Economic recovery in spain 2014 en

June 2014

Economic recovery in Spain will gain momentum in 2014-2015

The Consejo Empresarial para la Competitividad (CEC) is composed by the following chairmen and CEOs*

Mr. César Alierta. Telefónica. CEC ChairmanMr. Isidoro Álvarez. El Corte InglésMr. Isak Andic. MangoMr. Emilio Botín. Banco SantanderMr. Antoni Brufau. RepsolMr. José Manuel Entrecanales. AccionaMr. Isidro Fainé. La CaixaMr. Francisco González. BBVAMr. Antonio Huertas. MAPFREMr. Pablo Isla. InditexMr. José Manuel Lara. Grupo PlanetaMr. Florentino Pérez. ACSMr. Rafael del Pino. FerrovialMr. Juan Roig. MercadonaMr. Ignacio Sánchez Galán. IberdrolaInstituto de la Empresa Familiar, represented by: Mr. Simón Pedro Barceló. Grupo Barceló Mr. Javier Moll. Editorial Prensa Ibérica Mr. Leopoldo Rodés. Havas Media GroupCEC Managing Director: Mr. Fernando Casado

* Alphabetical order

Consejo Empresarial para la CompetitividadPl. Independencia, 8 - 4º28001 MADRID - SpainT. (+34) 915 223 084

Layout by:IMAGIAofficina.esPrinted by:EGRAF, S.A.Date of publication:June 2014Legal deposit:M-18163-2014

Table of contents

1. Spanish economic recovery will gain momentum in 2014-2015 02 Recovery of the Spanish economy is confirmed 02

Recovery shows a pattern similar to that of past recoveries 03

Exports were the main driving force behind this growth 03

Investment will consolidate its recovery in 2014 05

Investments in machinery and capital goods continue to grow 05

Real estate investment: this time it’s different 07

Private consumption and employment grow 09

The effort to reduce public deficit will be less over the next two years 11

2. The current account surplus and the restoration of the financial balance strengthen Spain’s financing capacity in relation to the rest of the world and our attractiveness as a country 14

The historic improvement in the trade balance continues which forecasts current account surpluses equal to 2%-3% of GDP in 2014-15. 14

Improvement in quality and quantity of financial flows 21

Spain continues to be very attractive for productive foreign investment 21

The return of confidence is also reflected in positive portfolio flows 24

This improvement in confidence, thanks to external support, was also consolidated in “key players” 26

3. The clear progress in adjusting the existing imbalances continues 28 Debt of Spanish non-financial companies is reduced 28

Debt reduction of Spanish households picks up 32

Adjustment to the real estate market is nearing their end 34

Data on activity allows the surplus supply that existed to be adjusted 34

Increasing demand of non-residents and investors 35

Price adjustments nearing their end but with differences between provinces 36

The banking sector has already carried out an in-depth restructuring 36

4. The process of transforming the Spanish economy must be continued 40 There is room to increase the degree of economic openness 40

Unit labour cost containment is key... 41

… as well as increasing productivity for sustainable recovery 43

The value of education and human capital in the labour market 45

The main reforms initiated must be consolidated 47

Reform of public administrations: in search of efficiency in processes 48

Labour Reform: simplification and greater flexibility 49

Fiscal reform focused on growth and employment creation 49

Progress in reforms yet to be implemented 51

Reinforce the commitment to innovation, new technologies and digital economy 51

Energy policy focused on improving competitiveness and the industrial rebirth 52

Towards a high-quality and stable education system focused on current and future world challenges 53

02

Recovery of the Spanish economy is confirmed

After 2012, a year marked by distrust, the deterioration of financial tensions and the

acceleration of fiscal consolidation processes and structural reforms, the expectations

that the CEC presented a year ago in this same publication forecast that 2013 would be a year of transition of the Spanish economy towards a new growth cycle.

However, this was not the mainstream view of the analysts’ consensus. In particular,

70% of the research services that made predictions one year ago regarding the

growth of the Spanish economy expected less of a change in GDP for 2014 than

that forecast by the CEC, and 20% of them even forecast the continuation of a

recession period and drops in activity.

Fortunately, economic activity increased in 2013 as expected. Therefore, during

the third quarter of last year, the technical recession ended and the economy

once again set a positive growth rate. This recovery, which was strengthened over

the last quarter of 2013 and the first quarter of 2014, was in any case insufficient

to avoid the 1.2% drop in GDP for 2013 as a whole.

The most important factor behind this improvement was the rapid and decisive action taken by European and Spanish institutions. In particular, the

commitment to do “whatever necessary” to avoid a euro-break up on the part of

the ECB built a bridge which allowed European governments to take measures

to break the vicious cycle between sovereign bonds and the financial sector

and, in Spain’s case, it enabled part of the financial sector to be restructured

and recapitalised, and reforms to be implemented that improved the country’s

capacity for growth. The structural reforms adopted, including the labour market

reform, and the commitment shown to fiscal consolidation were also key factors

for laying the foundations of the recently begun economic recovery, along with

the continuous improvement in Spanish economic internationalisation.

Spanish economic recovery will gain momentum in 2014-20151

03

Recovery shows a pattern similar to that of past recoveries

As mentioned a year ago, the cycle changes in Spain seem to have a specific

order and the indications observed at that time held the promise of an imminent

turning point. In particular, recoveries have historically begun with a change in the trend of exports, which in this case have already accumulated four years of

growth and which will be covered in more detail in the next section of this report.

Just before the turning point of the economy, the increase in productivity and

the containment of salary increases reduced unit labour costs, consolidated

growth in exports and increased gross operating profit. This improvement in

the companies’ financial position is a step towards increasing investments in

machinery and equipment, as there is more certainty with regard to the prospects

of demand and since certain capacity restrictions are expected to no longer apply

in the medium term. Therefore, the performance of the majority of the remaining

macroeconomic variables coincides with the GDP. As shown below, this has

effectively been the scenario seen in the Spanish economy and, therefore, the expectations of a sustained recovery from this point forward are confirmed.

Exports were the main driving force behind this growth

Spanish exports of goods and services have grown consistently since 2012 above

those of the EU. For example, since the first quarter of 2012, exports in Spain grew,

in real terms, 12.1% compared to 2.1% in the EMU (see graph 1). In particular,

as it will be shown below in this report, Spanish exporters have not only been

especially successful in diversifying their destinations and type of products (75%

of the growth in exports during the crisis is due to these factors), but they have

also been able to beat out competitors in terms of price, as shown by the average

inflation of 1pp below that observed in the rest of the EMU since the beginning

of the crisis.

04

1. Spanish economic recovery will gain momentum in 2014-2015

This improvement in competitiveness was driven by the strong growth in productivity, which, together with the containment of salary increases,

contributed to an actual improvement of 14% in unit labour costs since the

maximum reached prior to the crisis (see graphs 2 and 3). Even more important

is that the labour market reform will enable this competitive edge to most likely

become permanent, unlike in the past, where it was achieved through temporary

instruments such as devaluations in the exchange rate.

Source: BBVA Research from Eurostat

Graph 1: Total exports of goods & services (1Q12-4Q13 % of cumulative change, sa)

Italy

Sweden

Denmark

Finland

Norway

Germany

France

Belgium

Ireland

European Union

United Kingdom

Eurozone

Austria

Switzerland

Netherlands

Portugal

Spain

-5% 0% 5% 10% 15%

05

These factors generally explain why the growth in exports was resistant to the crisis in 2013 (up 4.9% year-on-year), and will continue to be resistant in 2014-15 (up 6.1% and 6% year-on year, respectively), thereby giving rise to a historic trade surplus unseen since 1987. Although the contribution of foreign

demand to growth is expected to decrease over the next two years, this same

competitive edge that is allowing Spanish companies to gain market share

abroad, is allowing them to do the same in Spain, thereby limiting the growth of

imports and, therefore, allowing the contribution of foreign demand to growth to remain positive at around 0.5% of GDP.

Investment will consolidate its recovery in 2014

Investments in machinery and capital goods continue to grow

The deleveraging process of the private sector was carried out thanks to

the increase in net savings of households and companies. In particular, the

increase in productivity, the containment of salary increases and the decrease

in expenses resulted in five consecutive years in which the private sector had

the required financing capacity to allow for a clear improvement in its financial

Graph 2: Productivity (2008 = 100) Graph 3: ULC (2008 = 100)

Spain France Germany Italy United Kingdom Spain France Germany Italy United Kingdom

2008 2009 2010 20122011 2013

90

95

105

100

110

115

2008 2009 2010 20122011 2013

70

75

95

90

85

80

105

100

110

06

position (see graph 4). It is therefore to be expected that, together with the

increase in foreign demand for Spanish goods and services, the aforementioned

may translate into a process of growth in investments (see graph 5), once the

strong uncertainty is reduced. In fact, this is exactly what happened: over the

last year, economic policy decisions considerably reduced the uncertainty faced

by producers, both at the European level and in Spain. This can be seen in the

significant reduction in the risk premium (more than 500bp since its maximum

in mid-2012), or in the increase in net financial wealth (recovery of around 25%

from June 2012 to September 2013), in both cases as a result of the return of

capital flows to Spanish financial markets.

This explains why investments in machinery and equipment increased by 2.2%

in 2013 and linked four consecutive quarters of positive growth. From this point forward, this scenario of greater certainty and growth in exports is expected to continue driving investments in machinery and equipment. However, in view

of this improvement in exports, it is important to note that the improvement

in the financial conditions, and the fact that it is easier to access financing, will

trigger new investment projects that will reduce its dependence on the good

performance of exports.

Source: BBVA Research from INE Source: BBVA Research from INE

Graph 4: Spain: financing needs (-) / capacity (+) abroad (as a % of GDP)

Graph 5: Spain: exports and investments in machinery and equipment (2008 = 100)


Households Non-financial companies Public sector Total

2007 2013

-15%

-10%

0%

-5%

5%

10%

Dec

-99

Dec

-05

Dec

-02

Dec

-08

Jun-

13

Jun-

01

Jun-

07

Dec

-11

Jun-

04

Jun-

10

Dec

-14

Sep-

00

Sep-

06

Sep-

03

Sep-

09

Mar

-14

Mar

-02

Mar

-08

Sep-

12

Mar

-05

Mar

-11

Dec

-15

60

70

110

100

90

80

130

120

140

Exports of goods and services Investment in equipment and machinery

07

Real estate investment: this time is different

One of the characteristics of past recoveries in Spain was the growth in residential

investments, even before that of economic activity as a whole. Actions regarding

monetary policy, reducing real interest rates, boosted risk taking on the part of

savers, causing them to first invest in the residential sector. In fact, it is this type

of behaviour that was recently seen in certain autonomous communities along

the Mediterranean coast, where the increase in purchases by foreigners or even

non-resident Spaniards revived sales. However, in general, such a high level of

imbalance in the sector, with relatively high surplus supply, of around 2.2% of

residential assets —once frictional stock is discounted— and what still remains

of the deleveraging process to be carried out, implies that residential investment

shall remain weak over the coming quarters.

