Financial Stability and FiscalPolicy in Europe:The Spanish EconomyJorge SiciliaJoint Central Bankers Conference: Unconvent...
Financial Stability and Fiscal Policy in Europe                                                                           ...
Financial Stability and Fiscal Policy in Europe                                                                           ...
Financial Stability and Fiscal Policy in Europe                                                                           ...
Financial Stability and Fiscal Policy in Europe                                                                           ...
Financial Stability and Fiscal Policy in Europe                                                                           ...
Financial Stability and Fiscal Policy in Europe                                                                           ...
Financial Stability and Fiscal Policy in Europe                                                                           ...
Financial Stability and Fiscal Policy in Europe                                                                           ...
Financial Stability and Fiscal Policy in Europe                                                                           ...
Financial Stability and Fiscal Policy in Europe                                                                           ...
Financial Stability and Fiscal Policy in Europe                                                                           ...
Financial Stability and Fiscal Policy in Europe                                                                           ...
Financial Stability and Fiscal Policy in Europe                                                                           ...
Financial Stability and Fiscal Policy in Europe                                                                           ...
Financial Stability and Fiscal Policy in Europe                                                                           ...
Financial Stability and Fiscal Policy in Europe                                                                           ...
Financial Stability and Fiscal Policy in Europe                                                                           ...
Financial Stability and Fiscal Policy in Europe                                                                           ...
Financial Stability and FiscalPolicy in Europe:The Spanish EconomyJorge SiciliaJoint Central Bankers Conference: Unconvent...
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Financial Stability and Fiscal Policy in Europe: The Spanish Economy

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Presentation given by Jorge Sicilia, Head Economist of BBVA Group, at the Joint Central Bankers Conference: Unconventional Government Policies - New Orleans, November 15-17, 2012

Main Messages

Given the limitations in the design of European institutions, heterogeneity of fiscal imbalances and banking conditions in EMU produce a distorting financial fragmentation, exacerbated by market fears of euro breakup and supervisory ring fencing

Spanish fiscal imbalance has been the result of housing and financial bubbles. Fiscal consolidation is working, but the process is low and costly in recession times

Bank restructuring in Spain is helping to discriminate among institutions.

Solutions at the European level: a road map to a genuine EMU, with a banking and (eventually some type of) fiscal union, and policies from ECB to restore a more normal
functioning of the monetary transmission mechanism.

Solutions at the Spanish level: (1) fiscal adjustment, (2) complete banking restructuring,
and (3) structural reforms to increase potential growth.

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Financial Stability and Fiscal Policy in Europe: The Spanish Economy

