Luis M Linde: Brief review of recent developments in the Spanish
economy
Testimony by Mr Luis M Linde, Governor of the Bank of Spain, before the Senate Budget
Committee in connection with the draft State Budget for 2013, Madrid, 21 November 2012.
* * *
Ladies and gentlemen,
This is the first time I am following the tradition of the Governor of the Banco de España in
giving testimony to this House as part of the debate on the State Budget. It is a pleasure
to do so.
The Budget is being debated this year in a national and international economic context
beset by difficulties. Consequently, before analysing fundamental aspects of the Budget, I
think it is appropriate to briefly review some of the most significant recent developments in
the Spanish economy. I will confine my comments to those developments I consider most
important for the debate on this draft law.
The international setting and the euro area
In the current circumstances, marked by the need to complete a series of difficult
adjustments, the Spanish economy's ability to recover is heavily conditioned by the fragile
external setting. On the most recent projections of the main international organisations
and most private analysts, the euro area's gross domestic product - and, therefore, the
imports of our main economic partners - will hardly grow next year. The outlook for the
other developed economies is not much more favourable and, indeed, the available
projections for the emerging economies, which in recent years have been the main driver
of global economic growth, also show a weakening of activity.
The difficulties of definitively restoring confidence in the soundness of the Monetary Union
continue to weigh on the lack of momentum in the euro area. It is widely accepted that the
problems continuing to affect sovereign debt markets in the area and limiting its ability to
recover ultimately stem from the slowness shown by certain economies in adapting to the
new reality of belonging to a monetary union and from certain weaknesses in the original
design of European governance.
Since the tensions emerged, significant progress has been made in what could to some
extent be considered the first phase of reform of the euro: warranting a mention here, in
any event, are the strengthening of the Stability and Growth Pact, the Excessive Imbalances
Procedure and the European Semester. At the same time, however, the scope and depth of
the crisis have shown the need for a more far-reaching review, whose ultimate aim must
be to achieve a "genuine economic and monetary union". The Summit of Heads of State
or Government of the euro area in June this year marked the beginning of the second
phase of reform, which rests on three basic pillars: the banking union, further fiscal
integration and greater economic policy coordination.
As to the ECB, it has contributed to providing stability to the euro area both through its
more conventional remit, i.e. setting interest rates, and through its less conventional facet,
namely supplying exceptional amounts of liquidity through unorthodox channels. But the
roots of the current crisis in the euro area are not of a monetary nature and, consequently,
monetary policy alone cannot resolve those problems. Monetary policy can, however,
provide more time for the remedies aimed at resolving the underlying problems to be
effective.
On 2 August the Governing Council of the ECB adopted a new non-conventional measure:
the so-called Outright Monetary Transactions. This programme of purchasing government
debt on secondary markets, subject to compliance with certain macroeconomic conditions,
aims to repair the monetary policy transmission mechanism, thus ensuring that the effects
of the expansionary conventional measures adopted from the onset of the crisis reach
European households and firms alike, irrespective of their country of residence.
This ECB decision has had a stabilising effect on markets and eased the pressure on the
Spanish economy, although financial conditions remain very tight and uncertainty continues
to weigh on households' and firms' spending and investment decisions.
As stated, euro area measures should contribute to restoring the transmission channels of
monetary policy and, thereby, reduce financial tensions. They should also help to sever
the problematic public finances/banking system feedback loop, a vicious circle which
contributes to prolonging the climate of uncertainty and makes it difficult to resolve the
problems facing the euro area. Nevertheless, it should not be forgotten that the scope of
these actions is limited and that definitively overcoming the crisis in Spain will depend on
the progress achieved in other domains, including those which depend on our own economic
policy.
The Spanish economy
The challenges facing the Spanish economy are well-known: reducing its high dependence
on external financing, sustainably correcting the budget imbalance and strengthening the
drivers of medium- and long-term growth through substantial and lasting improvements in
competitiveness. Naturally, completing the clean-up and restructuring of the banking system
is also a key factor in this strategy, and I will briefly refer to this later on.
Significant steps have been taken in addressing these challenges. Nonetheless, the ongoing
adjustment of the Spanish economy is at a delicate juncture, since there are no
perceptible improvements in activity and job creation because many of the measures
taken are structural and will take some time to work fully through. The growth outlook for
the coming quarters is still not favourable, as shown by the forecasts released by different
organisations in the past few weeks, which point to a fresh contraction of activity in 2013.
