COMMISSION STAFF WORKING DOCUMENT Macroeconomic Imbalances - Spain 2014
Date: 2014-03-05
Institutions: European Commission
Subjects: Euro Group (euro area), Spain, budgetary equilibrium, competitiveness, economic growth, financial services, indebtedness, labour market, macroeconomics, public debt, real estate credit, stability pact, trade balance













EUR-Lex - 52014SC0080 - EN











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52014SC0080

COMMISSION STAFF WORKING DOCUMENT Macroeconomic Imbalances - Spain 2014 /* SWD/2014/080 final */









Results of in-depth reviews under
Regulation (EU) No 1176/2011 on the prevention and correction of macroeconomic
imbalances
Spain is experiencing macroeconomic imbalances which require specific
monitoring and decisive policy action. In several dimensions, the
adjustment of the imbalances identified last year as excessive has clearly
advanced and the return to positive growth has reduced risks. Yet, the
magnitude and inter-related nature of the imbalances, in particular high
domestic and external debt levels, mean that risks are still present. The
Commission will continue a specific monitoring of the policies recommended by
the Council to Spain in the context of the European Semester, and will
regularly report to the Council and the Euro Group. This monitoring will rely
on post-programme surveillance. 
More specifically,
the adjustment has been supported by decisive policy actions at the EU level
and by Spain. In particular, the recapitalisation and restructuring of weaker
banks have dispelled systemic concerns about the financial sector and allowed a
smooth ending of the financial assistance programme at the beginning of 2014.
The current account has turned into surplus, as a result of a combination of
import compression and strong exports, supported by competiveness gains. The
housing market has approached stabilisation. Employment destruction appears to
be coming to an end. On the policy front, the comprehensive agenda of
structural reforms outlined in the 2013 NRP is mostly completed from
legislative point of view, and attention is shifting to a challenging
implementation phase. These positive developments have led to a strong return
of confidence, manifest in the fall in market risk premia, the return of
foreign capital inflows and the rise in business and consumer confidence. 
Yet, the adjustment
is far from complete and vulnerabilities persist. More specifically, the very
high stock of private and public debt, both domestic and external, continues to
pose risks for growth and financial stability. Despite its recent contraction,
unemployment remains at alarming levels. The re-orientation of the productive
system towards exporting sectors and the recovery in international
competitiveness will have to be maintained to reduce the very large stock of
external liabilities and the burden that it causes in terms of negative flow of
incomes towards the rest of the world. The adjustment of private sector
balance-sheets is advancing, but high unemployment and falling incomes have
limited the pace of deleveraging of households. Non-financial corporations have
reduced debt at a somewhat more sustained pace. Going forward, the challenge is
ensuring that deleveraging will go hand in hand with positive credit flows to
financially healthy borrowers. Removing hindrances in the functioning of the
product and financial markets and efficient insolvency procedures could reduce
the drag on growth from deleveraging. In the labour market, building on the
positive effects of recent reforms on internal flexibility and wage settings,
additional reforms could be envisaged. Finally, significant revenue shortfalls,
higher social expenditure and costs of bank recapitalisation have led to a
substantial pressure on government deficits and a steep rise in government debt
to high levels. The 2013 fiscal deficit target might have been missed, although
the improving macroeconomic prospects should allow Spain to meet the 2014
headline target. Ensuring a reduction in government debt in the medium-term
will require sustained fiscal efforts.
Excerpt
of country-specific findings on Spain, COM(2014) 150 final, 5.3.2014
Executive Summary and Conclusions 7
1.       Introduction  11
2.       Macroeconomic
developments 13
3.       Imbalances
and risks 19
3.1.     CompetiTIveness
and sustainability of the external position  19
3.1.1.  Overview   19
3.1.2.  Drivers of
export performance  21
3.1.3.  Drivers of
imports 25
3.1.4.  Income balance
and capital transfers. 27
3.1.5.  Medium-term
evolution of net international investment position  27
3.1.6.  Euro area
dimension  28
3.1.7.  Conclusions 30
3.2.     Indebtedness
and Deleveraging  31
3.2.1.  Overview   31
3.2.2.  Financial
sector developments 32
3.2.3.  Adjustment in
the housing market 35
3.2.4.  Drivers of
indebtedness and deleveraging in the households sector 37
3.2.5.  Drivers of
indebtedness and deleveraging in the non-financial corporations sector 41
3.2.6.  General
government debt 42
3.2.7.  Conclusions 45
3.3.     Labour
market performance  46
3.3.1.  Overview   46
3.3.2.  Drivers of
labour market performance  47
3.3.3.  Medium-term
prospects 53
3.3.4.  Conclusions 55
4.       Policy
challenges 59
References 64
LIST OF Tables
2.1.     Key
economic, financial and social indicators - Spain  18
LIST OF Graphs
2.1.     External
and domestic demand, contributions to growth  13
2.2.     Decomposition
of debt by sector (non-consolidated) 14
2.3.     Decomposition
of rate of change of ULC, rate of change of ULC in (EA/EU) 15
2.4.     Relative
shares of tradable and non-tradable sectors 15
2.5.     Change in
employment and average propensity to export by industry  16
2.6.     Poverty
dynamics 17
3.1.     Decomposition
of external position (current and capital accounts) 19
3.2.     Current
account, gross components 19
3.3.     Share in
world exports of goods and services (2000=100) 20
3.4.     Net
lending/borrowing by sector 20
3.5.     Decomposition
of net international investment position  20
3.6.     Decomposition
of the Real Effective Exchange Rate (REER) 21
3.7.     Geographical
and sectoral composition of nominal (USD) rate of change of goods exports
(normalised to world goods exports) 22
3.8.     World
market shares for services 22
3.9.     Allocative
efficiency - manufacturing sector 24
3.10.   Non-cyclical
current account 25
3.11.   Imports of
energy and non energy product 26
3.12.   Imports by
broad economic category  26
3.13.   Financial
account balance by sector 27
3.14.   Decomposition
of rate of change of NIIP  28
3.15.   Spanish
imports as percentage of country exports (2011) 28
3.16.   Exposure of
foreign MFIs to Spain (ultimate risk basis - selected countries) 29
3.17.   Exposure of
foreign MFIs to Spain by sector (ultimate risk basis) 30
3.18.   NIIP by
sector 30
3.19.   Non-performing
loans 33
3.20.   Bank loans 33
3.21.   Credit
impulse to NFC   34
3.22.   Housing
prices 35
3.23.   Households
indebtedness indicators 36
3.24.   Contributions
to annual growth of households' debt 36
3.25.   Decomposition
of y-o-y changes in debt-to-GDP ratios, households 37
3.26.   Debt
sustainability, households 37
3.27.   Financial
position of households 38
3.28.   Doubtful
loans ratio of NFC by sector 41
3.29.   NFC
indebtedness and financial burden  41
3.30.   Debt
sustainability, non-financial corporations 42
3.31.   Profit
margins, NFC   42
3.32.   Activity and
unemployment 46
3.33.   Unemployment
by duration  47
3.34.   Employment
distribution by sector 47
3.35.   Employees as
a percentage of active population  48
3.36.   Evolution of
activity rates by age  49
3.37.   Evolution of
activity rates by gender 49
3.38.   Evolution of
fixed-term and indefinite contracts 50
3.39.   Wages, ULC,
unemployment 2000-2013  52
3.40.   Use of
flexibility measures by company (July 2013) 53
3.41.   Unemployment
rate, by level of education attained   55
LIST OF Boxes
3.1.     Insolvency
procedures in Spain  39
3.2.     Long-term
projections of general government debt 44
3.3.     Main
features of the 2012 labour market reform   50
3.4.     Model
simulation of the possible impact of a tax shift in Spain  56
LIST OF Maps
No table of contents
entries found.
In April 2013, the Commission concluded
that Spain was experiencing excessive macroeconomic imbalances, in particular
as very high domestic and external debt levels continued posing risks for
growth and financial stability. In the Alert Mechanism Report (AMR) published
on 13 November 2013, the Commission found it useful, also taking into account
the identification of excessive imbalances in April, to examine further the
persistence of macroeconomic risks and to monitor progress in the unwinding of
imbalances. To this end, this In-Depth Review (IDR) provides an economic
analysis 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:
·       The correction of macroeconomic imbalances has progressed, allowing
a return to positive economic growth and prospects of a stabilisation in the
labour market. Spain entered the financial crisis
with high external debt, poor cost competitiveness, high private sector debt, a
fragile financial sector and an overheated housing market. The burst of the
housing bubble triggered a sharp adjustment, aggravated by the drying up of
external capital inflows as the crisis progressed. A number of policy measures
were taken to reinforce the financial sector, restore competitiveness and shore
up public finances. The third quarter of 2013 marked the end of Spain's longest
recession in decades and employment interrupted a long decline in the fourth
quarter of 2013 (in quarterly terms). The return to positive growth occurred as
domestic demand started to exercise less of a drag on growth amid recovering
confidence and gradually easing financing conditions (although still relatively
onerous for smaller borrowers). Going forward, the recovery can be sustained
only if it does not result into a halt or reversal of the adjustment process,
as the ongoing correction of the original imbalances still has a long way to go
and new areas requiring close attention have emerged.
·       The current account has adjusted swiftly and is now in surplus (1.1%
of GDP in 2013), while indices of competitiveness have recovered a significant
part of the deterioration during the pre-crisis boom. While cyclical factors explain a share of the improvement in the
trade balance behind the turnaround in the current account, this latter appears
to also have firm structural roots. In particular, exports, which remained
resilient despite the loss in cost competitiveness in the years preceding the
crisis, accelerated considerably in 2012 and 2013, with expansion both at the
intensive and the extensive margins as the pressure for internationalisation
increased amidst contracting domestic demand. Exports of services have been
particularly dynamic. The import performance has been more mixed, as Spain has
a high import intensity of final demand and higher oil prices countered the
reduction of import volumes of non-oil goods. Yet, as a significant part of the
slump in domestic demand during the crisis is likely to be permanent, imports
will remain correspondingly lower. The current account balance is projected to
increase further in the coming years, to 1.6% of GDP in 2014 and 1.8% of GDP in
2015 according to the 2014 Winter Forecast.
·       The banking sector has been bolstered by the recapitalisation of
weaker banks, the transfer of problematic assets to Sareb (the asset management
company) and overall positive earnings results in 2013. In January 2014 Spain successfully exited the financial sector
recapitalisation programme initiated in July 2012, having met all bank-specific
and horizontal policy conditionality. However, despite favourable overall
leverage ratios, the banking system is still exposed to challenges from the
ongoing restructuring process, weak macroeconomic prospects, possible further
adjustment in the construction sector and in the real estate markets and
shrinking business volumes. 
·       The adjustment of the construction sector and housing market appears
to be approaching stabilisation. Between 2006 and
2013 the share of residential investment in total GDP fell by around 8 pps. to
4.4%, below the previous historical low of 7% in 1997. Both residential
investment and construction are still falling. The fall in house prices
accelerated in 2012, and by the third quarter of 2013, the cumulative decline
since the peak in the third quarter of 2007 was 36.2% in nominal terms and
43.8% in real terms. While there are indications of a slowdown or even
stabilisation in the price correction at the end of 2013, given the still weak
demand for housing and the remaining large stock of unsold houses some further
adjustment cannot be excluded.
·       Despite the progress achieved, the economy remains vulnerable given
still large stocks of accumulated imbalances. The
turn-around in flow variables is impacting stock variables only slowly, also
due to the contribution from denominator effects are forecasted to remain
contained in the short to medium run due to subdued nominal GDP growth. Large
domestic (private and public sector) and external debt will weigh on demand and
keep the economy vulnerable to shocks. The large pool of unemployed - a large
share of which are long-term unemployed - will likewise require a sustained
pace of job creation and effective activation policies over time to be
reabsorbed. 
·       Driven by valuation and denominator effects, the negative net
international investment position deteriorated further in 2013, in spite of the
positive net lending position. The NIIP was -97.8%
of GDP in the third quarter of 2013, down from -91.4% of GDP in 2012. The
positive impact of net external lending of 1.9% of GDP was more than offset by
negative valuation and denominator effects – the former linked also to the
recovery in prices of Spanish financial assets and the appreciation of the euro
exchange rate. Even disregarding valuation effects, it could still take a
decade of large current account surpluses to reduce the NIIP significantly.
Beyond the magnitude, the liability composition of the NIIP adds to external
vulnerability, given the large share of loans and fixed income instruments. 
·       Private sector deleveraging is advancing gradually. The total stock of non-financial private sector debt was 210% of GDP
in the third quarter of 2013 in non-consolidated terms (189% of GDP if
consolidated). This is some 22 pp. of GDP lower than the peak in the second
quarter of 2010, but still high. Most of the decline is due to non-financial
corporation debt, which is down by 16 pp. of GDP since the peak. Based on
historical evidence and considering the magnitude of the debt overhang,
deleveraging pressures will take still time to work out and continue to weigh
on domestic demand and on the financial sector. 
·       The imbalances accumulated in the private sector have spilled over
to the public sector. General government debt has
increased by almost 60 pps of GDP since 2007 and is forecast just below 100% of
GDP in 2014. Worries about the banking sector, high budget deficits and the
rapid increase in public debt, together with wider concerns about the stability
of the euro area, all contributed to a brisk rise in Spanish risk premia,
especially in 2012. Risk premia have narrowed considerably since the peak in
mid-2012 (the 10-year sovereign bond yield spread has fallen from above 600
bps. in summer 2012 to less than 200 bps. in February 2014) and nominal yields
are currently historically low. Due to the exceptional macroeconomic
conditions, in July 2013 the Council extended the deadline for correcting the
excessive deficit by two years to 2016. At present, the achievement of the 2013
budget deficit target appears still subject to risks. 
·       Structural inefficiencies have magnified the fall in employment. Limited firms internal flexibility in the use of resources,
duality, unresponsive wages and the sharp contraction in the labour-intensive
construction sector, have intensified labour shedding as a response to the economic
contraction. The concentration of fixed term contracts among youngsters and low
skilled, moreover, has led to a disproportionate burden of adjustment on these
groups of workers. The labour reforms have contributed to enhance firms'
internal flexibility and the responsiveness of wage bargaining to economic
conditions. A positive impact on labour market duality is much less clear at
this stage, but this may also be partly due to the high level of economic
uncertainty, which may make companies favour temporary employment. However, a
persistence of duality and lack of workers mobility when the recovery is more
consolidated would be an obstacle to allocative efficiency and productivity
growth. The labour market is also characterised by mismatch of labour demand
and supply – both from a skill and a geographical perspective. 
·       As the Spanish economy is tightly interconnected with the rest of
the euro area, developments in Spain could have a significant impact on the
other economies, and vice-versa. The contraction of
domestic demand impacted on Portuguese exports, almost one fourth of which are
directed to Spain. The Spanish market is less important for other euro area
economies, but nevertheless significant. Moreover, large flows of intermediate
and final goods in some sectors (e.g. in transport equipment) show that Spain's
production structure is closely integrated in particular with France and
Germany. While the large share of exports directed to the euro area shelters
Spain from movements in the euro exchange rate, an appreciation of the euro
would impact on Spain's exports outside the euro area exports, which have been
playing a growing role in recent years. Financial links between Spain and the
rest of the euro area are also intense. The high reliance of Spanish banks on
loans from the rest of the euro area (in particular France and Germany) implies
that financial shocks in other large euro area Member States could impact on
the funding of Spanish banks.     
The IDR also discusses the policy
challenges stemming from these imbalances and what could be possible avenues
going forward, in particular to promote the allocative efficiency of the
Spanish economy and support the on-going macroeconomic adjustment. A number of
elements could be considered: 
·       The structural reform agenda has been advanced decisively in the
last year, although there are still some important outstanding items and full
implementation of ongoing reforms will be essential to reap the expected
economic benefits. Beyond the measures to restructure
the financial sector, many structural measures have been taken in accordance
with the priorities identified in the National Reform Programme and the 2013
Country Specific Recommendations by the Council. The recent pension reform has
improved the long-term sustainability of public finances, while public
administration reforms are aiming at a rationalisation in competencies and a
leaner administration. Public finance management has been reinforced by the
internal stability pact between the central state and the regions, which is
already delivering fruits and could be used to full potential, and by the new
independent fiscal institution soon to become operational. The forthcoming
reform of the tax system, still to be elaborated, could contribute to make the
tax system more growth-friendly and tax revenues less volatile. The labour
market reforms and social partners' agreements have increased flexibility and
tempered the fall in employment. Measures in product and services markets are
important to enhance competition, thereby bringing down profit margins and
strengthening productivity, but they are still in the implementation phase in
some cases while the reform on professional services has been delayed. The
success of measures adopted to balance the electricity tariff system will be
fully tested in 2014, the first full year of implementation, while competition
in the retail and transport sector could be increased further. Going forward,
the delivery on the ground of the reform strategy will be essential to the
prospects of a sustained recovery. Such delivery depends often on joint
implementation efforts by various tiers of government. Furthermore, as
experience with the rebalancing process and reforms accumulates and is
analysed, there could be scope for complementary policy measures to smoothen
the adjustment and stimulate growth.  
·       Easing the reallocation of capital and labour would underpin both
potential growth and the external adjustment.
