The planned tightening of the fiscal stance should be deferred to 2011 to allow the economy to recover more firmly. However, structural reforms, including steps to curb age-related spending increases, need to be implemented to ensure long-term fiscal sustainability. Programmes to support construction of social housing should be halted: support to low-income households should be provided via means-tested cash benefits earmarked to rent payments. The effectiveness of the public employment service should be improved.
Output continues to decline
Activity contracted further in the first three quarters of 2009, albeit at a slowing pace, driven by sharply falling domestic demand. The drop in purchases of equipment in vestment particularly lowered imports, while exports expanded, resulting in a continued marked reduction of the trade deficit to a quarter of its pre-crisis level. Employment losses in seasonally adjusted terms are still significant, although their impact on unemployment has recently been offset by the decline in immigration and the levelling off of the rise in female participation. The unemployment rate for workers below the age of 25 is particularly high, reaching 39% in the third quarter. Consumer prices are falling on the back of the past decline in oil prices as well as subdued domestic demand. The harmonised core inflation rate dropped to 0.2 per cent in September, 1 percentage point less than in the euro area average. Manufacturing output has started expanding in recent months and order inflows have risen, although total orders are still close to historic lows. Assessments of business conditions in services have improved but remain consistent with continued contraction in the near term. The decline in housing transactions has levelled off and the fall in house prices has flattened. However, the stock of unoccupied new housing remains large.
The fiscal stance is projected to turn restrictive
The central government's budget plan for 2010, which has yet to be approved by parliament, withdraws some of the stimulus measures introduced in 2009, notably through the elimination of increased basic income tax allowances. Moreover, the plan includes an increase in the standard value-added tax (VAT) rate by 2 percentage points and an increase in the taxation of capital income. These tax measures are expected to raise tax revenues worth 1% of GDP. In addition, temporary reductions in household and business tax payments, equivalent to another 1% of GDP (resulting from accelerated tax refunds related to VAT and personal income tax credits), will be phased out in 2010. Spending on government employment as well as purchases of goods and services will be curbed and pub lie investment cut back throughout the projection period, in part reflecting the further withdrawal of stimulus measures in 2011.
Low interest rates support domestic demand in 2009 and 2010
Credit supply standards have eased and the rise in non-performing loans appears to have slowed. The share of such loans remains modest compared to previous downturns. Low interbank interest rates, to which mortgage rates are often indexed, will continue to provide relief to the financial situation of households in 2010, offsetting some of the cutbacks in real disposable income resulting from lower employment and higher tax rates. However, the projected rise in interest rates in 2011 will damp the recovery in business and household spending.
A slow recovery will keep unemployment high
GDP growth is expected to turn positive in the course of 2010 and gain momentum in 2011, albeit at a slow pace, held back by the high debt burden of domestic businesses and households and a significant drag from shrinking residential construction. The unemployment rate may peak close to 20% in the course of 2010, falling slightly towards the end of the projection period. The year-on-year inflation rate is projected to rise temporarily in the first half of 2010 but may drop to close to zero in 2011. Foreign trade could move close t o balance in 2011, reducing the current account deficit to around 3% of GDP.
Highly indebted households and firms pose risks
A slower recovery of international trade could trigger sharper employment losses, with further adverse effects on the financial situation of the relatively heavily indebted business and household sectors. On the other hand, lower house prices and progress in removing structural barriers to the development of the rented housing market could raise housing demand among the young and low-income households, often poorly housed, accelerating the adjustment in the housing market.
Spain: Demand, output and prices 2006 2007 2008 2009 2010 2011 Current prices Percentage changes, volume [euro] (2000 prices) billion Private consumption 564.6 3.6 -0.6 -5.1 -1.1 0.6 Government consumption 177.5 5.5 5.5 4.4 1.3 0.8 Gross fixed capital 301.2 4.6 -4.4 -15.3 -5.3 -0.8 formation Final domestic demand 1 043.3 4.2 -0.6 -6.1 -1.6 0.3 Stockbuilding (1) 3.8 -0.1 0.1 0.0 0.0 0.0 Total domestic demand 1 047.1 4.2 -0.5 -6.2 -1.6 0.3 Exports of goods and 259.1 6.6 -1.0 -13.5 5.5 7.8 services Imports of goods and 321.9 8.0 -4.9 -20.1 -0.4 5.4 services Net exports (1) -62.8 0.9 1.4 2.9 1.4 0.6 GDP at market prices 984.3 3.6 0.9 -3.6 -0.3 9.0 GDP deflator -- 3.3 2.5 0.3 0.2 0.0 Memorandum items Harmonised index of -- 2.8 4.1 -0.4 0.8 -0.1 consumer prices Private consumption -- 3.2 3.7 -0.9 0.7 -0.1 deflator Unemployment rate -- 8.3 11.3 18.1 19.3 19.0 Household saving -- 10.0 13.4 17.8 17.9 17.9 ratio (2) General government -- 1.9 -4.1 0.0 -8.5 -7.7 financial balance (3) Current account -- -10.0 -9.6 -5.3 -3.8 -3.0 balance (3) Note: National accounts are based on official chain-linked data. This introduces a discrepancy in the identity between real demand components and GDP. For further details see OECD Economic Outlook Sources and Methods (http://www.oecd. org/eco/sources-and-methods). (1.) Contributions to changes in real GDP (percentage of real GDP in previous year), actual amount in the first column. (2.) As a percentage of disposable income. (3.) As a percentage of GDP. Source: OECD Economic Outlook 86 database. StatLink http://dx.doi.org/10.1787/753858338337