Transcript

Transcript of a Conference Call on the Publication of the Staff Report for the 2013 Article IV Consultation with Spain

August 2, 2013

MS. GAVIRIA: Hello, everyone. Welcome to this conference call on the 2013 Article IV Consultation with Spain. As you know we posted yesterday under embargo in our Press Center the related staff report, a press release, also in Spanish, and an IMF Survey interview, as well as two videos. I hope you’ve had a chance to look at those. Now let me introduce the speaker, James Daniel, who’s the Mission Chief for Spain. He’ll start with a few remarks and then he’ll be happy to take your questions.

MR. DANIEL: Hello, everybody. Thank you for your interest. Let me summarize the main messages of the staff report. There are five key messages. Let me start with those and then I’ll go into them in a bit more detail.

The first message is that there’s been a strong reform effort in critical and difficult areas. The second is that these reforms are helping to stabilize the economy and correct imbalances. Third, the adjustment is proving, inevitably, to be difficult. Fourth, the recovery will likely be weak. And fifth, hence, the reform effort must continue.

Let me drill down a little bit on that. On the first point, the strong reform effort, I would draw your attention to Chart 2 on page 6, which shows a red line that points up, and you can see the Spanish red bar is very high. That’s the index of commitment to reform. You can see it’s very high.

So in terms of the reforms, what are we seeing? We’ve seen decisive action to help clean up the banks. You can also see that on Chart 20 on page 18. You can see the core Tier I ratio and the provisioning ratio. We’ve also seen a large reduction in the fiscal deficit despite the recession, one of the strongest in Europe, indeed amongst all advanced countries. You can see that on Chart 1 on page 4, where you can see the large Spanish red bar showing the large change in the cyclically adjusted deficit. There’s been a major labor market reform, and there are also many product and service market reforms underway.

Coming to the second point about reforms helping to stabilize the economy and correct imbalances, I would draw your attention to Figure 1 on page 5 that illustrates these main themes. Sovereign yields have fallen. Reliance on the ECB has also fallen. The external current account deficit has swung rapidly into surplus. Competitiveness has improved sharply. Output is stabilizing. Unemployment is also stabilizing on a seasonally adjusted basis. Private debt, especially corporate debt, is being reduced.

Coming to my third point about the adjustment proving, inevitably, to be difficult, over the last year unemployment has risen sharply and is very high, disproportionately affecting young and those on temporary contracts. Household incomes have fallen significantly. Here, Chart 5 on page 7 gives some illustration. Output has fallen for eight quarters now, down 7 percent from its peak. Financing conditions are very tight, especially for small firms. Government debt is rising rapidly as the deficit remains unsustainably high.

Coming to the fourth point, the recovery is likely to be weak, we see strong headwinds of unavoidable fiscal consolidation, of households and firms continuing to reduce their high levels of debt and of tight financing conditions. These headwinds will likely lead to growth only recovering gradually in the medium term and with equally gradual reduction in unemployment. The outlook is also quite uncertain, and we can see both upside and downside scenarios. And here I draw your attention to page 10 and Charts 9 and 10, where you can see these different scenarios illustrated.

Coming to my fifth point, hence, the reform effort must continue. On the labor market, it’s encouraging that there will be an independent review. And in this context we would point to more flexibility for firms to set wages and work arrangements according to their economic conditions. We would point to reducing duality. There’s still too much of a gap between those on well-protected permanent contracts and those on temporary contracts. For the unemployed, they need more training and more help to find jobs, and a reduction in the cost of employing them, including tax costs. We would also suggest that, given the urgency of the situation, it is worth exploring a social agreement that could perhaps bring forward the job gains and structural reforms. And you can see this discussed in more depth on the box on page 14.

On the insolvency regime, this needs to be made more efficient both for firms and individuals. On banks, the system is much stronger, safer, and leaner than a year ago, but risks remain elevated, which calls for keeping loan books clean and reinforcing both the quality and quantity of capital. It calls for removing possible supply constraints and, thirdly, for giving incentives to banks to do all these things.

On fiscal policy, despite the great progress in 2012, Spain is still only halfway along its needed consolidation path. Going forward, the consolidation should be gradual and growth friendly. And here we’d point to the benefits of raising indirect tax collections, which you can see from Chart 22 on page 21 is very low in Spain. We would point to reviewing the tax system to mobilize revenue in a fairer and more efficient way, and it’s encouraging this seems to be underway. We would point to ensuring the independence of the Fiscal Council and to ensuring the sustainability of the pension system. The recent Expert Committee report provides a strong framework.

On the business environment, we point to following through on the planned reforms, especially on market unity and professional services, where there will be important reforms.

And, lastly, on Europe: more should be done at the European level to ease Spain’s adjustment. In particular this would mean faster progress towards full banking union and more from the ECB to reduce financial fragmentation and ease credit conditions.

QUESTIONER: I’ve been taking a look at the paper and I don’t know if I’m right or wrong, but my feeling is that in spite of the loss of competitiveness, Spain still has a lot to do, but not on the wages side. It’s like wages have fallen significantly now because the biggest problem is with prices. Is that correct?