Effective competition in product and services markets and in network
industries, as well as an enhanced business environment, would contribute to
growth and to export potential and could also help to reduce the relatively
high import content of final demand. Dealing with legacy debt and the
restructuring of viable companies, allowing them to increase investment, would
be facilitated by effective corporate insolvency and pre-insolvency frameworks.
Incentives to consolidating the financial position of firms, and thus their
resilience to shocks could come from removing the debt bias in corporate
taxation. A review of the personal insolvency framework could provide a
modernised legal framework for lending to individuals and reduce risks of
permanent financial distress amongst households. In the face of the evidence of
higher competitiveness and stronger export capabilities in larger companies,
reviewing administrative and tax provisions that discourage small companies
from growing could usefully be explored. Tax and other policy measures that
would act to lower the high oil intensity and dependency of the economy would
also contribute positively to the external equilibrium. 
·       Ideally, access to finance for valuable projects and a reduction in
aggregate debt levels should go hand in hand. This
would happen if valuable companies and creditworthy individuals have access to
external funding, while overextended borrowers continue to work out their
overhang. While this healthy discrimination in lending appears to be occurring
to an extent, credit conditions for smaller borrowers have been easing only
slowly and remain relatively onerous. The coming into full operation of the
measures to strengthen access to non-bank financing will probably help, but
asymmetric information between banks and SMEs could remain an obstacle to
overcome in the light of widespread bank restructuring. Furthermore, there
could be merits in close monitoring and further reinforcing banks' capital
positions (as the Bank of Spain has been recommending in its supervisory role),
in view of the ongoing rise in NPLs, still adjusting real estate and
construction sectors and the bank balance sheet comprehensive assessment in
2014. 
·       Reabsorbing the very large unemployment over time rests on markets
for labour, product and capital and a business environment that support the
reallocation of resources towards the most productive sectors of the economy. The strong correlation between work status and measures of material
deprivation suggests that reducing unemployment is critical to addressing
social difficulties in the medium term. While a recovery in demand will help
reabsorbing the cyclical part of unemployment, the behaviour of the labour
market before and during the crisis points to deep structural shortcomings,
which the recent reforms have started to tackle. Moreover, the adjustment that
the Spanish economy is undergoing emphasises skills and geographical mismatches
between labour demand and supply. Recent labour market reforms have increased
internal flexibility and enhanced the responsiveness of wages to prevailing
market conditions, while several new measures aim specifically at facilitating
the entry of young and unqualified workers in the labour market. Mismatches
could be alleviated by an intensification of Active Labour Market Policies
(ALMP), the strengthening of public employment services and the extension of
vocational training. The dual VET system aims at a greater employability of
future generations; enhanced coordination between education and labour market
policies could help to rationalise the offer of formal education vocational
training and work-based training. Close cooperation between central and
regional authorities would help to make best use of scarce financial resources
and avoid fragmentation. Also relevant from an allocative efficiency point of
view is the limited mobility of resources currently employed under contracts of
indefinite duration, which could be related to the partly job-related
protection legislation rules. Containing labour costs, via wage moderation and
productivity increases, remains important to bridge the gap between labour
demand and supply. Reducing non-wage costs for companies, possibly as part of a
revenue-neutral tax shift from labour to consumption and other taxes (e.g.,
environmental or recurrent taxes on property), could provide a contribution to
employment and cost competitiveness. 
·       With continued fiscal discipline in line with EU commitments and
rules Spain can reverse the rise in general government debt during the crisis. Meeting the budgetary targets set out in the Council 2013 EDP
recommendation and moving speedily thereafter towards the medium-term objective
of a balanced budget would set public debt on a steady decline. Should growth
turn out above expectations, accelerating correspondingly the reduction in the
headline deficits would further underpin confidence and resilience to shocks.
The credibility of the consolidation strategy is reinforced when this is
underpinned by structural measures, of which significant ones have already been
taken recently, such as in the area of pensions, public administration reform,
des-indexation of public sector contracts. The forthcoming tax reform could
contribute to solid public finances by reducing the volatility of revenue and
by taking into account the need for alignment between revenues and expenditure
in the medium-term.  
On 13 November 2013, 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. The AMR serves as an initial screening
device helping 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 in the sense of the legislation and what type of
follow-up in terms it will recommend to the Council.
This is the third IDR for Spain. On the
basis of the previous IDR, published on April 10 2013, the Commission concluded
that Spain was experiencing excessive macroeconomic imbalances, in particular
as very high domestic and external debt levels continued posing risks for
growth and financial stability. Overall, the Commission finds it useful, also
taking into account the identification of excessive imbalances in April, to
examine further the persistence of macroeconomic risks or their unwinding. To
this end this IDR provides an economic analysis of the Spanish economy in line
with the scope of the surveillance under the Macroeconomic Imbalance Procedure
(MIP).
Against this background, Section 2 provides
an overview of the general macroeconomic developments.  Section 3 looks more in
detail into the main imbalances and risks, focussing in particular on (3.1)
competiveness and the sustainability of the external position; (3.2)
indebtedness and deleveraging and, (3.3) the performance of the labour market.
Section 4 discusses policy challenges.
Return to positive output growth and
stabilising financial markets amidst further adjustment of imbalances 
The correction of imbalances is
advancing, with some variables adjusting at a higher speed than others. The recapitalisation and restructuring of weaker banks has
contributed to restoring financial stability and confidence and set the ground
for a relaxation of financial market stress. On the external side, the current
account has turned into a surplus, with exports fuelled by a growing
internationalisation of companies and improving cost competiveness. It will
nevertheless take a long series of current account surpluses to narrow the
large net negative external investment position and reduce substantially
external debt. Private sector deleveraging has continued, with corporations
reducing debt levels more rapidly than households, but also in this case the
current trends in flows will need to be sustained over time to reduce the still
elevated debt stocks. Meanwhile, reversing the fall back from the crisis on the
labour market and on public finances have become major economic challenges.
General government debt has reached high levels and is still increasing. In the
labour market, the fall in employment appears to be finally bottoming-out but
reabsorbing the large number of unemployed, many of them long-term and
low-skilled, will be a major undertaking. 
The third quarter of 2013 marked the end
of the longest recession in decades. After a first
dip between Q3-2008 and Q4-2009, the Spanish economy recorded anaemic growth in
2010, entering again in recession in the second quarter of 2011 with soaring
unemployment. Following the GDP stabilisation in Q3, growth picked up in
Q4-2013 on the back of a less negative contribution from internal demand,
confirmed by a generalised improvement of economic sentiment indicators.
Private consumption and investment are set to accelerate further in 2014
contributing positively to growth, while the contribution from the external
trade position is expected to decline (Graph 2.1). Key macroeconomic indicators covering
2007 to the current forecast horizon (i.e. 2015) are summarised in table 2.1.
Financial markets have stabilised. A marked return of market confidence on Spain was manifest in the
narrowing of sovereign debt yields spreads vis-à-vis the core euro area Member
States, surging stock market prices and the resumption of foreign financing.
Domestic deposits also increased, allowing Spanish banks to reduce their
reliance on the Eurosystem. The financial sector recapitalisation programme
ended successfully in January 2014, leaving banks much stronger than one and
half year earlier. Yet, the restructuring and downsizing of the financial
sector is set to continue. 
Financing conditions for the
non-financial private sector have been gradually easing, most notably for large
borrowers. The reinforcement of banks' balance
sheets and recovering confidence on Spain in financial markets have led to
greater availability and  a lower cost of financing for larger companies. At
the same time, in spite of recent signs of easing and differentiation across
companies, lending standards and terms for SMEs remain on average relative
onerous, pointing to market fragmentation and the impact of the weakening or
cutting of historical links between banks and customers. The financial sector
is discussed in greater detail in section 3.2.
House prices have adjusted sharply and appear
to be approaching stabilisation. The cumulative
fall between Q3-2007 and Q3-2013 was 36.2% in nominal terms and 43.8% in real
terms. Even though prices were still falling at a 7.9% year-on-year rate in
Q3-2013, they increased by 0.7% compared to the previous quarter, the first
positive quarterly growth rate since Q2-2010. The market is also characterised
by much differentiation across locations. However, given the large stock of
unsold houses, it cannot be excluded that the adjustment may have somewhat
further to run, and price developments going forward might also be influenced
by the sale strategies  of Sareb (the asset management company) and commercial
banks. The housing market and the construction sector are discussed in detail
in section 3.2.
Deleveraging pressures remain a drag on
growth. The strong contraction of credit has been
the main driver behind the reduction in private sector indebtedness, but the
contraction of GDP has impeded a more rapid stabilisation of indebtedness
ratios (Graph 2.2). The gradually improving economic
outlook can be compatible with a continuation of deleveraging. Both households
and non-financial corporations are expected to maintain positive net lending
positions even as consumption and investment, as well as demand for credit,
pick up.
Whereas the private sector is on a path
of deleveraging, general government debt is still expanding. Rising social expenditure, the disappearing of a rich tax base
linked to construction and stabilisation interventions in the financial sector
have put general government debt on an increasing trend: from 2007 to 2012 it
increased by almost 60 pps.  and it is set to approach 100% of GDP in 2014.
Deleveraging pressures in the private and in the public sector are discussed in
section 3.2.
Strengthening current account and
competitiveness, but not reflected yet in the net international investment
position 
The current account has turned into
surplus (1.1% of GDP in 2013), after almost two decades of negative balances. The improvement was driven by the trade balance, with exports
accelerating considerably in 2012 and 2013, while import volumes continued to
contract. The current account balance appears set to increase further in the
coming years, according to the 2014 Winter Forecast. 
The process of internal devaluation
advances, resulting in low inflation and a recovery in price and cost
competitiveness. During the boom period Spain
registered a protracted positive inflation differential with the euro area and
the EU that entailed a strong deterioration in cost and price competitiveness.
With the fall in domestic demand and surging unemployment during the crisis,
inflationary pressures eased, first narrowing and then reversing the
differential with the euro area and the EU. Headline and core inflation have
fallen to around zero in late 2013 and are expected to remain very contained
during 2014. The real effective exchange rates (REERs) and nominal unit labour
costs (ULCs) have fallen by 12.0% and 6.8% respectively since 2009 (Graph 2.3).([1]) Productivity gains (largely associated with labour shedding)
together with moderate wage developments in later years explained the recovery
in competitiveness. The successful implementation of ongoing structural reforms
in product and services markets would support competitiveness. In particular,
measures aimed at overcoming regulatory fragmentation in the internal Spanish
market and at instilling better regulation principles across all general
government levels should enhance competition and reduce economic rents in
sheltered sectors. 
Several indicators suggest a structural
improvement of Spain's export capacity. The
analysis of cyclically adjusted current account suggests that the non-cyclical
balance could be somewhat lower than the headline figure. Exports have
increased both at the extensive and the intensive margins. Considering the
fixed costs associated with penetration in foreign markets, it is unlikely that
these gains will be reversed in the future. A part of the real import decline
is also likely to be permanent, as domestic demand and growth expectations are
not expected to return to pre-crisis levels.  
In spite of the current account surplus,
the NIIP has continued to deteriorate as a ratio of GDP, on account of
contracting GDP and negative valuation effects. The
latter reflect positively increased confidence in the perspectives of the
Spanish economy. Yet, a high external debt (especially in the form of loans)
exposes the economy to vulnerabilities – as it became evident in the wake of
the crisis. The external performance is discussed in detail in section 3.1.
Ongoing reallocation of resources  
The adjustment process has produced a
sharp alteration of the composition of employment and value added. The contraction of value added and employment relative to the
pre-crisis level has concerned all branches of the economy. In relative terms,
the share of tradable sectors in value added has interrupted its long declining
trend and the same applies when looking at the share of tradable sectors in the
compensation for employees (see Graph 2.4). The change in the relative composition
was mainly driven by the collapse of the construction sector and real estate
development and to a lesser extent by the downsizing of the financial sector
(this mainly in value added terms). 
Export-oriented firms have fared better. Micro-level data shows that exporting firms recorded better
performance index of industrial production and higher profitability rates
(based on firms' balance sheet data). Furthermore despite low rates of
aggregate capital utilisation, investments in equipment have registered a
significant increase in the last months of 2013, whereas sub-branches of the
tradable sectors reported positive expectations about employment creation. The
combination of this evidence suggests that a process of re-allocation of
capital and labour is on-going despite the fact that it not yet visible at a
high aggregate level (i.e. tradable versus non-tradable). This conclusion is
also supported by a recent analysis of the Ministry of Economy. Since the onset
of the crisis, as graph 2.5 depicts, exporting industries (e.g.
automotive, transport equipment, chemicals and pharmaceuticals, machinery and
equipment) have suffered much less than the average. A similar pattern is found
with respect to credit: i.e. a much lower aggregate reduction in exporting
industries. 
Record high unemployment and worsening social
indicators
The macroeconomic adjustment process in
the context of a dual and rigid labour market resulted in unprecedented
employment destruction, which is only starting to stabilise. The external rebalancing and the deleveraging pressures necessarily
required an adjustment also in the labour market. However, in a dual and overly
rigid labour market, the fall in aggregate demand produced an exceptionally
high employment destruction (more than 4 million jobs were lost since the
beginning of the crisis). The unemployment rate stood at 26.4% in 2013, below
the record high of 27.2% in Q1 of 2013. The reduction was however mainly due to
falling activity rates. Reductions in the labour force have mainly been driven
by net migration outflows. The participation of the younger population also
decreased, while the ratio of individuals not in education, employment, or
training to total population in young cohorts (the NEET rate) has been increasing
sharply. 
There is an increasing risk that long
term unemployment will cause hysteresis effects.
Spain has historically witnessed sudden and extensive surges in unemployment in
economic downturns. A sticky wage adjustment process and the significant share
of fixed-term contracts contributed to a high elasticity of employment to GDP.
While employment perspectives should improve as economic activity picks up, the
structural transformations the Spanish economy is undergoing (and in particular
the downsizing of the construction sector) accentuate the mismatch between
labour demand and supply, and the large share of long-term unemployment (52.2%
of total unemployment in Q4-2013) risks generating significant hysteresis
effects with a negative impact on the structural rate of unemployment.
Notwithstanding the positive impact of recent labour market reforms on internal
flexibility and wage setting, future employment outcomes will also depend on
improved matching in the labour market (to which ALMP and training and education
can contribute) and on the success of reforms in product markets and business
environment (see section 3.3). 
Social indicators have worsened
substantially with the crisis and higher unemployment. With social indicators typically strongly correlated with the
performance of the labour market, the surge in unemployment in Spain has had a
direct impact on poverty (see Graph 2.6). Between 2007 and 2012, the population
at-risk-of-poverty (AROP) ([2]) increased
from 19.7% to 22.2%, whereas the percentage of the population of people
at-risk-of-poverty or social exclusion (AROPE) increased from 23.3% to 28.2%.([3]) The difference between the two measures is mainly driven by the
increase in the number of households with very low working intensity (from 6.8%
to 14.3%).([4]) Poverty has
a strong gender profile, with poverty rates for single women well above the
average. Families with two or more children are also particularly exposed to
poverty risk, with the AROPE for household with three children or more being
above 45%. Child AROPE rates, already high by comparative perspective,
increased further to 33.8% - i.e. almost 10 pp. higher the euro area average.([5]) High poverty rates in households with children are consistent with
a high average early school leaving rates, which at 24.9% in 2012 is amongst
the highest in the EU. The rate has decreased in recent years, possibly also on
account of lower employment opportunities for low-skilled workers. 
Poverty has increased also amongst the
employed, whereas the elderly have on average been relatively sheltered during
the crisis. In terms of labour market status,
recent years marked a strong increase of poverty amongst the adult unemployed
population (from 49.5% to 62.3% between 2007 and 2012) and an increase in
poverty rates amongst the employed population. The latter finding can be
explained both in terms of falling earnings and of spill-over of labour market
status of other members of the household. Retirees, on the other hand, appear
to have been on average relatively sheltered over the crisis: the poverty rate
for those aged 65 and more dropped from 27.9% to 16.6% between 2007 and 2012.([6]) 
Higher social expenditure and
intra-household solidarity have cushioned to some extent the rise in poverty
levels. Expenditure on social protection in Spain
increased from 20.8% of GDP in 2007 to 26.1% of GDP in 2011.([7]) However, a significant share of the
increase is due to expenditure on pensions which rose from 9.2% of GDP to 11.4%
of GDP. Moreover, over the same period the number of beneficiaries (all
typologies) increased from 1,246,300 to 2,698,500, and the number of
beneficiaries of social assistance from 400,500 to 1,184,100. 
With falling disposable incomes, housing
costs (including the repayment of mortgages) have become a heavier financial
burden. The percentage of mortgage holders
declaring to bear a heavy financial burden for the repayment of debts increased
from 53.7% to 64.2% between 2007 and 2012.([8]) The situation of the labour market clearly drags on the process of
deleveraging and weigh on prospects for banks' profitability. Whereas the NPL
rate on mortgages has so far been contained, it remains on an upward trend. The
increasing length of unemployment spell risks reducing the capacity of affected
households to face their financial commitments.