In any case, the regional distribution of unsold new housing continues to be

mixed. While there are certain regions where the imbalance is still significant

(La Rioja, Valencia, Castilla-La Mancha, the Canary Islands and Murcia), there

are other regions where the proportion of unsold new housing is significantly

below the average, such is the case in Extremadura, Cantabria, Navarra and, to a

Source: BBVA Research from Ministry of Public Works Source: BBVA Research from INE

Graph 6: Spain: contribution to growth from housing sales (in pp)

Graph 7: Surplus supply of new unsold housing: 2013 projections (as a % of residential assets)

0%

1%

4%

2%

3%

5%

6%

RIO

CYL

CAN

AST

MU

R

AN

D

CNTES

PVA

CLM

ARABA

L

MA

D

VAL

GA

L

EXT

CAT

NAV

Foreigners Spanish Other Total

-40%

-30%

-10%

-20%

0%

10%

2010

2008

2012

2011

2009

2007

2013

08

lesser extent, Madrid and the Basque Country. These differences will be felt in the

recovery of the sector, thereby giving rise to different growth processes based on

the particular characteristics of each of the markets.

In any case, an improvement is expected in the key aspects related to purchasing housing over the next two years. Firstly, the projections for the

job market point towards the creation of employment beginning this year.

Secondly, mortgage interest rates will continue to be stable, and may even

drop slightly in 2014 and reach level around 3% in 2015 due to a decrease

in the mortgage spreads. Lastly, the recovery of financial wealth and the fact

that the process of correcting housing prices is nearing completion may affect

demand positively.

The demand for housing from foreigners is expected to remain strong and is

even expected to grow over the next two years. In addition, international investors

have become more interested in the sector, especially in the second half of 2013

(see the section on current adjustments).

The context within which the market will operate in 2014-2015 will therefore be

different from that of the most immediate past: in an environment where there

is a progressive recovery of demand, supply will continue to be adjusted due to

the scant number of houses that will be completed over the coming years, which

could bring stability to housing prices in 2015. The latest data confirms that

since mid-2012 the number of purchase and sale transactions for new housing

significantly exceed that of new housing offered on the market, a difference that

has been gradually growing, which indicates an increase in the rhythm at which

unsold housing stock is absorbed.

Therefore, after six years of intense adjustments to the real estate sector, with

a cumulative drop of around 54% in activity since its height in 2007, 2014 is

becoming a year of transition towards stability and is expected to end with an

adjustment towards more moderate housing investment than that of recent

years (down 3.5%). In 2015 we will start to see a recovery in this component of investment. Therefore, the ratio of investment to GDP has reached record

lows: in 2013 it stood at 4.4% and is expected to drop to around 4.1% in 2014,

significantly lower than the 1980-2013 historical average of around 7.8% (see

graph 8).


09

Source: BBVA Research from INE

Private consumption and employment grow

Although there have been improvements in indicators that traditionally precede

the recovery in GDP (exports, investments in machinery and equipment) and

changes have been detected in public policies aimed at avoiding additional

deterioration of domestic demand (less uncertainty, more flexible public

deficit goals), the turning point in indicators such as private consumption or

employment was expected once the GDP growth cycle began and this is in

fact what happened. In particular, the progress regarding economic activity and

the improvement in the efficiency of the job market as a result of the labour

reform passed in 2012 led to an increase in the number of people working in

the private sector, which was greater than that which could have been deduced

from the historic sensitivity of employment to changes in GDP. However, the

Spanish economy destroyed 494 thousand jobs in 2013 (295 thousand less

than in 2012). These results gave rise to a new spike in the unemployment

rate (from 1.3pp to 26.1%) despite the 1.1% reduction in the workforce.

Graph 8: Spain: housing investment (as a % of GDP)

1980

2002

1988

2010

2013

1984

2006

1992

1998

1982

2004

1990

2012

2015

(e)

1996

1986

2008

1994

2000

1981

2003

1989

2011

2014

(e)

1985

2007

1993

1999

1983

2005

1991

1997

1987

2009

1995

2001

0

2

10

8

6

4

12

14

10

It is important to note that this reform is largely responsible for the containment of salary increases that would have prevented the destruction of around 220 thousand jobs in 2012 and 2013, and would have avoided the destruction of around 1 million job positions had it been applied in 20081.

From this point forward, mixed signals are received from the data on the number

of persons registered within the Social Security system, with employment

acceleration, and the data from the quarterly survey of the labour market,

which continue to show job destruction. In any case, the consolidation of the

recovery will enable the positive trend to continue and the number of jobs

in 2014 to increase by 0.6%, a figure which should increase to 1.3% in 2015. Accordingly, the unemployment rate will also depend on the behaviour of the workforce and, according to our predictions, should be around 24.8% in 2014 and under 24% in 2015.

The progress regarding household’s disposable income as a result of this turning

point in the labour market, the improvement in their perception of the economic

situation, the increase in net financial wealth and the term of the Efficient

Vehicle Incentive Programme (PIVE) would have offset the deterioration in

non-financial wealth of homes, which would have stimulated private

consumption in recent months. In the future, private consumption will grow

in 2014 and 2015, underpinned by the improvement in key aspects. The cycle

change in the job market will therefore contribute to the increase in gross

household income both this year and, especially, the next. Accordingly, the

expected increase in net financial wealth, the lack of inflationary demand and

the expectation that official interest rates will remain at record lows will offset

the deterioration in non-financial wealth. Consequently, household consumer expenditure will grow by around 1.5% in 2014 and this rate is expected to pick up slightly in 2015.

1 See “Persistence of unemployment and salary dynamics in Spain”, in Situación España, Second Quarter of 2013, BBVA Research.


11

The effort to reduce public deficit will be less over the next two years

In addition to the aforementioned improvement in exports, investments in

machinery and equipment, and private consumption, there is also less negative contribution to domestic demand as a result of the unavoidable process of reducing public deficit. In particular, in 2012 and 2013 the government

implemented measures that could have exceeded 6.5% of GDP in order to

reduce public deficit from 9.1% of GDP (not including aid to part of the Spanish

financial system) to 6.6% of GDP at the end of 2013. The difference between the

size of the measures taken and the effective reduction that took place has to do

with the cyclical deterioration and its impact on total expenses and income of

public administrations.

This fiscal consolidation has been one of the greatest carried out in developed

economies and, therefore, it has allowed its European partners to recognise

the great effort that has been made. It should be noted that the cumulative fiscal effort, measured by the change in the primary structural balance, was almost 10% of GDP, reaching a 1.4% surplus in GDP in 2013.

This also allowed to set deficit objectives more consistent with the economic

scenario. For example, the objective of reaching a deficit in public accounts of

less than 3% of GDP was delayed by a few years until 2016, which allowed for

more attainable goals in the short term. Reducing public deficit to 5.5% of GDP in 2014 and to 4.2% in 2015, which is that currently planned, would imply an effort of around 1.5% in terms of GDP, since the expected economic recovery

should reduce certain expenses (unemployment, interest) and improve certain

components of income. This fiscal policy, which is more consistent with the

recovery, will therefore enable public spending to progressively reduce its

negative contribution to growth over the coming years.

Similarly, it should be mentioned that, in accordance with the tax measures

announced up until now, the tax balance would improve by 1.1% of GDP in

2014 and almost 0.6% of GDP in 2015, thereby allowing the government to

be more proactive in complying with its budgetary commitment to Brussels.

These measures are equivalent to the envisaged improvement in the structural

balance in this period, which would facilitate compliance with the tax objectives

in a scenario of nominal GDP growth. In addition, the effect on growth should

12

be less than that in the recent past, since only half of the measures would be

the result of an increase in revenues, while the remaining would result from a

reduction in public spending, mainly as a result of the application of CORA2.

Lastly, it is important to note that the harmful multiplier effect of a restrictive fiscal policy is clearly less in a financial climate of improvement and certain stability such as the current environment in Spain.

To sum up, over the last twelve months, there has been a significant improvement

in key aspects of the Spanish economy. The economic policy decisions

taken at the European level, and the reforms carried out in Spain, explain the

environment of greater certainty. This was a step towards a process of recovery

that has similarities and differences with regard to previous recoveries from a

recession. In particular, exports, net deleveraging of companies and families,

and investments in machinery and equipment have preceded the recovery

process and point towards sustainability in the medium term. The fact that

exports have grown despite the recession in Europe is especially positive, since

this growth was achieved without devaluing the currency, which would convert

the competitive edge obtained into a more permanent process.

The aforementioned is mostly due to well-focused reforms that have allowed companies to have more flexibility and that have saved jobs. Similarly, these reforms will boost employment creation even more than in previous recoveries. In fact, this can be seen the recent increase in the number of jobs and,

if consolidated, would represent a turning point in the prospects of household

income which seems to be positively affecting consumer expenditure. All of this has resulted in a scenario of moderate recovery, in which the GDP of the Spanish economy is expected to grow by around 1.3% in 2014 and around 2% in 2015.


2 Commission for the Reform of Public Administrations.

13

14

The historic improvement in the trade balance continues which forecasts current account surpluses equal to 2%-3% of GDP in 2014-15.

Since 2008 Spanish exports of goods have increased on average at a nominal growth rate of 7% per year3, a rate which is similar to that recorded from 2002 to

2007. However, although the growth rate of exports has been similar to that prior

to the crisis, this took place despite the slowdown of global growth from 4.8%

during the 2002-07 period to 3.2% over the last six years.

This buoyant export sector performance meant that Spanish exports of goods

in 2013 reached 234 billion euros, which in terms of per capita means that each

Spaniard now exports 5,026 euros, approximately 1,000 euros more than in 2008. It should be noted that Spain is one of the few developed countries whose exports grew in 2013. Compared to Spain’s 5.2% increase in foreign

sales, exports fell by 1.6% in France, by 0.2% in Germany and by 0.1% in Italy,

which is in line with the events taking place in the EU, while in the USA exports

grew by almost half, up 2.1%. Only Japan saw a growth rate greater than that of

Spain, with an increase in foreign sales of 9.5%.

This dynamic growth was made possible as a result of the diversification of Spanish exports both in terms of product and destination.

• In analysing the breakdown in 42 categories, the concentration has

decreased by 4% since 20094. The greater weight of capital goods (now

representing 21% of total exports), thanks to the increase in sales of

machinery and transport material, as well as in consumer goods (textiles,

clothing, jewellery and watches) and agroindustry, is noteworthy of

mention.

