Because it holds the presidency of the European Union for the first half of 2010, Spain is at least nominally responsible for leading the trading bloc out of the current financial crisis. However, the economic outlook for 2010 is bleak: Spain has become "the sick man of Europe" after six or seven consecutive quarters of negative growth and galloping unemployment that is nearly double the European average. In 2007, Spain's unemployment rate was 8.3%. By the end of November, the rate reached 19.4%. That compares with an average rate of 10% among the 16 euro zone countries. The economic crisis has demolished Spain's labor market — making it the fly in the ointment for the government of José Luis Rodriguez Zapatero, and one of the biggest concerns of the Spanish people.
The high unemployment rate is unlikely to improve anytime soon, according to Rafael Pampillón, professor of environmental economics and country analysis at the Institute de Empresa business school. "The high unemployment that the crisis has generated – 1.6 million new unemployed – along with the rigidity of the labor market itself are going to give us an unemployment rate of more than 20% of the active population for the rest of the year, which means 4.5 million unemployed overall." This figure is consistent with the forecasts by the Organisation for Economic Cooperation and Development (OECD) and the European Commission.
Most experts say Spain's economy must grow by 2% to 2.5% annually in order to create new jobs. Yet, International Monetary Fund (IMF) forecasts show no positive GDP growth until 2011, at which point it will still be below 1%. GDP growth will not climb above 2% until 2014, according to the IMF forecast from October. For 2010, the IMF projects GDP growth at 0.75%, while other estimates suggest barely positive growh of 0.3%. And while there could be some positive growth in the first half — Pampillón says there is a chance it could hit 1% — he agrees that "we won't see growth rates of between 2% and 2.5% until 2013 or 2014."
The Public Sector Deficit
Other imbalances will continue to threaten the Spanish economy this year, notably the widening government deficit. "The public sector deficit is produced, on the one hand, by the drop in tax collections and, on the other hand, by a disastrous policy of increasing unproductive public sector spending," Pampillón says. "Public spending should grow [only] in those activities that improve the competitiveness of the economy, and that improve the productivity of corporations." In his view, neither Plan E — the government's package of economic incentives (including aid for car buyers and infrastructure) — nor the spending generated by Plan E has helped. The fiscal imbalance is producing rapid growth in public debt and a reduction in the solvency of Spain, he notes. The result: "An increase in the risk premium and the interest rates that have to be paid in order to get foreign financing."
The recession is forcing Spain to lessen its dependence on foreign investment from levels that approached a maximum of 10% of GDP prior to the crisis to only 3.6% during the third quarter of 2009, according to INE, the National Statistics Institute. "This trend will continue in coming quarters, and the increase in public spending and investment won't be enough to compensate for the major retreat in private demand. So in 2010, the need for [foreign] financing could wind up being below 3% of the GDP."
This, says Pampillón, "is permitting Spain to reduce its net indebtedness to the rest of the world".
Is the Debt Rating in Danger?
Robert Tornabell, professor of finance at ESADE Business School, says that public sector debt is one of the greatest challenges facing Spain. "There is nothing worse than having three negative factors — a high deficit, negative GDP growth and rising unemployment rates," he notes. All three "increase the rate of [loan] arrears for banks and savings banks, raise financing costs for companies and, in another vicious circle, make it harder for economic activity to recover."
These three factors have led Standard & Poor's, the credit rating agency, to lower its rating on Spain's sovereign debt from "stable" to "negative." Things could be worse. Spain at least had a relatively low level of public indebtedness when it entered the crisis, Tornabell points out. Still, in 2010, total public debt could reach 67% of GDP, compared with the 55% at the end of 2009. The worsening account balances mean that Spain, like Greece and Ireland, must now pay higher debt servicing costs. "The downgrade of Greece's public sector debt [in December, by S&P] was bad enough to force it to pay 200 basis points [2%] higher [rates] than Germany [which sets the standard]. For Spain, the new premium moved from 50 basis points to 70 basis points above the rate Germany pays. Deteriorating economic conditions in 2010 could push Spain to pay 100 basis points – or 1% — above the German rate.
Experts note that it is highly unlikely that the public sector debt will come down this year, given that rising unemployment is likely to raise unemployment compensation payments. Add to that expenses for pensions, public health (since insurance coverage in Spain reaches the entire population), and interest payments on the public debt, and "at the end of 2010, we could reach [an annual] public sector deficit that surpasses 10% of the GDP," adds Tornabell.
The collapse in public revenues and thus spending will delay growth in consumption, especially if the executive branch decides to raise value-added and personal income taxes to offset the revenue losses. But consumption will not increase until people stop fearing that they are going to lose their jobs and those out of work begin to return. As a result, there is a broad consensus in Spain that it is essential for the country to undertake labor market reforms.
