A EUROMONEY SURVEY - MARCH 1996
Market Background
The tenacity with which Spain has held onto its place in the exchange rate mechanism of the European monetary system since it joined the mechanism in June 1989 is testament to the commitment of the authorities to convergence and integration with other economies in the ERM. All through the currency turmoil of the period between 1992 and 1993, Spain resisted leaving the ERM and has maintained its wide 6% bands around a central Ecu parity, although that parity has been devalued on four occasions since Spain joined the ERM.
Historically, the exchange rate has been dominated by periods of overvaluation. These happened after restrictive monetary policy designed to weigh down on inflation has sucked flows of short-term capital into the country. That was certainly evident in the early 1990s when the peseta sat at the top of the ERM and market players, convinced there would be no adjustment in central parities prior to monetary union, poured short-term flows into what they saw as a one-way bet. In the past, periods of overvaluation and uncompetitiveness have been followed by devaluation.
There have been four devaluations in the past 15 years: a 7% cut in the value of the currency in September 1992 after the UK quit the system and the lira floated, and a subsequent 6% devaluation in November of the same year. This was followed by an 8% devaluation in May 1993 and a 7% devaluation in March last year. The last devaluation was certainly more related to political factors, namely the political scandals in the socialist administration, than to any other specific factors.
The value of the peseta against the Deutschmark has risen considerably since that last devaluation, appreciating by as much as 6%. While there has been some retreat since early in the year, the currency has remained within a range of Pta84/Dm to Pta85/Dm for the first two months of the year. However, whether peseta strength will actually hit Spain's competitiveness is not becoming an issue this time around. While the peseta is a lot stronger than it was a year ago, the scandals of a year ago were at their peak and although the peseta has recently been regularly topping the ERM grid, this is tempered by the fact its central parity is considerably lower than it was before. On most measures of purchasing power parity, the peseta is correctly valued. (Estimates vary on PPP between around Pta83/Dm to Pta86/Dm.)
Economic background
The Maastricht criteria
As yet, Spain has not met any of the Maastricht criteria for eligibility to become part of any monetary union.
One of the biggest hindrances has been the budget deficit, which has averaged 6.6% of GDP since 1993. In 1995 the budget shortfall was almost double the proportion of GDP (3%) specified by the treaty. The targeted 4.4% of GDP for the budget deficit doesn't look unrealistic, whichever party wins the elections on March 3.
Debt was 64.9% of GDP at the end of November 1995, and has been climbing. Around 50% of debt is made up of three-year and five-year government bonds (bonos), 30% in short-term treasury bills and 20% in foreign currency and other accounts. Of the key components of debt, by far the largest is that of public debt, which rose 10.4% to Pta45.38 trillion in the first 11 months of 1995 against the same period in 1994. The debt of the 17 regional administrations climbed by 7.5% to Pta7.3 trillion in the same period, while central government debt rose 11% to Pta3.77 trillion.
Inflation Economic growth is likely to remain subdued, a factor that has contributed to Spain's success in reigning in inflation. Inflation has been one extremely positive factor for the currency, and Spain, in line with other western European economies, has been reaping the benefits of a benign inflationary outlook. In January, consumer price inflation slowed to 3.9%, the lowest annual rise since April 1988. The Bank of Spain is forecasting inflation will remain in a 3.5% to 4% range in the first quarter of 1996, and the bottom end of that range looks achievable by the end of 1996. Underlying inflation, which has been stubbornly high over the past year, is showing signs of slowing, a factor which suggests the slowing inflation rate is not just a result of lower food and energy prices and last year's value added taxation falling out of the index. This underscores the view Spain may at last have made a breakthrough into a new era of lower inflation.
Wage growth has been muted, making a lower-than-expected contribution to inflation, and high levels of unemployment are likely to continue weighing down on wages. The first collective wage agreement of 1996, for the banking sector, secured a nominal rise in wages of 3.5%, falling to 3% next year and 2.75% in 1998. Other sectors are likely to follow suit. Even so, for the Bank of Spain to achieve its longer term official forecasts of inflation at only 3% in 1997, it will need to keep a tight grip on monetary policy.
Unemployment Spain's unemployment problem remains thorny. Rigidity in Spain's labour laws has been blamed at least in part for the fact that 22.7% of the labour force is jobless. If the centre-right Partido Popular does gain power after the elections it will be faced with the problem of balancing the need to cut Spain's budget deficit and the need to introduce measures to cut unemployment in order to maintain its popularity.
Current account Spain's current account position has performed well in 1995, with the current account of the balance of payments actually in surplus by 1.3% of GDP. However, much of this is technical because of Spain's net over-payments to the EU. When these were repaid, they added a massive Pta2 trillion to the country's receipts. Even so, the deficit for 1996 is unlikely to be very large, and at a likely 0.5% of GDP will mark a better trend than ever before.
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