Council opinion of 4 March 2008 on the updated stability programme of Spain, 2007-2010
Date: 2008-03-04
Institutions: Council of the European Union
Subjects: Spain, budget estimate, economic forecasting, public finance, stability programme

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OPINIONS

COUNCIL

COUNCIL OPINION

of 4 March 2008

on the updated stability programme of Spain, 2007-2010

(2008/C 75/02)

THE COUNCIL OF THE EUROPEAN UNION,

Having regard to the Treaty establishing the European Community,

Having regard to Council Regulation (EC) No 1466/97 of 7 July 1997 on the strengthening of the surveil-
lance of budgetary positions and the surveillance and coordination of economic policies (1), and in particular
Article 5(3) thereof,

Having regard to the recommendation of the Commission,

After consulting the Economic and Financial Committee,

HAS DELIVERED THIS OPINION:

(1)

(2)

On 4 March 2008, the Council examined the updated stability programme of Spain, which covers the
period 2007 to 2010 (2).

Spain has been enjoying a long period of sustained growth averaging 3,75 % over the last twelve
years, well above the euro area (at around 2 %). Persistently low real interest rates and dynamic demo-
graphics have been feeding strong domestic demand and job creation as well as an unprecedented
growth in the housing sector.

In
Moreover, successive labour market reforms significantly reduced structural unemployment.
parallel, a number of imbalances have emerged or persist, such as a widening external deficit and the
inflation differential with the euro area, while productivity growth was consistently low. Regarding
public finances, a successful expenditure-based consolidation process took place since the mid-nine-
ties, which improved the government balance from a deficit of around 6 % of GDP to a close-to-
balance position in 2000 and a comfortable surplus since 2005. Total tax receipts have grown by
about 4,25 percentage points of GDP since the mid-nineties boosted by a tax-rich growth pattern.
Going forward, population ageing might negatively impact on the long-term sustainability of public
finances, mainly as a result of increasing pressure from pension expenditure.

(1) OJ L 209, 2.8.1997, p. 1. Regulation as amended by Regulation (EC) No 1055/2005 (OJ L 174, 7.7.2005, p. 1). The

documents referred to in this text can be found at the following website:
http://ec.europa.eu/economy_finance/about/activities/sgp/main_en.htm

(2) The update was submitted more than 3 weeks beyond the 1 December deadline set in the code of conduct.

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(3)

(4)

The macroeconomic scenario underlying the programme envisages that real GDP growth will decele-
rate from 3,8 % in 2007 to 3,1 % on average over the rest of the programme period. Assessed
against currently available information (1), this scenario appears to be favourable throughout the
programme period. In 2008, inflationary pressures, lower growth expectations, as well as the devel-
opments in the housing sector are expected to weigh on disposable income and point towards lower
GDP growth than projected in the programme. Also the growth composition presented in the
programme is favourable, in particular concerning the adjustment path of the residential construction
sector. While the programme expects a deceleration of investment in dwellings, the Commission
services' autumn 2007 forecast projects a contraction of the sector, starting already in 2008, implying
a stagnation of total investment in 2009. However, due to lower imports the contribution of net
exports to growth could improve compared to the programme. Finally, the programme's projections
for inflation appear on the low side in the light of the most recent available information on food and
oil prices.

For 2007, the general government surplus is estimated at 1,8 % of GDP in the Commission services'
autumn 2007 forecast, against a target of 1 % of GDP set in the previous update of the stability
programme. Half of the difference can be explained by the positive base effect from 2006. The other
half results from higher-than-targeted revenue growth in 2007, which was however partly offset by
higher-than-budgeted expenditure growth. Recent information points to the possibility of a better
final outcome above 2 % of GDP, owing to even higher-than-expected revenues in 2007, especially
from direct
taxes, reflecting the high dynamism of corporate profits. The better-than-expected
budgetary outcomes in 2006 were used to pursue more ambitious budgetary targets than those set in
the end-2006 update of the stability programme, although some municipal and regional expenditure
overruns were recorded. The Council notes that budgetary implementation in 2007 was broadly
consistent with the April 2007 Eurogroup orientations for budgetary policies.

