OREANDA-NEWS. August 17, 2015.

Helge Berger, Advisor, European Department, and Mission Chief for Spain
Sebastian Sosa, Senior Economist, European Department
Andreas Adriano, Senior Press Officer, Communications Department

MR. ADRIANO: Buenos dias. Good morning to all, and thank you for dialing in; and good afternoon to those in Madrid. Thank you for participating in this Conference Call on Spain, where we are going to present the final conclusions of the IMF Annual Review of the Spanish Economy, the so-called Article IV Consultation. With us today to discuss the report, Helge Berger, the IMF Mission Chief for Spain.

You will all have received the report at this time, and if you don’t, please get in touch with me, on back channel, and send an email to media@imf.org. I just wanted to repeat once more the ground rules. The documents that you have received as well as the contents of this conference call are under the same embargo, i.e. 6:00 a.m. Madrid Time; that’s 12:00 a.m. Thursday to Friday Washington. So 6:00 a.m. CET is the embargo. This is designed so that it can be in the Friday edition of the newspapers for those of you who work in newspapers. So, if you have any question or doubt about the embargo time, please get in touch with me.

I will turn now, the floor to Helge Berger, who will make some opening remarks, and then we will take your questions. Helge, the floor is yours.

MR. BERGER: Thank you, Andreas. I know some of you have been in Madrid to listen to the press conference for the concluding statements. If you are aware of the process, this is the next stage of the regular Article IV Consultation where we publish the so-called Staff Report, as well as the Selected Issues Papers, which are a collection of background papers supporting the staff report. They are worthwhile your time, if you had a chance to browse through them. I will make reference to a couple of them, but here I'll quickly summarize our main messages. I'll keep this brief so that you have time for questions.

So, we start by looking at the Spanish economy and its recovery--it's a strong one. The report discusses where this growth is coming from. We see it mostly coming from domestic demand, a strong rebound in consumption and investment. This, in turn, is anchored in what we see as a major shift in confidence into the Spanish economy and its future; this confidence, in turn, is linked to strong policies.

We stress in the report fiscal consolidation as one such element, and reforms as the other. There were a couple of reforms: the labor reforms of the last years stand out, and there is financial sector reform with ESM (European Stability Mechanism) support, as well as insolvency reform more recently. These policies were clearly helped by external factors--the European Central Bank and its actions, as well as the euro exchange rate and oil prices, and so on.

On the back of this, we had earlier this summer revised our growth forecast to 3.1 percent this year and 2.5 percent for next year, fairly strong in relative terms. In the Euro Zone, there are not many other countries growing that fast. Employment gains are clearly helping, and, in turn, supporting growth, while unemployment is coming down.

Any outlook comes with risks, and for today I'd just like to stress two. One is a domestic risk, where we think the largest issue is a potential reversal of structural reforms, given what I've just said, about how these reforms are supporting confidence. If you were to take them away again, you would hurt confidence, and thereby hurt growth. Clearly that would be detrimental to the recovery, especially if it comes at a time of heightened external risks or turmoil. And again, probably the best way to protect against such external risks is to continue with the reforms into the future.

What kind of policy prescriptions do we have? I want to highlight four for you just very briefly. Labor market reforms will be the first one. The issue of small firms and productivity is second. The third issue is ways to facilitate the reduction of private sector debt, and then, finally, I'd like to spend a couple of seconds on fiscal policy.

So, let me take them in turn. Labor market performance has improved in the last one to two years, and one of the reasons is that wage growth on the aggregate has been in line with productivity, has been moderate to a degree that was helpful for improving competitiveness, and we would like to stress that it is crucial that this continues into the future.

An area where we would like to hope for further improvement is wage differentiation across firms. Business conditions, if you look at it very closely in Spain and elsewhere, differ greatly between firms--by size, by their sector, by their region. It's important that wage developments reflect these differences between business conditions, and we haven't seen this kind of differentiation in Spain, where most of the wage shifts came at the aggregate level.

Going forward I think it's important to make sure this happens and there are many ways of helping here. One is to make sure that opt-out possibilities for small firms in the collective wage bargaining are actually used, and that the cost of conducting firm-level bargaining are not too high. You will find detailed recommendations in the report.

Duality remains a problem. We need to find ways to lower the difference between adjustment in employment between temporary and permanent contracts, and we have proposals in the report. Skills are an important factor for long-term unemployment and its reduction, so we have to make sure that the programs that exist are implemented in an efficient way.

