Hard Hit Spain

From high growth to laggard status, Spain has felt the pandemic’s economic sting. Now, a budget crisis threatens its recovery.

Hit by the worst recession since its civil war more than 80 years ago, Spain is one of the countries struggling hardest with the Covid-19 pandemic. The virus struck early and severely, and its impact on the economy has been nasty. Despite a superstrict lockdown in April, May and June, the country is experiencing fresh outbreaks that are impairing its efforts for a faster economic recovery.

Before the coronavirus, Spain was growing faster than its peers in the eurozone, at 2.8% per year according to the IMF; and it was an economic motor for the region. But three months of lockdown left public spaces and private pockets empty. In the second quarter, Spain was the worst performer in the eurozone; GDP shrank 21.5%, almost double the contraction that Germany experienced, according to revised Eurostat data.

“Over the first two quarters of 2020, the Spanish economy performed worse than other economies because it relies more on industries that are more affected by social distancing, such as leisure and tourism—and because of longer, more intense lockdown measures,” says Miguel Cardoso, chief economist for Spain at BBVA Research in Madrid.

How the country will recover depends a great deal not only on how the health crisis plays out, but also on how its multiparty coalition government is able to leverage European aid in the coming months.

“A further pickup in activity will be highly dependent on the containment of the health crisis,” a September report by the International Monetary Fund cautioned. “We currently project an annual loss of real output in 2020 of 12.8%. For 2021, real GDP could grow by 7.2%, helped by the utilization of the EU Recovery and Resilience Facility and its confidence effects.” But a rebound will depend on Spain’s ability to limit new infections, and it will take years for the economy to return to precrisis levels, the report added.

The IMF sees a GDP decline of around 13%, with a 6% to 7% recovery in 2021; but no analysts predict a return to a pre-Covid path before the end of 2022.

“Forget the ‘V’ shape of the recession,” says Juan Carlos Conesa, professor of economics at Stony Brook University in New York. “The pandemic has already lasted enough to produce long-term impact. There is a second wave of Covid cases in Spain, and this is bad.”

The recovery thus far in the second half has been very uneven, says Cardoso, highlighted by a pickup in consumer spending on food, technology and furniture. Major sectors like tourism, restaurants and hotels, however, remain far from rebounding.

The unemployment rate, a traditional weak point of the Spanish economy, rose to 16.2% in August, the highest and double the average rate in the eurozone; but economists were surprised it didn’t move higher, given the sharp GDP drop. Some expect it to do so in the coming months. Discouraged unemployed workers do not yet appear to be seeking replacement jobs and are expected to be out of work in 2021.

The Covid recession is different from previous ones in other ways as well. While past downturns sparked a boost in productivity, as less efficient businesses were replaced with more productive ones when the economy picked up again, that is unlikely to happen this time.

“This recession has hit, in particular, hotels and bars and activities that will reopen when the crisis is over without any relevant improvement in productivity,” says Conesa, who notes that Spain’s total factor of productivity has remained flat since the mid-1990s. “This is a big deal, because resources are going from more productive to less productive activities; and this is the opposite of what’s needed to keep developing and growing.”

Budget Stalemate

Expansionary fiscal and monetary policies have provided support and a lifeline to the economy this year, but uncertainty remains as to how fiscal policy will develop in the coming months. The big question mark,” says Cardoso, is the €1.8 trillion (about $2.2 trillion) recovery package. That includes the €750 billion European Recovery Fund, the fiscal stimulus deal reached in July by the 27 European leaders, and more than €1 trillion to be contributed over the next seven years by EU member states under the Multiannual Financial Framework.

The left-wing government that took power in January, a coalition of Prime Minister Pedro Sánchez’ Socialist Workers Party and the left-wing United We Can, plus independents, is trying to pass the country’s first budget in more than two years while the center-right opposition wants an independent agency to administer spending. The result is stalemate, despite the fact that a fast, efficient decision that gets funds circulating could make a big difference in the years to come. “The biggest impact from the European Recovery Fund could arrive in the second part of 2021, first part of 2022,” says Cardoso. “The domestic political talks are putting at risk the impact of the spending from the fund and its results. In Europe there will be two-speed economies, where countries with a stronger majority and a more common policy will have an advantage.”

But there is also a risk that the money will go to projects that are less effective at sparking long-term growth but that help to buy short-term political consensus.

“There is a concrete risk that most countries will go through a period of what Americans call ‘pork-barrel’ spending: a splurge to create political support, not aimed at long-term growth,” says Conesa. “Spain does not have a good track record in using productive resources in a short period of time.”

Rating agencies are eyeing the budgetary process closely. Standard & Poor’s currently gives Spain an A rating with a negative outlook while Moody’s places it at Baa1 and Fitch at A-. Both Moody’s and Fitch call the outlook stable.

Fitch’s outlook reflects the agency’s assessment of the resilience and performance of the Spanish economy in the years since it recovered from the global financial crisis, says Alex Muscatelli, director of the sovereign team in Fitch’s Frankfurt office, adding that the agency will review its outlook in December.

“Spain entered the financial crisis with sharp domestic imbalances in the real estate sector that were also reflected in a very high current account deficit,” he says. “These balances have been unwound. There has been a substantial correction on the balance sheets of companies and households as well as on the external accounts. The economy had rebalanced and was growing at a decent rate. We saw some reforms in the economy, especially in the labor markets. We have seen fewer improvements in public finances and in debt consolidation; but overall, we had a positive picture of the Spanish economy.”

Government estimates see Spain reaching a sovereign debt-to-GDP level of as much as 115.5% by the end of the year. As the recession drags on, the financial services industry is expected to suffer, with some likely worsening in credit quality. In September, the megaunion of CaixaBank and Bankia—itself the result of a merger of seven regional savings banks that came close to collapse during the financial crisis—reveals a banking system that is still preparing itself for whatever difficulties may lie ahead.

Many Spaniards, however, look on the bright side.

“There is room to be surprised by positive news,” says Cardoso. “In one year, we can have an effective vaccine or, more generally, an effective way to contain the contagion, which will combine with an expansionary European fiscal policy. Things will be much better than most people expect, us included.”