COMMISSION STAFF WORKING DOCUMENT In-depth review for SPAIN in accordance with Article 5 of Regulation (EU) No 1176/2011 on the prevention and correction of macroeconomic imbalances Accompanying the document COMMUNICATION FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT AND THE COUNCIL AND TO THE EUROGROUP Results of in-depth reviews under Regulation (EU) No 1176/2011 on the prevention and correction of macroeconomic imbalances
Date: 2013-04-10
Institutions: European Commission
Subjects: Spain, State aid, building speculation, competitiveness, economic growth, economic recession, economic reform, financial institution, indebtedness, labour market, macroeconomics, public debt, unemployment

EUROPEAN 
COMMISSION 

Brussels, 10.4.2013  
SWD(2013) 116 final 

COMMISSION STAFF WORKING DOCUMENT 

In-depth review for SPAIN 

in accordance with Article 5 of Regulation (EU) No 1176/2011 on the prevention and 
correction of macroeconomic imbalances 

Accompanying the document 

COMMUNICATION FROM THE COMMISSION TO THE EUROPEAN 
PARLIAMENT AND THE COUNCIL AND TO THE EUROGROUP 

Results of in-depth reviews under Regulation (EU) No 1176/2011 on the prevention and 
correction of macroeconomic imbalances 

{COM(2013) 199 final} 
{SWD(2013) 113 final} 
{SWD(2013) 114 final} 
{SWD(2013) 115 final} 
{SWD(2013) 117 final} 
{SWD(2013) 118 final} 
{SWD(2013) 119 final} 
{SWD(2013) 120 final} 
{SWD(2013) 121 final} 
{SWD(2013) 122 final} 
{SWD(2013) 123 final} 
{SWD(2013) 124 final} 
{SWD(2013) 125 final}

EN 

   EN 

 
 
 
 
 
  
 
 
 
 
 
TABLE OF CONTENTS 

Executive summary and conclusions ......................................................................................... 5 

1. 

2. 

2.1. 

2.2. 

Introduction .................................................................................................................. 8 

Macroeconomic situation and potential imbalances .................................................... 9 

Macroeconomic scene setter ........................................................................................ 9 

Adjustment of internal and external imbalances........................................................ 10 

2.2.1.  Current account and external debt.............................................................................. 11 

2.2.2.  Export performance and competitiveness .................................................................. 13 

2.2.3.  Housing market .......................................................................................................... 15 

2.2.4.  Deleveraging by households and non-financial corporations .................................... 17 

2.2.5.  Public debt.................................................................................................................. 18 

2.2.6.  Labour market ............................................................................................................ 19 

3. 

In-depth analysis of selected topics............................................................................ 21 

3.1. 

Private sector deleveraging ........................................................................................ 21 

3.1.1. 

Introduction ................................................................................................................ 21 

3.1.2.  Households................................................................................................................. 22 

3.1.3.  Non-financial corporations......................................................................................... 27 

3.1.4.  Conclusion.................................................................................................................. 30 

3.2. 

External debt sustainability and current account adjustment..................................... 31 

3.2.1.  The net international investment position .................................................................. 31 

3.2.2.  External debt sustainability ........................................................................................ 33 

3.2.3.  Progress in the adjustment of the external deficit ...................................................... 34 

3.2.4.  Conclusions ................................................................................................................ 42 

4. 

Policy Challenges....................................................................................................... 44 

References ................................................................................................................................ 48 

2 

 
 
 
List of graphs 

Graph 1: Real GDP growth and contributions ......................................................................... 10 

Graph 2: Net lending/borrowing by sector............................................................................... 12 

Graph 3: Net lending/borrowing by component ...................................................................... 12 

Graph 4: Productivity and wages ............................................................................................. 14 

Graph 5: REER (ULC in manufacturing) vis-à-vis EA16 and IC35........................................ 14 

Graph 6: Decomposition of developments in ULCs ................................................................ 15 

Graph 7: Decomposition of developments in the REER (ULC-based) ................................... 15 

Graph 8: Dynamics of housing and mortgage markets imbalances ......................................... 16 

Graph 9: House prices,  mortgages and residential investment ............................................... 16 

Graph 10: Evolution of domestic credit ................................................................................... 17 

Graph 11: Unemployment by age group .................................................................................. 20 

Graph 12: Change in the number of employees by contract duration...................................... 20 

Graph 13: Debt sustainability, Households (HH) .................................................................... 22 

Graph 14: Debt sustainability, Non-financial corporations (NFC) .......................................... 22 

Graph 15: Household indebtedness indicators ......................................................................... 23 

Graph 16: Decomposition of rate of change of household debt............................................... 23 

Graph 17: Household indebtedness, EU 27 countries, 2010.................................................... 24 

Graph 18: Household notional leverage................................................................................... 24 

Graph 19: Sectoral decomposition of credit flows................................................................... 25 

Graph 20: MFI lending to households...................................................................................... 25 

Graph 21: Financial position of households............................................................................. 26 

Graph 22: Households' total wealth ......................................................................................... 26 

Graph 23: NFC leverage indicators.......................................................................................... 27 

Graph 24: NFC indebtedness and financial burden ................................................................. 27 

Graph 25: Breakdown of NFC bank debt by sector ................................................................. 28 

Graph  26:  Evolution  of  share  of  doubtful  loans  in  total  loans  by  non-financial  corporate 
sectors....................................................................................................................................... 28 

Graph 27: Decomposition of change in ratio of NFC debt to GDP ......................................... 29 

Graph 28: Change in selected ratios from income accounts, NFC .......................................... 29 

Graph 29: Rate of change of credit to NFC ............................................................................. 30 

Graph 30: Sectoral breakdown of NIIP.................................................................................... 31 

Graph 31: Decomposition of rate of change of NIIP ............................................................... 31 

3 

 
 
 
 
Graph 32: Asset breakdown of NIIP ........................................................................................ 32 

Graph 33: Quarterly variation in BdE's assets against Eurosystem ......................................... 32 

Graph 34: Maturity composition of external debt.................................................................... 33 

Graph 35: External debt by issuer ............................................................................................ 33 

Graph 36: Evolution of forecasts of current account balance .................................................. 34 

Graph 37: Trade, income and capital account balances ........................................................... 35 

Graph 38: Components of income balance .............................................................................. 35 

Graph 39: Energy imports, volumes, 12-month moving average ............................................ 36 

Graph 40: Goods trade balance: energy and non-energy component ...................................... 36 

Graph 41: Saving and investment rates.................................................................................... 37 

Graph 42: Total exports and imports (current prices) .............................................................. 37 

Graph 43: Exports of goods and services, y-o-y growth (12-month moving average)............ 38 

Graph 44: Exports of goods by destination, contribution to y-o-y growth .............................. 38 

Graph 45: Employment distribution by firm size class in Spain, 2010.................................... 40 

Graph 46: Labour productivity distribution by firm size. Industry and services in Spain, 2010
.................................................................................................................................................. 40 

Graph 47: Extensive margin of exports, by country and company size, 2008......................... 41 

Graph 48: Intensive margin of exports, by country and company size, 2008.......................... 41 

Graph 49 Decomposition of import growth (Q1 2008 - Q2 2012) .......................................... 42 

Graph 50: Domestic demand and exports ................................................................................ 42 

4 

 
 
 
 
  
EXECUTIVE SUMMARY AND CONCLUSIONS 

In May 2012, the Commission concluded in the first In-Depth Review (IDR) that Spain was 
experiencing  very  serious  imbalances,  in  particular  as  regards  developments  related  to  the 
external position, private sector debt levels and the financial sector. As to the financial sector, 
since  last  year's  IDR,  a  programme  for  the  recapitalisation  of  the  financial  institutions  was 
signed in July 2012. The programme remains on track, thereby contributing to the controlling 
of  financial  sector  related  risks.  In  the  Alert  Mechanism  Report  (AMR)  published  on  28 
November 2012, the Commission found it useful, also taking into account the identification of 
a  very  serious  imbalance  in  May,  to  examine  further  the  risks  involved  and  progress  in  the 
unwinding of imbalances in an in-depth analysis. To this end, this IDR takes a broad view of 
the  Spanish  economy  in  line  with  the  scope  of  the  surveillance  under  the  Macroeconomic 
Imbalance  Procedure  (MIP).  The  main  observations and findings from this analysis  are  that 
the risks and negative economic trends associated to macroeconomic imbalances, as identified 
in the 2012 IDR1, are still powerful and have partly materialised: 

•  Negative feedback loops amongst a protracted economic recession, deleveraging and 
volatile  market  financing  conditions  remain  a  tangible  threat.  Private-sector 
deleveraging  is  imparting  a  significant  negative  impulse  to  domestic  demand  and  has 
plunged the economy into a double-dip recession since end-2011, which may extend into 
2014. Efforts to stem the rise in general government debt contribute to compress domestic 
demand.  Structural  rigidities  and  tight  financing  conditions  have  been  hindering  a  faster 
and  less  costly  (in  terms  of  output  and  employment)  adjustment  of  the  real  economy  to 
post-bubble  conditions.  In  turn,  the  contracting  economy  and  the  associated  surge  in 
unemployment  are  feeding  back  into  a  more  protracted  deleveraging  process.  Hence, 
while the adjustment of flow imbalances has advanced in 2012, risks to macroeconomic 
and financial stability have not yet dissipated. 

•  Spain  has  responded 

to 

to 

these  challenges  and 

the  country-specific 
recommendations  of  the  Council  under  the  2012  EU  semester2  with  efforts  to 
consolidate public finances and reform product and factor markets. A labour market 
reform  was  adopted  by  the  government  in  February  2012  and  passed  into  law  in  July 
2012.  A  comprehensive  reform  plan  was  presented  in  September  2012,  covering  further 
reforms  to  support  employment,  ensure  public  finance  sustainability,  and  strengthen  the 
business environment and competition. While measures have been taken or launched in all 
these  areas,  the  reform  agenda  remains  incomplete,  and  even  reforms  already  adopted 
have  not  always  displayed  their  full  effects  due  to  implementation  lags.  As  a  result,  the 
adjustment capacity of the economy remains unsatisfactory, with  much  of the burden of 
adjustment falling on employment.       

•  According to the Commission services' 2013 winter forecast, the unemployment rate 
is projected to rise further to 27% in 2013 (from 25% in 2012). The share of long-term 
unemployment  is  increasing,  and  with  it  the  probability  of  hysteresis  effects  that  would 
lower  the  growth  potential  of  the  economy.  Wages  have  only  belatedly  and  gradually 
started to respond to the slack in the labour market, partly in reaction to the 2012 reform 
of the labour market.  

1  
2  

European Commission, 2012a. 
http://register.consilium.europa.eu/pdf/en/12/st11/st11273.en12.pdf 

5 

 
 
 
 
                                                            
•  The  reduction  in  disposable  income,  rising  unemployment  and  falling  house  prices 
(down 31% in nominal terms from their peak) are weakening household capacity to 
repay  debt.  While  their  net  wealth  diminishes  (housing  being  the  bulk  of  it),  more  and 
more  households  are  affected  by  unemployment.  The  fall  in  house  prices  accelerated  in 
2012  on  the  back  of  a  large  stock  of  unsold  houses  and  falling  demand.  Residential 
investment  and  construction  activity  also  fell  further.  The  adjustment  in  the  housing 
market  is  not  completed,  and  further  drops  in  both  prices  and  investment  are  likely  to 
allow a narrowing of the gap between supply and demand.   

•  The  private  sector  faces  strong  pressures  to  deleverage.  The  non-financial  private 
sector debt-to-GDP ratio remains elevated, having declined by only around 15 pps. from 
the  2010  peak  of  227%.  The  reduction  in  debt  has  been  faster  for  non-financial 
corporation than in the household sector, due to different debt characteristics (in particular 
the  long  maturity  of  mortgages),  a  stronger  fall  in  non-financial  corporation  borrowing 
and  larger  debt  write-downs  on  non-financial  corporation  loans.  Non-performing  loans 
have increased and are expected to rise further due to the extended economic downturn.  

•  Net  external  debt  and  the  (negative)  net  international  investment  position  remain 
close  to  historical  peaks.  Net  external  liabilities  have  stabilised  at  above  90%  of  GDP 
since  2009.  The  vulnerabilities  associated  with  very  high  net  external  liabilities 
culminated  in  2012,  when  a  loss  of  market  confidence  on  Spanish  assets  led  to  large 
private capital outflows, which were partly offset by official capital inflows. In spite of the 
recent  easing,  financial  market  confidence  remains  highly  sensitive  to  economic  and 
policy developments. 

•  Both cyclical and non-cyclical factors have contributed to the sizeable improvement 
in the current account balance from a deficit close to 10% of GDP in 2007 to a deficit 
of  slightly  less  than  1%  of  GDP  in  2012.  This  improvement  has  been  driven  by  solid 
export growth and a sharp fall in imports, which can be related to some recovery in cost 
competitiveness  and  to  shifts  in  demand  composition,  possibly  of  a  lasting  nature.  Non-
price  competitiveness  factors  and  the  duality  of  the  economic  structure  (with  export 
companies being typically larger and more productive) have supported the robust export 
market  shares  performance  of  Spain.  At  the  same  time,  the  sharp  fall  in  imports  mostly 
related to the slump in domestic demand suggests that a considerable part of the current 
account reversal is cyclical. While around half of the losses in cost competitiveness during 
the  boom  period  have  been  reversed  so  far,  part  of  this  improvement  is  related  to  the 
impact of labour shedding on apparent labour productivity. Moreover, the decrease in unit 
labour  costs  (ULC)  has  not  fed  convincingly  into  final  prices.  Further  competitiveness 
gains  will  be  needed  to  underpin  the  dynamism  of  exports  and  import  substitution,  and 
thereby bring about a significant reduction of net external liabilities over time. 

•  High  and  fast  rising  general  government  debt  has  been  the  flip  side  of  the  ongoing 
adjustments  in  the  private  sector.  The  general  government  budget  deficit  has  fallen 
from  the  2009  peak  of  11.2%  of  GDP  but  remains  high  at  6.7%  of  GDP  in  2012 
(excluding  bank  recapitalisation  costs).  In  spite  of  a  substantial  fiscal  effort,  a  faster 
reduction in headline balances was hindered by the recessionary environment and shifts in 
tax  revenue  elasticitites. General  government  debt,  which  has  also  been  affected  by  the 
cost  of  bank  recapitalisations,  reached  84%  of  GDP  in  2012  and  is  set  to  record  further 
substantial increases in the coming years. The unwinding of macroeconomic imbalances 

6 

 
 
 
will only have run its full course once the fall-out on the general government sector has 
also been re-absorbed. 

The  scale  and  interrelated  nature  of  the  policy  challenges  stemming  from  these 
imbalances require a comprehensive and ambitious policy response. Notwithstanding the 
measures already adopted or proposed by the government, and whose positive effects depend 
on their swift and full implementation, a number of elements can be considered: 

•  The  rebalancing  of  the  economy  and  international  competitiveness  would  be  helped  by 
greater flexibility in the reallocation of resources. This would be fostered by measures to 
strengthen  competition  in  product  and  services  markets  (including  network  industries), 
improve the business environment, support the growth and internationalisation of firms. A 
review of the growth-friendliness of the tax system could also be considered.  

