european and spanish economic outlook - march 2014 - bbva research

European and Spanish Economic Outlook

Rafael Doménech London, March 31, 2014

European and Spanish Economic Outlook, March 2014

Main messages

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The global economic cycle is improving and we expect a moderate acceleration in growth in 2014-15 supported by the developed economies

Some economic policy uncertainties have been resolved but there are still risks, although not of a systemic nature, as it was the case in the past

For the first time since the beginning of the crisis the risks to our forecasts for the Spanish economy are to the upside. The recovery is being driven by exports, import substitution and the recovery in new lending. In addition, both financial tensions and fiscal consolidation are less intense

The scope of the reforms needs to be expanded if they are to underpin a robust and sustained recovery, and reverse the jobs destroyed within a reasonable period

4


Index

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Section 1

Global economy: a gradual acceleration supported by developed economies Section 2

Spain: upside risks for the first time since the beginning of the crisis

Section 3

Commitment to the reforms is crucial to consolidate recent market improvement and increase potential growth


Global growth will increase in 2014 an 2015

Global GDP growth (%) Source: BBVA Research 1

2

The global expansion will continue in 2014-15 this time around with higher contributions from advanced economies

Growth risks are more balanced with upward risks in the US and downward risks that remain: •  the exit from QE and flows to

emerging markets,

•  the uneven recoveries and vulnerabilities in EMs, and

•  the Eurozone

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2008 2009 2010 2011 2012 2013

(e)

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(f)Adv. Economies Emerging economies

Baseline Jan14 Baseline Oct-13


The global momentum is improving

Manufacturing PMIs Source: BBVA Research based on Markit Economics

BBVA Financial Stress Index Source: BBVA Research

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GlobalAdvanced economiesBBVA EaglesHSBC Emerging Markets Index

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Emerging Markets, left axis

Developed Markets, right axis

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The eurozone: positive growth with an increasing role of domestic demand

Exports will remain as the main driver of growth in both 2013 and 2014

Domestic demand has weighed on growth in 2013, but will contribute to the recovery in

2014-15

Overall: lower financial tensions, higher global growth, lower fiscal drag, ECB’s loosening bias

and Banking Union

Eurozone: GDP growth (y/y) Source: BBVA Research

-0.6

1.1

-0.4

1.9

-1.0

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Baseline Jan-2014 Baseline Oct-2013


1) The external environment remains positive

Drivers of (still slow) growth in the eurozone

3) The fiscal stance is less restrictive

2) Financial conditions have improved, especially in the periphery

4) The banking union is advancing, with bank exams and single supervision in 2014

Página 7


Growth at diverse paces and with different risks …

Growth cycle strengthens, mainly in advanced economies and in some emerging

economies. Economic policy remains as a supportive factor for growth in 2014-15

To reinforce the baseline scenario, policy-makers have to tackle domestic

vulnerabilities: banking issues and disinflation risks in the Eurozone, financial vulnerabilities in

China, and private domestic demand in emerging economies

The impact of FED’s tapering over global funding conditions, in the US and beyond,

remains as a factor of uncertainty

GDP growth (%yoy) Source: BBVA Research and IMF

3.22.9

3.63.9

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World US EMU BBVA-EAGLES

Baseline Nov-13


… with a widespread recovery across EMU countries …

GDP growth by country (%) Source: BBVA Research

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EMU Germany France Italy Spain

Current Forecast (February 14)

Previous Forecast (November 13)

Germany: slight upward revision. Mild recovery on track supported by domestic fundamentals

France: GDP virtually flat in 2013 while the moderate recovery for 2014 will depend on

the economic policy implementation

Italy: though activity stabilised in 2H13, sharp downward in 2013, Slight growth in 2014, but

downside risks increase

Página 9


… but with some important uncertainties for 2014

World: (1) risk of a sudden slowdown in emerging countries and its ability to rebalance its growth path (e.g., China), (2) effects on capital flows and financial

conditions from Fed exit strategy, and (3) geopolitical

U.S.: (1) risks in Fed exit strategy, (2) debt ceiling and fiscal consolidation in the long run, and (3) growth potential and doubts on secular stagnation

