2014 Spain’s fiscal adjustment on target; 2015 more challenging

The 2015 deficit target remains at 4.2% of GDP and below 3% of GDP in 2016, by which time the government is expected to reach a primary surplus of nearly 1% of GDP. Public debt is projected to increase to 100.3% of GDP in 2015 from 97.6% of GDP this year, to further increase in 2016, but to fall in 2017 to 98.5% of GDP, as the government plans to deliver a primary surplus of 2.7% of GDP in 2017.

Overall, we think that this year’s deficit target is within reach, especially after the upward revisions in GDP following the shift to the new 2010 accounting standards. The fiscal performance data available year-to-date show that the public sector deficit in H1 14 decreased by 5.5% y/y to 3.4% of GDP. The primary balance decreased by 22% y/y to 1.8% of GDP. There are also fiscal data available through end-July (excluding the local administration which generally lags by 1 month) which also confirm the consolidation trend observed in H1. As a result of the GDP accounting revisions and the government hitting the 2014 fiscal target, we deem the government’s 2014 debt projection (97.6%) as reasonable.

As for next year’s fiscal target, we consider it a bit ambitious. We estimate 2015 GDP growth being marginally below the government baseline (as discussed above) and the structural adjustment that the government will be actually delivering to be close to zero. This translates into an overall estimated deficit of  c.4.6% of GDP against 4.2% of GDP projected by the government. We see downside risks to the 2015 budget, partly because it is an electoral year for local, regional (May) and general (Nov) elections, which could lead to some expenditure slippages. At the same time financing costs could remain very low, possibly even lower than this year if the ECB actually deploys QE on sovereign debt. This year the government has incurred an average cost of debt (at issuance) of 1.8% with an average life of 8.2y for new debt, which brought down the average cost of outstanding debt to 3.6%, while increasing the average life of debt to 6.4y.

The 2015 draft budget details

On the income side, the 2015 draft budget estimates that overall income will increase by 4.3% y/y (nominal GDP is expected to increase by 2.7% y/y). Tax income is expected to grow by 3.5% y/y. The government is planning to cut both the personal and (to a lesser extent) corporate income taxes (PIT and to a lesser extent CIT) by EUR9bn in 2015-16. The average tax rate decrease is 12.5%, but it is geared towards the lower incomes. In particular those earning below EUR24,000 will see their average tax rate drop by 23.5%. This implies a reduction in PIT revenues of 0.3% y/y. In short, the estimated increase in the tax base as a result of the macroeconomic recovery is roughly paid back to tax payers through tax cuts. As for the CIT revenues, they are expected to increase by 5.6% y/y. Among the large taxes, the government expects the VAT revenues to increase the most, by 9.9% y/y to EUR60.2bn (PIT revenues are estimated at EUR72.bn; CIT revenues at EUR23.6bn).

On the expenditure side, the joint expenditure of all ministries, including transfers to social security and the public employment system, would see expenditures fall by 5.1%; excluding these transfers, the ministerial expenditure remains practically unchanged. Overall social expenditure increases by 0.7%; excluding the unemployment benefits, social expenditure actually increases by 3.7% y/y. The share of social expenditure (the lion’s share of expenditures) represents in 2015 53.9% of all expenditures, against 52.7% in 2014. Public pension expenditure increases by 3.2% y/y (to EUR115.7bn); pensions for public sector employees increase by 4.3% y/y (to EUR13.2bn). The government also budgets EUR4.7bn for active labour market policies, ie, an increase of 16.5% y/y.