For now, the government has laid out a "light" version of reform based on the direction taken by Germany. This plan seeks to avoid laying off industrial workers and, instead, reduces their hours and pays a compensatory subsidy. Experts say this approach will have a very limited impact because the Spanish model of growth in recent years has been heavily dependent on construction and services, which continue to be depressed by the financial crisis. Countries such as France and Germany, notes Pampillón, "which have already had positive growth in the second and third quarter, are putting their unemployed workers back to work in the same sectors as [they worked in] before the crisis. But in Spain, that isn't happening. We need a change in our model of production."
Now, the government is working on the Law of the Sustainable Economy, which won't take effect until the middle of 2010. Its main goal: Build an economic model based on energy efficiency and new technologies. This plan, already been approved by the parliament, has been criticized for not including structural reforms, including changes to the labor market, and any successes would take time.
Until now, it has been easier for many companies to resist the impact of the recession because of their high level of globalization, notes José Ignacio Galán Zazo, director of the Iberoamerican corporate management and corporate social responsibility department at the University of Salamanca. Notable examples of strong, global sectors in Spain include banks, such as Santander and BBVA (among the healthiest in the international sphere); energy, with companies such as the Iberdrola group and its subsidiary Iberdrola Renewables (the global leader); textiles, where the Inditex group owns such fashion firms as Zara, Berskha and Máximo Dutty); and telecommunications where Telefónica has a presence in most Latin American countries. Spain's weakness is in small and midsize companies, with their more localized reach.
Galán adds that educational reform should be an additional priority. "The weak points of our economy are its high unemployment rate and its low productivity, which are interconnected," he says. "A country that wants to be at the vanguard of development and compete on an international level needs to have markets and an educational system that match up with world-class countries." That means it needs a more advanced educational system that promotes "academic excellence and interaction with companies and society," he says. "This reform is not only urgent; it is the most significant structural variable in the twenty-first century for generating competitiveness and social and economic development."
Real Estate and Banking
Pampillón stresses another imbalance: idle capacity, which produces multiple effects. For example, on the commercial side, "bank offices have excess capacity, since many were created in order to provide loans for real estate and so forth; but now that [the volume of] such loans has been reduced, there are too many offices. The same thing happens with retail trade, where the imbalance is corrected by closing stores. This adjustment to the imbalances will be made at the cost of continuing to close down those companies that produce such goods and services." On the residential side, there is an oversupply of housing, "which is manifested in the more than one million new housing units that have not been sold, and about 300,000 units of unsold existing properties, all of which appear overpriced based on current demand. Experts agree that the real estate and financial sectors have been too slow to adjust.
The Spanish financial system is immersed in a restructuring process, particularly for savings banks, which face a very troubling 2010. Pampillón says that many banks and savings banks have assets that are tied to real estate and loans that will not be repaid as a result of high unemployment rates reflected in the rising rate of late payments and ultimately foreclosures. "They are going to have fewer loans, but more housing units among their assets." The market value of those assets could now be between 30% and 40% less than peak values. That suggests significant losses for the banks in the future, and Pampillón adds that "whether banks sell those houses or list them at their current market prices ['mark to market'], there will be significant losses. So financial institutions are going to reduce their capital, cut their own funds, and so forth; and the only way out is through a FROB [Fund for Orderly Bank Restructuring], capitalized by those institutions with public money." Ultimately, he adds, "the government will have to take control of these savings banks and [commercial] banks — which would, in effect, amount to nationalization."
To complicate matters further, the gradual withdrawal of lines of financing from the European Central Bank and the predictable rise in interest rates will raise financing costs for these institutions. Another problem, less predictable, will be the political influence that locally owned savings banks can exert, which could further restrict the flow of funds to businesses.
The Deterioration of Social Services
The short- and medium-term economic outlook is bleak, says Pampillón, "We will have to get used to very low growth and, as a result, very low tax revenues." He adds, "Although tax collections will start to grow a little bit with the [revival in] economic growth, we will nevertheless be at levels a lot lower than those of 2007." That means indebtedness will continue to grow and, sooner or later, "we will have to reduce social spending, which means the deterioration in social services and lower quality public services in education and health."
Galán notes that although Spain's immediate economic prospects are not good, "The [world's] leading countries will drive global production, and that will have a positive impact in a world that is interconnected and globalized."
Spain will also be challenged by the fact that it recently assumed the presidency of the European Union. Some in the international media have criticized the fact that Spain has been charged, in that role, with solving the European crisis. The Financial Times, for example, ran an article entitled, "A Stumbling Spain Must Guide Europe." But this great challenge, says Galán, is a great opportunity, which involves "laying the foundations of solid economic, educational and research policies that permit the competitiveness, progress and the social and economic development of the EU, in a way that enables us to compete with the U.S., China and other emerging powers. That way, when we talk about the crisis, we will be talking about the past."