EMU: (1) persistence of sovereign risk and financial fragmentation, (2) process to the Banking Union Bank (AQR and stress tests), (3) risk of deflation and the

burden of a very low inflation, and (4) Greece and Portugal programmes

Spain: political environment, scope of structural reforms, potential growth, recovery with a very low inflation in EMU, fiscal consolidation and banking

restructuring process

Página 10


Asymmetric shocks and an incomplete union in EMU

Shocks Symmetric Asymmetric

Complete union USA Incomplete union EMU

Differences in the asymmetry of shocks and institutions have resulted in very different response of economic policies during the crisis, …

… which now are affecting the effectiveness of the ECB to ensure its inflation target and to anchor inflation expectations

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Asymmetric shocks and an incomplete union in EMU

GDP per working age population 2Q08=100 Source: Eurostat and BBVA Research

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As a result of the imbalances accumulated before and during the crisis, and the lack of

banking, fiscal and economic union …

… EMU countries exhibit large differences in unemployment rates and in GDP per working-

age population, …

… which are correlated with creditor and debtor positions of each country -> consensus on

European economic policy is difficult 90

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EMU Germany France Italy

Spain Portugal USA


1. Financial uncertainties Banking union: key to reduce financial fragmentation

•  ECB as the ultimately responsible regulatory authority for all eurozone banks

•  Direct supervisor of top 130 banks

•  National authorities will supervise the less significant entities

•  Start: 04/11/2014

•  Prudential (Basel III), resolution framework (bail-in), harmonised deposit protection rules

•  Start: 2014 - 2016

•  Start: unknown

•  New Single Resolution

Authority in co-operation with national resolution authorities

•  Single Resolution Fund funded by bank contributions

•  Start: 2015 - 2016

Common Rules

Single Supervision

Single Resolution

Single Depo Guarantee Scheme

Pillar I

Pillar II Pillar III

Pillar IV Setting up a robust supranational framework

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Eurozone: interest rates of government bonds and new loans to non-financial firms, 2013 Source: BBVA Research based on ECB

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Despite the significant fall of financial tensions, financial fragmentation is still important …

Real interest rates in EMU countries with high unemployment rate much larger than in countries with

low unemployment rate

… particularly in countries where inflation is low -> differences in real interest rates larger than in

nominal ones

… interest rates of government bonds and new loans to non-financial firms highly correlated: sovereign and

banking risks spillovers still remarkable …

1. Financial uncertainties

Banking union: key to reduce financial fragmentation

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Government bond rates (1 to 3y), 1H2013


2. The costs and risks of a low inflation recovery Trend inflation & expectations well below the ECB target

Eurozone: unemployment rate and inflation Source: Eurostat and BBVA Research

Página 15

The double-dip recession (unemployment) and M3 growth partially explain the low rate of inflation in EMU

Although the probability of deflation is low (<10%) the combination of adverse shocks and expectations downward significantly increase this probability

Inflation expectations in swaps and trimmed mean inflation (optimal selection in terms of inflation

prediction for next 2/3 years) are about 1%

If 3 pp of higher unemployment explain 0.4 pp lower inflation, inflation expectations are currently less than

1.2% -> drag for the economic recovery

The regression coefficient of the inflation rate on the unemployment rate is equal to 0.125, statistically significant and robust to the exclusion of Cyprus, Greece and Spain.

DE

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EMU (Feb) NL FR IT

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SK ES

EL CY

EMU (EQ)

Inflation expectations:

1.2%

EMU (Mar)

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Infla

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Unemployment rate, Jan. 2014 (%)

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2. The costs and risks of a low inflation recovery

Trend inflation & expectations well below the ECB target

Spain: trending inflation (trimmed mean inflation, % y/y) Source BBVA Research based on INE

Eurozone: trending inflation (trimmed mean inflation, % y/y) Source BBVA Research based on Eurostat

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90CI 80CI 60CI

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Headline (official) Core (official)

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2. The costs and risks of a low inflation recovery

ECB: ready for further action?

