COUNTRY REPORT: SPAIN
Although the hardships are far from over, the Spanish economy and banking system may finally be on the mend.
The Spanish economy is regaining its mojo. It is hard to pinpoint any one factor responsible for the newfound resilience, since several components interrelate in a virtuous cycle. Three elements, though, stand out: rebounding exports, consumer confidence, and commitment to reform geared toward economic adjustments.
The speed of recovery has taken many by surprise. Jordi Gual, chief economist at Spanish bank La Caixa, recalls it was “hard to defend” his bank’s optimism two years ago, but “we were convinced the fruits of economic adjustments taking place would be reaped.” Spanish authorities and European leaders worked in tandem, reinforced by the assurance of the European Central Bank that the eurozone’s periphery economies would not be allowed to collapse. Concurrently, Spain was boosting productivity, controlling unit labor costs and improving competitiveness, which together has led to a current-account surplus.
| Barroso, Teneo Intelligence: “The jury is still out on the relative impact of labor agreements versus government policy change.” |
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Consumer confidence underlies the new flush of health. “Spending climbed up off the floor during the second half of 2013. The government was clearly no longer contemplating continued austerity measures, as in 20112013, except perhaps a bit more tinkering,” says Raj Badiani, senior principal economist at research firm IHS Global Insight.
In late 2013 the government reintroduced its customary Christmas bonus for public-sector workers (normally two months’ salary). By then employment was starting to pick up, driven by improved productivity. But how much of that improvement was derived from agreements between employers and unions and how much from government policies? “The jury is still out on that,” says Antonio Barroso, senior vice president at Teneo Intelligence. In the auto sector, for example, Ford, Renault, General Motors and Volkswagen had already been transferring production from other countries, attracted by a comparatively cheap Spanish workforce. “Those car industry agreements preceded the government reforms,” Barroso points out.
But the government has played its role, too, enacting legislation for 20122014 to moderate wages and increase internal flexibility. Collective bargaining, for instance, lets firms opt out of sector-wide bargaining to avoid the rigidity imposed across an entire industry. Work time can be more rationally distributed, say, over weekends and weekdays, to address fluctuations in orders. Rules for fair dismissal have been clarified. In addition, government programs for retraining and skill building are under way. The goal has been “to allow adjustment not by laying people off, but instead by adjusting wages,” says Fernando Navarrete, chief financial officer at development bank Instituto de Crédito Oficial (ICO).
Other employment regulations promote new hires for small businesses. The incentives include one-year trial periods, tax breaks and more part-time flexibility. Barroso expresses some concern over the gap between those with fixed, protected contracts, severance pay and job security, and those with temporary contracts. “It has created a dual labor market,” he explains. “It’s hard to fire those with fixed contracts, so employers rely on short contracts and create precarious work.”
The question now is: What economic growth rate—and in what areas—will encourage new jobs? During the bubble years, the economy was adding workers at an unrealistic rate, so those pre-crisis numbers no longer apply. “Historically, Spain needed several quarters with GDP [growth] over 2% for job creation,” says Navarrete. This time, though, the recent labor reforms might help generate jobs at lower rates.
GFmag.com Data Summary: Spain | Central Bank: Bank of Spain |
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International Reserves |
$46.7 billion |
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Gross Domestic Product (GDP) |
$1,387 billion |
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Real GDP Growth |
2010 -0.2% |
2011 0.1% |
2012 -1.6% |
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GDP Per Capita—Current Prices |
$29,797 |
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GDP—Composition By Sector* |
Agriculture |
Industry |
Services |
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Inflation |
2010 2.0% |
2011 3.1% |
2012 2.4% |
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Public Debt (general government |
2010 61.7% |
2011 70.5% |
2012 85.9% |
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Government Bond Ratings (foreign currency) |
Standard & Poor’s BBB- |
Moody’s Baa2 |
Moody’s Outlook POS |
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FDI Inflows |
2009 $8,411 million |
2010 $9,038 million |
2011 $15,876 million |
* Estimate Sources: GFMag.com, OECD, World Bank
SUPPLY-AND-DEMAND EQUATION
| Navarrete, ICO: “The goal has been to allow adjustment not by laying people off, but instead by adjusting wages. |
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The strengthening economy is now translating into investment demand, both for credit to support the export side and for internal demand across all sectors. Thus, supply and demand are rising together. “The banking sector has started to generate positive growth in new loans granted to the private sector, coupled with substantial improvements in funding conditions,” Navarrete notes. “It’s a good sign that firms are now asking for credit for investment and not just working capital.” Navarrete has a unique perspective on the state of business liquidity: ICO provides funding to banks, contingent on their lending to SMEs. As a purely wholesale institution, ICO does not compete with commercial banks through direct contact with SMEs. “Our role is to obtain advantageous funding and pass it on to SMEs, as a public-private partnership,” Navarrete explains. “Eleven percent of [Spanish] SME loans [with a maturity of] over one year are channeled through our products.”
