The Bank of Spain on Tuesday recommended drafting a medium-term plan with adjustment measures to offset the high debt (“the highest in many decades”) that the coronavirus health crisis will be leaving behind.
The proposed fiscal adjustments, to be adopted at a later time, include raising taxes. The central bank is specifically focusing on the reduced rates of value-added tax (VAT), on special taxes – particularly environmental levies, where there is a lot of room for action – and on existing loopholes in corporate tax.
In its Annual Report, the institution also recommends adopting the public spending review proposals drafted by Airef, a state agency that monitors fiscal responsibility. It additionally proposes reforms to the Social Security system to guarantee public pensions, which are hampered by high deficit levels.
“An ambitious program is required to reconstruct the multiannual fiscal margin within a strategy of growth and in a gradual way,” reads the report.
A record contraction
The announcement coincided with new figures that illustrate the economic impact of the Covid-19 pandemic in Spain. On Tuesday, the National Statistics Institute (INE) confirmed that gross domestic product (GDP) contracted 5.2% between January and March as a result of the lockdown.
This is the worst figure in the INE’s records, which go back to 1970. The closest thing was the first quarter of 2009, during the previous economic crisis, when the Spanish economy shrank 2.6%, half as much as this year. The number is only comparable to the postwar years in the mid-20th century, according to calculations made by historians.
And if the first-quarter data is bad, the second quarter is expected to be worse, since it includes two weeks when the economy nearly came to a full stop before confinement measures were gradually lifted again. Until official figures are provided, the Bank of Spain has estimated that the economy plummeted by around 20% between April and June.
The lockdown – one of the world’s strictest – also had another effect: people spent less between January and March, and the household saving rate rose to 11.2 % of disposable income, the highest figure since the third quarter of 2009, when Spain was going through a deep economic crisis.
Whereas Kristalina Georgieva, the head of the International Monetary Fund (IMF), was recently telling governments to “spend as much as you can,” Bank of Spain Governor Pablo Hernández de Cos has only ventured to say that “a premature removal of stimulus measures would increase the risk of longer-lasting damage.”
Despite the cautious tones, the message remains clear: there will be no repeat adoption of the strict austerity measures introduced a decade ago during the economic crisis, and which have gone down as one of the most disastrous episodes in European economic policy.
“At this time there is no question that fiscal policy must act resolutely to save jobs and businesses, and thus prevent enormous social and economic costs in the medium to long term,” said Hernández de Cos.
But while now is not the right time to make spending cuts or raise taxes to address the ballooning debt and deficit levels, that day will inexorably come, and the Bank of Spain wants to be ready for it.
“Once the crisis has been overcome, we will find ourselves with the highest public debt in many decades. We will then have to embark on deep budgetary reforms to reduce indebtedness and leave some margin to deal with potential future difficulties,” said the governor.
“Once the recovery has taken hold, it will be necessary to implement a fiscal consolidation program to change the dynamics of the public debt-to-GDP ratio,” added the institution’s director of policy studies, Óscar Arce, at the report presentation.
In the absence of a fiscal effort, he warned, this ratio could soar beyond 110% of GDP in 2030 “even in the best-case scenario,” after hitting 120% this year. If, on the contrary, Spain embarks on “a structural fiscal effort” and meets its EU deficit target of below 3% of GDP, debt would fall under 100% of Spain’s economic output.
English version by Susana Urra.