Spain: Economy in Focus – Q3 2017

October 23, 2017

Europe’s fourth largest economy has continued to grow at a faster rate than the Euro Zone average and is now in its fourth year of expansion. GDP has now surpassed its pre-crisis peak. The strong recovery has been supported by a more balanced growth pattern than in the pre-crisis years, with net exports positively contributing to growth despite the strength of final demand. Domestic demand remains the main driver of growth, supported by strong job creation. The growth forecast for 2017 and 2018 has been revised upwards following strong activity in the first quarter. However, growth is still anticipated to ease over 2017 and 2018, to an annual average of 2.8% this year and 2.4% next year.

Private consumption is expected to remain the main contributor to growth, but to slow down as job creation weakens and other factors that supported household disposable income gains in recent years, such as the decline in oil prices, gradually abate. Following lethargic growth in the second half of last year, investment is expected to rebound this year and next year, driven by the gradual recovery of construction investment. By contrast, equipment investment is forecast to moderate in line with final demand.

The contribution of the external sector to growth turned positive last year, as exports recorded sizable gains in market shares and import growth remained contained despite the strength of final demand. Exports are expected to accelerate this year, as Spain continues to record good gains in export market shares and its trading partners recover. However, export growth is expected to moderate next year, despite a pick-up in growth in Spain’s export markets, as gains in market shares slow down.

Imports are also expected to rebound this year and moderate next year, in line with final demand. As imports are anticipated to continue growing at a slower rate than exports, net trade is expected to make a positive contribution to growth throughout the forecast horizon. After widening last year, Spain’s current account surplus is forecast to decline this year and next year, as a consequence of worsening terms of trade. However, this decline is mostly offset by an improving capital account, and Spain’s net external lending position is anticipated to remain broadly stable.

Developments in the price of oil are set to continue dominating consumer price inflation in the short term. Headline inflation is forecast to turn positive, rising from -0.3% in 2016 to 2.0% in 2017 before decreasing to 1.4% in 2018, as the base effects of energy price increases fade away in the second half of 2017. Core inflation is expected to gradually recover, as wages pick up, the output gap closes, and second round effects from energy price increases are passed-through into consumer prices.

Administrative data suggest that the pace of job creation in the first quarter of 2017 picked up after a slowdown in the second half of last year. Although employment growth is set to ease, it is projected to remain strong, allowing for further reductions in the unemployment rate, which is expected to fall below 16% by next year, the lowest level since 2009. Wage growth is anticipated to pick up moderately this year, and, combined with low productivity gains, should lead to increases in nominal unit labor costs. Cost-competitiveness gains vis-à-vis the euro area are expected to continue, though slowing down.

Spain’s general government deficit narrowed to 4.5% of GDP last year, a reduction of 0.6% of GDP compared to 2015. Thanks to measures adopted in the autumn to strengthen corporate tax revenues, the final quarter of the year yielded more than half of the total deficit reduction achieved during 2016.

This year, the forecast incorporates a number of additional measures adopted by parliament in December 2016. These consist primarily of base-broadening measures in the field of corporate taxation, but also of increases in excise duties on alcohol and tobacco as well as a broadening of the base for social contributions. Previous improvements in financing conditions imply that interest expenditure is set to continue decreasing. In combination with the positive macroeconomic outlook, which should support tax revenues and reduce expenditure on unemployment benefits, the deficit is expected to narrow to 3.2% of GDP in 2017. In 2018, at unchanged policies, it is expected to narrow further to 2.6% of GDP on the back of the cyclical recovery.

Risks to the fiscal outlook mainly relate to contingent liabilities and uncertainty regarding the impact of recent tax measures. After deteriorating significantly in 2015, Spain’s structural deficit was expected to have widened further by some 1% of GDP in 2016. It is set to improve marginally in 2017 before stabilising in 2018. Over the the next couple of years, the general government debt ratio is expected to decrease slightly to 98.5% of GDP, as a result of relatively strong nominal GDP growth more than offsetting the budget deficit.

The IBEX year to date is up 11.5% with the top performing stocks in the index being Banco De Sabadell (+43.08%), Caixabank (+40.64%) and Cellnex Telecom (+39.04%). In addition, the biggest drags on the index have been Tecnicas Reunidas (-23.10%), Siemens Gamesa Renewable (-13.97%) and Acerinox (-13.76%).

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