• However,whatwassurprisingaboutthisprocessofexpansionwasthe

diversification by destination. In analysing the breakdown of foreign

sales to 200 countries, the Herfindalh concentration index shows a

drop of more than 20%. The share of exports to Europe decreased by

2 The current account surplus and the restoration of the financial balance strengthen Spain’s financing capacity in relation to the rest of the world and our attractiveness as a country

3 This rate excludes 2009 where exports fell by 16%. 4 According to the Herfindalh index, the concentration by product of Spanish exports since 2009 went from 680 to 655.

15

more than 6pp to 67.9% of the total at the end of 2013. Exports to the

eurozone decreased by 8pp to 48.1%, the weight of exports to Latin

America (Brazil accounts for 45% and today is the destination of 6.5%

of spanish exports) increased by 1.6pp, the share of exports to Africa

increased by 1.2pp to represent 7% of the total (60% accounted for by

North Africa), and the weight of exports to Asia increased to 0.6pp to

represent 5.3% of the total.

• Graph9showsthebreakdownofSpanishexportsbydestinationin2009

and in 2013. There is also a breakdown by destination of German exports

in 2013. In general, the growing trend observed in Spanish exports is to

have a distribution similar to that of Germany, reducing sales to eurozone

countries and increasing exports to the majority of emerging countries,

especially to Europe and Asia. In fact, in view of the differences, it could

be asserted that the share of exports to the eurozone could be reduced

further and those to Asia and emerging European countries could be

increased. However, there will logically be differences since, due to cultural

and economic ties, the weight of Latin America for Spain is double that for

Germany, which is also true for Africa, and specifically North Africa.

Graph 9: Distribution of exports by destination (as a % of total)

Germany Spain (today) Spain (2009)

Eurozone North America AsiaRest of Europe Latin America Africa Other

56%

48%

36%

18%

4% 5% 6%7%7%

9%

2%4%

6%5% 5%

16%

3%

9%

4%

20%

31%

16

It would therefore be logical for exports to continue growing at high rates over the coming years as a result of transferring the portfolio of Spanish exports to destinations with stronger growth. In fact, this should continue to be

the strategy of the export sector since, as detailed in several reports, from today

until 2020 the weight of trade between countries in the northern hemisphere

will likely decrease by half (from 40% to 35% of the total), while trade between

countries of the southern hemisphere will increase significantly from the current

16% to 25% in 2020.

The number of exporters grew to an average annual rate of 11.4% in the 2011-13 period. This means that the number of exporters today is 53% greater

than prior to the crisis, which contrasts with the net decrease of total companies of

more than 6% since the beginning of the crisis.

• Madridistheregionswiththelargestgrowthintermsofthenumberof

exporters, growing at a rhythm of twice that of the country’s average.

Madrid is followed by Extremandura, where the number of exporters grew

over the past three years at an average annual rate of 17.8%, followed by

Cantabria. The regions with the least dynamic performance in terms of

the number of exporters include Catalonia (annual average of 6.5%) and

Galicia (8.7%).

• However, the number of companies that export regularly5 presents a

positive but very modest trend, since at the end of 2013 there were 6%

more than just prior to the crisis. However, the fact that four consecutive

years of exporting are needed (since at least 2010) and taking into account

that the number of exporters began to increase starting from that year, it

should not be discarded that as of 2014 the number of regular exporters

will begin to increase significantly.

The great challenge of the Spanish business fabric is to increase the average size

per company, since large enterprises have very similar export intensity to that of

the main European countries, with the advantage that the historic ties and the

geographical proximity allow diversification by destination to be greater than

other European countries.

2. The current account surplus and the restoration of the financial balance strengthen Spain’s financing capacity in relation to the rest of the world and our attractiveness as a country

5 A company is considered to regularly export when it has carried out export activities consecutively over the last four years.

17

Not only will the competitiveness of the economy and Spanish companies continue

to be fundamental in this progress towards greater internationalisation, but also the

commitment of public and private sectors with the key player, the company, by means of “commercial diplomacy” and the de facto support with credit lines

through COFIDES, ICO, FIEM, CESCE and ICEY to support growth in the short and

medium term. Developing the internationalisation certificates and bonds market,

together a greater ability to access guarantees and collaterals in internationalisation

transactions, will be fundamental in this regard, whereby these types of financing

initiatives should be key in the strategic internationalisation plan for the

2014-2015 period.

• In2013,66%ofexportersthatreceivedfinancingor71%ofSMEscreated

or stabilised employment in Spain (vs. only 34% in 2012).

• Atleast1,000internationalisationprojectshadexplicitfinancialsupport

from these organisations. This support also entailed raising external

financing of 2.5 billion euros.

• Asmentioned in thissection, there isaclear focuson internationalisation

plans by diversifying markets and products so that the improvement is not

cyclical but rather structural, whereby the following are especially noteworthy

of mention:

Graph 10: Number of exporters

2013 Pre-crisis

No. of regular exportersNo. of exporters

+53%

+6%

98,798

150,992

41,16338,938

18

- A growing financial weight towards projects in emerging countries

such as Mexico, Peru and Colombia in Latin America; Angola and South

Africa in Africa; Southeast Asia and, especially, in developed countries

towards the USA market.

- Growing presence in the food and agriculture sector, where innovation,

safety and product quality is especially valued, the extensive Energy

sector, the Automotive sector, the Engineering sector and the

Transport Infrastructure sector.

The aforementioned factors, such as diversification by products and especially

countries, the improvement in competitiveness thanks to the reduction in

unit labour costs (see below), the increase in the tendency to export and the

priority of public institutions to promote this approach have led to a structural change in Spanish exports. Graph 11 shows the average annual growth in

exports of goods and services under two scenarios during the 2002-08 and

2010-13 periods. The dark blue bars of the graph indicate the estimated growth

in exports taking into account the diversification pattern, the organic growth

of the countries to which Spain exports and the export propensity prior to the

crisis. The light blue bars include the changes in the geographical pattern and

the export propensity since 2010, and the organic growth of the countries to

which Spain exports. Lastly, the green bars relate to the growth in exports of

goods and services seen in the national accounts of Spain. Various conclusions

can be reached:

• Duringthe2002-08period,exportsincreasedatanaverageannualrate

of 3.5%, which is below the rate at which they would have increased

(5.1%) had the organic growth of the destination countries and the

diversification pattern been taken into account. This represents a loss of

growth of almost 0.5pp per year.

• Had this pre-crisis pattern been preserved, Spanish exports would

have increased by 2.8% per year vs. 6.6% in the 2010-13 period, which

would have represented a 1.1pp less in GDP growth than that actually

recorded.


19

• However, if the improvement in the exporting tendency and the

diversification by geographical areas are included, the growth rate of exports

would increase to 6.6%, a rate similar to that finally recorded. This means that

since 2010 these changes have been incorporated into the Spanish export

sector, thereby more than doubling the theoretical growth in exports.

• Lastly,overthenextthreeyears(2014-16),exportswilllikelygrowby5%

considering the pre-crisis pattern and taking into account the growth

estimates of the destination countries, which is very much in line with the

5.5% growth estimated by the International Monetary Fund. On the other hand, if the current exporting pattern is maintained, which is what should happen, exports would increase at an average annual rate of 9%, which would represent additional GDP growth of almost 1pp per year from the levels currently envisaged.

* This corresponds to the growth forecast for exports of goods and services carried out by the IMF in April 2014

Graph 11: Growth in exports of goods and services (average annual growth rate, constant prices)

5.1

3.5

2.8

6.6 6.6

5.0

5.5 *

9.08.8

2010-2013 2014-20162002-2008

Exports of goods and services (yoy, estimated), pre-crisis pattern Exports of goods and services (yoy) Exports of goods and services (yoy, estimated), post-crisis pattern

20

This improvement in exports, together with the adjustment to imports, has represented a shift of more than 84,060 million euros in the trade balance since 2007 (8.1% of GDP). That said, almost 60% of this adjustment (see table

1) is explained by the increase in exports, whereas the remaining 40% would be

from the drop in imports. If exports are broken down into three groups: goods

related to the primary sector, medium-high added value goods and durable

consumer goods (more elastic than income and more related to the construction

sector), we see that two-thirds of the improvements in exports were a result of high-added value goods, while food and energy accounted for the rest. Lastly,

durable consumer goods are those that suffered the most following the drop in

the volume exported.

With regard to the drop in imports, the analyses carried out6 recently indicate

that, despite the fact that the deterioration in final demand explains a high

percentage of the negative performance of imports throughout the economic

crisis, the Spanish economy is immersed in a process of substituting imports (non-energy) for domestic production, which would explain the 42% drop in imports. Specifically, and for the first time in over two

decades, domestic products had a competitive edge in terms of price over

imported goods, which evidences the current internal devaluation process in

progress. In addition, this competitive edge in terms of price was reinforced

by a relative demand for imports that was more flexible with regard to the

relative price, which enhanced the substitution process. This is also reflected

in the competitiveness indicators calculated using various methods, which reflect improvements since the beginning of the crisis between 8%-10%


6 Situación España, 4Q13 BBVA Research. Substitution of imports for domestic production during the crisis: preliminary evidence.

2013 vs. 2007Trade balance improvement

(as a % of GDP)% accounted for

by exports

Primary sector* 0.4% 42%

Medium-high added value goods** 6.1% 65%

Durable consumer goods*** 1.6% -7%

Total 8.1% 59%

* Food, energy products and raw materials ** Semi-finished goods, manufactured goods, capital goods and other merchandise *** Automotive sector and other durable consumer goods

Table 1: Improvement in the trade balance (2013 vs. 2007)

21

compared to the main partners. In other words, our domestic and export

cost indices increased by 8%-10% less than those of other partners.

Over the next two years, the projections made by international and Spanish

organisations estimate additional improvements in the current account balance from surplus levels of around 1% of GDP in 2013 to a range of 2%-3% in 2015. This is the result of maintaining an annual growth rate of 5%-6% in exports and a progressive recovery in imports7.

Accordingly, not only did the foreign trade deficit turn into a surplus for the first

time since 1987, thanks to the aforementioned improvement in competitiveness

and diversification, but there are also signs that this will continue in the future as

shown in the paragraphs above. This view would also be backed by the last report

on positioning countries towards foreign trade prepared every two years by the

World Economic Forum. The last report placed Spain among the leaders (in fourth place) in terms of growth potential, mainly as a result of the availability and quality of its transport infrastructure and services. The return from trade credit (main obstacle in recent years) and the improvement of ICTs in the value chain would be the additional leverage needed to back this improvement in the future.