(5) Within the broad goal of maintaining macroeconomic and budgetary stability, the most recent update
of the stability programme aims at respecting the medium-term objective (MTO), which is a balanced
position in structural terms (i.e.
in cyclically-adjusted terms net of one-off and other temporary
measures), by a comfortable margin. The headline general government surplus is targeted to decline
from 1,8 % of GDP in 2007 to 1,2 % of GDP in 2008 and to remain stable thereafter. The deteriora-
tion in 2008 stems from a small increase in the expenditure ratio and a decline in the revenue ratio
by 0,5 percentage point of GDP. Direct taxes are expected to fall by 0,25 percentage point of GDP in
2008 as a result of lower economic growth and the ongoing impact of the 2007 tax reform. After
2008, revenue and expenditure components are assumed to remain broadly stable. The primary
balance is planned to decline from an estimated surplus of 3,4 % of GDP in 2007 to 2,7 % in 2008,
remaining broadly stable thereafter. The structural balance calculated according to the commonly
agreed methodology is projected to slightly decline from 2,25 % in 2007 to 1,75 % in 2008 and to
increase to around 2 % in 2009 and 2010. Compared with the previous programme, the new update
presents, building on the better-than-expected 2007 outturn, somewhat better targets for 2008 and
2009 against a broadly similar macroeconomic background.

(6)

The risks to the budgetary projections in the programme appear broadly balanced in 2008, but
outcomes could be worse than projected in 2009 and 2010. Specifically, in 2008, the impact of
possibly lower economic growth would be broadly offset by the positive base effect from higher
revenues in 2007 than estimated in the programme. However,
the favourable macroeconomic
assumptions for 2009 and 2010 would not be compensated by other factors, which points to the
risk of lower budgetary surpluses. In particular, tax revenue projections may turn out to be optimistic
on the back of less buoyant corporate profits and housing market. On the other hand, Spain has a
good track record of budgetary consolidation.

(7)

In view of this risk assessment, the budgetary stance in the programme seems sufficient to maintain
the MTO by a large margin throughout the programme period. The fiscal policy stance implied by
the update is in line with the Stability and Growth Pact throughout the period. The Council notes
that it is also consistent with the April 2007 Eurogroup orientations for budgetary policies for the

(1) The assessment takes also into account the Commission services' autumn 2007 forecast and the Commission assessment

of the October 2007 implementation report of the national reform programme.

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year 2008. The projected weakening in the structural surplus in 2008 cannot be regarded as entailing
a pro-cyclical stance but partly reflects a decline in the tax revenue as a percent of GDP resulting
from a slowing of the economy and the fading housing boom.

Spain appears to be at medium risk with regard to the sustainability of public finances. The
long-term budgetary impact of ageing is well above the EU average, mainly as a result of a relatively
high increase in pension expenditure as a share of GDP over the coming decades. The budgetary posi-
tion in 2007, reflected in a strong primary surplus as well as a low and decreasing debt ratio, contri-
butes to offsetting the projected long-term budgetary impact of ageing populations. However, this is
not sufficient to fully cover future spending pressures. Maintaining high primary surpluses over the
medium term and implementing further measures aimed at curbing the substantial increase in age-
related expenditures would contribute to reducing risks to the sustainability of public finances.

The stability programme is fully consistent with the October 2007 implementation report of the
national reform programme (NRP). In particular, the update provides a qualitative assessment of the
overall impact of the NRP within the medium-term fiscal strategy as well as sufficient information on
the direct budgetary costs associated with some of the reforms envisaged in the NRP, e.g. R & D,
education and infrastructures.

(8)

(9)

(10)

The budgetary strategy in the programme is broadly consistent with the country-specific broad
economic policy guidelines and the guidelines for euro area Member States in the area of budgetary
policies issued in the context of the Lisbon strategy.

(11) As regards the data requirements specified in the code of conduct for stability and convergence
programmes, the programme provides almost all required data and has some gaps in the optional
data (1).

