EcoFlash

Towards a protracted increase in the public deficit?

ECO FLASH  
N°21-02  
21 January 2021  
SPAIN: TOWARDS A PROTRACTED INCREASE IN THE PUBLIC DEFICIT?  
Guillaume Derrien  
Strong fiscal support is currently key  
to limit the impact of the coronavirus  
shock on growth and employment. But  
in the long term, the question of public  
finances control will be asked.  
THE STRUCTURAL DEFICIT CONTINUES TO WIDEN  
Structural balance (% GDP)  
Primary structural balance (% GDP)  
2
0
In its November forecast, the European  
Commission predicts that Spain’s  
structural public deficit will widen to  
-2  
-
-
4
6
7
.2% of GDP in 2022. This would be the  
biggest deficit since 2010 – 2009 being a  
record high – and the largest within the  
Eurozone .  
-8  
1
-
10  
2
002 2004 2006 2008 2010 2012 2014 2016 2018 2020f 2022f  
Spain will not stabilise its primary struc-  
tural deficit, which could surpass 5% of  
GDP by 2022. Nevertheless, the impact  
on public expenditures will be softened  
by low sovereign rates.  
f : forecasts  
CHART 1  
SOURCE: EUROPEAN COMMISSION, BNP PARIBAS  
Fiscal policy in Spain will remain very expansionary in 2021. According to the Ministry of  
1
Finance, the public deficit is forecast to reach 7.7% of GDP this year , after a shortfall of 11.3%  
in 2020. Given the uncertainty over the pandemic’s evolution over time and the prolongation of  
any lockdown measures or restrictions, these figures may have to be revised in the months  
ahead.  
Three major obstacles – some of which  
will be amplified by the Covid-19 crisis –  
will limit any decline in the public deficit  
ratio: rising unemployment and poverty, years of improvement, resulting largely from the impact of austerity measures implemented by  
the impact of the ageing population on  
pension financing, and the sluggish level  
Although the deficit has surged since the first lockdown last March, the underlying trajectory of  
Spanish public finances was already on a downward slope well before the epidemic outbreak.  
Indeed, the structural fiscal balance, which excludes cyclical fluctuations in revenues and  
spending, has swung back into deficit from 2016 onwards (see chart 1). This followed several  
2
the Mariano Rajoy administration (mainly cutbacks in investment spending and wages) .  
of potential growth.  
2
3
Between 2009 and 2016, primary structural spending by the general government dropped from 42.5% of GDP to  
8.4% of GDP. Over the same period, structural revenue as a share of GDP increased from 35.0% to 38.1% (Source:  
European Commission).  
The bank  
for a changing  
world  
Eco Flash 21-02 // 21 January 2021  
economic-research.bnpparibas.com  
2
As things currently stand, efforts to combat the health crisis should spending will rise by 0.4% of GDP to reach 9.4% of GDP by 20308.  
keep the public deficit at a high level in the years ahead, due to a  
protracted increase in public spending.  
PUBLIC SPENDING: A BEFORE AND AFTER COVID?  
According to the European Commission, structural public expenditure  
as a share of GDP will remain, by 2022, nearly 6.5 points higher than  
3
Primary structural income (% GDP)  
the pre-Covid 2019 level (see chart 2) . The expenditure categories  
44  
42  
40  
38  
36  
that are expected to increase the most, as a share of GDP, are social  
transfers, wage compensations and intermediate consumption.  
Primary structural expenditure (% GDP)  
ST  
1
OBSTACLE: A JUMP IN POST-COVID SOCIAL WELFARE SPEN-  
DING?  
