Via IMF (Den Internationale Valutafond)

Spain: IMF Staff Concluding Statement of the 2020 Article IV Mission







March 11, 2020







A Concluding Statement describes the preliminary findings of IMF staff at the end of an official staff visit (or ‘mission’), in most cases to a member country. Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF’s Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, or as part of other staff monitoring of economic developments.

The authorities have consented to the publication of this statement. The views expressed in this statement are those of the IMF staff and do not necessarily represent the views of the IMF’s Executive Board. Based on the preliminary findings of this mission, staff will prepare a report that, subject to management approval, will be presented to the IMF Executive Board for discussion and decision.









  • In 2019 the Spanish economy continued to grow faster than the euro
    area average. But the outlook for 2020 is now highly uncertain with
    the impact of the coronavirus evolving. To mitigate this impact,
    policies should ensure that the health sector has sufficient
    resources and provide well-targeted support for the most affected
    sectors and vulnerable groups.

  • Socio-economic disparities in Spain remain large, mainly reflecting
    high structural unemployment. Reducing the prevalence of temporary
    contracts must be the cornerstone for greater equity. This should
    be bolstered by more targeted and modernized active labor market
    and education policies. Improved social assistance programs, an
    earned income tax credit scheme, and enhanced supply of affordable
    rental units would support the poorest.

  • Determined fiscal and structural efforts are needed to unleash new
    public and private resources for more economic resilience, social
    inclusion, and innovation. Sustainable fiscal measures are crucial
    for reducing elevated public debt over the medium term and
    addressing the persistent deficit in the pension system.
    Intensified structural policies should aim to boost productivity,
    thereby lifting the economy’s potential and improving public debt
    dynamics.

  • Banks need to continue building up high-quality capital to enhance
    their resilience against shocks. Although balance sheets in the
    banking system have continued to strengthen, low profitability
    remains a challenge amid the low interest rate environment in the
    euro area.


The economic outlook is highly uncertain in the near term due to the
global coronavirus outbreak

Spain has experienced five years of strong—above euro average—growth, job
creation, and sustained current account surpluses. But in
2019 domestic, and especially external, uncertainty weighed on confidence,
leading households to start rebuilding their record-low savings and taking
a toll on investment. On top of some anticipated deceleration as the
business cycle matures, temporary disruptions from the global outbreak of
the coronavirus to supply chains, trade, tourism, and domestic consumption
are now expected to slow economic growth further in 2020. The magnitude of
the slowdown hinges on the scope and the duration of the outbreak, which is
highly uncertain at this moment. Over the medium term, GDP is forecast to
expand in line with potential growth of about 1.6 percent, constrained by
low productivity growth as the policy standstill during recent years did
not provide new impetus. Unemployment, which halved from its post-crisis
peak, has almost reached its estimated structural rate and is forecast to
decline only marginally going forward.

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Fiscal policy needs to protect people during the coronavirus outbreak

Against the backdrop of the coronavirus outbreak, it is understood that the
government must ensure sufficient resources for the health sector as well
as targeted support to the most affected, and that these temporary one-off
measures would have to be stepped up as needed to prevent and contain the
virus and mitigate the economic impact. Beyond these needs, additional
discretionary spending initiatives in the 2020 budget, including the
already legislated pension and wage measures, should be sustainably
financed by new revenue measures or changes in the composition of spending.
Overall, the fiscal stance in 2020 can be broadly neutral with automatic
stabilizers operating freely in support of economic activity in addition to
temporary measures adopted in response to the coronavirus. A temporary
delay in fiscal consolidation should be accompanied by a credible
commitment to future adjustment.

