According to the Bank of Spain, the economy continued to grow solidly in early 2016, with balanced GDP developments boding well for the rest of the year and 2017. However, we acknowledge heightened risks to our baseline assessment, namely political and fiscal challenges.
IHS perspective | |
Significance | Spanish economic recovery continued to evolve in early 2016, and at a slightly stronger pace than we had anticipated. |
Implications | The main engines of growth remained household spending and corporate investment in the first quarter. |
Outlook | Balanced real GDP gains during 2015 and early 2016 alongside positive survey data bode well for the remainder of the year and 2017. However, the risks to our baseline assessment are now tilting to the downside. They stem from the uncertainty surrounding the formation of the new government, the need to address the missed public-sector budget deficit target in 2015 and optimistic near-term fiscal goals and increasingly challenging external environment. |
According to the national statistical office, the economy posted its 10th consecutive gain by early 2016, following nine consecutive quarters of decline. Real GDP grew by 0.8% quarter on quarter (q/q) in the first quarter of 2016, matching the 0.8% q/q gain in the final two quarters of 2015. Meanwhile, real output was up 3.4% year on year (y/y) in the first quarter, after the economy grew by 3.2% in 2015 as a whole. IHS had estimated that real GDP grew by 0.63% q/q and 3.3% y/y in early 2016 prior to the central bank estimate of 0.7% q/q.
We suspect both consumer spending and business investment continued to drive the recovery in the first three months of 2016.
Private consumption appeared to grow for an 11th successive quarter, and at a solid pace, probably around 0.8% q/q in early 2016. Clearly, households are being elevated by strong job creation and temporary factors lifting purchasing power. They include lower global crude oil price, tax cuts brought forward by six months to July 2015 and government paying public-sector employees of one-quarter of the extra salary payment suspended in December 2012. Other factors have placed household spending on a sustainable upward trajectory. First, consumer confidence has benefitted from reduced sovereign financial tensions, alongside Spain developing a broad-based recovery, falling consumer prices, and a lower unemployment rate compared with one year ago, triggering more upbeat spending intentions. Therefore, consumers are returning to the high street to satisfy pent-up demand for durables, attracted by discounted prices, with the additional spending being financed by a lower propensity to save.
Business capital spending continued to spiral up, and remained a strong performer during the first quarter. The upturn in machinery and equipment investment appeared to continue, while construction investment is likely to have posted a modest gain. The main spur behind the upturn in corporate (excluding construction) investment has been improving financials, triggering a release of some pent-up demand for items such as new machinery, alongside higher level of capacity utilisation and the improvement in the availability of credit.
Outlook and implications
Balanced real GDP gains during 2015 and early 2016 alongside positive survey data bode well for the rest of the year and 2017. A key factor is the recovery being underpinned by continued gains in employment, household income, and corporate financials. In addition, a positive domestic demand backdrop implies Spain is well-placed to take advantage of converging supportive external factors, namely lower energy costs and a more competitive euro. We continue to argue that extended low oil prices are helping to restore consumers' purchasing power, even as limited wage growth remains a major headwind for the household sector, while elevating companies' margins and supporting higher investment and employment. The retreat in both global crude-oil prices and the euro played a major supporting role in Spain during 2015, and built on the original recovery platform of improving sentiment across the economy in line with notably calmer sovereign financial conditions, record-low interest rates, and the labour market bouncing off the bottom.
Nevertheless, we expect the recovery's pace to lose some momentum during the remainder of 2016 and 2017, with real GDP growth likely to edge back to around 0.6% quarter on quarter, as normal spending patterns return amid diminishing pent-up demand among households and firms; additionally, economic sentiment has lost its edge after the inconclusive general election in late 2015. Still, the near-term outlook remains encouraging, and we expect the economy to grow 2.7% in 2016 and 2.4% in 2017, according to the April forecast.
As a major crude-oil importer, Spanish households are enjoying the fruits of lower global oil prices. The fall in energy costs has been a major factor behind negative or marginal consumer price inflation since mid-2014, helping stoke a firmer revival in real household incomes. Specifically, gross household disposable income in real terms rose by 3.4% y/y in the final three months of 2015, and by 2.8% y/y in 2015 as a whole. Nevertheless, despite welcome gains since mid-2014, household gross disposable income in real terms at end-2015 was still 6.8% below its fourth-quarter peak in 2009. Other supports are materialising, including several income tax cuts during 2015, helping ease the pain of continual nominal wage compression.
Since the start of the recovery in late 2013, the prevailing tendency has been for better-than-expected data to trigger higher near-term growth projections. However, we now believe the risks to our baseline assessment are less advantageous. They stem from the uncertainty surrounding the formation of the new government, the need to address the missed public sector budget deficit target in 2015 and optimistic near-term fiscal goals and increasingly challenging external environment.
Prime Minister Mariano Rajoy will hope that continued positive labour demand, household real income and GDP developments will sway more voters to give his government more electoral credit for navigating Spain from a near depression to being one fastest growing Eurozone economies should the country return to the ballot box.
Rajoy will argue that the continued improvement in the labour market is further proof that his stable government are the best custodians of the recovery, while being best placed to create an environment that encourages business to ramp up their employment and investment plans. Still, a key electoral issue remains the current standard of living crisis, with household gross disposable income in real terms by end-2015 still 6.8% below its fourth-quarter peak in 2009.
Risks to the baseline assessment
Our baseline assumes growth will remain solid in the near term, but lose momentum in an orderly manner. However, economic risks could trigger a sharper slowdown. First, consumer spending is likely to remain a major engine of growth in the near term, but risks to the household economy are significant. They include an elevated unemployment rate, insecure job contracts, past real income losses, a collapse in housing equity, and restricted access to credit. Second, after having missed its public-sector budget deficit goal yet again in 2015, Spain could have little option but to find some new spending cuts once a new government is in place. External risks are tilting to the downside, and relate to threats to global growth from the slowdown in emerging market economies and China's rebalancing.
Heightened political risks could derail the recent improvement in economic sentiment. A dispersed political landscape is an obstacle to deepen existing labour-market reforms and to meet future fiscal targets. Meanwhile, the Catalonia region is demanding secession from Spain. Clearly, should the split occur, Spain would face economic and fiscal challenges and potential dislocations. Entrenched political uncertainty could threaten the early pillars of the recovery, namely by pushing up Spanish sovereign borrowing costs, while derailing the recent improvement in sentiment.