Let's also talk about another structural issue which sometimes does not get enough play in the discussion of Spain and its medium-term growth prospects. And this is how small firms are conducting themselves. There are a large number of small firms in Spain, and relatively speaking, more than in many other European countries. These small firms tend to have very low productivity.

It has to do, to a large degree, with a lack of economies of scale: the larger you are the more productive you can be. And in order to deal with this, we think it's important to systematically look at the reasons why Spain is standing out. We think that regulation and taxation are playing a role here, but it's a difficult subject, and our main point is that it's worthwhile to make collective efforts to understand where this is coming from.

There is a lot of growth potential in such endeavor. If you were to systematically address the differences in firm size between Spain and Germany, let's say; and if you were to lower structural unemployment a little bit, you could easily double medium-term growth in Spain, which would mean that the current high growth rates would continue beyond this year and next. This would be a formidable achievement.

If you are interested in details, there is a box in the staff report, Box No. 2, I think, and a chapter in the Selected Issues Paper, the first chapter, will be helpful and provide further details.

Quickly, let's talk about facilitating private sector deleveraging. Here, the question that we have on our mind is: how can we make sure that the private sector debt continues to decline? For private sector debt to decline the recent insolvency reform is clearly important. Implementation is key here. It has to be very clear as to what the reform is doing; so we need to make sure that it's understood how revocation is handled, how payment plans are being handled. This is an area where we think more can be done. Public sector debt should also be involved in facilitating private sector debt deleveraging.

The final area of interest is fiscal policy, and we need to make sure that public sector debt, which is now approaching 100 percent of GDP--a high number--is put on a firmly declining path. The trick here is to make sure that the consolidation, which is required, is growth-friendly. We think this can be done, at the national level, foremost by looking towards indirect taxation. It's well-known that there are large gaps between the different VAT rates for different goods and services in Spain. This could be remedied and could help with fiscal consolidation.

Another aspect is, however, that we have to make sure that everybody helps with consolidation. All levels of government have to chip in. That calls for strengthening the regional fiscal framework to bring in this level of government in as well.

Whatever you do in terms of fiscal policy, needs to be done in a way to protect the most vulnerable. There are ways of doing this, related to any our specific recommendations, and the Staff Report has a lot of details for you to look at.

That would be it from my side; happy to hear your questions.

QUESTIONER: Yes. Hello. Good morning to everyone. I have a couple of questions here about all the documents in the report. First of all my first question would be about wages, and I would like to know if there is a percentage of how much these wages have to go down in the medium future?

Also, I would like to talk about the debt sustainability, and I would like to know which levels of public debt would be unsustainable for Spain, and if there is any specific number there? And then, also, if you see any political risk on the coming Presidential Elections by the end of this year? Thank you.

MR. BERGER: All right. Thank you for your questions; all three of them are very interesting.

On wage developments: we looked at wage developments as far as we can anticipate them for this year based on both the national agreement and what we know about its repercussions for the sectoral and firm level wage increases. And we would call this increase in the level of wages broadly in line with our recommendations. And to make this clear, our recommendation is for wage growth, for wage increases in line with productivity increases and competitiveness. And so the number that we currently have, as we can anticipate it, was broadly in line with this recommendation.

However, any such recommendation is very time-bound. So if circumstances change, we'll have to look at it again. Competitiveness by definition is a function of relative wage developments between different countries, as well as a lot of productivity developments, so there is no single number that will be valid for any number of years.

On your second question, on the sustainability of debt: we think that under the baseline, Spanish debt to GDP, while it will be breaching 100 percent, is on a declining path. The question is, is that declining path steep enough? We would hope that what we call structural consolidation – that is, the adjustment in the primary structural balance, excluding cyclical developments and interest rate payments – that this adjustment is to the tune of 0.5 percentage point per year.

If you did this, you would see the debt ratio to be at around 85 percent in 2020, as opposed to 95 percent, which is a much higher number, under the current expected fiscal path. So, a reduction from about 100 to 85 is a reduction that is a bit steeper and would be preferable. Still the goal is to make sure that a downward path is firmly established.