After its brutal thrashing during the European financial crisis, Spain’s banking sector is not yet out of the woods. “We have seen green shoots of sorts,” Badiani confirms, but nonperforming loans are still mounting. Recent information from the Bank of Spain suggests that although new credit to households and nonfinancial firms is increasing, the overall loan stock continues to slip, with deleveraging continuing for consumers and corporates. But the sector is on the mend, thanks to increased provisions for NPLs, consolidation among savings banks and the creation of a “bad bank” to absorb toxic real estate loans.
| Badiani, IHS Global Insight: “Speanding climbed up off the floor during the second half of 2013.” |
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Establishing a bad bank was the final necessary step. Now that the industry’s balance sheet has shed toxic loans, banks can reopen normal credit channels. Meanwhile, ironically, the reorganization creates another headwind, making certain institutions “very nervous,” according to Badiani. Across the board, banks obtained massive portfolios of repossessed property, which they intended to hold until prices recovered. Nevertheless, prices kept falling, causing some panic; the central bank pressured the banks to release repossessed real estate onto the market; and the bad bank has been absorbing toxic assets at such cheap and discounted rates that it undercuts other banks’ holdings.
Housing prices fell by 37% from 2007 to 2013, a number that may even underestimate the extent of the drop, as prices reflect initial valuations rather than final transactions. Badiani foresees a trough in 2015, for a total decline of over 50% since the crisis. Employees with permanent contracts comprise the majority of mortgage holders in the €600 billion ($823 billion) retail mortgage market. Since the labor reforms, it has become easier for firms to terminate those contracts and offer less severance, putting more mortgage payments at risk.
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Gual, La Caixa: |
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How close real estate prices are to the bottom remains questionable, but foreigners have already begun to snap up perceived bargains, especially commercial opportunities like shopping malls. La Caixa’s Gual distinguishes two types of foreign buyers. Short-term investors, like distressed funds, anticipate returns in two or three years. He says, “We also have those with longer-term orientation, like family offices, who don’t expect such a quick recovery and plan to use the assets in the rental market.”
The town of Seseña, situated between Madrid and Toledo, symbolizes the dilemma. The site of speculative developments during the bubble, it still remains “a ghost town, in the middle of nowhere,” says Teneo Intelligence’s Barroso. “Houses are hard to sell in such an isolated area.”
Gual sounds a hopeful note for Spain’s banks. Assistance programs offered through the European Commission, the ECB and the International Monetary Fund have been successfully completed, using less than half of available funds, he notes. The restructured banking industry has reduced capacity by 25% to 30%, as it has boosted capital, liquidity and loan-to-deposit ratios. The system still faces stress tests and a quality assessment review by the ECB, “but we expect no major surprises,” he says, confident the NPL ratio will soon level off: “The banking industry’s balance sheet is much healthier [now] than two years ago, which is why we have seen share prices rebound and a price-to-book ratio around one.”
“It’s hard to fire those with fixed contracts, so employers rely on short contracts and create precarious work.”
– Antonio Barroso, Teneo Intelligence
The list of challenges for Spain to overcome on the path to economic wellness remains daunting: The recovery is still patchy and might be temporary rather than structural. The dynamic export sector does not reach many SMEs, which employ the bulk of the labor force. Unemployment is still high, especially among the young, removing a leg of potential support for housing. The eurozone imposes strong discipline, but an external shock could derail progress.
The bottom line: Optimism is justifiable, but it is too soon to be sure growth will be sustainable.