Improvement in quality and quantity of financial flows

Spain continues to be very attractive for foreign investment in production

Foreign direct investment (FDI) has always played a major role in Spain’s

economic history. According to the recent unified data available from the

UNCTAD, FDI stock in Spain is 47% of GDP, which is above that of the United States (26.2%), France (39.5%), Germany (21.1%) and Italy (17.7%). In

addition, annual foreign direct investment flows have always been positive and

relatively stable since the mid-’90s, representing between 5% and 24% of total

investment in Spain. Even in 2009, the worst year in terms of growth in recent

history, FDI inflows were 6.8% of total investment. According to UNCTAD data,

Spain was ranked thirteenth worldwide in terms of FDI received8 and third in

the EU15, only after the United Kingdom and Ireland.

7 For example, the la Caixa research service estimates that if Spain maintains the competitive edge it has had since the beginning of the crisis, it could have trade surplus of more than 125 billion euros in 2018.

8 http://unctad.org/en/Pages/Publications/Global-Investment-Trends-Monitor-(Series).aspx.

22

In 2013, there are several noteworthy aspects regarding the figures on foreign

investment into and out of Spain. Firstly, foreign direct investment in production

received increased in 2013 by almost 9% to 15,800 million euros. Secondly,

80% of this investment received was assigned to “greenfield” investments, in

other words, investments that have the greatest impact on production and

employment in the country. Lastly, in 2013 the divestment process of Spanish

companies abroad was slowed down, which shows that the process of adjusting

the trade balance was coming to an end.

With regard to investment received, the concentration by country in 2013

is very similar to that of previous years. The first seven countries investing

in our country account for 75% of total flows received. Of these countries,

the greatest increases came from France (905 million euros) and the United

Kingdom (863 million euros), while the greatest losses were experienced by

the USA (-983 million euros) and Luxembourg (-482 million euros). With regard

to other countries, the increase in 2013 of 240 million euros from Hong Kong,

the 250 million euros from Japan and the 440 million euros from Mexico are

worth mentioning. In terms of areas, the EU-15 as a whole accounted for 73% of

total investment, up 16.5% compared to 2012. Latin America also increased its

investment in Spain by 48% and gained weight in total investment from 5.2%

in 2012 to 7.1% 2013.

In historic terms and as was the case with exports, the concentration by country of origin of the FDI inflows decreased over time. In fact, 2013 was the

year with the greatest diversification in history. Graph 12 shows the breakdown

by country of FDI in 2013 with regard to the average of the last decade (1998-

2007). The main conclusion reached is the drop in the weight of non-euro

countries (especially the United Kingdom) and the increase in the share of

emerging countries, especially in Latin American.


23

It is important to note the growth position of foreign multinationals in Spain,

which, according to the latest available data, total more than 13,000 foreign

companies (70% of which are represented by the top 100 on the Forbes list)

that are responsible for 7% of employment. With regard to the number of projects, Spain received 660 FDI projects over the last 24 months from almost 500 companies, significantly above the average of the Nordic countries (100), Switzerland or Italy (around 180), the Netherlands or Ireland (around 300) and even France (550). This investment represented the net creation of 58,000 jobs.

Accordingly, Sovereign Wealth Funds continue to focus on Spain, maintaining

and even increasing investments in various spanish companies9. Over the last

year, funds such as the Norwegian fund maintained its investments in Spain,

while others, such as that of Singapore, China or Qatar, significantly increased

their investments in our country.

Graph 12: Breakdown of FDI inflows by country

9 Sovereign Funds 2013. KMPG, Invest in Spain and Esade.

Eurozone Rest of Europe North America Latin America Other Asia Africa

20131998-2007

57%60%

17%

9%7%

5% 5%

1%

25%

11%

4% 4%2%

0%

24

Numerous recent examples, such as those listed below, despite the private

consumption crisis that we have experienced, confirm the attractiveness of Spain,

which is ranked first in Europe in terms of quality of life for expatriates and third worldwide, a country with excellence in innovation activities and as a key platform in high added value sectors:

• EstablishmentinSpainofEuropeanR&Ddistrictsofleadingmultinationals

in added value sectors (videogames, cloud computing, aeronautics,

sound equipment, biotechnology),

• Strong investments in cutting-edge technology projects (biomass,

healthcare, information technology, electronic machinery),

• Increase in plant capacity in key sectors (pharmaceutical, automotive,

auto parts, electric equipment) or

• NotablecommitmentofforeigninvestmentinSpanishlogisticsplatform.

The return of confidence is also reflected in positive portfolio flows

Changes in the Spanish financial balance reflect, on one hand, the deleveraging

situation and, on the other hand, the recovery of confidence that Spain is

undergoing. Graph 13 shows, by period, net FDI flow, portfolio and other

investments (loans) over various periods on a net basis. Therefore, from 2005

and 2007 the portfolio and loan flows showed positive values while the net

FDI was negative due to the fact that the inflows (30.5 billion euros) were less

than the outflows (72.3 billion euros) as a result of the strong commitment

of Spanish multinationals to invest abroad. Subsequently, from 2008 to 2012

portfolio flows (bonds and equity) disappeared and were replaced by loans,

while net FDI stagnated. Lastly, 2013 reflects the greater confidence in the country with positive net portfolio flows and FDI inflows reaching record highs in the 2005-07 period, together with the deleveraging process, which explains high loans repayment.


25

This greater confidence is reflected in several indicators of Spanish public debt, where despite the demanding issuance timetable we continue to see a

stable appetite:

• Thedemand/supplyratiohasremainedunchangedatalevelof2.5since

the beginning of 2013 for both long-term and short-term issuances. In

1Q14 a slight improvement was recorded which was in line with the

confirmation of the scenario of economic recovery observed in recent

months, thereby allowing the issuance of 34% of that envisaged in

bonds and obligations for the entire year and 28% of the total estimated

needs,

• Theproportionof long-termdebt (bondsandobligations) continues

to increase and already represents almost 90% of the total stock (vs.

80% in 2009), which provides stability and predictability to the cash

refinancing plans and allows the total average life of the debt to be

raised to almost 6.3 years,

Graph 13: Spain: financial account changes (billion euros)

2005-07

82.5

2008-12

45.2

2013

-25.3

Investment portfolio Other investments FDI Total

26

• Thepercentageofdebtinthehandsofnon-residents,bytypeofinvestor,

at the end of 1Q14 stood at 40.3% of the total, up from the record low

of 34.8% recognised in 2011. From 2010 to 2012, non-residents barely

accounted for 6% of the debt issues, while in 2013 they purchased 94%

of the total debt flow. A portion of this greater share by non-residents

was at the cost of less exposure of Spanish financial institutions.

This improvement in confidence, thanks to external support, was also consolidated in “key players”

That mentioned above is reflected in the change in view and discourse of the rating agencies when talking about Spain. The significant adjustment carried out

in the current account, the exceptional capacity of the Spanish economy to refocus

on tradable sectors and the competitive edge earned thanks to the reduction in

unit labour costs, are the main reasons which, according to the rating agencies,

would rule out any drop in rating in the near future.

In addition, rating agencies continue to view positively the government’s commitment to reform (reform of public administrations and fiscal reform) as

well as the path taken until now with the approval of the reform of the labour

market, the financial sector and the pension system.

In addition to that mentioned, there were various positive surprises in the last

quarters of 2013 which dispelled two of the main doubts regarding the Spanish

economy: i) credibility of and commitment to the fiscal adjustment and ii) the

clear turning point in economic growth.

• Credibility of the fiscal adjustment once the 2013 fiscal objective

was in fact met. The deviation in current terms is barely 500 million

euros, whereby growth below that budgeted would explain most of

the deviation. The prospects for compliance in 2014 are optimistic,

although doubts have arisen regarding the 2015 objective once the

neutrality of the fiscal reform is expected. In addition, the pressure

on the capacity to refinance the maturities has disappeared, which is

reflected in the lengthening of the term of the debt and the return of

foreign investor interest.


27

• Economic recovery, with the end of the recession between 2-3 quarters

previously envisaged by most analysts and a growth based more on

domestic demand and an improvement in the labour market situation.

It should be taken into account that the figures on employment created

in March show how employment in the construction industry was

generated for the first time since 2007, and how the industry continues

to create jobs for the third consecutive month and services for the

eighth consecutive month. In the first quarter of 2014, employment

was therefore created at an annual rate of 2.5%, up 1.4% compared to

the fourth quarter of 2013.

Lastly, it should be mentioned that most international bodies (mainly the OECD and IMF) and business surveys are confident in Spain’s ability to increase exports and its path towards internationalisation. Therefore, the

latest IMF projections estimate there will be a continued improvement in the

Spanish current account until reaching a surplus of 3.4% of GDP in 201910.

Along this same line, business community believes that Spain will increase its

share in world trade over the coming years, and be able to maintain or even

strengthen its rhythm of exports that began during the crisis11. In any case, this

improvement in exports should be sustainable and will allow the country not

only to have financing capabilities in relation to the rest of the world for the first

time in 16 years, but also to maintain this capability over the medium term.

10 WEO projections of April 2014.11 “The Spanish economy in 2033” report of PWC.

28

The clear progress in adjusting the existing imbalances continues3After having seen in the previous section how the main imbalance in the

Spanish economy (the export sector) was successfully corrected, we are going

to review the trend in the main imbalances generated by the Spanish economy

during the period of economic expansion: the high level of debt in the private

sector. As in the case of the export sector, streamlining decisions regarding

consumer expenditure and investment in a context of lower domestic demand

as a result of the economic crisis, together with the credit crunch, contributed to improving private debt ratios starting in 2011. Since then and until 2013, Spanish private debt fell 25 points of GDP to 207%, whereby the business sector accounted for 14 points of this reduction as a percentage of GDP. This is one of the reasons that explains the fact that the private sector currently has a financing capacity of more than 7% of GDP.

Spain’s level of private debt is returning to levels that are considered sustainable, which is one of the conditions to ensure the economic recovery in progress is sustainable and that it is accompanied by a progressive

improvement in domestic consumption and employment.

Therefore, the government must continue with its policy of adjustments and

modernisation, adjusting debt levels and preventing the crowding out of

private sector investment. Since 2008, the government increased the weight

of its debt/GDP ratio from 40.2% to 93.9% at the end of 2013, following a

growing leveraging path that is contrary to the deleveraging carried out by

companies and households, which has also affected bank financing with the

growing weight of the government and a decrease in the financing capacity of

companies and households. It is essential that the government, companies and households maintain the common objective of optimising their leverage ratios in order to lay the foundations for sustainable growth which

facilitates the creation of employment. Lastly, as seen in the section below,

measures will continue to be implemented in order to increase productivity

from all key economic fronts and agents.

Debt of Spanish non-financial companies is reduced

Spanish companies contributed significantly to the deleveraging process of the Spanish private sector, carrying out processes to optimise investments,

divestments, cost adjustments and process efficiencies. From the record highs

posted mid-2010, the debt recognised on corporate balance sheets dropped

29

by 188,600 million euros, 14 points of the GDP. Another factor that heavily

influenced this trend is the drop in the weight of short-term bank financing in

total loans: at the beginning of the 2000s, they represented 25% of the loans

and in 2013 represented less than 10%. Therefore, non-financial companies are

slowly finding new forms of financing, thereby reducing their exposure to the

financial sector (see graphs 14 and 15).

