Spain’s economy thrives on tourism boom: What’s next?

The Spanish economy is booming and has been outperforming peers and expectations for over two years now. For example, it grew by 0.8% QOQ in the first two quarters of the year, compared to the eurozone aggregate of 0.3%. We project GDP growth in Spain to soften from recent high rates, but to remain strong and higher than in the eurozone in the coming quarters, hovering around 0.4%. Recent PMI figures support our short-term view, as they are softening but still comfortably in expansionary territory. August’s composite PMI stood at 53.5, down from 56.6 in May.

Spain’s recent success has been largely driven by booming services export. Indeed, whereas investment is still smaller than it was before the pandemic and private consumption has only just surpassed its Q4 2019 level – with per capita consumption still below that level – services exports are 38% higher than in Q4 2019. Services exports in general have performed well, not least due to increased geographical diversification and improved competitiveness, but the tourism sector is thriving the most. Tourism accounts for over 13% of GDP, and record after record is being broken. The number of visitors and (real) expenditure by tourists are both far higher than in 2019, and the rate of acceleration is fast. Real consumption expenditure by non-residents, for example, was 44% higher in Q2 2024 than at the end of 2019. Tourism is not only driving consumption expenditure, but high accommodation occupation rates are also driving record investments in hotels. As an added benefit for GDP growth, services exports have a low import content. As a result, exports have grown twice as fast as imports since the start of 2021, and the gap between export and import volumes has never been this large.

Hence, whereas the economy’s large tourism content led it to suffer more than other large member states during the pandemic and to recover much slower, it has been driving Spain’s outperformance in the past two years.

There is still scope for higher-than-usual growth going forward. Business travel and tourists from certain faraway destinations, such as Japan, are not yet back at pre-Covid levels. But there are limits. Capacity constraints limit growth, and higher prices will constrain demand: Prices for package holidays within Spain have risen 30% in two years’ time. And local opposition against mass tourism is growing exponentially, especially in coastal areas and big cities. Local governments are trying to crack down on excessive tourist flows without undermining the revenue tourism generates too much. Finally, increasing droughts and water scarcity limit the number of tourists the country can bear, with the tourism sector using disproportionate amounts.

As the boost from tourism export is expected to soften, consumption and investment will increasingly determine the pace of growth. Consumption should be supported by growth in households’ real disposable income, on the back of employment and wage growth, and a reduction in inflation. That said, a significant boost in quarterly consumption growth from 0.4% and 0.3% QOQ in Q1 and Q2, respectively, is not really in the cards.

Inflation has come down significantly from its peak, but services inflation is sticky due to the strength in the tourism sector. Moreover, survey data and producer price indices currently give no reason to expect a substantial drop in non-energy goods inflation. Finally, food inflation has come down a lot, but we foresee limited scope for a further reduction, partly because of the phasing out of VAT cuts on basic foodstuffs later this year. We project inflation to fall from 3.2% this year to 2.6% next year and 2.4% in 2026. Note that a Donald Trump victory in the US presidential elections and resulting tariff hikes are among the assumptions behind our inflation forecast for 2026. At the same time, wage growth is still high, but softening. Softening wage growth combined with the inflation outlook keeps a lid on real wage growth. Real wage growth is projected to be close to zero this year, on average, as well as in the next two years.

Meanwhile, employment growth is still decent, but slowing. Although the share of firms indicating that a lack of labor holds back business is at historical highs, the number of job openings has come down quite a bit in the past few months. Moreover, significantly increased labor costs and weak profit margins, especially in services, raises the question what will have to give going forward as the possibilities of further price increases arguably becoming more limited. A combination of a slowdown in both wage and employment growth seems likely.

As such, we expect employment will continue to grow in the coming quarters, but at a softer pace than in recent years, in line with lower activity growth. Note that, unlike in some other member states, labor hoarding in Spain is not particularly high in an historical context and, as such, is unlikely to act as a major drag on employment growth when activity picks up.