Comprehensive
policies
are needed to narrow social inclusion gaps

The job-rich recovery has helped to mitigate inequality and the risk of
poverty, but both remain higher than in other EU countries, especially for
the young. Rising pressure on rental affordability in some urban centers
has added to the social challenges. The government’s medium-term economic
agenda, centered on the objective of lowering socio-economic disparities,
is well placed. However, this is a complex task against the backdrop of the
uncertain economic outlook and elevated public debt. Supporting the social
objectives requires a comprehensive approach to promote a more inclusive
labor market. In particular:

Duality:
Persistent labor market segmentation has important economic and social
costs. In the short term, the ongoing efforts to address abuse of temporary
contracts should be deepened as these have already paid some dividends in
supporting conversion of temporary to permanent hiring. Over the medium
term, a structural shift is needed that reduces the incentives for
employers to overly rely on temporary contracts. Shifting to a higher share
of permanent jobs could be achieved, for example, by minimizing the
employment protection gaps between fixed-term and open-ended contracts
while creating an employer-based separation fund. This would reduce labor
market duality without necessarily raising the overall dismissal costs for
employers or lowering employment protection for most workers.

Flexibility:
Labor market institutions should continue to provide sufficient flexibility
to set wages and working conditions that take into account firm-specific
needs,especially in light of the rising downside risks to the economy. To
limit the social consequences from temporary shocks, such as the
coronavirus, “short work schemes” could be adopted, which would allow
enterprises to cut working hours while preserving jobs with the government
making up some of the employees’ lost wage income. Moreover, there is room
for better coordination of collective bargaining between the sectoral and
firm levels through more effective use of the guidelines set in the higher
level of agreements.

Hours worked and in-work poverty:
As in many advanced economies, the share of labor has declined over the
past two decades, driven largely by technological progress and global
integration. Moreover, average hours worked have fallen and in-work poverty
has increased in recent years. Efforts should be made to explore and
address specific aspects of the labor legislation that may have caused
these inadvertent developments. In particular, there is a need to identify
factors that contribute to the reduction in the duration of temporary
contracts and potential abuse of the greater flexibility in part-time
contracts. In addition, to support low-income households and tackle in-work
poverty, the introduction of an earned income tax credit program could be
considered, which is a more targeted and efficient tool than the minimum
wage in addressing poverty and income inequality.

Skills mismatch:
Active labor market and education policies should focus on improving the
employability of young people, the low-skilled, and the long-term
unemployed. The recently adopted action plans are important steps toward
promoting youth employment and reducing long-term unemployment. Moreover,
enhanced vocational training and lifelong learning programs need to ensure
timely acquisition of new skills against the fast-paced change in skill
demand.

  • Social assistance spending:
    The redistributive effects of social assistance programs in Spain are
    relatively weak, since few measures support those most in need and
    protection is tilted toward pensioners. Making social spending more
    effective and equitable will entail increasing the coverage of the most
    disadvantaged groups and the adequacy of several social assistance
    programs (especially spending on minimum income schemes, family and
    housing). This requires not only additional resources but also lowering
    the administrative access hurdles to increase participation, improve
    coordination of benefits across all levels of government, and realize
    efficiency gains as highlighted in the recent spending reviews.
  • Policies for greater rental affordability
    : Though homeownership remains high, demand for rental housing has
    increased, especially among young and low-income households,
    contributing to a steep rise in rental prices in many cities and
    arguably compounding intergenerational inequality. To support rental
    affordability and foster access to areas of strong job creation,
    policies could focus on reducing supply-side rigidities (e.g., by
    simplifying land use regulation and accelerating rezoning processes),
    improving access to rent support for the neediest (e.g., improving
    regional processes for granting tenant allowances), increasing in some
    locations the stock of social rental housing for low-income groups, and
    ensuring good transport infrastructure between fast growing cities and
    more affordable locations.
  • Policies for more gender equality:
    Despite significant progress in recent decades, gender inequality
    persists in a number of areas, leaving still sizeable inequality in
    employment and wages. Policies to enhance gender equality in the labor
    market should focus on boosting family and childcare support and
    promoting working arrangement flexibility.


