Spain and the EU: Assessment of policy responses to COVID-19
Fecha: mayo 2020
SEFO, Spanish and International Economic & Financial Outlook, V. 9 N.º 3
Sumario
[expand title="The Great Lockdown of the Spanish economy"]Economic restrictions imposed on March 13th, as well as broader global dynamics, will have a material impact on previously published forecasts. For this reason, Funcas has updated its economic projections. Our baseline scenario now predicts GDP will contract by 8.4% in 2020, with the public deficit and debt levels reaching over 10% and nearly 114% of GDP, respectively. Data indicate that retail, accommodation, food services, cultural and sports activities, and personal services sectors are the most directly affected by lockdown measures. The only sectors expected to end the year with a similar level of GDP prior to the COVID-19 crisis are the primary sector, the mining and energy industries, healthcare and education. As expected, employment levels have also deteriorated, though much less than in earlier crises thanks to short-time work arrangements. Indeed, 3.3 million employees are registered as part of a government sponsored furlough scheme. Although the external sector is expected to make a small positive contribution to GDP, tourism receipts and exports have fallen significantly. Importantly, the Spanish economy’s ability to rebound will largely depend on the maintenance of jobs at sustainable enterprises, the rapid implementation of government programmes, and the Spanish Treasury’s ability to capture financing at reasonable terms.
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Financing policies are essential in the context of a public health pandemic that results in the paralysis of economic activity. However, the effectiveness of these policies will hinge on the duration of lockdown measures as well as the timely and effective disbursement of funds to the real economy. At present, the forcefulness and direct nature of US policy contrasts with the uneven and issue-ridden nature of the European response to the COVID-19 crisis, which could lead to greater divergence within Europe. EU member states have issued aid primarily in the form of state guarantees for loans provided by banks to companies facing difficulties. In Spain, 200 billion euros has been earmarked for public-private financing schemes, but the roll out has been gradual. While state guarantees are expected to cushion the effect of a rise in NPLs, there will be a time lag. In the EU, aid has also been mostly directed at stimulating bank lending, with the ECB having stepped up its buyback programme. Having rejected the idea of ‘coronabonds’, the EU is expected to announce a new reconstruction fund later this year. However, looking forward, it is possible that the bloc’s uneven response will result in an asymmetric recovery across the EU.
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Regulatory and supervisory authorities have adopted temporary measures to shore up banks in advance of the expected rise in defaults and in recognition of their key role in the transmission mechanism for financial aid. Banks will be able to operate below the capital conservation buffer (CCB), the Pillar 2 Guidance, and liquidity coverage ratio. In Spain, the sum of the CCB and average Pillar 2 Guidance would release around 58 billion euros for the Spanish banking system. Regulators have also relaxed collateral measures, such as lowering the minimum size threshold for domestic credit claims from 25,000 euros to zero. This will provide liquidity to support additional measures, such as public guarantees used to ensure credit flows to SMEs and the self-employed, which is especially important in Spain given that SMEs account for over 99.9% of all companies. Additionally, the ECB’s decision to accept less than investment grade debt is significant given the potential for ratings downgrades and the fact that sovereign debt accounts for approximately 10% of the Spanish banks’ total assets. However, since Spanish banks are predominately retail focused, regulatory loosening that targets market risk and volatility in financial markets will have less of an effect on the industry.
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Tax revenue from corporate income tax has not recovered to pre-crisis levels in Spain. That is an anomaly in the European Union and comparable only to the situation in Italy. The government is contemplating the passage of measures this year which would increase annual corporate tax revenue by approximately 1.5 billion euros. Implementation of those measures depends on the ability of the minority government led by Pedro Sánchez to garner the support needed to pass the 2020 budget. The government is also assessing the possibility of enacting a new tax on BigTech which according to official estimates would generate annual tax revenue of around 1 billion euros. In any event, settlement of that tax has been postponed until the end of the year pending an agreement on a global minimum level of corporate tax on technology giants and other large multinationals which is currently under discussion at the OECD.
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With a capital adequacy level 4.2 percentage points higher than in 2008, Spanish banks appear better positioned to withstand the economic fallout from COVID-19 than during the previous financial crisis. Notably, Spanish banks boast aboveaverage profitability and efficiency compared to their eurozone peers, their loan-to-deposit gap has improved, and they have a healthy buffer of liquid assets. That said, the IMF and the European Commission are forecasting a bigger contraction in GDP in Spain (8%-9.4%) than in the eurozone (7.5%-7.7%). Although government-backed guarantees, the aid rolled out to prop up business and household income and the easing of bank regulations may help cushion the impact of the crisis on the banks, a GDP contraction of that magnitude will drive non-performance higher and require the recognition of provisions. Moreover, although the Spanish banking sector’s solvency ratio is significantly above regulatory requirements, it is 2.3 percentage points below the eurozone average. Furthermore, even though a deep restructuring effort has left Spanish banks among the most efficient in Europe, efficiency has deteriorated in recent years. As a result, Spain’s banks will need to continue with their cost-cutting efforts and reduce their capacity even further in order to weather the COVID-19 crisis.
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Current forecasts for the Spanish economy suggest that the COVID-19 pandemic will result in an economic contraction of between approximately 7% and 13% in 2020. Faced with that scenario, the government has passed a raft of employment, fiscal and financial measures to mitigate the destruction of jobs and businesses. One of the most significant initiatives is the deferred payment of state taxes and social security contributions by six months. That deferral option is longer than the two to four months granted in some other European countries. However, the scale and reach of the initiative in Spain are significantly smaller than its equivalent in Germany, France, Italy, Denmark and Belgium, for example. In addition, these countries have offered direct grants or subsidies to firms, not just tax deferrals. One of the reasons for that difference is the fact that in Spain, taxes can only be deferred by companies with revenue of less than six million euros in 2019. For this reason, the government may want to consider a more decisive commitment to prop up corporate liquidity and pre-empt job losses. While this would inevitably result in a higher deficit over the short-term, it could pay off in the longrun by providing the economy with a stronger foundation upon which to stage a recovery after the health crisis has abated.
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Economic figures published in April by Eurostat suggest that Spain’s fiscal consolidation experienced a setback in 2019. Unfortunately, this setback will become substantially greater given the economic paralysis caused by COVID-19. The uncertainty surrounding the COVID-19 crisis makes forecasting both growth and the deficit extremely difficult and has contributed to a wide range of forecasts published by the Bank of Spain, the European Commission, the AIReF, the IMF, BBVA and Funcas, among others. These institutions have forecasted a GDP contraction of between 6.8% and 12.4% with the public deficit ranging from 7.2% to 11.0%. Though much of the deficit reflects the impact of the recession and the costs of one-off fiscal measures, there remains an important structural component. Indeed, structural deficit is among the highest in the European Union, with the EU Commission calculating a cyclically-adjusted budget deficit for Spain at slightly over 3% in 2020.
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