•  The  adjustment  capacity  of  the  economy,  the  absorption  of  the  large  number  of 
unemployed  workers  and  competitiveness  rest  decisively  on  a  well-functioning  labour 
market.  To  this  end,  it  would  be  useful  to  (i)  undertake  a  comprehensive  review  of  the 
impact of the 2012 labour  market  reform against its stated objectives (greater efficiency 
and reduced labour market duality, higher internal flexibility, a wage bargaining process 
that ensures a better alignment of wages to economic conditions, greater employability of 
young  workers  and  greater  use  of  permanent  contracts)  with  a  view  to  ensure  its 
effectiveness  and  (ii)  to  enhance  active  labour  market  policies  (ALMP),  public 
employment services and vocational training, so as to improve employability and raise the 
quality and effectiveness of training and job matching.  

•  The stability of the financial system and its capacity to finance the real economy rely on 
the swift completion of the recapitalisation and restructuring of the banking sector and the 
strengthening of the regulatory and supervisory frameworks foreseen in the context of the 
financial sector programme. Increasing the availability of non-bank financing sources and 
targeted measures for SMEs would also help to alleviate financing constraints on growth 
and  the  reallocation  of  resources.  Measures  to  foster  a  larger  and  more  efficient  rental 
market  could  help  stabilise  the  housing  sector  and  promote  geographical  mobility  of 
workers. 

•  Ensuring the long-term sustainability of public finances will require continuous efforts in 
the years to come. The credibility of the fiscal adjustment would be reinforced by basing 
consolidation  on  structural  measures  (including  to  ensure  the  sustainability  of  the  social 
security system) as required by the recommendations under the Stability and Growth Pact, 
and  by  further  action  to  reinforce  the  medium-term  orientation  and  institutional 
framework of public finances.  

7 

 
 
 
 
1. 

INTRODUCTION 

On  28  November  2012,  the  European  Commission  presented  its  second  Alert  Mechanism 
Report (AMR), prepared in accordance with Article 3 of Regulation (EU) No. 1176/2011 on 
the prevention and correction of macroeconomic imbalances.3 The AMR serves as an initial 
screening device, which helps to identify Member States that warrant further in-depth analysis 
to determine whether imbalances exist or risk emerging. According to Article 5 of Regulation 
No. 1176/2011, these country-specific “in-depth reviews” (IDR) should examine the nature, 
origin and severity of macroeconomic developments in the Member  State concerned, which 
constitute,  or  could  lead  to,  imbalances.  On  the  basis  of  this  analysis,  the  Commission  will 
establish  whether  it  considers  that  an  imbalance  exists  and  what  type  of  follow-up  it  will 
recommend to the Council. 

the  Commission  concluded 

This  is  the  second  IDR  for  Spain.  Based  on  the  previous  IDR,  which  was  published  on  30 
May  2012, 
that  Spain  was  experiencing  very  serious 
macroeconomic  imbalances,  in  particular  as  regards  developments  related  to  the  external 
position,  private  sector  debt  levels,  and  the  financial  sector.4  Overall,  in  the  AMR  the 
Commission  finds  it  useful,  also  taking  into  account  the  identification  of  a  very  serious 
imbalance last May, to examine further the progress and the risks involved in the unwinding 
of imbalances in an in-depth analysis. To this end this IDR takes a broad view of the Spanish 
economy  in  line  with  the  scope  of  surveillance  under  the  Macroeconomic  Imbalance 
Procedure (MIP). 

Against  this  background,  Section  2  looks  in  more  detail  into  these  developments  covering 
both external and internal dimensions. This is followed by two focus sub-sections in Section 3 
on  (i)  private  sector  deleveraging  and  (ii)  external  debt  sustainability  and  current  account 
adjustment. Section 4 discusses policy conclusions.  

3 
4 

http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=CELEX:32011R1176:EN:NOT 
These  imbalances  and  adjustment  challenges  were  analysed  in  detail  in  the  2012  In-depth  Review 
(European Commission, 2012a).   

8 

 
 
 
 
                                                            
2. 

MACROECONOMIC SITUATION AND POTENTIAL IMBALANCES 

2.1.  Macroeconomic scene setter 

The  credit-driven  housing  and  domestic  demand  boom  of  the  early  2000s  left  the 
Spanish  economy  saddled  with  major  external  and  internal  imbalances.  As  analysed  in 
greater detail in the 2012 IDR, the strong economic expansion in the period 1996-2007 (more 
than 3½% real GDP growth per year) was heavily skewed towards domestic demand and in 
particular residential investment. This unbalanced expansion, which was fuelled by abundant 
availability of external private financing following a sharp reduction in risk premia before and 
after euro-area accession, resulted in the accumulation of high domestic and external debt, the 
emergence  of  a  massive  real  estate  bubble,  significant  competitiveness  losses  and  recurrent 
and widening current account deficits. The sharp correction of this boom in the context of the 
international  financial  crisis  triggered  a  protracted  economic  recession  with  massive 
employment  losses.  Since  the  beginning  of  the  crisis  (Q3  2008  to  Q4  2012),  real  GDP  has 
dropped by around 5.7% and the number of people employed has fallen by almost 3.5 million 
(17% of total employment). 

While the adjustment has started, the unwinding of imbalances will continue to weigh on 
the  medium-term  growth  outlook.  After  a  temporary  stabilisation,  the  economy  fell  back 
into recession at the end of 2011. Real GDP kept on falling throughout 2012 and is expected 
to stabilise only towards the end of 2013. On an annual basis, a projected contraction of 1.4% 
in 2013 is expected to be followed by a subdued recovery of around 0.8% (under a no-policy 
change  assumption)  in  2014.  Private-sector  deleveraging,  very  high  unemployment,  tight 
financing  conditions,  and  fiscal  consolidation  constrain  domestic  demand  and  imply  a 
profound shift in the composition of demand towards net exports (see Graph 1). As a result, 
the  current  account  deficit  has  been  narrowing  and  is  expected  to  turn  into  a  surplus  from 
2013 onwards.  

Wage growth has belatedly started to react to the sharp fall in employment. The labour 
market  situation  deteriorated  further  in  2012.  Unemployment  reached  26%  in  the  fourth 
quarter of 2012 and is expected to keep increasing in 2013. Wage growth started to moderate 
more  noticeably  in  2012,  finally  responding  to  the  sharp  deterioration  in  the  labour  market. 
Thanks  largely  to  high  apparent  productivity  growth  on  the  back  of  labour  shedding,  unit 
labour costs sustained their fall in 2012 (-3.4%) and this trend should continue in 2013, albeit 
at  a  slower  pace.  Inflation  remains  elevated,  essentially  due  to  fiscal  measures,  but  also 
potentially  reflecting  weak  competition  in  some  product  and  service  markets  and  the 
application of indexation clauses. Inflation was 2.8% in February 2013, while core inflation 
reached 2.3%. 

9 

 
 
 
 
Graph 1: Real GDP growth and contributions 
pps.
8

6

4

2

0

-2

-4

-6

-8

forecast

06Q1

07Q1

08Q1

09Q1

10Q1

11Q1

12Q1

13Q1

14Q1

Domestic demand incl. inventories

Net external demand

GDP (y-o-y %)

Source: Commission services' 2013 winter forecast (European Commission, 2013a).  

2.2. 

Adjustment of internal and external imbalances 

Spain  faces  daunting  adjustment  challenges  and  risks  following  the  bursting  of  the 
housing and credit booms. The correction of imbalances started in 2008 and is ongoing. The 
adjustment  of  flows  (i.e.  current  account  deficit,  investment  in  construction,  credit  growth) 
has advanced, but the adjustment of stock variables has been much more gradual and will take 
considerable  time.  Very  high  external  debt  leaves  the  economy  vulnerable  to  changes  in 
external  financing  conditions.  Restoring  external  equilibrium  requires  a  move  to  a  sizeable 
current  account  surplus  position,  backed  by  further  improvements  in  competitiveness  and  a 
major  re-allocation  of  resources  to  the  tradables  sector.  Private  sector  deleveraging  is 
weighing  on  economic  growth,  while  the  economic  recession  and  the  deterioration  in  the 
labour  market  are  simultaneously  making  the  reduction  of  private  debt  more  difficult.  The 
bursting of the construction and housing bubble has weakened bank balance sheets, creating 
risks for financial stability and adding to overall tight financing conditions, which can in turn 
slow down the rebalancing of the economy. Moreover, the economic downturn and the cost of 
support to the financial sector have resulted in a substantial deterioration of public finances, 
which is reflected in the rapid increase in general government debt. The links and feedbacks 
between  the  sovereign,  the  banking  sector  and  the  real  economy  are  strong,  calling  for 
enhanced monitoring of the adjustment progress in all areas. 

An  important  development  since  the  2012  IDR  has  been  the  granting  of  financial 
assistance to Spain for the recapitalisation of financial institutions.5 Spanish banks have 
been  adversely  affected  by  the  bursting  of  the  real  estate  and  construction  bubble  and  the 
economic recession that ensued. The banking sector was characterized in the previous IDR as 
a  source  of  vulnerability  with  respect  to  financial  stability  and  credit  provision  to  the  real 
economy. Growing market tensions in the run up to the request for financial assistance of 25 
June  2012  confirmed  this  assessment.  Up  to  EUR  100  billion  were  made  available  via  the 

5 

See  the  Commission,  services'  reports  on  the  financial  assistance  programme  to  recapitalise  financial 
institutions in Spain, European Economy-Occasional Papers, 118, 121, 126 and 130. 

10 

 
 
 
 
 
                                                            
ESM, upon agreement by the Eurogroup in July 2012, while actual disbursements amounted 
to EUR 41.4 billion. The core of the programme is an overhaul of the weak segments of the 
Spanish  financial  sector  through  significant  recapitalisation  and  restructuring  as  well  as  a 
segregation  of  problematic  assets  from  those  banks  receiving  public  support  in  an  external 
Asset Management Company (AMC). Regulation and supervision will also be reinforced. The 
financial assistance will be provided for the period July 2012 to end-December 2013.   

The  banking  sector  programme  is  having  a  positive  impact  on  the  stability  of  the 
financial sector in Spain. The second review under the programme, concluded in February 
2013,  confirmed  that  the  programme  is  on  track.6  Successful  implementation  of  the 
programme is contributing to reducing the funding costs of banks. This should gradually feed 
into  an  easing  of  lending  conditions  to  households  and  non-financial  corporations.  Given 
deleveraging  pressures,  credit  growth  is  likely  to  remain  subdued  for  some  time,  but  this  is 
compatible with restoring credit flows to productive sectors. 

The  economy  remains  at  a  critical  juncture,  leaving  no  room  for  complacency  on  the 
reform side. The capacity of the economy to undergo the necessary structural transformation 
depends  on  the  smooth  functioning  of  its  factor  and  product  markets.  The  sharp  fall  in 
employment  and  sluggish  adjustment  of  prices  suggest  significant  shortcomings  in  these 
areas. Increasing price and cost competitiveness through sustained wage and price adjustment 
and increasing labour productivity beyond the cyclical adjustment related to labour shedding 
is a precondition for returning to a higher growth path, generating employment opportunities, 
ensuring the external rebalancing of the economy, limiting the costs (in terms of output and 
employment)  of  private  sector  deleveraging,  and  supporting  the  consolidation  of  public 
finances. 

2.2.1.  Current account and external debt  

The current account deficit has narrowed further in 2012. The long period of economic 
expansion that began in the second half of the 1990s and ended in 2007 was characterized by 
rising current account deficits and growing external indebtedness (see Graph 2 and Graph 3). 
During  this  time,  both  households  and  non-financial  corporations  significantly  increased 
investment  expenditures,  the  bulk  of  which  went  into  residential  investment.  These 
investments  were  largely  financed  by  capital  inflows  channelled  via  the  Spanish  banking 
sector.  As  explained  in  the  2012  IDR,  the  deterioration  of  external  financing  conditions 
prompted  a  relatively  rapid  adjustment  of  the  current  account  balance.  The  current  account 
deficit fell to 0.8% of GDP in 2012, from a peak of 10% in 2007 (and 3.7% of GDP in 2011). 
The  reduction  in  the  external  deficit  (including  both  current  and  capital  accounts)  has  been 
even more pronounced. The medium-term evolution of the external deficit will depend on the 
extent to which recent adjustments have been of a permanent rather than cyclical nature (see 
Section 3.2 for more details). In the short-term, according to the Commission services' 2013 
winter  forecast,  the  external  balance  is  expected  to  shift  from  a  deficit  to  a  surplus  in  2013 
(1½% of GDP) and this surplus is set to double in 2014. 

The improvement in the net lending position of the private sector has consolidated. The 
net lending/borrowing (NLB) position of the non-financial private sector has reached close to 
10%  of  GDP  by  end-2012  (Graph  2).  According  to  the  Commission  services'  2013  winter 
forecast,  both  households  and  non-financial  corporations  are  expected  to  remain  net  lenders 

6  

http://europa.eu/rapid/press-release_MEMO-13-58_en.htm 

11 

 
 
 
                                                            
over  the  forecast  horizon  (2013-14).  This  confirms  the  assessment  of  the  previous  IDR. 
However,  there  has  been  some  shift  in  the  composition  of  private  sector  NLB,  with  non-
financial corporations accounting for an increasing share at the expense of households. This 
development has been mainly driven by a change in the behaviour of saving rates. Households 
have been accumulating savings since 2008, with the saving rate averaging 14% (i.e. 3 pps. 
above the long-term historical average). This trend was reversed in 2012, when the household 
saving  rate  plummeted  to  a  historical  low  of  under  9%  (four-quarter  moving  average)  amid 
falling  disposable  income  and  rising  unemployment.7    Conversely,  the  saving  rate  of  non-
financial  corporations  has  been  sharply  on  the  rise,  as  companies  reduce  costs  and  strive  to 
rebuild their balance sheets. The impact of higher private sector net lending on the external 
deficit has been largely counteracted by a sizeable net borrowing position of the public sector 
since 2008. From a sectoral perspective, the move to a sustained current account surplus will 
therefore require further balanced improvements in both private and public sector NLB.  

