2017 Article IV Consultation with Spain

Source: IMF
Type of item: Recommendation / Analysis
Date: 13/10/2017

Strong, balanced, and employment-intensive expansion of the Spanish economy continued during the first half of 2017, and the recovery reached a significant milestone when real GDP surpassed its pre-crisis peak.

Past structural reforms, wage moderation and resulting cost competitiveness gains, favorable monetary and external conditions, and fiscal relaxation have provided impetus to the recovery.

Spain should deepen reforms, including steps to reduce structural unemployment, strengthen the business environment and competition, and make the financial sector more resilient along the lines of recommendations in the Financial Sector Stability Assessment (FSSA) (comprehensive and in-depth assessment of a country's financial sector).

 

Challenges remain: public debt and structural unemployment are high, population aging is creating fiscal pressures, and productivity lags that of EU peers.

This document includes the following recommendations in the corresponding reform areas

1. GROWTH AND COMPETITIVENESS

1.1 R+D and the knowledge society

- Innovation capacity could be enhanced by increasing the efficiency of public R&D, improving public-private cooperation, and enhancing private R&D investment.

- Low private research and development (R&D) investment and the limited ability of firms to innovate remain largely unaddressed.

- Improve access to non-bank financing for frontier innovation.

1.4 Education

- Reform of the education system is needed to enhance innovation

- Further actions to reduce high structural unemployment. Improvements in the quality of education and training which would also reduce the risk of poverty and exclusion among vulnerable groups.

- To be the most effective, active labor market policies should complement efforts to improve the quality of formal education and training. This would also help to address skills mismatches and to raise productivity. 

2. COMPETITION AND REGULATION

2.1 Competition enforcement

- Need to accelerate competition‑enhancing reforms to boost growth prospects

- Policies that keep the economy competitive are critical to sustain labor demand.

2.2 Regulation of product and service markets

- Further steps are needed to eliminate the remaining regulatory entry barriers and administrative burden from licensing requirements that are affecting competition and firm TFP growth particularly in sectors more exposed to regulation.

2.3 Red tape and business environment regulation

- Fully implement the Market Unity Law which establishes a single market in Spain by eliminating differential treatment of economic activity by the central, regional, and local authorities. The law aims at breaking down administrative barriers and fostering competition

- Foster firm growth. Minimize regulation-induced disincentives for firm growth. Tackling the remaining size-related rules and regulations, including on reporting, auditing, and labor regulation, could further stimulate firm growth and productivity.

- Address remaining deficiencies in the insolvency regime.

2.4 Professional services

- Jumpstarting the delayed liberalization of professional services would level the playing field, increase transparency, and lower costs in many currently protected professions. 

3. LABOUR MARKET

3.1 Labor market regulations

- Further efforts are also needed to reduce labor market segmentation, reflecting the still significant gap between the cost to firms of permanent and temporary workers.

- Authorities should take additional measures to improve the attractiveness of open-ended contracts for employers and to reduce administrative and legal obstacles that add to the cost of such contracts.

- Allow firms more flexibility over working. Set working conditions in line with firm- and sector-specific conditions are critical to sustain labor demand.

3.2 Active Labour Market policies

- To be the most effective, ALMPs should complement efforts to reduce labor market duality and improve the quality of formal education and training.

- ALMP policies are funded by a relatively low level of spending per person wanting work.

- Improve the effectiveness of active labor market policies (ALMP), for example through consolidation of hiring subsidies into better-targeted schemes (particularly for the low-skilled and long-term unemployed).

- Strengthening the Public Employment Services' capacity to offer individualized support; better targeting job measures, particularly demand-driven skills training, to increase the employability of low-skilled and long-term unemployed;

- Other ways to improve the cost-effective delivery of ALMPs would be much better-managed use of the EU's Youth Guarantee, refined collaboration with private job-placement agencies, and enhanced coordination between active and passive labor market policies.

- Conducting regular evaluations would likely improve the cost-effectiveness of existing ALMPs.

 


4. FINANCIAL SYSTEM

 4.1 Recapitalization and Restructuring

- The authorities should accelerate bank balance sheet cleanup, including through ambitious NPL reductions as it remains relatively high in few banks, weighing on their earnings.

- To address banks' remaining weaknesses and legacy issues, banks' property value assumptions should be carefully analyzed and supervisory actions applied to enhance progress.

- Lowering impaired assets, especially in banks that have lagged others in their adjustment process, deserves immediate attention.

- Banks need to continue improving profitability, building capital buffers, and adjusting funding positions to ensure their lending capacity to accommodate credit demand as it picks up over the medium run and to increase resiliency to shocks.

- Timely privatization of state-owned banks is also important

- Managing the performance of the asset management company (Sareb), is also important. It may need to accelerate asset sales at a higher discount to generate sufficient cash flows. Sareb's business plan, which appears to be based on unduly optimistic assumptions, should be regularly reviewed and adjusted, if needed, to ensure its consistency with the macrofinancial outlook and keep in check externalities to banks.