The overall conclusion is that the medium-term budgetary position is sound with high general government
surpluses above the MTO and a relatively low debt ratio. However, given favourable economic growth
assumptions and the end of the housing boom, the projected government revenue might turn out to be on
the high side. In this context, a careful assessment of the impact on the general government balance of
permanent tax cuts and/or expenditure increases will be crucial to maintain a strong budgetary position and
to ensure the long-term sustainability of public finances, which is at medium risk. Fostering productivity-en-
hancing expenditure items, such as R & D, infrastructure and education, is important to underpin a smooth
adjustment of the economy in the light of large external imbalances, the contraction of the housing sector
and the existing inflation differential with the euro area.

In view of the above assessment, while maintaining a strong budgetary position, Spain is invited to further
improve the long-term sustainability of public finances with additional measures to contain the future
impact of ageing on spending programmes.

Spain is also invited to improve compliance with the submission deadline for stability and convergence
programmes specified in the code of conduct.

Comparison of key macroeconomic and budgetary projections

Real GDP
(% change)

SP Dec 2007

COM Nov 2007

SP Dec 2006

2006

2007

2008

2009

2010

3,9

3,9

3,8

3,8

3,8

3,4

3,1

3,0

3,3

3,0

2,3

3,3

3,2

n.a.

n.a.

(1) In particular, table 1b (price developments), item 3 (HICP); table 1c (labour market developments), item 6 (compensation

of employees) and the data on the functional classification of public expenditure are missing.

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HICP inflation
(%)

Output gap (1)
(% of potential GDP)

SP Dec 2007 (4)

COM Nov 2007

SP Dec 2006 (4)

SP Dec 2007

COM Nov 2007 (2)

Net lending/borrowing
vis-à-vis the rest of the
world
(% of GDP)

General government
balance
(% of GDP)

Primary balance
(% of GDP)

Cyclically-adjusted
balance (1)
(% of GDP)

Structural balance (3)
(% of GDP)

Government gross debt
(% of GDP)

SP Dec 2006

SP Dec 2007

COM Nov 2007

SP Dec 2006

SP Dec 2007

COM Nov 2007

SP Dec 2006

SP Dec 2007

COM Nov 2007

SP Dec 2006

SP Dec 2007

COM Nov 2007

SP Dec 2006

SP Dec 2007

COM Nov 2007

SP Dec 2006

SP Dec 2007

COM Nov 2007

SP Dec 2006

2006

2007

2008

2009

2010

3,4

3,6

3,5

– 1,1

– 0,6

– 0,9

– 8,1

– 8,1

– 7,5

1,8

1,8

1,4

3,4

3,5

3,0

2,3

2,1

1,8

2,3

2,1

1,8

39,7

39,7

39,7

2,7

2,6

2,7

– 0,9

– 0,5

– 1,2

– 9,0

– 8,7

– 8,2

1,8

1,8

1,0

3,4

3,4

2,5

2,2

2,0

1,5

2,2

2,0

1,5

36,2

36,3

36,6

3,3

2,9

2,6

– 1,4

– 0,9

– 1,5

– 8,9

– 9,1

– 8,4

1,2

1,2

0,9

2,7

2,7

2,3

1,8

1,6

1,6

1,8

1,6

1,6

34,0

34,6

34,3

2,7

2,7

2,5

– 1,9

– 1,8

– 1,6

– 8,8

– 9,3

– 8,7

1,2

0,6

0,9

2,6

2,1

2,2

2,0

1,4

1,6

2,0

1,4

1,6

32,0

33,0

32,2

2,8

n.a.

n.a.

– 1,6

n.a.

n.a.

– 8,7

n.a.

n.a.

1,2

n.a.

n.a.

2,6

n.a.

n.a.

1,9

n.a.

n.a.

1,9

n.a.

n.a.

30,0

n.a.

n.a.

Notes:
(1) Output gaps and cyclically-adjusted balances according to the programmes as recalculated by Commission services on the basis of the

information in the programmes.

(2) Based on estimated potential growth of 3,5 %, 3,7 %, 3,4 % and 3,2 % respectively in the period 2006-2009.
(3) There are no one-off and other temporary measures in the most recent programme and Commission services' autumn forecast.
(4) Private consumption deflator.

Sources:
Stability programme (SP); Commission services' autumn 2007 economic forecasts (COM); Commission services' calculations.