  1. 1. Financial Stability and FiscalPolicy in Europe:The Spanish EconomyJorge SiciliaJoint Central Bankers Conference: Unconventional Government PoliciesNew Orleans, November 15-17, 2012
  2. 2. Financial Stability and Fiscal Policy in Europe November 2012Main messages1 Given the limitations in the design of European institutions, heterogeneity of fiscal imbalances and banking conditions in EMU produce a distorting financial fragmentation, exacerbated by market fears of euro breakup and supervisory ring fencing2 Spanish fiscal imbalance has been the result of housing and financial bubbles. Fiscal consolidation is working, but the process is low and costly in recession times3 Bank restructuring in Spain is helping to discriminate among institutions.4 Solutions at the European level: a road map to a genuine EMU, with a banking and (eventually some type of) fiscal union, and policies from ECB to restore a more normal functioning of the monetary transmission mechanism.5 Solutions at the Spanish level: (1) fiscal adjustment, (2) complete banking restructuring, and (3) structural reforms to increase potential growth. Page 2
  3. 3. Financial Stability and Fiscal Policy in Europe November 20121. Financial Stability and Fiscal Policy in EuropeThe fragmentation of financial markets in EMU10-y yields, Spain and Italy, %Source: BBVA Research and Haver ECB, October summit still leaves doubt on The euro is 7.5 Greece. EFSF leverage Inconclusive Greek irreversible. ineffective elections. Risk of Massive bond 7.0 Greek exit purchasing GER, FRA ECB purchases with agreement on PSI SPA and ITA 6.5 conditions bonds 6.0 5.5 EFSF established 5.0 4.5 4.0 ECB’s first LTRO Increasing Doubts on Spain 3.5 (fiscal, reforms, banking) 3.0 Feb-10 Mar-10 May-10 Feb-11 Mar-11 May-11 Feb-12 Mar-12 May-12 Jun-10 Jun-11 Jun-12 Apr-10 Apr-11 Apr-12 Jan-10 Dec-10 Jan-11 Dec-11 Jan-12 Sep-10 Oct-10 Sep-11 Oct-11 Sep-12 Oct-12 Jul-10 Aug-10 Nov-10 Jul-11 Aug-11 Nov-11 Jul-12 Aug-12 Nov-12 Spain Italy Page 3
  4. 4. Financial Stability and Fiscal Policy in Europe November 2012 1. Financial Stability and Fiscal Policy in Europe The fragmentation of financial markets in EMU EMU: Composite measure of financial fragmentation* Source: Bloomberg and BBVA Research6,05,0 Country risk premia in periphery reflect imbalances heterogeneity, but not only4,03,0 Imbalances have interacted with the convertibility risk,2,0 contributing to exacerbate financial tensions1,0 The ECB announcement (OMT) has significantly0,0 reduced convertibility risk-1,0 Jan-09 Mar-09 May-09 Jul-09 Sep-09 Jan-10 Mar-10 May-10 Jul-10 Sep-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-09 Nov-10 Nov-11 * Components; (i) the cross country coefficient of variation of bank lending rates to corporates and households (average) (ii) the Target 2 balances of surplus (iii) gross liquidity provision by Eurosystem as a share of bank assets and (iv) the interquartile range of Euro area countries’ two-year government bond yields. To combine these varied indicators, we calculate a Z-score for each, and then estimate the first principal component of these Z-scores Page 4
  5. 5. Financial Stability and Fiscal Policy in Europe November 2012 1. Financial Stability and Fiscal Policy in Europe The fragmentation of financial markets in EMU EMU: Change in interest rate on new bank loans (In basis points, December 2010 to July 2012) Source: ECB, IMF and BBVA Research 140 120 The monetary policy transmission mechanism in IT Europe relies in banks, which reflect the tensions in 100 funding in their lending conditions PT 80 Households loans SP 60 CY But there is a very long way to go to return to the IRE 40 previous level of financial integration FR 20 0 NTH AU Heterogeneity among countries will remain, mainly on -20 FI BE two fronts: fiscal and banking sector GER -40 -60 -80 -60 -40 -20 0 20 40 60 80 100 Corporate loans* Not including ongoing merger processes and fiscal credit. With them, €54bn Page 5
  6. 6. Financial Stability and Fiscal Policy in Europe November 20121. Financial Stability and Fiscal Policy in EuropeSpanish imbalances in European perspectiveFiscal Imbalances (% GDP) Banking imbalances : capital injections and marketSource: BBVA Research based on AMECO openness Source: BBVA Reaerch based on European Commissionand ECB 15% IE (43%) 13% Public Capital Injection (%GDP) 11% CY 9% EL 7% LU BE 5% PT ES NL 3% AU DE 1% SI ITMT FR SK FI -1%-80% -60% -40% -20% 0% 20% 40% 60% Target Position (%GDP) Page 6
