The deleveraging of the Spanish economy: a long way to go

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January 8th, 2016

One of the main macroeconomic imbalances of the Spanish economy is its high levels of public and private borrowing, and a notable proportion of this debt is in foreign hands. Bringing debt down to sustainable levels is vital to improve growth capacity and reduce external vulnerability. Although the economy's total debt has started to fall in the last three years, it is still very high. A detailed analysis of the trend in debt by institutional sector, however, reveals very different situations.

In 2015 Q1,1 the non-consolidated debt of households and firms represented 70.6% and 108.1% of GDP, respectively, 14.2 and 25.0 pps lower than the peaks reached in 2010 Q2. Therefore, after five years of deleveraging, the private sector would approach more sustainable levels. If we take the euro area as our benchmark, Spanish firms reached the level of debt of its European peers in 2015 Q2. Households, however, are deleveraging somewhat more slowly as most of their debt is long-term and fewer options are available to them to deleverage. Although this debt is still 10 pps above the level of European households, if the last year's rate of reduction continues, Spanish households will reach the level of the euro area in just two years. Moreover, in a context of GDP growth and low interest rates, reducing the indebtedness ratio is compatible with positive flows of credit to the sector. Therefore excessive debt, which limited the performance of the private sector at the beginning of the recovery, is now starting to lose its role as a burden for growth.

Unlike what is happening in the private sector, public debt is still growing although it is showing some signs of stabilising. According to the excessive deficit procedure,2 this stood at 99.3% of GDP in 2015 Q3, just 0.4 percentage points below of maximum level, as a percentage of GDP, reached in 2015 Q1. In fact the increase in public debt over the last five years, namely 42.9 pps, has more than offset the fall in private debt over the same period (39.2 pps). However, this situation is likely to change very soon: in the coming quarters public debt will stabilise at around 100% of GDP and, should the expected path of deficit reduction be realised, will gradually fall.

Lastly the sector of financial institutions completes the economy as a whole. Their debt is generally not taken into account since their main function is financial intermediation and, consequently, if all their debt were included, it would be counted twice. We have therefore adjusted the level of bank debt and have only taken into account debt not used to finance the rest of the resident sectors or, in other words, debt taken out to finance other activities such as buying the shares of other companies. According to our calculations,3 the adjusted debt of financial institutions has fallen to almost zero, with a cumulative drop of 17.1 pps since the real estate bubble burst in 2007. In any case it is important to note that, from the perspective of financial institutions, total debt is relevant for the purposes of the obligations imposed on the sector.

The Spanish economy has therefore started to deleverage as a whole, albeit at a different rate in each sector. In 2015 Q2 total debt represented 279.8% of GDP, only 22.4 pps below the peak of 2012 (302.2%). Moreover, a large part of the loans and debt securities are held by non-residents, so the economy is still vulnerable to potential changes in sentiment among international investors. Specifically, in 2015 Q2 external debt represented 169.2% of GDP and, unlike total debt, shows no signs of falling. On the one hand financial institutions have reduced their direct external dependency but this has almost entirely been offset by an increase in the Bank of Spain's external debt, which channels Eurosystem funding towards the Spanish banking sector. On the other hand external public debt has increased rapidly: from less than 20.6 pps in 2007 Q2 to 50.8 pps currently. In summary, the Spanish economy is still very much in debt, especially with external lenders. The process of private sector deleveraging has almost been completed; now that there is a tail wind, the public sector should also follow suit.

1. Data from the financial accounts published by the Bank of Spain.

2. The non-consolidated debt of the public administration, according to the financial accounts, stood at 128.0% of GDP in 2015 Q2. However, it is necessary to consolidate public sector debt as, in practice, it comes from a single treasury.

3. Deposits from the rest of world and resident deposits have been added to the loans and debt securities of the liabilities of financial institutions, deducting resident loans and debt securities.