Spain: from hero to zero
Following several years of robust expansion, Spain has experienced the worst Covid-19-induced economic hit among advanced economies. Despite an impressive bounce-back in the third quarter of 2020, the Spanish recovery has visibly lagged behind euro area peers owing to the slower pace of normalisation in tourism-intensive services as well as persistent structural vulnerabilities. Furthermore, the pick-up in activity has now stalled due to the rapid resurgence of the virus and new quarantine measures in place, signalling weak near-term momentum, though less so than during the spring lockdown. Lack of political consensus has left the government to rely heavily on the Next Generation EU fund for boosting growth, but major effects are not expected to be seen until 2022 and 2023. A Covid-19 vaccine should give the economy another sizable boost once available for mass deployment. In the meantime, the outlook offers little comfort, and Spain is set to continue to underperform its major euro area peers.
Following a disastrous first half of the year, the euro area economy witnessed an impressive bounce-back in the third quarter. While the recovery came up stronger than expected across the region, there remain substantial cross-country differences. Spain, in particular, stands out, embarking on its recovery path after having been the worst-hit advanced economy by the Covid-19 pandemic; in cumulative terms, Spanish output fell by an unprecedented 22% during H1 2020. This is a sharp contrast to several years of robust export-led expansion prior to the pandemic, when Spain consistently outperformed its major euro area peers.
A rapid yet incomplete Q3 recovery
In the third quarter, Spanish economic growth surged by 16.7% qoq, led by a recovery in domestic demand. A historic real GDP expansion, however, masks underlying weaknesses. First, the sharp bounce-back was largely mechanical, i.e. reflecting the lifting of strict lockdown measures, easing supply-side constraints and releasing strong pent-up demand. In other words, the strong Q3 figure owes much to the fact that the economy was doing so poorly in the first place.
Second, the recovery has been only partial and uneven across sectors. Industrial production has recovered to more than 96% of its pre-pandemic level. Services, meanwhile, have seen a slower pace of normalisation, reaching slightly less than 90% of their pre-crisis peak. The latter is mainly related to the large share of tourism-related activities (accounting for 12% of GDP – the most of any major euro area economy), which have struggled with the 75% collapse in international tourist arrivals between June and September 2020. As such, it is not surprising that Spain has been a major laggard in terms of the post-lockdown recovery in the euro area (figure 1).
New lockdown measures point to a bumpier road ahead
At the same time, there are signals that the recovery is likely to be short-lived. A sequential decline in growth momentum was already visible in high-frequency data by end-Q3, and most recently, a rapid resurgence of the virus and new containment measures (e.g. a nationwide curfew on bars and restaurants) has further reduced mobility. All this implies another negative qoq growth figure in Q4, though not as dramatic as in Q2 2020. Compared to the spring lockdown, current restrictions have been less severe so far and have not triggered similar supply chain disruptions. Furthermore, fiscal support remains in place, in particular the ERTE furlough scheme, which is set to cushion the negative shock from the second wave on the labour market.
While a bumpier road ahead is now a pattern expected across the euro area in the near term, Spain is set to see an even weaker recovery than major euro area economies. Besides the excessive reliance on tourism, additional macro vulnerabilities stand out amid a coronavirus-type of shock. These include a handful of long-lasting structural problems, such as a large share of SMEs with generally more limited financial and technological resources or structural impediments in the labour market. Even before the outbreak of Covid-19, Spain had the highest unemployment rate in the EU. This year, it has increased by a mere 3 p.p. to 16.5% in September, indicating that job destruction has been contained by a furlough scheme, now extended until January 2021. Still, with a large share of temporary contracts and an elevated youth unemployment rate, the risks of more pronounced job shedding as well as long-term labour market scarring remain high.
In addition to the underlying structural weaknesses, the inherently unstable political situation makes things more complicated. The left-leaning minority government of Social Democrats and Podemos has been operating under the 2018 budget from the previous centre-right government, unable to pass a budget after more than two years in office. The lack of political consensus helps explain why Spain has been lagging in terms of immediate fiscal stimulus (additional spending and foregone revenues, based on the IMF methodology), so far estimated at 3.5% of GDP, which is well below that of Germany (8.3%) and Italy (4.9%). Furthermore, Spain has limited fiscal space, with government debt jumping above 110% of GDP in Q2 2020.
Next Generation EU fund is set to boost the economy
To boost post-pandemic growth, the Spanish government is therefore relying heavily on funding from the EU. Under the new Next Generation EU fund, Spain, together with Italy, is expected to benefit the most because the allocation key is linked to the initial impact of the crisis. The government estimates that Spain will receive EUR 140 billion, or 11.2% of 2019 GDP, evenly split between grants and loans. The authorities plan to allocate EUR 70 billion of recovery fund grants during 2021-23 and would only seek to access the equivalent amount of loans in the following years. The government projects that the grant-based stimulus will result in additional cumulative GDP growth of 7-8 p.p. through 2021-2023 period.
There are, however, several caveats to these projections. The disbursement of the grants is expected no earlier than in the second half of 2021, with a risk of possible delays. Hence, the material effects of higher investment are likely to be seen in 2022 and 2023. Furthermore, sound project implementations will be crucial to boosting growth in line with the projections, which cannot be guaranteed. Finally, from a long-term perspective, unless new EU funds are accompanied by structural reforms, there is a risk that the overall impact on potential growth will be muted.
In addition to the New Generation EU fund, a Covid-19 vaccine should give the Spanish economy a sizable boost, particularly due to Spain’s high exposure to tourism. At the same time, there remains considerable uncertainty surrounding timing of broad vaccination, which is likely taking well into 2021. So, although we see a light at the end of the tunnel in the medium term, the near-term outlook offers little comfort, and we expect Spain will continue to underperform its major euro area peers in the coming quarters.