The latest figures from the last few months have been encouraging for the Spanish economy. The first positive quarter-on-quarter growth figures have been recorded and the impetus, which initially came only from the foreign sector, is also starting to be seen in other components of domestic demand.

Among analysts, both national and international, such positive indicators raise several questions: how quickly can the unemployment rate be lowered? How fragile is the recovery? And, lastly, is the recovery solid enough to correct the debt imbalances still affecting Spain's economic system?

The issue of how strong the exit might be from the recession must be tackled from two perspectives. Firstly, the GDP growth that is plausible to expect and, then, to what extent this growth might create jobs. Regarding the rate of growth in GDP, experience tells us that, after debt recessions such as the one we have just gone through, reactivation tends to be very weak. In the current case we expect a very modest expansion, estimated at 0.8% year-on-year for 2014. In spite of its moderate size, this growth should be enough to change the tone of the Spanish labour market. After the labour reform introduced in 2012, the market has become more flexible. New labour regulations have allowed firms to adjust better to the economic cycle by using their workforce more efficiently. Should the change in cycle consolidate, by the middle of the coming year we might already see a positive year-on-year growth rate for employment.

The second big issue is the fragility of the recovery. Here the news is less encouraging. Spain's recovery is based on the adjustments being made in prices, costs and spending but is also largely the result of Mr. Draghi's intervention in 2012, assuring international investors that he would do whatever he could to guarantee the integrity of the euro area. European policy is partly accountable for the recovery and lies behind the return to Spain of considerable capital flows, both via direct investment and also financial and portfolio investment. However, these flows can be volatile and the developments in international financial markets over the coming months will be crucial. If the situation remains calm and with low volatility, the increasing withdrawal of restrictions on liquidity could even push the economy to grow at a rate of around 1%. On the other hand, if turbulence, perhaps caused by US monetary policy, takes hold of the markets and increases risk aversion, it will be difficult for a vulnerable economy such as Spain's to avoid the adverse effects. In this case, growth would be almost zero.

Lastly, some analysts question whether Spain's economic recovery will be enough to withstand the heavy burden of debt accumulated over the last ten years. Regarding this point, it should be remembered that the most relevant debt is the external one, i.e. in the hands of non-residents. Although gross debt is a good reference to analyse potential liquidity risks, when discussing the capacity to meet repayments the most important concept is net debt, i.e. to discount the assets held abroad by residents. For Spain, this debt represents approximately 90% of GDP. Its reduction to figures close to 30% of GDP, more sustainable in the long term, will require quite a few years of high positive current account balances in the order of 2% on average. Is this possible? Some of us think it is; that the change in the foreign sector is structural and that this will last because it has been achieved without resorting, as in previous episodes, to the artificial mechanism of nominal devaluation. But as the economic recovery consolidates there is the risk of a further deterioration in the external balance due to rising imports. Consequently, in order to successfully complete the process of redressing the external balance, it will be necessary to continue improving external competitiveness through strict cost and price control and through an increase in productivity.

Jordi Gual

Chief Economist

30 November 2013