Graph 2: Net lending/borrowing by sector  Graph 

3:  Net 

lending/borrowing  by 

% of GDP

10

5

0

-5

-10

-15

99 00 01 02 03 04 05 06 07 08 09 10 11 12*

Households
Financial corporations
Total Economy

Source: 
* own estimates 

Commission 

General government
Non-Financial corporations

component 
% of GDP

6

4

2

0

-2

-4

-6

-8

-10

-12

-14

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12*

Capital account (KA)
Current transfers
Income balance
  Trade balance - services
  Trade balance - goods
Trade balance
Current account balance (CA)
Net lending/borrowing (CA+KA)

services 

(Eurostat)

Source: Commission services (Eurostat) 

The improvement of the trade balance is only partly driven by permanent factors  and 
remains incomplete. A precise quantification  of the  relative  weight  of  cyclical  versus  non-
cyclical factors is not straightforward (see Section 3.2 for more details). In the case of exports, 
while non-price-related factors continue to play a role (increasing geographical diversification 
and product specialisation), recent improvements in price competitiveness should help sustain 
the strong export performance in the coming years. With regard to imports, the observed shift 
in  the  composition  of  final  demand  towards  exports  implies  a  reduced  overall  response  of 
imports  to  final  demand,  as  their  elasticity  to  domestic  demand  is  much  higher  than  their 
elasticity to exports (1.5 compared to 0.6). Nevertheless, the slump in domestic demand and 

7 

Record  low  saving  rate  of  households  in  Q3  2012  has  been  also  driven  by  some  temporary  factors. 
Households  increased  their  consumption  in  this  quarter  as  they  advanced  their  purchases  ahead  of  the 
expected Value Added Tax (VAT) increase. 

12 

 
 
 
 
 
                                                            
the  severe  deterioration  in  the  labour  market  have  clearly  been  key  drivers  of  the  fall  in 
imports and have contributed to the adjustment in the trade balance. Without these factors the 
current account would have recorded a much higher deficit. While part of the fall in demand 
can also be considered to be of a lasting nature, further improvements in export performance 
and  a  further  rebalancing  of  the  economy  away  from  domestic  demand  are  needed  to  bring 
about  the  durable  external  surplus  required  to  reduce  the  very  high  level  of  net  external 
liabilities8 (see Section 3.2 for more details).  

Since  2009,  the  net  international  investment  position  (NIIP)  has  remained  broadly 
unchanged  in  terms  of  GDP.9  The  NIIP  stands  at  a  very  high  level  of  -92%,  substantially 
above  the  MIP  scoreboard  threshold  of  -35%.  The  composition  of  Spain's  NIIP  adds  to  the 
vulnerability of the Spanish economy to external financial shocks (see Section 3.2 for more 
details).  Indeed,  in  the  first  half  of  2012,  Spain  experienced  a  major  shortage  of  private 
external financing, which was filled by an increased reliance on Eurosystem financing. While 
these problems have abated since late 2012, they demonstrate the extent of vulnerabilities and 
the  potential  repercussions  on  financial  stability,  the  real  economy  and,  thus,  also  public 
finances.  Central  bank  credit  has  counteracted  the  potential  impact  of  a  'sudden  stop'  in 
external  financing  and  a  major  credit  crunch,  thus  making  it  possible  for  policy-makers  to 
introduce policies addressing the underlying structural problems.  

2.2.2.  Export performance and competitiveness 

Exports  of  goods  and  services  have  been  resilient.  Despite  a  significant  loss  of  cost  and 
price  competitiveness  during  the  boom  years,  Spain  experienced  a  modest  loss  in  export 
market share in comparison to other European countries. As discussed in the 2012 IDR and in 
Section  3.2,  this  puzzle  can  be  explained  by  the  duality  of  the  Spanish  economy  (different 
characteristics of export firms compared to the national average) and the impact of non-price 
competitiveness  factors.  Spanish  export  firms  remained  relatively  competitive  during  the 
decade  prior  to  the  crisis,  while  on  average  the  economy  recorded  significant  losses  in 
competitiveness. In addition, Spain's good export performance appears to be due to improved 
product specialisation as well as to geographical diversification. In the most recent years, the 
robust  export  performance  has  also  been  supported  by  some  improvements  in  cost 
competitiveness, as unit labour costs have been falling since early 2010 (see Graph 4). This 
trend is expected to continue in 2013-14, according to the Commission services' 2013 winter 
forecast, but at a more moderate pace. While exports of services have been less dynamic than 
exports of goods in the period 2010-2011, this trend reversed in 2012, driven by rapid growth 
of exports of non-tourism services (see Section 3.2 for more details). Exports of non-tourism 
services  are  expected  to  increase  their  relative  importance  in  the  composition  of  Spanish 
exports in the coming years. 

An unfavourable size distribution of firms may hamper further improvements in export 
performance.  Spain  has  traditionally  been  characterized  by  a  relatively  low  number  of 
exporting  firms  compared  to  its  European  peers,  although  this  number  has  been  steadily 
increasing. Thus, the rise in the number of exporting firms (the extensive margin) appears to 

8   As  an  illustration,  according to the  Commission  services'  estimates,  a  primary  current account  surplus  of 
1% of GDP would be required on average to reduce the net international investment position (NIIP) to 50% 
of GDP over 20 year horizon.  
The  negative  NIIP  peaked  in  2009  at  93.8%  of  GDP,  declined  slightly  to  89.5%  of  GDP  in  2010  and 
increased again to 91.7% in 2011, driven by the denominator effect. 

9 

13 

 
 
 
                                                            
have contributed significantly to the growth of exports since 2008. However, how lasting is 
the  presence  of  smaller  firms  in  export  markets  remains  to  be  seen.  More  generally, 
international  evidence  suggests  that  the  export  performance  of  different  countries  is  closely 
correlated  with  firm  size.  This  highlights  the  need  to  review  possible  regulatory  and  other 
obstacles that could prevent the emergence of a firm structure more conducive to a stronger 
export orientation of the economy (see Box 1). 

A  rise  in  apparent  labour  productivity  and  stronger  wage  moderation  have  brought 
about an improvement in indicators of international cost competitiveness. . Considering 
the real effective exchange rate (REER) vis-à-vis industrialized countries (IC-35) deflated by 
the Harmonized Index of Consumer Prices (HICP), the appreciation of REER between 2000 
and 2008 was significant (around 20%) and the subsequent adjustment has been much smaller 
(around  7%).  The  REER  deflated  by  unit  labour  costs  (ULC)  in  manufacturing,  suggests 
instead that Spain has already recovered about half of the cost competitiveness lost up to 2008 
(see  Graph  5-7),  extending  further  the  trend  observed  in  the  previous  IDR.10  However,  the 
adjustment  of  ULC  has  been  largely  driven  by  the  economic  recession  and  very  high 
unemployment,  and  it  could  partly  reverse  once  the  cyclical  conditions  improve.  Further 
lasting improvements in competitiveness and the rebalancing of the economy towards tradable 
sectors will also require further adjustments in relative prices and wages between the tradable 
and non-tradable sectors. The adjustment of relative wages has started to be supportive of the 
rebalancing only more recently. In the long run, increases in productivity at firm level would 
need  to  accompany  apparent  labour  productivity  improvements  to  a  larger  extent  to  deliver 
sustainable competitiveness gains. 

Graph 4: Productivity and wages 

Graph  5:  REER  (ULC  in  manufacturing) 
vis-à-vis EA16 and IC35 

y-o-y %
8

Index 2000=100
135

6

4

2

0

-2

-4

130

125

120

115

110

105

100

95

90

04

05

06

07

08

09

10

11

12

00 01 02 03 04 05 06 07 08 09 10 11 12

Compensation per employee

Productivity

EA16

IC35

Source: Bank of Spain (BdE), Spanish National Statistics
Institute (INE) 

Source: Ministerio de Economía y Competitividad 

10   While REER deflated by ULC has adjusted significantly, the adjustment has been less pronounced if REER 
deflated  by  export  prices  is  considered,  where  only  about  one  third  of  the  competitiveness  lost  has  been 
recovered. This implies that improvements in external cost competitiveness will not be as fast as implied by 
the ULC reductions. 

14 

 
 
 
 
                                                            
Graph  6:  Decomposition  of  developments  in
ULCs11  

Graph  7:  Decomposition  of  developments  in 
the REER (ULC-based)12  

)

%

(

y
-
o
-
y
e
g
n
a
h
c

f

o
e
a
R

t

8

6

4

2

0

-2

-4

98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14

Growth rate of GDP deflator
Real compensation per employee
Productivity contribution (negative sign)
Nominal unit labour cost
ULC in euro area

)

%

(

y
-
o
-
y
e
g
n
a
h
c

f
o
e
t
a
R

6

4

2

0

-2

-4

-6

-8

98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14

NEER
REER (HICP)

Relative HICP (-)
REER (ULC)

Source: Commission services (Ameco) 

Source: Commission services (Ameco) 

2.2.3.  Housing market 

The adjustment in the housing sector has been severe but has not bottomed out yet. The 
housing boom in Spain was unusually long and intense. House prices almost tripled between 
1997 and early 2008, while the construction of housing more than doubled from its 1995 level 
(see 2012 IDR). The weight of investment in construction reached 22% of GDP in 2006-07, 
up from 15% in 1995. This represented a significant diversion of productive resources from 
the tradable sector to the non-tradable construction sector. The turning point had already been 
reached in late-2006 and early-2007, when interest rates started to rise. As the economy still 
grew  by  close  to  4%  in  2007,  the  initial  adjustment  was  relatively  soft.  However,  the 
economic and financial crisis in 2008 triggered a much sharper correction (see Graph 8 and 
Graph  9).  In  particular,  a  combination  of  a  sharp  drop  in  housing  demand  and  existing 
oversupply  of  houses  resulted  in  a  downward  correction  of  house  prices,  which  has 
accelerated in recent quarters. 

11 
12 

2012-14 based on Commission services' 2013 winter forecast (European Commission, 2013b). 
2012-14 based on Commission services' 2013 winter forecast (European Commission, 2013b). 

15 

 
 
 
 
 
 
 
 
 
 
 
 
 
                                                            
Graph  8:  Dynamics  of  housing  and 
mortgage markets imbalances 
y-o-y %

y-o-y %

Graph  9:  House  prices,    mortgages  and 
residential investment 
150

30

20

10

0

-10

-20

-30

01Q1

03Q1

05Q1

07Q1

09Q1

11Q1

MFI loans for house purchase (rhs)
Residential Investment, nominal terms (lhs)
Relative house prices (lhs)
Source: BdE, Eurostat, ECB, OECD 

99Q4

07Q3

12Q2

35

25

15

5

-5

-15

-25

-35

130

110

90

70

50

30

10

-10

House price index
(2005=100)

Outstanding
household long-term
loans
(% of GDP)

Residential
investment
(GFCF, dwellings)
(2005=100)

Source: BdE, Eurostat, OECD 

The  fall  of  investment  and  employment  in  construction  is  continuing,  driven  by 
residential construction. The share of residential investment in total GDP fell from 12.5% of 
GDP in 2006 to 5.3% in the fourth quarter of 2012, below the historical low of 7% in 1997. 
However, the adjustment is still ongoing, with residential investment falling by 8.7% year-on-
year in the fourth quarter of 2012. At the same time, employment in the construction sector 
fell  by  around  1.6  million  (2008-12),  and  continues  to  fall  even  though  the  weight  of 
construction in employment has reached its lowest level since 1976. In addition, the number 
of house permits is still declining, suggesting that the trough in this sector may not be reached 
before 2014-15.  

Absorption  of  the  excess  supply  of  houses  is  progressing  slowly.  The  oversupply  of  new 
housing  is  estimated  by  the  government  to  be  around  700,000  units.13  Demand  for  housing 
has  been  weak  and  is  set  to  deteriorate  further  in  line  with  its  fundamental  determinants, 
including falling household real disposable income and declining population. Tight financing 
conditions and the expectation of further price declines also contribute to depressing demand. 
Sales of new houses fell from more than 400,000 in 2007 to around 115,000 in 2012. Taking 
into  account  the  number  of  transactions  between  July  2011  and  June  2012,  it  could  take 
approximately six years to absorb the remaining stock of unsold houses.14 

House  prices  are  expected  to  fall  further.  The  fall  in  house  prices  accelerated  in  2012  (-
12.8% year-on year in Q4 2012), reaching an overall fall of 31% in nominal terms and 38% in 
real terms since the peak in 2007.15 This is consistent with what was anticipated in last year's 
IDR. Given the still ongoing adjustment in the construction sector, the stabilization of house 

13  An updated estimate should be available in the first half of 2013 
14  Housing needs are estimated to exceed 200,000 dwellings per year (considering the evolution of population 
and the recent trends in home composition). To the extent that these housing needs are converted into an 
effective housing demand, the stock of unsold dwellings could be absorbed in a period of about four years. 

15   Based on the Spanish National Statistics Institute's (INE) house price index. 

16 

 
 
 
 
                                                            
prices  may  have  now  been  pushed  towards  2014,  notwithstanding  considerable  variation  in 
housing market conditions across regions. Other factors impacting on house prices include the 
elimination of tax incentives as of the beginning of 2013 and the transfer of problematic real 
estate  assets  from  state-aided  banks  to  the  AMC  (Sareb16).  Sareb's  large  portfolio  of 
foreclosed assets will consist predominantly of houses. While its sales of assets are likely to 
be gradual, its presence may incentivise other players in the market to accelerate their sales, 
thus leading to a faster adjustment of prices and a quicker stabilisation of the housing market.   

2.2.4.  Deleveraging by households and non-financial corporations 

Private sector deleveraging is progressing predominantly through the adjustment in net 
lending. The credit boom, with annual growth rates of around 20% in the middle of the last 
decade,  was  largely  driven  by  loans  related  to  construction  and  housing,  although  loans  for 
household consumption also played a role. The fall in housing demand from 2008 onwards, 
along  with  the  tightening  of  credit  conditions,  contributed  to  a  contraction  of  credit.  In 
November 2012,17 total domestic credit shrank by 3.6% year-on-year, driven by the decline in 
credit  to  the  private  sector  (-4.5%,  see  Graph  10).  Domestic  lending  to  non-financial 
corporations and households fell by 8.7% and 3.4% year-on-year respectively.  

Graph 10: Evolution of domestic credit 
y-o-y %

Total domestic non-MFI loans

Loans to general government

Non-financial corporate loans

Household loans

40

30

20

10

0

-10

-20

2007

2008

2009

2010

2011

2012

2013

Source: BdE 

Despite  a  significant  adjustment  in  terms  of  credit  flows,  private  sector  debt  remains 
particularly  elevated.  Households  and  firms  remain  overly  indebted  relative  to  other  EU 
countries as well as by historical standards as measured with respect to their assets and their 
capacity  to  repay  debt  (see  Section  3.1  for  more  details).Overall,  the  private  sector  has 
reduced  its  indebtedness  by  about  15pps.  of  GDP  from  its  peak,  but  leverage  is  still  much 
above  the  pre-boom  levels  and  the  MIP  scoreboard  threshold  (213%  of  GDP  in  Q3  2012 
against the MIP scoreboard threshold of 160%). Given the size of the imbalances as well as 

Sociedad de Gestión de Activos Procedentes de la Reestructuración Bancaria, S. A. 

16 
17   The latest available data are for January 2013. However, these data (as well as data for December 2012) are 
artificially affected by the impact of the transfer of assets from banks which were already state-owned at 
the time of the stress test to Sareb. 

