OFICINA

ECONÓMICA
DEL
PRESIDENTE PR09OEP012

SPANISH ECONOMY: FINANCIAL CRISIS AND POLICY RESPONSES

J. Ignacio Conde Ruiz

Director, Department of Economic Policy
Economic Bureau of the Prime Minister

Giornate di Studio nFA 2009

1
 OFICINA
ECONÓMICA 1994-2008: Convergence with Europe…
DEL
PRESIDENTE

The Spanish economy experienced 14 consecutive years of positive growth, which have
allowed it to converge with Europe in per capita terms.

GDP - volumes
6
QoQ YoY
5

0
III IV I II III IV I II III IV I II III IV I II IIIIV I II IIIIV I II IIIIV I II IIIIV I II IIIIV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II
-1
1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Convergence with Italy in GDP per capita Convergence with the EU25 in GDP per capita
(ppp) terms. (ppp) terms.
GDPper Productivity Hours / total Employment Demographic GDPper Productivity Hours / total Employment Demographic
Spain/Italy inhabitant / hour employment rate factor (*) Spain/EU25 inhabitant / hour employment rate factor (*)

2000 83,3 88,5 91,3 101,9 101,2 2000 92,7 98,4 100,2 93,9 100,3
2005 97,3 99,5 91,4 103,1 103,8 2005 97,9 97,5 99,6 99,8 101,1
2007 103,4 106,1 89,4 104,5 104,4 2007 101,6 101,7 97,9 100,1 102,1
(*) Population aged 15-64 / Total population. (*) Population aged 15-64 / Total population.

2
 OFICINA
ECONÓMICA An Over-sized residential construction sector
DEL
PRESIDENTE

Housing investment in Spain, as

%GDP (1996-2008) Housing starts in Spain
250.000
8,0
Spain
7,5
Euro zone (2008) 200.000
7,0
6,5
6,0 150.000
5,5
5,0 100.000
4,5
4,0 50.000
3,5
3,0
I IIIIIIV I IIIIIIV I IIIIIIV I IIIIIIV I IIIIIIV I IIIIIIV I IIIIIIV I IIIIIIV I IIIIIIV I IIIIIIV I IIIIIIV I IIIIIIV I IIIIIIV
0
I II IIIIV I II IIIIV I II IIIIV I II IIIIV I II IIIIV I II IIIIV I II IIIIV I II IIIIV I II IIIIV I II IIIIV I II IIIIV I II IIIIV
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

Housing: investment, employment

Housing, Price index
(annual growth rate)
20
20,0
15
15,0
10 Ministerio de la Vivienda
10,0
TINSA
5,0 5
INE
0,0 0
I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV
-5,0
-5
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
-10,0
-10
-15,0
-15
-20,0 I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I II III IV I
-25,0
2002 2003 2004 2005 2006 2007 2008 2009
Inv. Vivienda Ocupados

The decline in the housing sector started in 2006. The international financial crisis turned
into a more severe process what could have been a smooth adjustment.
3
 OFICINA Over-sized residential construction sector: the
ECONÓMICA
DEL
adjustment is costly in terms of employment …
PRESIDENTE

Housing sector as %GDP by country Labour force growth in 2008*

Variation pp.
2007 2008 IV q 2008 (IVq 2008 -IVq 2007)
EU15* 1,2
Spain* 7,5 6,6 6,0 -1,75
Euro area 5,7 5,5 5,3 -0,36 Germany 0,4
France 5,6 5,6 5,5 -0,18 Spain 3,0
Germany 5,5 5,4 5,4 0,03 France 0,7
Italy 4,8 4,8 4,8 -0,09 Italy 1,4
United Kingdom 3,3 3,0 2,9 -0,35
United Kingdom 1,1
* Spain variation: Iq 2009-IV q2007

Employment *Average: I-III q

19.600.000
19.400.000 Unemployment (2000-2009)
19.200.000
4.500 18
19.000.000
unemployed (thousands) 17
18.800.000 4.000 16
unemployment rate (RHS)
18.600.000 15
3.500 14
18.400.000
13
18.200.000 3.000
12
18.000.000
2.500 11
10
2.000 9
8
july 2008 may 2009 dif % 1.500 7
Total 19.382.121 18.103.487 -1.278.634 (100) I II IIIIV I II IIIIV I II IIIIV I II IIIIV I II IIIIV I II IIIIV I II IIIIV I II IIIIV I II IIIIV I
Construction 2.361.177 1.830.059 -531.118 (41,5)
2000 2001 2002 2003 2004 2005 2006 2007 2008 09
Industry 2.731.068 2.416.364 -314.704 (24,6)
Services 13.150.027 12.644.412 -505.615 (39,5)

