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Thursday, May 14, 2009

Spain's Economy Shrinks At A 7.2% Annual Rate In The First Three Months Of 2009

by Edward Hugh: Barcelona

According to preliminary estimates from the Spanish National Statistics Office published today, GDP contracted by 1.8% in the first three months of 2009 when compared with the last quarter on 2008. This follows a 1.0% drop in Q4 2008. This is equivalent to a 7.2% annualised rate of contraction, which is, of course, sharp.

Over the first quarter of 2008 (that is year on year) GDP decreased by 2.9%, the sharpest decline recorded in almost 40 years. In fact you would need to go back to 1945 to find a year in which the Spanish economy contracted as strongly as it is likely to this year.

The contraction was mainly caused by a very large slump in private domestic demand, a factor which was partially offset by a surge in government spending, and partly by the positive contribution of external trade, which (ironically) since imports fell more rapidly than exports as the current account deficit closes meant that less demand "leaked out". Of course, such declines in imports also reflect declines in living standards for the population at large.

Basically, even if the output were to remain stationary for the remaining three quarters of the year (which it obviosuly won't), GDP would still fall by 2.6% over the year. However, since the economy will obviously still continue to contract, it is much more realistic to anticipate a fall in GDP of between 5% and 7% for the year as a whole.

The current recession is likely to be a long one. The current financial crisis, which, as I explained in my last post, has simply served to bring into focus the inherent unsustainability of the previous growth model: deep housing crisis, high indebtedness of the private sector, weak price competitiveness, very high unemployment… S0 as I say, ECB and EU Commission help will need to be on their way, and massive structural reforms now seem inevitable.

Despite some recent positive development (decrease in interest rates and prices, fiscal stimulus measures, slight improvement in confidence, ECB purchase of cédulas hipotecarias…), Spain will not recover even as other economies begin to breathe again. The worst year undoubtedly could be 2011, and the unemployment rate by that stage could reach anywhere between 25% and 30% of the labour force if you accept the March 17.5% number as good.

Bottom line, a complete nightmare, with the only bright spot being imminent control of the political system being assumed in Brussels and Frankfurt, since along with the economy the political "automatic stabiliser" system also seems to be broken. Could, I ask myself, recent events in Hungary give us any indication of the most likely way out of this mess.

Spain's Contraction Moderates In April

The rate of contraction in the Spanish economy did slow slightly in April, but I wouldn't rush to draw anything more than a bit of cold comfort from that little detail, since economic activity is still declining at one of the fastest rates among major developed economies. One measure of the slight easing of the pain can be found in the EU Sentiment Index, which registered a 5 month high of 71.9 in April, up ever so slightly, but like every other indicator we are looking at, still way way below levels you would expect to see in more "normal" times.

Sharp Reduction In The Rate Of Global Manufacturing Contraction In April

The Spanish economy, like any other, is to some extent sensitive to movements elsewhere in the global economy, and it is not unimportant to note that the JPMorgan Global Manufacturing Purchasing Managers’ Index (PMI) - which is based on surveys covering over 7,500 purchasing executives in 26 countries which between them account for an estimated 83% of global manufacturing output - posted a reading of 41.8 in April, thus coming in well below the critical 50 neutral mark separating expansion from contraction for the 11th successive month. In rising from the 37.3 level shown in March, the PMI managed to post its largest month-on-month improvement in the series history attaining in the process a seven-month high. The sharpest point in the contraction was last December, when the indicator hit the all time series low of 33.7.

The picture painted by the index was, however, a mixed one, and emerging economies generally fared rather better than developed countries. This was especially the case in China and India, the only two countries covered by the survey to actually to report increases either for output or new orders. Rates of contraction in output eased to a seven-month low in the United States and to the weakest since last October in the euro area. And please note, output and new orders in Spain and Japan continued to fall significantly faster than the global average, although even in these cases the contraction rate improved markedly over earlier rock bottom lows.


The rate of decline in Spanish manufacturing slowed again in April (for the fourth consecutive month), and April's PMI rose to 34.6 from 32.9 in March. This is now significantly up from December's record low of 28.5, but the contraction remained very strong, and this was still one of the lowest readings globally.

The pace of deterioration eased in output, new orders and employment, though stocks of purchases and finished goods hit series lows. Survey responses suggested the rate of decline in the badly hit jobs market had eased slightly from earlier falls, but the reading still remained well below growth levels, and Spain's economy continues to bleed jobs, adding to levels of employment which the latest labour force survey data suggests has now risen above 4 million (or 17.3% of the economically active population). Staffing levels have declined every month since September 2007, according to survey records.

The PMI - which is simply a survey indicator - backs up the findings of Spain's own National Institute of Statistics, who announced last week that the industrial production in March declined by a calendar adjusted 24.7% year-over-year, after falling 22.5% in February.

The seasonally adjusted index gives a dramatic and clear indication of the long march into decline which currently characterises Spanish industry.

Services Also Contracts More Slowly

The contraction in global services activity also seems to be easing up, following the pattern displayed by the manufacturing sector, and the JPMorgan Global Services Business Activity Index rose for the second month running in April, registering at 43.8 its highest level since last September. It is important to keep clearly in mind, however, that the headline index remained well below the critical dividing line of 50 which separates growth from contraction, and thus we are still firmly within global recession territory. So stabilistation in the contraction is not the same thing as recovery.


Spanish service sector activity continued to decline in April although as elsewhere the rate was much slower than in previous months. The headline activity index stood at 42.5, still well below the critical 50 level indicating growth, but way above 34.1 in March and November's record low of 28.2. April's figure was in fact the highest recorded since May 2008 but nevertheless marked the 16th consecutive month of contraction as the deep recession weighed on new orders and jobs. According to Andrew Harker ,economist at Markit Economics, "Jobs continued to be lost at a fast pace, indicating that the labour market remains a key source of weakness."

