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Wary Brussels boosts Spain’s deficit forecast to 3.5% of GDP for 2017

European Commission sees signs of slowdown, questions Madrid’s ability to meet tax revenue forecasts

In the context of exceptional global uncertainty, the Spanish economy remains strong. In a report to be released today, the European Commission forecasts growth slightly above 2% for 2017 and 2018, and while highlighting the country’s “surprising” expansion, detects signs of a slowdown. But Brussels is less optimistic about Spain’s ability to meet its deficit-reduction requirements, forecasting a deficit equivalent to 3.5% of GDP for this year, four-tenths of a percentage point above the objective, and two-tenths higher the forecast of three months ago.

EU Commissioner for Economic Affairs Pierre Moscovici with Spanish Economy Minister Luis de Guindos.
EU Commissioner for Economic Affairs Pierre Moscovici with Spanish Economy Minister Luis de Guindos. EFE

Europe also suspects Spain will rake in less revenue from its latest tax hikes, despite claims from Madrid this will be a record €202.6 billion in 2017. If Brussels is right, this will mean the government of Prime Minister Mariano Rajoy will have to impose extra cuts to the tune of €4.3 billion.

The report begins by noting that Spain’s economic growth has exceeded expectations in recent quarters, but uses the word “uncertainty” more than 80 times over the course of its 200 pages, usually in the context of Brexit or US President Donald Trump.

The Commission says nothing about the difficulties Rajoy will face in approving his budgets

However, Spain is no longer the biggest risk facing Europe: after a bumpy adjustment following the 2012 rescue, Spain’s economy is growing above the EU average and creating jobs in the process. That said, the Spanish economy is still being held back by a huge debt and by a fragile fiscal situation that could prompt huge headaches if global risks generate instability and risk premiums start to rise again, the report’s authors state.

Brussels applauds Spain’s economic performance, noting that 2016 saw a third consecutive year of growth, expanding at almost twice the EU average due to “more balanced” fundamentals, strong domestic demand, and exports that for the first time since the beginning of the recovery made a net contribution to growth. GDP growth will remain “strong” although it will tend to slow down, and the tail winds provided by lower oil prices, tax cuts, and improved financial conditions thanks to the European Central Bank, have subsided.

The Commission says it expects Spain to continue creating jobs, albeit at a slower rate than up until now, with unemployment falling to 17.7% this year, and down to 16% in 2018, predicting that salary growth and low productivity will put labor costs on a par with the EU average after several years of strong competitiveness.

Of greater concern to Brussels is the difference between the Spanish government’s optimistic forecast of its deficit reduction and its own, which is four-tenths of a percentage point lower, at 3.5% of GDP for this year and 2.9% for 2018. The consequences could be important.

If Brussels is right, Spain’s deficit will be four-tenths of a percentage point above the 3.1% of GDP objective

The 2017 deficit is particularly worrying: if Brussels is right, Spain’s deficit will be four-tenths of a percentage point above the 3.1% of GDP objective.

When Brussels forecast a deficit equivalent to 3.3% of GDP in January, it warned the government it should be ready to take additional measures if it failed to meet its targets. Those four-tenths of a percentage point would translate into further cuts of €4.3 million achieved through reduced public spending and higher taxes.

Brussels is less optimistic about Spain’s ongoing GDP growth, and particularly about tax revenue. Despite his electoral promises, Prime Minister Mariano Rajoy has planned hikes on company tax, alcohol, tobacco and social security contributions. But Brussels believes that Spain will still not collect enough revenue and says that this will have a direct impact on the government’s ability to meet its debt reduction commitments, highlighting the potential losses from the cost of the bank bailout and efforts to protect the banking system’s assets.

The Commission says nothing about the difficulties Rajoy’s minority government will face in approving its budgets, but it is worth noting that Spain’s structural deficit worsened in 2016 and will only improve slightly this year, stabilizing in 2018. To put it simply, Spain will not be able to put its public accounts in order even with 3% growth. Furthermore, the public debt will increase slightly this year and stabilize at around 100% of GDP. External debt, public and private, is very high. If the road ahead really does get rocky and the markets once again cause trouble, Spain could face further problems.

English version by Nick Lyne.

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