Domestic demand joins the growth

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February 7th, 2014

Improvement in the growth scenario for 2014. The latest economic figures are helping to face this year with renewed optimism. January's business indicators have maintained the upward trend they enjoyed at the end of 2013, which closed with GDP growth of 0.3% quarter-on-quarter in Q4. Moreover, growth is consolidating on increasingly solid foundations: there is notable recovery in domestic demand and the foreign sector continues to make gains in competitiveness. Given this outlook, the IMF has significantly raised its growth forecasts for Spain for 2014, from 0.2% to 0.6% annually, one of the biggest revisions among developed countries. Nonetheless, our own growth forecasts for this year are higher. The dynamism seen in domestic demand over the last few months, slightly above what we previously predicted, has led us to revise our annual growth forecast to 1.0% (compared with 0.8% previously). In this scenario, the Spanish economy will once again create jobs for the first time since 2007, with the employment rate rising by 0.6% annually. All this without forgetting the support for growth provided by the foreign sector, allowing a further advance in the current surplus to 1.6% of GDP in 2014. However, this improvement in the economic outlook must be interpreted with caution. In spite of leaving behind the biggest recession of the last few decades, getting back onto a sustainable path of long-term growth and correcting the imbalances present in the economy is still no easy task.

The recovery in domestic demand consolidates the exit from the recession. The upward trend over the last few months demonstrates a rebalancing of the supports for the economy. According to the Bank of Spain, growth in GDP in 2013 Q4 was exclusively due to the contribution from domestic demand (namely 0.3 p.p.). This performance contrasts with its weakness in the last recession. The recovery in retail and consumer goods and in industrial production of the final months of last year would therefore suggest a significant contribution from consumption and investment to growth in Q4.

Confidence continues to rise at the start of 2014 and augurs a further increase in consumption and investment. The improved expectations of economic agents are essential to maintain the gradual advance in domestic demand. In this respect, of note is the increase in consumer confidence in January which, boosted by the better perspectives  surrounding the labour market, could be giving rise to decisions to consume that had been postponed until now. This will continue to reduce the savings rate in 2013 Q4, after decreasing by 0.1 percentage points the previous quarter, down to 10.5% of gross income. With regard to investment, the significant advance in industrial confidence should consolidate the recovery in investment for the coming quarters, good news given the sharp decline recorded over the last few years.

The labour market's change in trend has been confirmed: the Spanish economy started to create jobs again in 2013 Q4. Reviving the labour market is still a priority for the Spanish economy. Unlike what has happened over the last few years, the labour force survey for 2013 Q4 provided good news. In spite of that quarter's drop in the number of employees (65,000 workers), if we take seasonal factors into account (Q4 tends to be a period of net job losses), employment grew by 0.3% quarter-on-quarter, the first increase since 2008 Q1. With a view to 2014, we expect the economy's growth (above 0.3% quarter-on-quarter throughout the year) to generate net employment, with an annual increase in employment of 0.6% (see the Focus «Job creation will come at differing speeds» published in last November's Monthly Report). In these circumstances, the unemployment rate will fall in 2014 to 25.2% (compared with 26.4% recorded for the whole of 2013).

The recovery in consumption is not enough to allay fears of deflation. January's figures show a drop in inflation from December's rate of 0.3% to 0.2%. The fall in energy prices would explain a large part of this drop. Over the coming months, we expect the greater dynamism in private consumption to put inflation to get back on an upward path. However, there are three factors that could keep the rate of growth in prices at a moderate level. Firstly, if the downward pressure on energy prices continues over the coming months. Secondly, the weak trend in prices for industrial goods which, in December 2013, fell by 0.5% year-on-year. Lastly, the wage moderation observed over the last few years could also continue to slow up price rises. In 2013, the average wages agreed in collective bargaining agreements grew, on average, by 0.6% annually, far from the 3.6% recorded in 2008. As a result of all this, we expect inflation to remain at relatively low levels throughout 2014, below the figure for the euro area.

Deleveraging progresses apace. In 2010, Spain's private sector had one of the highest debt levels of all the countries in the euro area. Since then, and in spite of the difficult economic situation, both households and non-financial firms have managed to significantly reduce their levels of debt to 78.2% (87.5% in 2010 Q2) and 130.8% of GDP (144.0% in 2010 Q3) respectively, reaching similar levels to those of 2007. Given that private sector deleveraging is not complete yet, we expect this to continue slowing up the consumption and investment of economic agents. However, the economy's change in trend, together with the reduction in the interest burden over the last few months, will help to reduce the impact of deleveraging on growth.

Temporary slowdown in the foreign sector at the end of 2013. After a promising start to 2013, exports lost steam in the last few months of the year with zero contribution to GDP growth in 2013 Q4. In spite of the good tourist season in 2013, with a record total of 60.7 million foreign visitors, the current account surplus slowed up its growth rate recorded throughout the year. In November, the cumulative balance for the last twelve months fell slightly to 7.8 billion euros, endangering our prediction of a surplus for the year as a whole of 1.1% of GDP. The performance of the trade balance would explain this lower growth. In November, exports of goods were down by 2.2% year-on-year, hindered by the widespread drop in sales to outside the euro area and particularly to the USA (–15.2% year-on-year). However, the bulk of the evidence available suggests that this is just a temporary reduction. The forecast for exports by Spanish firms rose significantly in 2013 Q4, with North America being precisely one of the markets with the best prospects for trade. Consolidation of growth in the euro area will also help exports to recover.

The bank bail-out programme has been completed satisfactorily. In general, the conclusion reached by the European Commission and ECB is positive: financial supervision has improved and the banking sector has healthier balance sheets. This improvement has allowed banks to return to their traditional sources of wholesale funding: in January, issuances of bank debt were successful, auguring less dependence on Eurosystem funding which, in December, had already fallen to 201.9 billion euros. Moreover, according to the EC's report, credit to the private sector will touch bottom in 2014. In this respect, the figures from November 2013 show a lower rate of decrease in credit, namely 12.6%  year-on-year (compared with 13.0% in October). In spite of these signs of improvement, the EC warns that reforms should continue in order to consolidate the restructuring of the sector.

The efforts being made towards fiscal consolidation must continue. Adjustment of the fiscal balance lost steam at the end of 2013. The latest data available point towards a deviation from the deficit target that we estimate at 0.2 percentage points, up to 6.7% of GDP (7.2% if we include losses due to the bank bail-out). A smaller adjustment than required by the central government and autonomous communities would explain this deviation. This performance contrasts with Social Security's room to manoeuvre seen in November, with a cumulative deficit of 0.3% of GDP (1.1 p.p. below the target). However, the breakdown of revenue shown by this good figure is due, in part, to the increase in current transfers (mainly by the central government), going from 11.5 billion euros between January and November 2012 to 18.8 billion euros last year. With a view to 2014, the recovery in the economy and the gradual fall in the cost of financing Spain's public debt should help the deficit target to be reached, namely 5.8% of GDP.