Although job retention mechanisms (ERTE temporary unemployment  
scheme, tighter corporate bankruptcy conditions…) have helped limit  
the economic shock on the labour market so far, Spanish unemployment  
4
has already jumped by 725,000 (+22%) over the course of 2020 . A large  
proportion of the newly unemployed workers should be able to find  
jobs again once the pandemic has receded and lockdown restrictions  
have been lifted. Yet according to the Bank of Spain’s latest forecasts,  
the current crisis will leave its mark on the labour market: the  
unemployment rate is not expected to return to pre-crisis levels before  
34  
2002 2004 2006 2008 2010 2012 2014 2016 2018 202 f0 :ffo 2r e0 c 2a 2s tf s  
CHART 2  
SOURCE: EUROPEAN COMMISSION, BNP PARIBAS  
5
the end of 2023 .  
As in most western countries, the population dependency ratio, i.e., the  
ratio between the over-65 age group and the working-age population  
In 2020, the government has already implemented long-term measures  
to respond to the deteriorating social situation. The Minimum Vital  
Income, Spain’s universal minimum income, was created last June.  
Intended to help a total of nearly 850,000 households, the programme  
will grow in importance in 2021, with its budget increasing to EUR 3 bn  
from EUR 1 bn in 2020. Moreover, the IPREM index, which is the metric  
used to calculate most of the country’s social welfare benefits, will be  
adjusted upwards by 5% this year. This has been the biggest annual  
increase since the index creation in 2004.  
(
20-64 age group), is rising steadily. Currently (2020), Spain’s depen-  
dency ratio is close to the European average. Yet the aging of its popu-  
lation will accelerate in the years ahead, more rapidly than the OECD  
9
average . Eventually, Spain will have the highest dependency ratio in  
Europe and the second highest in the OECD after Japan. Since 2013,  
Spain has gradually raised the legal retirement age, which will limit  
somewhat the imbalance between contributors and beneficiaries: the  
retirement age has risen from 65 in 2013 to 66 in 2021 and will reach  
The government plans to create new sources of income to offset these  
new expenditures. These include the creation of a “green” tax on waste  
and plastics, a digital tax, a “Tobin” tax on financial transactions and  
6
7 by 2027.  
However, the deficit of the retirement system is not only due to an  
imbalance between contributors and beneficiaries. The calculation of  
retirement pensions in Spain is indeed “generous” if we compare it  
to other OECD countries: in particular, the replacement rate (i.e. the  
percentage of the last salary received at the time of retirement) is over  
80%, one of the highest levels in developed countries.  
6
a reinforcement of its efforts to reduce tax fraud . According to the  
government, these new sources of revenue would bring in an additional  
total of EUR 6.1 bn in 2021, which would only very partially close the  
gap between the State’s primary structural income and expenses, which  
7
was estimated at about EUR 42 bn in 2020 (European Commission) .  
One of the main sticking points in the coming years will be the way of  
calculating pension adjustments. In 2017, the government decided to  
suspend the calculation method introduced in 2013. To simplify, with  
this method, the adjustment in pensions was made so that pension  
expenditures rose in line with social-security revenues. This allowed  
for a better fiscal balance in the long term, but at the expense of a low  
adjustment rate on pensions. Instead, since 2018, changes in pensions  
have been aligned with the consumer price index, resulting in much  
bigger annual increases (1.6% in 2018 and 2019, compared to 0.25%  
Other factors are also expected to continue driving up social welfare  
spending in the medium term. These include ongoing efforts to raise  
the minimum wage towards a target of 60% of the median wage (one of  
the current government’s campaign promises).  
ND  
RISE  
2
OBSTACLE: THE SHARE OF PENSION EXPENSES CONTINUES TO  
The second major spending vector comprises retirement pension  
funding, the cost of which will continue to rise steadily in the years  
ahead, as the population ages. As a share of GDP, retirement pension  
10  
under the method established in 2013) .  
3
4
5
6
European Commission calculations exclude temporary and one-off measures implemented by governments to counter the Covid-19 crisis.  
Source: SEPE, the Spanish employment agency.  
7
4
The structural primary deficit is estimated at 3.6% of potential GDP in 2020. With potential GDP estimated at EUR 1,164.4 bn, this brings the structural primary deficit to EUR  
1.9 bn (1164.4 x 0.036 = 41.9).  