Over the next two years companies will likely continue to improve their financial

position, with additional reductions in their debt levels, especially bank debt,

albeit at a slower pace than that seen in 2012 and 2013. Even when there are

significant differences by activity sector, in aggregate terms, business margins

must be maintained or even reduced by taking into account the restrictions in

order to continue adjusting labour costs and expectations regarding gradual

recovery for income. In addition, as investment in fixed assets is revived, the

available resources and incentives to repay debt are less. In any case, the financing capacity of the business sector may, on average, be around 3% of GDP in 2014 and 2015.

Source: Afi, Bank of Spain Source: Afi, Bank of Spain

Graph 14: Debt of Spanish companies (as a % of GDP). 3Q13: latest available data

Graph 15: Financing structure of Spanish non-financial companies (trillion euros)

Gross debt Net debt * Trade debt Current financial debt

Non-current financial debt Equity

m05

m09

m07

m11

m06

m10

m13

m08

m12s0

5

s09

s07

s11

s06

s10

s08

s12

s13

70%

80%

120%

110%

100%

90%

150%

140%

130%

(*) Net debt = gross debt less cash and deposits

0703 1101 0905 1300 0804 1202 1006

0

0.5

2.5

2

1.5

1

4.5

4

3.5

3

30

One of the main signs of the deleveraging process in which Spanish companies are immersed is the change in their saving position. At the

beginning of the 2000s, the sector as a whole made annual decisions regarding

investments in fixed assets (machinery, transport equipment, etc.) for an

amount similar to 15% of GDP, while the savings generated, understood as

the volume of net income, was around 10% of GDP. This gave rise to certain

financing needs, covered mostly by debt, of around 5% of GDP. Since 2010,

the companies have altered their financing position and have become net

lenders to other institutional sectors. This trend can be explained not only by

the intense contraction in investment expenditure, but also by the process of

adjusting costs (especially labour costs) which gave rise to the slowdown in

demand. The improvement in the gross debt/EBITDA ratio (total liabilities excluding capital) and net debt/EBITDA ratio (deducting the value of the financial assets in cash and deposits) is also a good indicator of corporate stabilisation. These ratios dropped by between 30%-40% at the end of 2013 with regard to those at the beginning of the crisis.

The aforementioned deleveraging, along with the recovery of operating profit

(up 4% in 2013), enabled the ratio of debt to gross operating profit to be reduced

to the levels in 2002 (approximately 8x times from a ratio greater than 12x in

2007), thereby also confirming the strong reduction in debt and the substantial

improvement in companies’ capacity to repay debt. The expected recovery in domestic demand will allow net income to be increased, thereby bolstering the recovery of operating profit in the future. It is important to note, in line

with that mentioned above, that the improvement in operating profit to 21% of

GDP (vs. 17% in pre-crisis years), has allowed the debt ratios to return to 2001-2004 levels in terms of available income or operating profit.

3. The clear progress in adjusting the existing imbalances continues

31

The still high deleveraging rate is being translated into sharp drops in outstanding

credit balances. However, since the end of 2013 we have begun to glimpse the first signs of recovery in terms of the volume of new loans granted to SMEs; a

trend that was also confirmed by the latest bank loan survey carried out for 1Q14.

For example, in 1Q14 new transactions granting loans to companies for less than

one million euros reached a volume of 31 billion euros, compared to the 28 billion

euros in the same period of 2013.

The incipient recovery envisaged for granting new bank loans will benefit those companies with viable business models that were adversely affected by the adjustments to demand and the credit crunch. In this regard, there were

several recent initiatives focused precisely on providing corporate financing. Royal

DecreeLaw4/2014,onurgentmeasuresregardingrefinancingandrestructuring

corporate debt, intends to facilitate debt refinancing agreements, other than

insolvency proceedings, in order to ensure the survival of viable companies

which, as a result of their high level of debt and economic situation, are unable to

meet current financing conditions.

Table 2: Level of income, consumption, savings and investment in fixed assets of Spanish companies

Given that 3Q13 provides the latest available data, the position in 2013 is the cumulative result of the last four quarters. Source: Afi, INE

Billion euros; cumulative data over 12 month 2008 2013% of

change

GVA (gross value added) 517.4 505.5 -2.3%

EBITDA (gross operating profit) 181.1 214.0 18.2%

Available gross income or gross savings 66.3 151.3 128.3%

+ Net capital transfers 12.7 9.6 -23.8%

= Capital resources 78.9 160.9 103.9%

– Gross capital formation* -180.1 -118.2 -34.4%

= Financing capacity (+) / needs (–) -101.2 42.8

* Includes amortisation and depreciation. Plus acquisitions of non-productive non-financial assets (land)

32

The recovery of bank lending will therefore be essential in order to slowdown the mortality in the small and medium enterprises segment. New financial

initiatives other than through banking channels need to be developed, such as

the creation of Alternative Fixed Income Market, although the relative importance

of the market in the structure of Spanish corporate financing is still very low.

Debt reduction of Spanish households picks up

The deleveraging process of households is going slower than that carried out by companies, however it has begun to pick up speed as of 2012. The

debt assumed by households reached record highs in 2010 at 130% of their

gross income available, whereas at the end of 2013 this debt represented 116%,

despite the adjustments to family income. In terms of GDP, the debt ratio was

reduced by 10 points (87.7% in 2010 compared to 77% in 2013). In fact, net debt

transactions (new loans granted less repayments) were negative for an amount of

35,000 million euros in 2012 and 43,000 million euros in 2013, which is consistent

with the low rate at which new mortgage loans were granted. For example, in

2013 the new loans granted to households to acquire housing amounted to

21,400 million euros, compared to the 31,300 million euros in 2012 and very far

from the 139,000 million euros of 2007.

The sharp reduction in housing investment and the adjustment to consumer expenditure allowed the drop in available income (due mainly to the destruction

of employment and the progressive containment of salary increases) to be offset,

giving households a margin to repay the debt. In this regard, Spanish households

shifted from having borrowing needs, understood to be the difference between

the savings generated and the housing investment, of almost 3% of GDP in 2007

on having a savings surplus for almost the same amount.

The notable improvement that the recovery of the net financial wealth of households is having on restructuring their balance sheets is worthy of note

in this section. At the end of 2013, Spanish families reached record levels of net

financial wealth, surpassing the maximum reached in 1Q07 with an improvement

of approximately 370 billion euros (a 54% revaluation) compared to the record

lows of 1Q09, a consequence of the continuous positive flow of net financial

wealth to the balance sheets as a result of their financial assets appreciating and

repaying their liabilities at a faster rate. Although net financial wealth continues

to be below pre-crisis levels in terms of available gross income, this ratio could


33

be reached in 2014, reducing the need to increase savings and, therefore, not

putting pressure on private consumption.

The aforementioned allowed 4Q13 to be the first quarter in five years with an annual growth rate for total net wealth –including real estate– that was positive (1.2%), after two consecutive quarters with positive quarterly growth.

Following the sharp adjustment in the value of families’ total real estate wealth

(almost 1.6 trillion euros since the maximum of 2Q08), it is to be expected that the

normalisation and subsequent recovery thereof still places more emphasis on the

driving effect of total wealth on family consumption.

From this point forward, our projections give continuity to the debt reduction process of households although, and just as in the case of companies, at a more contained rate. In 2014 and 2015, net debt transactions could be negative amounting to 20 billion euros per year. In this regard, the distribution of the debt by

segments of household income is key. The recent context of interest rates reaching

record lows reduces the incentives for households without income restrictions to

repay their debt at a quicker rate; accordingly, it is difficult for the improvement in

income expectations to be focused on the lower income percentiles that bear a

greater financial burden. The combination of both effects, together with the incipient

increase in consumer expenditure, should slowdown the debt containment process.

Source: Afi, Bank of Spain Source: Afi, Bank of Spain

3Q13: latest available data

Graph 16: Debt of Spanish households (as a % of their gross available income)

Graph 17: Savings and housing investment of Spanish households (as a % of GDP)

80%

90%

130%

100%

120%

140%

110%

04 120806 1005 0907 1311

Gross savings (available income less consumption) Housing investment

m05

m03

m09

m07

m11

m06

m04

m10

m13

m08

m12s0

5

s03

s09

s07

s11

s06

s04

s10

s08

s12

s13

4%

5%

9%

8%

7%

6%

13%

12%

11%

10%

34

Adjustments to the real estate market are nearing their end

Data on activity allows the surplus supply that existed to be adjusted

After five years of adjustments to the sector, current activity levels indicate an

increase in supply of 35,000 homes/year, a levelmuch lower than the annual

demand for new housing of around 148,000 homes, which would indicate that

the margin for an additional reduction would be very scant. In fact, this situation

is already giving rise to an increase in approvals in those provinces where demand

is recovering even more. As seen in the first section, the weight of this sector in

the economy was significantly reduced, whereby it went from representing 12.5%

of GDP in 2006 to 4.4% in 2013, which limits its additional negative contributions.

To put the situation into perspective, this ratio is much less that the historical

average in Spain (8%) and only slightly less than the current ratio of the European

Union as a whole (4.6%).

The new housing stock for sale has been gradually reduced at an increasing

rate since 2009 and, according to data from the Ministry of Public Works,

stood around 580,000 in 2012. Based on the rate of activity, the reduction will

be more intense over the coming years, boosted by a progressive recovery in

demand.


Source: Ministry of Public Works and National Secretariat of Nutrition and Food Safety (SESAN)

Graph 18. Spain: New housing stock for sale (units)

125,000

0

250,000

375,000

625,000

750,000

500,000

04 120806 1005 130907

14 (e

)

15 (e

)

11

35

Increasing demand of non-residents and investors

Despite the tax changes that have conditioned the underlying housing

demand, the trend of this demand in the future is conditioned by the type of

buyer:

• Residents:despitethefactthatitshouldbeimprovinginlinewiththe

economic situation, principal housing demand will continue to be

weak. Social demographic trends, contained margin for improvement

in available income and more demanding financial and tax conditions

will be the main hindering factors. However, the reduction in the

uncertainties and the improvement seen in the confidence of families

is expected to begin to reflect a gradual improvement in normal

housing demand.

• Foreign residents and non-residents: the purchases show a clear

acceleration with growth rates of 12% in 2013, representing 16% of

the total transactions. Purchases were above 40% in the main tourist

provinces along the Mediterranean coast and the Canary Islands.

• Investors: the large share that investors have in residential and

non-residential purchases shows that the price adjustment

expectations have begun to no longer be a factor limiting demand.

