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Spain – country risk analysis: LOW RISK FOR ENTERPRISE

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GDP: USD1425bn (World ranking 14, World Bank 2021)

Population: 47,3mn (World ranking 30, World Bank 2021)

Form of state: Parliamentary monarchy

Head of state: Pedro Sánchez

Next elections: General elections, 2023

Strengths:

• Good performance and competitiveness in some specific sectors, although competitiveness gains are starting to reverse
• Presence of large international companies
• Fiscal deficit is now below 3% of GDP, and the public debt-to-GDP ratio has started to decrease
• Bridge between Latin America and the rest of the world
• Large economy
• Good infrastructure network

Weaknesses:

• Still high public debt (>97.4% of GDP)
• High private debt
• Still high unemployment (14.5%) despite progress
• No recent structural reform on education and training
• Fragmented political landscape, internal tensions over sovereignty issues (Catalonia)

Trade structure by countries

Exports:

France 15.2%

Germany 9.8%

Italy 8.0%

Portugal 7.5%

United Kingdom 5.5%

Imports

10.6% Germany

9.7% China

9.5% France

6.3% Italy

4.7% United States

Trade structure by product

Exports

Road vehicles – 13.7%

Vegetables and fruits – 6.4%

Medicinal and pharmaceutical products – 5.3%

Petroleum, petroleum products, and related materials – 4.8%

Articles of apparel & clothing accessories – 4.1%

Imports

Petroleum, petroleum products, and related materials – 9.4%

Road vehicles – 8.9%

Medicinal and pharmaceutical products – 6.0%

Electrical machinery, apparatus and appliances, n.e.s. – 5.4%

Articles of apparel & clothing accessories – 4.7%

What is the risk to businesses and investors?

Spain’s 2015 budget deficit was 5.16% of GDP, versus the EU target of 4.2%. Spain’s national debt rose to over 100% of GDP in Feb-16.

The new minority coalition is likely to have limited power and support to push through further structural reforms required to bring the budget into line and the national debt under control. This leaves Spain vulnerable to the headwinds in the global economy.

The Spanish economy is proving to be resilient despite the uncertainty. GDP grew by 0.8% in Q1 2016 according to the national statistics institute, which exceeded the Bank of Spain’s estimate of 0.7%.

What is the risk of Catalan independence?

Background

Catalonia has its own language and culture and has been a key industrial and economic center. Although historically never a country in its own right, calls for Catalonia’s independence have grown since the restoration of democracy in the late 1970s. One of the main complaints is that their tax revenue subsidizes other parts of Spain. Successive Spanish governments have emphasized unity as mandated by the Spanish constitution and have resisted holding a referendum on independence.

Key potential impacts of Catalonia’s possible independence

Regional GDP: Catalonia’s GDP amounted to €209bn in 2014.

Exports: from Catalonia amounted to €5.3m in May-15.

Debt allocation: The effect of a Catalonian exit from Spain would also depend on how much debt it would take with it. If it were to take 19% of the Spanish national debt – the same proportion the region contributes to GDP, the effect would be neutral for Spain. However, if the debt allocation were to match the 16% population figure or 11% national expenditure on the region, Spain’s debt-to-GDP would increase significantly.

Effects to date from the uncertainty and actions taken

Companies relocating out of Catalonia: Uncertainty over the region’s future has led to thousands of companies, including two of the country’s top banks, moving their legal headquarters from Catalonia to elsewhere in Spain.

Risk of civil disobedience: Attempts by the Spanish government to prevent independence will heighten the risk of social unrest.

Expense and distraction: The national government reportedly spent €8m on security to prevent Catalonia’s citizens from voting in the disputed referendum

Polarisation of the issue and debate. It has become clear that the only tool the Spanish government seeks to use in resolving the Catalonia questions is the judiciary and the police. For all the efforts to keep Catalonia Spanish, the unionists are not using diplomacy and appealing to hearts and minds.

Spain’s image abroad: Reports of excessive police violence and a outright lack of political diplomacy have eroded any perceived moral high ground that the Spanish government may have had.

Fighting high energy prices

In Spain, the reopening of the economy post Covid-19 boosted growth in 2021 (+5.1%). However, inflationary pressures, supply-chain disruptions, and the Russia-Ukraine war have worsened the outlook in the short term. Swings in consumer spending played an important role in growth in the first half of the year, with a decline in Q1 and a strong rebound in Q2, and investments have kept up good momentum.