3.1.      CompetiTIveness
and sustainability of the external position
3.1.1.   Overview 
The bust of the housing bubble and the
financial crisis has prompted a sharp current account adjustment. From a deficit of 10% of GDP in 2007, the current account
registered a surplus of 1.1% of GDP in 2013 (Graph 3.1), which is forecast to widen to 1.8% of
GDP by 2015. Indicators of competitiveness have also improved, reversing a good
part of the losses accumulated in the boom period. ULC have been falling since
2010, on the back of labour shedding induced productivity growth, and – more
recently – subdued wage dynamics. 
The export performance has been very
robust, contributing to the re-balancing of the economy. Exports of goods and services increased from, respectively, 17.6%
and 8.8% of GDP in 2008, to 23.5% and 10.6% of GDP in 2013 (Graph 3.2). Export of goods as a share of GDP is
still well below the share of Germany (42.7% in 2013), but compares well with
two other large euro area economies (21.4% of GDP and 25% of GDP in France and
Italy respectively). Moreover, the share of services in Spanish exports is well
above other large euro area economies (Germany, France and Italy are at 7.7% of
GDP, 6.1% of GDP and 5.4% of GDP respectively) and comes close to the
performance of the UK (12.3% of GDP). 
The evolution of Spanish exports' market
shares also compares well with other large euro-area economies (despite decreasing in relative terms due to globally increasing
trade flows – see Graph 3.3). From 2008 to 2013 the export market
share for goods decreased only marginally, from 1.8% to 1.7% (the corresponding
values for other large euro area economies are: Germany: 9.0 to 7.8; France:
3.8 to 3.2; Italy: 3.4 to 2.8). Advanced countries’ nominal shares tend to
evolve relatively better than real shares. As competition in more standard
products intensifies, these countries usually export more sophisticated and
high-quality products characterised by higher unit-values. That was the case
before 2007, also in Spain, where export shares fell more in real than in
nominal terms due to high export prices. However, since 2007 real shares have
performed better than nominal shares owing to price and wage moderation in
advanced countries. The recent development of export market shares in
Spain, particularly in real terms, points to structural competitiveness gains.
The evolution of the real share in comparison with the nominal indicates the
exporters’ moderation of prices paves the way for a positive behaviour of
exports in the medium term. 
In spite of a sharp contraction in real
imports, imports values proved quite resilient.
Following the trade collapse of 2009, import of goods attained 24.7% of GDP in
2013 – i.e. not far from pre-crisis levels, whereas the import of services
attained a ratio of 6.9% of GDP in 2013 – i.e. above pre-crisis levels. As
discussed below this is largely due to the behaviour of import prices – in
particular energy (for more details see discussion in section 3.1.3 and Graph 3.11).
The turnaround in the current account is
the counterpart of deleveraging in the private sector (see Section 3.2). Non-financial corporations and households
have moved into very large net lending positions, more than compensating the
large net borrowing position of the government (Graph 3.4).   Going ahead, further reductions in
the budget deficit would support a larger surplus in the current account even
in the event of a stabilisation of private sector net lending. 
In spite of the current account surplus,
the Net International Investment Position (NIIP) deteriorated in 2013 on
account of negative valuation effects. In Q3-2013
the NIIP stands at –97.8 % of estimated GDP, i.e. more than 15 pps higher than
before the crisis and more than 60 pps higher than the value in the early 2000s
(Graph 3.5). 
This section will continue with a
discussion of the drivers of exports and imports, the level and the structure
of the NIIP and trade and financial links with the rest of the euro area,
before providing some conclusions. 
3.1.2.   Drivers
of export performance
Spanish exports have been resilient in a
medium-term perspective. Remarkably, this was the
case also during the sizeable pre-crisis deterioration competitiveness
indicators (Graph 3.6). This well-known phenomenon has been
referred to as the ‘Spanish paradox’. ([9])  Econometric evidence confirms the long-term positive relationship
between relative-price-based competitiveness indicators and exports, but also
suggests that other factors (non-cost determinants) may more than compensate
the dynamics of relative costs and prices. ([10]) In empirical studies,  the real exchange rate typically explains
well below 10% of the change in (country-specific) exports; world (trade)
developments explain about 80%, while the residual 15% is linked to a path
dependency that implicitly captures other unspecified factors. Moreover, Spain
stands out in these analyses in that the explicative power of cost
competitiveness and path dependency are below the average of other countries.([11]) The higher explanatory power of foreign demand  suggests that
other factors have allowed Spain to benefit relatively more from the increase
in global trade flows and thus offset the negative dynamic of aggregate losses
in cost competitiveness. 
The export mix (in terms of products and
geographical markets) and the relative efficiency of exporting firms can help
explain the export performance of Spain. Firstly,
the concentration of exports in growing regions and/or growing markets
contributes to determining the export performance of a country. Other factors
include the extent of competition of other countries as well as the role of
exporting industry in other sectors (i.e. high or low dependence). Secondly,
the analysis of the behaviour of firms is key to understand the aggregate
export performance of a country. ([12]) This analysis typically relies on micro-data at firm-level in
order to capture the heterogeneity that exists both across sectors and across
different enterprises of different size.  
Spain has been successful in stepping up
its export product and geographical specialisation.
The change in goods export market shares can be decomposed through a
shift-share analysis in four components, namely: (i) initial product
specialisation; (ii) initial geographical specialisation; (iii) market share
gains in product markets and (iv) market share gains in geographical
destinations. Although the negative contribution of initial geographical specialisation
(mostly the EU) was more sizable in the case of Spain than Germany (Graph 3.7), in recent years Spain has registered
larger positive contribution from penetration in new geographical markets –
mainly the Emerging And Growth Leading Economies (EAGLEs). The decomposition
also shows a relatively favourable contribution (relative to Germany) of the
initial product specialisation and market share gains signalling that, despite
the lower technological content of its export, Spain was able to withstand
relatively well increasing competition from developing economies. 
A more granular analysis points to
specific strengths of Spain's goods export mix.
Spain fares well in terms of levels of global complexity and connectivity. ([13]) The average complexity of Spanish exports is more than double that
of global exports, whereas its average industry connectivity is above the
global average. Amongst the best performing industries are sectors with a high
weight in Spanish exports such as machinery (33%), other chemical products
(11%) and other metallic products (8.9%). 
The performance of export of services
has also been positive – both in quantitative and qualitative terms. Spain's share in world's service exports is significantly greater
than its share in goods' export (3.3% versus 1.6% in 2012), mainly on account
of its large tourism sector. While the share of Spain in world tourism has been
decreasing in the last decade([14]), Spain has
been able to expand its share in other services – mainly services to
enterprises – characterised by higher value added and possibly higher future
growth potential (see Graph 3.8). The share of turnover in foreign
markets increased in most sub-sectors related to services to enterprises,
especially in software publishing, computer programming, consultancy and
related activities, engineering activities and related technical consultancy.
Significant penetration in foreign markets also occurred in accounting,
bookkeeping and auditing activities and tax consultancy as well as in management
consultancy activities. Whereas the increase in the export markets for goods
mainly occurred in the EAGLEs, the expansion of export of services was
concentrated in North America and in the UK.([15])
At micro level, Spanish exporting firms
are more efficient than non-exporting firms, and compare well to euro area
competitors. The data point to higher productivity
levels amongst Spanish exporting firms (typically bigger than
non-exporting firms) ([16]) and to
broadly comparable export propensity at the extensive margins to peers in other
euro area countries. ([17]) This is
consistent with the economic literature that has highlighted the importance for
international competitiveness of firm-level factors (capacity to specialise and
exploit new and dynamic markets) besides structural conditions prevailing in
the individual countries including labour- and product-market functioning, the
degree of technological diffusion, innovation, taxation and financing
constraints.([18]) 
The relative strength of exporting firms
appears to have offset part of the deterioration in aggregate competitiveness
measures.  Productivity performance at the firm
level is the result of improvements in product quality and processes, but also
relative strengths in relation to the management of the firm, distribution
channels and after-sales services. ([19]) Antrás et al. (2010) find that when firm-level ULC developments
are considered (instead of aggregated ULCs), Spain’s export performance is less
paradoxical. Productivity growth in the largest firms has outperformed that of
smaller firms over the past decade and, in turn, the exports of those firms
increased faster than those of other smaller firms.  It thus appears that
the behaviour of Spanish companies has in some instances allowed them to overcome
structural weaknesses vis-à-vis their peers in other countries: the proportion
of high-skilled employees is lower in Spanish firms, although the presence of
managers with international experience and of employees participating in
training courses is high; the proportion of Spanish firms that invest in
R&D is lower, but Spanish score better in the generation of process
innovations; the participation of Spanish firms in global value chains is lower
and predominantly passive (by contrast, a higher percentage of Spanish firms
import standardised inputs, in line with the Spanish economy’s high import
dependence).([20]) 
The export base is widening. The overall success of Spanish firm internationalisation strategy
can be measured against the increase in export at the intensive and extensive
margin. According to data released by ICEX (Spanish Institute of Foreign
Trade), the number of Spanish exporting firms has grown significantly in recent
years, at an annual average of 6.0% from 2008 to 2011. According to provisional
data for 2013, the number of exporting firms further increased by 11.7% - a
year-on-year rate similar to the record increase of 12.6% registered in
2011. ([21]) 
The size distribution of Spanish
companies, skewed heavily towards micro companies, drags on the aggregate
export capacity of the economy. Most of the
variables positively contributing to export propensity and/or intensity are
more frequently observed (or have higher average values) in larger firms. As
pointed out in several early studies – there is a strong positive correlation
between company size, productivity and export potential. ([22]) Interestingly, even when taking into account the contribution of
the other variables discussed above, company size remains the single most
significant factor explaining the export performance. ([23]) This contributes to the high degree of concentration of exports.
Despite the recent increase in the extensive margin, moreover, the increase at
the intensive margin has been largest amongst largest companies. This has
resulted in a further increase in the degree of concentration of
exports. ([24])
Structural factors, and in particular
low allocative efficiency, appear to constrain firms' growth and hamper the
export potential. The above evidence suggests that
low aggregate productivity was less rooted in micro-level determinants, but
rather in structural features that prevent an efficient allocation of resources
and more productive firms to grow faster. This view is supported by a recent
study by the Bank of Spain which shows that (i) the loss of competitiveness
during the boom did not occur among the largest firms with the greatest
presence in international trade and (ii) the aggregate slow-down in productivity
is the result of a lack of flexibility, which prevented resources from being
efficiently reallocated between sectors and firms.([25]) Commission services estimates further confirm this result.
Allocative Efficiency (AE) for the manufacturing sector is defined in Graph 3.9  as the percentage increase in
manufacturing productivity in Spain and in Germany connected with the actual
allocation of employment across firm size classes, relative to a baseline
scenario in which employment is allocated randomly (according to a uniform
probability distribution) across the different firm size categories. The
slightly positive value means that resources are allocated in a more efficient
way relative to the baseline. The maximum attainable level assumes that the
size class with the highest labour productivity has a 100% market share, while
maintaining the observed labour productivity level per size class and
unweighted average labour productivity level for the calculation of the index.
Lower figures for allocative efficiency point to forces in the economy
preventing competition to work properly, such as excessive regulation,
rent-seeking and ineffective procurement. The gap with respect to the optimal
allocation is much larger for Spain than for Germany. ([26]) 
3.1.3.   Drivers
of imports 
A significant part of the fall in
imports is likely non-cyclical. In constant prices,
total imports fell by almost 17% between 2008 and 2013. Regressing imports on
final demand components confirms that this fall was mainly driven by contacting
private consumption and investment in equipment and in construction, whereas
the pick-up of exports contributed positively to imports.([27]) As part of the fall in demand is itself structural, the
corresponding fall in imports can be considered as permanent. In particular,
the downsizing of construction (explaining around 30% of the fall in imports)
can be assumed to be lasting and revised expectations and higher risk premia
are likely to have lowered the expected trajectory of private investment and
consumption. 
At the same time, the cyclical component
of the current account remains important. According
to Commission services estimates, the cyclically corrected current account
features only a marginal surplus in 2013 (Graph 3.10). Moreover, these estimates are subject
to the uncertainty related to the estimation of potential output and might
underestimate the potential for a rebound in in imports when demand picks up
and/or potential output growth reverts to normal values. ([28]) 
The relative high use of foreign inputs
by Spain's industries limits the capacity to compress imports. Preliminary evidence suggests that despite an initial reduction in
the import content of exports, as trade volumes resumed, the import content of
exports returned to its historical high levels. The latter was estimated by
Commission Services at almost 30% in the years before the crisis.([29]) Importing intermediate goods raises the probability of exporting,
probably because of the accessibility to a greater variety of inputs at a lower
cost, and it could thus signal the efficiency of exporting sector in leveraging
the benefits of international specialisation. ([30]) The Spanish economy is also more specialised than other euro area
economies in sectors featuring relatively higher import content. Moreover, for
several industries (and especially for the large automotive industry), import
dependence may be explained by the relative weight in production of
subsidiaries of foreign firms. Indeed, there appears to be a positive
relationship between FDI and import intensity and Spain shows by far the
highest ratio of stock of FDI to GDP amongst large euro area economies (almost
48% in 2012). However, FDI have not all gone into productive activities – much
of it went into real estate - and the generalised high import content in
all branches of the economy might also be linked to inefficiencies in the
domestic markets. ([31]) ([32])
Import values, moreover, resumed
relatively quickly, on the back of increasing oil prices and the high
structural dependence of the Spanish economy on fuel products. The import of goods in terms of GDP could have been almost 1 pp
lower between 2008 and 2012, had the index price of fuels and lubricants
remained at the value of 2008.([33])  The high dependency of Spain on energy products represents a
weakness for its external position (Graph 3.11). 
The process of internal devaluation
could foster import substitution. In particular, if
restored competitiveness translates into lower prices on domestic markets,
import substitution could occur – at least for import goods that are subject to
greater price elasticity. The impact is therefore likely to occur more with
respect to consumer goods, which however have limited weight in total imports
(Graph 3.12).([34])
3.1.4.   Income
balance and capital transfers.
High net external debt implies a
significant negative income balance. The evolution
of the income balance is closely linked to the composition of the debt – both
in terms of instrument and in terms of borrower. Net financial flows will
remain sensitive to variations in risk premia on Spanish assets. In recent
times, official flows not only cushioned the withdrawal of private capital, but
also allowed to contain interest payments, despite mounting debt (Graph 3.13). In 2013, the flow of income to
remunerate foreign capital was in the order of 1.1% of GDP and it is set to
increase to 1.8% of GDP in 2015.
The balance of current transfers and of
capital account should nearly offset in the coming years. The balance of current transfers (or secondary incomes) is mainly
made of transfers between public administrations and remittances. Transfers to
the EU budget should remain broadly in line with the evolution of GDP.
Remittances from foreign workers working in Spain have fallen significantly as
many immigrants have returned to their countries of origin in the wake of the
crisis, and there has been an increase in remittances from abroad. The
contribution of current transfers from the EU budget is likely to reduce
slightly. All in all, the balance of transfers will likely maintain over the
medium term a negative, but decreasing contribution to the net financing
position. As per the balance of capital transfers, it has traditionally been
positive (about ½ pp. of GDP between 2008 and 2013) on account of capital
transfers from the EU. However, these transfers are also likely to decline in
absolute and relative terms in the years to come.
3.1.5.   Medium-term
evolution of net international investment position
The re-absorption of the NIIP will
require a prolonged period of significant current account surpluses. A prolonged period of large trade deficits and negative income
transfers contributed to the sizable deterioration of the NIIP (Graph 3.14). Going ahead sizable trade balances
surpluses will be needed to offset the negative contribution of the balance of
primary income. Even if the current account were to reach a record level of
3.4% of GDP, it would take about 10 years for the NIIP to reach -35% of GDP.
This would imply a surplus in the trade balance and balance of current
transfers of about 6.5% of GDP. A more realistic scenario would be to attain by
the end of 2023 a NIIP of -50% of GDP. This would require still sizable average
current account balance and a balance of trade and current transfers of 1.7% of
GDP and 5.1% of GDP respectively –i.e. a figure in line with current forecast
for 2014 and 2015. Note however that such projections are extremely sensitive
to the underlying hypotheses.([35]) The
projections moreover neglect the impact of valuation effects.
The weight of loans and bonds increases
vulnerability to external shocks. With regard to
the structure of its NIIP, Spain has a large net external debt (-88.1% of GDP,
mostly due to liabilities related to bonds and loans), while its equity
position improved sharply in the last few years and turned positive in 2010.([36]) Measures to reduce the corporate debt bias, i.e. favouring a shift
in companies financing towards equity, would at the same time strengthen the
competitive positions of Spanish enterprises, and impact favourably on the
composition of NIIP. 
3.1.6.   Euro
area dimension
Spain is tightly interconnected with the
euro area through trade and financial linkages. Spain's
GDP is about 10.6% of overall euro area output and the Spanish market is the
destination of a significant share of other euro area's exports. At the same
time, in spite of an increased geographical diversification of exports in
recent years, Spain is directing about 50% of its exports in goods and more
than 40% of its services to other euro area Member States. The main euro area
destinations are the large euro area economies. France, Germany and Italy
account respectively for 17.2, 10.3 and 8.2% of total export of goods in 2011.
Portugal also accounted for 8.2% of the total exports of goods in 2011. Germany
is the largest euro area exporter to Spain: 11.8% of Spanish imports come from
Germany. Germany is closely followed by France (10.8%), while a significant
share is also represented by imports from Italy (6.6%) and the Netherlands
(4.1%). Outside the euro area, about 7% of Spanish imports come from China, and
around 4% from the US and from the UK. From the perspective of the exporting
countries, Portugal features the highest link, with exports to the Spanish
market constituting more than a fifth of total exports (graph 3.15). Exports from France and Italy to
Spain make up around 7% and 6% respectively of these countries' total exports. 

