IMF Says Spain Has Improved But Nation Needs "Urgent Action" To Stimulate Growth

The IMF made a rather negative assessment of the Spanish economy overnight, noting its improvement from the doldrums of last summer but reiterating that the country has a long way to go. The IMF said that unemployment remains unacceptably high which calls for urgent action to generate growth and jobs, both by Spain and Europe.

Progress Has Been Made

The IMF first noted that Spain has made progress from a year ago, when the country's banking system nearly crumbled prior to its 100 billion euro bailout. They noted that labor reforms have helped to quell economic imbalances and that sovereign spreads have decisively and positively narrowed.

However, the economists noted that the lowering of borrowing costs have not fed through to the real economy, the so-called breakdown in the transmission mechanism that European Central Bank President Draghi has alluded to time and again. "Hampered by private sector deleveraging and fiscal consolidation, and compounded by labor market rigidities, output has contracted for seven quarters and unemployment has reached 27%."

Outlook

"In our baseline scenario, we expect growth to start to turn positive later this year and to gradually pick up to around one percent in the medium term, with limited gains in employment." However, they note that exports have been a bright spot and should continue to do be going forwards. "The external sector will likely continue to be the bright spot, but probably not enough to generate sufficiently strong growth given weak domestic demand."

Nevertheless, they see the government's assessment as overoptimistic and see the Spanish authorities lowering its own forecasts before year end. "An upside scenario similar to the government's is certainly possible, especially in the medium term if the envisaged reforms are fully implemented by Spain and Europe. But there are also downside risks: private sector deleveraging could weigh more heavily on growth or financial market pressures could intensify."

Jobs Jobs Jobs

The IMF notes that the government in Spain needs to focus on fixing the labor market now that the financial sector seems to be stabilizing. "The focus should be on a pro-jobs strategy that allows the economy to grow and hire. This means building on existing progress in making prices bear more of the adjustment than quantities, helping the private sector delever, making sure banks can extend credit to healthy businesses, and minimizing the drag from the inevitable fiscal consolidation."

Spain also needs to push through reforms that deregulate certain industries, which will allow more jobs to form in certain service sectors. The IMF also notes that the large unionization of workers in Spain is contributing to unemployment excesses and that less reliance on union contracts should help to boost employment, so long as the government sticks to plans to reduce the power of unions.

"Europe Should Do More"

The IMF also noted in its assessment of Spain that the European authorities can do more to help Spain rather than let the country suffer while the entire continent drifts through recession. "Recent euro-area actions have reduced tail-risks and financial market stress. Nevertheless, these initiatives have not been sufficient to reverse financial fragmentation, fix the broken transmission mechanism, and deliver higher growth and employment, neither for the euro-area nor Spain."

"Of particular importance to Spain would be moving faster to full banking union, which would help break the sovereign/bank loop by allowing Spanish firms to compete for funds on their own merits rather than on their country of residence. Further ECB measures to reduce the much higher borrowing costs facing Spain's private sector would also be important." Also, the OMT backstop safeguards Spanish banks from another swift spike in yields, says the IMF, and Spain should maintain a program that is OMT-eligible should they need such a backstop in the future.

Posted In: NewsGlobalEcon #sEconomicsMarketsIMF
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