  7. 7. Financial Stability and Fiscal Policy in Europe November 20121. Financial Stability and Fiscal Policy in EuropeThe three faces of the housing and financial bubbleSpain: Value added growth by sectors (%y/y) Explanatory factorsFuente: BBVA Research a partir de INE Low real interest rates (EMU, risk under-pricing) and population growth due to immigration Economic growth driven by strong demand. Potential growth of rest of sectors close to 2% Unlimited liquidity in international financial markets, searching for low risk financial assets Banks: high competition in volumes with low prices. Savings banks allowed to operate out of original regions and influenced by politics A simple type of financial engineering: increase of mortgages’ term and LTV with low interest rates Page 7
  8. 8. Financial Stability and Fiscal Policy in Europe November 20121. Financial Stability and Fiscal Policy in EuropeThe three faces of the housing and financial bubble Credit to Private Sector Spain: current account balance and capital flows (% GDP) (% of GDP) Source: BBVA Reaerch based on Bank of Spain and ECB Source: BBVA Research based on Bank of Spain data180% 43% 40 12160% 35 10 36% 30 08140% Real 25 20 06120% Estate 13% 89% 15 04100% 77% 10 5 0280% 0 00 53% 49% -5 -0260% 44% -10 41% -04 -1540% 63% 62% -20 -0620% 30% 29% 38% 40% -25 -08 -30 10% -10 0% 7% 6% 7% 7% 6% -35 Dec-00 Dec-08 Sep-12 Dec-00 Dec-08 Sep-12 -40 -12 Oct-10 Oct-01 Oct-06 Oct-07 Oct-11 Apr-03 Oct-03 Apr-09 Oct-09 Oct-12 (e) Apr-02 Oct-02 Apr-04 Oct-04 Apr-05 Oct-05 Apr-12 Oct-00 Apr-08 Oct-08 Apr-10 Apr-01 Apr-11 Apr-06 Apr-07 Spain EMU Eurosystem Rest Consumption Housing Businesses FDI inflows Current account (calculated as a residual; rhs axis) Page 8
  9. 9. Financial Stability and Fiscal Policy in Europe November 20122. Fiscal PolicyThe response of the fiscal balance: the bubble Spain: Tax base for corporates and VAT as % of GDP Source: AMECO and BBVA Research 20,0 18,0 16,0 The housing and financial bubble gave place to 14,0 extraordinary revenues for the public sector: 12,0 10,0 (1) VAT for total price of houses, (2) corporate taxes of financial and real estate companies, (3) import taxes 8,0 due to the huge current account deficit 6,0 4,0 Despite the fact that these revenues were extraordinary, public spending increased in the same amount, 2,0 particularly in the case of regional governments 0,0 1990 1998 1991 1983 1989 1996 1997 2006 2007 1993 1999 2003 2009 1982 1984 1985 1992 1994 1995 2002 2004 2005 1980 1988 2000 2008 2010 1981 2001 2011 e 1986 1987 Dweling purchase operation of VAT Consolidated tax base of Corporate Tax Page 9
  10. 10. Financial Stability and Fiscal Policy in Europe November 20122. Fiscal PolicyThe response of the fiscal balance: the adjustment Surpluses in 2005-7 based on extraordinary revenues, but structural deficit above 1.5% of GDP With the crisis all these revenues disappeared (below their steady state values) and the Government implemented expansionary fiscal policies Since 2009 a significant fiscal consolidation process begun. In 2014 if target achieved, better structural deficit than in 2007. Page 10
  11. 11. Financial Stability and Fiscal Policy in Europe November 20122. Fiscal PolicyFiscal consolidation: composition and multipliersSpain: fiscal adjustment and GDP growthSource: BBVA Research based on INE 5 4 Composition of fiscal adjustment towards 2014: 25% revenues measures, 75% expenditure measures 3 2 Despite the significant adjustment expected in 2012 (around 4%of GDP in measures), the economy will only contract by around 1,4% 10 Debate on fiscal multipliers-1-2 2011 2012 2011 2012 Fscal adjustment (in GDP pp) GDP growth, % Page 11
  12. 12. Financial Stability and Fiscal Policy in Europe November 20123. The financial sectorBanks’ weaknesses became apparent after the bubble 1. The risk of credit portfolios was underestimated: NPL represented in June 2012 16% of GDP 2. Branches and employment also boomed: 25% of excess capacity 3. Too much reliance on wholesale funding: 35% of total banking assets in 2012 4. Too much reliance on ECB funding: 35% of GDP Page 12
  13. 13. Financial Stability and Fiscal Policy in Europe November 20123. The financial sectorThe MoU: a comprehensive and definitive plan After a slow restructuring process, the MoU is a comprehensive and definitive plan 1. Solvency: The €100bn credit line exceeds the foreseeable needs (€59bn in bottom up stress test) 2. Cleaning-up of balance sheets will be further enhanced. Tremendous provisioning effort with minimum public funds 3. Bad bank: segregation of real estate assets will enhance transparency and focus on banking business 4. Mergers: further consolidation in the sector with resolution of non-viable entities and restructuring of ailing entities. 5. A new framework of crisis management, bank restructuring and resolution, with burden sharing Page 13
