The future of the euro, a focus on the Spanish Economy

 Katia Velasco subdirectora del Master en International Finance del IEBThe Spanish economy comes from a difficult position. The loose monetary and credit policies led to excessive private sector indebtedness and a housing bubble (house prices rose 82%) between 2003 and 2008 which then burst. The burst of the housing bubble had a number of consequences:

• Deterioration of the labour market, unemployment rose from 8.3% in 2006 to 21.6% in 2011.
• Deterioration of the financial sector solvency and balance sheets due to its exposure to the real estate sector.
• Lack of control in public accounts, as a result of a strong discretionary fiscal expansion.
• Weak economic performance and a double dip recession.

Is there light at the end of the tunnel? There appear to be some good news:

• Declining Unit Labour Costs are boosting competitiveness. The adjustment in ULC has been heterogeneous across economic sectors; from ‐21.9% in the construction sector to ‐4.3% in the services sector.
• Export‐led growth has been sustained by gains in relative productivity.
• Aggressive clean-up of balance sheets in the Financial Sector is ongoing.
• The private sector is de-leveraging at a fast speed.

Also, the Spanish Government has introduced a two pillar approach to promote growth and reduce the deficit:

1. Public sector reform, fiscal consolidation and discipline: Stability Programme (SP) 2012-2015 to strengthen the structural fiscal framework and introduce budget austerity.
2. Private sector structural reform: National Reform Programme (NRP) 2012 including important Labour market reforms.

The Government also expects negative growth in National Demand to be partially offset by export‐led growth in 2012 and 2013, private consumption and investment to resume growth in 2014, a public deficit of 5.3% of GDP in 2012, an unaltered the target of 3% for 2013, and a Debt to GDP ratio reduction starting from 2014 onwards.  However, it´s not all good news. Having recorded a deficit in 2011 of 8.51%, Spain will unlikely meet its European deficit target of 5% in 2012. Current Spanish deficit forecasts are 6.4% from Brussels and 6.8% from the IMF. Also, there are other non-neglectable threats to the Government´s outlook, some of which include:

• The medium term nature of the benefits of the reforms. In the medium term, and up to 2015, the average Spaniard will see purchasing power continue to drop due to the recently introduced labour reforms.
• Also, do these reforms come too late? For example, wouldn´t it have been easier to introduce unemployment benefit cuts when unemployment was 8% rather than today´s 25%? The timing and medium term nature of the reforms could cause social unrest.
• Change to the political environment. Spain will hold its next general election in November 2015.
• Last but not least, private consumption and investment may resume growth much later than 2014. Partly as a consequence of European growth being lower than forecasted, partly due to high unemployment persisting and house prices continuing to fall. According to Fitch house prices will continue to fall until 2014 (having fallen 40% since 2008 prices).

Some clouds seem to have lifted for Spain, however, there is a long road ahead for the Spanish economy to recover and it will most probably not be a smooth ride.