IMF warns of ‘considerable’ risks to Spain economy

The IMF warned Tuesday of “considerable” risks to Spain’s battered economy, saying the authorities had responded robustly to the serious challenges but repairs were incomplete.

Spain faced grave economic risks if it failed to crack down harder on spending, shake up the financial sector and loosen up the labour market, the International Monetary Fund said.

The Fund issued the warning two days after about 200,000 Spaniards took to the streets to protest austerity measures and unemployment, and as markets showed deep concern about euro zone sovereign debt strains as Greece flirted with a possible default.

“The repair of the economy is incomplete and the risks are considerable,” the Washington-based IMF said in a report summarising a review of Spain’s economy by its analysts.

“Downside risks dominate,” it said.

In the short term, investor fears about sovereign risk in the euro zone could grow, raising the costs for Spain to borrow money from the financial markets, it said.

In the medium term, Spain risked a long, slow recovery and stubbornly high unemployment.

“In this scenario, domestic headwinds could intensify, creating a downward cycle of falling house prices, slower bank balance sheet repair, and faster household and corporate deleveraging. Combined with potentially unresponsive labor costs, this could undermine employment growth.”

Spain’s economic crisis, triggered by the 2008 property bubble collapse and the international financial crisis, sent the unemployment rate soaring to 21.29 percent in the first quarter of 2011.

The government and central bank had pushed through a “strong and wide-ranging policy response” over the past year, helping to rebalance the economy, the IMF said.

Spain managed to cut the annual public deficit from 11.1 percent of annual gross domestic product (GDP) in 2009 to 9.2 percent of GDP in 2010, the Fund noted.

But Madrid would likely have to take “additional measures” to meet its medium-term targets of cutting deficits further, and eventually dipping below the European Union’s agreed 3.0-percent ceiling.

The IMF said its own forecasts for growth of 1.5-2.0 percent in the medium term were less optimistic than Spain’s, meaning the authorities would have to find an extra two percent of GDP in savings through 2014.

Spain’s government agreed June 10 to back a bill loosening up the collective bargaining system, part of a slew of hotly debated labour reforms that include cutting the cost of firing workers.

The government has also enacted measures to strengthen bank balance sheets, cut state spending, raise the retirement age and sell off state assets including the national lottery.

But the IMF said the reform agenda remained “challenging and urgent”, with underlying problems such as weak productivity growth and a “dysfunctional labour market” yet to be fully addressed.

“Combined with the risks to the outlook, this means that the reforms to date need to be strengthened,” it said.

The IMF criticised a lack of transparency in semi-autonomous regions’ deficit reporting, and called for a strict application of Madrid’s deficit rules on wayward regional governments.

For the medium term, it also urged a “nationwide comprehensive review” of major spending programs.

Despite “far-reaching” action by Madrid, markets were still nervous about Spain’s banking system and doubtful about whether real estate losses were being fully recognized, the IMF said.