Since July 2008 1,3 million people have lost their jobs. The construction sector is the
sector with the highest decline in employment and accounts for 40% of the total
decrease.
4
 OFICINA
ECONÓMICA
A highly indebted economy… not all real estate
DEL
PRESIDENTE

•Spain has had high investment rates for the last 10 years. It was not
exclusively housing, e.g. investment in equipment was larger
•The large immigration flow (+4 millions between 2000 and 2007) spurred a
rise in capital expenditure to maintain the capital-per-worker ratio.

Capital-per-worker ratio
Investment in equipment (average growth, 1995-2008, %)

10
8
6
4
2
0
UK
EU -15

Italy
Germany

Netherlands

Denmark

Spain
Austria
Finland

France

Source: Eurostat

5
 OFICINA Some credit developments.....
ECONÓMICA
DEL
PRESIDENTE

Credit to businesses Credit to households

1.000.000 Services 1.000.000

Servicios (ex
(excluding
900.000 developers)
promotor) 900.000
800.000 800.000
700.000 700.000 Other
Otros
Promotor
Developers
600.000 600.000
500.000 500.000
Consumprtion
Consumo
400.000
Construction
400.000

m
300.000 Construccion

u
e
n
ilo
s
300.000

m
r

u
e
n
ilo
s
200.000

r
200.000 Vivienda
Housing
100.000
100.000
0 Manufacturing
Industria 0
93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09
93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09
Fuente BDE Fuente BDE

• During 2000-2008 credit grew 8% a year on average, while GDP grew 2.8%.
• Mortagage credit accounts for 21% of total credit to households, while the EMU
average is 12%.
• Construction-related credit is 43% of total business credit.
• Credit to other productive activities is 57% of total business credit.

6
 OFICINA ...with a major external financing need
ECONÓMICA
DEL
PRESIDENTE

Balance of Payments: financing the deficit

(net flow, M€ cumulative last 12 months)

National investment (m.a.4, %PIB) National savings (m.a.4 %PIB)

200.000 Short term financing
32
P ortfolio investment
160.000 30
Foreign direct investment

120.000 current account balance 28

current
26 account
80.000
balance
24
40.000
22
0 20
-40.000 18
I II III IV I II III IV I II III IV I
-80.000

-120.000 2006 2007 2008 2009

2004 2005 2006 2007 2008 2009

The financial crisis has transformed the way the balance of payments is financed
(from portfolio investment-i.e. mortgage-backed securities-to short term financing ECB)
The external financing need of the Spanish economy was 9,1% of GDP in 2008, the
first decline in 5 years

7
 OFICINA
ECONÓMICA The Spanish banking model at a glance
DEL
PRESIDENTE

A balanced mix of tradition and innovation

• A business model focused on long-term customer-bank relationship:

 The emphasis is on the customer as opposed to the product. 54 % of bank assets

are credits, while they only account for 30% of assets in the EMU.
 The core-business hinges on recurrent operations and multi-product services.
Thus: originate-to-hold rather than originate-to-distribute.
 Borrowers`risk assessment and monitoring are of greater relevance in an
originate-to-hold framework.

Productive activities
70% Actividades Productivas
Households non
Familias no hipotecario
mortgage
60%
Familias hipotecario
Mortgage
50%

25%
40% 39% 25% 28%
36%
30% 13%
10% 15% 12% 9% 7%
20% 12% 8%
11%
6% 10%
4% 5% 8%
10% 19% 3% 18% 19%
11% 15% 12% 10%
9% 9% 7%
0%
UEM Francia Alemania Italia España

8
 OFICINA
ECONÓMICA The Spanish banking model at a glance
DEL
PRESIDENTE

The Spanish banking sector is highly competitive:

 Real lending spread (defined as the difference between real lending rates and real
deposit rates) well below the EU average.
 Concentration, (as measured by the Herfindhal index: the sum of the square of the
market shares), is also far below the average for EMU countries.

