A scenario of gradual recovery is taking shape

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June 3rd, 2013

The Spanish economy is still in recession but a scenario of gradual recovery is taking shape. GDP's rate of contraction fell in the first quarter compared with the previous period (–0.5% in 1Q 2013, –0.8% in 4Q 2012) and leading business and confidence indicators for the second quarter suggest a gentle upward trend. All this is consistent with a scenario of gradual recovery, with a second quarter in which negative growth rates will still be recorded and a second half of the year with very moderate but positive rates. Our scenario predicts a 1.4% decline in 2013 and 0.8% growth in 2014. In its latest Economic Outlook, the OECD presents a somewhat more pessimistic scenario with –1.7% growth in 2013 and 0.4% growth in 2014 (previous forecast: –1.4% and 0.5%, respectively). According to this institution, the Spanish economy will continue in recession in 2013 due to its fiscal consolidation and private sector deleveraging, undermining domestic demand. The growth of its trading partners and gains in competitiveness-cost, together with improvements in financing terms, will be the points of support for the economy.

This revitalization is being driven by the foreign sector but domestic demand is presenting a more contained deterioration. In the first quarter, GDP's rate of contraction fell thanks to the positive contribution of 0.1 points by exports and a smaller decline in domestic demand (–0.6% in 1Q 2013 compared with –2.0% in 4Q 2012). The fall in the rate of decline for domestic demand can be explained by the favourable trend of two components. On the one hand, the slump in private consumption eased notably (–0.4% in 1Q 2013 compared with –1.9% in 4Q 2012) with the disappearance of the negative effect on consumption caused by the VAT hike in the fourth quarter. Due to the same effect, capital goods investment also performed better, recording quarter-on-quarter growth of 0.1%  (compared with –5.2% in 4Q 2012). Although this improvement is partly temporary, the decline in domestic demand does not seem, for the moment, to be getting any worse (see the Focus «The points of support for domestic demand»).

Better figures for the labour market and retail sales are encouraging optimism regarding an imminent revival. In spite of the bad situation of the labour market, the most recent data indicate a somewhat more favourable trend. The number of people registered as employed with Social Security grew by 51,077 in April, a positive figure if we take into account the fact that, unlike other years, Easter fell in March. On the other hand, registered unemployment fell by 46,050 people, reducing the year-on-year rate of change by 0.8 percentage points to 5.2%. Although the recovery in the labour market will lag behind the GDP trend, as usually happens in episodes of recovery, there are increasing signs of this stabilizing. Demand indicators are also showing some improvement in line with this situation. April's retail sales rose by 0.5% monthly (%), adjusted for seasonal and calendar effects, leading to a significant rise in the year-on-year rate of change from –8.7% in March to –5.5% in April. Although consumer confidence fell slightly in May, it stood at –31.6 points, above the average for the first quarter (–32.6). The current level of these indicators is still compatible with a decline in private consumption in the second quarter but the rate will be lower.

Leading supply indicators are showing an upward trend but remain in the contraction zone. Industrial production improved substantially in March with a year-on-year change, adjusted for calendar effects, that went from –6.9% in February to –0.6% in March. Although this series is erratic and consequently part of the increase is likely to correct itself over the coming months, the upward trend seems to gradually be consolidating. The PMI manufacturing index improved slightly in April but, with 44.7 points, remained in the zone of recession. The confidence index for industry also increased in May (–14.7) compared to its figure for April (–17.4). On the whole, supply indicators seem to confirm the positive trend observed since June 2012, pointing to the slowdown in activity easing.

The real estate sector has cooled down again due to the end of tax incentives for buying a home. The construction sector is continuing to adjust and has now accumulated 5 consecutive years of contraction. Sales were only boosted temporarily by tax incentives in force up to December 2012. In March, sales fell once again by 12.6%  year-on-year. At the same time the number of mortgages granted is also continuing to fall: in March these were down 34.1% year-on-year. As long as domestic demand goes on recovering, household deleveraging diminishes and sources of financing recover, the real estate industry will tend to stabilize.

The restructuring of the banking sector is making good headway but is still not complete. With tensions diminishing in the sovereign debt market, banks' funding conditions have also improved: banks have issued bonds and mortgage-backed securities at a reasonable cost. Other signs of the sector getting back to normal are the fact that they are increasingly less reliant on the Eurosystem and non-resident sources of funding have stabilized. In an additional effort of transparency to ascertain the quality of all the assets on banks' balance sheets, the Bank of Spain has toughened up the criteria to classify refinanced and restructured loans. These loans total over 208 billion euros for the sector as a whole. Of these, 37% are doubtful loans and are 41% covered by reserves, while 21% are classified as substandard and are 18% covered. The new classification criteria could lead to more provisions being required.

The points of support for the economy are the foreign sector and an agenda of encouraging reforms. The Spanish economy's external imbalance has been corrected: in the first quarter, the current account balance posted its first surplus since 1997. This has largely been possible thanks to the good performance by the goods balance which, in March, posted its first trade surplus in five decades (634.9 million euros in March compared with a deficit of 3.3 billion in 2012). This correction was due to the 20.8% year-on-year increase in sales outside the euro area and to the 15.0% decrease in imports thanks to falling oil prices. We expect the current balance to continue growing throughout the year (see the Focus «Current correction... sustainable?»). This is mostly possible due to the significant gains in competitiveness achieved over the last few years. In particular, unit labour costs have adjusted considerably, a trend that continued in the first quarter (–3.2% year-on-year) and which the bulk of the evidence available suggests will continue in the coming quarters.

The latest tourism figures reinforce the role being played by the foreign sector as the driving force for the economy. Entries by foreign visitors picked up in April (increasing by 3.1% year-on-year), a good figure if we take into account
the fact that, unlike other years, Easter was in March. If we add together March and April and thereby eliminate the effect of Easter, this year-on-year change rises to 5.2%, a notable increase compared with the beginning of the year. Should the trend observed between January and April continue, the number of tourists entering Spain could reach 59 million this year, close to the record figure achieved in 2008.

The EC is prioritizing growth, relaxing its deficit targets and defining a strict agenda of structural reforms. The new deficit targets are slightly less strict than those contained in the Stability Programme. Specifically, these are 6.5% for 2013, 5.8% for 2014 and 4.2% for 2015 (instead of 6.3%, 5.5% and 4.1%). For 2013, the EC estimates that the measures announced will be enough to meet this target but, as from 2014, new measures must be approved. For the time being, the latest budget spending figures provided by the central government show that the deficit up to April (2.4 points of GDP) is similar to the one recorded in 2012. Given that, for the whole of the year, the government deficit must fall by 0.3 percentage points, greater effort is very likely in the coming quarters. For their part, the autonomous communities have a larger deviation with their deficit increasing by 0.1 points compared with 2012, while they need to reduce this by 0.5 points. However, this figure must be analyzed with caution as it only corresponds to one quarter. Moreover, a comparison with the balance at this time last year could be misleading as most of the adjustment took place during the second half of 2012. The EC is stressing the need to continue making progress in structural reforms and has set a demanding schedule. With regard to the labour market, there is a need to evaluate the labour reform of 2012 and present modifications (if necessary) in September. In the fiscal sphere, the sustainability factor must be incorporated into pensions by the end of 2013 and the tax system revised by March 2014. In the area of energy, the electricity tariff deficit must be tackled. And, moreover, a range of draft bills must be passed and  implemented, such as the one on the single market, the reform of local administration and the entrepreneur act, among others.