The growing development of real estate investment companies and

the inflow of foreign funds in the market will allow the investor base to

expand in the sector and will give rise to greater professionalization for

segments such as the rental one. Although at first glance the interest

seems to focus more on other areas of the market –offices and retail–,

there are also significant transactions in the residential sector due in

part to the impression that most of the price adjustments have already

taken place. Three real estate investment companies are currently

listed, the SAREB has carried out a dozen transactions with wholesale

investors and important financial institutions have outsourced the

management of the real estate portfolio, which gives depth to players

of this type.

36

Price adjustments nearing their end but with differences between provinces

The price of housing decreased by 38% in real terms from its maximum values, a percentage greater than the overstatement estimates given by various studies. Throughout 2013 there was a change in the rate of reduction to 4.2% compared

to the 9.7% decline of 2012. The changes in the prices reflect the trends seen in

demand, with more moderate adjustments and even increases in the provinces

where foreign demand has greater weight and in those that attract greater

investment.

Although a swift recovery of the real estate market is not to be expected over

the next two years, the record lows, both in housing starts and in demand, are

expected to be left behind in 2013 in terms of flows, which will be reflected by

the levelling off of the general drop in prices during this year and stability in 2015.

The banking sector has already carried out an in-depth restructuring

The reform of the financial system was a fundamental element in ending the crisis. The actions taken have driven the stabilisation of the sector by means of:

• Asharpincreaseoftheprovisions,sincefromthebeginningofthecrisis,

the sector provided provisions equal to 25% of GDP,


Source: Ministry of Public Works and Bank of Spain

Graph 19: Spain: Housing price (year-on-year % of change and 1Q08 (max) = 100)

-15% 30

-10% 40

1 0% 80

5% 70

-5% 50

25% 110

20% 100

15% 90

0% 60

Mar-96 Mar-08Mar-02Mar-99 Mar-11Mar-05

Annual change Level (1Q08 = 100) (right scale)

37

• A46%reductioninexposuretotherealestatesector,withouttakinginto

account the provisions,

• Theperformanceofastrictstresstestthat identifiedvulnerableentities

(30% of the sector) and their capital needs, thereby dispelling any doubts

as to the solvency of the rest of the sector and carrying out a series of

actions amounting to almost 100 billion euros,

• The necessary recapitalisation of entities with public money and the

segregation of assets to the SAREB, for almost 51 billion euros, which

represented a 52% deterioration and a transfer of 200 thousand assets

(including real estate assets and loans to developers),

• Theapprovalofseveralreforms,includingthegovernanceofthesavings

bank sector and the introduction of improvements regarding the

supervision and acting capacity of the Bank of Spain.

The restructuring and recapitalisation of entities, and the compliance of all

milestones agreed upon with European authorities has led to the definitive end of the financial assistance programme in January 2014. This has allowed

Spanish banks to recover their solvency and to access financial markets, thereby

reducing the need to resort to assistance from the European Central Bank. These

improvements are seen clearly in:

• Thechangesinthecapitalisationof listedentities inrelationtotheirbook

value, which went from levels of 0.5 in mid-2012 to amply standing at above

1 at the end of 2013.

• Thesolvencyofthesectorhasincreasedconsiderably,asshownbythecore

tier 1 ratio which stood at 11% (see graph 20).

Graph 20: Core tier 1 in Spanish banks (as a % of risk weighted assets)

Dec-06 Dec-07 Dec-08 Dec-11Dec-09 Dec-12Dec-10 Jun-13

7%

9%

8%

10%

11%

38

Lastly, there was a sharp adjustment to installed capacity with a 27% reduction

in the number of offices between 2008-2013, until reaching the levels at the end

of the 1980s, and major cutbacks to workforces of around 20% during this period,

not to mention the significant consolidation of the number of entities from

45 savings banks in 2007 to the current figure of 9 commercial banks and two

much smaller savings banks.

The latest bank survey indicators disclose several events that confirm not only the

return to normalcy, but also a slow and gradual recovery of bank lending: • Theriskfactors(eitheroftheeconomyasawhole,orthecompanyitself )

are no longer an unfavourable factor in the supply of credit,

• Demandforcredithasincreasedforthefirsttimeinthreeyears,

• The fragmentation of bank lending is gradually being resolved, as

evidenced by the expected improvement in SMEs in Spain in accessing

credit. The tightening that took place in country risk would also be

expected to be transferred to bank loan rates which, together with

other initiatives (ECB, Alternative Fixed-Income Market) that temper the

problem, also lead to greater optimism.

Source: Bank of Spain

Graph 21: Spain: Operating branches (thousands)


1985 1990 1995 20102000 2005 Dec-1320

30

25

35

40

45

39

The next steps for the sector must be based on four pillars:

• Future capacity to obtain profitability is in line with the cost of capital

currently required by the market. Despite the fact that the banking

system is no longer posting negative figures, mainly as a result of the

decrease in provisions and unproductive assets, the low turnover and the

extraordinarily low interest rates make it extremely difficult to generate

profit, thereby maintaining the pressure on entities to achieve efficiency

gains.

• Topasstheasset quality tests and the stress test to be carried out by the

European Banking Authorities in 2014. Although we do not have all the

details, no significant impact on the Spanish financial system is expected.

After having passed an exhaustive exam regarding the lending portfolio

in 2012, entities were restored and recapitalised, which generated greater

cushions to absorb adverse scenarios.

• Withdrawal from the public sector of the entities involved, with

advances such as the sale of NovaGalicia or the 7.5% in Bankia and the

asset management of the SAREB where, after the start-up, asset sale

transactions had already begun to be carried out.

• Expand the financing possibilities by developing and consolidating

alternative mechanisms such as the Alternative Fixed Income Market or

through purchasing senior tranches of asset backed securities.

In summary, following the restructuring carried out and the process of

strengthening its balance sheets, the banking sector is prepared to accompany the economy in its recovery and to compete in the eurozone retail market that is being created. In addition, the diminishing regulatory uncertainties, the

reduction in the financial fragmentation associated with the banking union and

the pressure to generate profitable assets have once again made lending activities

the focus point for entities, which can already incipiently be seen in the lending

conditions and in financing flows.

40

The process of transforming the Spanish economy must be continued4There is room to increase the degree of economic openness

The transformation of the Spanish economy is apparent in the reduction of the weight of industries related to construction activities and an increase in those engaged in the production of goods and services sold abroad. With

regard to demand, the weight of investment in construction in relation to GDP

dropped from 22% in 2007 to 10% in 2013, whereas exports of goods and services

increased its share from 27% to 35% during that same period. With regard to

supply, although the export industries are not easily identifiable in the Spanish

accounts classification, since they are distributed among all production sectors,

the whole of the transport, trade and tourism related sectors increased its weight

in GDP from 21% to 24%. Since 2009 the industry has shown a trend to increase

its weight in GDP (from 15.5% to 17.5%).

Accordingly, the fact that in this economic cycle the Spanish recovering starts

with high levels of external debt enables it to maintain a foreign trade surplus as a

necessary condition (although not sufficient) in order for the period of economic

growth to be long lasting. In other words, the growth pattern must generate the capacity for external financing, even during years of expansion, unlike

what is normally the case in our economy, such that foreign debt consolidates a downward trend, which may represent a reduction of around 50 billion euros

over the next quarters until the end of 2015.

Source: Spanish National Institute of Statistics (INE) and Banco Santander

Graph 22: Weight of exports and imports on GDP (%)

Exports Imports

20

35

30

25

45

40

Feb-07 Feb-15

Projections

Feb-11Feb-09 Feb-13

41

The intense process of recovering competitiveness that began in 2008 will

continue over the coming years based on two variables: cost control and

improvement in the productivity of the economy, which will allow, among other

things, a progressive increase in the weight of exports on the GDP until reaching

40% of GDP (see graph 22).

Unit labour cost containment is key...

The reduction in unit labour costs (ULC) with regard to our competitors recorded

since 2008 has been one of the main elements on which the change in production

of the Spanish economy has been based, with a cumulative drop of 8% since its peak.

Between 2008-2009 this improvement was based on the increase in productivity per

employee as a result of the drop in employment; as of 2010 the reduction in ULCs

was due to an increase in productivity (which accumulated and increased of 13%)

and the containment of salary increases. The aforementioned shows that the ULCs

of Spain compared to the EU are currently around the same levels as when the euro

was adopted in 2000, while compared to broader groups of competing countries

they are at somewhat higher levels, similar to those of 2004 (see graph 23).

There is a certain consensus with regard to the fact that over the coming years the

reduction in our ULCs will continue with regard to competitors, although its origin

will be slightly different from that of recent years: as we enter into a period of

Source: Bank of Spain

Graph 23: Competitiveness indices relative ULCs, 1999 = 100

Compared to the eurozone Compared to EU28 Compared to developed countries

95

125

115

105

145

135

Mar-99 Mar-11Mar-05Mar-02 Mar-08

42

employment creation, the increase in productivity is expected to slow down and the improvements in competitiveness will come almost exclusively from internal cost containment.

In this respect, European Commission projections (see graphs 24 and 25) consider

that the competitive edge of the Spanish economy will be extended in 2014 and

2015, exclusively as a result of the containment of salary increases, since growth

in productivity in Spain is expected to be positive, although slightly less than that

recognised compared to our competitors.

Our outlook, however, is more positive. With regard to costs, we are confident

that salaries growth rate will be in line with the increases in productivity and the

labour market situation. Accordingly, the containment of business margins is also

expected to contribute to improving the competitiveness of the Spanish economy,

since certain resources are highly underused (high output gap), the recovery of

consumption in this economic cycle will be moderate and the structural reforms

intended to improve operations of the markets (increasing competition) will produce

results.

We are therefore confident that the improvement in productivity of the economy,

resulting from the change in the production model and the structural reforms,

exceeds the expectations of international organisations and, in general, that expected

by the consensus forecasts.

4. The process of transforming the Spanish economy must be continued

Source: “European economic forecasts. Winter 2014”. European Commission Source: “European economic forecasts. Winter 2014”. European Commission

Graph 24: Nominal unit labour costs: Spain vs. industrialised countries (average annual growth)

Graph 25: Spain: breakdown of ULC growth (average annual growth)

2008-2009 2010-2013 2014-2015

5.5

-1.8-2.5

0.6 0.6

-0.8

2008-2009 2010-2013 2014-2015

3.7 4.0

1.0 1.0

-1.9

-0.2

Spain Industrialised countries Productivity (- sign) Compensation per employee

43

... as well as increasing productivity for sustainable recovery

The improvement in productivity is a fundamental element in order for the Spanish economy to be able to extend the economic recovery that began in the second half of 2013 and, above all, in order to be able to increase its potential growth as it overcomes the effects of the crisis. The OECD estimates

that the potential growth of the Spanish economy will be 1.3% in 2015, up from

the average 0.9% in 2008-13. The Bank of Spain estimates that over a longer

period of time this potential growth could reach almost 2%12. Recovering the

rates similar to those of the pre-crisis period (around 3% in 2000-2007) could

face two types of obstacles:

• Itispossiblethattherewasapermanentincreaseinpost-crisisfinancing

costs. This could lead to lower growth investment rates compared to

pre-crisis period.

