Spain Takes A Breather

Not so very long ago, Spain’s economy was firing on all cylinders, with GDP growing more than expected, and outpacing the rest of the European Union. But since 2015, with exports slowing and tourists heading to different destinations, GDP growth has been decelerating. Nevertheless, Spain is still outperforming the Continent, and is expected to continue to do so, at least in the next few years, despite political turnover in Madrid, royal scandals and the disruption caused by Catalonia’s messy demand for independence.

“The Spanish economy has been one of the outperformers of the euro area ever since it came out of the recession in 2013,” says Antonio Montilla, European economist at BNP in London. “Over this period, we have seen the economy growing very strongly, something around 3% over the last three years, which is unprecedented in recent history. This is expected to continue.”

According to the IMF World Economic Outlook, in the three years from 2015, Spain’s GDP rose an average of 3.3%, against 2.1% for the euro area and 2.4% for the EU as a whole. Now it is expected to retreat. This year, Spain’s GDP is expected to expand 2.7%, down from 3% last year but still well above the 2% seen for the rest of the eurozone.

“After such a long period of growth, the current deceleration is natural; and the issue is whether the Spanish rate of growth will tend to converge back to its normal growth rate,” says Montilla. “We are probably approaching that convergence, but Spain keeps expanding above the eurozone average.” Montilla is still looking for a 2% average growth rate in 2019, and just 1.5% for the eurozone. “The story here is that the economy is slowing at a faster pace compared to the eurozone,” he says. “But it continues to perform better than average and it should continue to do so at least until 2019.”

External Factors Turn Neutral

Spain’s recent brisk turnaround followed the deepest financial and economic crisis of the post-Franco decades. The 2008 deflation of the property-market bubble hit the banking system hard, and then, one by one, all the country’s major industries. In 2012, Spain’s European partners bailed it out, yet the following year, the economy contracted nearly 2% anyway, as unemployment surged past 26%. After such a sharp recession, radical job-market reform and a deleveraging of private debt triggered a recovery; a multitude of new firms and businesses added breadth and dynamism to the old mix of construction and a few large and traditional companies.

External factors also gave the economy an extra boost. Oil prices hit a record low, the euro was devalued, and terrorism scares in other popular destinations such as Turkey and North Africa drove tourists back to Spain—all of which supported the economic expansion. Most of these favorable external elements are now played out, however.

“All good things come to an end; and most of these positive external factors have now turned out neutral, or even negative,” says Angel Ubide, head of economic research for Global Fixed Income at Citadel. “Oil prices have gone up. The euro has appreciated a little bit. Interest rates have stopped falling. Tourism is still very good, but no longer exceptional. What we are seeing this year is a small deceleration with respect to the unsustainable fast pace of the last two or three years.”

Exports are expected to pick up again. “Between 60% and 70% of Spanish exports go to Europe; and we think that some of this slowdown is temporary, as European demand is going to pick up going forward,” says Miguel Cardoso, chief economist for Spain at BBVA Research—although in the case of tourism, he adds, the slowdown may be more lasting. “It worries us a little bit more, because for the last three to four years Spain has been benefiting from the uncertainty that we’ve seen in some of the competitor countries. And it seems that an improved perception regarding security in some of those destinations might be behind the deterioration in tourism flows to Spain.”

Open Questions

The wild card in this guardedly optimistic scenario is Catalonia: Will the political turmoil in this rich region spill over into the economic realm? A year after Catalonia unilaterally declared its independence from the central government in October 2017, only small, inconclusive signs are emerging in the data.

“We’ve seen a slowdown specifically in Catalonia, and that also is important to note,” says Cardoso. “It’s very, very difficult to say what’s behind this trend, and there are several elements affecting it. For sure there is the political uncertainty; but there is also, for example, the terrorist attack that Catalonia suffered just over a year ago.” Cardoso also notes a decline in the growth of Catalonians enrolled in social security.

The dramatic declaration of independence and Madrid’s decision to jail the region’s leaders have created a state of uncertainty that will remain at least until their trial and the next regional election—with no dates set for either. “Catalonia is in limbo,” says Ubide. “Is that bad for the Catalan economy? Probably, at the margin, yes. But is that bad for Spain as a whole?” He points out that some investment that might have otherwise gone to Catalonia may now be bound for Madrid or Valencia. “The latest regional numbers I have seen show that Catalonia has a slowdown stronger than the national average,” he says, “but that is not necessarily conclusive of what the future will bring to the region.”

Spain’s other big—and traditional—hurdle is the jobs market. Much of the country’s economic future will depend on whether new jobs are able to generate higher revenue. “Employment has registered remarkable growth in recent years,” says Antonio Cortina, deputy director of economic research at Banco Santander. “The unemployment rate has been reduced from 27% to around 15%, thanks to growth, competitive improvements of Spanish companies and the labor reforms undertaken during the crisis.” A 15% rate of unemployment is still high, however; Spain must carry off the trick of reducing that figure while increasing labor income.

In Santander’s baseline scenario, unemployment drops to around 11% in 2021. “The fundamental challenge now is to promote more-inclusive growth by reducing the duality of the labor market, boosting productivity and improving wages, particularly in the lower income segments,” says Cortina. That will, he adds, require another application of reformist energy to the labor market. But with growth, at least, the government has some breathing room.