Pre-Crisis Growth Levels Unlikely

BMI View: Spain's recovery will gather steam in 2014 and 2015, with exports remaining strong due to improving competitiveness. Consumer spending will also support growth, but a lack of progress on deleveraging will ensure that household incomes remain under pressure.

The worst is now over for Spain's economy, reflected by the country registering its second successive quarter of economic growth in Q214 ( see chart below). We expect the recovery to pick up pace over the coming quarters, and forecast real GDP growth of 1.3% in 2014 and 1.7% for 2015. Nevertheless, the unbalanced nature of the recovery will prevent growth from returning to pre-crisis levels.

We believe Spanish real GDP growth will remain overly-reliant on exports, while squeezed disposable incomes will prevent household spending from a full recovery. Declining unemployment (down from 26.0% in 2013 to 24.5% in Q214) is making investors overly complacent about the challenges still facing households. Youth unemployment remains above 55%, wage growth is stagnant and households have made a lack of progress on deleveraging. In our view, these factors imply the economic recovery remains unbalanced and is not yet built on firm foundations.

Recovery Gathering Steam
Spain - Real GDP Growth, % chg y-o-y

BMI View: Spain's recovery will gather steam in 2014 and 2015, with exports remaining strong due to improving competitiveness. Consumer spending will also support growth, but a lack of progress on deleveraging will ensure that household incomes remain under pressure.

The worst is now over for Spain's economy, reflected by the country registering its second successive quarter of economic growth in Q214 ( see chart below). We expect the recovery to pick up pace over the coming quarters, and forecast real GDP growth of 1.3% in 2014 and 1.7% for 2015. Nevertheless, the unbalanced nature of the recovery will prevent growth from returning to pre-crisis levels.

Recovery Gathering Steam
Spain - Real GDP Growth, % chg y-o-y

We believe Spanish real GDP growth will remain overly-reliant on exports, while squeezed disposable incomes will prevent household spending from a full recovery. Declining unemployment (down from 26.0% in 2013 to 24.5% in Q214) is making investors overly complacent about the challenges still facing households. Youth unemployment remains above 55%, wage growth is stagnant and households have made a lack of progress on deleveraging. In our view, these factors imply the economic recovery remains unbalanced and is not yet built on firm foundations.

Private Consumption: We forecast private consumption to contribute an average of 0.4 percentage points (pp) to growth in 2014 and 2015, weak by historical standards but an improvement on the negative contributions witnessed over the past few years. As discussed above, pressure on disposable incomes is unlikely to abate over the next few years, and is reflected by the savings ratio dropping from 10.4% in Q114 to 9.4% in Q214. That said, our outlook for households has improved somewhat in recent months. Lower inflation expectations suggest a modest boost to the real value of household disposable incomes. A recently announced tax overhaul should support this trend, with the top rate of income set to fall to 45% from 52% in 2015.

The corporate tax will be lowered to 25% from 30%, which should help attract business investment and employment in the service sector. Corporations have made more progress on deleveraging than households ( see chart below), with the corporate debt-to-income ratio falling as companies reduced their stock of debt amidst unfavourable economic conditions. We now expect business activity to increase in light of improving business confidence and reduced economic uncertainty. Reflecting this trend, Spain's services purchasing managers index (PMI) reading for July came in at 56.2 reflecting growing optimism that conditions for corporations will continue improving over the next few months.

Household Deleveraging Has Only Just Begun
Spain - Household and Corporate Debt-To-Income Ratio, %

Government Spending: Although our long-held view that the ruling People's Party (PP) administration would ease up on austerity in the run up to the parliamentary elections scheduled for 2015 looks to be playing out ( see 'Reform Momentum On Hold Until 2015, April 4), we do not believe government expenditure will contribute significantly to growth over the coming years. Aside from the aforementioned tax cuts planned for 2015, we expect wariness over the prospect of rising borrowing costs to prevent the government from completely abandoning fiscal prudence. A public debt load of over 90% of GDP and a fiscal deficit above 5.0% means the government has limited room to drive growth. Accordingly, we forecast government spending to subtract an average of 0.2pp from growth in 2014 and 2015.

Housing Sector Restricting Fixed Investment
Spain - Fixed Investment

Gross Fixed Capital Formation: Fixed investment will show only limited signs of recovery ( see chart above), restricted by a lack of government spending on infrastructure and the collapse in Spain's property bubble. Recovering house prices are unlikely to translate into more residential housing construction, with over 3mn home currently lying empty due to excessive construction in the years leading up to the financial crisis. The only bright spot for fixed investment is strong exports feeding through into higher capacity utilisation, which has risen to 75.8 in July from 69.8 at the beginning of the year. This implies some investment in productive assets over the coming quarters.

Exports Still The Main Growth Driver
Spain - Real GDP Contribution To Growth

Net Exports: Net exports will continue to be the main driver of growth over the next few years, but its contribution will begin to wane as recovering domestic demand boost imports. Collapsing demand during the economic crisis pushed the current account into surplus, aided by competitiveness gains in the export sector. Falling wages and structural reforms have increased labour market flexibility and made Spanish goods more attractive aboard, particularly compared to rival eurozone markets such as France and Italy. The eurozone recovery should ensure that external demand remains steady, and we forecast net exports to add an average of 1.3pp to growth in 2014 and 2015.

Taken together, our real GDP forecasts show that Spain's recovery will outperform the eurozone over the next few years ( see chart below), reflecting the progress the country has made tackling underlying structural issues. However, we believe Spain's economic recovery will remain tepid unless further reforms are implemented to improve labour market flexibility. The rhetoric from the ruling People's party (PP) implies that any further reforms are now unlikely, meaning that unemployment is likely to remain high and continue limiting consumption for some time to come.

Overtaking The Eurozone
Real GDP Growth, % Chg y-o-y
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