On your last question on risks: I think our main focus on this is on the economics of it. As I tried to stress in my opening remarks, we see the potential of doubts about what will happen to the reforms that are helping currently with the recovery in Spain as a key domestic risk. So if, for whatever reason, we were to retreat from the existing set of reforms, especially in the labor market, but also in other areas, we would think that this would put a question mark behind the global outlook for Spain. Given how much growth we need still to further reduce unemployment, this would not be a good thing.

QUESTIONER: Good morning. Thank you for doing this. My question is on taxes. The government has just announced lowering a little bit the income tax, and you’re also talking about raising the taxes. How do you see the prospect for this area in the near future? I mean, that we have elections in several months and no party is going to talk about raising taxes.

MR. BERGER: In general, if we talk about the need for fiscal adjustment and for this adjustment to be growth friendly, one big element is a broader shift from direct taxation, like income taxation or corporate taxation to indirect taxes, like VAT or excise duties. So there’s a scenario in which fiscal adjustment will continue in Spain in a helpful way where direct taxation goes down and indirect taxation, such as the effective level of VAT goes up because we’re going to reduce exceptions. This would be compatible with the general push to bring down public sector debt in a firm way.

The immediate impact of these latest announcements that you’re referring to, is a little bit difficult to evaluate at this point, and it’s something we’ll have to look at. Clearly, these are difficult times for fiscal policy, and when you have elections that is true for any number of countries at any point in time. But again, in principle, growth and fiscal adjustment is compatible with the shift from direct taxation to indirect taxation.

QUESTIONER: Hi, good morning. I just had two really quick questions. In the report you say that Spain, if it’s able to keep and maintain the reforms, has potential for tremendous growth. That’s a quote, tremendous. So I was just wondering if you could elaborate a bit more on that? Also, when you refer to Spain and the external shocks like something steaming from the Greek economy could have an impact on Spain, so I’m just wondering if this is just a case for Spain in particular or is there risk in the periphery? In a way, do you think Spain is in a weaker position than Italy, for example?

MR. BERGER: First on the potential growth, thanks for the opportunity to clarify this. The report has an illustration of what you rightly quoted as a potential for growth in the future. To put this into perspective, have a look at how we see the growth profile. So we have more than 3% this year and 2.5% next, and then it gradually converges towards what we see as Spain’s potential growth. That is the kind of growth the economy can have if you ignore the business cycle going forward. This is roughly about 1.3%, 1.5% per year.

The point that the Staff Report and the underlying analytical report makes is that you could easily double this long term growth if you put down the right reforms.

Now, let’s be specific here. The illustration we do in the Staff Report, Box 2, is to say what if you were changing the distribution of firms in Spain, for example, to the German one? You would have just as many small and medium and large firms relative to each other, as in Germany. (You could take another example, you don’t have to take Germany.) In addition, assume that the difference between the productivity of the smaller firms and the larger firms was also similar to Germany. What that would give you is overall is fewer small firms in Spain, and small firms that are more productive than they are currently. This, on its own, would give you about 9% higher GDP in that long term.

Now, add some other reforms. I would think about labor market reforms here that would lower structural unemployment from about where it is now, which is roughly 16.5%, to about 10%, and then you get another boost to GDP level.

If you do it all together (and the details, again, are in the paper) then you could see potential growth double to levels of around 2.5% during the next ten years or so. This is a tremendous potential for additional growth. It’s sort of the reverse image of the deep structural problems that currently are facing in Spain. I think most people in Spain, most policymakers, are perfectly aware of this. We’re not telling them anything new. I think what we try to contribute is a sense of scale, and ideas of how to actually make use of this.

You were asking about risks. The Staff Report mentioned external risks. With regard to Greece, I think it’s prudent to do so and we still see some uncertainty coming from there. It’s hard to exclude further periods of volatility for Spain as for other countries in the Eurozone. So it’s not something unique to Spain. Recently, financial markets have reacted positively to the new round of negotiation, and this is a good development.

Now, to be really clear, we think that the overall level of contagion, of potential contagion that Spain could be exposed to, is definitely lower than it has been in the past. This reflects both Spain’s track record in terms of reforms--we reiterate that the strengthening in the banking sector is important, and the more resilient labor market is important--and policy measures taken at the euro area level. All of this is anchoring confidence. So, yes, there are still contagion risks, but they are similar to other countries, and they are certainly lower than they were in the past.

Just to move back to my policy line on reforms, to finish this. The clearer we are on not reversing existing structural reforms and fiscal consolidation, the clearer is the commitment of policymakers to continue the reform agenda, the stronger is the defense against any such external risk.

