IMF Comment: Spain to Curb Spending & Support Banking
April 28th, 2009
- IMF urges Spain to curb fiscal spending
- Spain must prepare bank bailout contingency plans
- Spain risks L-shaped adjustment without reforms
Spain should be wary of extra fiscal stimulus measures and must prepare contingency plans for bank bailouts to head of possible systemic risk, the International Monetary Fund said on Wednesday.
In a report following a regular review of Spain, the IMF said Spain had to present plans to cut a ballooning budget deficit and needed to launch reforms in labour and economic markets to raise economic competitiveness.
“Further fiscal stimulus measures should be considered only if warranted by a further worsening of the downturn,” the IMF said in the report. “Plans to achieve fiscal sustainability need to be spelled out.”
“Without more reforms to increase flexibility, staff is concerned that Spain could get stuck in a low-growth extended-adjustment (L-shaped) equilibrium,” it said, adding that Japan, Portugal and Germany had suffered such a scenario.
The IMF said Spanish banks had weathered the crisis well, thanks to strong supervisory policies, but needed support given a struggling economy.
The Spanish government says it is working on restructuring its banks and now is not the time to cut public spending, given the paralysis of construction and real estate sectors.
Deteriorating asset quality and higher capitalisation demanded by markets will continue to weigh on the outlook for Spanish banks and increase chances of mergers, the IMF said.
IMF directors said the vulnerability of Spain’s savings banks, stemming from their dependence on local real estate activity, called for close monitoring.
“Prudential banking policies and credibility are strong, but contingency plans are required to augment bank capital if systemic pressures arise,” the IMF said.
After 15 years of rapid growth led by a housing boom, Spain has entered a sharp downturn with soaring unemployment after foreign funding dried up during the global financial crisis.
“What started as a soft landing turned into an abrupt unwinding of imbalances,” the IMF said.
The IMF expects the economy to contract 3 percent this year and 0.7 percent in 2010, in line with Bank of Spain forecasts.
Spain’s fiscal deficit and public debt is ballooning, reflecting discretionary spending measures and a drop in important tax bases, including housing revenues.
“You don’t want to dig a hole so deep now that you have difficulty coming out of it when the economy normalises,” said Bob Traa, head of the IMF mission to Spain, during a press conference in Washington.
The government has announced 70 billion euros ($90.46 billion) in fiscal stimulus and measures to strengthen banks.
“You cannot continuously keep pushing new fiscal stimulus into the economy because at some point you need to take that back,” said Traa.
He expected Spanish house prices to fall 30 percent from peak to trough, and said Spain was perhaps half way through that process.
Story from The Guardian
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