• Thepossibleadversechangeinactivitygrowthrates.

However, there is one factor in our favour to enable potential growth to increase

which must be taken advantage of as much as possible: the application of structural reforms intended to improve the operations of the markets, in

particular the job market, and drive changes in production models:

• Reduction of the NAIRU (non-accelerating inflation rate of unemployment)

over the coming years, as a result of the impact of the labour reform and

other measures implemented by the government. Given that none of the

NAIRU estimates made by official bodies take into consideration these

impacts13, there is room for an additional reduction in the NAIRU and,

therefore, an increase in GDP growth beyond that considered by such

official Institutions.

12 Hernández de Cos, P., Mario Izquierdo and Alberto Urtasun (2011). “An estimate of the potential growth of the Spanish economy”, Occa-sional papers N 1104, Bank of Spain.

13 The European Commission has been particularly pessimistic in its NAIRU estimates for Spain, indicating higher figures that those given by the IMF, the OECD, the Bank of Spain or the Ministry of Economy, which implies a lower potential GDP estimate and a more narrow output gap, which would entail greater risk of inflation as the expansion cycle progresses. However, the estimation method of the European Commission has been greatly criticised, since it assumes static expectations on wage formation, which give rise to a highly pro-cyclical NAIRU estimate. Whereas other bodies introduce dynamic expectations, which better take into account the change that has taken place in wage formation in Spain.

44

• An increase in productivity by changing the economic model. If we

analyse the sources of GDP growth, with regard to the supply side in the

2008-2013 period (table 3), we find that there was a sharp drop in the use

of the labour factor behind the economic recession as well as a slowdown

in the accumulation of capital in comparison with the 1996-2007 expansive

period. Despite this fact, the capital factor continued to contribute positively

to GDP growth (0.6pp of the annual average), even slightly higher than that

posted in the European Union or in the euro area (0.4pp).

• The most notable is that the total factor productivity (TFP)14, which

performed quite unfavourably in the 1996-2007 expansion period, has now

positively contributed to GDP growth, performing better than that recorded

in the European Union or in the eurozone.

• In the future, the capital/employment ratio is expected to have a less

dynamic behaviour, since although the investment process will be revived,

this will be carried out by creating employment. However the increase in TFP

may be consolidated, which will determine that the growth in productivity

of the Spanish economy is greater than the European Union average.


14 The endogenous component of productivity which is not explained by the accumulation of labour and capital production factors.

Table 3: Factors explaining GDP growth (contributions)2008-2013 period, annual

Spain UE27 EUR18

GDP -0.6 0.1 0.0 PFT 0.5 -0.2 -0.1 Employment -1.7 -0.1 -0.3

Capital 0.6 0.4 0.4

Table 4: Factors explaining the growth in productivity (contributions)2008-2013 period, annual averages.

Spain UE27 EUR18Apparent productivity of employment 2.1 0.3 0.5 FT 0.5 -0.2 -0.1

Capital intensity (capital/employment) 1.6 0.5 0.6

Source: European Commission and Banco SantanderEUR18 = eurozone

Source: European Commission and Banco Santander

45

Therefore, on one hand we have a labour reform that introduces structural changes

giving rise to increases in employment flexibility and permanent efficiency earnings

and a production model for the changing Spanish economy, which should make

compatible employment creation and an increase in productivity. However, on

the other hand, a significant number of unemployed persons with productivity

levels that are lower than those currently working need to be absorbed, which

could result in a obstacle to TFP. To consolidate this increase in TFP, investment in human capital and R&D, and the structural reforms mentioned below must continue to be supported.

The value of education and human capital in the labour market

Recent history with regard to human capital evolution in Spain has proved to be successful. In analysing the series offered by the Valencian Institute of Economic

Research (IVIE)15, a significant improvement can be seen in the level of education

for Spaniards over the last 50 years:

• In1964,12%ofthepopulationover16yearsofagewasilliterateand82%

had at most a primary level of education. 4% of the population completed

secondary education and only 2% went on to university.

• In 2013, the illiterate population wasminimal (2% of the working-age

population and 0.3% of the active population). Those with higher

education made up 18% of the working-age population and 29% of the

population currently working.

In relation to the job market, the level of education positively influences entry to the labour market, whereby in Spain it is profitable to get an education: • Laborforceparticipationrateofuniversitygraduatesis33pointshigher

than for those that have only completed mandatory education.

• Populationfrom25to64yearsoldwithahigherlevelofeducationhave

a greater employment rate and higher salary level, which is true for Spain

as well as the OECD and the EU21. In 2011, 80% of those people that

completed higher education in Spain were incorporated into the labour

market, whereas the population with secondary education or less reached

an employment rate of 25%.

15 No. 144 Human Capital, IVIE and Bancaja.

46

• Similarly, the role of education as a factor protecting against

unemployment was reinforced during the crisis, since employees with

higher education had lower unemployment rates not exceeding the

rates reached prior to the crisis (13.9% in 2013 vs. 16.4% in 1995) as

shown in graph 26.

• Withregardtothatmentionedabove,havinghighereducationstudies

in Spain means reducing the probability of unemployment over the

long term by 70% compared to workers with only primary education,

and by almost 40% compared to those that only completed secondary

education.

• Lastly, salaries are clearly conditional upon an employee’s training. In

Spain16 the average salary of a university graduate is 41% higher than

that of someone who only completed secondary education and 63%

higher than someone with only primary education.

Other indicators that show the clear transformation of the Spanish economy

through improvement of its human capital is the change undergone in the structure

of the production industry and, subsequently, in employment, towards sectors with

greater productivity (see graphs 27 and 28). The weight of the services sector on

employment from 1980 to 2013 increased from 45% to 76% and from 54% to 72%

in the case of GVA (gross value added). Lastly, it should be noted that there is a two-

way relationship between human capital and the production structure: advances in education enable the transformation of the production structure and vice versa, a change in production structure requires human capital with greater training.


16 Education outlook, OECD (2001).

Source: INE

Graph 26: Spain: Unemployment rate by education level (%)

Illiterate Uneducated and primary education Mandatory studies University studies

0

40

30

10

20

60

50

1964

1984

1972

1992

1978

1998

1968

1988

1976

1996

1982

2002

2010

2004

2012

2006

1966

1986

1974

1994

1980

2000

2008

1970

1990

50%

40%

29%

14%

47

The main reforms initiated must be consolidated

In recent years, the government has initiated an in-depth programme of structural reforms, the positive impact of which is already reflected in the

signs of recovery of the Spanish economy. Those reforms related to the

pension system, the financial sector, the labour market and controlling and

reducing public expenditure are particularly worthy of note. In recent months,

these reforms have been backed by the main international bodies such as the

OECD, the International Monetary Fund and the European Commission, which

recently removed Spain from the list of countries with excessive imbalances.

According to the 2013 Going for Growth report issued by the OECD, Spain holds first place in terms of reform momentum among the five largest

European economies. This progress was also recognised by the three main

ratingagencies,Standard&Poor’s,Moody’sandFitch,whichimprovedtheir

outlook for Spain.

All this is giving rise to a fundamental change in the Spanish economic model

with significant improvements in competitiveness and productivity and a greater

weight of innovation, technology and knowledge. However, it is essential not to fall into complacency and to continue moving forward with the structural reforms for the purpose of increasing the potential growth of the economy and promoting job creation, which is a top priority for Spain.

Source: INE Source: INE

Graph 27: GVA (gross value added) by line of business 1980 vs. 2013 (%)

Graph 28: Spain: Employment by line of business 1980 vs. 2013 (%)

Services Industry Construction Agriculture Services Industry Construction Agriculture

1980 2013

54.0 72.1

30.3

17.58.3 7.8

1980 2013

44.975.6

27.2

13.59.3

18.6 6.04.9

48

Firstly, we consider consolidating the progress made through the reform

of public administrations, the labour reform and the restructuring of the financial system to be of key importance. Secondly, it is essential to continue

with the improvements in the economy’s competitiveness, and focus on the

industrial rebirth and a model based on innovation and knowledge. Lastly,

the tax system should be focused towards a system that is more favourable to

growth and the job creation.

Reform of public administrations: in search of efficiency in processes

In June 2013 the report of the Expert Commission for the Reform of Public

Administrations (CORA) was submitted. The package of measures intends to

incorporate management criteria in the public administrations that have been

carried out in companies now for some time, for the purpose of increasing our

public services at a lesser cost, in other words “to do more for less”.

The set of actions that are already in place will allow duplicities to be eliminated, processes to be simplified, the market unit to be guaranteed and the institutional structure to be alleviated. The various measures presented include

the establishment of a zero-based budget for all public administrations; centralized

purchases systems; an electronic invoice system that uses information technologies

to reduce processing and filing costs; a single window for license and authorisation

management; or the streamlining of payments to suppliers by announcing the

average payment period of the various public administrations. At the end of 1Q14,

in accordance with the public administration figures, almost 30% of the measures

related to CORA were carried out and this figure is expected to reach 50% at the

end of this year.

All of this must be reflected in the consolidation of public finances in order

to be able to comply with the deficit objectives, which is key to guaranteeing

the long-term sustainability of our growth model. In this regard, we estimate

that the adjustment to the primary balance must be between 3% and 5% of GDP. In the event the government’s restructuring and rationalisation measures

are not sufficient, supplementary actions may be adopted such as a plan to

strengthen the struggle against tax fraud or an asset management plan for

assets and privatisations.


49

Labour Reform: simplification and greater flexibility

Employment creation is without a doubt the top priority of economic policy. In

this regard, the labour reform of 2012 has begun to see results, with a decrease in

unemployment of almost 150,000 people in 2013, the first reduction since 2006,

and a net creation of employment starting in 3Q13. The reform should therefore

be positively valued since it has allowed for labour flexibility and facilitated job

creation. According to the valuation carried out by the OECD, this has meant

increasing the probability of transitioning from unemployment to employment

(both very short-term temporary and medium- and long-term permanent work).

However, certain adjustments must still be carried out in order to implement the

basic principles of the reform:

• Simplify the number of employment contracts, thereby reducing the

labour market dualism and the large differences in protection between

temporary and permanent contracts.

• Encouragethesearchforjobpositionsthroughactive and well-managed employment policies, especially for unskilled members of the labour force.

• Reduce tax costs of the labour factor which continue to be above the

OECD average17.