17 

 
 
 
 
 
 
                                                            
the  historical  and  cross-country  experience,  the  deleveraging  is  likely  to  take  long  (see 
Section  3.1  for  more  details)  and  to  continue  to  hold  back  domestic  demand.  By  the  third 
quarter  of  2012,  the  debt-to-GDP  ratio  had  declined  by  around  7  pps.  for  households  and  8 
pps. for non-financial corporations compared to their respective peaks.  

Non-performing  loans  (NPL)  are  set  to  rise  further.  The  current  double-dip  recession 
could put additional strain on the balance sheets of households and non-financial corporations. 
The already-record-high unemployment rate is projected to increase further and to affect to a 
greater extent those households with formerly stable employment, who are the most exposed 
to housing loans (see Graph 11). The level of non-performing mortgage loans, although still 
relatively  low,  has  been  increasing  in  recent  quarters,  reaching  3.5%  in  the  third  quarter  of 
2012 from around 3% in 2011. The real estate and construction sectors account for the bulk of 
total NPL. In the third quarter of 2012, the share of NPL stood at 30% for real estate activities 
and 26% for  construction sector, compared to 8% level for industry, excluding construction 
and a similar level for other services. As the adjustment of the housing market continues and 
further drops in house prices are expected, the NPL in these two sectors are likely to increase 
further in the coming months.  

Spanish financial institutions have significantly increased their loan loss provisions since 
the  beginning  of  the  crisis.  This  process  has  accelerated  in  2012  with  Royal  Decree  Law 
(RDL) 2/2012 and RDL 18/2012, which raised the provisioning requirements for real estate 
developers  exposure.  Between  2008  and  September  2012,  banks  increased  their  specific 
provisions by about EUR 92 billion (around 8% of GDP). The ongoing recapitalisation of the 
Spanish  banking  sector  under  the  financial  assistance  programme  ensures  capital  buffers  in 
the event of further rises in NPL.18  

The high stock of private debt remains a drag on growth and a source of vulnerability, 
exacerbated by rigidities in product and service markets. Prolonged deleveraging implies 
significant  negative  effects  for  growth,  financial  stability  and,  via  these  two  channels,  for 
public finances. Even though risks for financial stability stemming from the deterioration of 
bank's  assets  are  being  addressed  by  the  ongoing  banking  sector  capitalisation  and 
restructuring,  they  could  still  be  reignited  in  case  of  a  steep  deterioration  in  the  economic 
environment or external financial shocks. There is in particular the risks of negative feedbacks 
between  deleveraging  in  the  non-financial  private  sector  and  fiscal  consolidation,  lower  
growth  and  employment,  the  capacity  of  households  and  companies  to  repay  debt  and  the 
capacity and willingness of the banking sector to provide financing to the real economy. The 
negative impact of the necessary adjustment is greater in an  environment of inflexible labour 
and product markets (see Section 3.1 for more details). 

2.2.5.  Public debt 

General government debt is a rapidly emerging imbalance, largely as a consequence of 
the  adjustment  in  the  private  sector,  the  weak  macroeconomic  outlook  and  financial 
sector  support.  The  misalignment  between  public  expenditure  and  public  revenues,  which 
were based on a tax-rich growth pattern during the housing boom, has contributed to fuel the 

18   The capital needs were estimated on the basis of an asset-quality review and a bottom-up stress test. Both 
the  baseline  and  adverse  scenarios  of  this  exercise  can  be  still  considered  valid  references  according  to 
current 
see 
http://www.bde.es/f/webbde/SSICOM/20120928/informe_ow280912e.pdf. 

macroeconomic 

developments 

forecasts. 

updated 

details, 

and 

For 

18 

 
 
 
                                                            
 
increase  in  debt.  In  nominal  terms,  general  government  debt  has  increased  by  about  102% 
since end-2008 (until Q4 2012 when it reached 84% of GDP) and is expected to reach close to 
100%  of  GDP  by  2015  despite  fiscal  consolidation.  One  of  the  important  effects  of  rising 
fiscal deficits and growing general government debt has been a significant increase in Spanish 
risk premia, with knock-on effects on the cost of financing of the financial and non-financial 
private sector.  

The 'electricity tariff deficit' implies a considerable contingent liability for the budget as 
well as non-negligible macroeconomic risks and may negatively affect the debt dynamics 
in  the  future.  In  2012,  the  deficit  (i.e.  the  gap  between  regulated  'access  tariffs'  paid  by 
consumers  and  various  regulated  costs  -  including  distribution  costs  and  subsidies  for 
renewable energy production) reached over EUR 5 billion (around 0.5% of GDP), exceeding 
the envisaged level of EUR 1.5 billion by a wide margin. Some new measures were recently 
adopted  to  contain  the  deficit  in  the  future,  including  new  taxes  on  energy  production,  a 
revision  of  the  annual  adjustment  of  regulated  costs,  and  a  simplification  of  the  system  of 
support  to  renewable  energy  sources.  Despite  these  measures  the  electricity  tariff  deficit  is 
still  expected  to  be  sizeable  in  2013,  leading  the  authorities  to  propose  in  February  an 
extraordinary  credit  from  the  state  budget  of  EUR  2.2  billion.  The  accumulated  tariff  debt 
amounts to almost 3% of GDP. 

2.2.6.  Labour market 

The  economic  adjustment  in  the  context  of  a  dual  and  overly  rigid  labour  market 
structure has contributed to a dramatic decline in employment. Employment was affected 
disproportionately by the economic downturn due to the downsizing of the construction sector 
and to rigidities in the labour market. The lack of flexibility at the firm level coupled with a 
system  of  dual  employment  protection  has  resulted  in  a  massive  dismissal  of  (mostly) 
temporary  workers.  A  comprehensive  labour  market  reform  was  adopted  in  February  2012 
and passed by law in July 2012. This reform allows firms greater flexibility to adjust wages 
and employment (including working hours) to their specific economic situation. It also lowers 
dismissal costs of permanent workers and reviews dismissal procedures as a means to reduce 
duality.  However,  severance  pay  for  unfair  dismissals  remains  elevated  in  international 
comparison,  while  the  gap  between  severance  pay  for  temporary  and  permanent  contract  is 
biased  in  favour  of  employment  of  limited  duration.  Given  the  current  weakness  of  the 
Spanish  economy  and  the  relatively  short  time  span  since  the  entry  into  force  of  the  final 
provisions of the reform, it may still take some time before its effects become fully apparent. 
However, evidence regarding wage moderation and duality appears to be more mixed and a 
thorough  assessment  of  the  reform  would  have  to  critically  review  the  impact  on  wage 
dynamics and labour market segmentation. Active labour market policies (ALMP) play a still 
insufficient  role  in  promoting  labour  mobility  and  in  reducing  the  occupational  and  skills 
mismatch.  

There  are  growing  risks  of  hysteresis  effects  in  the  labour  market  and  thereby  of  a 
reduction  in  future  potential  output  growth.  The  unemployment  rate  reached  26%  in  the 
fourth quarter of 2012 (see Graph 11) and is expected to increase further in 2013, according to 
the Commission services' 2013 winter forecast. The youth unemployment rate reached 55%. 
A  novel  trend  since  the  previous  IDR  is  that  permanent  employment  is  now  decreasing  at 
similar  rates  as  temporary  employment  (see  Graph  12).  Moreover,  the  duration  of  the  crisis 
has led to an increase in long-term unemployment. In the last quarter of 2012, more than one 
half  of  total  unemployment  was  long  term  -  twice  the  level  of  2008.  In  this  context,  the 

19 

 
 
 
employability  of  young  and  long-term  unemployed  (many  of  the  latter  are  low-skilled 
workers, especially from the construction sector) poses a major challenge. 

Improving  employability  would  be  important  to  address  these  risks  and  ensure  the 
effectiveness of the February 2012 reform.  Reinforcing active labour market policy could 
help activating the unemployed and upgrading their skills, especially for those more at risk, 
like  the  young  and  long-term  unemployed  and  low-skilled.  It  would  also  contribute  to 
promote the rebalancing of the economy towards more export-oriented sectors. 

Graph 11: Unemployment by age group 

Graph  12:  Change  in  the  number  of 
employees by contract duration 

e
c
r
o
f

r
u
o
b
a

l

e
h
t

f
o
%

60

50

40

30

20

10

0

1,500,000

1,000,000

500,000

0

- 500,000

- 1,000,000

r
a
e
y

i

s
u
o
v
e
r
p
r
e
v
o

e
g
a
n
h
C

05

06

07

08

09

10

11

12

- 1,500,000

< 25 years
> 55 years

25-54 years
total

Source: Commission services (Eurostat) 

Source: INE 

00 01 02 03 04 05 06 07 08 09 10 11 12

Permanent

Temporary

20 

 
 
 
 
 
 
 
 
 
 
 
 
 
3. 

IN-DEPTH ANALYSIS OF SELECTED TOPICS 

3.1. 

Private sector deleveraging 

3.1.1. 

Introduction 

Private  sector  indebtedness remains a major macroeconomic imbalance in Spain. Both 
households and non-financial corporations more than doubled their debt levels as a share of 
GDP in the decade following the introduction of the euro. With credit flows averaging around 
23% of GDP during 2000-2007, the stock of private sector debt peaked at 227% of GDP in 
2010, leaving the Spanish private sector amongst the most indebted across the Member States. 
The large debt overhang implies significant deleveraging pressures, which will take time to be 
alleviated  and  will  continue  to  weigh  on  domestic  demand  and  economic  growth.  The 
overexpansion  of  lending  has  also  resulted  in  a  large  amount  of  impaired  assets  in  banks' 
balance  sheets,  requiring  public  support  for  the  recapitalisation  of  a  significant  part  of  the 
banking system.  

While the deleveraging19 process gained speed over 2011 and 2012, the impact on debt 
stocks is gradual. The total stock of debt stood at 213.5% in the third quarter of 2012, some 
15 pps. of GDP lower than the peak reached in the second quarter of 2010, mostly due to a 
fall  in  non-financial  corporation  debt.  A  gradual  decline  in  debt  is  in  line  with  historical 
experience showing that deleveraging processes take considerable time and imply large output 
losses,  particularly  when  accompanied  by  banking  and  housing  crises.20  A  reduction  in  the 
debt-to-GDP  ratio  can  occur  through  different  levers:  (i)  negative  net  credit  flows,  (ii) 
inflation, (iii) real GDP growth, and (iv) debt write-offs.21 In Spain, it is being driven mainly 
by  the  reversal  of  credit  flows,  although  write-offs  are  also  playing  a  role  in  the  corporate 
sector.  The  prolonged  economic  contraction  hampers  the  deleveraging  process  via  the 
denominator  effect  but  also  via  its  impact  on  the  saving  potential  of  households  and  non-
financial  corporations.  Labour  and  product  market  rigidities  and  a  high  degree  of  price  and 
wage  inertia  have  magnified  the  loss  in  output  and  employment  associated  with  the 
reallocation of resources in the economy and deleveraging. 

Different  benchmarks  suggest  that  the  private  sector  is  subject  to  high  deleveraging 
pressures. Both households and firms remain overly indebted in terms of both the actual level 
of debt and the build-up of debt over the boom period 2000-08. When comparing current debt 
levels to static benchmarks such as that based on the MIP threshold methodology or pre-boom 
level of the debt ratio in 2000, the required remaining adjustment of the debt-to-GDP ratio is 
considerable: for households it would be 24 to 36 pps. and for non-financial corporations 45 
to  60  pps.  (see  Graph  13  and  Graph  14).  In  an  alternative  approach  private  sector  debt  is 

19 

Throughout the text, deleveraging should be interpreted as a decrease in the debt-to-income or the debt-to-
asset ratios, as specified in the text.  

20  Countries with boom-bust credit cycles typically have deep recessions and sluggish recoveries, with GDP 
remaining  9-10%  below  the  pre-crisis  trend  in  the  next  5-10  years  (IMF  (2009)).  Deleveraging  episodes 
accompanied  by  a  housing  crisis  took  5.5  years  on  average  across  high-income  OECD  economies  and 
reduced private debt-to-GDP ratios by 20 pps. If they were accompanied by a banking crisis, they took 7 
years,  the  reduction  in  debt-to-GDP  was  30  pps.  on  average  and  the  recovery  in  GDP  was  considerably 
slower  (see  Aspachs-Bracons,  et  al.,  2011).  Evidence  presented  by  IMF  (2012a)  indicates  that  housing 
crises, which are preceded by a build-up of household debt, result in a fall in real private consumption and 
GDP  of  4%,  on  average,  over  a  5-year  period.  In  the  absence  of  a  banking  crisis  the  decline  in  private 
consumption is limited to 2%. 

21  When considering debt-to-assets, valuation effects on assets and liabilities are also important. 

21 

 
 
 
                                                            
considered  sustainable  if  the  notional  leverage  is  stationary22  -  i.e.  if  deflated  debt  were  to 
evolve in line with deflated assets. Graphs 13 and 14 show that, between 2001 and 2007, the 
gap between actual debt and its balanced or sustainable path increased rapidly, especially for 
households. In the case of households, this was due to a significant extent to the expansion in 
liabilities  associated  with  rapidly  rising  house  prices.  Taking  into  account  the  recent 
correction, the gap between actual debt-to-GDP ratios and their balanced paths is 29 and 12 
pps.  for  households  and  non-financial  corporations  respectively.  The  following  sub-sections 
look at the household and non-financial corporation sectors in greater detail.  

Graph  13:  Debt  sustainability,  Households 
(HH)23 
% GDP
100

Graph  14:  Debt 
financial corporations (NFC)24   
% GDP
160

sustainability,  Non-

Indebtedness, HH sector

2000 level

Statistical threshold

Sustainable benchmark

90

80

70

60

50

40

30

20

Indebtedness, NFC sector

2000 level

Statistical threshold

Sustainable benchmark

140

120

100

80

60

40

20

96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11

96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11

Source: Commission services (Eurostat) 

Source: Commission services (Eurostat) 

3.1.2.  Households 

Spanish households' leverage grew at a very fast pace in the run up to the financial crisis 
in 2008. Driven mostly by low interest rates, abundant credit availability, and easy financing 
conditions,  the  household  debt-to-GDP  ratio  increased  to  86%  of  GDP  in  2010,  more  than 
twice the level in 2000 (see Graph 15). As a share of gross disposable income, household debt 
surged  to  131%  in  2007,  from  69%  in  2000.  Much  of  the  increase  in  household  debt  was 
linked to residential mortgages. Consumer credit also contributed to the increase, although to 
a much lesser extent (see Graph 16).  

22 

The 'notional leverage' is the ratio of debt-to-assets adjusted for valuation effects. It represents an indication 
of the ability of households and non-financial corporations to incur liabilities. 

