The Spanish economy could be one of the stronger performers in the coming year, and so Spain is therefore getting much of the attention. However, although economic activity is now picking up in Spain after years of recession, investors should be aware of just how much further the country has to travel before the recovery is sustainable.
Crisis
Spain was one of the countries worst hit by the global financial crisis, suffering a long and harsh recession. The Spanish economy finally exited from its downturn in the third quarter of 2013, recording GDP growth of 0.1 per cent quarter on quarter, having contracted for the previous nine quarters. High frequency economic data released at the end of last year suggests that fourth-quarter growth will be stronger, while forecasts for the year ahead suggest a continued improvement in economic output. Economic sentiment reached a six-year high in December and the composite purchasing managers’ index is now nudging the pre-recession average.
The economic recovery in Spain has been driven by trade, which has been the largest contributing factor to GDP over the last few quarters. Exports are increasing as Spain regains its international competitiveness – although this has mainly been achieved thanks to falling wages caused by very high unemployment.
The economic recovery in Spain has been driven by trade, which has been the largest contributing factor to GDP over the last few quarters.In other areas, Spain’s economy still faces stiff headwinds, not least from all the deleveraging that households need to complete. Much of this deleveraging is an overhang from Spain’s property bubble, as Spaniards battle to reduce the huge amount of mortgage debt that still weighs on their finances.
A very low inflation rate of 0.3 per cent year-on-year in December is making debt reduction more difficult. Such a low level of inflation means that debt is not falling in real terms, and therefore debts cannot simply be inflated away over time.
The labour market is starting to stabilise and the unemployment rate has declined slightly in recent months. But at an outrageously high 26 per cent, unemployment will continue to hold wage growth down and constrain disposable income.
While consumer demand may be muted in 2014, the Spanish economy will get some support from domestic demand. There has been some sign of a pick-up in business investment intentions and the private sector is further through the deleveraging process than households. However, credit conditions look set to remain tight, and this could hold back growth.
The “Troika” of international lenders (the International Monetary Fund, the European Union and the European Central Bank) has agreed to let Spain’s banks exit from the bank recapitalisation programme that was set up in 2012 to support the Spanish financial system, as it is satisfied that bank balance sheets are now suitably strong enough.
But this is the year that the ECB will undertake its asset quality review, looking into the strength of Europe’s major lenders. Credit conditions are already very tight in the region and banks could reel in lending to pass the AQR. Therefore, lending is likely to remain strict.
The decline in fiscal drag is providing some encouragement that Spain’s government is trying to rein in spending and should allow for more growth over the coming year. The official target for 2014 is a deficit of 5.8 per cent when the impact of bank recapitalisation is excluded. Both Moody’s and Standard & Poor’s upgraded the outlook for Spain at end of last year given the improvement that had been made to the government’s books. The Spanish government forecasts the fiscal drag will equate to 0.6 per cent of GDP in 2014, compared to 1 per cent in 2013.
Balance
Economies need to be balanced. A recovery driven by one sector of the economy is clearly more susceptible to shocks. So far, the export story is driving Spanish growth and this will likely continue over the coming months.
However, the potential for a more balanced economy comes from the amount of deleveraging that has been done in the private sector and the reduction in fiscal drag on growth, despite credit conditions remaining very tight.
Kerry Craig is global market strategist for JP Morgan Asset Management