Over the medium term, lowering fiscal vulnerabilities remains a key
policy priority

Over the medium term, reducing public debt and the fiscal deficit remains
critical, particularly given rising social spending pressure. Despite
strong economic growth during the past five years, Spain has made limited
progress in lowering public debt. The reductions in fiscal deficits were
largely driven by robust economic activities and lower interest payments.
As a result, public finance is still quite some distance away from the goal
of a structurally balanced budget. To rebuild fiscal buffers, a gradual
pace of consolidation should be pursued over the medium term until a
balanced budget is reached, provided that the economy grows with or above
its potential.

To meet growing social and investment demands in support of technological
advancements, fiscal policy should focus on mobilizing additional revenues
and enhancing spending efficiency along the lines recommended in the recent
expenditure reviews. Spain’s tax-to-GDP ratio is relatively low compared
with regional peers, indicating potential room for structural improvement,
especially by strengthening VAT collection, raising excise duties and
environmental levies, and reducing tax system inefficiencies while
protecting the most vulnerable. The adoption of measures to create fiscal
space should be a precondition for further expansion of public spending.

The persistent deficit in the contributory pension balance requires a
long-term commitment to contain the pressure on pension spending
arising from population ageing.

Implementing the sustainability factor (discount factor linked to life
expectancy at the start of pension payments) would be one important
contribution, especially since its announcement nearly a decade ago has
given future pensioners some time to prepare for its impact.

Specific measures to balance pension sustainability and social
acceptability could include: (i) raising the effective retirement age by
incentivizing longer work lives; (ii) increasing revenues without raising
the already high contribution rates; and (iii) encouraging supplementary
savings.


A boost to productivity is needed to sustain higher economic growth
rates

In addition to overcoming labor market segmentation and enhancing skill
levels, which would both contribute to higher productivity, efforts should
focus on promoting the economy’s innovative capacity. In that respect, the
government’s plan to promote digitalization and its associated new
employment opportunities is welcome. But to ensure its success, Spain’s
business community, which is dominated by small firms, needs to be in a
position to absorb new technologies and innovate. Thus, innovation policies
need to be complemented by incentives for firms to grow, such as modifying
size-contingent regulations, reducing regulatory fragmentation, improving
market access to enhance competition, boosting private-public innovation
collaborations and enhancing the take-up of R&D incentives.


The financial system needs to safeguard its resilience against risks

Spanish banks have continued to sell impaired asset portfolios which has
improved asset quality. However, banks’ average return on equity remains
low and profitability challenges persist, as for many European banks, amid
the low interest rate environment.

The build-up of macro-financial risk appears still to be manageable but
warrants continued monitoring. New reputational and legal risks may put
additional pressure on bank profitability. Therefore, there is a need to
keep strengthening high-quality capital positions. The
recovery in the housing market continues, particularly in major cities and
coastal areas, but as yet there are no indications of any significant house
price overvaluation, and signs of moderation have emerged. Consumer lending
is still growing swiftly though from a low level.

Banks need to raise their CET1 capital ratio, which for the banking system
as a whole is still among the lowest in the euro area. A preemptive
activation of the countercyclical capital buffer could be eventually
considered should near-term risks clearly dissipate and the projected
credit gap—the difference between the stock of credit and its estimated
equilibrium level—close after sustained deleveraging. A positive
countercyclical capital buffer would help increase banks’ resilience
against shocks, and its release during an economic downturn should mitigate
the potential tightening of credit supply.

Continued efforts are needed to address low bank profitability; further
reduce non-performing assets; and rigorously manage lending standards as
well as reputational, cybersecurity, and liquidity risks. It is also
critical to finalize secondary regulations for some of the macroprudential
tools. Finally, supervisors should closely monitor any financial stability
risks stemming from the impact of the coronavirus.

*****


The IMF mission team would like to thank the Spanish authorities, the
ECB, and other counterparts for the open and constructive discussions.


IMF Communications Department
MEDIA RELATIONS

PRESS OFFICER: Andreas Adriano

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