EurozoneEY Eurozone Forecast September 2013

AustriaBelgiumCyprusEstoniaFinlandFrance

GermanyGreeceIreland

ItalyLuxembourg

MaltaNetherlands

PortugalSlovakiaSlovenia

Spain

Spain

Portugal

France

Ireland

Finland

Estonia

Belgium

Slovakia

Austria

Slovenia

Italy

Greece

Malta Cyprus

Netherlands

Luxembourg

Germany

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Outlook for Spain

Economy bottoms out, but solid growth will remain elusive

Spain

Portugal

France

Ireland

Finland

Estonia

Belgium

Slovakia

Austria

Slovenia

Italy

Greece

Malta Cyprus

Netherlands

Luxembourg

Germany

1EY Eurozone Forecast September 2013 | Spain

Highlights

• The Spanish economy may be stabilizing more quickly than we had expected. Economic activity surprised on the upside in Q2 2013, with quarterly GDP declining just 0.1% and the unemployment rate falling for the first time in two years. More recent evidence from the Purchasing Managers’ Index (PMI) surveys for both the manufacturing and services sectors signaled a return to growth in August for the first time in two years — and the economy is also benefiting from lower financing costs.

• But a return to solid and sustainable growth still appears some way off. We forecast that GDP will fall by 1.5% this year, with only modest growth of 0.4% expected in 2014. The pace of expansion will gradually gain momentum as the drag from fiscal cutbacks eases and the economy restructures. We expect growth to rise to 1.1% in 2015 and 2% in 2017.

• Renewed job losses are likely when the summer holiday season comes to an end, with the unemployment rate expected to peak at over 27% at the turn of the year. Moreover, unemployment will remain high for years to come, as the domestic economy struggles to return to sustainable growth.

• Although the performance of emerging markets has been disappointing recently, the global economic outlook remains supportive of a gradual recovery in foreign demand and the ongoing diversification of Spain’s export markets. We forecast export volumes to rise by 2.4% in 2013 and about 4% a year in 2014–17.

• Risks to the outlook remain skewed to the downside. In particular, the ongoing easing of financial market tensions remains dependent on progress with structural reforms in both Spain and Europe, and progress toward a banking union is especially important.

GDP growth

2013

–1.5% GDP growth

2014

0.4%

Unemployment

2013

26.8%

Exports of goods and services growth

2013

2.4%

2 EY Eurozone Forecast September 2013 | Spain

Economy bottoms out, but solid growth will remain elusive

The recession is coming to an end …

The latest data suggests that the Spanish economy may stabilize sooner than we had expected. The pace of contraction in economic activity slowed markedly in Q2 2013, with GDP posting a decline of just 0.1% and the unemployment rate falling for the first time in two years, helped by a strong rebound in the tourism sector. The improvement has also been reflected in business surveys such as the PMI. After showing signs of stability in June and July, both the manufacturing and services sector PMIs signaled a return to growth in August for the first time in two years.

… but the recovery will gather momentum only gradually

Domestic demand is now showing signs of bottoming out, supported by the knock-on effects of buoyant export sales and more moderate fiscal consolidation efforts. While it now seems plausible that the economy will return to expansion by the end of this year, helped also by lower financing costs, nevertheless a return to solid and sustainable growth still appears some way off. We forecast GDP will fall by 1.5% this year, with only modest growth of 0.4% expected in 2014. The pace of expansion will gradually gain momentum as the economy rebalances, with growth forecast to rise to just over 1% in 2015 and 2% in 2017.

Fiscal consolidation should remain on target this year

Although the fiscal consolidation effort has been relaxed this year, the Government is still aiming to reduce the deficit to 6.5% of GDP from 7% last year (excluding one-off bank recapitalization costs). Last year, the majority of the adjustment in the public deficit occurred in the second half of the year and it is likely that this pattern will be repeated in the coming months, putting renewed pressure on the economy. In light of the measures approved by the Government, we expect the budget deficit for this year to be broadly on target for the new levels approved by the European Commission (EC) in May. Whether the stability targets will be met in future years will depend on the continued implementation of fiscal adjustment measures.

Spain (annual percentage changes unless specified)2012 2013 2014 2015 2016 2017

GDP –1.6 –1.5 0.4 1.1 1.4 2.0

Private consumption –2.8 –2.5 0.2 1.0 1.5 2.1

Fixed investment –7.0 –6.1 –0.1 2.0 2.1 2.3

Stockbuilding (% of GDP) 0.8 0.5 0.2 0.2 0.3 0.4

Government consumption –4.8 –4.4 –3.2 –1.0 –0.3 0.7

Exports of goods and services 2.1 2.4 4.8 4.4 3.4 3.3

Imports of goods and services –5.7 –5.1 1.0 3.8 3.5 3.4

Consumer prices 2.4 2.0 1.2 0.9 1.0 1.0

Unemployment rate (level) 25.1 26.8 27.6 27.5 27.1 26.4

Current account balance (% of GDP) –1.1 0.0 0.9 0.9 0.8 0.7

Government budget (% of GDP) –10.6 –6.4 –5.6 –4.5 –3.2 –2.3

Government debt (% of GDP) 84.2 92.8 99.6 104.5 107.6 109.0

ECB main refinancing rate (%) 0.9 0.6 0.5 0.5 0.5 0.7

Euro effective exchange rate (1995 = 100) 115.5 119.4 117.7 114.1 112.8 112.1

Exchange rate ($ per €) 1.28 1.31 1.24 1.19 1.18 1.18

Source: Oxford Economics.