The extensive trade linkages within the
euro area are also a reflection of Spain's participation in international value
chains. A significant share of the imports and
export linkages between Spain on one side and France and Germany on the other
side are related to the high degree of integration in specific industries,
particularly the automotive sector. Due to these interdependences, fluctuations
in domestic demand or other types of shocks, that originate in one of them is
likely to be transmitted to the other. Portuguese exports to Spain, on the
other hand, are diversified as no industry captures more than 10% of total
exports.([37]) 
Whereas concerns about Spain's financial
and macroeconomic stability and the on-going adjustment process have had
contractionary effects on other parts of the euro area, the direct role of
trade linkages is likely not to have been major. To
assess the extent to which economy activity in one country spillover across
border, inter-sectoral and inter-regional links need to be taken into account.
The spillover effects from low growth in Spain can be quantified by simulating
a 1% reduction in domestic final demand in Spain.([38]) The results show that the spillover effects generated by the
domestic final demand changes tend to be small in a static perspective. Portugal
is impacted the most, followed by France and Italy. The impact on Portuguese
exports, a decrease by 0.16 percent, is almost 3 times larger than the impact
on French exports. French and Italian exports decrease by some 0.06% and 0.05%
respectively. This impact is in contrast with the sharp contraction in trade
witnessed in the years following the crisis. It is indeed likely that
simultaneous contractionary effects lead to more than addictive results. In
this respect, the simultaneous adjustment of several euro area peripheral
countries might have a stronger impact than what suggested in a single country
simulation. In the case of Portugal, moreover, even the static simulation
suggest a sizable negative impact, considering that the magnitude of the contraction
of final demand in real value between 2007 and 2013 was in the order of 10 pp. 
Spain would be to a limited extent be
affected by an appreciation of the euro. The
discussion in section 3.1 has highlighted the resilience of the Spanish export
sector, which suggests that moderate exchange rate variations should not alter
fundamentally exports prospects. Moreover the growing contribution of non-tourism
service exports should also reduce the risk of negative spillovers from an
appreciation of the euro, considering that services tend to be less price
elastic.
The external private sector has
significantly reduced its exposure towards the Spanish financial sector. Graphs 3.16 and 3.17 highlight the substantial reduction of
the exposure of foreign banks towards the Spanish private sector and especially
the banking system. The reduction has been particularly significant for German
banks, which had significantly increased their exposure in the boom years. The
exposure of the French banking system was also sizable. Recent data show a
comparable exposure of Germany and France of about EUR 90 and EUR 80 billion
respectively. The exposure of the UK is in the order of EUR 60 billion, whereas
the exposure of the Dutch and US banks is below EUR 40 billion. 
This reduced private sector exposure has
been offset to a large extent by the official sector. Private capital outflows were compensated by an increased recourse
to Eurosystem financing by Spanish banks, and Spain also drew EUR 42 billion
from the financial sector assistance programme. With the stabilisation of
financial markets, Spanish banks have been able to reduce their Eurosystem
borrowing. The net claims of the Banco de España vis-à-vis the Eurosystem
decreased from a peak of EUR 406.3 bn in Q2-2012 to EUR 263.7 bn in Q3-2013,
while recovering confidence on Spanish assets led to an increase in the share
of public debt owned by foreigners. Consequently in Q3-2013, the external
liabilities of the Bank of Spain and of the General Government amounted to
26.3% of GDP and 37.0% of GDP respectively. The net liabilities were somewhat
less, given the reserves of the Bank of Spain and other assets held by the
Government, yet the joint net liabilities represent more than half of the
Spanish NIIP. 
Spain exposure to the euro area is
relatively limited, but risks could come from its exposure to foreign markets. According to BIS data, Spanish exposure to foreign banks is
estimated at EUR 1,118 bn in September 2013 (i.e almost 110% of GDP). Almost
EUR 500 bn correspond to exposures with EU Member States, of which however
exposure to euro area is less than EUR 200 bn. The highest exposure within the
euro area is with Portugal (about EUR 50 bn), followed by Germany and France
(EUR 44 bn and EUR 31 bn respectively). Outside of the euro area, exposure with
the UK is almost EUR 300 bn. At present, the risk of negative spillover could
rather come from Spain's significant exposure with Latin America (more than EUR
350 bn, concentrated in Mexico and Brazil).   
3.1.7.   Conclusions 
A significant part of the current
account adjustment is likely to be of permanent nature. This permanent component is however the result of both 'good news',
i.e. the very positive export performance, and 'bad news', i.e. the likely longer-lasting
reduction in domestic demand and potential output. More granular analyses
points to elements of intrinsic strength at firm level that have supported the
export performance, as well as to a dynamism. Moreover, there is growing internationalisation
of companies and geographical diversification has also increased. Considering
the fixed costs of entering foreign markets, these trends are unlikely to
reverse. Exports are thus set to remain a main growth driver, in particular if
supported by policy measures that prioritise higher allocative efficiency
through better functioning labour and capital markets and enhanced access to
technology while removing all hurdles to company growth. 
A significant reduction in the large
negative external liabilities will take many years.
Meanwhile, the large external financial dependence will remain a source of
vulnerability. The external adjustment will need to be supported by cost
dynamics, via higher productivity and appropriate wage dynamics. A contribution
could come from a tax shift geared to increasing employment (see Box 3.4). The process of internal devaluation
would also support increased import substitution. Some structural
weaknesses on the import side – in particular the external reliance on imported
energy products – could be mitigated by reforms and tax policies geared to
reduce energy intensity and the high oil dependence. 
The risk of direct negative spillover
from the rest of the euro area appears limited.
Spain in particular has benefited from broadening its geographical markets. The
high share of non-tourism exported services and the demonstrated performance in
non-cost competitiveness provides a protection from the risks posed by an
appreciating euro. The financial exposure of Spain is spread globally, and
overall limited towards euro area Member States, with the exception of
Portugal. With still visible financial fragmentation affecting Spanish lending
markets, financial and economic prospects in Spain remain however sensitive to
the progress in the ongoing reinforcement of euro area governance. 
3.2.      Indebtedness
and Deleveraging
3.2.1.   Overview 
Private sector deleveraging has
accelerated since the end of 2012, in particular for non–financial
corporations. Households and non-financial
corporations' debt more than doubled in terms of GDP in the decade following
the introduction of the euro, on the back of loose financing conditions and
overoptimistic income expectations. Credit flows were above 20% of GDP on average
and annual credit growth rates averaged 18% during 2000-2007. With debt of 230%
of GDP (non-consolidated data) in 2010 (215% of GDP in consolidated terms), the
Spanish private sector became amongst the most indebted across the Member
States. The deleveraging process started in 2010 and gained momentum as of the
second half of 2012. By the third quarter of 2013, the stock of debt amounted
210% of GDP in non-consolidated terms (189% of GDP in consolidated terms), some
22% of GDP lower than the peak reached in the second quarter of 2010, out of
which almost 15 pp. were registered since the second quarter of 2012. The
distribution of the correction is uneven, most of which being due to the fall
in debt of non-financial corporations by 19% of GDP since the peak
(consolidated data). 
This process has gone in parallel with
restructuring in the banking sector and a sharp correction in the real estate
market and construction. Spanish banks suffered
considerable funding and capital stress with the implosion of the real estate
bubble, which caused a sharp deterioration in their asset portfolio and
systemic concerns about the banking sector and the capacity of the sovereign to
support it, culminated in the summer of 2012. While credit demand was falling
in line with economic activity, banks also had an incentive to shed risks to
rebuild their capital ratios, in an environment of heightened risk aversion.
The recapitalisation and reform process undergone in the last couple of years
have all but eliminated such systemic concerns, and set an essential basis for
a renewed capacity of banks to provide lending to the real economy at more
favourable conditions. Meanwhile, the fall in both prices and activity
indicators in the housing market has continued apace, bringing this market
closer to an inflection point. 
In contrast to the private sector,
general government debt has continued to increase.
The expansion of aggregate social expenditure and the disappearing of a rich
tax base linked to construction coupled with stabilisation interventions in the
financial sector have led to a sharp increase in government debt, which is set
to reach nearly 100% of GDP in 2014, about 60 pps. of GDP higher than in 2007.
This section will continue with an overview
of development in the financial sector and the housing market, and then move to
analyse sectoral debt development in the household, non–financial corporations
and government sectors before providing some conclusions. 
3.2.2.   Financial
sector developments
The Spanish banking sector has been
adversely affected by the burst of the real estate and construction bubble and
the economic recession that followed. Several
Spanish banks have accumulated large stocks of problematic assets. With the
exception of a few large and internationally diversified credit institutions,
Spanish banks lost access to wholesale funding markets on affordable terms,
thus becoming highly dependent on Eurosystem refinancing. Moreover, the
borrowing capacity of Spanish banks was severely limited by the impact of rating
downgrades on collateral availability. Concerns about viability of some of
these banks became a source of market stress and eventually led to the Spanish
government requesting external financial assistance from EFSF/ESM in June 2012.
The Programme, as agreed by the Eurogroup on 9 July 2012, covered a period of
18 months([39]) and
entailed an external financing by the euro area Member States of up to
EUR 100 billion. Eventually, the total amount of funds disbursed was
limited to EUR 41.3 billion.
By the end of the financial assistance
programme, the resilience of the Spanish banking sector had improved
considerably. In particular, the solvency position
of banks has been bolstered after the recapitalisation of parts of the banking
sector, the transfer of assets to Sareb and overall positive earnings results
over 2013. On average core tier 1 capital ratio stood at 10.5% while total own
funds ratio was at 12% at the end of September 2013. Compared to their peers,
Spanish banks are not amongst the banks with the highest capital ratios, but
rank favourably in terms of overall leverage. 
The exposure of the Spanish banking
sector to the construction and real estate development sector has been
significantly reduced. According to the Banco de
España, the total exposure amounted to EUR 308 billion at the end of December
2011. By the end-2012, the exposure of Spanish banks to the construction and
real-estate development sector had decreased by around 50% of the total (net of
provisions). Somewhat more than half of the reduction is explained by the
transfers to the Sareb, while 40% of the reduction derives from the provisions
made by institutions as a consequence of RDL 2/2012 and RDL 18/2012.([40]) These two Royal-Decree Laws established new provisioning
requirements to cover asset impairments related to the banks’ real estate
activity
Some recent policy measures will
contribute to shore up banks' core capital. This is
also important in view of the new EU Regulation on capital requirements ([41]) and the comprehensive assessment to be carried out by the ECB in
2014 along with the entry into force of the new single supervisor. First,
the Banco de España issued a recommendation on a maximum 25% of paid-in-cash
dividends for 2013 and, more recently, also for 2014. Second, the tax legislation
on deferred tax assets (DTAs) was amended and it will allow banks to avoid the
deduction of an amount which has been initially estimated at around EUR 30
billion from the fully loaded common equity tier 1.([42]) 
The liquidity situation and the financing
structure of the Spanish banking sector have been strengthened. In particular, banks are shifting towards more stable sources of
finance such as deposits and the repo market. The annual growth rate of
household and non-financial corporate deposits reached about 4% and 7%,
respectively as of December 2013, reversing a declining trend recorded in most
of 2012. In turn, the liquidity generated by the fall in the loan-to-deposit
ratio is being used by banks to reduce their reliance on the Eurosystem and on
the wholesale market.
Notwithstanding the advanced stage of
the cleaning up of balance sheets, the ongoing restructuring of banks might
continue to weigh on credit conditions for smaller customers. The ratio of non-performing loans (NPLs), which typically lags the
cycle, continued to increase in recent months and reached 13.6% at the end of
December 2013 (Graph 3.19).([43]) This rise has been driven by the higher stock of impaired assets
but also, increasingly, by the denominator effect, i.e. shrinking total loan
portfolio. While the stock of impaired assets rose by EUR 20 billion between
June and December 2013, total loans declined by EUR 71 billion during the same
period. In addition, most recent increases have been also driven by the
reclassification exercise of the restructured loans portfolio performed by
banks on guidance from Banco de España.([44]) Going forward, the increases in NPL ratio at system level are
expected to be more limited. Nevertheless, the risk stemming from increasing
NPLs is mitigated by a comfortable coverage ratio.
Sustaining profitability will remain a
challenge given the modest medium-term GDP growth outlook and the low policy
interest rate environment. The third quarter of
2013 has confirmed the positive trend for bank profitability in 2013, which is
on average above both the baseline and significantly above the adverse scenario
of the 2012 stress test by Oliver Wyman. For the vast majority of banks the net
interest incomes have declined compared to the first three quarters of 2012 due
to both the impact of low interest rates on assets with floating rates (i.e.
mortgages) and shrinking business volumes. The latter trend is expected to
continue in the medium-term as households and non-financial corporation
continue to deleverage. In spite of this and of the significant contribution
from non-recurring items in some cases (including revenues from the burden
sharing exercises for some state-aided banks, incomes from the carry trade
activity and sales of assets), pre-provisioning profits demonstrate the banks'
capacity to generate internal resources. Furthermore, although provisioning
requirements are still high, they are on a clear declining trend, and operating
costs are being reduced rapidly.
Bank lending has been on a declining
path since 2007 but a stabilisation may be approaching. Recent data shows some deceleration in the contraction of domestic
bank private credit (Graph 3.20). Adjusted for the effect of the asset
transfer to Sareb, private domestic credit declined by around 7.7% y-o-y in
December 2013. Whereas the decline in domestic credit to households accelerated
to about 5.3% y-o-y, the contraction in bank credit to non-financial corporates
decelerated to around 10% in the last three months of 2013, and was also
alleviated by increasing market issuance by larger companies. 
The biggest annual contraction in
lending took place in the construction and real estate sectors. This was also partly due to the transfers of assets to Sareb,
while lending to other economic sectors contracted at a slower pace. This shows
that the reallocation of resources in the Spanish economy continues. Despite
ongoing contraction in stock of loans to NFCs, 'credit impulse' defined as the
change in new credit issued as a percentage of GDP, is pointing to a turnaround
in activity (Graph 3.21). This is confirmed by the most recent
data on new lending to NFCs, which recorded an annual increase of around 7% in
December 2013. These data are consistent with banks' funding and capital plans,
in which private sector lending is expected to bottom out in 2015 driven by
lending to NFCs. 
Going forward, lending conditions are
expected to improve. Standards for approving loans
have stabilized in the second half of 2013. In the fourth quarter bank lending
survey, there was a slight easing of credit conditions for SMEs, for the first
time since the first quarter of 2010. Therefore, the tightening trend observed
since the beginning of the crisis appears to be bottoming out, in particular as
banks expect some credit standards relaxation for loans to NFCs and consumer
credit in the next three months. 
While banks continue to consider weak
solvent demand as the main contributor to the ongoing decline in lending to the
private sector, frictions on the supply side have also played a role, affecting
in particular SMEs. These frictions relate to the
on-going restructuring process, regulatory changes (i.e. reinforced capital
requirements) and persisting euro area financial market fragmentation. In
particular, the restructuring of the financial sector might have weakened or
broken long-term lender/borrower relations. Asymmetric information is
particularly harmful to SMEs. While larger companies can access non-bank
financing sources (i.e. by issuing bonds or raising equity), SMEs rely
predominantly on bank financing and, hence, are disproportionally affected by
the on-going restructuring. Despite the recent reduction in the banks' cost of
funding, lending rates remain elevated, especially for SMEs and households.  
There is encouraging evidence showing
that lenders are effectively differentiating between companies.  According to the Banco de España, on average, most indebted
companies and sectors at the start of the crisis have been deleveraging
faster.([45]) By
contrast, firms that started from a low level of debt have actually increased
their leverage over the period, indicating that credit continues to flow to
companies in a stronger financial position. The pattern has been similar for
large companies and SMEs. However, in general the latter have reported
difficulties in accessing credit.
The evolution of the real estate market
remains important for banks' future profitability.
In recent quarters the Spanish banking sector has become a key player in the
real estate market, including housing. In the first half of 2013 the five largest
Spanish banks and Sareb sold around 35,000 properties, amounting to 25.5% of
all the transactions in urban properties (houses and other properties attached
to them) according to the Spanish Official Association of Notaries.([46]) Banks have incentive to sell the properties as their net
accounting value was drastically reduced after the new provisioning
requirements for non-performing loans and repossessed properties introduced by
RDL 2/2012 and RDL 18/2012. At the same time, they continue their accumulation
of real estate assets, which implies that the number of repossessions exceeds
the number of sales. Therefore, the on-going adjustment in the housing market
and construction sector needs to be carefully monitored. 
3.2.3.   Adjustment
in the housing market
The Spanish housing market has adjusted
sharply following the burst of the housing and lending bubble. The share of residential investment in total GDP fell from 12.5% of
GDP in 2006 to 4.4% in 2013, below the previous historical low of 7% in 1997,
and the adjustment is still ongoing, with residential investment falling by
8.3% y-o-y and investment in construction by 10.3% in the third quarter of
2013. Employment in the construction sector fell by around 1.8 million between
Q3-2008 and Q3-2013, and continues to fall even though the weight of
construction in employment, at 5.8%, is below its historical average. 