However, the adjustment undertaken is essential in laying the groundwork for a new phase
of economic growth which will allow a substantial and lasting reduction in the unemployment
rate. The resumption of growth of the Spanish economy will depend above all on our
perseverance in pushing through the reforms.
As I mentioned in my address to the Spanish Parliamentary Budget Committee, and as I
believe bears repeating here, economic policy has to continue striving towards two main
goals: promoting competitiveness and growth, and restoring the sustainability of public
finances. I will focus particularly on this second stage of the adjustment.
Fiscal consolidation
In the present circumstances, ensuring the credibility of the process of fiscal consolidation
is a priority. After the heavy slippage in the deficit in 2011, it is crucial to dispel doubts as
to the capacity to control the upward path of public debt. Credibility is the main alleviating
factor to mitigate the contractionary impact, in the short run, of the necessary adjustment
measures.
For the consolidation to be credible, the expenditure-reducing and revenue-enhancing
measures have to be well-designed and consistent with our chosen path; in addition,
experience indicates that to prevent slippage, it is advisable to work with a highly
conservative projection of public revenue. When forecasting revenue, underestimates are
more acceptable than overestimates. Also, adequate early warning tools are required to
detect in advance any possible deviations and to make, where necessary, the required
corrections in time. The Budgetary Stability Law provides an appropriate tool for controlling
expenditure. In the area of credibility, it is highly advisable to define a
multi-year
budgetary time horizon which offers certainty to agents and, moreover, to deploy fiscal
measures which combine actions with a short-term impact and others acting on the
sustainability of public finances in the medium term, impinging, among others, on those
expenditure items most affected by population ageing.
Regional government finances
Let me begin my analysis of the 2013 State budget by looking at regional government
finances.
Spain is today a country characterised by strongly decentralised public expenditure. On
2011 figures, central government accounted for 22% of total expenditure, social security
for 32%, regional government for 34% and local government 12%. Thus, 46% of public
expenditure was by regional and local government. With this structure of public expenditure,
the setting of budgetary objectives for the various political and
administrative tiers, on one
hand, and the monitoring of their fulfilment, on the other, are two sides of the same coin.
Both are fundamental in building the credibility of budgetary policy.
Let me mention here what I consider to be an extremely significant advance. At the end of
October the Ministry of Financial Affairs and Public Administration began to publish for the
first time, as a result of the commitments made under the Stability Law, monthly data on
the regional government budget outturns. As these figures become available regularly, in
accordance with the related Law, the task of monitoring regional government expenditure
will be made immensely easier. This is fundamental for the timely detection of any slippage
from stated budgetary objectives and for standing ready to respond appropriately. It should
also be noted that in the past few weeks a good number of regional governments
announced their budgets for 2013, although it is still early to make a full diagnosis of overall
regional government expenditure.
These developments remedy some of the weaknesses in the information available for
assessing the budgetary adjustment scheduled for 2013. Even so, the fact that the
presentation of the various budget documents by the various governments is not formally
coordinated makes the work of analysts harder, given that, obviously, what matters from
the macroeconomic standpoint or for the analysis of public finances is general government as
a whole.
The State and Social Security Budget for 2013
Let me now turn to the essential features of the State and Social Security Budget for 2013,
beginning with a reference to the budget outturn in 2012.
The budget deficit is being reduced this year in very adverse economic and financial
circumstances. Indeed, as a result of the risks of possible slippage, a series
of
supplementary fiscal measures were adopted for the 2012 Budget. Their effects have
begun to be perceived only in the second half of the year. Notwithstanding, on the
information available, the possibility of slippage can still not be ruled out. Meeting the
target will depend on the numerous tax measures taking effect in the last quarter of the
year ultimately yielding the expected returns, and on that offsetting the growth of debt
service payments, unemployment benefits and pensions. Given the importance of meeting
the deficit target in 2012, it should be foreseen that possible slippage in certain items may
be offset with possible adjustments to others.
