Spain overshoots public-sector budget deficit target in 2015

Spain overshot its public-sector budget deficit again in 2015, according to Acting Budget Minister Cristobal Montero, the eighth straight year of missed fiscal targets. Montero announced at a press conference that the country's public-sector budget deficit (including state assistance to several banks) narrowed to 5.24% of nominal GDP in 2015 from 5.7% in 2014 and 6.9% in 2013. Excluding state aid granted to banks, the general government fiscal shortfall was 5.18% of GDP in 2015. This overshot the recently informally updated estimate of 4.5% of GDP and the official 4.2% presented in the 2015-2018 Stability programme which was approved by the European Commission (ECOFIN). We had expected the government to miss its deficit target throughout most of 2015, and had an estimate of 4.8% of GDP in our latest forecast update.

Montero said the fiscal slippage was predominately due to the 17 autonomous regions missing their deficit target for a fourth successive year in 2015. Specifically, the regions recorded a cumulative fiscal shortfall of 1.66% of GDP (above its agreed 0.7% target), with only three regions meeting their targets, while Catalonia and Valencia were the most notable offenders. The head of the Independent Authority of Fiscal Responsibility had warned the government that Spain risks missing its public-sector budget deficit target for 2015. He noted that the Spanish autonomous regions' target of 0.7% of GDP, and said, "When we analyze the budgets of the autonomous regions for 2015, we don't see enough measures or an evolution of revenues to allow them to even get close to the target of 0.7%". He also warned of the high probability of that the social security fund, responsible for state pension obligations and unemployment benefits, would fail to reach its target due to weaker than anticipated revenues. The government expects the social security fund shortfall to narrow to 0.6% of GDP in 2015 and 0.3% in 2016 from 1.1% in 2014.

We do not have the final central government budget deficit for 2015, but it was under pressure by some impulsive and arguably inappropriate recent policy actions ahead of the general election, namely bringing forward income tax cuts without deeper spending cuts in a relaxed 2016 budget plan. Overall, both central government and the autonomous regions failed to meet its goal of limiting the growth in government spending in real terms to just 0.1% (Stability Programme 2015-2018), and rose by a larger than anticipated 2.7%.

Meanwhile, the Bank of Spain reported Spain's public debt to nominal GDP ratio was 99.2%, or EUR1.072.2 trillion (USD1.167 trillion) at the end of the fourth quarter of 2015. This was down slightly from an all-time high 99.3% at end-2014, but well above a record low of 35.5% at end-2007. Furthermore, Spain's public debt ratio appeared to remain above the Eurozone average, which stood at 91.6% of GDP in the third quarter of 2015. Most Spanish public debt was held by central government, which stood at 87.0% of GDP in the final quarter of 2015, up from 86.0% in same quarter a year earlier. Meanwhile, debt at the regional level (17 autonomous governments) stood at 24.2% of GDP at end-2015, compared to 22.7% in the corresponding quarter of 2014. Some of the most indebted regions were Cataluna and Comunidad Valencia at 35.3% of GDP and 41.3% of GDP in the fourth quarter, respectively.

Outlook and implications

We have argued that the Spanish fiscal consolidation plan remains a work in progress, with more tightening measures likely to be considered after the new government is in finally in place during the second half of 2016. We have argued that 2016 central government budget plan fails to convince that the country can deliver its current multi-year public-sector budget deficit reduction targets. The planned income tax cuts brought forward to 1 July 2015, coupled with continued risks of controlling regional/municipal spending further strengthens our assessment that Spain will continue to fall short of its immediate public-sector deficit target. Specifically, we expect the general government budget deficit to stand at 3.3% of GDP in 2016 and 3.0% in 2017, according to the March forecast, overshooting the current official projections of 2.8% and 1.4%, respectively. A major risk is the autonomous regions' deficit targets of 0.3% of GDP in 2015 and 0.1% in 2016, particularly with the several key regional governments appearing to step back from new austerity measures despite continued missed deficit targets. In addition, IHS projects the fiscal shortfall will not fall below 3.0% of GDP until 2018. This reflects more cautious growth projections and the need to finance substantial welfare commitments and to lower personal and corporate tax rates during 2015. In addition, income-tax revenues could be below target despite employment reviving. Income-tax receipts have been held back by weak earnings growth and the fact that much of the employment growth has been in low-paid jobs or in self-employment (self-employed people tend to pay less tax than employed workers.

We are more cautious than other observers about Spain's pace of economic growth in the next few years, noting improving but still historically low employment and real income levels. Specifically, we expect real GDP growth to slow from 3.2% in 2015 to 2.7% (official projection is 3.0%) in 2016, 2.4% (2.9%) in 2017 and 2.2% (2.5%) in 2018. Importantly, the pace of recovery is likely to lose some momentum in the next few years, with real GDP growth likely to edge back in line with diminishing pent-up demand among households and firms allowing more normal spending patterns. Furthermore, Spain is still enveloped by a standard of living crisis which will take some time to unwind, with household gross disposable income in real terms still several years from recouping the losses endured during the crisis. Another challenge facing the recovery is that reviving employment is being partly fuelled by firms ramping up their temporary contracts to meet new labour requirements. Again, a large pool of short-term workers leaves Spain at risk of sharp swings in the demand for labour and in the unemployment rate as has happened during the various stages of the economic cycle. In addition, a significant use of temporary contracts behind the influx of new jobs will dampen the upside of private consumption and the housing market, with temporary workers being more risk averse and cautious spenders while being locked out of the retail mortgage market.

The lack of a new government after an inconclusive general election last December suggests a delayed visit to the austerity table, implying a major risk to the 2016/17 public sector budget deficit targets. The European Commission's commissioner for economic affairs Pierre Moscovici has warned Spain is at risk of breaching EU fiscal rules, suggesting the 2016 budgetary plan needs to be revised. Acting prime minister Mariano Rajoy had been reluctant to deepen spending cuts ahead of the general election in late-2015, but we anticipate a new round of spending cuts in late 2016 if Rajoy wins the likely fresh election in mid-2016.