The Spanish economy's recovery has consolidated in 3Q 2013

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October 3rd, 2013

The Spanish economy's recovery has consolidated in 3Q 2013. Leading activity and confidence indicators have not disappointed and are continuing the upward trend they have been following since almost the start of the year. In fact, the latest data available point to the Spanish economy having already got back on the path of growth. For example, both the PMI for manufacturing and services surpassed the levels as from which, historically, economic activity usually posts positive rates of growth. Moreover, the entrance of new orders in both sectors means we can be relatively optimistic about their trend for the rest of the year. All this would confirm our scenario of recovery in the second half of the year. However, we expect the still weak domestic demand to keep this rate of growth moderate (0.1% quarter-on-quarter in 3Q and 4Q 2013).

The foreign sector continues to lead the recovery. As has been the case almost non-stop since 2008, the support provided by the foreign sector to growth is still crucial. The figures for goods exports show a slowdown in demand from the emerging countries. However, this is being offset by a rise in purchases from European countries. The economic recovery of the euro area, Spain's main trading partner, lies behind this revival. A similar performance can be seen in the case of foreign tourist visits which, boosted by the upswing in visits by European tourists (accounting for more than 90% of the total), are on the way to recording the best summer season in history with 22.5 million tourists coming to Spain between June and August. The opening up of new markets that traditionally did not visit Spain so often (such as the Nordic countries and Russia) and the upward trend in visits by tourists from the main European countries augur further peaks over the coming years.

Investment in capital goods is adding to this growth. Traditionally, this component has reacted more quickly and sharply to changes in activity and this time does not appear to be an exception. In the year to date, it has become the main component in domestic demand to contribute continuously to the economic recovery (with contributions to quarter-on-quarter GDP growth of 0.1 and 0.2 percentage points in 1Q and 2Q 2013, respectively). The decrease in uncertainty regarding the Spanish economy's recovery, the gradual opening up of traditional financing channels and the good rate of recovery in demand, principally with a rise in foreign orders, all lie behind this improvement in productive investment. A trend that will continue, according to the qualitative indicators for 3Q: in September the composite index for investment in capital goods accelerated its upward trend recorded over the last few months, which would place growth in investment in capital goods at similar or higher levels than those of 2Q. Similarly, industrial capacity utilization continues to increase, gradually approaching its historical average (80.3% between 1995 and 2007 compared with 73.9% recorded in 3Q 2013).

The recovery in domestic demand is still awaiting an improvement in consumption which, in spite of posting five consecutive quarters of quarter-on-quarter falls, has contracted at an increasingly smaller rate. Demand indicators point to a very gradual improvement in household consumption in 3Q. On the one hand, the rate of decline for retail and consumer goods decreased from –5.0% year-on-year in 2Q 2013 to –3.7% on average between July and August. On the other hand, consumer confidence continued to improve in September and for the fourth consecutive month, bringing it ever closer to its historical average. Nonetheless, the underlying factors determining trends in household consumption do not augur any sharp upswing in the short term. The weakness of the labour market and household deleveraging are hindering the recovery in the short term (we expect its contribution to the quarterly rise in GDP to be 0.1 percentage points in 2014 compared with 0.5 percentage points recorded on average between
2000 and 2007).

The labour market is showing further signs of stabilising. August's figures have improved compared with this same month in other recent years. Although, for seasonal reasons, job losses are particularly high in August, the reduction in 2013 was 99,069, a significantly lower figure than the one recorded in August the five previous years (approximately 160,000). Moreover, the improvement in employment expectations was almost widespread throughout all sectors, further increasing hopes of a recovery in the labour market. Given this situation, the unemployment figures were also better than in previous years, remaining almost constant in August (compared with increases, on average, of 67,703 people in the same month in 2008 and 2012), although this is partly due to a smaller labour force.

Private sector deleveraging continues with credit shrinking further in July, by 13.1% year-on-year. This decline is widespread throughout all sectors although particularly marked for developers and builders (partly due to the accounting effect produced by transferring assets to the Sareb). In spite of this, some signs can be seen of a possible shift in trend over the coming months. For the first time since the start of the recession, the bank loan survey has shown an intention to loosen conditions for granting loans on the part of financial institutions over the coming months. It therefore appears that the recent improvement in funding enjoyed by the banking system (both retail and wholesale) is gradually being passed on to the real economy. The sorting out of financial institutions throughout this year, which is now at a highly advanced stage, also helps to explain this recovery in traditional financing channels in the sector. Given such a scenario, the troika believes the bank bail-out is going well, although it warns that this is not yet complete.

Foreign investment towards Spain has picked up. Greater confidence in the Spanish economy's ability to recover is resulting in an increase in foreign investment. The revival of flows of financing has benefitted both companies (via an increase in foreign direct investment) and the public sector (via bond purchases). This scenario contrasts clearly with the one seen just over a year ago, when doubts surrounding the Spanish economy meant that the Eurosystem was practically the only possible source of financing. Today, however, almost no capital is being obtained via this channel. The fall in the risk premium over the last month is another sign of the gradual recovery in investor appetite.

Doubts are growing as to whether Spain will meet its fiscal target for 2013. 2012's public deficit, before taking into account the losses caused by aid to the banking sector, has been revised downwards by 0.2 percentage points, from 7.0% of GDP to 6.8%, due to the improvement in the final balance of local government corporations. According to the Stability Programme, the deficit must remain almost constant this year (6.5% of GDP). Consolidated figures for the fiscal balance in 2Q show a slight adjustment in the year so far: the cumulative deficit for the first half of the year was 3.8% of GDP, 0.1 percentage points less than in the same period of 2012. The lower deficit of the autonomous communities and the increased surplus of local government corporations lie behind this improvement. However, the provisional figures for 3Q warn of a possible deviation from the path of fiscal consolidation. In August, the government deficit reached 4.6% of GDP, 0.8 percentage points above this year's target. Achieving such a large reduction in the last four months of the year seems complicated. By way of example, the measures adopted in the last few months of 2012 (including the VAT hike and elimination of the civil servant bonus payment) helped to reduce the government deficit by 0.6 percentage points between August and December 2012. Although this September the government approved the co-payment of some medicines, new regimes in the area of environment tax and the elimination of corporation tax rebates, the deficit target will be difficult to achieve.

The government trusts that the economic recovery will help it achieve its budget targets for 2014. The government's forecasts for the coming year have improved slightly: the GDP growth forecast has risen by 0.2 percentage points to 0.7% year-on-year thanks to stronger domestic demand. Moreover, job losses are expected to end in 2014, the year when the unemployment rate will fall to 25.9%. Within this scenario, the central government expects to reduce its deficit by 0.1 percentage points in 2014 (to 3.7% of GDP). According to the central government budget, improved economic activity will help to increase tax revenue enough to achieve this target. However, a possible deviation from
the fiscal deficit target this year could disrupt this projection and require further adjustment measures to be made in
the coming year.