The draft State Budget for 2013 sets an overall general government deficit target, in
National Accounts terms, of 4.5% of GDP, in line with European commitments. That is
down from 6.3% envisaged for 2012, excluding from that figure the impact of the measures to
support banks which must be recorded this year (amounting to around 1 pp of GDP). The
Budget envisages that the public debt ratio will increase from 85% of GDP in 2012
(including €30 billion of FROB debt due to the drawdown in December of the credit line
agreed with the European authorities) to 91% of GDP in 2013.
The fiscal effort these targets entail is highly ambitious (around 2 pp in terms of the
cyclically adjusted primary deficit), in a setting which will remain difficult. The macroeconomic
scenario accompanying the budget envisages that GDP in real terms will contract 0.5%, as
a result of the 2.8% fall in national demand which would be partly offset by a 2.3 pp
contribution by the external sector. The main difference between this macroeconomic setting
and that of the IMF or the European Commission is the lower decline in gross capital
formation projected in the budget.
Achievement of the targets set for 2013 may be jeopardised if tax receipts are affected by
lower economic activity. Expenditure in the State and Social Security Budget is dominated
by the interest on government
debt, spending on contributory pensions and unemployment
benefits. The sharp rise in these items reflects the increase in debt and the higher cost of
new issues, demographic trends and the unfavourable performance of the labour market.
To offset this expansionary trajectory, the Budget adopts an austere stance on other
expenditure items, in particular the remuneration of public employees and real
investment.
Lastly, I must mention that the Budget for 2013 saw the culmination of one of the most
important agreements of the Toledo Pact, namely the separation of the Social Security
System's funding sources: on one hand, contributory pensions, funded solely by social
contributions and, on the other, non-contributory supplements and non-contributory
pensions, funded by taxes. This separation, which began to be applied in 2002, will finally
be completed in 2013.
The bank restructuring process
Finally, I would like to comment on the bank restructuring process under way further to the
agreement entered into with the European authorities last July.
Bank restructuring is progressing as scheduled. In June the evaluation exercise was
completed, enabling an estimate of the capital needs for the whole system to be made,
and confirming that they were clearly below €100 billion; at the end of August the Royal
Decree-Law on credit institution restructuring and resolution was approved, constituting a
new code in this area; at the end of September the exercise was completed, enabling the
capital needs for each of the banks participating in the exercise, which accounted for 90%
of the Spanish banking system, to be determined; and, last Thursday, the Decree which
will regulate the activity of the Asset Management Company for Assets Arising from Bank
Restructuring (SAREB) was approved, another key step in the implementation of the
programme agreed with the European Commission.
The analysis concluded in September enabled the classification of banks for restructuring
purposes to be confirmed. Previously, the banks without additional capital needs had
already been determined (Group 0) as had the banks controlled by the FROB (Group 1), to
use the terminology of the Memorandum of Understanding; this classification was completed,
dividing the other banks with capital needs into: a) those with plans to achieve the capital
levels required using their own means; and b) those which will require State aid to do so.
The latter were requested to provide restructuring plans which are currently being
studied.
At the end of this month, it is planned to approve the restructuring plans of the banks in
Group 1 (those controlled by the FROB), and those of Group 2 (the other banks which will
require State aid) will foreseeably be approved before year-end. The restructuring plans
envisage the transfer of assets to the asset management company, which will become
operational in December, and the recapitalisation of banks which need it. Each bank
will
have a schedule for implementing the measures that it must adopt, and these are expected
to be completed in the first quarter of 2013.
Conclusions
The State Budget for 2013 represents a substantial effort in terms of austerity. The intended
fiscal adjustment is certainly very ambitious, given the ongoing recessionary setting for
public finances next year. Central government efforts would be insufficient if not
accompanied too by the adjustment to which regional and local government have committed.
From the macroeconomic standpoint, some data show progress is being made in rebalancing
the Spanish economy. The bulk of the correction has already been made by the current
account and it is close to balance in 2012 which, foreseeably, will enable it to run a
surplus in 2013. Similarly, we can see improvements in the competitiveness of the
Spanish economy both with regard to labour cost indicators and productivity. We forecast
that in 2014, and measured by unit labour costs, Spain will have recovered practically all
of the competitiveness lost between 1998 and 2008.
The correction of imbalances will be essential for regaining market confidence. And here,
both budget policy and further structural reforms will be a pivotal contributing factor. The
year 2013 poses considerable challenges and difficulties. If we manage to overcome them,
they will put us on the path of economic growth and job creation.