Spain: short-term gloom, medium-term hope
Spain was the euro area country hit hardest by the coronavirus-induced recession in H1 2020. In our baseline scenario, we see the Spanish economy contracting by 10.5% in 2020 and rebounding by 6.0% in 2021. GDP should return to its 2019 pre-crisis level in 2023 in our view, but risks remain tilted to the downside mainly due to the recent resurgence of new covid-19 cases and related restrictions.
While prospects for the Spanish economy look gloomy in the short term, over the medium-term things could improve thanks to the EU’s recovery fund, labelled Next Generation EU (NGEU). Given the severity of the impact of covid-19 on its economy, Spain will be one of the main beneficiaries of the NGEU. Spanish prime minister Pedro Sánchez unveiled last week the details of a recovery plan called “España Puede (Spain Can)", designed to secure the €140bn it calculates it should receive from the NGEU.
He also committed to include €27bn of expected NGEU funds up front in the 2021 Spanish budget. Yet Spain has been rolling over its 2018 budget for the last three years, as political fragmentation has made approval of a new one impossible. However, it is probable that pressure from Brussels and economic interests will push politicians towards a budgetary agreement this time. The government’s plan is ambitious but, as in other countries, the main risk will be implementation.
Despite the rise in new infections, Spanish sovereign bond yields have continued to fall, with the 10-year yield at 0.14% on October 12, close to an all-time low. Nonetheless, political fragmentation in Spain pushed S&P Global to downgrade the outlook on Spain’s sovereign rating from stable to negative in September.
When it comes to the 10-year Spanish government bond spread over the Bund, market participants appear to require a 20 bps premium over what is suggested by Spain’s rating. This is probably linked to Spain’s difficulties in containing the spread of the virus, and to the weakness of the minority government. We continue to forecast the 10-year Spanish spread to end the year close to 80 bps, slightly above recent levels (69 bps on October 12).
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