As a whole, the economy slowed in Q1 by 0.2% and grew by +1.3% in Q2, the latter well above market expectations (+0.4%). While we expect less support from household consumption in the coming quarters due to high inflation, growth is likely to remain robust in Q3, supported by EU-funded investments, the steady recovery in tourism during the summer, and the strong labor market. That said, consumer and business confidence, as well as PMI data, suggest that growth momentum might be fading. We expect growth to remain robust in 2022 (+4.3%), but to contract in 2023 (-0.3%) due to heightened uncertainty, high inflation denting consumer spending, falling external demand, and deteriorating financial conditions, which will constrain business investments. In this sense, we expect to Spain’s economy to return to its pre-pandemic size only in 2024.

The current objective is to address the issue of high energy prices, amounting to EUR15bn in direct aid, tax cuts, and fuel-price reduction; EUR10bn in loans to companies, gas cap prices for power production and, more recently, reducing the VAT from 21% to 5% for domestic natural gas. Despite the help from the fiscal measures, inflation is extremely high and ran above 10% in June-August 2022, with a slight deceleration observed in September. Although food and energy are the main drivers of inflation, core inflation is escalating, too, meaning that price pressures have been disseminated. Given our outlook for food and energy prices, we expect inflation will remain elevated in Spain until the end of 2023 (+5.7% for the average of the year).

Wage growth remains moderate, increasing by 2.5% on average in H1 2022, and the share of wage agreements with indexation clauses remains moderate, though this is rising. For the year, we expect wage growth to increase by 2.8% on average, i.e. significantly below inflation, which will result in a loss of purchasing power. Unemployment remains high but has declined more than expected and the labor reform approved in February 2022 might limit the widespread use of short-term labor contracts. After reaching 15.5% in 2020, Spain’s unemployment rate fell to 14.8% in 2021. We forecast it to decline to 14.1% in 2022, the lowest level since 2008.

In the 2021 budget, the government allocated EUR27bn (2.3% of GDP) of the EUR69.5bn in grants it requested from the Next Generation EU (NGEU) facilities over 2021-2026, mostly from the Resilience and Recovery Facility (RRF) with EUR59.2bn and REACT-EU with EUR12.4bn. The funds are mostly destined to finance green and digital projects as well as job creation. The 2023 budget is expansionary despite targeted tax increases e.g. banks and wealth and thanks to more projected NGEU spending, which has underperformed so far.

Fiscal figures improved but the long-term outlook remains fragile

Downside risks to this scenario persist, mainly as regards the low efficiency of EU funds implementation in the recent past. Uncertainty over the energy and food price developments could weigh on economic activity because private consumption (which is contracting progressively) accounts for 55% of GDP and Spain has many energy-intensive production sectors. In this context, while Spain’s LNG terminals account for the highest regasification capacity in Europe, energy imports still cover above 70% of final energy consumption. In addition, implementation risks could limit the impact of the stimulus package on growth. The previous take-up of EU funds (34%) and public sector effectiveness are also relatively low. Spain’s budget deficit contracted since 2020 but is still expected to remain around 5% in 2022 due to the emergency measures in reaction to the energy crisis. Note that strong tax revenues are helping the deficit to shrink fast this year, but we expect this effect to fade over time as the economy slows and inflation softens.

Pressure on companies may continue and business insolvencies are already on the rise

Tax income is also decreasing. Public debt remains high according to EU standards – 118.4% of GDP in 2021 – and will remain around this level in the following years. Interest rates are expected to keep rising until the beginning of 2023. Spain’s current account has been in surplus since the sovereign debt crisis, and we expect it to reach 0.6% in 2022. The European stimulus package geared towards a green and digital economy could help boost productivity

and innovation to bridge the productivity and growth gap between Spain and the EU-8. However, it is uncertain whether the stimulus package will directly benefit one of the most volatile segments – the overreliance on SMEs with low margins – in the short term.

Business-friendly environment but reforms needed

Spain is ranked 31 out of 190 economies in the World Bank’s Ease of Doing Business rankings, ahead of other major European economies such as France (33), Italy (58), and Portugal (39). Despite reforms since the 2008-09 crisis, structural weaknesses persist, particularly an over-reliance on tourism and labor market inefficiencies.

Spain faces higher risks to employment, given the predominance of SMEs, which are more vulnerable to liquidity shocks, and the high share of temporary contracts. Spain relies on EU demand and supply more than other countries and energy prices have escalated faster than in the Eurozone overall, which worsens the balance of risks. As a result, sectors such as transport, the electro-intensive industry, and construction might be significantly affected.

Despite pressure from the energy crisis, the Spanish government’s ability to provide more financial support is limited due to persistent primary deficits. Recently the left-wing central government announced a temporary wealth tax in 2023 to help finance the extra fiscal costs. Note that with municipal and regional elections next May, the risk of fiscal slippage could rise.