The survey showed staffing levels declined in April for the 14th month running as service providers cut jobs due to lower activity and to keep costs down. Hotel and restaurant firms were the hardest hit. However despite Spain's deep and ongoing economic crisis, April's survey was marked by confidence levels not seen in 15 months. Many of those surveyed by Markit said they believed the crisis would end within a year, with two-fifths of panellists expecting activity to be higher in 12 months and just 22 percent forecasting lower activity. However, companies remained relatively cautious about short term economic prospects.

The service sector thus is showing a significantly sharper rebound from the record declines of the last few months than is to be seen in the manufacturing sector, which continued to contract at a rapid pace in April.

Prices continue to fall, and services output prices registered the third-fastest decline in the survey's history, second only to February and March this year, with those surveyed citing increased competition for new business and pressure from clients. Service providers also reported falls in input costs due to reduced labour costs and lower prices from suppliers, but, according to Markit, the decrease here was less marked than that for output prices.

House Sales Continue To Fall (More Slowly)

Spanish house sales fell again in March, but as the desperate seekers of green shoots are so eager to point out, at the slowest pace in the last 11 months, according to data from the National Statistics Institute. Home sales fell 24.3 percent to 34,895 in March in what for what was the 13th straight month of decline, but the level was below the rates of 37.5 percent in February and 38.6 percent in January. Of course, once contractions have been running for more than twelve months you start to get what are known in the trade as "base effects" (since this years figure is simply down from an already reduced number the year before), and it is possibly more interesting to follow the actual number of sales, which you can see on a three monthly average basis (to iron out some of the seasonal quirks in the data - an old economists "quick'n dirty" trick) in the chart below. It's not too clear that we can talk about any "easing" in the recession looking at this chart. Even with monthly sales running 10,000 or so higher than the present level, the construction industry would still be in a huge slump.

In fact some increase in sales is only to be expected as banks repossess homes from houseowners and property developers due to the soaring rate of debt defaults, only then to put them on the market at ever lower prices. And again, the March housing results were influenced by the statistical impact of a sharp, 39 percent fall in March 2008 sales (the base effect) and the fact Easter fell in March last year. Nonetheless the number of sales was slightly up on February.

So what we are talking about is less deterioration, not any visible improvement.

While The Number Of Mortgages Goes On Dropping

The average value of the mortgages signed in February was down by 12.1% year on year and reached 148,798 euros The number of mortgages that change conditions increases 24.6%, while registered cancellations decrease 29.7% During the month of February, the average amount per mortgage constituted stood at 148,798 euros, 12.1% less than for the same month the previous year, and 1.2% lower than that recorded in January 2009. The average value of housing mortgages was 123,643 euros, down 17.0% year on year, but up 1.3% on January.

The number of new mortgages was down 28.5% year on year.

While the total value of mortgages issued was down 37.2%.

Bottom Line: No End In Sight (Far From It)

So basically, while it is true to say that we undoubtedly saw a moderation in a number of indicators in April, this is still a far cry from any kind of green (or even Brussels) sprout, or anything vaguely resembling one. And the key to the story is to go back to where we started - the credit crunch. It may all seem like a long time ago now (like in August 2007) but all this started after many years of exaggerated bank lending to Spanish households and corporates sent property prices, and with them relative wages and prices, way out of line with the true net worth of the underlying economy and labour force. It is like Spain suddenly developed a version of "twisted vertebrate illness". And now all these distortions need to correct themselves. And since for two years now the Spanish government and people have vigourously failed to face up to the underlying cause of the problem, there is little alternative at this late stage in the game to a pretty violent correction.

The heart of it all has been excessive bank lending, lending which basically came from the exterior (since Spain was low on domestically generated saving, everyone wanted to "invest" in property) and basically made possible and funded a large external deficit (which is now also closing, again painfully, since exports are not rising, and all the work will be done by falling imports and living standards). Basically to get 4% annual GDP growth Spain's corporates and households were increasing borrowing at a rate of around 20% per annum. The credit crunch has put a stop to all that, and year on year household borrowing is gradually dropping to zero (before going negative, see chart below).

In fact total household borrowing is now below the level of June 2008, so the rate will turn negative in June at the latest.

And of course the same thing is happening with housing loans, and total mortgages outstanding have now dropped for the last four months.

The rate of decline in lending to corporates has been slower (all those non performing loans building up, since more debt and less revenue and profit ultimately don't add up), but the key moment will come when the banks can no longer hang on to all the debt and they have to start to let things go in earnest.

In fact, total Spanish debt reached something like 250% of GDP before this burst (with a 20% y-o-y growth rate in loans and a 10% of GDP annual current account deficit) and this level is evidently completely not sustainable. During this correction the net indebtedness of the Spanish nation will have to drop significantly as a proportion of GDP. Ironically, as GDP contracts, debt has still been rising, as government has simply stepped in to take on the burden with more or more state borrowing. Ultimately this won't work. The EU commission estimate that the Spanish deficit will hit around 9% of GDP this year, and my guess is that this is the last year where such abuse of borrowing will be tolerated. I say abuse, since while no one would argue Spain doesn't need to run deficits at this point, there is simply no sense at all in running them without a plan, simply to buy time, and hope. This in Spanish is called a "huida hacia adelante", and this is exactly what Spain's policy has been about - running ever faster to try to catch up with your own shadow.

So as I say, debt to GDP is most probably rising even now, but it is obviously going to have to come substantially down, which is why I insist on saying, this correction has hardly even gotten underway yet.