The fall in house prices, which
accelerated in 2012 and the first half of 2013, might be approaching an end. The cumulative fall in house prices between Q3-2007 and Q3-2013 was
36.2% in nominal terms and 43.8% in real terms. While nominal prices were still
falling in annual terms  by 7.9% Q3-2013, they increased by 0.7% compared to
the previous quarter, the first positive quarterly growth rate since Q2-2010
(Graph 3.22). Another sign that the housing market
might be approaching stabilization are recent statistics on home sales, which
tend to react faster to changes in supply and demand than house prices. After
declining continuously since 2007, annual home sales have stabilized at around
320,000. For the first ten months of 2013, 235,000 houses were sold, 11.3% more
than in the same period last year. This stabilization comes on the back of
increasing foreign demand (foreign investment in the Spanish real estate sector
grew by 28% in December 2013, y-o-y, according to Banco de España). However,
domestic demand for housing remains weak given high unemployment and tight
credit conditions.([47]) Similarly,
there are also preliminary signs of stabilization in building permit
applications, albeit at a very low level of around 35,000 a year (compared to a
record 866,000 in 2006).
Yet, further adjustment in house prices
cannot be excluded. Demand for housing is still
weak and the stock of unsold houses, estimated at around 400,000-580,000, very
large.([48]) The
acceleration of business activities of Sareb and of sales of real estate assets
by Spanish banks could also contribute to bring forward any further price
adjustment. While it is difficult to forecast future house price developments,
on balance, available studies suggest that the degree of overvaluation is much
reduced, although some undershooting of prices cannot be ruled out.([49]) Declining house prices negatively affect household wealth, as over
80% of total wealth is real estate related.
Housing market policy distortions
contributed to the housing boom. Spain is
characterized by high home ownership rate of 85% compared with 72% for the
whole EU. Apart from cultural factors placing a strong preference on house
ownership, a housing policy skewed towards promoting home ownership (i.e. tax
deductions) was one of the factors that contributed to the housing bubble in
Spain. The high incidence of home ownership in Spain is mirrored by the
underdevelopment of the rental market. Only 11% of houses are rented compared
to 28% for EU average. This lack of viable rental market may have aggravated
the adjustment process in the years following the burst of the bubble to the
extent that it has limited labour mobility.
Spain has taken measures to remove tax
and regulatory distortions in favour of house ownership and hindering the
rental market. Apart from the elimination of a
general tax deduction on new house purchases in December 2012, most recent
measures have improved the institutional framework of the rental market. The
Law on liberalisation of the rental market (Law 4/2013 ([50])) adopted in May 2013, increased the flexibility of the regulatory
regime and strengthened incentives for landlords and legal certainty. In
addition, social housing policy has been also recently redirected towards
support for tenants, i.e. rented accommodation. While it is too early to see
any impact of these recent changes on the share of households living in rented
accommodation in Spain, some encouraging signs can be observed. In particular,
11 new real estate investment trusts have been set up and listed on the stock
market since the reform. In addition, further development of rental
opportunities is also one of the strategic goals of Sareb. In this context,
Sareb is also working with several regional governments to assist them in their
social housing policies by temporary leasing up to 2 000 homes.
3.2.4.   Drivers
of indebtedness and deleveraging in the households sector 
Acquisition of dwellings has been the
primary driver of households' rise in indebtedness.
The household debt-to-GDP ratio more than doubled since 2000, to peak at 87% of
GDP in 2010 (Graph 3.23). Debt as a share of gross disposable
income or as a share of assets displays a similar picture. Such brisk increase
in indebtedness was mostly explained by the credit demand for housing
purchases. Total credit to households grew by some 20% on average between 2004
and 2007. Residential mortgages' contribution to annual credit growth stood
well above 10 pps. until 2007, recording highs above 20 pps. in 2005 and 2006,
whereas the contribution of consumer credit was much lower. The sharp
deceleration of credit growth to households at the onset of the crisis and the
contraction of credit growth thereafter has naturally been led by a negative
contribution from credit for dwellings purchases (Graph 3.24). 
Household debt is falling gradually but
it remains high. Household debt has fallen from a
peak of 87% of GDP in 2010 to 78.2% of GDP in the third quarter of 2013.This
reduction has occurred mostly through negative credit flows (Graph 3.25), whereas the long average maturity of
the stock of outstanding mortgages has slowed down debt reduction. To gauge how
far the correction has advanced, a first approach is to compare current debt
levels to static benchmarks such as the MIP threshold ([51]) or the pre-boom debt ratio, e.g. in year 2000. According to this
approach, the required remaining adjustment of the debt-to-GDP ratio for
households would stand at 23 to 35 percentage points (Graphs 3.26). In an alternative approach private
debt is considered sustainable if the notional leverage is stationary - i.e.,
if deflated debt evolves in line with deflated assets.([52]) Between 2001 and 2007 the gap between actual household debt and
its balanced or sustainable path widened rapidly. However, the recent
correction, together with the increase in the sustainable level since 2007, has
significantly narrowed the gap, by almost 20 pps. to some 21 pps of GDP at the
end of 2012. 
The interest burden has remained contained (Graph 3.27) as a result of the fall in the Euribor
rate, to which most mortgages interest rates are linked, as well as of
refinancing programmes offered by credit institutions.([53]) Yet, over-indebtedness is a heavy burden for lower income
households that have contracted debt (about 15% of those in the lowest 20% of
the income distribution according to ECB data), as debt service has absorbed an
increasing share of their disposable income, in some cases above 100%. Nevertheless,
the rate of NPLs on mortgages has remained until recently very subdued, owing
to a strong paying back culture and limited recourse to personal default (see
Box 3.1 for more details). 
Household debt is expected to continue to
fall in the coming years. Household deleveraging
efforts will be eased by a recovery of the economy and of the labour market,
leading to gradually higher incomes, and supported by the recent sharp recovery
in financial asset prices, which has allowed households to recoup some of the
wealth losses during the crisis. Easing financing conditions and a
stabilisation of house prices, on the other hand, could result in a revival of
new credit. These forces will impact on the behaviour of the savings rate. Wealth
losses on financial and non-financial assets, increased uncertainty  and the
sharp increase in unemployment spurred a surge in the saving rate to around 16%
in 2009 (possibly also suggest offsetting to an extent a fiscal expansion at
the time) (Graph 3.27). Since then, consumption smoothing in
a context of falling incomes has led the saving rate to decline sharply to
below its long-term historical average level of 11%. A moderate recovery of the
savings rate approaching to the historical average, as embodied in the
Commission services' 2014 winter forecast, would be consistent with a mild
increase in consumption and households maintaining a substantial net lending
position. Together with more favourable denominator effects as GDP growth turns
positive, the maturity profile of outstanding mortgages could also favour a
more rapid decline in debt the coming years. A reform of personal insolvency
could help speed up the restructuring of distressed household debt, but any
such reform would need to carefully take into account financial stability
considerations.
 (Continued on the next page) 
 Box (continued) 
3.2.5.   Drivers
of indebtedness and deleveraging in the non-financial corporations sector
Corporate deleveraging has accelerated
in the recent quarters. The adjustment in the
corporate sector tends naturally to be faster than in the households sector, as
a result of larger debt write-offs, mainly on construction and real estate
loans, and the shorter maturity of debt. In the run-up of the crisis
non-financial corporation debt increased from around 45% of GDP in 1996 to
above 140% (non-consolidated data) in 2010 largely in real estate and
construction sectors. In consolidated terms, debt amounted to almost 130% of
GDP. A decline was initiated thereafter, bringing down the debt/GDP ratio to
132% of GDP by the third quarter of 2013, still well above the euro area
average of 97% (non-consolidated data). 
Deleveraging is sharpest in the
construction and real estate sectors. After being
responsible for more than half of total credit flows between 2000 and 2007([54]), the construction and real estate sectors have seen a drop in bank
debt by 13% of GDP (thereby representing around 36% of total bank lending to
non-financial corporations in the third quarter of 2013). This adjustment also
reflects the larger incidence of write-offs on lending to these two sectors and
the transfer of assets to Sareb. While the ratio of doubtful loans to total
loans is around 12% for industry and services non-related to real estate or
construction, it reaches 31% and 34% in construction and real estate
activities, respectively, with 60% of total doubtful loans being linked to real
estate and construction activities (Graph 3.28). Non-performing loans in these two
sectors have stepped up in the last quarters. More generally, disaggregated
lending analyses by the Banco de España show that the reduction in debt is more
intense in companies that very highly leveraged at the beginning of the crisis.

Despite the recent correction,
non-financial corporations remain highly indebted both with respect to their
assets as well as their capacity to repay debt.
Beyond the debt-to-GDP ratio, the debt-to-asset ratio is also high, at above
110% in the third quarter of 2013 (consolidated data for both assets and debt)
compared with around 80% in the euro area. Likewise, non-financial corporations
debt is five times higher than the gross operating surplus (a proxi for firms'
capacity to generate income), (Graph 3.29). Comparing to other benchmark (as
explained in in the section on households) such as the MIP threshold or the
debt ratio in year 2000, the required remaining adjustment would still be - 44
to 59 percentage points of GDP respectively (Graphs 3.30). With respect to the sustainable
notional leverage the gap between current non-financial corporation debt ratio
and their balanced path has remained broadly stable, amounting to some 19 pps.
of GDP at the end of 2012. 
The evolution of profits will influence
the pace of future adjustment. Net lending of the
non-financial corporate sector has risen sharply, especially in the most recent
quarters, as a result of increased savings and the fall in investment. The
increase in gross savings has been mainly driven by the increase in gross
operating surplus, related to a reduction in employment and real wages, and to
a lesser extent from an increase in value added. Profit margins have also
increased as tight credit conditions led firms to rely more heavily on own
financing, mainly retained earnings (Graph 3.31), s in line with what has happened in
other euro area countries recovering from high indebtedness, high cost of
financing or both. With the stabilisation of the economy and of financial
conditions, the adjustment in non-financial corporate balance sheet is expected
to moderate in the medium-term. While corporate savings would be supported by
improved profitability, investment would be expected to pick up amidst improved
expectations and rising capacity utilisation.
3.2.6.   General
government debt
General government debt has reached high
levels. Buoyant economic growth, a particularly
tax-rich composition and sizeable revenue windfalls, especially linked to the
housing boom, led government debt to decline significantly during the
pre-crisis phase, to 36.3% of GDP in 2007. The outbreak of the economic and financial
crisis reversed this trend. The collapse of tax bases, surging unemployment,
fiscal stimulus in the early years of the crisis have caused large general
government deficits and a rapid debt increase, also spurred by the bank
recapitalisations and contributions to the EU and euro area financial
assistance institutions. Government debt is expected to approach 100% of GDP
this year and grow further in 2015. 
Further fiscal consolidation in the
medium term will be needed to bring government debt down. Model simulations (see Box 3.2) unveil an underlying upward trend in
general government debt in the medium term in the absence of further fiscal
consolidation, followed by a stabilisation at a high level. The high
debt-to-GDP ratio makes government debt developments vulnerable to adverse
shocks and imposes a high interest burden on public finances. The simulations
show that only by complying with the structural adjustments path recommended by
the Council to ensure the correction of the excessive deficit by 2016 and then
progressing towards the MTO, Spain can ensure a reduction in the debt ratio
after 2016 that allows it to reach 60% of GDP in 2030.
 (Continued on the next page) 
 Box (continued) 
3.2.7.   Conclusions
Deleveraging by the private sector has
advanced further but is far from complete and will continue to constrain
growth. While the correction has accelerated,
households and non-financial corporations continue to be highly indebted.
Deleveraging has so far taken place mainly through negative credit flows,
against the background of difficult economic conditions (negative growth,
rising unemployment, low inflation and negative valuation effects). Large debt
levels keep households and non-financial corporations exposed to interest rate
increases and income shocks and limit their capacity to consume and invest.
Overall, developments in Spain are consistent with the empirical evidence
showing that deleveraging processes following banking and housing crises imply
sizeable output losses.([55])
Deleveraging by households could progress faster in the medium term if the
economy gains momentum, while a pick-up in investment could imply some scaling
down of the net lending position of non-financial corporations from the current
high level. 
Effective structural reforms and
well-working lending markets facilitate the deleveraging process. As reported in the 2013 IDR, both theory and model simulations
point to reduced output and employment costs of deleveraging under flexible
factors and product markets, that promote a reallocation of currently employed
resources across sectors and firms and thereby support higher growth in both
the short and medium run. The success of the structural reform agenda and
restoring well-functioning bank lending and capital markets are essential in
this respect. Beyond the measures already taken to reinforce the banking sector
and foster access to non-bank financing, further measures aimed at limiting the
negative impact of asymmetric information in bank-customer relations could be
envisaged. Moreover, a more efficient regulatory framework for both personal
and corporate insolvency could contribute to the deleveraging process and
facilitate the allocation of credit to the viable sectors of the economy.
Despite a much more solid position, the
banking sector will still deserve close attention.
The continued increase in NPLs, a modest medium-term GDP outlook, and the low
interest rate environment are challenges for banks profitability. A
stabilisation in the real estate market, if confirmed, would remove a lingering
source of concern, although exposures to this sector are highly provisioned.
Particularly important seems to ensure continuous efforts to repair banks'
balance sheets and maintain an adequate level of provisions and capital. This
would avoid lending forbearance and contribute to strengthen the flow of new
credit to the viable part of the economy. 
A critical challenge going forward is to
stem and reverse the rise in government debt.  Reversing
the rise in government debt will be dependent on unfaltering fiscal discipline
in the years ahead, concretised in high-quality measures that reduce
structurally the budget deficit and are least harmful to short and medium term
growth prospects. Given the high level of decentralisation in Spain, a combined
effort by all levels of administration will be important for the success of
such a strategy, starting from the effectively implementation of the ongoing reforms
in the public administration.
3.3.      Labour
market performance
3.3.1.   Overview 
The period between the second half of
the 1990s and 2007 was characterised by an unprecedented surge in employment. Strong economic growth was accompanied by fast job creation, namely
in labour intensive sectors such as residential construction, and a moderate
increase in productivity.  Overall, 7 million jobs were created. Yet, even at
the peak of the boom in Q3-2007, employment and activity rates ([56]) stood at only 54.4% and 59.1% respectively, and the unemployment
rate was 8%. Other indicators of dysfunctional labour market institutions were
the high rate of structural unemployment and the high share of temporary
employment (31.7% of the total). 
The breakout of the crisis in the
context of a dual and rigid labour market and large sectoral shifts triggered a
dramatic increase in unemployment (Graph 3.33).
While output fell by a cumulative 5.9% between 2007 and 2013, approximately 4
million jobs were lost since 2008 (19.5% of the total) and unemployment surged
to a record high rate of 27.2% in Q1-2013. Labour market outcomes were heavily
affected by the sharp downsizing of the construction sector since 2008.
Notwithstanding the massive increase in unemployment, wages reacted very slowly
to the changed economic conditions. The massive labour shedding hit first and
foremost temporary workers. That the challenges facing the labour market in
Spain had long-standing structural roots is also confirmed by the fact that
Spain had approached unemployment levels close to 25% also during other
economic downturns in the early 1980s and the first half of 1990s. ([57]) 
Notwithstanding recent encouraging signs
in joblessness inflow, unemployment persistence remains the most pressing
near-term concern. Both higher inflow rates and
lower outflow rates contributed to the rise in unemployment at the beginning of
the crisis, but, at this stage, where unemployment shows the first signs of
stabilisation, the risk of persistence is largely determined by the evolution
of the outflow rate, which remains overall depressed, and depends on job
creation and matching efficiency. After having increased in 2012, the job
separation rate ([58]) has been
trending downwards since the first half of 2013.
Young people and the low-skilled are
particularly exposed to high and prolonged unemployment rates (Graph 3.34). The high and rising share of unemployed workers
facing long spells without a job (long-term unemployment rate: 52.2%) ([59]), points to a significant risk of hysteresis. Long-term
unemployment has severe implications for job finding rates and labour market
matching, and eventually results in widespread deterioration of human capital,
discouragement and labour market withdrawal. The risk is strongest for youth
and the less skilled workers, who have been disproportionately affected by the
rise in unemployment. The fraction of young people not in employment, education
or training increased from 14.4% in 2008 to 18.8% in 2012 ([60]), and their unemployment rate increased from 24.6% in 2008 to 55.7%
in 2013. For low-skilled workers, the unemployment rate stands at 39.9% ([61]). All in all, these figures imply a high probability that the
underlying structural rate of unemployment has shifted significantly upwards. 
This section will explore the drivers of
the increase in unemployment and prospects and the contribution of labour
market to rebalancing. 
3.3.2.   Drivers
of labour market performance 
The crisis has hit employment across all
sectors, but most strongly construction and some manufacturing sectors. Given the large share of low-skilled workers typically employed in
construction, matching problems are likely to have been exacerbated by the
sectoral concentration of job losses (Graph 3.35). There are also very large
differences in the effects of the crisis on employment across regions, to a
large extent explained by regional patterns of sector specialisation (as
suggested by, among others, a high correlation between differences in
employment losses across regions and employment losses in the construction
sector) and, eventually, further aggravated by the lack of geographical
mobility of workers. ([62]) 
Public sector employment has also been
reduced significantly since 2011. The cumulative
downsizing in public employment since the peak in 2011 has been 13.2%. In 2013,
public employment decreased by 5.4%, faster than private employment, which
declined by 2.3%. After the adjustment in the size of public administration in
2011 and 2012, the public sector accounted for 20.6% of the employment in 2013
(Graph 3.36). Most job cuts were carried out by the autonomous regions and
municipalities, which are responsible, among others, for providing education
and health services.
