Iberian Peninsula 2018

Spain and Portugal return to growth

Spain and Portugal were on the brink of collapse in 2012.

Painful austerity measures and deep structural reforms played a key role in spurring competitiveness in both nations, which were badly hit by the 2008 recession.

Two fundamental drivers that explain the recovery have been the notable rise in tourism arrivals, reaching year-on-year record levels, and the European Central Bank’s (ECB) aggressive monetary policy.

Spain received approximately 82 million foreign visitors in 2017, while smaller Portugal is expected to have hosted nearly 10 million tourists. This means that both countries are enjoying their seventh consecutive record years for tourism.

Meanwhile, the ECB quantitative easing program injected liquidity into the market by maintaining an ultra-low interest rate policy and purchasing corporate and government bonds.

This policy has boosted the economy of the continent as a whole, and has been extremely helpful in reducing interest rates for southern Europe countries’ 10-year government bonds.

Today, Moody’s is the only credit rating agency that still rates Portugal’s sovereign debt as “junk,” while interest rates for Spain’s 10-year bonds have waned considerably since 2012.

Current forecasts from the European Commission—outlined in its Autumn 2017 report—indicate that Spanish GDP growth will register at 3.1% for 2017 and 2.5% in 2018, while the Portuguese economy is estimated to grow by 2.6% and 2.1% for the same periods.

Compared to Spain’s -2.9% growth in 2012 and Portugal’s -4%, according to the World Bank, these figures show how much can change in five years.

Portugal, the anti-austerity success?

In October, unemployment fell to a 12-year monthly low in Portugal, hitting 8.4%, while exports are booming and tourist arrivals are on the rise.

But in order to achieve this miraculous recovery, the government has implemented a mix of austerity and anti-austerity measures in two separate periods.

First came the budget cuts.

Former Prime Minister Pedro Passos Coelho reduced spending to comply with the requirements of the three-year international bailout program of his country, which was completed in 2014.

Then came the anti-austerity era. In 2015, the leader of the Socialist Party, Antonio Costa, became the prime minister after his party successfully struck a deal between the Communist Party and the Left Bloc to form a minority government.

With the EU-led bailout completed and Costa in office, the new Portuguese government stimulated the aggregate demand by expanding public spending.

Costa claims that his Keynesian recipe has allowed the country to reduce its budget deficit.

However, its highly indebted banks are the Achilles’ heel of Portugal, and remain the main concern for foreign investors.

As an example, the state authorized the injection of EUR2.5 billion to the public bank Caixa Geral de Depósitos in the first quarter of 2017 to help the institution address its solvency problems.

Costa’s increasing public expenditure comes at a time when the country’s 10-year bonds have decreased to near 2%, prompting concerns about whether these projects could be implemented if debt service payments bounced back up to 6% or 7%, as they were before he took office.

Spain, taming the separatist drive

Spain has also worked hard to tackle unemployment. Falling from a figure of 26% in 2013 to around 17.1% now, it is clear that progress has been made.

As with Portugal, tourists have flocked to Spain to visit historic cities such as Seville and Toledo or to enjoy the sunny Mediterranean coast, while exports have increased exponentially due to a cheaper euro.

In addition, foreign direct investment has amounted to EUR126 billion, registering a 140% increase in 2017 compared to 2016, according to a report compiled by KPMG.

The real estate market is also booming because of low-cost ECB funding, increasing the price of new houses by 5% in 2017, the highest surge of the past decade.

On the other hand, Spain’s banking sector still faces challenges because of the bad assets they own, and Banco Popular’s failure last year was the best example of such problematic portfolios.

Arguably, the main risk that the country faces is political. The separatist drive from some citizens of Catalonia, Spain’s northeast region, threatened the very unity of the state.

Catalan separatists gained momentum when they held an illegal referendum for independence in October, although turnout was only 43%.

However, their push for independence has had a severe impact on the performance of both the Spanish and Catalan economies.

Approximately 3,208 companies have relocated their head offices outside of Catalonia, evidence of the uncertainty that surrounds the future of this region.

Should the crisis linger, Spain would experience some hurdles.

Interest of its sovereign debt could rise, denting the finances of the central government. Uncertainty could also lead to reduced consumption, thus impacting tax collection. And more companies could flee Catalonia, reinforcing the message that the region is an unreliable destination for investment.

The separatist agenda is the main obstacle in the way of continued economic growth in Spain; putting out the fire will be the top priority for its central government in 2018.