Fiscal reform focused on growth and employment creation

The full fiscal reform implemented in March 2014 as the result of the report of the

expert commission intends to design a simple, sufficient and growth-oriented tax system that protects social development and reduces the negative effects on

the market unit.

The proposal is structured into two phases. The first phase, starting in 2015, intends

to reduce direct taxation by reducing personal income tax withholding rates and

corporate income tax rates, which are offset through the elimination of tax credits,

tax relief and tax exemptions, thereby maintaining tax revenue around 37%-38% of

GDP. This reform is expected to stimulate growth, with an estimated positive impact

in three years of 0.3% on GDP and 0.2% on employment. Subsequently, a fiscal

devaluation would then be carried out starting in 2016, which would consist of

reducing contributions (-3pp) to create employment, which would be offset by an

increase in VAT. As a result, employment and GDP are expected to increase by 0.7%.

17 Going for Growth, 2013.

50

The CEC considers that the reform is generally headed in the right direction,

intending to improve the competitiveness of the corporate sectors and promoting

economic growth. It is therefore logical to implement a tax system that stimulates

the fundamentals (employment and savings) and mitigates or moderates existing

mismatches (effective taxation of consumption or environmental policy). With

regard to personal income tax, we agree that this tax figure should be simplified, reducing the number of brackets and the marginal rates of the progressive scale, and improving the taxation on income from savings. With regard to

wealth and inheritance taxes, we agree with the proposal to reduce these taxes,

and even consider that one of them should be eliminated, since personal income

taxes already fulfil the function of redistributing wealth and these taxes represent

double taxation. It is important not to lose sight of the overall tax effect of taxing

stock with regard to taxing income.

With regard to corporate income tax, we consider that the reduction in nominal rates

will have a positive effect on growth and the creation of employment, as has been

indicated by the European Union, the OECD and the IMF. However, the reduction in

tax rates must be accompanied by a procedure such as that proposed by the expert

commission, which allows the negative accounting impact of recognising deferred tax

(assets and liabilities) at a new tax rate to be eliminated. In addition, the tax must have

an effect on the companies’ true profits and, therefore, all expenses necessary to obtain

such income must be allowed to be deducted, whereby the taxable profit approaches the accounting profit as much as possible. In order to facilitate the transition to a

new growth cycle, companies must be allowed to recover their investments through

adequate amortisation regimes and the provisions must be deductible. The rules

limiting the deductibility of finance costs should not be detrimental to the natural

form of financing of certain activity sectors or investment projects. It is also important

to avoid international double taxation, thereby maintaining or improving the current

mechanisms to avoid such double taxation and extend the period applicable for

outstanding tax credits to at least five years or much it to the period for offsetting tax

loss carryforwards. Measures should also be implemented to allow Spanish companies

to regain internationalisation and to continue providing incentives for key activities to

modernisethebusinessfabricsuchasR&D.

Lastly, with regard to discretional taxation imposed by the regions, we agree that

certain taxes that have scant collection capabilities should be eliminated in order

to maintain the market unit and avoid the same taxable events from being taxed

by different bodies.


51

Progress in reforms yet to be implemented

Reinforce the commitment to innovation, new technologies and digital economy

As seen previously, the growth in exports arose, to a large extent, from

refocusing the economic structure which has evolved from a very labour

intensive and low value added model to activity sectors driven by innovative and knowledge-based companies. The development and implementation of

ICTs and the growing university population were key factors in this change in the economic model caused by the crisis.

However,despitehavingdoubledoverthelast15years,R&Dexpenditurewas

1.3% of GDP compared to the European Union average of 2%, thereby resulting

in, for example, a lower number of patents per habitant compared to other

European countries or lower efficiency of the technological parks implemented

in Spain. For example, according to the innovation ranking developed by the

European Union, Spain is below average in the group of countries known as

“moderate innovators”. Although international competitiveness and the ability

of companies to bring their innovations to the market are our main strengthens,

the challenges of corporate investment in innovation and the capacity for innovation of SMEs must be addressed.

Therefore, the first step should be focused on increasing investment in

advanced machinery and capital goods, software and hardware, and the

capacity for innovation of SMEs. With regard to the latter, it is essential that

these businesses reach a certain size, beyond which they begin to expand

internationally and enter a virtuous circle of innovation and competitiveness.

A successful path of action on an international level is that of promoting

public-private collaboration aimed at encouraging SMEs to develop their own

innovation activities and to engage in Company-University collaboration aimed

at developing and implementing new products and processes.

It is necessary to continue moving forward in the digital economy, which is a

key factor in maintaining our competitive position. Factors such as bandwidth

and connectivity to the Internet have an important multiplying effect on the

productivity of the economy18. Therefore, governance of the Internet linked

to the new global context will be key for confidence, accessibility and digital

52

transparency. Similarly, greater competition from an environment open to

innovation and greater interoperability between applications and services will

be fundamental.

Lastly, the massive adoption of ICT will require an intelligent regulatory

framework based on policies focused on results, with a case-by-case supervision

and the appropriate framework for data protection and the free circulation of

informationwithin the EuropeanUnion.Optimal investment inR&D requires

clear public action in order for external factors to be reduced, both through the

compliance of property rights and information mismatches between investors.

Energy policy focused on improving competitiveness and the industrial rebirth

The energy sector is a key element for economic growth and employment

creation, both as a result of its importance on the competitiveness of the industrial

fabric, guaranteeing safe supply and quality, and as a result of the pulling effect of

its investments and purchases.

In recent years, electricity invoices in Spain and in Europe have become more

expensive due to costs not included in the generation of energy and its distribution

through the electricity grids. In Spain, the costs not related to the supply and

that relate to regional, environmental, social, industrial and tax policies represent

over 50% of the price of energy for the consumer, whereas in the United States

they are less than 10%. Consequently, residential electricity invoices in Spain are

2.5 times higher than those of the United States.


18 By way of example, according to the International Data Corporation, companies that use cloud computing are able to reduce computer costs by between 10% and 20%.

53

Therefore, the costs not related to what it costs to generate and distribute the energy should be eliminated, and the tax policy should be revised, which is

what certain countries such as the United Kingdom, Belgium or Italy have been

doing. In addition, as in the case of the financial sector, a common European policy that reconciles the sustainability and competitiveness objectives is needed,

along with more interconnections to allow a single European market to be

formed. Lastly, it is essential to create a single regulator that promotes a stable, predictable, transparent and harmonic framework that guarantees investments

and does not encourage inefficient and socially unjust models.

Accordingly, the successive accumulation of tariff shortfalls in Spain gave rise to

a debt of around 30,000 million euros, with a high debt service cost that is being

borne by electricity consumers. The solution should be found in line with the

measures taken regarding the banking recapitalisation process, in other words,

to seek financing with low interest rates and long-term repayment. In essence,

the problem is the same, the decapitalisation of the sector as a whole which

endangers the economic sustainability of the system.

In short, a sustainable energy framework, with greater regulatory clarity, more Europe, more market and more long-term stability is needed. All in order to

guarantee quality supply that is respectful to the environment, rewards energy

efficiency and the balanced development of efficient renewable technologies,

and facilities the industrial rebirth of the continent.

Towards a high-quality and stable education system focused on current and future world challenges

The education system is a key element for a country’s long-term competitiveness

and must respond to the world’s current challenges and needs. In this regard,

the government’s recent education reform seems well focused on continuing to reinforce the average level of education and professional training, key factors

for the development of the production system. Greater specialisation of students

and technical training, the entry of concepts such as creativity in training,

offering students 14 years old and up the possibility of choosing programmes,

and moving the age forward at which professional training can be accessed are

some of the measures necessary. Greater system standardisation and quality by

implementing level tests with certain regularity and granting aid based on criteria

of excellence are also necessary.

54


As a starting point, our education system has positive elements which we

must value and take into account when carrying out incremental continuous

improvement. For example:

• We are the fourth country in Europe in terms of employees with

higher level education in technical/scientific professions, with 40% of

the population between 30 and 34 years old with university training,

compared to less than 32% in Germany.

• The Shanghai ranking19, which classifies the top 500 universities

worldwide, includes four Spanish universities between positions 200 and

300, and ten universities are among the top 500 worldwide. Although

there is no Spanish university included among the top 100 or 200 in

the world, 20% of Spanish public universities are included in the top 3%

worldwide. Among the Top 200 in specific disciplines, Spain ranks 50th

in maths, 96th in physics, 74th in chemistry, 94th in IT and, lastly, 146th in

business and economics.

• WeplayaleadingroleinEuropeintermsofbusinessschools.

However, there is significant room for improvement in our education system, and

we need to reassess the focus of training employees for the future. Quantitative aspects (financing, selection, follow-up) and qualitative aspects (excellence, effort, meritocracy, exemplariness and best practices) must also guide this transformation. The most urgent challenges of our system include the following:

• Thehigh level of school dropout in secondary education and professional

training or academic failure. We cannot tolerate a 25% school dropout

rate, which is double that of the European Union,

• The need to increase the high school and professional training graduation rate. The second stage of secondary education has become

a very important piece in a market where specific knowledge, abilities

and competencies necessary in the world labour market are increasingly

sophisticated and require the ability to respond to uncertainties and

changing economic demands. In Spain, despite the fact that the

graduation rate in the second stage of secondary education (88% of the

typical graduating population) stood above the OECD average (83%) and

19 Academic Ranking of World Universities 2013 (ARWU).

55

the EU21 average (83%), the number of graduates in this educational

stage should continue to grow, since there is a large shortage in relation

to the adult population. The labour market requires an efficient and

attractive system for professional training at all levels which balances job

market that is very much in need of qualified professionals.

• The need to train employees currently working at companies.

Continuous training of entrepreneurs and professionals, which is being

left behind, needs to be promoted so that they are able to adapt to

changing processes and demands. The intensive use of temporary

workers in the Spanish economy, due to a labour cost structure where

temporary contracts were more advantageous than having permanent

employees, has had a damaging effect on the quality of the workforce. It

is to be expected that the labour reform, the main objective of which is to

end this duality of permanent and temporary employees, allows for the

return of investment in training within the company while at the same

time retaining talent.

• Bring the university closer to the company and to the current needs

of the job market. Given the high level of university graduates in Spain,

greater emphasis should be placed on professionalising the university

and orienting the university system to satisfy the market’s demands of

the 21st century.

• Lastly, it is essential to promote a long-term and stable view of our

education model. According to experts, the results of an education

policy begin to show after a period of at least ten years. However,

in recent decades Spain has undergone continuous changes in its

education system, adopting significant reforms over an average period

of five years.

In short, our education system needs to be refocused towards new training niches

that allow us to move to a production model that is actually based on growth,

and in which innovation is the cornerstone that differentiates our professionals

due to their ability to create added value.

Pl. Independencia, 8 - 4º28001 MADRID - Spain

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