Will the ECB change its mind

towards QE?

•  Rates were kept unchanged. They retain a downward bias

•  Mr. Draghi once again used verbal intervention to strengthen his forward guidance

•  Inflation significantly below 2% for a long period of time (1.5% for 2016)

•  Mr. Draghi seemed to downplay the potential role of other instruments available for eventual further policy action

Latest What do we expect? Policy pause until 2016

Once it has become clear that the ECB is ready to accept inflation of 1.5% in 2016 without taking further action, the expectation of further (decisive) measures in the short-term in the absence of sizeable shocks is very low Any and all liquidity measures remain on the table (SMP non-sterilisation) in the event of an unwarranted tightening in money markets

Do not expect a weakening of the euro in the very short run

Página 17


3. The risks of a sudden stop in emerging economies

EMU fragile recovery may be affected by external factors

EMU: historical decomposition of GDP per wap (%, y/y) Source: BBVA Research

Página 18

The first part of the double-dip crisis in EMU was driven by financial tensions and the

collapse of external trade

Although of a milder magnitude, a sudden stop in emerging countries could have significant

effects on EMU recovery

Similarly, Fed exit strategy may affect financial conditions in EMU


Index

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Section 1

Global economy: a gradual acceleration supported by the developed economies Section 2

Spain: upside risks for the first time since the beginning of the crisis Section 3

Commitment to the reforms is crucial to consolidate the improvement in the markets and increase potential growth


The recovery of the Spanish economy is confirmed …

Spain: GDP growth and MICA-BBVA forecasts (% QoQ) Source: BBVA Research based on INE

Página 20

After three years in recession, domestic demand started to make a positive contribution

to growth again in the second half of 2013…

… as a consequence of improved fundamentals, less restrictive fiscal policy, reduced

uncertainty and increased import substitution

The available information points to growth of at least 0.4% in 1Q14

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(f)

CI at 60%CI at 40%CI at 20%Data (f: MICA-BBVA Research forecast)


… the risks are to the upside for the first time

Página 21

Spain: GDP growth forecasts, 2014 (% YoY) Source: BBVA Research based on Consensus Forecast Inc.

Economic policy decisions have eliminated the risk scenarios

The differential performance of the Spanish economy confirms this improvement in the

trend

If these trends are confirmed, growth could be even stronger than we are forecasting

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GDP Growth forecast

March-2014 (mean: 0,9%)December-2013 (mean: 0,6%)March-2013 (mean:0,3%)

BBVA ResearchFEB-2014


Upside risks: 1. Exports will continue to expand

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Spain: growth and breakdown of goods exports by broad geographical area Source: BBVA Research based on Datacomex

We expect the recovery to continue driven by the increase in exports

The deceleration in exports is a temporary phenomenon and will reverse in a scenario of

stronger global growth

The slowing momentum in EMs has been offset by the recovery in the EMU 0

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Nominal growth, 1Q13 average % YoY (LHS)

Nominal growth, 4Q13 average % YoY (LHS)

Share over total exports in 2013 (%, RHS)


Upside risks 2. An increase in savings and financial wealth

Página 23

Spain: net real household financial wealth (Deflated by the private consumption deflator; seasonally adjusted data) Source: BBVA Research based on Bank of Spain and INE

The increase in corporate and household savings has been an essential part of the

recoveries in Spain …

… that has helped in the deleveraging process and in the improvement in the financial

situation of the private sector …

… and these, together with the stabilisation and improvement in the value of wealth, has

driven an increase in consumption and investment

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Real net financial wealth (billion €)

2Q12-3Q13: +24.8%


Spain: 10Y bond yield (Difference vs. our November 2013 forecast in bp) Source: BBVA Research

Upside risks 3. More certainty and fewer financial tensions

Página 24

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2014 2015

Improved international perceptions of the Spanish economy have allowed Spain to reduce

its dependence on ECB funding

Reduced financial tensions are reflected in the economy with a lag of 6-9 months

A permanent 100bp drop in sovereign interest rates implies up to one percentage point more

growth for the economy


Upside risks 4. More dynamic investment

Página 25

Spain: exports and investment in equipment and machinery (2008=100) Source: BBVA Research based on INE

