IMF Executive Board Concludes 2018 Article IV Consultation with Spain

On November 19, 2018, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation [1] with Spain.

The Spanish economy continues to make up ground lost during the crisis, but the recovery is maturing. Real GDP growth is projected to moderate to 2.5 percent in 2018 and 2.2 percent in 2019 before gradually slowing to its potential rate, estimated at around 1.75 percent over the medium term. Strong private consumption and investment demand were the main drivers of growth. The external position strengthened further, supported by continued current account surpluses, but is still moderately weaker than suggested by medium-term fundamentals. The labor market has improved but significant challenges remain. While the unemployment rate fell to 14.6 percent, below its long-term average, Spain’s youth joblessness, the share of temporary contracts, and involuntary part-time employment remain among the highest in the EU.

Public debt remains close to 100 percent of GDP. The headline fiscal deficit has continued to come down in 2017 and is projected to fall below the 3 percent of GDP Maastricht criterion in 2018. But much of this reduction can be attributed to the strong economic cycle and low interest rates, while there was no adjustment in the underlying fiscal position in 2018.

The private sector has deleveraged further amidst favorable lending conditions, while the health of the banking system has steadily strengthened. The total private sector debt-to-GDP ratio fell by nearly 10 percentage points in 2017. But some segments of corporates and households are still overly leveraged, and loans for consumer durables are expanding quickly, though from a low base. The decline in nonperforming loans (NPLs) and foreclosed assets has accelerated, helped by economic growth, rising property prices, and bank sales of troubled assets. Nevertheless, the NPL ratio for lending in Spain was still at 6.4 percent in the second quarter of 2018. Spanish banks continue to lag European peers in terms of capital ratios.

Executive Board Assessment [2]

Executive Directors welcomed Spain’s continued strong economic growth and decline in unemployment, which reflects the economy’s improved fundamentals. However, Directors noted that notwithstanding the achievements, several downside risks are clouding the medium-term outlook. They encouraged the authorities to persevere with policies and reforms aimed at further enhancing economic resilience, reducing public debt, improving productivity, reducing inequality and increasing employment, especially raising long-term and youth employment.

Directors called for rebuilding fiscal buffers. Given the still high level of public debt, they stressed the need to resume structural fiscal consolidation and bring public debt down faster. They welcomed the authorities’ fiscal deficit target for 2019. In this context, they encouraged the authorities to adopt a sound package of measures and plan for contingency actions in case of potential fiscal shortfalls.

Directors noted the government’s intention to raise additional revenues, given the relatively low revenue-to-GDP ratio. They considered that revenue measures can bring the deficit down, help finance more social spending, and support the government’s goal of lowering inequality. However, a careful design of tax measures is key to limit distortions and negative growth implications. Directors encouraged the authorities to consider gradually reducing the number of goods and services that qualify for reduced VAT rates, addressing tax system inefficiencies, and raising environmental taxes.

Directors stressed the need to safeguard the pension system’s financial viability while enhancing its social acceptability. They noted that linking pension growth permanently to inflation, without offsetting measures, could put pension spending on a sharp upward trajectory. Directors called for a comprehensive, transparent, and equitable approach to pension reforms.

Directors welcomed the further strengthening of the banking system. They stressed the importance for banks to continue raising high-quality capital as a shield against shocks, including from potential spillovers related to market volatility. Directors underscored the need for rigorous management of liquidity and interest rate risks, in particular, ahead of the eventual gradual normalization of the ECB’s accommodative policies. They welcomed the authorities’ plan to create a macroprudential authority to better address potential financial stability risks and to swiftly expand the Bank of Spain’s macroprudential toolkit.

Directors welcomed the strong job creation and underscored the need to make the labor market more inclusive. They called for preserving the thrust of past labor market reforms. Directors encouraged the authorities to continue to address labor market duality, strengthen active labor market policies, enhance incentives for greater labor mobility across regions, and ensure wage flexibility. They emphasized that wage increases should be aligned with productivity growth.

Directors underlined that raising productivity growth requires new impetus. They highlighted the need for policies that facilitate competition, foster innovation, address skills mismatches, and dismantle barriers for firms to grow. Directors also encouraged the authorities to improve regional coordination with a view to lower regional productivity disparities.