Part-time employment withstood better
the effects of the crisis than full-time employment, but it is still used less
than in other EU Member States. The number of
workers in part-time employment has increased by slightly more than 24% since
2007, and the percentage of persons working part-time reached 16% of total
employment in 2013 ([63]), versus an
EU-28 average of 19.9%. However, many of these are likely to be involuntary
part-timers ([64]). Fostering
stable part-time employment, as a tool against unemployment and duality, is
also the main stated purpose of Royal Decree-Law 16/2013, adopted in December
2013, which is particularly addressed to young people.
Activity rates in Spain were generally
high, but have been falling lately due to demographic factors, migration and
the extension of education and training. During
2007-2012, the proportion of the population aged between 15 and 64 in the
labour force increased by about 2.5 pp, an unusual development in light of the
sizeable increase in unemployment rate and the typically pro-cyclical behaviour
of the participation rate. The activity rate stood at 59.6% in 2013 (or 22.7
million active persons). However, there is now some evidence of labour force
withdrawals in specific groups, and the protracted slack in labour utilisation
increases the risk that unemployed workers drift out of the labour force. ([65]) The withdrawals observed so far have been largely concentrated
among youth, migrants and the low-skilled, who may be harder to bring back to
the labour force. In general, a still limited, but growing trend is observed
regarding discouraged workers.
Workers with an immigrant background are
among those most strongly hit by the crisis in Spain and also those seeing the
fastest fall in participation. The unemployment
rate for workers with an immigrant background stood at 37.1% in 2013 (vs. 24.6%
for Spanish nationals). These workers were disproportionately employed in
construction, retail trade, and tourism, all sectors making an extensive use of
temporary contracts. Discouraged workers from this group account for a large
part of outward migration flows since the start of the crisis and more
generally of withdrawal from the labour force. Nevertheless, their activity
rate is still 16 pp higher than the Spanish nationals. ([66]) Much less noticeable, a limited exit of Spanish nationals as a
result of the crisis has also taken place between 2008 and 2012. ([67])
Falling participation rates for youth
partly reflect a prolongation of education and training. The activity rate of young people under 25 has fallen from 55% in
2008 to 41.3% in 2013 (Graph 3.37), partly reflecting more young people staying
or going back to the education and training system, and, to a lesser extent,
migration flows and demographics. In this regard, any negative effects on youth
attachment to the labour market may have scarring effects on labour supply. 
At the same time, the crisis has led to
an 'added worker effect' in labour participation. This materialises in a steep increase in the female participation rate
from 48.9% in 2007 to 53.3% in 2013, Graph 3.38, possibly in response to
increased first-earner, male unemployment. ([68]) In the case of older workers, the impact of the recession on their
increasing participation has been affected by regulatory changes such as, among
others, the increase in the legal retirement age introduced by the 2011 pension
reform and the restrictions on early retirement adopted in March 2013, ([69]) which may have induced older workers to extend their active life
in order to sustain prospective incomes. Relative to past recession episodes,
all these factors point to diminished risks of labour force withdrawal among
older workers despite the persistence of unemployment. ([70])
The labour market remains characterised
by significant duality.  Despite the different
reforms and measures implemented since the 1980s (for instance, easing
open-ended contracts with financial incentives), and most notably the labour
market reforms of 2010 and 2012 (which have narrowed the gap in firing costs
between temporary and open-ended contracts and promoted internal flexibility in
firms)([71]), and in the
context of the negative current economic situation and still uncertain outlook,
labour market segmentation remains a feature of the Spanish labour market, with
greater incidence on some groups of workers, namely the young and low-skilled. 
In Q4-2013, the temporary employment rate stood at 23.9% (Graph 3.38), up from
23.7% in 2012. 
The impact of recent reforms on duality
will become clearer when the recovery is better established. The massive dismissal of (mostly) temporary workers from 2008 to
date has resulted in an increased share of permanent workers in the total stock
of employees. However, since the beginning of 2012, growth of permanent
contracts among the new contracts has picked up ([72]), outpacing that of temporary contracts, which nonetheless still
constitute about 92.4% of the total new labour contracts signed ([73]). The high share of new temporary contracts may be motivated by the
broad economic uncertainty and the current productive structure (which
determines the average life of contracts). Adding to the unstable economic
context, some administrative difficulties and uncertainties persist in relation
to the use of the new subsidised indefinite contract for SMEs. The
simplification of the contract templates (effective from January 2014) and the
announced streamlining of hiring subsidies will increase transparency and may
reduce information costs for employers.
Segmentation raises the volatility of
employment and has negative consequences on the labour market integration of
young, low-skilled workers. ([74])  Negative externalities on the whole economy arise from low
training incentives and productivity. ([75]) In addition, segmentation can condition decisions on the type of
production and it can make it more difficult for companies to adapt quickly to
technological or demand shocks. ([76])  Finally, the fact that protection is linked to the job tenure
with current employers might be a disincentive to mobility and hence to
allocative efficiency. ([77])
The rigidities in the labour market were
manifest in the behaviour of wages and low productivity. Economy-wide labour productivity growth was weak in Spain compared
to other advanced economies in the period 1996-2006, but has accelerated since
2007, most markedly in 2009. ([78]) However,
the substantial hourly productivity gains are a consequence of, among others, a
decline in total working hours, and also reflect composition effects, since job
losses were largely concentrated in low-productivity sectors such as
construction. 
Before the 2012 labour reform, Spain's
collective bargaining system featured an intermediate degree of centralization
(at the sectoral and regional level), which did not allow for a sufficient
adaptation to the macroeconomic conditions, nor to the microeconomic conditions
of the company. ([79]) This rigid system was exacerbated by the so-called ultra-activity,
i.e. the automatic indefinite prolongation of existing contracts in the absence
of renewals. In addition, the conditions to opt out of the collective
agreements were too strict and rendered its use very difficult. Thus, the
bargaining structure largely prevented wages from being configured as an
additional adjustment element, while also hindering their role as an incentive
mechanism. ([80]) Partly
explained by this nominal wage inertia and by the more frequent use of
temporary contracts, labour shedding played a stronger role ([81]) in adjusting labour input in Spain than in other European
countries, with adverse effects on employment. 
A labour market improvement has followed
swiftly the first signs of recovering economic activity in the second half of
2013. Unemployment stabilised at the end of 2013,
largely due to the contraction of the labour force and to some seasonal
factors, but also to a halt in the decline in employment levels (which showed a
first positive increase in the registers to the Social Security in December
2013). Self-employment has progressed more favourably than average employment ([82]), seemingly partly fuelled by the new measures on entrepreneurship,
in place since March 2013 (Youth Entrepreneurship and Employment Strategy
2013-2016) and September 2013 (Law on Entrepreneurship). 
The enhanced internal flexibility
brought about by the labour market reform and the social partners’ agreement is
likely to have had a positive effect on employment.
The  comprehensive labour market reform adopted in 2012, together with the
social partners' agreement for wages, employment and growth 2012-2014, ([83]) set the basis for a more flexible and resilient labour market (see
Box 3.3 for more details).  The reform created the ground for working hours to
react more flexibly to labour market shocks. ([84]) This could lead in the future to a reduction in labour demand
fluctuations over the economic cycle, especially for temporary contracts.
Without a downward adjustment of average working hours employment losses could
have been even more severe. Different estimates suggest also that the reform
has helped to limit job losses, although varying substantially between the 225
800 (estimated by the national authorities) and 60 000 (estimated by BBVA
-Banco Bilbao Vizcaya Argentaria). ([85]) Conversely, there is no evidence to date of substantial impact on
duality. 
The 2012 reform is likely to have
contributed to wage moderation, especially in new collective agreements. The agreed wage increase for 2013, calculated provisionally with
the information on the collective agreements registered up to December 2013, stands
at 0.57% (0.37% for firm-level agreements and 0.58% for higher-level
agreements, in line with the social partners' agreement for 2012, 2013 and 2014
signed in January 2012). As for the collective agreements which start deploying
their effects in 2013, the agreed wage increase is lower, 0.41% (0.39% for
firm-level agreements and 0.41% for higher-level agreements). ([86]) According to 2013 Q3 data, the labour cost of companies increased
0.2% y-o-y, standing at 2,461 euro per worker. However, the wage cost per
worker per month decreased 0.2%, standing at 1,801 euro on average. As working
hours have also decreased by 0.3%, labour costs per hour worked have increased
by 0.5%. 
The surge in unemployment is a key
factor to explain the deterioration in poverty and exclusion indicators in
Spain. ([87]) The share of people living in households with very low work
intensity increased to 14.3 % in 2012 (from 6.7% in 2007). Poverty among the
unemployed population has increased from 39% to 46% between 2007 and 2012, also
in line with the increase in long-term unemployment. The fall in income among
the long-term unemployed influences the increase in income differentials, since
the long-term unemployed, having expired up their right to earnings- related
unemployment allowance, are now protected under social assistance schemes,
managed by the regions (whose replacement rate is significantly below typical
poverty thresholds).  This evolution is clearly visible in the decrease in
total expenditure on contributory unemployment benefits by 16.4% between 2012
and 2013,  reflecting a fall in the .number of unemployment benefit recipients
(-17.4% y-o-y in December 2013) and unemployment benefit coverage rate (-4.1%
y-o-y, to 61.4%). ([88])
In-work poverty has also increased,
mainly as a result of lower household work-intensity. At 12.3%, the in-work poverty rate remained high in 2012 (18.8% for
part-time workers, 10.9% for full-time workers), reflecting the
deterioration for some clusters of the employed population (notably young
people, the low skilled and temporary workers) and the fact that the main
social policies pertain to unemployment and non-contributory pensions for
elderly and people with disabilities, not so much to households with
economically active members. Poverty and social exclusion amongst employed
workers are also related to the quality of employment, with temporary
employment leading to a higher poverty risk not only in the short term, but
also in the medium and long term. 
3.3.3.   Medium-term
prospects 
On the back of a further decrease in the
labour force and stabilisation of employment, unemployment is projected to fall
in 2014. The 2014 WF projects unemployment to fall
from 26.4% in 2013 to 25.7% in 2014. While the recent evolution of labour
market indicators suggest an approaching turning point, it is difficult to
judge if they prelude a serious inroad into unemployment. The answer depends
very much on the strength of the recovery in activity, in the face of headwinds
from deleveraging, and the reactivity of employment. Employment has been
traditionally highly reactive to output changes in Spain, with greater
variation in unemployment in situations of GDP stagnation or growth near to
zero. ([89]) Labour
market developments during the crisis also confirm that significant dualism
tends to increase the sensitivity of employment to fluctuations in output. ([90]) The recent reforms could have lowered the GDP growth level at
which employment starts to react to GDP growth. At the same time, the large
share of long-term unemployed complicates the challenge of a substantial
reduction in the unemployment rate. 
Spain needs to achieve internal and
external equilibrium. The recovery in cost
competitiveness to rebalance the economy externally and the reabsorption of
unemployment (and the reduction in structural unemployment) might point to
differing adjusting needs. While the external rebalancing is advanced and, as
discussed in section 3.1, does not depend only on relative labour costs,
mobility of workers across different sectors and occupations, in particular
towards those with the highest growth and export potential, as well as
compatible wage settings, would support the reabsorption of unemployment.
Duality limits productivity and
medium-term growth potential. ([91]) The duality of the labour market, including the fact that
protection is linked to tenure with current employers, is likely to be a hurdle
to allocative efficiency, while the  lower incentives to invest in human capital
and building up skills of temporary workers reduce their productivity.([92]) 
The reabsorption of unemployment would
be supported by further improvements in unit labour costs. This adjustment is at work. Overall, labour costs have been
falling since Q1-2012, by a cumulated 3.6%, while the GDP deflator has risen by
0.4%. A continuation of wage moderation, along the lines of the 2012-2014
inter-confederal agreement, would contribute to a reduction of the current
estimated high level of the NAWRU and promt its convergence towards the less
cyclical structural unemployment rate (predicted solely on the basis   of key
policies variables such as the tax wedge, the unemployment benefits and the
active labour market policies). 
A tax shift away from labour could
complement structural reforms and have a positive impact on both employment and
cost competitiveness. A revenue-neutral reduction
in social security contributions financed via consumption and/or other taxes
could be considered in the framework of the up-coming review of the tax
system.([93]) Model
simulations (see Box 3.4) suggest that considerable tax shifts are needed to
have large employment effects. Targeted reductions are likely to be more
effective in reducing unemployment for a given amount of the tax shift, in
particular if focussed on low skilled due to the higher elasticities of both
low-skilled labour demand and supply. Moreover, the short-term employment
impact can be expected to be larger when employers' social security
contributions are reduced, as the impact on labour demand is more direct.  The
impact of a social security contribution cut targeted only to new additional
and stable hires, as the government announced on 25 February to be planning,
can only be assessed when the details on the actual design and implementation
of such mechanism become available. In principle, this type of scheme can
support employment creation, while the impact on competitiveness and on the trade
balance is likely to be limited as the cost of the stock of existing employment
is not affected and the amount of the associated tax shift (if any) would
likely be contained. Introducing a flat social security payment would imply a
larger reduction in the cost of higher wage new net employees. 
In addition to the strength of aggregate
demand and wage setting, a determinant of unemployment persistence is the
efficiency with which jobseekers are matched with job openings ([94]).  The structural transformations
undergoing the Spanish economy are generating a mismatch between demand and
supply of labour, which may require policies enhancing support to job-search
and activation of unemployed. ([95]) This is one of the goals of the on-going revision of the active
labour market policies framework in Spain, upon which resources are to be
allocated among regions depending on results. ([96]) Persistent regional disparities in labour market conditions also
point to mismatch across regions. More could be done to improve the matching of
workers and jobs, namely through measures to incentivise activation and
mobility, and to strengthen public employment services and training programmes,
including vocational training. 
In the medium term, the success of
recent reforms tackling shortcomings in Spain's education systems that have
contributed to high youth and low-skilled unemployment will be important. ([97]) Although on a fast declining trend,
Spain still stands out for a high early school leaving rate (24.9% in 2012).
Further declines are likely in the light of the economic context and the
ongoing reform of the education and training system.  The high rate of early
school leaving is not incompatible with the improved educational attainment
registered during the last three decades (40.1% tertiary educational attainment
in 2012). However, Spain's investment in human capital has not enabled
convergence with the EU in relation to the population with higher secondary
education, mainly vocational education and training. The polarisation of
Spain's educational attainment has given rise to high levels of unemployment
among the low skilled, but also to an imbalance between the supply and demand
for qualified work, resulting in high levels of graduate unemployment, and a
significant underemployment or overqualification (Graph 3.41). Spain
ranks as one of the countries with the highest degree of qualification mismatch
in the EU, showing also great variations in the share of over-qualified and
non-employed university graduates over the business cycle. ([98]) Estimates show that 26% of the Spanish labour force is
overqualified for their job, with higher proportions for young people (44%).([99]) The fact that this trend has been sustained over recent years, is
at odds with human capital theory. ([100]) 
3.3.4.   Conclusions
Reducing unemployment is the most urgent
challenge facing Spain. Recent polices have helped
to avert even worse outcomes and are expected to deploy further positive effects
as the recovery gathers speed. Nevertheless, the urgency of the labour market
and social situation magnifies the need for a swift and adequate implementation
and close monitoring of all the measures adopted and planned. A number of
critical structural problems, as emerged from the preceding analysis, would
need to be fully addressed in order to achieve a sustained decline in
unemployment, accompanied by better prospects for sustained productivity gains.

 (Continued on the next page) 
 Box (continued) 
Absorbing displaced workers from
permanently downsized sectors and facilitating the shift towards a more
export-led economic growth implies a large-scale sectoral reallocation of
labour over time. This process would be accelerated
by appropriate developments in labour costs, enhanced mobility of workers both
across sectors and geographically, and enhancing skill-match. There is a role
to play for labour market policies, including strengthening ALMP and employment
services, education and training and other flanking policies, such as a tax
shift bringing lower labour costs and easier access to rental accommodation. 
Measures are being taken in all these areas, but their effects will be visible
only over time, also due to the longer implementation lags related to the
division of responsibilities between the centre and the regions, in particular
for ALMP and employment services. Effective cooperation will be paramount also
to ensure the swift implementation of the national Youth Guarantee
Implementation Plan in 2014.
There is a strong complementarity
between measures directly geared to the labour market and other policy areas. In particular, it is essential to increase
competition, removing barriers to entrepreneurship and growth and facilitating
the allocation of resources towards more efficient sectors and firms. The
competitiveness gains from lower unit labour costs would benefit the whole
economy only if not absorbed in the medium term by higher firms' margins. A
rapid and thorough implementation of ongoing reforms in product and services
markets (such as the market unity law and the professional services law),
together with measures to modernise public administration, will thus be
critical for employment prospects. The same goes for the reforms of education
and training, which have an important role to play to address skill mismatches
and increase human capital.  
