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BBVA Research: “Europe must prevent 2012 from being another wasted year in the economic recovery“


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• "Uncertainties surrounding the solution to the European sovereign debt crisis are undermining economic growth and dampening expectations for coming quarters” according to Jorge Sicilia, Chief Economist of the BBVA Group

• The uptick in the risk premium and increased expectations that it will take longer to ease to levels more aligned with the fundamentals of the Spanish economy could delay growth until 2012

• Spain is forecast to grow 0.8% in 2011. While for 2012 GDP growth is expected to be in line with 2011 (1%), factors are emerging that suggest that the situation in Europe and Spain could move dangerously close to a risk scenario of lower growth or even recession

• Time is growing short to correctly implement the policies approved at the last European summits and for Spain to achieve the adjustment targets established. Our base case scenario is predicated on these conditions

• According to Rafael Doménech, Chief Economist for Developed Economies, “to reduce financial tension and boost confidence in economic recovery the sovereign debt crisis affecting Europe needs to be resolved and Spain must comply strictly with its fiscal commitments, progress in bank restructuring and carry out more ambitious structural reforms”

In the last edition of Spain Economic Outlook, BBVA Research observed a slowdown in the world economy in the past few months and increased risk of a downtrend for four reasons. First, economic growth was lower than expected in the second quarter, mainly in the developed economies. Second, the sovereign debt crisis in Europe has intensified and turned more systemic. Third, the feedback between sovereign concerns and the health of the European financial system has intensified, fuelling the risk of a negative impact on economic activity. And last, higher risk aversion has significantly increased financial market volatility.

Going forward, confidence and volatility indicators in European financial markets already suggest activity in Europe will be flat in the latter part of the year, boding poorly for the strong growth seen until now by Spanish exports, explained BBVA Group Chief Economist, Jorge Sicilia.

On the domestic front, the imbalances accumulated before the crisis was unleashed are still correcting, driven in some industries by the fiscal consolidation process. Therefore, the incipient recovery in GDP seen in the last few quarters has slowed and growth could even turn negative in the final quarter of 2011.

Spain is forecast to grow 0.8% in 2011. And while for 2012 GDP growth is expected to be in line with 2011 (1%), factors are emerging that suggest that the situation in Europe and Spain could move dangerously close to a risk scenario of lower growth or even recession.

For Jorge Sicilia, “time is growing short to correctly implement the policies approved at the last European summits and for Spain to achieve the adjustment targets established. Our base case scenario for 2012 is predicated on these conditions”.

To prevent scenarios of lower growth from emerging, the sovereign debt crisis affecting Europe must be resolved and at the same time Spain must comply with its fiscal commitments, progress in bank restructuring and carry out more ambitious structural reforms”.

In the opinion of BBVA Research, the reforms undertaken to date have not been sufficient to resolve the problems affecting the Spanish economy and therefore should be expanded in order to achieve sustained growth. The new government emerging from the general elections on 20 November will have to “urgently face an extensive and far-reaching raft of reforms”, focused on three main spheres.

First, in the area of public finances, actions must bear in mind the structural fall in revenue, by curbing expenditure or seeking new sources of funding, but also to i) develop institutions in line with the new fiscal rule written into the Constitution, ii) increase transparency and planning (multi-year budgets) and iii) develop incentives to meet the stability targets at all levels of public administration.

While BBVA Research considers the commitment to fiscal stability shown in the reform made to the Spanish constitution is good, the disappointing performances in terms of deficit of the social security system, and above all, the autonomous communities, could cast doubt over the public administration’s overall capacity to meet its budgetary targets in 2011 and the coming years. The growing probability that deficit targets will be missed, not to mention the cuts to growth forecasts for 2012 and the increasing likelihood of a risk scenario emerging suggest that, “fiscal consolidation should be more intense than previously estimated and prepared to correct any potential shortfall in income”.

BBVA Research also thinks that progress must be made in restructuring part of the Spanish financial system to allow for a smooth deleveraging and to meet the higher demand for credit when the recovery gains momentum.

The restructuring process “is still incomplete”. As a result, some institutions may not be ready to weather adverse scenarios and could remain vulnerable to rapid swings in market conditions. This would limit their ability of offer credit, especially bearing in mind the high capital requirements.

Third, BBVA Research considers that the necessary reforms must be carried out to reduce the dramatic levels of unemployment promptly and favor the reallocation of factors of production towards the fastest growing industries and businesses and those with the greatest growth potential and capable of creating stable and quality employment.

Dual economies like Spain offer myriad examples of business excellence on an international level, which explain the resilience of Spanish exports in recent quarters. Immediate challenges include generalizing this behavior among all other companies and sectors, freeing up the enormous potential growth of the Spanish economy and tearing down barriers to the reallocation and efficient use of resources that are often idle.

For Rafael Doménech “rather than regretting what Europe had yet to do to improve the situation of the Spanish economy, we should look at what Spain can do to help Europe overcome its problems. This means meeting its fiscal targets and adopting truly ambitious measures to boost growth and create jobs”.



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