Against this backdrop, real disposable income should continue to grow, but growth is likely to slow. On the upside, private consumption is likely to benefit from currently high household saving rates, which have grown on the back of a significant increase in real disposable income since Q3 2022. Only during the pandemic years did households save a larger share of their income. Improving consumer confidence alongside a reduction in interest rates should induce households to consume relatively more. Lower rates make saving less attractive and both new and outstanding credit less expensive. Due to the large share of variable rate loans, indebted Spanish households were relatively hard-hit during the past years’ hiking cycle. The opposite holds when rates are coming down, as we showed earlier this year, potentially freeing consumption spending capacity.

Investment will benefit from lower rates and EU funds

Lower rates are also expected to support housing investment (link in Spanish) quite rapidly. Weakness in mortgage demand and housing transactions, amongst others, has already bottomed out at the end of 2023, and the recovery certainly has scope to run further. Business investment will probably benefit somewhat further out, though demand for goods will likely have to improve first before investment in industry can really take off. Low capacity utilization rates currently do not warrant much investment in expansion yet, though rates are slowly picking up. Finally, EU recovery funds are expected to increasingly reach the economy this year and in 2025 to 2026, boosting investment. Amounts of recovery funds are currently estimated to reach about 1% of GDP from this year until 2026, up from 0.7% of GDP last year.

However, waning support for the government in parliament is putting the disbursement and adequate use of Recovery and Resilience Facility funds at risk. Moreover, the take-up of common EU funds, such as cohesion funds, has fallen behind, as expected, due to a lack of capacity to absorb these funds on top of the large RRF funds. The weakly mandated government also faces a major challenge to pass a 2025 budget through parliament. The latter challenge could have implications for Spain’s fiscal trajectory. The trajectory should be contractionary from next year to adhere to the EU budget rules, but might in fact end up being roughly neutral.

Growth to slow but to remain strong

All in all, the outlook for Spain remains good, but GDP growth is likely to soften from 2.7% this year to 1.9% next year and 1.5% in 2026. This is better than the outlook for the eurozone, which is projected to grow by 0.7% in 2024, 1.3% in 2025, and 1.2% in 2026. Compared to other eurozone countries, Spain benefits relatively more from EU recovery funds and the tourism boom, while it suffers less from industrial weakness. Moreover, its growth potential in the short to medium term is higher on the back of better demographics than in, for example, Germany and Italy.

Catalan separatist parties have expressed unwillingness to support the Sánchez government any longer. The hardline Together for Catalonia party (Junts), led by Carles Puigdemont, is upset about the formation of the socialist-led Salvador Illa government in Catalonia, which implies there is no real outlook for an official referendum on Catalan independence. Not that many were actually expecting that dialogue between the socialist-led central government and the previous separatist-led Catalan government would lead to a legal referendum on the matter, but any glimpse of hope for the separatists has now disappeared.

Furthermore, actual deployment of a highly contested amnesty law is still being fought in court. Importantly, it seems unlikely Puigdemont himself will be granted amnesty for his role in the independence referendum, as he has been charged with embezzlement of EU funds. Meanwhile, the Republican Left of Catalonia party (ERC) has also said it is rethinking its support for the government, as it awaits a formal agreement on the right to collect and distribute taxes in Catalonia at the discretion of the Catalan government. Sánchez’s Spanish Social Workers’ Party (PSOE) had promised this agreement to get ERC support for Illa, but First Deputy Prime Minister María Jesús Montero later rejected it in press conferences.

Support of Catalan parties or the right-wing opposition is required for a majority in parliament and hence to push through legislation – that is, reforms – to obtain EU funds from the Recovery and Resilience Facility. Moreover, a government caught up in a power struggle arguably will have less time to devote to formulating reforms and investment plans and putting received grants to use. By the same line of reasoning, passing the 2025 budget will prove very challenging.

All in all, it is likely that policy will stall further and the 2023 budget will be rolled over once again, now into 2025. Junts has already rejected the government’s proposed amendments of budget targets and will likely vote against a new budget, if the government were to propose one. The government will try once more to get the targets approved, but nothing seems to have changed to accommodate Catalan frustrations.

Note that Spain will have to run a contractionary budget, that is, its structural primary balance has to shrink, from 2025. Existing targets and policy might be sufficient to adhere to the EU budget rules in the short to medium term. If those rules are respected, they will mean a budget deficit of 3% in 2024, 2.7% in 2025, and 2.5% in 2026. But with a lame-duck government incapable of altering course when needed, the risk of fiscal slippage and noncompliance is non-negligible.