9
1
The 2018 Ageing Report: Economic and Budgetary Projections for the EU Member States (2016-2070), European Commission paper, May 2018.  
0 See Pensions at a Glance 2019: How does Spain compare? OECD, November 2019.  
The bank  
for a changing  
world  
Eco Flash 21-02 // 21 January 2021  
economic-research.bnpparibas.com  
3
RD  
3
OBSTACLE: SLUGGISH POTENTIAL GROWTH LIMITS THE  
POTENTIAL GDP: SPAIN & EUROZONE  
DECLINE IN THE PUBLIC DEFICIT-TO-GDP RATIO  
The expected increase in public spending takes place in the context  
of sluggish underlying GDP growth. Spain’s potential growth rate had  
already been reduced by the successive crises of 2008 and 2011, and  
could be impacted negatively again by the coronavirus shock. The  
contraction in 2020 GDP was unprecedented, and certainly exceeded  
100=2008  
Spain  
Eurozone  
1
1
1
13  
11  
09  
1
1%. A recent study by the European Central Bank highlights the  
107  
05  
103  
1
1
negative impact of Covid-19 on long-term growth . This is explained  
mainly by the sharp decline in the number of working hours, as a  
large share of workers have been placed in temporary unemployment.  
According to European Commission estimates, between 2019 and 2022,  
Spain’s potential GDP level will increase by 1.4%, one of the slowest  
growth rates in the Eurozone, and lower than the increase in structural  
public spending. Spain’s potential growth trajectory could hold well  
below that of the Eurozone as a whole (see chart 3).  
1
101  
99  
2008  
2010  
2012  
2014  
2016  
2018  
2020f  
2022f  
f : forecasts  
Spain’s low potential growth rate reflects in part the country’s  
ageing population, which undermines the labour force’s contribution  
to economic growth. But this is not the only obstacle. Spain is not  
investing enough. Investment (gross fixed capital formation) as a share  
CHART 3  
SOURCE: EUROPEAN COMMISSION, BNP PARIBAS  
1
2
of GDP remains lower than the European Union average . Positively,  
the EUR 140 bn national recovery plan (Recovery, Resilience and  
Transformation Plan) will stimulate investment and boost potential  
growth in the years ahead. None of this will have a major impact  
on Spain’s public finances, since virtually all of the package will be  
financed through sums received from the European recovery fund.  
Even so, the persistent low trend in growth reduces manoeuvring room  
for the authorities to significantly lower the public deficit ratio in the  
medium to long term.  
SPAIN: CONSOLIDATED PUBLIC SECTOR DEBT (% OF GDP)  
120  
100  
80  
60  
40  
20  
0
*
**  
With the health crisis extending into 2021, strong support from fiscal  
policy is necessary. Thanks to the ECB’s ongoing monetary measures  
and the low trend in inflation, Spain’s sovereign rates remain at  
1
3
historically low levels . However, in the long term, worries about the  
rapid build-up in debt could resurface once the health crisis is over and  
the economic recovery durably on track. In response to the increase in  
the structural deficit, at the end of last year the European Commission  
stated that, among other measures, it might condition part of the  
allocation of the European Recovery Fund on measures designed to  
1
998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020f 2022f  
f : forecasts  
CHART 4  
SOURCE: AMECO, BNP PARIBAS  
1
4
help sustainably balance the social security fund . By year-end 2022,  
the Spanish debt ratio could approach 125% of GDP, an increase of  
more than 25 points of GDP above pre-Covid levels (see chart 4).  
Guillaume Derrien  
1
1
1
1
1 Bodnar et al. (November 2020), The impact of COVID-19 on potential output in the euro area, ECB Economic Bulletin  
2 See BNP Paribas EcoConjoncture, Southern Europe: why is potential growth so low?, November 2020  
3 Spain draws more than EUR 130 bn of orders in record sale of 10-year debt, Financial Times, 13 January 2021.  
4 “Brussels urges Spain to reform pensions and jobs in return for EU funds”, El Pais, 8 December 2020.  
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