Spain GDP November 2016

Spain

Spain: Unprecedented challenges to policy implementation under new weak government loom

Spain has been thrust into uncharted waters after forming the weakest minority government in modern times under returning conservative Prime Minister Mariano Rajoy, who will be required to negotiate constantly with opposition parties to pass laws, including, most imminently, a new budget for 2017. Pressing issues will test just how capable Spanish politicians are of striking deals in this new fragmented reality. Early indications suggest that Spain is unlikely to roll back reforms already approved, but difficulties in striking cross-party deals are likely to thwart the pace of reform implementation going forward.

The new government is expected to be hostile, as Unicredit Research Economist Edoardo Campanella explains:

“Each measure will have to go through endless and draining negotiations between the PP and Ciudadanos, as well as with the PSOE. Therefore, it is hard to expect the adoption of major reforms like, for instance, a further consolidation of the banking system or a further overhaul of the labor law.”

First and foremost, the People’s Party (Partido Popular, PP) government must agree a new budget with opposition parties, due to be presented before year-end. As the opposition parties are unlikely to approve further cuts, the PP has hinted at the need for revenue increases. Analysts expect an increase in the corporate tax rate and additional indirect taxes on oil and tobacco, after the PP assured that any new revenue-raising measures would not threaten economic growth, which appears to rule out any changes to VAT—which the EU had recommended increasing—and income tax rates.

Spain is under severe pressure from the European Commission to submit a new 2017 budget draft to reduce the fiscal gap for next year. It has repeatedly missed targets under the Excessive Deficit Procedure, but the Commission has so far waived sanctions. More lenient deficit goals were set most recently in July, under the assumption that Spain’s caretaker government would be unable to address the excessive shortfall. Although Spain is on track to meet the latest 2016 target following changes to corporate tax laws, additional efforts to rein in the deficit will be needed for 2017, when the Commission foresees Spain deviating from the deficit target by EUR 7.7 billion.

Despite the difficulties ahead, it is not in the interest of either the Spanish Socialist Workers’ Party (Partido Socialista Obrero Español, PSOE) or the liberal newcomer Citizens party (Ciudadanos, C’s) to seek to topple Rajoy’s government in the near future, which should at least ensure some degree of political stability in one of the Eurozone’s fastest growing economies. According to polls, the PP would be well positioned to benefit from early elections if these became necessary, unlike the PSOE or C’s. While the PSOE is at risk of being surpassed by anti-austerity party Podemos, failure to sustain a government would likely undermine C’s credibility.

To avoid the opposition using the minority government as an opportunity to strike down recent contentious reforms, the PP has taken steps to avoid any backtracking, particularly regarding the 2012 labor market reform, and has signed a support agreement with C’s that will see progress in certain economic areas. This should go some way towards allaying investors’ concerns, who were fearful that a reform rollback could see Spain loose hard-fought gains in export competitiveness.

Incumbent Prime Minister Mariano Rajoy only managed to secure a second term as head of Spain’s government after winning a confidence vote in parliament on 29 October. Rajoy needed support from liberal newcomer party Citizens (Ciudadanos, C’s) and a controversial last-minute abstention of the Spanish Socialist Workers’ Party (Partido Socialista Obrero Español, PSOE) to pass the confidence vote, following more than 300 days of political impasse and two inconclusive elections.

Spain’s economy has been largely unscathed by months of political stalemate, and the new government is unlikely to weigh on the recovery. However, the challenges the government faces to implement reforms with a fragmented parliament, and Catalonia’s intention to hold a referendum on independence from Spain in mid-2017 even without the Spanish government’s consent, are clouding the country’s outlook. FocusEconomics panelists expect the economy to grow 3.1% in 2016, which is up 0.1 percentage points from last month’s estimate. For next year, our analysts see the economy easing and growing 2.2%, which is unchanged from last month’s forecast.


Author:, Economist

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