Spain’s 2024 economic and policy outlook

The Spanish economy has cooled significantly since early this year, as the boost from post-pandemic reopening has faded and the global economic environment has worsened. Moreover, consumers and businesses increasingly feel the impact of higher interest rates, while excess pandemic savings have been depleted, and companies are winding down pandemic-induced stockpiling. Recent survey data confirms our view that growth is broadly stagnating in the current quarter (see figure 1), with the services sector balancing weakness in the manufacturing sector, where sharp declines in new orders are accompanied by ongoing falls in production and increasing spare capacity.

Labor market puts floor below demand

We expect growth to remain weak at the start of the year before it gains some traction. Due to the high vacancy rate and many businesses reporting a lack of available workers, we deem a large increase in unemployment unlikely. Labor market tightness will continue to support wage growth. That said, real wage growth seems to have peaked already, and employment growth has slowed significantly since the first half of the year. Hiring has basically come to a halt and is unlikely to reaccelerate sharply (see figure 2). Moreover, excess pandemic savings, corrected for inflation, are largely spent. Therefore, the impact of higher mortgage payments on consumer demand is expected to increase. As such, we project households to continue to spend but growth to slow.

Higher interest rates impede demand

Meanwhile, higher interest rates and tighter credit conditions have significantly suppressed credit growth. Indeed, mortgage lending is down substantially, bank lending to businesses has nosedived, and the credit impulse is deeply negative (see figure 3). Admittedly, the repayment of pandemic credit facilities implies that credit data probably overstates the investment weakness to come. Even so, the data, combined with the bank lending survey, confirms that higher interest rates are still working their way through the economy. On the upside, grants from the EU pandemic recovery fund and more focus on the need for government investment across the EU should limit the negative impact of higher rates and increased uncertainty on investment spending.

All in all, we project GDP growth to slow from 5.8% in 2022 to 2.3% this year and 1.4% next year. That’s a muted growth rate for 2024 compared to pre-pandemic years, but it is still substantially higher than the eurozone average. That is partly due to the fact that Spain is set to receive more NextGenerationEU (NGEU) grants than some of its peers. Furthermore, energy prices have risen substantially less in Spain over the past two years, leaving fewer scars. Moreover, the manufacturing sector is less important for Spain, and it is less dependent on exports to China. So, weaknesses in both areas hurt Spain less. Finally, Spain’s growth potential is larger, as the population is aging less rapidly than, for example, Germany and Italy.

Spain’s incumbent prime minister, Pedro Sánchez, has defeated the odds by winning the investiture vote in parliament. With only 179 votes in favor and 171 against, the victory was very narrow and required the support of many parties, including the far-left Sumar and nationalist Basque and separatist Catalan parties. Sumar will join Sánchez’s center-left Spanish Socialist Workers' Party (PSOE) in a coalition government – since the vote, Podemos left Sumar due to personal frictions. To get the backing of the Catalan separatists, Sánchez offered them regional debt forgiveness and amnesty for those prosecuted for their involvement in the separatist movement leading up to the illegal referendum on and subsequent declaration of independence in 2017. An amnesty bill has been filed in the Chamber but will take months to be finalized and voted on.

The bill is highly controversial, fiercely opposed by right-wing parties, and even lacks support among PSOE voters. Amnesty might improve the relationship between Sánchez and pro-independence Catalan parties, but it causes unease among voters and worsens the relationship between the left PSOE and the right People’s Party. In other words, it raises tensions across the country and leaves even less scope for any cooperation on future policymaking.

Policymaking by the new government will also suffer from instability from within, due to the many parties Sánchez depends on for passing laws. The two coalition parties PSOE and Sumar – which itself is a confluence of parties – only control 147 seats in the 350-seat parliament. The Catalan pro-independence party Junts, headed by self-exiled Carles Puigdemont, already warned the new government that it will have to earn its support “piece by piece” throughout the legislature. It told Sánchez it will withdraw support if talks about the future of Catalonia are not sufficiently constructive and that he should “not tempt his luck” regarding the amnesty law.

The goal of Junts and Esquerra Republicana (ERC) is Catalan independence, with, at the very least, the right to hold a referendum on the matter. Both are out of the question for PSOE, so it is questionable how sufficient progress in bilateral talks on Catalonia’s future can be made – although, admittedly, amnesty used to be a no-go as well. Meanwhile, the future application of the amnesty law is still quite uncertain. The right-wing opposition cannot hold up the law, but the European Commission has raised questions, and judges across the country have preemptively displayed their stance against the law. If the courts that will have to apply the amnesty law challenge its constitutionality, the implementation will effectively be stalled until the Constitutional Court has cast its verdict.

Against this background, policymaking will likely be slow, with separatists holding a firm grip on the agenda. A weakly mandated government that also has to make time for the Catalan cause will probably have a hard time effectively dealing with challenges ranging from water scarcity to labor market mismatches, an aging society, and high public debt. Moreover, it puts at risk the granting and use of cohesion funds and future NGEU funds. It is partly for these reasons that we have lowered our medium- to long-term projections for Spain.

Furthermore, based on the coalition agreement and the fact that PSOE and Sumar have to cater to the wishes of many parties, we believe it will be difficult to keep fiscal balances in check. The agreement and intentions certainly include features that could benefit the Spanish economy, but the risk of weak progress and fiscal slippage is high. Yet, rising interest costs (see figure 7), high public debt (111.6% of GDP), and slowing growth require a substantial improvement in Spain’s primary balance to prevent the debt ratio from spiraling in the second half of this decade.

We previously calculated that, over the next five years, Spain would have to improve its primary balance from the forecast -1.8% of GDP in 2023 to close to 0% to stabilize its debt ratio. Hence, more would be required to bring the debt ratio down as required by the EU budget rules. These budget rules are due to come back into force next year, although it remains unknown in what form. Due to the rising interest costs, a substantial improvement in the primary balance is also required to comply with the EU’s maximum deficit target of 3% of GDP. Indeed, according to our projections, the primary balance would have to improve to -0.7% next year and then gradually to +0.2% in 2028 (see figure 8).