- Efforts to accelerate balance sheet cleanup should build on the European Central Bank (ECB)'s guidance on reducing NPLs, the application of revised domestic accounting rules on provisions (Bank of Spain Circular 4/2016), and a careful analysis of banks' property value assumptions. Supervisory actions should be applied to incentivize progress

- To structurally improve banks' profitability, there is a merit to exploring the scope for further consolidation through mergers, rationalization of business lines and branch networks, and diversification of earnings away from interest income.

4.2 Other financial measures

- Facilitate access to equity financing for innovative startups will be important to raise potential growth and competitiveness sustainably going forward. This places a premium on continued efforts to deepen market-based financing via alternative exchanges, venture capital, and securitization.

- Further improve access to finance for SMEs, especially for market-based financing to support frontier innovation.

- Address remaining deficiencies in the insolvency regime.

- For the insurance sector, additional efforts to improve matching of assets and liabilities are desirable.

- Building on the recent steps taken, a comprehensive reform of the credit cooperative sector is essential, particularly to strengthen corporate governance and improve resolvability. The latter is also important for smaller banks.

- The macroprudential toolkit should be expanded to strengthen the ability to deal with build‑up of systemic risks. Establishing a systemic risk council would augment the capacity for risk oversight, policy coordination and crisis prevention.

- The legal basis should be established for the use of for more effective macroprudential tools, including possibly limits on loan-to-value and debt service-to-income given the continued importance of real estate exposures on banks' balance sheets.

- The FSAP also recommends further enhancing the Anti-Money Laundering / Combating the Financing of Terrorism regime (AML/CFT), including by providing additional resources to the AML/CFT supervisor (SEPLAC).

- The Bank of Spain's role in safeguarding macrofinancial stability should be strengthened, including to lead systemic risk surveillance in support of the proposed Systemic Risk Council.


5. FISCAL POLICY AND PUBLIC ADMINISTRATION

 5.1 Economic Governance

- Enhance expenditure efficiency. Planned expenditure reviews, including for pharmaceutical spending and hiring subsidies, could raise the quality and efficiency of service provision, and should be expanded to other areas, such as education spending.

- Reform regional fiscal framework to improve regional compliance with fiscal targets by more automatic and stricter enforcement of targets and providing regions with greater power to mobilize their own revenues.

- All levels of government need to contribute to rebuilding fiscal buffers, which calls for implementing enforcement tools in the short run and enhancing the incentives and capacity for regional and other governments to build space over the medium term.

- Over the medium term, the regions' revenue-raising capacity should be enhanced to better match the greater degree of expenditure decentralization.

5.2 Fiscal consolidation and fiscal reform

- Room lies mostly on the revenue side, including gradually reducing the number of goods and services that qualify for reduced VAT rates (improve VAT collections).

- Reducing tax system inefficiencies. Many deductions, exemptions, and fiscal incentives still litter Spain's tax system, despite the 2014 tax reform. Broadening the tax base by removing these distortions.

- Raising environmental taxes. Harmonizing environmental taxes with those in other EU countries, particularly excises on unleaded petrol.

- Create the fiscal space to cushion future shocks, for example by relying more on indirect taxes.

- Regional financing framework. Priorities would be to enforce the existing fiscal framework, strengthen oversight institutions and procedures, reinforce conditionality, and step up monitoring under the regional liquidity mechanisms for non-compliant regions.

- The deficit in the contributory pension's balance requires offsets elsewhere to meet the fiscal targets.

6. WELFARE STATE

 6.1 Social Security and Pensions

- Implementing fully the 2011 and 2013 pension reform package will ensure the system's financial sustainability.

- More transparency about the current and future health of the pension system is critical to support future pensioners' retirement planning, especially since public pensions are not meant to provide all of one's retirement income. One possible approach to encourage supplementary savings would be automatic enrollment, with an option to opt out, in a government-administered savings plan that is portable across jobs.

- Encourage supplementary savings, while keeping in mind intra- and inter-generational equity.

- Linking pensions to life expectancy via the so-called sustainability factor (a discount applied to the first pension received by those that retire from 2019 onwards).

- Further extending the length of the contributory period required to obtain a full pension.

- Increasing the number of contributory years used to calculate the pension base. Lengthening the pensionable earnings reference period to the full contribution period.

- The contribution floor and ceilings could be raised faster than the maximum and minimum pensions.

6.2 Health system

- Enhance expenditure efficiency. Planned expenditure reviews, including for pharmaceutical spending.

6.3 Other welfare state reform

- To reduce high structural unemployment improvements in the quality of education and training which would also reduce the risk of poverty and exclusion among vulnerable groups.