- The Spanish government intends to slowdown the pace of fiscal consolidation. It has pushed back its target for reducing the public deficit below 3% of GDP from 2014 to 2016.
- The European Commission must officially approve the new budget trajectory, but it already esteems that it is coherent with Spain’s economic situation.
- Spain will continue to make major efforts not only in terms of public finances but also structural reforms.
On Friday, April 26, the Spanish government unveiled its new Stability Programme for 2013-2016. The programme calls for a net slowdown in the pace of fiscal consolidation, since the public deficit will not be brought below 3% of GDP before 2016, instead of 2014 as previously planned. The Spanish administration is now counting on reducing the public deficit by about 1 point of GDP a year. The new deficit reduction targets are 6.3% of GDP in 2013, 5.5% in 2014, 4.1% in 2015 and 2.7% in 2016 (vs. its previous targets of 4.5% in 2013 and 2.8% in 2014). In 2012, the public deficit peaked at 10.6% of GDP, or 7% excluding temporary measures to support the banking sector.
To be ratified, the new pace of fiscal consolidation must be officially approved by the European Commission (EC) on 29 May. As part of the European Semester, member states and the EC work closely together to define targets to reduce the public deficit. In the first half of the year, member states send their Stability Programmes to the EC, which either approves them or recommends modifications. During the National Semester, in the second half of the year, governments transcribe the stability plans into national budgets. Without making a definitive pronouncement, the EC has already stated that “the postponement of the correction of the excessive deficit to 2016 [in Spain] was consistent with the current technical analysis”. This suggests that the new public deficit trajectory will probably be approved.
Discussions during the European Semester generally focus on budget efforts, namely on reducing the structural deficit (i.e. corrected for cyclical factors and temporary measures). In Spain, the government lowered its 2013 growth forecast from -0.5% to -1.3%, and this downward revision argues for an adjustment of “nominal” public deficit targets, while structural reform efforts remain very high: in the period 2013-2016, the Spanish authorities foresee a structural adjustment of 4.2 points of GDP. Spain can also soften its austerity policy now that it has regained some fiscal credibility, even at the expense of an abrupt drop off in activity and employment. According to the IMF, for example, Spain made the biggest budget efforts of any country in Europe in 2012, second only to Greece. The country also recapitalised its banking sector for EUR 37bn (3.6% of GDP) under a European programme. With the ECB’s implicit support via OMT, Spanish sovereign rates have eased considerably to about 4% on 10-year government bonds. This gives the government some rooms to manoeuvre to adopt a slower but also more credible pace of consolidation.
The probable easing of budget targets in Spain also fits within a change of focus taking place in Europe in recent months. Henceforth, discipline focuses less on sharp spending cuts and more on implementing structural reforms. Spain will probably be given until 2016 to reduce its public deficit to below 3% of GDP, but it will have to begin immediately to reform its pension system, expand job market reforms and increase competition in its markets for goods and services.
Along with its Stability Programme, the Spanish government also presented its new National Reform Programme. Its eight key points include a public administration reform plan (creation of an independent fiscal authority; fight against redundancy at various levels of the state; public sector pension reforms), measures to support small businesses and boost international development (special VAT regime, tax incentives, creation of internationalisation bonds), energy sector reforms and the liberalisation of services. What can be expected from this new strategy? Adopting a softer pace of consolidation while accelerating structural reforms could fuel a return to growth by late 2013 or early 2014 (on a quarterly basis).
Assuming the reforms gradually boost medium-term growth and activity begins to converge with its potential as of 2015, it should become easier to reduce public deficits. By narrowing the output gap (the difference between observed and potential output) by 1 point the public deficit would decline by an average of 0.5 points of GDP. The mechanism would be the opposite of the one currently at work: the unemployment rate would ease towards its natural level, increasing the tax base and reducing unemployment-related spending. Once the output gap is closed, the budget deficit equals its structural component. In 2012, the EC estimated Spain’s structural deficit at 5.9% of GDP and the negative output gap at 4.5%. Taking into account the structural fiscal effort planned through 2016, and assuming the output gap will be reduced by half by then, the public deficit should come around 2.8% of GDP in 2016.
BY Thibault MERCIER