Herfindhal Index Real lending spread

Real interest rate spread

4
700

3,5
600

500 3

2,5 Germany
400
Spain
Spain
2
300 France
MU13
1,5 Italy
200
Italy 1
100
0,5
0
2003 2004 2005 2006 2007 0

2005Jan

2006Jan

2007Jan

2008Jan
2007Jul
2004Jul

2005Jul

2006Jul

2008Jul
2004Apr

2006Apr

2007Apr
2005Apr

2008Apr
2004Oct

2005Oct

2006Oct

2007Oct

2008Oct
Source: ECB

9
 OFICINA
ECONÓMICA The Spanish banking model at a glance
DEL
PRESIDENTE

Securitisation in the Spanish banking model is used mainly for funding as opposed to
risk-transfer purposes.
Since 2003, deposit growth has been lower than credit growth, causing a growing
funding gap. This gap reached 14% of total credit by the end of 2008, while in 2003 it
was 9%.
The outstanding value of securitization instruments and bonds issued by the Spanish
financial system (with data up to the third quarter of 2008) was about 480.000 million €

Issuance of structured securities

Funding gap

90
80
70
60
France
50
Germany
40
Italy
30
Spain
20
10
0
2001 2002 2003 2004 2005 2006 2007 2008

10
 OFICINA
ECONÓMICA The Spanish banking model at a glance
DEL
PRESIDENTE

 The main vulnerabilities of the Spanish financial system in this crisis are:
i) high exposure to the housing sector, which is not experiencing a soft landing …
ii) The growing financing gap of the Spanish banking sector and the difficulties to refinance
debt in dried-up wholesale funding markets.
However, these weaknesses have been dealt with succesfully thanks to the ECB´s un-
conventional measures and the prevalence of long term debt

Resort to ECB financing Maturities of debt of financial institutions.

Millions of euros
650,000 Bancos españoles (derch) 80,000

BCE (izq)
70,000
600,000
60,000 250.000
550,000 50,000 200.000
500,000 40,000
150.000
30,000
450,000 100.000
20,000

400,000 10,000 50.000

nov-06

nov-07

nov-08
jul-06

jul-07

jul-08
sep-06

ene-07

sep-07

ene-08
mar-08

sep-08

ene-09
mar-07

mar-09
may-09
may-07

may-08

0
2009 2010 2011 2012 Mas de 2013

11
 OFICINA One of Europe's most opened economies …
ECONÓMICA
DEL
PRESIDENTE

Openness index World exports

Imports (%
Importaciones GDP)
(%PIB) 40,0
50,00 Exportaciones
Exports (% (%PIB)
GDP) 30,0
20,0
40,00
10,0
0,0
30,00
-10,0
-20,0
20,00 World exports
-30,0
Industrial countries
-40,0
10,00 Other countries
-50,0

0,00
-60,0
Spain e f m a mjn jl a s o n d e f m a mjn jl a s o n d e f m a mjn jl a s o n d e f m
España Germany France Italy
Alemania Francia Italia UK
Reino Unido US
EEUU Japan
Japon

2006 2007 2008 2009

Exports are still suffering from the global recession and have declined 19%, which has
affected goods (-20.5%) and services (-15.9). On the other hand, imports of goods and
services decreased 22.3%

12
 OFICINA The timing of the crisis (1): The Lehman Brothers
ECONÓMICA
DEL bankruptcy collapsed financial markets and sharpened
PRESIDENTE the downturn

The Lehman Brothers bankruptcy caused great turmoil in financial markets,

leading to a sharp decline in stock prices and a great increase in volatility.
13000
100
12000 Lehman 90 Lehman
Brothers
11000 80 Brothers
declares
70 declares
10000 bankruptcy
60 bankruptcy
9000 50
Ibex
40
8000 VIX
Dow Jones 30
7000 20
10
6000 0
06/02/2008 8/26/2008 11/19/2008 02/18/2009 05/14/2009

Spain has implemented internationally-coordinated policies to stabilize the

financial system: i) extension of the deposit guarantee coverage (100,000
Euros), ii) Fund for acquisition of Financial assets, iii) State guarantees backing up
the new bank debt and iv) recapitalization of troubled banks

13
 OFICINA The policy response: Fiscal policies aimed at
ECONÓMICA
DEL
supporting employment and output and resuming
PRESIDENTE credit to the economy

In light of G20 recommendations, all countries have put in place the largest concerted
effort to support demand and employment in history

Effect on GDP level (%), 2009-2010 Approximate cost of the discretional

measures 2008-2009 (%GDP)
2,5
2008 2009
2

1,5

0,5

U
K

Ita
ly
d
In
ia
B
p
S
in

C
a

ra
in
h

p
n
a

Ja

z
aK
re
o
M

n
e
ra

il
F
C

c
d
n
a

oe
x
rm

ic
gA
e
ra
v
G
A
u
tra

n
ae
s

y
Source: OCDE

li

S
d U
n
ite
a
Source: IMF

s
Spain is one of the countries that have made a greater fiscal effort, as compared
to the other main developed economies and to other EU countries.
Also, according to the OECD, Spain was the third developed country to
implement a stimulus package. The measures included in Plan E could
contribute 1% GDP Growth in 2009.