23   Sustainable  benchmark:  Private  debt  is  considered  "sustainable"  whenever  it  implies  that  debt  evolves  in 
line  with  deflated  assets  (i.e.  assets  corrected  for  valuation  effects).  In  technical  terms,  the  debt-to-assets 
ratio adjusted for valuation effects (i.e. "notional leverage") should be stationary. Statistical threshold: This 
is the debt-to-GDP ratio corresponding to the third quartile of the 1995-2008 distribution of this variable for 
EU27 Member States. 

24   See footnote 23. 

22 

 
 
 
                                                            
Graph 
indicators 

15:  Household 

indebtedness 

100

)

%

,
s
t
e
s
s
a
&
P
D
G

.
s
v
(

s
o
i
t
a
r

t
b
e
D

90

80

70

60

50

40

30

20

10

0

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12

140

120

100

)

%

,
I

D
G

.
s
v
(
o
i
t
a
r

t
b
e
D

80

60

40

20

0

Graph 16: Decomposition of rate of change 
of household debt 
%

35

30

25

20

15

10

5

0

-5

04Q1 05Q1 06Q1 07Q1 08Q1 09Q1 10Q1 11Q1 12Q1

Debt / GDP (lhs)
Debt / GDI (rhs)

Source: BdE, INE 

Debt / assets (lhs)

House purchase

Consumer credit

Other

Source: BdE 

Total

The  increase  in  household  debt  went  hand-in-hand  with  the  accumulation  of  non-
financial  assets.  Non-financial  assets  represent  the  bulk  of  Spanish  household  wealth.25 
Compared to most other Member States, the gap between household debt-to-financial assets 
and debt-to-total assets ratios in Spain is relatively higher. This can be explained by the fact 
that the proportion of housing assets in household balance sheets is also higher in Spain than 
in other Member States (see Graph 17). As such, the household balance sheet expansion in the 
boom  period  gave  rise  to  a  mild  increase  in  the  leverage  ratio  as  debt  grew  broadly  in  line 
with  an  expanding  value  of  non-financial  assets  (see  Graph  18).  However,  if  adjusted  for 
valuation  changes,  where  valuation  effects  on  debt-generating  instruments  are  minor 
compared  to  those  on  assets  (in  particular  considering  the  large  increase  in  house  prices), 
household debt grew much faster than deflated assets, implying a sharp increase in notional 
leverage. Even on this metric, the debt total asset ratio remains below 20%, which is relatively 
low by international standards.  

25 

Indeed,  87%  of  household  total  net  wealth  is  related  to  housing,  reflecting  a  high  ownership  ratio  and  a 
significant degree of ownership of secondary houses, while the remaining 13% constitutes financial wealth.  

23 

 
 
 
 
 
 
 
 
 
 
 
 
 
                                                            
Graph  17:  Household  indebtedness,  EU  27 
countries, 2010 
% of assets

160

140

120

100

80

60

40

20

0

T

I

E
B

I

T S
M

R
F

T
A

7
1
A
E

E
D

U
L

E
E

L
N

I

T F
P

Y
C

S
E

L
E

K
S

E

I

O
R

G
B

Z
C

K
U

U
H

T
L

E
S

L
P

K
D

V
L

euro area

non-euro area

Graph 18: Household notional leverage26 

%
25

20

15

10

5

0

Debt to financial  assets

Debt to total  assets

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11

Debt to deflated financial assets Debt to deflated total assets

Debto to total assets

Debt to total notional assets

Source: Commission services (Eurostat) 

Source: Commission services (Eurostat) 

The household debt-to-GDP ratio is on a mild downward path, driven by an adjustment 
in the flow of credit. When GDP growth contracted following the outbreak of the crisis, the 
debt-to-GDP ratio continued to increase. Subsequently, the debt ratio stabilized and moved on 
a downward path from the second half of 2010 onwards, falling from 87% of GDP to around 
80% of GDP in the third quarter of 2012. As a share of gross disposable income, debt fell to 
123%,  despite  falling  disposable  incomes  in  2010-12.  These  ratios  remain  high  from  both 
historical  and  cross-country  perspectives.  Household  borrowing  has  been  contracting  since 
2009 (see Graph 19). The contraction was faster in consumption loans than mortgages, but the 
former account for a small part of total debt (see Graph 20).  

26   See footnote 22. 

24 

 
 
 
                                                            
Graph 19: Sectoral decomposition of credit 
flows 
% of GDP
40

35

30

25

20

15

10

5

0

-5

-10

-15

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12*

Household

Non financial corporations

Private sector EA17

MIP Threshold

Private sector

Graph 20: MFI lending to households  

y-o-y %

40

30

20

10

0

-10

-20

04

05

06

07

08

09

10

11

12

Loans for house purchase

Loans for consumption

Source: 
* estimation based on quarterly data 

Commission 

services 

(Eurostat)

Source: Commission services (Eurostat) 

Households appear to have gradually exhausted their financial asset buffers. During the 
crisis, the composition of household financial assets has shifted towards less risky and more 
liquid instruments, in particular deposits. As discussed earlier, the household saving rate has 
already fallen below its pre-crisis level. Debt servicing burden has risen somewhat from the 
low  levels  seen  in  the  first  period  of  the  financial  crisis,  as  disposable  income  has  been 
diminishing  (see  Graph  21).  Real  disposable  incomes  are  being  squeezed  by  rising 
unemployment, wage moderation and relatively persistent inflation due to the impact of hikes 
in indirect taxes and tariffs. Household net wealth has also declined (see Graph 22), mainly 
due to the fall in real estate prices, which has gathered pace in recent months. Total wealth 
remains high by international standards but near-term prospects for both incomes and wealth 
are  negative  as  unemployment  continues  to  rise  and  house  prices  are  expected  to  decline 
further. Moreover, the predominance of non-financial assets reduces the degree of liquidity of 
household wealth. All in all, the household capacity to repay debt has been weakened and is 
subject to risks going forward. 

25 

 
 
 
Graph 21: Financial position of households  Graph 22: Households' total wealth  

)

%

,
I

D
G

(

s
o
i
t
a
R

20

15

10

5

0

-5

00 01 02 03 04 05 06 07 08 09 10 11 12

Interest payments / gross disposable income, Households
Interest payments / gross disposable income, Households, EA
Saving rate, Households
Gross disposable income (pct change)

% of GDP
800

700

600

500

400

300

200

100

0

90

92

94

96

98

00

02

04

06

08

10

12

Real estate wealth

Net financial wealth

Source: Commission services (Eurostat) 

Source: BdE 

The household sector has moved into a net-lending position since 2008. Falling employee 
compensation,  wealth  losses  on  financial  and  non-financial  assets  and  increased  uncertainty 
spurred a sharp increase in the saving rate to around 19% in 2009. Subsequently, the saving 
rate declined to a historical low of 8.8% of gross disposable income (GDI) in the third quarter 
of 2012, well below its long-term historical average level of 11%. Households are expected to 
remain net lenders over the coming years, but the saving rate is expected to remain subdued 
due to the combination of falling disposable income and already low per capita consumption 
expenditure. This will limit the ability of households to rapidly reduce their debt ratios.  

The  pace  of  household  deleveraging  is  also  constrained  by  the  high  share  of  mortgage 
debt.    More  than  90%  of  household  debt  consists  of  mortgages,  almost  all  of  which  have 
variable  interest  rates  linked  to  the  12-month  Euribor  rate.  These  mortgages  have  maturity 
periods of over 20 or 30 years. The burden on households has been mitigated by the fall in 
euro-area  short-term  interest  rates,  as  well  as  by  refinancing  programmes  offered  by  many 
credit  institutions.27  Recently,  the  government  has  taken  measures  to  protect  the  most 
vulnerable  mortgage  borrowers.  In  addition,  Spain  has  relatively  complex  and  lengthy 
bankruptcy  procedures  for  both  households  and  non-financial  corporations.  As  a  result, 
bankruptcy procedures are rarely undertaken by households and the personal insolvency rate 
is very low.28 Finally, tax incentives for owner-occupied housing, now discontinued for new 
purchases, may be discouraging households from earlier repayment of outstanding mortgages.  

The rate of non-performing mortgages is low (3.5% in the third quarter of 2012) but its 
rise has accelerated recently. This low rate is partly explained by generally prudent loan-to-
value ratios29 and the legislation that makes borrowers liable for all their assets in the event of 

27 

It is estimated that households save as much as 30% of monthly mortgage payments when compared to the 
initial date when the loan was taken (S. Gonzalez, 2012).  
Insolvencies in Europe’, CreditReform, February 2012 

28  
29   According to the 2011 European Banking Authority's EU-wide stress test, the mortgage loan-to-value ratio 

was slightly below 55% in 2010. 

26 

 
 
 
 
 
                                                            
the  risk  of  default.  The  current  recession,  if  prolonged,  could  additionally  strain  household 
balance sheets and hamper orderly deleveraging efforts.   

3.1.3.  Non-financial corporations 

Non-financial corporations are highly indebted relative to other EU countries as well as 
by historical  standards.  Their  debt increased from around 45% of  GDP in 1996  to  around 
140% in 2010 (see Graph 23). The debt-to-asset ratio is also high, in particular if assets are 
measured on a consolidated basis (excluding intra-sector incurrence of debt). The ratio stands 
at 133% of GDP, vis-à-vis a euro-area average of 76%. Similarly, when measuring leverage 
with  respect  to  gross  operating  surplus,  a  proxy  for  firms'  capacity  to  generate  income  and 
thus repay the debt, non-financial corporations appear to be highly leveraged, as  debt is six 
times higher than the gross operating surplus (see Graph 24). All in all, Spanish non-financial 
firms appear over-indebted with respect to both their assets and their capacity to repay debt. 

Graph 23: NFC leverage indicators 

160

140

120

100

80

60

40

20

0

)

%

,
s
t
e
s
s
a

l

a
t
o
t

&
P
D
G

,
y
t
i
u
q
e
.
s
v
(

s
o
i
t
a
r

t
b
e
D

Graph 24: NFC indebtedness and financial 
burden 
900

35

800

700

600

500

400

300

l

s
u
p
r
u
S
g
n
i
t
a
r
e
p
O
s
s
o
r
G

f
o
%

30

25

20

15

10

5

0

l

s
u
p
r
u
S
g
n
i
t
a
r
e
p
O
s
s
o
r
G

f
o
%

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12

01 02 03 04 05 06 07 08 09 10 11 12

Debt / GDP

Debt / assets

Source: BdE, INE 

Debt / equity

Debt / assets, consolidated

Interest payments (lhs)

Indebtness ratio (rhs)

Source: Commission services (Eurostat) 

The increase in indebtedness of non-financial corporations was to a large extent driven 
by  the  real  estate  boom.  During  the  years  of  strongest  growth  of  credit  to  non-financial 
corporations (2004-08), credit to construction and real estate activities accounted for 54% of 
the  overall  credit  growth.  As  a  result,  the  bank  debt30  of  the  construction  and  real  estate 
sectors  represents  10%  and  32%  of  total  bank  lending  to  non-financial  corporations 
respectively in the third quarter of 2012 (see Graph 25). Other sectors appear relatively less 
indebted  and  in  line  with  EU  and  euro-area  averages  (except  for  sectors  like  hotels  and 
restaurants whose leverage is slightly higher than in most euro-area countries).  

30  Debt is defined as the sum of loans and securities other than shares. Loans (banks debt) represented 98% of 

the overall debt in the third quarter of 2012. 

27 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
                                                            
Graph 25: Breakdown of NFC bank debt by 
sector  
(3Q 2012) 

Graph  26:  Evolution  of  share  of  doubtful 
loans 
loans  by  non-financial 
total 
in 
corporate sectors 

2%

15%

41%

10%

agriculture

industry (excl.
construction)

construction

real estate

32%

other services

%
35

30

25

20

15

10

5

0

total
real estate
construction
agriculture
industry (excl. construction)
other services

09Q1 09Q3 10Q1 10Q3 11Q1 11Q3 12Q1 12Q3

Source: BdE 

Source: BdE 

The very weak financial position of the construction and real estate sectors will continue 
to impact on the evolution of corporate deleveraging. These two sectors have the highest 
leverage (measured by the debt-to-asset ratio) and account to a large extent for the increase in 
non-performing loans in the corporate sector (see Graph 26). While the ratio of NPL to total 
loans  is  around  8%  for  industry  and  services  not  related  to  real  estate  or  construction,  it  is 
26% for construction and 30% for real estate activities. According to the latest Bank of Spain 
(BdE) data (Q3 2012), 74% of total NPL are linked to real estate and construction activities. 
A scenario of higher defaults in the construction and real estate sector has been considered in 
the  bottom-up  stress  test  exercise  of  the  Spanish  banking  sector  aimed  at  establishing  the 
necessary recapitalisation amounts under the financial assistance programme.  

The  deleveraging  of  non-financial  corporations  has  accelerated  in  recent  quarters.  A 
rapid adjustment of credit flows started when the Spanish economy entered into a recession in 
2009  (see  Graph  19).  Since  then,  nominal  debt  has  been  on  a  declining  path.  By  the  third 
quarter of 2012 it had decreased by around 6% from its peak in 2008, although the pace of 
deleveraging  has  been  uneven  across  different  sectors.  In  particular,  while  credit  to  the 
construction sector has adjusted significantly, credit to real estate activities has been adjusting 
in  line  with  the  non-financial  corporation  sector  average  (see  Graph  29).31  This  different 
speed  of  adjustment  of  flows  is  also  impacting  the  adjustment  of  the  stock  of  accumulated 
debt (-41% for construction sector vs. -12% for real estate activities). Due to the contraction 
in  GDP  (denominator  effect),  the  debt-to-GDP  ratio  started  to  decrease  only  in  2010  (see 
Graph  27).  The  adjustment  in  the  corporate  sector  tends  to  be  faster  than  in  the  household 
sector.  This  is  largely  due  to  the  greater  importance  of  debt  write-offs,  mainly  as  regards 
construction  and  real  estate  loans,  and  the  shorter  maturity  of  debt.  By  the  third  quarter  of 
2012, the non-financial sector debt-to-GDP ratio had decreased by 8.4 pps. from its peak. The 
adjustment  with  respect  to  consolidated  financial  assets  has  been  much  more  significant, 

31  Anecdotal evidence suggests that big construction companies, which are also present on the international 

market, have started divesting their assets abroad thus helping to reduce their indebtedness. 

28 

 
 
 
 
 
                                                            
nearly 14 pps. However, when measured against equity or financial assets (non-consolidated), 
leverage is still on an upward path due to negative valuation effects. 

