The risk of an inadequate policy response emphasizes even more the need for fast disbursements from the EU recovery fund. Forget about the legacy clusters that emerged in the Eurozone debt crisis: Following the pandemic reshuffling, the core is still formed by solid export-based economies (
Germany, Austria,
Finland) but it is increasingly thinning as
France looks to exit the Covid-19 crisis clearly weakened and
the Netherlands may struggle to put forward an adequate policy response. For the CEE countries, their position as Europe’s manufacturing hub contains economic risks, but they face a major sanitary challenge combined with elevated political risks. Meanwhile,
Greece and Portugal still give reason for concern, but Spain is the new
Italy having switched from poster to problem child. See figure 6 for the summary of the three risk clusters – sanitary, economic and political - by country.
Spain at a crossroads: ambitious fiscal stimulus, record high political fragmentation
Spain’s political gridlock is only making the sanitary crisis worse, as regional and central governments have failed to agree on a nationwide strategy to curb the second wave. Political tensions on the content of the 2021 budget have also delayed much-needed stimulus measures and reforms that would boost the economic recovery. With the return of targeted lockdowns and strict social distancing to fight rising Covid-19 infections, we expect Spain to see the largest GDP contraction in 2020, far worse than all of its Eurozone peers. We expect growth to contract in Q4. A moderately strict lockdown (50% of that seen in the spring) in Spain’s Madrid and Catalonia regions (40% of Spain’s GDP) should lead to a -1.3% q/q contraction, putting an abrupt halt to the recovery initiated in June.
Spain has recently presented a proposal for a EUR72bn stimulus package (6% of 2019 GDP), in part financed with the EUR140bn it should receive from the EU Recovery fund. This ambitious plan could boost GDP growth by 4.7pp in the next three years. Detailed policies are yet to be announced, but the heavy focus towards public investment (green growth, infrastructure, innovation and education) could yield a higher fiscal multiplier than the stimulus packages of its Eurozone peers. While this is an encouraging step, political hurdles to implementation remain as left- and right-wing parties struggle to find common policy denominators. Parliament could eventually vote a watered-down budget. The risk is for the recovery in 2021 to be only a mechanical rebound, making Spain lag behind its neighbors thereafter.
Fiscal policy: Clearly this is not the moment for complacency. Decisive action across the entire policy spectrum - including health, fiscal and monetary (in that order) - and at both national and supranational level, is urgently needed to keep centrifugal tendencies at bay. Certainly, the ECB will make sure to continue to cap sovereign risk premia, but this hardly qualifies as a sufficient nor sustainable policy response. At best it will help buy time for a meaningful fiscal response to bear fruit. After all, without more structural policy initiatives, an ever more expansive ECB policy comes with risks attached, ranging from mounting financial stability concerns to a rising politicization and in turn loss of independence. The focus must shift from relying on an ECB that is ever “lower for longer” to a fiscal policy that goes for “structurally stronger” by underpinning a credible growth strategy centered on the transition towards a green and digital economy. And make no mistake: given the task at hand, the necessary fiscal policy support will resemble a marathon more than a sprint.
Figure 6 - Risk clusters summary