Global economic growth slowed considerably in the final quarters of 2011 due to the weaker growth in Europe (contraction in the fourth quarter) and in emerging economies. However, the reasons for the slowdown in the two areas could hardly be more different. Whereas Europe suffered from persistent financial stress given the lack of any meaningful progress in resolving the crisis, emerging economies performance is the result of, among other reasons, more restrictive policies designed to prevent over-heating.

Looking ahead, global growth should pick up in the second half of 2012, led by emerging economies as their domestic policies become more accommodative for growth in domestic demand. Meanwhile, although the US is likely to grow slower than during previous recoveries, it should significantly outpace Europe, which looks set to see GDP contract by 0.5% in 2012 and a slow recovery in 2013. We would point out that these forecasts depend on a relatively quick solution to the debt crisis and a considerable reduction in financial stress so as to prevent a larger impact on growth. The gap between core and peripheral growth rates should remain large, in part due to sharp fiscal adjustment and deleveraging in peripheral countries.

Risks are still on the downside, awaiting European policies that reduce uncertainties

Although some progress has been made since October, a definitive resolution to the European crisis requires more decisive action on three fronts. First, concerns surrounding Greece’s solvency must be cleared up in an orderly fashion and as quickly as possible, with an agreement with private sector bondholders. At the same time, the mechanisms created to prevent contagion in countries that are solvent, but faced with liquidity problems, must be increased and made more flexible to become more effective. Second, structural reforms that stimulate growth must be introduced, including reforms to make financial institutions stronger without triggering sudden deleveraging and restricting credit. And third, the governance agreements approved recently in the Eurozone must begin working so they can provide a clear roadmap to fiscal union, strengthen monetary union, prevent future crises and enhance the credibility of European institutions and countries.

As the improvement in governance becomes evident, Europe’s institutions should focus on reducing structural deficits and not nominal, or current, deficits without adjusting for the economic cycle, in order to avoid fiscal policies more pro-cyclical than strictly necessary, with the negative consequences on growth; and, also, to boost that adjustment measures will be structural.

Spain back in recession again

In addition to correcting its economic imbalances, Spain has seen confidence erode, export growth fall, expectations of deeper fiscal adjustment in 2012 because of the failure to meet 2011 budget targets, weaker activity and, above all, a deterioration in employment in the fourth quarter last year. Estimates for 2011 show average GDP growth of 0.7%.

Confirmation of increased uncertainty bodes for a worsening in key fundamentals for the Spanish economy. On the one hand, access to financing looks likely to remain tight and expensive because of Europe’s financial debt and banking crisis. Meanwhile, the increase in risk premiums, coupled with more ambitious fiscal plans than considered a year ago and also the slowdown in international trade, has dimmed growth prospects for Europe, which is likely to result in weaker demand for Spanish exports. On the domestic front, the main change stems from the deviation from the budget deficit target. While all this means a sharp cut to economic growth forecasts for Spain, there are some mitigating factors. For instance, the ECB’s monetary (and liquidity) policy is more prone to supporting demand and financial stability than expected three months ago. This, together with an increase in the growth differential between Europe and the rest of the world, should cause a weaker euro, which could speed up competitiveness gains for exporters.

Forecasts point towards a 1.3% contraction of GDP in 2012, and a slow recovery in 2013, which could come faster if the announced structural reforms are ambitious enough

In short, GDP looks set to contract in 2012, and if current circumstances remain, the recovery will be slow. The outlook could change if ambitious structural policies are adopted swiftly and decisively. If they are implemented properly, the adjustment would be less painful (especially in terms of employment), paving the way for a faster and stronger recovery.

The deviation from the 2011 budget deficit target undermined the credibility of all public administrations. Therefore, it is even more urgent now to adopt measures that make up for the shortfall in 2011, that guarantee that targets are actually reached this year, that implement effective control mechanisms on autonomous communities (the main culprits), and, in short, that restore the credibility of public accounts in general.

In this respect, the government’s response has been firm and well received, but it is still not enough to ensure that this year’s target will be met. Turning to the Social Security, its reliance on job creation to generate income and its inflexible spending make it unlikely that this year’s targets will be achieved.

With the Budget Stability Organic Law, Spain is acting ahead of the enforcement of the Stability Pact to be signed by 25 European countries at the next meeting

Regarding the medium-term commitment to stability in public finances and control over the autonomous communities, the Draft Organic Law on Budget Stability sends a clear and firm message to the rest of the European partners. Spain is one of the first countries to adopt this type of legislation and, in principle, it will do so with a broad political consensus. The Draft Law contains several proposals defended in this publication, such as the definition of fiscal target in the structural deficit, the generalisation of a fiscal rule at all levels of public administrations or more transparent reporting for a correct assessment of fiscal policies. It also promotes practical and credible instruments for encouraging compliance with these rules. However, the approach to be used for defining the stage of the economic cycle has not yet been made public. A clear, simply method that can be reproduced easily and assessed externally is also a necessary condition for the reform to achieve the desired level of success. Moreover, it must state explicitly that the deficit target must be established in structural terms and there must not be any confusion regarding the conditions for speeding up the debt reduction process so that fiscal policy does not lead to pro-cyclical actions that could cause imbalances.

The new labour market reform should prevent that the adjustment in 2012 concentrates on job destruction again

Because of the rigidities facing companies and workers to changing their working conditions, the adjustment to the Spanish labour market between 2007 and 2009 focused on employment rather than on the number of hours worked. That’s why the commitment to internal flexibility mechanisms and the call for wage moderation and productivity-linked remuneration (included in the agreement on employment and collective bargaining in 2012-2014) are a step in the right direction, but not enough. The new labour reform must drive internal flexibility as an alternative to job destruction. With an unemployment rate approaching 23%, Spain’s labour market requires particularly determined measures. To be precise, safeguard clauses should be removed to prevent temporary increases in prices from being passed on to wages and generating an inflationary spiral through second-wave effects. In addition, the current structure of collective bargaining must be updated and the system of wage opt-out clauses must be made more flexible. Therefore, the government must make brave proposals that go beyond what has been agreed until now by the trade unions and employers and that prevent the expected economic slowdown in 2012 from causing employment to plummet.

Spanish financial system: a positive restructuring that must be finished

The economy minister announced last 2nd of February a Restructuring Plan for the Spanish financial system. New measures mean an advance because impose a bigger effort in real state portfolios reorganization and use more realistic hypothesis in assets valuation. These requirements, which are more demanding to entities, will have a large o short impact in the sector configuration depending on how they will be applied. Other positive aspect of the Plan is that minimize public support, which performance will be limited to contingent capital injections, with market remunerations, in the entities that can’t increase their provisions on their own.

The current restructuring in order to be a success is important that in its implementation be a priority reach a more efficient financial system, well managed, with sustainable results and be financed in capital markets, all of this require a less fragmentation. For this, after specify unviable entities, is necessary to give them a definitive solution; given incentives to adequate mergers and acquisitions based on strict economic efficiency criteria. Besides, the installed capacity adjustment has to be speeding up, both in offices and staff. Finally, is a must build the foundations to flow the credit to productive activities, in a way that the necessary deleveraging doesn’t prevent sectors and enterprises with good future perspectives be financed.

Source: BBVA research


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