MR. DANIEL: Thank you for your question. I don’t think your characterization is entirely correct. We do see a large improvement in competitiveness indicators in Spain, as you can see from Chart 4 on page 7. It’s perhaps a little difficult to understand. But what that shows is that while Spain has made up the loss of competitiveness as defined by the unit labor costs since 2000, this has been achieved by productivity gains, not labor cost gains. Productivity gains probably reflect a lot of labor shedding because the more marginal workers are let go in which case the productivity of those who remain is higher. So while that’s a positive feature for competitiveness, the gains have been predominantly made through these kinds of productivity gains, which also reflect a loss of jobs. And, in fact, if you were to turn to the chart on page 12, Chart 13, that will give you the nominal wages. And you can see the differential between Spain’s wages and those of its partners, for example, Italy, France, and Germany. That gap has not actually changed very much, although as you can see on Chart 14 there is increasing wage moderation going on. I think our message will be that this will need to continue.

QUESTIONER: My question is about the staff report. I think this is the first time the report mentioned the social tension as one of the concerns or one of the factors in these assessments. I want to know your opinion on how Spain is going to tackle this reform with high unemployment in the medium term, and if you think Spain should carry out a new labor market reform.

MR. DANIEL: Obviously, given the difficult economic environment, it will be challenging, but I don’t have much to add on the political or social aspects. I would come back to you on the new labor market reform. I think what we’re saying here is that the recent reform has been strong and there are indications that it’s definitely working in the right direction, and we would like to see more of this. And if this does not get reflected, then I think there would be need for additional reform.

In terms of increasing flexibility of work arrangements, we’re seeing more indications that there is more flexibility. For example, we have ultra-activity now, which is expiring. So I think now is a good moment to see if that’s working enough.

We also look to the forthcoming independent review to have an opportunity to take stock of where we are and perhaps how to move forward. There are some areas that obviously do look as if they need more reform and that’s on, for example, duality. We don’t see much evidence of substantial progress there, although it’s also fair to say that perhaps one wouldn’t expect it in the downturn.

QUESTIONER: In your report you outline a sort of worst-case scenario in which you see more financial distress, etcetera, and in which growth won’t return until 2017. I was just keen to get a sense of how realistic that scenario was.

MR. DANIEL: Let me just start by saying the context. The baseline is our central scenario and we see the risks as broadly balanced between the two. It could be better. It could be worse. In terms of the likelihood of that, I don’t want to put particular numbers on it, but there are a lot of uncertainties. And in a way we saw a similar recovery in the end of 2010 and in 2011 and things didn’t go so well after that. I think we’re more optimistic that that’s not going to happen this time, but it’s I think important to realize that the objectives of continuing reform is not just to try and get the upside scenario to materialize, but also to prevent downside scenarios materializing.

This is a scenario that’s also largely within the government’s control. If they continue with their reform measures, we could see definitely the upside scenario occurring. And we’d also point to the fact that one of the big differences between the two scenarios is what we call the fiscal multiplier. Under the upside scenario, we have a low fiscal multiplier, which means that the fiscal consolidation doesn’t have much of a drag on growth. On the downside scenario, we have a multiplier where it does have a big drag. And the extent of the drag on growth will depend on the measures that the government chooses: good quality measures will reduce the drag and bad quality measures will increase it. So there’s quite a lot of policy determination in the scenarios.

QUESTIONER: I’d like to know a little bit more on what you think about the current fiscal framework for the regional governments. My feeling is that you put a lot of emphasis in the actual implementation. Is that correct?

MR. DANIEL: Let me give you some context on that one. I’m glad you’ve given us an opportunity to talk about it. I probably should have said a bit more about it.

Let me just backtrack to being in the same room on the same call a year ago. I remember getting a lot of questions about the regions from journalists. I also remember getting a lot of questions from investors. There was a lot of concern about the regions. We had seen a big overshoot by the regions in 2011, and it was a real risk factor. And this year have you noticed that there’s not been that much in the report on regions. Regions came very close to their targets, and we feel much more confident that the regions are, indeed, undertaking consolidation. I think this is a very positive factor. When I look across all the regions in Spain, I see all of them have improved their deficit considerably compared to 2011. And I look at some regions like Castilla-La Mancha or Extremadura, and quite a few others that have really made a very big reduction in their deficit. I’ve also noticed -- and this is something that perhaps should get more recognition -- that the transparency has improved substantially on the regions, not only in 2011 and a bit last year, when we worried about the regions and we also didn’t have data. Now we have much better data. So this is a major step forward.

Now, we would put this down to two factors. First of all, I think the regions themselves are generally committed to fiscal consolidation and taking many difficult measures. I would also put it down to the improved mechanisms that have been put in place. There are a couple of things. There’s the financing arrangements; many regions now get financing from the center and that comes with stricter controls. There’s also the new Organic Budget Law, which allows for more controls and transparency.

So I think what we’re saying here is that major progress has been made in terms of regional finances and that will need to continue. And in particular we see that the Organic Budget Law, as it continues to be developed -- and you can see in the selected issues paper more on this – we see scope for improving the way it’s applied. And that will help cement these gains that have been made in 2012.

MS. GAVIRIA: Thanks you. We end this conference call here. Thanks, everyone, for participating.