14
 OFICINA The policy response: Fiscal policies aimed at
ECONÓMICA
DEL
supporting employment and output and resuming
PRESIDENTE credit to the economy

This stimulus, named Plan E, uses both the revenue side and the expenditure side in
order to create a fiscal mix to foster the economic activity. In the revenue side, which
amount 2/3 of the total amount, include tax cut in PIT (Personal Income Tax), CIT
(Corporate Income Tax) VAT and the elimination of the wealth tax. In the expenditure
side is included an ambitious investment plan of 0.8 GDP points, and an industrial fund
of 0.3 GDP, to foster the new economic model, including R&D.

2008 2009

Total Fiscal effort 2,5 4,7

Tax cuts 1,8 1,1

Expenditure 0 1,1

Automatic stabilizers 0,7 2,5

In addition to this, we should take into account the effect of the automatic
stabilizers, amounting 2.5 GDP points only in 2009, according to the Bank of
Spain.

15
 OFICINA Rigorous fiscal policy over the booming years pays off: A
ECONÓMICA
DEL comfortable margin for countercyclical fiscal policies.
PRESIDENTE

Deficit (%PIB) Public debt (%PIB)

3,00 140
España Italia UE27 2008 2009 2010
2,00 120

1,00 100
0,00
80
-1,00
60
-2,00
40
-3,00
20
-4,00

-5,00 0
Spain Germany United France Italy
Kingdom
7
9
1
8
9
1
9
1
0
2
1
0
2
0
2
3
0
2
4
0
2
5
0
2
6
0
2
7
0
2
8
0
2

Source: European Comission, spring 2009.

Source: Eurostat.

• Rigorous fiscal policy before the crisis: three years of surplus

• Debt/GDP ratio among the lowest in advanced economies.
• Countercyclical policies over the recession will only have a limited impact on the ratio. As a
result, the expected debt/GDP ratio in 2010 remains well below EU average.

16
 OFICINA The timing of the crisis in Spain: the current situation….
ECONÓMICA
DEL
PRESIDENTE

1Q 2009 (QoQ) Spain Italy

GDP volumes -1,9 -2,6
Final consumption expenditure -1,3 -0,8
Household and NPISH final consumption expenditure -1,7 -1,0
2008 Spain Italy Final consumption expenditure of general government -0,1 -0,3
GDP volumes 1,2 -1,0 Gross capital formation -4,4 -6,8
Final consumption expenditure 1,5 -0,5
Gross fixed capital formation -4,2 -5,0
Exports of goods and services -11,9 -11,8
Household and NPISH final consumption expenditure 0,1 -0,9 Imports of goods and services -10,9 -9,2
Final consumption expenditure of general government 5,3 0,6
Gross capital formation -2,8 -4,2 1Q 2009 (YoY) Spain Italy
Gross fixed capital formation -3,0 -3,0 GDP volumes -3,0 -6,0
Exports of goods and services 0,7 -3,7 Final consumption expenditure -1,7 -1,7
Imports of goods and services -2,5 -4,5 Household and NPISH final consumption expenditure -4,0 -2,5
GDP per capita PPP 104 100 Final consumption expenditure of general government 5,4 0,7
Gross capital formation -13,3 -15,2
Gross fixed capital formation -13,1 -12,6
Exports of goods and services -19,0 -21,7
Imports of goods and services -23,3 -17,0

•The crisis hit Italian output harder than Spanish output. This can be observed
both in quarter-on-quarter growth (-1,9% vs. -2,6%) and in year-on-year
growth (-3% vs. -6%).

•In terms of employment (LFS) the opposite is true. In the first quarter of
2009, Spanish employment has decreased -6,4% compared with the same
quarter of 2008, while it Italy it has decreased only -0,9%.
17