The recovery we expect in the EMU and the continuing export growth …

… should translate into an increase in private-sector investment

In fact, the investment in equipment and machinery had grown 6.3% by 4Q13

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Upside risks 5. Improvement in new lending flows

Página 26

Spain: new lending and credit to households, NPISH and non-financial entities Source: BBVA Research based on Bank of Spain (February 2014)

The Spanish economy is going through an evitable deleveraging process …

… that is compatible with new lending for financially viable projects

There has been a turning point and an improvement in corporate lending, which we

expect to consolidate in 1H14

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Public sector: breakdown of the public deficit excluding aid to the financial sector (% GDP) Source: BBVA Research based on MINHAP

Upside risks 6. A smaller fiscal effort needed in 2014

Página 27

The significant fiscal consolidation efforts in 2012 and 2013 …

… have resulted in containment of the public deficit at 6.6% of GDP …

… therefore allowing for a smaller fiscal effort needed in 2014

(e) advance; (f) forecast

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Spain: LFS employment (Variation in annual average, %) Source: BBVA Research based on INE

Upside risks 7. Changes in the labour market

Página 28

Net job-creation has started sooner than we expected, partly as a reflection of wage

moderation

Had labour institutions been better at the beginning of the crisis, millions of job losses

could have been avoided

Employment growth in 2014. Additionally the fixed social security contribution for permanent

contracts can boost employment

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Spain Outlook 4Q13 Spain Outlook 1Q14


Index

Página 29

Section 1 Global economy: a gradual acceleration supported by the developed economies Section 2

Spain: upside risks for the first time since the beginning of the crisis

Section 3

Spain: commitment to the reforms is crucial to consolidate the improvement in the markets and increase potential growth


The need to broaden the scope of the reform agenda

GDP growth and job-creation Source: BBVA Research and Lebergott (1964)

Assumptions for the USA and the EMU are consistent with BBVA Research´s scenario. The Spanish scenario has been built assuming both that producvity per worker rises 0,6% (as it was the case between 1992 and 2007) and that GDP grows on average 2,5.

Página 30

The recovery in employment will be very sensitive to economic growth

The objective should be to introduce the necessary reforms to increase economic

growth to close to or more than 2.5%

Unless this happens, job-creation will be limited and the recovery slow

80#

85#

90#

95#

100#

105#

Peak# 2# 4# 6# 8# 10# 12# 14# 16# 18#years#

#Employmen

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#begining#the#crisis#=

100# Spain,#2007B2025#EMU,#2007B2017#USA,#2007B2014#

USA,#1929B1940#


Spain: unemployment and public deficit Source: BBVA Research based on INE and MINHAP

An efficient tax system and fiscal sustainability

Página 31

Tax revenues dropped sharply in Spain as a consequence of the recession …

… and the fiscal consolidation process requires sufficient resources to ensure that Spain’s

finances remain in good health…

… but with a structure that drives economic growth and job-creation, two key factors for

reducing the deficit

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18% (2013)

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The need to broaden the scope of the reform agenda

Página 32

1. To continue the deleveraging and improvement in the finances of the Spanish economy: finalising the restructuring of the financial sector and

attracting foreign direct investment

3. Reforms to improve competitiveness further (internal devaluation), increase the international attraction of Spain in terms of physical, human and

technological capital

4. To continue with the reforms that reduce the duality in the labour market, improve the way it functions and increase employability

-> more and better-quality jobs

2. Public-sector reform, fiscal consolidation and long-term sustainability of public finances, with an efficient tax system that create incentives to growth

and job-creation -> Report of the Experts Committee

European and Spanish Economic Outlook

Rafael Doménech London, March 31, 2014


Macroeconomic scenario

Página 34

S pain EMU S pain EMU S pain EMU S pain EMUHouseholds final consumption expenditure -‐2,8 -‐1,4 -‐2,5 -‐0,5 0,9 0,7 1,3 1,2General government final consumption exp. -‐4,8 -‐0,5 -‐1,2 0,3 -‐1,1 0,5 1,3 0,7Gros s fixed capital formation (G.F .C .F .) -‐7,0 -‐3,9 -‐5,9 -‐3,1 0,2 1,6 5,2 5,0