QUESTIONER: Good morning. You refer in your press release to the fact that Spain’s being held by what you call, significant external tailwinds. Can you explain what you mean by that, please?

MR. BERGER: We try to understand, as we should, where growth is coming from. I talked at some length about the domestic sector’s consumption and investment, but net exports are also helping more than they would without these external tailwinds. There essentially two types. One is monetary policy which is both internal and external for Spain. It’s internal in the sense that it’s coming from the European Central Bank which is also Spain’s Central Bank [for monetary policy]. It’s external in the sense that it’s not directly determined with an eye on Spain, but determined based on the ECB’s calculus for the Eurozone overall.

Clearly, there has been a major change the last years where we have seen interest rates for the Spanish sovereign decline by more than 5 percentage points since their peak in 2012. That is a major tailwind. We have seen, somewhat later, financing costs for Spanish firms and the households decline as well. That also is a major factor here. Then we have another type of truly external tailwinds coming from the change in oil prices--the level is much lower than it used to be. Spain is an energy intensive economy, so this is a major plus both for consumers and investors alike.

Finally, the depreciation of the Euro relative to many other economies has also helped Spanish exports. Overall these are additional factors for growth. I would think that the improvement in confidence and what this has done to help the rebound on consumption and investment, that is domestic demand, on balance is probably the more important factor.

QUESTIONER: Thanks for doing this. My question is about the slowdown that is expected in the forecast from 2016 until 2020. I would like to know the reasons for this. With respect to the banking system, my question is, does the IMF consider that more mergers are needed in Spain?

MR. BERGER: Thank you. Now, on that decline in growth, I mean, the big picture is what I mentioned a couple of minutes ago: that in the medium term what you think in terms of growth is increasingly driven by what you think is the long term potential growth rate. Now, there’s, of course, no precise number of where this is, but we’ve done the math, we’ve run the models. We think that long term potential growth rate in Spain is in the order of 1.2% to 1.5%, somewhere in there.

So, if the current rebound in growth is fading out, and I’ll tell you why I think it does, this is where the economy is headed. So if you want to, keep growth at the current very high level, which is extremely welcome, what you need to do is to take care of the level of growth in the medium and long term--which points you to, first of all, the issue of debt levels, and, second, to structural reforms. In terms of debt level, one of the things you can do is to make sure that the insolvency reform is effectively implemented, for example.

Now, how does that exactly work? How does the short term, medium growth of converge? In the Spanish case, think about household savings. They have been very, very high in the crisis as households were very cautious, being very uncertain about the future. Then as confidence came back, that uncertainty went away. That almost immediately impacts this kind of precautionary saving that households do. The more certain they are about the future, the more confident they are. The more confident they are that the unemployment is going down, the more confident they are in spending, and that spending will generate growth.

However, this [growth] push from a reduction of savings, from the very high crisis level to current levels, more aligned at the historical normal, at some point comes to an end. As it comes to an end, the kind of growth we have is closer to that long term growth potential I was talking about. Similar with investment. Firms, like households, are very, very cautious when confidence is low and uncertainty is high. They hold back with investment. As confidence comes back and uncertainty diminishes then there is more, but this rebound, this undoing of the investment freeze, at some point also goes away or normalizes. Then you are in line with long term potential.

So this is how this works. There’s nothing particular about this. This is something you see after deep recessions in many countries. What is specifically Spanish about it, at least in our mind, is that this re-emergence of confidence had a lot to do with reforms and fiscal policy, and so this is not independent of policy action. That’s my discussion earlier.

On the banking system, I think the banking system is doing much better. The report has a couple of pages and paragraphs about it, talking about how profitability has improved and so on, but there’s also a discussion about the challenges, and that includes the low interest rate environment. That includes the anticipated increase in regulatory capital demands coming from international changes, European changes, and so on. Whether this will mean that banks, merge or not, we have not taken a particular view. Maybe that’s something to think about in the future.

MR. ADRIANO: Do we have more questions?

OPERATOR: It appears we have no further questions in the queue at this time.

MR. ADRIANO: All right. Then we’ll come to a conclusion. Thank you all for participating, and just to remind you once more, the contents of the call are under the same embargo as the documents and that is 6:00 a.m. Madrid time and if you have any further doubts or questions please contact me. You have my email or you can write to media@imf.org. Thank you very much and have a good day.