Graph 27: Decomposition of change in ratio 
of NFC debt to GDP 
% of GDP
30

Graph  28:  Change  in  selected  ratios  from 
income accounts, NFC 

Change, as a % of GVA

-8

-6

-4

-2

0

2

4

6

25

20

15

10

5

0

-5

-10

Labour costs
/ GVA

Distributed income (paid)
/ GVA

(Net interest, net taxes, net
transfers and others -
distributed income received)
/ GVA

2001-2007

2007-2011

01

02

03

04

05

06

07

08

09

10

11

Nominal holding gains/losses
Other changes in volume
Net credit flows
Real GDP contribution
Inflation contribution
Total

Source: Commission services (Eurostat) 

Source: Commission services (Eurostat) 

Encouragingly, companies and sectors that were highly indebted at the start of the crisis 
have  been  deleveraging  faster.  A  recent  study  by  the  Bank  of  Spain  (see  BdE  Economic 
Bulletin,  January  2013)  looks  at  the  evolution  of  corporate  indebtedness  between  2007  and 
2011  at  firm  level  and  by  sector.  The  results  show  that  companies  and  sectors,  which  were 
highly  indebted  at  the  onset  of  the  crisis,  have  been  reducing  debt  faster  than  the  average, 
while firms that started from a low level of debt have actually increased their leverage over 
the period. The pattern has been similar for large companies and SMEs. The findings suggest 
that deleveraging can be compatible with a healthy reallocation of lending.  

The non-financial corporate sector has moved to a positive and increasing NLB position 
since  2010,  as  savings  have  increased  and  investment  has  fallen.  The  increase  in  gross 
savings  has  been  the  main  driver  behind  the  increasing  net  lending  position.  In  particular, 
corporations  increased  their  gross  savings  through  two  main  channels:  a  decrease  in  the 
compensation  of  employees  and  a  significant  fall  in  taxes  and  interest  rate  payments  (see 
Graph 28). In a context of turbulence and tight borrowing conditions, companies have been 
building  up  internal  financing  buffers  by  maintaining  high  profit  margins  instead  of  fully 
passing the wage moderation on to lower (export) prices32 (see Section 3.2 for more details) 
as well as by restructuring and reducing investment. In the near term, the adjustment in non-
financial corporation balance sheets is expected to continue as corporate savings increase on 
the back of improved profitability, while investment in real estate and construction continues 
to shrink. 

32   The need  to deleverage  and rebuild balance  sheets  and  the  associated maintaining of  high profit  margins 
suggests that improvements in external cost-competitiveness may be slower than reductions in unit labour 
costs for as long as the deleveraging process continues.  

29 

 
 
 
                                                            
The rise in the corporate net lending position observed since the beginning of the crisis 
seems  to  reflect  a  lasting  balance-sheet  adjustment.  The  factors  that  have  triggered  the 
balance  sheet  restructuring  such  as  changes  in  risk  premia,  lower  asset  prices,  and  lower 
growth  expectations,  are  likely  to  shape  firms'  behaviour  in  the  years  to  come,  while  the 
impact of the sudden disruption of private foreign capital flows, which have also contributed 
to  the  rise  in  the  net  lending  position,  should  progressively  fade  out.  This  points  to  a 
protracted balance sheet adjustment process. 

Graph 29: Rate of change of credit to NFC 
y-o-y %

50

40

30

20

10

0

-10

-20

00 01 02 03 04 05 06 07 08 09 10 11 12

Total

Construction

Real estate activities

Source: BdE 

3.1.4.  Conclusion  

The  analysis  above  shows  that  the  adjustment  of  private  sector  debt  imbalances  is 
progressing but it is far from complete. Deleveraging has taken place so far mainly through 
negative  credit  flows,  against  the  background  of  difficult  economic  conditions.  Households 
and non-financial corporations continue to be highly indebted and the deleveraging dynamics 
are likely to prevail over the short-to-medium term as credit is contracting, house prices are 
still  correcting  and  overall  economic  activity  is  deteriorating.  Both  households  and  non-
financial corporations are highly exposed to interest increases and income shocks.  

Private  sector  deleveraging  has  significant  repercussions  on  growth,  financial  stability 
and, via these two channels, on public finances. Deleveraging weighs on domestic demand 
and  thus  growth  through  negative  wealth  effects  and  constrained  consumption  and 
investment. The process is further exacerbated by deleveraging in the financial sector and the 
necessary  fiscal  consolidation,  which  prevents  the  government  from  implementing  demand-
management  policies  to  offset  the  adverse  macroeconomic  effects.  The  recent  easing  of 
financial market conditions, if maintained and fed through the economic system, will support 
an orderly deleveraging process.   

Model  simulations  illustrate  the  importance  of  market  flexibility.33  A  fall  in  household 
debt-to-GDP  ratio  by  9  pps.  over  a  six-year  period  would  lead  to  a  marked  contraction  in 
output by 5 to 6 pps. due to a significant contraction in housing investment and consumption. 

33 

The simulations were run with DG ECFIN's QUEST model.  

30 

 
 
 
 
 
 
                                                            
The  high  degree  of  real  and  nominal  rigidities  in  the  labour  market  implies  a  relatively 
contained  fall 
increases  significantly.  In  contrast, 
employment,  investment  and  production  would  fall  significantly  less  if  labour  and  product 
markets were more flexible. The results highlight the potential of structural reforms in labour 
and product markets to alleviate the impact of deleveraging on the economy.  

in  wages,  while  unemployment 

Risks to financial stability have been mitigated by the ongoing bank restructuring and 
recapitalization  programme.  The  recapitalization  of  the  Spanish  banking  sector  under  the 
financial assistance programme and the transfer of problematic assets to Sareb aim at ensuring 
the  stability  of  the  banking  sector  -  even  in  case  of  further  defaults  on  real-estate 
development-related  assets.  Yet,  bank  asset  quality  will  have  to  be  kept  under  close 
monitoring, also in view of high deleveraging pressures. 

3.2. 

External debt sustainability and current account adjustment 

The  current  account  deficit  has  fallen  from  10%  of  GDP  in  2007  to  0.8%  of  GDP  in 
2012. Adding the capital account, the external deficit34 was 0.2% of GDP in 2012, down from 
a  peak  of  9.6%  in  2007.  This  adjustment  has  contributed  to  the  stabilisation  of  the  NIIP  in 
terms of GDP, although at a very high level. 

Graph 30: Sectoral breakdown of NIIP  

Graph 31: Decomposition of rate of change 
of NIIP 

% of GDP

20

0

-20

-40

-60

-80

-100

-120

)

%

(

y
-
o
-
y
e
g
n
a
h
c

f
o
e
t
a
R

15

10

5

0

-5

-10

-15

-20

05Q4

06Q4

07Q4

08Q4

09Q4

10Q4

11Q4

06Q1

07Q1

08Q1

09Q1

10Q1

11Q1

12Q1

Private sector
MFI (excl central bank)
General Government
Central Bank (incl reserves)
Net international investment position (NIIP)

Valuation changes
Net transaction effect (rest FA bal.)
Investment income effect
Nominal growth effect
Change in NIIP (y-o-y)

Source: Commission services (Eurostat) 

Source: Commission services (Eurostat) 

3.2.1.  The net international investment position  

Net external liabilities have stabilised since 2009 at around 90% of GDP (see Graph 30). 
This  level  has  not  significantly  changed  since  the  2012  IDR  and  it  implies  continued 
vulnerabilities (the MIP scoreboard threshold is 35%). Inevitably, the adjustment of the stock 
of net external liabilities is slower than the adjustment in terms of flows as measured by the 
external deficit. With stagnating nominal GDP, interest payments and valuation effects have 

34 

The external balance (deficit or surplus) is defined as the sum up of the trade balance (goods and services), 
the income balance and the capital account balance. 

31 

 
 
 
 
 
 
 
 
                                                            
become the main drivers of the NIIP ratio (Graph 31). Even though valuation effects have had 
a positive effect on NIIP since 2010, the estimated cumulative valuation effect since 2000 is 
still negative, around -20% of GDP (European Commission (2012b)). Interest payments will 
continue  to  contribute  negatively  due  to  the  high  net  external  liabilities,  even  though  the 
implicit yields on Spain's external liabilities are slightly lower than those on external assets.  

Some of the risks associated with this very high external exposure materialised in 2012. 
The 2012 IDR stressed that this large external imbalance exposed Spain to potential external 
financing problems (Graph 32). In the course of 2012, private external financing dried out and 
was to an important extent offset by increased Eurosystem flows. Already in spring 2010 and 
summer  2011  there  were  two  episodes  of  private  capital  outflows,  which  could  qualify  as 
sudden  stops.35  In  2012,  the  magnitude  of  these  outflows  was  much  higher  (Graph  33). 
Consequently, borrowing from the Eurosystem rose from around 6% of GDP in spring 2010 
to 8% of GDP in the summer of 2011 and 12% of GDP in the second quarter of 2012. The 
Bank of Spain's NIIP moved from balance in the third quarter of 2011 to a deficit of 30% of 
GDP  in  the  second  quarter  of  2012  (see  Graph  30).  This  amount  offset  the  reduction  of 
external  financing  for  other  sectors,  mainly  monetary  and  financial  institutions  (-21%  of 
GDP), the Spanish government (-6.4%), and the non-financial private sector (-2.8%). Private 
external  financing  resumed  in  the  second  half  of  2012,  following  inter  alia  the  ECB 
announcement of the Outright Monetary Transactions (OMT) and progress in addressing the 
crisis at euro-area level and with reforms at the national level.   

Graph 32: Asset breakdown of NIIP  

% of GDP

20

0

-20

-40

-60

-80

-100

2005

2006

2007

2008

2009

2010

2011

2012

Reserves assets

Financial derivatives

Direct investment

Other investment

Portfolio investment

International investment position

Graph  33:  Quarterly  variation  in  BdE's 
assets against Eurosystem  
% of GDP

6

4

2

0

-2

-4

-6

-8

-10

-12

-14

2005

2006

2007

2008

2009

2010

2011

2012

Source: Commission services (Eurostat) 

Source: Commission services (Eurostat) 

External gross debt is above 160% of GDP and the share of short-term external debt is 
significant.  Although  the  bulk  of  Spanish  external  liabilities  is  long-term  (67%  of  total 
liabilities including direct investment), short-term debt is still sizeable. In the third quarter of 
2011,  short-term  debt  (excluding  borrowing  from  the  Eurosystem)  was  45%  of  GDP.  Even 
though it decreased to 27% of GDP in 2012 (Q3 2012), this fall was predominantly driven by 

35  

 Merler and Pisani-Ferry (2012).  

32 

 
 
 
 
                                                            
the substitution of private financing (in particular to financial and monetary institutions) with 
monetary authorities financing (see Graph 34 and Graph 35).  

Graph 34: Maturity composition of external 
debt 
% of GDP

Graph 35: External debt by issuer 

% of GDP

180

160

140

120

100

80

60

40

20

0

180

160

140

120

100

80

60

40

20

0

02

03

04

05

06

07

08

09

10

11

12

02

03

04

05

06

07

08

09

10

11

12

Direct investment

Long-term

Short-term excl. BdE

BdE

Source: BdE, INE 

Direct investment
BdE
Other resident sectors

Source: BdE, INE 

OFMIs
Public administrations

3.2.2.  External debt sustainability 

External  debt  will  have  to  shrink  significantly  in  order  to  reduce  financing  risks  and 
ensure  long-term  sustainability.  Even  though  there  is  no  consensus  on  what  constitutes  a 
'safe' or 'sustainable' level of either the NIIP or gross external debt, available studies generally 
point to the order of magnitude of around 50% of GDP (also depending on the composition of 
liabilities and other country specific factors36). This is also the level recorded in Spain in the 
mid-2000s, before the near doubling of the negative NIIP in the second half of the 2000s. The 
current crisis has provided further evidence that large negative NIIP can expose countries to 
severe financial shocks and is not compatible with a smooth long-term growth path. 

The reduction of external debt requires a shift to recurrent external surpluses. There are 
four  main  channels  through  which  the  adjustment  of  NIIP  can  take  place:  i)  a  shift  of 
liabilities from debt to equity (while keeping the overall level of NIIP unchanged it implies an 
improved composition of the external position and a reduction of the external debt, ii) higher 
nominal GDP (denominator effect), iii) positive valuation effects, and iv) an external surplus. 
The  first  channel  depends  mainly  on  the  decisions  of  private  foreign  and  domestic  agents, 
who react to relative risk-adjusted returns on assets. Given the subdued outlook for nominal 
GDP growth, any significant contribution from the denominator effect on reducing the NIIP is 
unlikely in the short-term. As noted above, interest payments will continue to add to the debt 

36   European Commission (2012b).  

33 

 
 
 
 
 
                                                            
burden,  while  the  impact  of  valuation  effects  is  difficult  to  predict.  This  leaves  a  sustained 
current account surplus as the main pathway to achieve a reduction in net external liabilities.37  

3.2.3.  Progress in the adjustment of the external deficit 

The adjustment of the external deficit has accelerated in the course of 2012. The external 
deficit fell to 0.2% of GDP in 2012, a reduction of 3 pps. with respect to 2011 (see Graph 37). 
The  evolution  of  the  different  components  of  the  external  deficit  has  been  uneven.  Overall, 
the  improvement  in  the  current  account  balance  has  surpassed  expectations  (see  Graph  36), 
driven by the trade balance, which turned into a surplus at the end of 2012. The income and 
capital  balances  have  been  broadly  stable.  The  rest  of  this  section  analyses  the  evolution  of 
the different components and the outlook.  

Graph 36: Evolution of forecasts of current account balance  
bn EUR

20

0

-20

-40

-60

-80

-100

2009

2010

2011

2012

Date of the forecast

2009

2010

2011

2012

2013

Source: Consensus Forecasts 

37   Estimates of the required current account adjustment are sensitive to the target level set for the NIIP and to 
assumptions concerning in particular valuation effects, interest rates and GDP growth. For instance, with a 
cautious set of assumptions, Goldman Sachs (2013) estimates that Spain's current account needs to improve 
by 10-15 pps. of GDP from the current (estimated) cyclically-adjusted level of about -5% of GDP in order 
to reduce the NIIP to -25% of GDP over a 20-year horizon.  

34 

 
 
 
 
 
 
                                                            
Graph  37:  Trade, 
account balances 
% of GDP

2

0

-2

-4

-6

-8

-10

-12

income  and  capital 

Graph 38: Components of income balance  

% of GDP

1

0

-1

-2

-3

-4

-5

05

06

07

08

09

10

11

12

05

06

07

08

09

10

11

12

Capital account

Income balance

Trade and services balance

External deficit

Property incomes

Others

Current transfers

Income balance

Source: INE 

Source: INE 

The  high  level  of  net  external  debt  implies  a  significant  and  persistent  negative 
contribution  of  the  income  balance  to  the  external  account.  The  income  balance  deficit 
was  on  average  2.5%  of  GDP  in  the  last  years  driven  by  interest  payments,  the  main 
component  of  property  incomes  (see  Graph  38).  Current  transfers  have  also  been  negative, 
averaging 1% of GDP. A certain reduction in current transfers is foreseeable in the future, as 
immigrant  remittances  (0.7%  of  GDP)  could  fall  given  the  high  unemployment  rate  of 
immigrants.  However,  due  to  the  high  interest  rate  burden,  no  major  shifts  in  the  income 
balance are expected in the short-term.  