E quipment and cultivated as s ets -‐3,9 -‐4,4 0,8 -‐2,5 6,0 2,8 7,8 7,1E quipment and machinery -‐3,9 -‐4,4 0,7 -‐2,5 5,8 2,9 7,8 7,1Hous ing -‐8,7 -‐3,4 -‐8,4 -‐3,0 -‐3,4 1,0 5,0 3,6O ther cons tructions -‐10,6 -‐4,8 -‐11,8 -‐4,9 -‐4,2 -‐0,7 1,5 2,9

C hanges in inventories (*) 0,0 -‐0,5 0,0 -‐0,1 0,0 0,0 0,0 0,0Domes tic Demand (*) -‐4,1 -‐2,1 -‐2,8 -‐0,9 0,4 0,8 2,0 1,7E xports 2,1 2,7 5,2 1,2 6,5 3,5 6,7 4,9Imports -‐5,7 -‐0,8 0,3 0,2 5,2 3,3 7,4 5,1E xternal Demand (*) 2,5 1,5 1,6 0,5 0,6 0,3 -‐0,1 0,2

GDP mp -‐1,6 -‐0,6 -‐1,2 -‐0,4 0,9 1,1 1,9 1,9Pro-‐memoria

GDP exc luding hous ing -‐1,2 -‐0,5 -‐0,8 -‐0,2 1,2 1,1 1,8 1,8GDP exc luding contruction -‐0,4 -‐0,2 -‐0,1 0,0 1,5 1,2 1,8 1,7Total employment (LF S ) -‐4,5 -‐0,7 -‐3,1 -‐0,8 0,4 0,1 1,0 0,7Unemployment rate (% Active pop.) 25,0 11,4 26,4 12,1 25,6 12,0 24,8 11,6C urrent account balance (% GDP ) -‐1,1 1,2 0,9 2,1 1,6 2,1 1,7 2,0Public debt (% GDP ) (**) 86,0 93,0 94,7 95,6 99,1 96,1 101,4 95,7Public defic it (% GDP ) -‐6,8 -‐3,7 -‐7,0 -‐2,8 -‐5,8 -‐2,4 -‐5,1 -‐2,1C P I (average) 2,4 2,5 1,4 1,4 0,5 1,0 1,0 1,4C P I (end of period) 2,9 2,2 0,3 0,8 0,7 1,3 1,2 1,5(*) C ontribution to GDP Growth

(f): forecas t

2013 (f) 2014 (f) 2015 (f)

(**) E xcluding a id to the banking s ector in S pain

2012(% YoY)


Changes in the corporate insolvency law will facilitate corporate debt restructuring

New RDL on corporate debt restructuring Source: BBVA Research based on BOE

Measures

ü  Possibility of individual debt refinancing agreements

ü  Simplified procedures for collective debt refinancing agreements

ü  Reduction in the level of required majorities to impose refinancing agreements on dissident creditors

ü  BoS needs to develop new provisioning framework for refinanced loans

ü  In case of insolvency, fresh money with privileged status and old debt non-subordinated

ü  Takeover exemption when creditors convert into equity

ü  Other measures: including fiscal benefits…

New measures announced last week remove obstacles to agreements between financial creditors and debtors

Spanish Financial System

•  Increases legal certainty

•  If restructuring ends in insolvency, financial creditors are not in a worse position

•  Foreseeable better provisioning framework

•  Conversion of debt into equity raises new issues (management, capital consumption..)

Corporates

•  Deleveraging of worst quality loans

•  Adjustment of debt to companies’ financial capacity

•  New funding for viable business plans

european and spanish economic outlook - march 2014 - bbva research

Economy & Finance