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Spain Politics November 2019

Spain: Political uncertainty to continue clouding the economic outlook as elections produce another fragmented Parliament

Spain’s general election on 10 November failed to break the long-standing political deadlock, yielding a deeply fragmented Parliament yet again amid the momentous gains scored by far-right Vox and the breakthrough of new parties, which now total 16—the highest number in the country’s modern democratic history.

As anticipated by earlier polls, the center-left Spanish Socialist Workers’ Party (PSOE, Partido Socialista Obrero Español) retained the largest share of seats in Congress. Moreover, in what largely came as a surprise, PSOE leader Pedro Sánchez and Pablo Iglesias, head of leftist United We Can (UP, Unidas Podemos), reached a tentative deal on a government coalition just two days after the election, seemingly reconciling their differences which had prevented reaching an agreement last time around and which helped trigger the snap vote. Nevertheless, together they still fall short of a parliamentary majority, setting the stage for tough negotiations ahead to secure the backing from smaller parties to form a government. In addition, even assuming a government is sworn in, the possibility of a new election in the near term remains on the table due to the fragile position of the coalition as it would continuously need to secure enough support to pass legislation. Therefore, in light of continued political instability ahead, risks to the economic outlook seem now to have risen amid the constraints to enact much-needed reforms and as the economy starts to show increasing signs of weakness.

Looking at the election results in more detail, although the PSOE-UP alliance is likely to receive support from other small parties, together they still fall below the 176-seat threshold for an absolute majority. Consequently, a second-round investiture vote will likely be needed to install a PSOE-led minority government. It remains highly uncertain, however, how this will play out as Sánchez needs to convince smaller parties to get on board or at least abstain from the vote. In particular, it looks increasingly likely that Catalan separatist parties will play a key role in this regard, complicating matters further given the tense relationship of the Spanish government with the regional administration. Furthermore, even if a government is formed, it will be a fragile one, raising the specter again of new elections.

This situation was highlighted by Alvise Lennkh, director at Scope Ratings, who noted that:

“Any variation of a minority government would likely be weak and subject to the support of opposition parties for each legislative bill, complicating its governance and medium-term survivability.”

Meanwhile, touching on the governing prospects for a PSOE-UP minority coalition, Jessica Hinds, European economist at Capital Economics, commented that:

“Winning the backing of parliament is far from assured. So, it is certainly possible that we will end up with fresh elections should the government fail to win the necessary support or the coalition between PSOE and Podemos breaks down.”

Oriol Carreras, economist at CaixaBank, also has a similar take:

“It is highly likely that the term [of a PSOE-led minority government] will be short, but we do not expect a repetition of elections within the next year.”

In terms of policy impact ahead, Julián Pérez García, director at CEPREDE, stressed that although “some increase in public expenditure as well as some tax increase” is expected from a PSOE-led coalition, “we can’t expect significant changes in the policy mix as it will be very difficult to approve new budgets”. This was also echoed by Hinds, who pointed out that “while the pre-agreement between PSOE and Podemos included plenty of promises that would normally entail higher public spending, we think that the coalition will struggle to get parliamentary support for its budget. So the fiscal stance is likely to remain neutral in 2020.” Similarly, Carreras assessed “economic policy to be similar to that outlined in the previous Budget proposal plan”, referring to the no-policy change budget unveiled last month by the Sánchez-led acting government.

Despite the likely steady state for policymaking ahead, economists at Fitch Solutions elaborated on what the policy agenda of a left-wing PSOE-led coalition could look like:

“[The coalition] would support a worker- and family-friendly economic agenda. It would entail a weaker focus on the business environment. In the medium-term, the perception of an abrupt leftist turn in policy-making could trigger some volatility across Spanish assets (we have already seen this with the IBEX slipping and Spanish bond yields rising following the announcement of the PSOE-UP deal). Moreover, weaker fiscal consolidation owing to fiscal concessions to firm support from regional parties and increased social spending for the broader economy. Some tax increases targeting corporates. This could trigger potential clashes with the EU over budget deficit targets.”All in all, the election did not ease the political gridlock that has plagued the country for years, pointing to more political uncertainty ahead and constraints to enact meaningful policy measures.

And although the economy still maintains a healthy pace of expansion, political instability, coupled with mounting domestic and external headwinds to growth, could start to weigh on the outlook. FocusEconomics Consensus Forecast panelists project that GDP will expand 1.7% in 2020, which is unchanged from last month’s forecast, and 1.7% again in 2021. Meanwhile, the Central Bank expects the economy to grow 1.7% in 2020 and 1.6% in 2021.

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