3EY Eurozone Forecast September 2013 | Spain

Tight credit conditions will persist for some time …

Tight financial conditions are likely to continue to dampen economic activity in the near future, amid restructuring of the banking sector. Spanish banks continue to struggle with rising bad loans, which reached a new high of 11.6% of total loans in June 2013, notwithstanding the earlier absorption of around €50b of doubtful loans by the government-backed “bad bank”. New provisioning requirements on restructured loans will probably accelerate the pace of increase in coming months. Some banks may struggle to restore capital levels as a consequence and a new injection of public funds into the sector cannot be ruled out.

… adding to the pressures facing Spanish businesses

Difficult access to credit is compounding the pressures faced by businesses from the weak demand environment. Nevertheless, there are already signs of an upturn in private sector spending on machinery and equipment, fuelled by the strength of export demand and less weakness in domestic demand. However, any recovery in investment expenditure is likely to remain concentrated in the corporate sector, as residential investment will continue to be dragged down by the ongoing adjustment in construction, a

prolonged process that we expect to last for the next two years at least. Overall, we expect investment spending to contract by about 6% this year, before stabilizing in 2014 and then growing by 2% in 2015.

Weak labor market will undermine consumer spending …

Despite the recent good news from the labor market, renewed job losses are likely when the summer holiday season comes to an end, with the unemployment rate expected to peak at over 27% at the turn of the year. Moreover, despite some of the workforce leaving to seek employment elsewhere in Europe, unemployment will remain high for years to come as the domestic economy struggles to return to sustainable growth.

The expected fall in annual inflation to below 1% by the second half of 2014 should offer some relief to consumers, but will not prevent disposable incomes from falling in real terms over this period. As a result, we expect consumer spending to contract by a further 2.5% in 2013, with only modest growth of 0.2% in 2014. As the economy finally starts to create new jobs, incomes will rise and generate a gradual recovery of consumption in subsequent years.

Figure 1Contributions to GDP growth

% year

–8

–6

–4

–2

0

2

4

6

8

1985 1988 1991 1994 1997 2000 2003 2006 2009 2012 2015

Forecast

Net exports

Domestic demandGDP

Source: Oxford Economics.

Figure 2Non-performing bank loans

% of loans outstanding

0

2

4

6

8

10

12

1980 1984 1988 1992 1996 2000 2004 2008 2012

Source: Haver Analytics.

4 EY Eurozone Forecast September 2013 | Spain

Economy bottoms out, but solid growth will remain elusive

Figure 3Unemployment rate

%

6

10

14

18

22

26

30

1980 1984 1988 1992 1996 2000 2004 2008 2012 2016

Forecast

Source: Oxford Economics.

Figure 4Government balance and debt

% of GDP

0

20

40

60

80

100

120

1992 1995 1998 2001 2004 2007 2010 2013 2016–12

–10

–8

–6

–4

–2

0

2

4

Government debt(right-hand side)

Government budget balance(left-hand side)

% of GDP

Forecast

Source: Oxford Economics.

… leaving the export sector as the main driver of recovery

With domestic demand likely to remain weak for some time as a result of the unwinding of imbalances accumulated during the pre-recession period, the export sector will be the main driver of recovery. The tourism industry is expected to make a continued strong contribution to this upturn, helped by ongoing gains in competitiveness. But exports of goods and non-tourism services are also benefiting from the ongoing improvements in Spanish competitiveness. Although the performance of emerging markets has disappointed recently, the global economic outlook remains supportive of a gradual recovery in foreign demand and the ongoing diversification of Spain’s export markets. Overall, we forecast export volumes of goods and services will rise by 2.4% in 2013 and by about 4% a year in 2014–17.

Continued progress with structural reforms is crucial

Risks to the outlook remain skewed to the downside. In particular, the ongoing easing of financial market tensions remains dependent on progress with structural reforms in both Spain and Europe, with progress toward a banking union especially important.

The EC reinforced the urgency of structural reform implementation in its May 2013 report on the country’s reform and stability program, with the publication of a strict calendar of reform targets that will be closely monitored. Not surprisingly, labor market reforms are high on the list of priorities, together with structural fiscal reforms to underpin the long-term sustainability of the public finances. The key message from the EC report is that the relaxation of the public deficit targets must be taken as an opportunity to speed up the structural reforms that will be necessary to return the economy to solid and sustainable growth.

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About Oxford Economics

Oxford Economics was founded in 1981 to provide independent forecasting and analysis tailored to the needs of economists and planners in government and business. It is now one of the world’s leading providers of economic analysis, advice and models, with over 500 clients including international organizations, government departments and central banks around the world, and a large number of multinational blue-chip companies across the whole industrial spectrum.

Oxford Economics commands a high degree of professional and technical expertise, both in its own staff of over 80 professionals based in Oxford, London, Belfast, Paris, the UAE, Singapore, New York and Philadelphia, and through its close links with Oxford University and a range of partner institutions in Europe and the US. Oxford Economics’ services include forecasting for 190 countries, 85 sectors, and over 2,500 cities sub-regions in Europe and Asia; economic impact assessments; policy analysis; and work on the economics of energy and sustainability.

The forecasts presented in this report are based on information obtained from public sources that we consider to be reliable but we assume no liability for their completeness or accuracy. The analysis presented in this report is for information purposes only and Oxford Economics does not warrant that its forecasts, projections, advice and/or recommendations will be accurate or achievable. Oxford Economics will not be liable for the contents of any of the foregoing or for the reliance by readers on any of the foregoing.

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