The negative energy balance weighs on the trade balance. Net external energy dependence 
remains  high  and  has  been  on  an  increasing  path,  although  with  some  correction  in  the  last 
years (see Graph 39). Advances in domestic generation of energy, mainly renewable energy 
sources, have not translated into a substantial reduction of energy imports. The energy balance 
has contributed 3.6 pps. of GDP to the external deficit (see Graph 40) in 2012, also as a result 
of an increase in energy import prices by 10% on average.  

The  capital  balance  has  contributed  positively  to  the  total  external  deficit,  in  line  with 
historical evidence. This contribution has been relatively stable in the last years, around ½% 
of GDP (see Graph 37). The future development of the capital balance will depend to a large 
extent on the financial flows from the EU (these flows constituted 70% of the overall balance 
in 2011), and as such it is mostly exogenous to the economic situation. 

35 

 
 
 
 
Graph  39:  Energy  imports,  volumes,  12-
month moving average  
2005 = 100

Graph  40:  Goods  trade  balance:  energy 
and non-energy component  

140

120

100

80

60

40

20

0

r
a
e
y
g
n
v
o
m

i

,

P
D
G

f
o
%

0

-2

-4

-6

-8

-10

96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12

96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12

Energy balance

Total balance

Non-energy balance

Source: Ministerio de Economía y Competitividad 

Source: Ministerio de Economía y Competitividad 

3.2.3.1.  Assessing the cyclical/non-cyclical nature of trade balance adjustment 

It is challenging to assess the cyclical versus non-cyclical nature of the on-going external 
deficit adjustment. Permanent adjustment may come from (i) changes in the relationship of 
exports  and  imports  with  their  corresponding  determinants  (prices  and  demand)  and/or  (ii) 
from  permanent  shifts  in  these  determinants.  In  the  case  of  exports  there  is  evidence  of 
growing diversification of destinations and product specialisation (see also 2012 IDR), which 
would raise the sensitivity of Spanish exports to changes in world trade. On the import side, 
the responsiveness to final demand would be reduced by a permanent rebalancing of demand 
towards exports. As discussed below, the evidence is not conclusive about these changes. 

Top-down analyses based on the historical relationship between the current account and 
the  output  gap  suggest  a  still  significant  role  of  cyclical  factors  in  the  external 
adjustment. This overall conclusion is consistent with the persistence of an external deficit so 
far in spite of a growing output gap and soaring unemployment.38 However, estimates of the 
cyclical versus non-cyclical factors in the external balance adjustment vary substantially. For 
instance,  Deutsche  Bank  (2012),  applying  estimated  short-term  coefficients  to  the  cyclical 
component  of  determinants  of  exports  and  imports,  concludes  that  the  non-cyclical  trade 
balance improved by around 2 pps. of GDP (2007-11) compared to a total reduction of around 
6 pps. – i.e. around one third of the total adjustment would be non-cyclical. Goldman Sachs 
(2013),  based  on  a  cyclical  adjustment  of  current  account  balances,  shows  a  non-cyclical 
improvement of around 5 pps. out of an overall 7 pps. reduction. Commission services' model 
estimates  also  point  to  a  small  cyclical  component.  Overall,  the  wide  range  of  estimates 
demonstrates the limitations of these approaches and the need to complement them with more 
detailed analyses.  

38  According to IMF (2012c), in the presence of more flexible product and labour markets, Spain could have 

moved to an external surplus already in 2011, compared to the observed deficit of 3.2% of GDP. 

36 

 
 
 
 
 
 
 
 
                                                            
The apparent improvement in cost competitiveness is largely due to demand factors. As 
noted in Section 2, in the period 2007-2012 cost competitiveness has recovered a part of the 
cumulated losses between 2000 and 2007. The positive development in cost competitiveness 
results  from  a  sizeable  increase  in  apparent  productivity  and  slower  wage  growth.  These 
improvements are tightly linked with labour shedding, partly reflecting the downsizing of the 
construction  sector,  and  the  slump  in  domestic  demand.  To  an  extent,  however,  they  also 
reflect  efforts  by  companies  to  improve  underlying  productivity,  some  belated  movement 
towards  realigning  wage  dynamics  with  underlying  economic  trends  and  shifts  in  the 
composition of output away from construction-related activities with low productivity.  

A  saving-investment  perspective  points  to  a  sizeable  non-cyclical  component  in  the 
external  adjustment.  The  reduction  in  the  current  account  deficit  over  2007-2011  was  6.3 
pps. of GDP. In terms of the saving and investment counterparts, there were two main drivers 
(see Graph 41). On the investment side, the downsizing of investment in housing, 5.8 pps. of 
GDP in the period 2007-11, is unlikely to be reversed fully in the coming years, and in fact, as 
noted  in  Section  2,  it  has  not  ended  yet.  However,  in  the  same  period  the  saving  rate  (as  a 
percentage  of  GDP)  fell  by  3.1  pps.  and  part  of  this  reduction  may  also  be  of  a  permanent 
nature, which would reduce the net permanent adjustment of external deficit. 

3.2.3.2.  The role of exports in the adjustment of the external trade balance  

Exports have driven a large part of the trade balance adjustment but volume data show 
that the fall of import volumes has been more rapid than shown by nominal data. . The 
trade balance adjusted from a deficit of 5.8% of GDP in 2008 to a surplus of 1% of GDP in 
2012 (6.8 pps. adjustment, see Graph 42). This sharp adjustment was predominantly driven by 
the increase of the share of total exports in GDP (around 80% of the overall adjustment) and, 
to a lesser extent, by the reduction of the share of total imports in GDP (the remaining 20%). 
However,  these  shares  are  significantly  influenced  by  different  behaviour  of  export  and 
import prices. In real terms, exports grew by 11% between 2008 and 2012, while imports fell 
by 15%.  

Graph 41: Saving and investment rates 

% of GDP

35

30

25

20

15

10

5

0

95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11

Saving rate

Investment in construction

Total investment

Graph  42:  Total  exports  and 
(current prices) 
% of GDP

imports 

40

30

20

10

0

-10

-20

-30

-40

00 01 02 03 04 05 06 07 08 09 10 11 12
Imports

Trade balance

Exports

Source: INE 

Source: INE 

37 

 
 
 
The resilience of Spanish exports is manifest in a relatively modest loss in export market 
shares compared to other European countries. As outlined in the 2012 IDR, between 1996 
and 2011, Spanish exports of goods and services expanded only slightly below the trend for 
world exports, with the total Spanish export market share decreasing from 2.2% to 2.0%. This 
relatively  good  performance  of  exports  was  driven  by  both  exports  of  goods  and  services. 
While services have been less dynamic than goods in the period 2010-11 (see Graph 43), they 
surpassed the growth rate of exports of goods in 2012, predominantly driven by non-tourism 
services (more than compensating for the deceleration of tourism services). The rise in non-
tourism services exports can be related to the increase in direct investment abroad by Spanish 
firms during the expansion period, and as such is expected to persist in the coming years.  

The relatively good historical performance of export market shares does not match with 
the  evolution  of  price  competitiveness.  As  shown  in  Section  2,  the  REER  deflated  by 
consumer prices appreciated by 20% in the period 2000-08 and has since adjusted by around 
7%.  This  combined  evidence  of  good  performance  with  respect  to  world  market  shares  and 
significant  losses  in  terms  of  price  competitiveness  has  fuelled  a  debate  about  this  apparent 
'Spanish paradox'. The two main factors which may explain the relative resilience of Spanish 
exports  despite  competitiveness  losses  are  the  duality  of  the  Spanish  economy  and  other 
factors related to non-price competitiveness.39 

Graph  43:  Exports  of  goods  and  services,
y-o-y growth (12-month moving average)  
%

Graph  44:  Exports  of  goods  by  destination, 
contribution to y-o-y growth 
%
30

25

20

15

10

5

0

-5

-10

-15

-20

00 01 02 03 04 05 06 07 08 09 10 11 12

Goods

Services

25

20

15

10

5

0

-5

-10

-15

-20

-25

00 01 02 03 04 05 06 07 08 09 10 11 12

Non-tourism services

Tourism services

Euro area

Rest of EU27

Non-EU

Source: INE 

 Source: Ministerio de Economía y Competitividad 

The expansion of exports of goods during the crisis has been supported by some strong 
underlying fundamentals: 

•  Increasing  geographical  diversification  (see  Graph  44).  The  share  of  non-EU-27 
countries in Spanish merchandise exports increased from 27% in 2000 to 30% in 2009 
and  33%  in  2011,  according  to  Eurostat's  data.  Exports  to  emerging  markets  have 

39 

See Cardoso et al. (2012). 

38 

 
 
 
 
                                                            
registered very dynamic growth, especially to Latin America, North Africa and some 
Asian emerging markets. This has broadened the traditional export base of the Spanish 
economy.  

•  Growing  diversification  of  exports  by  products.  On  some  measures,  the  Spanish 
export  sector  is  one  of  the  most  diversified  both  in  terms  of  products  and  client 
countries.40  Furthermore,  the  weight  of  more  complex  sectors  in  Spanish  exports  is 
above  the  world  average.  These  characteristics  allow  Spanish  exports  to  achieve  an 
international advantage in terms of product diversification.41  

Going  forward,  it  will  be  crucial  to  continue  strengthening  both  price  and  non-price 
competitiveness.  The  implementation  of  the  reform  agenda  should  increase  the  relative 
attractiveness  of  tradable  activities  by  reducing  rents  in  sheltered  sectors,  facilitate  the 
reallocation of resources, reinforce the link between wages and economic and firm conditions 
and remove obstacles to firms' growth (see Box 1). 

40   Hausmann et al. (2011). 
41   Correa-López and Doménech (2012). 

39 

 
 
 
                                                            
Box 1: Firm size and export potential 

A  small  average  firm  size  might  limit  the  export  potential.    International  comparisons  show  that 
differences in aggregate export performances by country can often be explained by differences in the 
size  distribution  of  firms  and  the  sectoral  structure.  For  firms  that  are  similar  in  size,  but  located  in 
different  countries,  the  probability  that  they  export  and  the  proportion  of  production  exported  are 
similar. But compared to companies oriented towards a domestic market, export-oriented firms have 
higher levels of productivity, are bigger and closer to the efficiency frontier than non-exporters (see 
Ahn (2001)). This is confirmed by analysis of Spanish companies. In Spain, firms with less than 10 
employees represent around one third of employment in manufacturing and more than 40% in services 
(see Graph 45 and Ahn (2001), Banco de España (2013), and Galán and Martín (2012)). Productivity 
differences according to firm size are particularly pronounced in Spain (see Graph 46). 

Graph  45:  Employment  distribution  by  firm  size
class in Spain, 2010 
%
50

45

40

35

30

25

20

15

10

5

0

r
e
k
r
o
w

r
e
p
s
d
n
a
s
u
o
h

t

R
U
E

0-9

10-19

20-49

50-249

250 plus

Graph 46: Labour productivity distribution by firm 
size. Industry and services in Spain, 2010 

100

90

80

70

60

50

40

30

20

10

0

0-9

10-19

20-49

50-249

250 plus

Firm size class

Firm size class

Industry

Services

Industry

Services

Source: Commission services 

Source: Commission services 

Labour  market  regulations,  administrative  burden,  fragmentation  of  the  internal  market  and  fiscal 
requirements  as  well  as  transport  costs  may  explain  the  atomization  of  Spanish  firms.  The  different 
requirements in terms of labour regulations and administrative and tax burden for small firms might 
discourage  the  growth  of  small  companies  (see  La  Caixa  (2012)).  Thus,  the  distribution  of  workers 
according  to  company  size  shows  a  concentration  of  firms  in  the  category  between  20  and  49 
employees. In addition to institutional factors, trade-related variable costs (i.e. transport costs) appear 
to be a key factor limiting the growth of Spanish firms when compared to other European countries 
(see Rubini et al. (2012)). The geographical position of Spain could explain this higher importance of 
transport  costs,  especially  for  exporting  firms.  However,  non-export  firms  are  also  affected.  In 
particular,  the  deficiencies  in  transport  infrastructure  (a  lack  of  interoperable  interconnections  with 
other  Member  States  and  poor  integration  between  transport  modes  (see  European  Commission 
(2012c)) may explain the significance of transport costs.  

Limited access to financing for SMEs can compound small firm size as a limiting factor to the export 
potential. Public support can partially substitute for weak collaboration between SMEs in Spain, but it 
does not entirely help to overcome the barrier of sunk costs, which is especially high for small firms 
and firms that venture into foreign markets. Fragmented business structure and large numbers of micro 
firms  increase  firm  dependency  on  bank  financing,  while  alternative  financing  sources  are 

40 

 
 
 
 
 
 
 
underdeveloped. The possibility of recourse to a wider range of financing sources could increase the 
firms' export propensity (see Martín et al. (2009)).  

Graph  47:  Extensive  margin  of  exports,  by  country 
and company size, 2008 

Graph  48:  Intensive  margin  of  exports,  by  country 
and company size, 2008 

100

90

80

70

60

50

40

30

20

10

0

70

60

50

40

30

20

10

0

AT

FR

DE

HU

IT

ES

UK

AT

FR

DE

HU

IT

ES

UK

10-19

20-49

50-249

Over 249

Total

10-19

20-49

50-249

Over 249

Total

Source: EIFIGE 

Source: EIFIGE 

A relatively low overall extensive margin reflects the high number of SMEs and the significant gap in 
productivity between small and large companies. Spain has similar shares of exporting firms in some 
firm  size  categories  as  its  European  peers.  However,  given  fragmentation  of  the  industrial  structure, 
the total extensive margin, i.e. the total share of Spanish companies engaged in export activities, has 
been  relatively  low  (see  Graph  47).  The  intensive  margin  (the  proportion  of  overall  production  that 
firms export) also tends to be lower in Spain (see Graph 48). In 2010, the intensive  margin was the 
major  source  of  export  expansion  (as  firms  were  recovering  from  the  2009  slump  in  international 
trade). More recently, many smaller companies also started to export and the extensive margin became 
an  important  export  engine  in  2011  and  2012.  Weak  domestic  demand  will  continue  to  provide  a 
strong  incentive  for  firms  to  engage  in  export  activity.  However,  the  situation  may  reverse  when 
domestic demand eventually recovers.  

3.2.3.3.  The role of imports in the adjustment of the external trade balance 

The large fall in imports reflects mostly cyclical factors, but also shifts in the level and 
pattern  of  demand.  Total  imports  fell  by  15%  in  constant  prices  between  2008  and  2012, 
which contrasts with a GDP fall of 5% in the same period. Econometric analysis confirms that 
the  decline  of  imports  was  mainly  driven  by  the  fall  of  private  consumption  and  reduced 
investment in equipment and in construction. Exports contributed positively to import growth 
(see Graph 49).42 While the contraction of private consumption and investment in equipment 

42  With  the  target  of  disentangling  the  different  contribution  of  final  demand  components  to  import 
adjustment, a regression for imports over the final demand components (private consumption, investment in 
construction, investment in equipment and exports) is estimated (all variables in constant price terms and 
logs).  Additionally,  import  prices,  seasonal  dummies  and  other  dummies  are  included  in  the  regression, 
with sample period since Q1 1995 until Q3 2012.  