  14. 14. Financial Stability and Fiscal Policy in Europe November 20123. The financial sectorStress test results: a very heterogeneous sectorCapital needs, adverse scenario* (€bn)Source: Bank of Spain30 With these results, an important step of the20 restructuring process has been completed € 59bn10 Entities will present recapitalization plans, and 0 public capital injection will be around €40bn-10-20 The heterogeneity of the system is confirmed:-30 Solvent institutions manage 70% of the assets BBVA Kutxabank NCG Banco Sabadell+CAM Popular Catalunyabank Caja3 CEISS Bankinter Bankia-BFA Ibercaja Liberbank BMN Unicaja Grupo Santander Caixabank+Cívica Banco de Valencia According to Bank of Spain, non-viable entities will be sold, but not liquidated * Not including ongoing merger processes and fiscal credit. With them, €54bn Page 14
  15. 15. Financial Stability and Fiscal Policy in Europe November 20123. The financial sectorThe future: drivers and determinants Deleveraging Regulation • Credit/GDP: from 160% to • More capital and liquidity 110% • Alternatives to bail-out for • Convergence: 5-10 years resolution Liquidity Profitability • ‘Back to basics’: deposits • Retail: (-) volumes (+) prices will play a more important • Wholesale: (-) liquidity role (+) risk aversion • Banking union will avoid • Higher provisions finacial fragmentation Page 15
  16. 16. Financial Stability and Fiscal Policy in Europe November 20124. The solution at the European levelThe road map to a more genuine EMU • Fiscal rule (fiscal compact) • Surveillance of all imbalances (European Semester) Measures adopted • Permanent rescue fund (ESM) • ECB: a credible and effective backstop (OMT) Short run: pending on approval • Road map to a European banking supervision Medium run advances on • Periphery countries: deleveraging and reforms integration: political agreement • European level solutions: implementations of the banking union between core & periphery with a common supervision and direct bank recapitalization (ESM) The final stage: • Fiscal union: sovereign debt mutualization & Treasury A more stable monetary and • Complete banking union: single resolution mechanism and deposit economic union guarantee Page 16
  17. 17. Financial Stability and Fiscal Policy in Europe November 20125. The solution at the Spanish levelThe quest for growth to correct imbalancesSpain: public debt sensitivity to differentassumptions (% of GDP)Source: BBVA Research and Minhap110100 GDP growth is crucial for the correction of imbalances (deficit, debt, credit and NPL) 90 80 70 Illustrative Examples: public debts sustainability exercises 60 Spain Baseline 50 Spain Baseline +100 bp risk premmia 40 Spain Baseline -1pp of growth No margin of maneuver for demand policies: Spain baseline + both risks supply policies needed 30 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Assumptions: averages (2012-2018) Primary Public Spread with GDP Nominal Surplus (+) / Gemany (pp)* Growth Deficit (-) Macro Baseline 278 2.6 0.9 Page 17
  18. 18. Financial Stability and Fiscal Policy in Europe November 20125. The solution at the Spanish levelStructural reforms: what has been done? Reduce implementation Budget Stability Law, Structural budget targets risk of fiscal policies Reduce long term risks Pension reform that increases progressively retirement age, and on public finances number of working years used to calculate pension. Copayment on medicine expenditures and justice procedures. Reduction of unfair dismissal costs (to 33 days per year worked Labor market from 45), clarify economic dismissals (20 days), prioritize firm agreements Restructuring of financial Sufficiently high backstop, a credible and transparent process, and sector a clear calendar with a specific deadline to end it decisively Improve market Reduction of red tape (open a business). Eliminate electric tariff regulation deficit. Improve tax efficiency Increase of consumption taxes, elimination of tax deduction on home purchases Page 18
  19. 19. Financial Stability and Fiscal Policy in Europe November 20125. The solution at the Spanish levelStructural reforms: what is pending? Reduce implementation Aggressive implementation of Budget Stability Law risks in fiscal policy Reduction of medium Truly Independent, Credible, Budget Agency, further pension term risks on public system reform (Bring forward sustainability factor, promote late finances retirement, etc.) Improve Liberalize energy, telecom, professional services sectors competitiveness Labor market and Improve active labor market policies, dual formation, education Human capital reform Improve property rights of leasers, reduce operating costs of firms Improve regulation (market unity) Promote small firm Alternative sources of funding, centralize instruments growth
  20. 20. Financial Stability and FiscalPolicy in Europe:The Spanish EconomyJorge SiciliaJoint Central Bankers Conference: Unconventional Government PoliciesNew Orleans, November 15-17, 2012

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