The analysis in Sections 2 and 3 shows
clear progress in the adjustment of imbalances but it also highlights that
winding down the large stocks of domestic and external debt will require
sustained efforts, and that unemployment and government debt have grown into
major policy challenges. In particular, risks to
banking sector stability have been put under check; the external lending
position is now in surplus; the housing market contraction seems to be
approaching stabilisation; confidence has improved significantly and the
economy has started to grow again. Yet, both the private and the public sectors
remain highly indebted on a number of indicators, with government debt still on
an ascending trajectory. External liabilities also remain very large, while the
labour market situation, in spite of recent signs of stabilisation, is
critical. Until these imbalances are corrected, the economy remains vulnerable
to external or domestic shocks, including policy setbacks, which could cast
doubts on the continuation of the ongoing adjustment. 
These significant economic challenges
warrant close monitoring and policy attention.
Against this background, this section discusses different areas of intervention
that could contribute to address the above challenges. The adjustment was
supported by intense policy action over the last year, driven by the
commitments in the 2013 National Reform Programme and Stability Programme, the
country-specific recommendations issued by the Council in July 2013 and for the
financial sector by the conditionality under the financial sector assistance
programme.([101]) The scale
and interrelated nature of the remaining economic challenges call for a
determined continuation of this policy response. A few key reforms are still in
the pipeline, and many of the reforms recently adopted will deliver their
results only upon full and effective implementation. The effective cooperation
of all tiers of governance (central, regions and local administrations) is a
key ingredient to the success of many reforms. In addition, additional policy
measures to underpin further the adjustment process might be considered as
further experience and insights are gained.
The following paragraphs discuss policy
challenges in relation to the macroeconomic imbalances and risks identified in
section 3. Most related policy measures are nevertheless cross-cutting and
likely to contribute to the broader adjustment process, despite being more
relevant for specific dimensions thereof. Often these policies are
complementary, making their combined implementation important to reap the
expected economic benefits. 
Enhancing competitiveness and reducing
external vulnerabilities  
Reducing the large negative NIIP
requires sustained external net lending surpluses, in turn requiring sizeable
positive trade balances over time. On current and
forecasted net lending positions, and abstracting from valuation effects, it
will take a number of years to bring the NIIP to levels generally considered as
compatible with the absence of vulnerabilities. Moreover, a rebalancing of
external liabilities towards equity and away from debt would also strengthen
the resilience of Spain to external financial shocks.
Structural factors have underpinned the
buoyant performance of exports in recent years.
Spanish exports shares were relatively resilient even during the boom period,
in spite of unfavourable aggregate ULC and REER dynamics, suggesting a role for
other competitiveness factors. More recently, exports volumes have grown on the
back of rapidly increasing export propensity of Spanish firms both at the
intensive and extensive margins. The number of exporting firms is now larger
and the range of countries toward which Spain exports is broader. Considering
the fixed costs associated with export activity and in particular with entering
new markets, this trend is unlikely to reverse as internal demand picks up.
Moreover, the gains in relative cost competitiveness spurred by the internal
devaluation process will support firms' internationalisation efforts. There are
instead risks that imports might rebound strongly once activity picks up, due
to the high external dependence on oil and the relatively elevated import
content of final demand. 
There is scope to increase further the
export potential of the Spanish economy. In going
forward further labour cost moderation and increased competition on product and
service markets would contribute positively to aggregate productivity growth
and international competitiveness. The recent experience has however also shown
that non-cost competitiveness explains a significant share of the Spanish
export performance. Exporting firms in particular have adopted efficient
production and marketing strategies and maintained high levels of productivity
(both by national and international standards). In this respect, the
fragmentation of the Spanish production system, where the dominance of micro
and small companies point to obstacles to firms' growth, appears as a
bottleneck to expanding the export potential. Improving the allocation of resources
across firms and sectors, requires efficient labour and capital markets, but
also a friendly business environment, without unjustified entry and growth
barriers, and competitive service and product markets. 
Recent reforms in capital and product
markets support competitiveness but there could be scope for further deepening. The 2013 law on the market unity aims at removing measures that may
directly or indirectly obstruct the free movement of goods and services and the
establishment of economic operators throughout Spain – and could allow firms to
grow in size and exploit economies of scale. The planned reform of professional
services and associations could increase competition in an important sector,
which is also a large input to other activities. The reform is nevertheless met
with strong opposition and has not yet been approved. Efficiency gains and
lower prices could also derive from more competition in the retail sector,
where there could still some scope to streamline authorisation schemes in spite
of recent reforms. Tackling capital constraints and administrative and tax
provisions that discourage companies from growing and becoming more competitive
would enhance productivity and competitiveness. Larger firms can reap benefits
of scale and scope (through product differentiation and/or vertical integration
in markets up or down the value chain), and this could also contribute to lower
import dependence. Energy policy could play a role in reducing the dependence
on external energy sources. 
The foreseen reform of the tax system
offers an opportunity to contribute to the external adjustment process. A more environmental friendly taxation could support the reduction
of the oil intensity of the economy, with a positive impact on imported
volumes. A well-engineered tax shift could support employment and be beneficial
to external competitiveness by reducing the cost of labour and at the same time
making imports relatively more expensive. Sizable effects on the trade balance,
however, tend to require very large tax shifts. 
Sustaining the deleveraging process and
strengthening the financial sector 
The high deleveraging pressure on the
private sector continues to drag on growth and to pose challenges to financial
stability. The economy would likely benefit from a
speedier debt reduction amongst non-financial corporations. A return to
positive growth coupled with the right incentives could create the necessary
space for frontloading the debt reduction. Some measures have already been
taken to reduce the debt bias – e.g., the entrepreneurship law has introduced a
tax break to foster SMEs' re-investment of profits on fixed assets or on real
estate assets linked to the company's economic activities. In spite of recent
measures, significant shortcomings still appear to limit the application and
the effectiveness of insolvency procedures. An effective insolvency (including
the pre-insolvency stage) framework would contribute to allocative efficiency
by (i) reducing incentives to invest in tangible assets as collateral, (ii)
freeing-up resources locked in low productivity investments and (iii) promoting
the debt restructuring of insolvent firms with solid growth perspectives. 
Debt reduction could accelerate in the
household sector as income starts recovering and older mortgages come to
maturity. The elimination of the tax deductibility
of mortgage payments as of the beginning of 2013 has greatly reduced the bias
towards home-ownership. To address debt distress of residential mortgage
debtors, the government has adopted measures to strengthen the protection of
mortgage debtors, facilitate debt restructuring and tightened conditions to
launch foreclosures. While these measures have proved helpful, an organic
revision of the personal insolvency framework could provide legal stability,
help the work out of distressed household debt and rebalance creditor/borrower
relationships. 
The medium-term resilience of the
Spanish economy requires putting government debt on a declining path. Meeting the targets set out in the context of the Excessive Deficit
Procedure (EDP) until 2016 and abiding by the provisions of the Stability and
Growth Pact (SGP) thereafter is essential to reverse the rise in the government
debt/GDP ratio. The fiscal adjustment would be more effective and less costly
if based on structural fiscal measures. The government has already adopted a
number of measures with a view to generating efficiency gains and budgetary
savings. A careful follow-up of the implementation of the recent reforms of the
public administration (including at the regional and local levels) would ensure
the planned savings actually materialise. The stated aims of the forthcoming
tax reform are to make the tax system more growth-friendly and tax revenues
less volatile. As such, it can play an important stabilising role for public
finances, for which the volatility of tax revenues has been a major challenge
during the crisis. Moreover, positive growth surprises may offer the
opportunity to accelerate the reduction in the headline budget deficit and consolidate
the regained confidence of investors in Spanish assets.
The ongoing restructuring of the banking
sector improves its capacity to finance economic growth. The financial assistance programme for the recapitalisation of
financial institutions that ended in January 2014 has contributed to restoring
banks' health and stemming concerns about financial stability. Despite the
considerable progress achieved, the restructuring process in the savings banks
will still take time to be completed and the system remains exposed to possible
adverse international and domestic developments. Maintaining or increasing
robust capital positions would boost further the resilience of Spanish banks
and strengthen their lending capacity. The new rules on deferred tax assets and
the continuation of prudent dividend policies, as recommended by the Bank of
Spain in its supervisory role, would support the building-up of capital
buffers. 
The development of the rental segment
contributes to the stabilisation of the housing market. Notwithstanding large specific provisions, the speed and nature of
the adjustment in the housing market continues to be an important factor for
banks' profitability going forward and for the success of Sareb, the asset
management company created in the context of the recapitalisation of Spanish
banks in 2012.  In this respect, it is encouraging that there are first
tentative signs of an approaching stabilisation, to which the recent reform of
the  regulation of the rental market seem to have contributed by increasing the
attractiveness of this market segment also for specialised investors. A bigger
offer of rental accommodation would also support geographical mobility. 
Spain needs to find a path where the
financing of valuable projects and further reduction in aggregate debt levels
go hand in hand. Ideally, the deleveraging process
should be concentrated in overstretched companies and households, while other
borrowers should be able to finance ongoing and new productions at competitive
rates. There is encouraging evidence that healthy Spanish firms with solid
growth perspectives were able to increase their external finance even as
aggregate credit was falling. Yet, credit access conditions for smaller
borrowers, while improving, are still much tighter than in other Member States,
partly due to persisting financial fragmentation. Efforts have been made to
develop non-bank financial intermediation and alleviate credit shortages for
SMEs caused by supply frictions. Considering the significance of SMEs in the Spanish
productive system, additional measures could be envisaged. As difficulties in
accessing credit for SMEs are traditionally linked to information asymmetries,
measures to foster the availability and comparability of information for the
assessment of creditworthiness of SMEs (e.g., via the use of standardised
credit scores) could be explored. 
Tackling unemployment
The macroeconomic adjustment process has
weighed heavily on the labour market. Spain is not
new to episodes of sharp employment destruction. However, the severity of the
current economic downturn and its sectoral nature (with the sharp contraction
of the construction sector), combined with structural weaknesses in the labour
market caused an unprecedented fall in employment. The duality of the labour
market, the lack of reactivity of wages to the economic context and mismatches
between demand and supply increased the cost of adjustment. At present,
large-scale reallocation of labour across sectors and companies still appear
needed for both internal and external equilibrium, so as to provide the
preconditions to absorb displaced workers from permanently downsized sectors
and facilitate the shift towards a more export-led economic growth.
Even though the fall in employment
appears to be coming to an end as the economy starts to recover and the impact
of the labour market reforms to be felt, unemployment remains the most urgent
policy challenge to address. The unemployment rate
is down from the peak registered in 2012 but still very high at 26.4%. While
this decline has been mostly due to a drop in the active population – driven by
net migration outflows, ageing population and incipient discouragement effect,
employment grew in the fourth quarter of 2013 for the first time since early
2008 and in spite of a still muted rate of output growth.  Building on previous
reforms in 2010 and 2011, a comprehensive labour market reform was passed into
law in July 2012. The social partners' agreement for wages, employment and
growth for 2012-2014 complemented the reform. The reforms have set the basis
for a more flexible management of human resources at firm level and modified
bargaining procedures, and likely even worse outcomes in terms of employment.
Yet, the challenge of bringing down the high structural rate of unemployment is
huge, as long-term unemployment is high, skill mismatches pervasive and
geographical mobility low. 
Containing unit labour costs, building
on recent progress, remains important to close the gap between supply and
demand of labour. The reforms and social partners'
agreement have contributed to a reduction in real labour cost and to restoring
cost competitiveness, although this process started late in the crisis. A
positive shock to employment could come from a revenue-neutral tax shift from
labour to consumption and/or other taxes, such as environmental taxes or
recurrent property taxation. The short term impact would be stronger if the
reduction was applied on labour employer social security contributions – due to
sticky wage adjustment. Moreover, targeted reductions for groups most affected
by unemployment or inactivity would likely have a stronger impact than a
generalised cut in labour costs. Competitive product and services markets are
required to ensure that the lower labour costs result in expanded investment
and production and lower prices. A social security contribution cut for new
additional and stable hires, as the government announced on 25 February to be
planning, would go in the direction of cutting the cost of labour for companies
(proportionally more for higher wage workers if implemented via a flat social
security payment) and thus stimulating labour demand. The impact on cost
competitiveness would likely be limited as the labour cost of existing
employment is not affected. The details of the measure are however not
available at the time of writing.    
Effective activation policies could
contain hysteresis effects from the large share of long-term unemployment. The 2013 Annual Employment Plan strengthened the incentives for a more
effective use of ALMP funds by regions starting from 2014. The new active
labour market policy approach will be complemented by the launch of the single
job portal, planned to gather all central and regional government public
employment services' information for jobseekers and employers and to be linked
to the modernisation of employment services. Yet, there is scope for better
working public (and private) employment services to improve individualised
guidance and labour market intermediation, and reduce information costs,
stimulating inter-regional mobility and skill adaptation. A Youth Guarantee
Implementation Plan, to be implemented in the second half of 2014, complements
on-going initiatives to combat youth unemployment. It includes actions targeting
people below 25 years not in employment, education or in training (NEET). It is
important that the rather complex institutional set up for these policies does
not delay progress or undermine effectiveness in these critical areas. 
In the long-run, skill mismatches can
only be fully addressed by reforms in the education and training systems. The recently approved law on the quality of education aims, among
other objectives, at improving the links between the labour market and the
education system and at reducing the percentage of early leavers from education
and training in Spain, currently among the highest in the EU28. Particularly
important in this respect is the reform of the VET system (including the
development of a dual vocational training system). Effective cooperation
between regions and the central administration would enhance the effectiveness
of the reform, while closer coordination between education and labour market
policies could rationalise the supply of formal education vocational training programmes
and work-based training, reducing information costs and supporting the
up-skilling of youngsters. 
Reducing duality in the labour market
over time would support an efficient allocation of resources and productivity. Addressing duality is an area where the success of recent reforms is
less clear relative to other objectives, although more reliable conclusions
will be possible only when the economic recovery will be more firmly
established. At the moment, new contracts are still dominated by fixed-term
contracts and there has been a significant increase in part-time – part of
which likely involuntary. While temporary contracts are useful in specific
circumstances and facilitate the transition in and out of unemployment, they
have negative effects on the acquisition of skills and on productivity. A less
commonly highlighted sign of a dual market is that job-to-job mobility of
workers with undetermined spell contracts tend to be relatively low. This could
be related to dismissal protection being linked to tenure with current
employers - a significant disincentive to mobility (in particular of
skilled-workers, more likely to have indefinite contracts) in times of high
economic uncertainty. Both elements, the negative impact on individual
productivity of temporary workers and the lack of mobility of permanent
workers, act as obstacles to an efficient use of human capital. Recent
initiatives that the authorities expect to lower duality are the administrative
simplification of contract templates (rendering information on contract
categories more user-friendly) and measures to incentivise stable part-time
employment. However, there could still be a need for more determined actions to
close the gap in the relative attractiveness of indefinite and temporary contracts
and review disincentives to mobility. 
Increasing employment is crucial to
buffer the social cost of the on-going macroeconomic adjustment process. Beyond efficiency, also equity considerations call for a rapid
reabsorption of unemployment and a reduction in labour market duality in the
medium term. The burden of the macroeconomic adjustment has weighted heavily on
the household sector, and within the household sector, certain segments (young
and low skilled) have suffered disproportionately from unemployment and/or in
work poverty. The high poverty rate recorded amongst household in working age
and in particular younger households are in sharp contrast with the decreasing
poverty rates amongst the elderly population. Also child poverty rates are
particularly elevated by international standards. The sizeable increase in
total social expenditure during the crisis could not offset the impact of the
crisis and of surging unemployment on social indicators. 
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([1])  The REERs figures are deflated by unit
labour cost.
([2])  At-risk-of poverty rate (AROP): share
of people with an equivalised disposable income below 60% of the national
equivalised median income.
([3])  People at-risk-of poverty or social
exclusion (AROPE): are individuals who are at-risk-of poverty (AROP) and/or
suffering from severe material deprivation (SMD) and/or living in household
with zero or very low work intensity (LWI). 
([4])  People living in households with very
low work intensity: share of people aged 0-59 living in households where the
adults (excluding dependent children) work less than 20% of their total
work-time potential during the previous 12 months.
([5])  Number of children aged 18 or less
living in poor household over total population aged 16 or less.
([6])  The poverty figures are higher when
anchoring the poverty line at pre-crisis levels (2007 incomes). In this case
the poverty rate for 2012 is above 28% - and it is likely to be higher in 2013,
considering the further deterioration of employment in the last couple of
years. 
([7])  This corresponded to an increase from 5,237 pps (purchasing power
standards) per inhabitant in 2007 to 6,031 pps in 2011. Expenditure on social
protection include: social benefits, which consist of transfers, in cash or in
kind, to households and individuals to relieve them of the burden of a defined
set of risks or needs; administration costs, which represent the costs charged
to the scheme for its management and administration; other expenditure, which
consists of miscellaneous expenditure by social protection schemes (payment of
property income and other). 
([8])  The statistic on the financial burden of the repayment of debts from
hire purchases or loans is asked to mortgage holders. Household can choose
among the following answers: (i) “a heavy burden”, (ii) “somewhat a burden”,
and (iii)“not a problem”. The question captures households’ perceptions about
the influence of mortgage repayments and housing costs in particular, on their
financial situation more generally.
([9])  See Antràs et al. (2010) and
Crespo-Rodríguez et al. (2012).