41 

 
 
 
 
 
                                                            
were  most  likely  largely  driven  by  cyclical  factors,  the  adjustment  of  investment  in 
construction  (explaining  around  30%  of  the  fall  in  imports)  can  be  assumed  to  be  largely 
permanent. If part of the adjustment in private consumption is also considered to be lasting (as 
households have revised downwards their income expectations and try to reduce their debt in 
a context of more limited availability of credit) about one half of the total fall in imports could 
be maintained over time.  

The post-crisis composition of final demand points to a lower import content for a given 
level  of  final  demand.  The  weight  of  domestic  demand  in  GDP  decreased  by  6.8  pps. 
between  2008  and  2012  while  the  weight  of  exports  increased  by  5.7  pps.  (see  Graph  50). 
Econometric evidence points to an import elasticity to domestic demand more than twice as 
high  as  that  to  exports.43  The  rebalancing  of  the  Spanish  economy  towards  exports  can  be 
expected  to  continue  in  the  coming  years,  even  factoring  in  a  modest  recovery  in  domestic 
demand. The balance-sheet adjustment of households, corporations and the public sector will 
continue constraining the expansion of domestic demand. 

Graph  49  Decomposition  of  import  growth 
(Q1 2008 - Q2 2012) 

Graph 50: Domestic demand and exports 

Prices

Exports

Equipment

Construction

Private consumption

-5
Source: Commission services 

-10

0

5

%

3.2.4.  Conclusions  

% of GDP
110

108

106

104

102

100

98

96

94

92

% of GDP

34

32

30

28

26

24

22

20

00 01 02 03 04 05 06 07 08 09 10 11 12

Domestic demand (lhs)

Exports (rhs)

Source: INE 

While the external deficit is adjusting at a fast rate, the stock adjustment of negative net 
external liabilities is, necessarily, much less advanced. The level of external debt remains 
very elevated. This high level of external debt and its composition increase the vulnerability 
of  the  Spanish  economy  to  financing  shocks.  A  lasting  external  surplus  will  be  needed  to 
bring about a reduction of external debt.  

The  recent  improvement  of  the  trade  balance  appears  to  have  been  driven  by  both 
cyclical  and  non-cyclical  factors.  A  precise  quantification  of  the  relative  weight  of  these 

43 

The estimated elasticity of imports to domestic demand is 1.5 and to exports 0.6 

42 

 
 
 
 
 
                                                            
factors is difficult. The sharp fall in employment, private consumption and investment suggest 
an important cyclical component behind the current account improvement and the measured 
improvement  in  cost  competitiveness.  This  is  corroborated  by  top-down  analysis.  There  is, 
however, also evidence of robust fundamentals, such as greater geographical diversification of 
export markets and products and changes in the level and compositions of domestic demand. 
Stronger  productivity  improvements  at  firm  level  would  consolidate  and  further  deliver 
competitiveness gains  

Supporting a further expansion of export potential is a key policy objective to underpin 
the  rebalancing  of  the  economy  and  the  improvement  in  the  current  account.  The 
incentive  to  reallocate  resources  towards  the  tradable  sector  and  the  ability  of  companies  to 
compete  on  international  markets  depend  crucially  on  the  proper  functioning  of  domestic 
markets. Opening up sheltered sectors, reducing barriers to firms' entry and exit and to their 
possibility to grow as well as reducing the administrative burden would support this process. 
There  may  also  be  failures  and  limitations  in  the  market  for  bank  loans,  which  could  be 
relieved  by  developing  non-bank  financing  sources  and  by  specific  measures  to  support 
access  to  finance  by  export  firms  (especially  for  SMEs).  A  contribution  to  exports  would 
come  also  by  lower  export  costs  –  i.e.  resulting  from  a  higher  efficiency  of  the  transport 
infrastructure efficiency or from export promotion strategies that alleviate the costs of export 
market  entry  for  SMEs.  In  this  respect,  the  Spanish  authorities  have  taken,  or  announced,  a 
number of policy initiatives aimed at export promotion. In particular, the measures included in 
the  Royal  Law  Decree  20/2012,  which  enlarge  the  system  of  warranties  to  exports,  and  the 
plan  to  create  an  internationalization  agency  (expected  by  Q2  2013)  with  the  objective  of 
rationalising public export promotion instruments.44 

44 

International experience on measures to facilitate size growth of small firms, and their export profile, has 
been  basically  based  on  advice  and  information  provision  to  those  sectors  and  firms  which  have  been 
identified with higher export potential. Other measures try to associate small firms with related large firms 
(their  suppliers,  partners  or  clients)  for  joint  actions  in  the  external  markets  (Ministerio  de  Industria, 
Turismo y Comercio (2011)). 

43 

 
 
 
                                                            
4. 

POLICY CHALLENGES 

Despite  the  measures  already  taken  by  Spain,  several  important  and  interconnected 
policy challenges  are  identified in  this report. Spain  needs to  simultaneously reduce high 
levels of external and private sector debt, regain competitiveness and revive economic growth 
through  a  further  rebalancing  of  the  economy  towards  more  export-led  growth,  taking  into 
account the inter-linkages with financial sector restructuring and public sector consolidation. 
Developments since the 2012 IDR have confirmed the difficulties of balancing these different 
needs  and  the  vulnerability  of  the  economy  and  the  financial  system  to  shocks, 
notwithstanding progress in some areas and policy advances.  

The complexity and severity of the challenges require a comprehensive policy response 
and close monitoring. The recent easing of wholesale funding costs has not yet fed through 
the real economy, and both financial markets and non-financial sector confidence remain very 
sensitive  to  economic  and  political  news.  With  unemployment  already  at  extremely  high 
levels and growing, completing and implementing decisively the structural reform agenda is 
essential to support the rebalancing of the economy and hence growth and employment during 
the deleveraging process. A stronger economy would back up progress in the consolidation of 
public finances and the stabilisation of the financial sector.  

Progress  with  respect  to  the  timetable  of  the  government  structural  reform  plan  of  27 
September  2012  has  been  mixed.  The  plan  intended  to  provide  a  concrete  response  to  the 
country-specific recommendations under the 2012 European semester. It covered (i) structural 
fiscal reforms, (ii) labour market and education reforms and (iii) product market reforms and 
measures to improve business environment.  

Further  steps  to  strengthen  competition  in  product  and  service  markets  (including 
network  industries),  improve  the  business  environment,  support  the  growth  and 
internationalisation of firms, widen the sources of firm financing, and review the growth 
friendliness  of  tax  system  would  contribute  to  a  greater  adjustment  capacity  of  the 
economy: 

•  The draft law on Market Unity adopted by the government on 25 January 2013 
has  the  potential  to  reduce  the  fragmentation  of  the  domestic  market.  The  first 
draft of the law covers two main dimensions: i) defining principles of better regulation 
and good governance  to be applied at all levels of government and ii) laying down a 
general  principle  of  'mutual  recognition',  whereby  any  goods  or  services  that  have 
been  authorised  in  one  region  can  be  marketed  anywhere  else.  Once  it  enters  into 
force,  this  law  would  reduce  fragmentation  and  spur  competition  and  allow  reaping 
efficiency gains via economies of scale.  The degree of ambition of the draft law and 
the timely adoption should be preserved. 

•  Further measures to enhance competition in the network industries as well as to 
tackle  the  energy  tariff  deficit  appear  warranted.  It  is  important  to  ensure  the 
effectiveness,  autonomy  and  independence  of  the  newly  created  supervisory  and 
sectoral  regulatory  authority.  The  'electricity  tariff  deficit'  implies  a  considerable 
contingent liability for the budget as well as non-negligible macroeconomic risks and 
may negatively affect the debt dynamics in the future. Despite some recently adopted 
measures,  further  steps  to  contain  its  potential  impact  on  the  public  finances  are 
warranted.  

44 

 
 
 
•  Anti-competitive regulations and non-justified entry barriers, e.g. in professional 
services,  remain  a  problem.  A  draft  law  aiming  at  reforming  professional  services 
was  to  be  adopted  by  the  government  by  end-2012  but  is  still  being  finalised. 
Measures to facilitate entry and exit of firms - in particular to lower the administrative 
burden, widen the choice of company forms, review of insolvency laws, increase the 
availability of financing channels to reduce bank-dependency - would help businesses 
to reallocate resources and create jobs. Following up on the payment of large amounts 
of arrears to suppliers of regional and local administrations, avoiding the building up 
of public administration arrears in the future would support firms' liquidity and be an 
indication  of  improved  public  finance  control.  In  addition,  intensifying  the  fight 
against  the  informal  economy  would  contribute  to  a  level-playing  field  amongst 
companies. 

•  The  export  potential  would  be  boosted  by  the  removal  of  barriers  to  firms' 
growth  and  by  providing  targeted  support  to  internationalisation.  A  review  of 
size-dependent policies with lock-in effect in the area of labour regulations as well as 
administrative  and  tax  burden  could  reveal  their  role  in  skewing  firm  composition 
towards  SMEs.  At  the  same  time,  SMEs  may  need  assistance  to  enter  and  remain 
present  in  export  markets,  an  area  in  which  measures  are  being  taken.  In  addition, 
targeted measures, facilitating access to finance for exporting firms, especially SMEs, 
as well as reducing transport costs, would also be useful to support internationalisation 
and firms' growth.  

•  There has been progress in rebalancing the tax system. VAT revenue and revenue 
from  environmental  taxes  in  Spain  have  been  amongst  the  lowest  in  the  EU.45 
Moreover, tax-to-GDP ratios have decreased considerably as part of the rebalancing of 
the economy towards a less tax-rich growth pattern. Some recent measures have gone 
in  the  direction  of  improving  the  efficiency  of  the  tax  system.  These  include  an 
increase of VAT rates and a wider scope of application of the standard rate as well as 
measures  aimed  at  reducing  the  tax-induced  bias  towards  indebtedness  and  home-
ownership.  A  number  of  environmental  taxes  have  been  increased  or  introduced. 
Going forward, the scope to further limit the application of reduced VAT rates (or to 
raise  those  rates),  to  further  increase  the  role  of  environmental  taxes,  notably  as 
regards energy and fuel taxes, and reduce tax expenditure could be explored.  

The extent of the unemployment challenge warrants that the impact of the 2012 labour 
market  reform  be  closely  monitored  and  the  reforms  complemented  by  accompanying 
measures:   

•  It  is  important  to  monitor  closely  whether  the  reform  of  the  labour  market  is 
attaining its objectives. Recognising that a well-working labour market is key to the 
correction  of  imbalances  and  to  growth  and  employment,  aims  at  greater  efficiency 
and  reduced  labour  market  duality,  higher  internal  flexibility,  a  wage  bargaining 
mechanism that ensures a  better alignment  of  wages to economic conditions, greater 
employability  of  young  workers  and  greater  use  of  permanent  contracts.  Further 
measures were adopted in July 2012 to phase out certain hiring subsidies and to link 
unemployment benefits better with job-search activities. A Royal Decree approved in 
November 2012 provided the basis for establishing a dual vocational training system. 

45  According to the latest available data (2011). 

45 

 
 
 
                                                            
On  22  February  2013,  the  government  adopted  a  Royal  Decree-Law  which  contains 
part  of  the  (short-term)  measures  included  in  the  Youth  Entrepreneurship  and 
Employment Strategy 2013-2016. A first assessment of the labour market reform was 
to be carried out by the authorities before the end of 2012. 

•  An overhaul of ALMP and public employment services would help to absorb the 
large number of unemployed and support competitiveness. More effective ALMP, 
better  collaboration  between  regional,  national  public  and  private  employment 
services,  as  well  as  intensifying  the  implementation  of  education  and  vocational 
training policies would be important complements to the labour market reform in this 
respect.  It  is  key  to  activate  the  unemployed  and  upgrade  their  skills  through  better 
targeting and provision of training opportunities (including on-the-job training) and to 
better  link  unemployment  benefits  with  job  search  and  training  activities.  These 
measures would also contribute to improving the cost competitiveness of the Spanish 
economy in the longer term, including by boosting productivity growth. 

Completing  the  ongoing bank restructuring  and recapitalisation is essential to support 
an easing of financing conditions for households and companies. As part of the financial 
sector  programme,  the  banking  sector  is  undergoing  a  deep  restructuring.  The  restructuring 
plans  endorsed  by  the  Commission  in  November  and  December  2012  in  line  with  State  aid 
rules are designed to ensure a return to viability and thus to minimise the impact on credit to 
the healthier part of the economy46, but smooth credit provision will also depend on the ability 
and  willingness  of  the  stronger  banks  to  extend  credit.  Completing  the  recapitalisation  and 
restructuring of banks in line with the banking sector programme, as well as strengthening of 
the  regulatory  and  supervisory  framework  are  essential  in  this  respect.  The  authorities  are 
complying  with  the  deadlines  and  the  programme  is  on  track.  The  reallocation  of  resources 
within the economy would also benefit from the development of non-bank financing sources, 
so  as  to  widen  financing  options  for  companies  according  to  their  needs  and  their  stage  of 
development.  There  appears  to  be  scope  to  review  the  bankruptcy  regulatory  framework  to 
make it more effective, while bearing in mind the possible impact on financial stability.     

There  has  been  progress  in  removing  distortions  in  the  housing  market,  which 
contributed to promote past disequilibria. In particular, the tax deductibility of interest rate 
payments on new mortgages has been eliminated and the institutional framework of the rental 
market is in the process of being strengthened. A larger, more efficient, rental market would 
also  ease  geographical  mobility  of  workers  and  thereby  improve  the  adjustment  capacity  of 
the economy.  

Fiscal consolidation has further to go to secure lasting financial market confidence. The 
commitments  under  EU  surveillance  procedures  provide 
the  framework  for  fiscal 
consolidation. Putting greater emphasis on the medium-term strategy, basing consolidation on 
structural measures, as well as improving efficiency and quality of public expenditure at all 
government  levels  would  contribute  to  confidence  building  and  ensure  reductions  in  the 
structural and headline deficits. In addition, there is scope to further strengthen the long-term 
sustainability  of  the  pension  system  and  of  social  security.  Regarding  the  fiscal  framework, 
implementation  of  the  Budget  Stability  Law  remains  uneven.  There  have  been  important 
improvements  in  budgetary  transparency  through  more  timely  and  regular  reporting  on 

46     See European Commission (2013c), the programme's second review report. 

46 

 
 
 
                                                            
 
monthly  and  quarterly  budgetary  developments  at  different  levels  of  government.  However, 
the  monitoring  instruments  envisaged  in  the  Budget  Stability  Law,  including  in  particular 
early warning mechanisms, have not been fully effective. In addition, preparations for setting 
up  an  independent  Fiscal  Council  have  been  delayed  and  it  appears  unlikely  that  this  body 
will be operational in time to play an active role in the preparation of the 2014 budget law. 

47 

 
 
 
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49