Spain: Slouching To Recovery

The recuperation of Spain’s economy will take longer than hoped.

The Spanish economy, one of the worst hit by Covid-19 in 2020, is recovering from the pandemic. However, a mix of supply-side bottlenecks such as microchip shortages and growing energy costs are affecting the pace of its healing. The risk of new pandemic waves still hangs over business, especially tourism, while the European Union’s NextGenerationEU (EU Next Gen) plan for massive spending to address climate change, healthcare and other key issues—is far from being implemented. It will take months, if not years, before its impact on Spain’s economy is felt. It may end up as a good thing in a country expected to have the world’s oldest population by 2050.

A surprising sharp revision in September of second-quarter GDP figures—down from 2.8% to 1.1% over the prior quarter—gave some economists pause. Relying heavily on services and tourism, Spain’s economy remains deeply hurt by the pandemic. Still, Q2 GDP was a robust 17.5% ahead of the prior year, according to Trading Economics.

“This revision does not change the main story,” says Miguel Cardoso, chief economist for Spain at BBVA Research. “Spain is emerging from the Covid-induced recession of 2020, but the pace of the economic growth is going to be slower than expected.”

Some economists have revised estimates downward for the full year; others may do so in the coming weeks. JP Morgan, for example, pushed back its projection for Spain returning to pre-pandemic activity levels by two quarters. Alex Muscatelli, director of the Sovereign Group at Fitch Ratings, likewise expects “that the Spanish economy will only reach its pre-pandemic level in the third quarter of 2022.”

According to BBVA’s Cardoso, Spain was expected to end 2021 with an economic growth of around 6.5%, “while it now might end the year at around 5% or 5.5%.” Spain’s GDP declined by 10.8% in 2020. Positive surprises are still possible, he says, explaining that over the summer internal demand was particularly strong. “Tourism did particularly well over the summer months. There was a lot of catching up in spending with domestic tourism—Spaniards remaining at home and visiting Spain,” says Cardoso. “BBVA data based on credit cards show that services accelerated—September spending on services is 40% over the level of 2019.”

Bottlenecks from the supply side are affecting employment and activity. Large automakers, such as Volkswagen’s SEAT subsidiary and Renault, announced partial assembly suspensions due to a lack of microchips from Asia; Spain is Europe’s second-largest car producer after Germany. “The current shortage of microchips was expected to have ended by now,” says Cardoso. “Instead, it is still going on and is now expected to last well into 2022.”

“This is of course bad for employment and the aggregate demand,” he adds.

Energy costs are surging as well. The Socialist-led coalition government has supported administrative measures to drive down household energy bills and keep inflation in check. “This is important because Spain was at risk of losing competitiveness versus the rest of Europe,” Cardoso says. “However, there are still plenty of reasons for prices to climb, for example the cost of other commodities such as oil or steel, or transportation costs.” Inflation in Germany hit a 27-year high of 3.9% annually in August; Spain’s CPI rose to 3.3% year over year the same month.

Extraordinary public spending bolstered the economy through the worst of the pandemic, but it has been scaled down this year. “We lowered our unemployment forecast for 2021 to 15.8% from 16.2%, as Spain’s ERTE [a state-backed temporary unemployment program] prevented an increase in the number of jobless,” says Fitch’s Muscatelli.

EU Next Gen Lag

How quickly Spain will benefit from the EU Next Gen plan, which consists of almost €70 billion (over $80 billion) in grants plus a smaller amount in loans, remains unknown. “We initially envisaged some concentration, especially between 2022 and 2023; but we now recognize that, likely, some of the spending will be back-loaded. At the same time, we are quite confident that the funds will be utilized in the planned way,” says Muscatelli.

The government had initially aimed to spend €25 billion of these funds in 2021; but now implementation before year end looks unlikely. Most EU NextGen projects must be approved and executed by local governments, many of which, economists say, lack the resources and understanding to move quickly in such endeavors.

One of the first plans for the use of the EU Next Gen funds is a €4.3 billion package to expand the production and use of electric vehicles and related components. Spain is a leader in the use of electric trains, but not, so far, of electric cars. The plan is to inject money into different segments of the manufacturing chain, from lithium extraction to electric battery cell assembly; and it also calls for additional private investments. The government also plans to invest in new public charging stations and other measures to promote electric cars.

Measures like these should boost long-term productivity and GDP growth. This will help Spaniards—and Europeans generally—to maintain living standards as the population ages.

“Initially, the EU Next Gen plan was presented as a countercyclical plan to help recovery from the Covid recession, but it will actually be a medium- to long-term plan to transform the European economy,” says Cardoso.

Economists say it is difficult to predict how the use of these funds will impact the structural, long-term growth of the Spanish economy. “The impact of the use of these funds on the medium-and-long-term growth potential is very important. However, now it is very difficult to forecast the exact size of the impact. For the moment, we do not make assumptions in our sovereign rating base case on the upside to our growth assessments,” says Muscatelli. Fitch currently rates Spain as A- with a stable outlook and estimates that Spain’s medium-term growth potential is around 1.2%.

Another issue is how much the European Commission is willing to use the funds—or the threat of withholding them—to pressure Spain to undertake economic reform, says José Ignacio Conde Ruiz, an economics professor at the Universidad Complutense in Madrid and the deputy director of Spain’s independent think tank Fedea. “That’s the unknown, and I think it is going to be the crucial point,” says Conde Ruiz. The Spanish government already implemented pension reform, bringing back an indexation of pension payments. But the current government, led by incumbent Prime Minister Pedro Sánchez, has little time or political space to implement unpopular reforms.

“For the next 12 to 18 months, there are no major worries for Spain,” says Steven Trypsteen, economist covering Spain and Portugal at ING. “If you look a bit further into the future, the more structural issues come to the surface. There are political problems: the divergence between political parties, the left and the right; the high level of debt; and the low structural growth, around 1%.” These factors are not new, Trypsteen notes, but “have somehow been made worse by the pandemic.”

Still, he believes the crisis has inspired a new political understanding with respect to long-term investments in technology and education. “This different mindset bids some optimism for the future,” he says. “There is a possibility that the long-haul impact [on growth and productivity] from the pandemic will be positive.”