([10]) According to Correa Lopez and Domenech
(2012), if Spain had experience the real effective exchange rate depreciation
of, say, Germany, its export market share would have increased by 20 pp
(equivalent to 6% of Spanish GDP).
([11]) See Crespo Rodríguez et al. (2012). The
authors estimated an error correction mechanism model using a sample of ten
countries for the period 1995 Q1-2011 Q3, in which the exports of each country
are were modelled as a function of the volume of world exports (general world
trade developments) and its relative price/cost competitiveness.
([12]) Indeed the emerging consensus in
academic and policy circles is that aggregate external competitiveness is an
expression of high firm-level productivity (Altomonte et al., 2012).
([13]) Hausmann et al. (2011). A sector’s complexity index is higher the
lower the number of countries capable of making the sector’s goods and the
higher the extent of product diversification of those countries. Sectoral
proximity or connectivity is a measure of the average distance of a sector to
each of the products that are exported globally. The higher the connectivity,
the greater a sector’s ability to extend exports to other sectors that may use
its productive knowledge. Accordingly, countries with the highest international
advantage in terms of product diversification will have a domestic distribution
of exports geared towards more complex and more connected sectors.
([14]) Some concerns have been voiced about the risk that Spain remains
locked into conservative tourism model, excessively reliant on costal seasonal
tourism and increasingly subject from competition from cheaper destinations
(see Valls and Perera (2012)).  
([15]) IMF (2013). 
([16]) According to Correa Lopez and Domenech
(2012), productivity in terms of value added per employee and output per
employee is respectively more than 60% and more the 200% higher in exporting
firms than in non-exporting firms.  
([17]) According to Martín and Tello (2013),
estimations suggest that Spanish firms, having controlled for their individual
and sector characteristics, do not have a lower probability of exporting than
German ones. Similar firms, in particular as regards size, have comparable propensity
to export. 
([18]) Altomonte et al. (2013) and European Commission (2013).
([19]) ECB (2012). Disentangling the weight of
the two channels is empirically complicated, since the factors that generate
productivity gains improve the competitiveness of the firm by lowering
productive costs and increasing the quality of the final product.
([20]) This discussion refers to the average
characteristics of Spanish firms. Indeed some sectors (especially the
automotive) feature an extremely high degree of participation in global value
chains, resulting in high aggregate measures of integration.
([21]) It is noteworthy that the increase in
the number of firms exporting less than EUR 5,000 was almost 70% between 2008
and 2012, whereas the number of firms exporting more than EUR 250 Mn (the
second largest group in terms of increase) increase by 26%. Yet, the
enterprises exporting the largest volumes registered the highest increase on
the intensive margin. These indicators can be taken as signals of the still
significant export potential – especially considering the high fixed costs
typically associated with penetrating in foreign markets.  
([22]) Large Spanish companies are equally, or
even more, productive compared to their European peers. A study of
Fedea-McKinsey demonstrate that Spain would have a 30% higher level of
productivity than Germany if it maintained current productivity levels, but
changed its company-size mix to resemble that of Germany. In a similar vein,
Altomonte et al. (2011) estimate that Spain's exports would be 25% higher if it
had the same industrial fabric as Germany. See also European Commission (2012).
([23]) According to Correa Lopez and Domenech (2012),
an increase of 10 employees in the median firm size (specifically, from 50 to
60 employees) would increase the probability of exporting by 1.69%. An increase
of 10 percentage points in the median of white collar workers or an increase in
foreign ownership (induced by a 10 percentage point increase in the average
share of foreign ownership) would increase the probability of exporting by
about 0.6%. By contrast, raising average expenditure on R&D and technology
adoption by 50% would increase the probability of exporting by 0.24%.
([24]) According to ICEX, the largest 100
companies (in terms of exporting volumes) were exporting 37.3% of total exports
in 2010. Preliminary data for 2013 suggest that this percentage could have gone
up to 40.2%.
([25]) The authors of the study also rely on firm-level microdata, but
propose a different methodology. Specifically changes in ULCs are decomposed
into three main components. The first component fixes the domestic market share
of each firm and multiplies it with improvements in ULC. The second component
fixes the ULC at the beginning of the period and multiplies it with the change in
market shares (i.e. a measure of re-allocation capacity of the economy). The
third component is a residual interaction effect. The authors conclude that
"[…] changes in ULCs at the firm level play an important role in
explaining the changes in ULCs relative to Germany, but the capacity to
reallocate resources between firms within a single economy is even more
important. In other words, lower resource reallocation, in comparison with
Germany, towards firms that initially had lower ULCs explains more than 50% of
the relative aggregate changes in ULCs", Crespo-Rodríguez et al. (2012).
([26]) For more details on the methodology
refer to European Commission (2013).
([27]) European Commission (2013).
([28]) See also box I.3 in the Commission
Services winter Forecasts. European Commission (2014).
([29]) Estimates are based on input-output tables using the World
Input-Output Database (WIOD).
([30]) See Martin and Tello (2013).
([31]) Spain ranks particularly low in the
UNCTAD FDI Contribution Index introduced in the 2012 World Investment Report. The
latter ranks economies on the basis of the significance of FDI and foreign
affiliates in their economy, in terms of value added, employment, wages, tax receipts,
exports, research and development (R&D) expenditures, and capital formation.
([32]) Cabrero and Tiana (2012)  suggest that as in the case of limited
penetration in foreign markets, high import dependence may be linked to
insufficient size of enterprises and limited investment in R&D
([33]) This figures is based on the COMEXT data, under the assumption of
inelastic demand for fuels and lubricants. 
([34]) Econometric evidence suggests that
consumption goods are more responsive to relative prices than are aggregate
imports, while intermediate goods are typically less responsive, due to lack of
readily available domestic substitutes. 
([35]) These simulations are based on the following hypothesis: average
GDP growth of 1.8%, average inflation of 1.9%, average domestic yield at 4.3%
and average foreign yield at 3.9%. For example if
inflation were to remain subdued over the whole next decade (e.g. 1%) the
average current account needed to attain a NIIP of -50% would increase from
1.7% of GDP to 2.3% of GDP.
([36]) These instruments are more volatile and sensitive to changes in
investors' confidence – as shown by instances of capital stops during the
crisis. Moreover fixed income instruments are non-state-contingent (i.e. they
have to be serviced whatever the economic situation of the debtor) unlike
equity (i.e. dividends are paid only if the economic situation of the “debtor”
allows it).
([37]) Trade in transport equipment
constitutes a large share of the trade between Spain and Germany and between
Spain and France. Transport equipment makes up for the largest share of Spanish
imports from Germany, 22%. Imports of chemical products and metals make up for
15 and 11% of Spanish imports from Germany respectively.  Some 26% of Spanish
exports to Germany are made up of exports of transport equipment. The flows of
intermediate and final goods produced by this industry shows how well
integrated countries are in each other's value chains. While intermediate goods
account for 60% German exports of transport equipment to Spain, final goods
account for 72% of Spanish exports of transport equipment to Germany.  French
exports to Spain also comprise to a large extent of goods produced by the
transport equipment industry, 23%, and 22% of Spanish exports to France are in
transport equipment. The second largest share of French exports to Spain is
occupied by the chemical products industries whose exports constitute 13% of
total French exports. 
([38]) For that purpose we consider, in a
multiregional setting (using the WIOD Input-Output table), a decrease of 1% in
domestic final demand in Spain. Note however that the I-O analysis captures the
spillovers through sectoral interrelation within and beyond a country's
borders. This approximation to spillovers has some shortcomings, particularly
those stemming from the assumption of a Leontief production function (no
substitution between factors). Estimations using general equilibrium approaches
(e.g. QUEST), though more aggregated in sectoral terms, do involve more complex
transmission channels.  The increase in exports is calculated using the WIOD
multi-regional Input-Output table. The table for 2011 is used. A new vector of
final demand, in which final demand in Spain is decreased by 1%, is used to
calculate sectoral output in all countries and industries and, ultimately, new
export figures by country. The model used is the standard Leontief expression: X
= (I – A )-1 FD where, X: output vector; A: matrix of technical
coefficients; FD: new final demand consisting of final consumption expenditure
by households, final consumption expenditure by non-profit organisations
serving households (NPISH), final consumption expenditure by government, gross
fixed capital formation and changes in inventories and valuables. Exports in
country 'i' are sales of each industry to intermediate demand and to final
demand in the rest of the countries.
([39]) However, the restructuring of the banks
receiving public support under the State aid rules is expected to take up to
five years.
([40]) According to the Banco de España's
Financial Stability Report (May 2013).
([41]) Regulation No. 575/2013 on prudential
requirements for credit institutions and investment firms and amending
Regulation No. 648/2012 (Official Journal of the European Union 27.06.2013).
([42]) The amendment is applicable to all
companies and covers all DTAs stemming from provisioning for (i) credit
insolvencies, (ii) foreclosed assets and (iii) pension funds for the company’s
employees. The fiscal impact of the new regulation is limited to three specific
cases (i.e. the company is not able to generate enough profits to offset
remaining DTAs within the 18-year period, insolvency or liquidation procedure
of the company, and accounting losses at the end of a concrete year) and
depends on the probability of occurrence of those events. As the new rules
apply to all companies, the total fiscal impact will also depend on the
possible effects materialising in the non-financial sector (See Box 2 in the 5th
Review Report for more details).
([43]) The upward trend in NPL has been only
interrupted by two transfers to Sareb in December 2012 and February 2013. As a
result of these transfers the overall share of construction and real estate
sectors in the overall stock of non-performing loans decreased from 58% in Q3-2012
to 45% in Q3-2013.
([44]) According to preliminary data published
by the Banco de España in November 2013, banks reported a total amount of EUR
181.3 billion of restructured loans (based on balance sheet data as of March
2013), with the bulk of these loans (roughly 73%) being classified as
substandard and non-performing.
([45]) See Menéndez and Méndez (2013).
([46]) This figure is likely underestimated as
banks do not disclose separately some urban properties.
([47]) While credit conditions remain
relatively tight, the proportion of home buyers who pay in cash has increased
significantly. Depending on the estimate, 55-70% of all houses bought in 2013
were purchased without mortgage according to J. G. Montalvo (2013).
([48]) According to the latest government estimates
(Ministerio de Fomento), there were 583,453 of empty new dwelling at the
end-2012. This number is estimated to be lower, at around 400 000, by Tinsa
(private appraisal company).
([49]) See for instance Cuerpo and Pontuch
(2013) and the OECD Economic Outlook 2013.
([50]) The Act on Flexibilization and
Promotion of the Rental Housing Market was adopted by the Spanish Parliament on
23 May 2013.
([51]) The debt-to-GDP ratio corresponding to the third quartile of the
statistical distribution using 1995 to 2008 data for the EU27 Member States.
([52]) The 'notional leverage' is the ratio of debt-to-assets adjusted
for valuation effects. In the case of households these assets also include
non-financial assets, notably dwellings. It represents an indication of the
ability of households to incur liabilities. According to the stationarity
benchmark approach, net worth must be (weakly) increasing in order for debt to
be sustainable (see Cuerpo et al., 2013). 
([53]) Already in 2012, it was estimated that households' monthly
mortgage payments have been reduced by as much as 30% when compared to the
initial date when the loan was taken (Gonzalez, 2012). 
([54]) Here debt is defined as the sum of loans and securities other than
shares. 
([55]) 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 WEO, Sept 2009). Empirical
evidence suggests that deleveraging episodes accompanied by a housing crisis
took 5 years and a half 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, reducing debt to GDP by 30 pps on average and
were accompanied by a considerable slower recovery  in GDP (see e.g.
Aspachs-Bracons, et al., 2011). Evidence presented by IMF (2012) 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%.
([56]) People aged 16 and over.
([57]) See García Montalvo (2012).
([58]) Measure of the
probability that an employed person becomes unemployed in the next month.
([59]) Source: Eurostat, Q4-2013, for people
unemployed for 12 months or more, expressed as a percentage of total
unemployment.
([60]) Estimated at 900,000 in 2012 (Source:
Draft Spanish Youth Guarantee Implementation Plan)
([61]) Source: INE, 2013, for people with
primary education.
([62]) Even before the crisis, internal migration
rates in Spain were very low, leading to a mismatch between qualified workers
and jobs (OECD, 2008a).
([63]) Source: INE.
([64]) 60.9% of total part-time employment of people
between 15 and 64 years was involuntary in 2012 (vs. 27.6% in EU-28). Source: Eurostat.
([65]) Past evidence suggests that the peak
effect of downturns on labour force participation could display a lag of up to
3 or 4 years. See OECD Economic Outlook (2011).
([66]) This difference in activity rates is
largely explained by the different age structures of both population groups.
([67]) According to national data, 24.3% of the
people leaving Spain in 2012 were people born in Spain. Of this, 59% were
Spanish nationals aged 25-39 years, and 15.3% aged 15-24. 
([68]) Partly related to national policies implemented before and in the
first years of the crisis, which have supported female and elderly
participation through, for example, child-care facilities and hiring subsidies.
([69]) An additional element to take into account
is the outcome of past and recent reforms in pension and tax and benefit
systems that contributed to the rise in the effective retirement age. These
policy developments may help explain the increased participation of elderly
workers.
([70]) See OECD (2010).
([71]) Since
mid-1990s, Spain has both restricted the conditions under which temporary
employees can be hired and sought to entice employers with incentives for
increasing the hiring under permanent contracts.
([72]) The share of new open-ended jobs
increased by 8.3% y-o-y in December 2013 (Source: Public Employment Service,
January 2014). 
([73]) The percentage of temporary employment
is also boosted by the number of fixed-term contracts of very short duration,
which may suggest the use of consecutive temporary contracts with the same
person. In 2013, 84.9% of the temporary jobs had a duration of less than 3
months (source: INE).
([74]) See García Serrano and Malo (2013).
([75]) See OECD (2013)
([76]) See Bassanini et al (2006).
([77]) See Jimeno (2011). 
([78]) Productivity per hour worked increased
up to 31.5 euro/hour worked in 2012, close to the EU-28 average of 32, but
still well below other large euro area economies (42.6 in Germany, 45.4 in
France, 45.6 in the Netherlands and 39.4 in United Kingdom). Source: Eurostat.
([79]) According to the Calmfors-Driffill
hypothesis (Calmfors and Driffill, 1988), the intermediate level of centralisation
in collective bargaining generates worse results in terms of the unemployment
rate.
([80]) See Estrada et al. (2011).
([81]) See OECD (2010).
([82]) In Q4-2013, self-employment decreased
by -0.30 y-o-y vs. a decrease of -1.35% for employees. (Source: INE)
([83]) Agreement on Employment and Collective
Bargaining 2012-2014, signed by the main business associations and trade unions
– CEOE, CEPYME, CCOO and UGT – in January 2012. 
([84]) According to national data, the share
of workers affected by adjustments in the working time varied between 15-25% in
2012 and 60.5% in 2013, although with great divergences in relation to the
firm's size. 
([85]) See Domenech (2013).
([86]) This information is provisional, covers only
the data on agreements registered up to December 2013. 
([87]) As in section 2, poverty is defined in relative terms, as the
percentage of people with an equivalised disposable income
below the risk-of-poverty threshold, which is set at 60 % of the national
median equivalised disposable income (after social transfers). Poverty is usually seen from the viewpoint of the individual
household, when trends in household size affect the number and composition of
the ‘poor’ category. The fall in the average number of children may explain the
better situation in families. 
([88]) Source: Public Employment Service,
January 2014
([89]) See Estrada et al. (2011). 
([90]) See IMF (2014).
([91]) See Crespo Rodríguez et al. (2012).
([92]) See Jimeno (2011).
([93]) The level of unemployment justifies
considering such a measure even though Spanish labour tax rates are not particularly
high by European comparison. The implicit tax rate on labour (33,5%) and the
tax wedge (37% at 67% of average wage) for 2012 were lower than the EU averages.
([94]) An often used gauge of matching
efficiency is the relationship between open vacancies and unemployment (the
Beveridge curve). Another source of unemployment persistence is the lower level
of female labour market participation.
([95]) See OECD (2013).
([96]) The Spanish Government approved the Annual Employment Plan for 2013
in August 2013. On 8 November 2013 the first distribution of funds to the
regions (totalling of €1,342.58 million) for the
implementation of active labour market policies, corresponding to 2013. The PAPE 2013 contains 33 agreed structural and strategic/policy
common objectives for all Public Employment Services (national and regional).
The strategic objectives for 2013 are: (i) Improving the employability of young
people and promote entrepreneurship; (ii) Improving the employability of other
groups particularly affected by unemployment (people older than 55, long-term
unemployed, recipients of PREPARA programme); (iii) improving the quality of
the 'professional training for employment' system, and (iv) Strengthening the
links between active and passive policies. In 2014, 40% of the funds will be
distributed according to results achieved in 2013, 25% with respect to the
strategic objectives and 15% responding to the structural ones.
([97]) See García (2011).
([98])  See
Dolado et al. (2013). 
([99]) See OECD (2012).
([100])         See García Montalvo (2013): According
to human capital theory, anticipation of lower returns to education, lead
future workers to invest less in education. In the long run, any excess supply
of highly educated entrants to the labour market will be reduced.
([101])         The assessment of progress in
the implementation of the CSRs will take place in the context of the 2014 European
Semester.