up of credit institutions.
The crisis has also shown that monetary policy cannot be the only euro area stabilisation
mechanism. We must equip ourselves with a permanent fiscal stabilisation mechanism that
allows us to face future crises without the need for ad hoc political agreements. The
European funds approved during this crisis may be a good precursor of this mechanism.
And we must also debate the reform of the Stability Pact. It should be simplified and tailored
to the current circumstances, namely the low interest rate environment. Further, its scant
capacity to successfully steer countries to build up fiscal buffers in boom periods for use in
crises must be resolved.
The medium-term challenges also affect monetary policy.8 These challenges arise from the
progressive reduction in the so-called natural interest rate in recent decades. It is attributed
to demographic factors, such as population ageing, or technological factors, such as lower
productivity growth, which have altered the balance between the supply of saving and the
demand for investment. The upshot is that, to stabilise inflation, real interest rates must now
be lower. The problem lies in the fact that there is a lower bound on nominal interest rates,
meaning that monetary policy is more effective in combating inflation than deflation or, even,
persistently low inflation.
Against this background, the main central banks have deemed it necessary to review their
monetary policy strategies. In the case of the ECB, this review is ambitious; it not only
analyses how to address this situation, but also the design and optimal use of monetary
policy instruments, inflation measurement, the interactions between monetary and
macroprudential policy, communication by the institution, and the impact of climate change,
digitalisation and globalisation.
One of the key issues will be the definition of the price stability objective. The current
objective, consisting of a rate below but close to 2%, needs reformulating. First, it is
necessary to clarify the inflation level it is wished to attain - e.g. 2% - to make it easier for
citizens to understand and to allow a sufficiently high buffer, above zero, that will afford
more leeway to interest rate policy. Further, this objective must be more symmetrical in
nature, making it clear that our response to slippage below the objective will be as forceful
as with deviations above it. Our determination to achieve symmetrical results in inflation
developments around this objective will also be patent.
Another key aspect is what monetary policy instruments we should have. In the setting
described, asset purchase programmes and liquidity-providing operations for banks should
be part of the normal "toolbox". Moreover, we should equip ourselves with sufficiently
flexible instruments to head off fragmentation dynamics that may compromise the proper
transmission of monetary policy euro area-wide.
Finally, allow me to voice some thoughts on the main challenges in the banking sector
regulatory and supervisory area. The crisis has but highlighted the importance of a healthy
banking sector, with sufficient buffers to absorb unexpected losses. We must ensure that
the sector's resilience remains in place for new risks that may emerge.
A reminder, too, that the Basel III global reforms have still to be implemented. The aim is to
homogenise the calculation of risk-weighted assets across institutions and, to achieve this,
a key element is the so-called output floor. Essentially, a floor is set on the reductions banks
can obtain using internal models to calculate minimum capital requirements instead of the
standardised approach. This objective remains wholly in place. Indeed, after having delayed
implementation by one year, all the members of the Basel Committee on Banking
Supervision it is my privilege to preside have committed to fully implement this reform on
the new date.
At the national level, the coordinated supervision of risks to financial stability has been
strengthened with the creation of the Spanish macroprudential authority (AMCESFI). In
parallel, new macroprudential instruments have been made available to the Banco de
España, increasing our capacity to act ahead of episodes of excessive or inappropriate
credit growth.
Aside from these improvements, it would be worth reflecting on our institutional financial
architecture. In the wake of the previous international financial crisis, some countries
changed their models, generally moving to more integrated models involving a greater role
for central banks. Among these, we have witnessed the separation of the responsibilities for
preserving the financial soundness of all financial institutions irrespective of their nature
(banking, insurance, securities, etc.) and for overseeing the conduct of their relations with
customers, assigning such responsibilities to different authorities (to the Banco de España
and to the CNMV, respectively). This is, in my view, an optimal institutional arrangement for
managing potential clashes between both responsibilities and for enhancing the efficiency
and effectiveness of the supervisory activity.
As I said, it will be important to respond to the new risks that emerge, which include most
notably climate change and digitalisation.
In the case of climate change, we supervisors must ensure that banks correctly assess risks
and incorporate them into their portfolio management. We must also fulfil a complementary
role by developing databases and appropriate reporting requirements, and by including
risks in financial stability analyses. Indeed, many supervisors are developing environmental
stress tests.
As to technological developments, there are prominent risks associated with cyber attacks
or with dependence on external services providers. But there are also those arising from the
growing competition with technological companies, which may become disruptive.
The consequences for prudential authorities are significant. We must maintain proactive
supervision, since the traditional regulatory framework may not be enough. And we will have
to question the regulatory perimeter, so that the habitual mantra of "same activity, same
risks, same rules" is genuinely operational. Finally, we must strengthen cooperation among
authorities given the diversity of sectors affected.
Governance of the information that firms have on customers is a particularly important issue.
It appears reasonable that, if it is considered necessary for this information to be available
to all operators, such an obligation should have no exceptions, and that its scope should
be clear, always observing customer rights.
BigTech also exerts pressure on the sector's profitability, which is already weakened by the
impact of the pandemic and by developments in the wake of the global financial crisis. To
improve matters, banks should pursue efficiency gains, cutting costs and using new
technologies more intensively. In particular, they should refine the use of the information
they have, which enables them to improve their business model without raising their risk
profile. Consolidation processes may also be useful, though an evaluation of the merits of
each proposal is needed, particularly regarding the impact on financial stability. European
transnational operations would be particularly positive, given that they would help further
the Banking Union.
As you can see, the to-do list is an ambitious one, given both the number of tasks and how
demanding they are. This is why we must set to work as soon as possible, mindful that the
rewards are substantial. Accomplishing these tasks is a job for all of us: authorities,
legislators, firms and citizens. We can all contribute to reducing uncertainty when it comes
to foreseeing how the future will be. In the spirit of Abraham Lincoln's words, who stated
that "the best way to predict your future is to create it", we are all jointly responsible for
setting in train the reforms that can obtain a better future for us and the coming generations.
Thank you.