Spain’s 2021 budget is based on positive assumptions of an immediate economic recovery, lately threatened by a second wave of Covid-19 infections, and the government’s ability to channel the EU recovery budget towards pro-growth investments in the right time.
The Spanish government’s projection of a downward trajectory of the debt-to-GDP ratio next year, as defined in the 2021 Draft Fiscal Plan (PPP), assumes a sustainable economic rebound supported through transfers from the Next Generation EU (NGEU) recovery fund.
We see a problematic threat to the government’s expected economic outlook, which also influences its fiscal and debt projections.
The Spanish government expects an economic recovery of 9. 8% of GDP in 2021, which includes the positive effect of EU recovery funds, following an 11. 2% contraction this year. The government’s hypothesis is that the stimulus fund will resume the trajectory of genuine GDP at 2019 degrees until early 2022. For 2023, the expansion trajectory would be the same as it would have been in the absence of a pandemic due to an ongoing crisis, the positive effect on the resulting investments, which are the country’s expansion prospects expected to increase to 2%, compared to an existing estimate of around 1. 5%.
We see 3 dangers for the Spanish government’s economic forecasts.
Firstly, the prolonged wave of infections is forcing Spain to reintroduce limits on economic activity, which will most likely oppose the recovery in the fourth quarter, after the very strong physical expansion in the third quarter (16. 7% quarter-on-quarter). Falling output in the fourth quarter and only a slow recovery in early 2021 will lead to a slowdown in expansion next year.
Second, as long as the crisis persists, Spanish businesses and households will not focus on investment and spending, as a V-shaped recovery implies, but on their own survival and savings, which will undermine personal demand in the coming quarters.
Thirdly, EU resources, through grants from the recovery fund, will have to be channelled well into public investment projects and structural reforms that improve growth. Spain has a poor track record when it comes to turning the EU budget into fiscal stimulus.
Undoubtedly, the Spanish government has strengthened the governance of the EU recovery budget by centralising it in the Cabinet Office and pushing for reform plans to streamline administrative processes and public procurement. However, the administrative capacity to use such a gigantic amount of budget in an effective and timely manner can constitute a significant challenge for the Spanish public sector. In fact, at 39%, Spain has the lowest cumulative absorption rate of the European Structural and Investment Funds 2014-2020 among the EU-27, comparable to Italy’s is even lower than Portugal’s (54%).
The budgetary outlook depends fundamentally on the need for a giant tranche of the EU budget (around €27 billion, or around 2. 2% of 2019 GDP) to be well channelled into expansion over the next year. The government estimates that this budget, basically allocated to productive investment spending, will boost Spanish GDP expansion by about 2. 6 percentage points, given its forecast of an expansion rate of 9. 8% in 2021, compared to 7. 2% in a policy situation of no change.
For this year, the government expects a budget deficit of 11. 3% of GDP, with an improvement to 7. 7% in 2021. This compares with our most conservative forecast, also based on a less favourable expansion outlook, of a budget deficit of 13% of GDP. GDP in 2021-2020 and 8. 5% in 2021, largely in line with IMF forecasts of 14. 1% and 7. 5%.
Other dangers related to a less physically potent economic recovery come with the crystallization of contingent liabilities on the balance sheet. According to the DBP, the maximum amount of public pledges on loans that can be obtained amounts to around €160 billion, or 13% of 2019 GDP. In the government’s scenario, changes in stock flows are expected to contribute to widening the debt-to-GDP ratio through issuances of 2. 5 percent in 2021.
Overall, we expect the public debt-to-GDP ratio to remain on a slightly expansionary trajectory over the medium term, from 122% this year to 125% through 2025. This compares with the government’s projection of 118. 8% for this year and a reduction in the short-term rate to 117. 4% in 2021. On the positive side, strong market access and favorable financing situations continue the government’s fiscal reaction to the pandemic.
The Treasury has thus completed about 90% of its investment program for 2020. Thanks to the ECB’s purchase programmes, the Eurosystem now holds more than 23% of Spain’s government debt, ensuring low investment costs, with a 10-year government bond yield of around 0. 1%.
In addition, given the favourable borrowing conditions, the government has only requested the subsidy part of the NGEU programme, in addition to the €21. 3 billion loan requested under the SURE unemployment programme, of which €6 billion has been transferred, thus cutting the government’s borrowing needs.
Finally, due to recurrent errors in obtaining parliamentary aid for government budgets, Spain is still operating under the 2018 budget. However, we expect the government to pass its budget this time, the ruling minority coalition between the PSOE and Unidas Podemos will enlist the help of outdoor groups to do so.
The emergency has triggered a state of alarm, which temporarily strengthens the powers of the government and increases the political value of the belief that the interests of parties are above those of the state.
The failed attempt by the far-right Vox party to boost an anti-government censorship movement shows that most opposition parties are unlikely to jeopardise the country’s chances of receiving EU recovery funds, which are contingent on the approval of the budget. If the budget is not approved, the appropriations would be negative, as highlighted through Scope’s action on Spain’s score in August, when the outlook for the A- sovereign score was revised to negative.
Alvise Lennkh is Deputy Head of Public and Sovereign Sector Ratings at Scope Ratings GmbH.