Download the full report Spain’s credit vulnerabilities to Covid-19: growth, labour market and public finances

Scope Ratings expects Spain to experience a deep recession, with growth contracting around 8% of GDP this year, followed by a strong rebound in 2021, assuming a gradual recovery of economic activity starting H2 2020.

For now, the coronavirus shock has triggered an unprecedented health and economic crisis in Spain by exposing structural economic weaknesses, from a rigid labour market characterised by extensive use of temporary contracts to the lack of structural fiscal adjustments made over previous years of favourable economic conditions. In turn, the pandemic has revealed the costs of Spain’s political inertia of recent years during which the country’s political fragmentation – notably, a series of administrations led by parties without a parliamentary majority – has held back economic reforms.

At the same time, the Covid-19 shock also highlights the strong European institutional support for Spain, ensuring for now that the country has escaped a liquidity crisis.

“The ECB’s actions are underpinning favourable market access for euro area countries, which is crucial for avoiding a liquidity crisis in the short-term as well as for supporting debt sustainability over the medium term,” says Alvise Lennkh, director at Scope.

This is a fundamental difference, in terms of the severity and timing of credit-implications, compared with developments, for example, during the euro area crisis in 2012, when the return on benchmark Spanish government securities rose above 7%. Financing rates for Spain have remained favourable, with the 10-year government bond yield below 1% at the time of writing.

“The importance of the euro area architecture in supporting countries’ market access is a fundamental credit strength, especially during this crisis,” says Lennkh.

“Our credit analysis will centre on the materiality and reversibility of the impact of the shock on Spain’s economic and fiscal outlooks,” he says.

The Spanish economy is particularly vulnerable to the pandemic and lockdown-related shocks given the structure of the economy: about 30% of economic activity and 40% of employment relates to tourism and recreation.

A high share of employment in the sectors hardest hit by the pandemic and a widespread use of temporary contracts (22% of all employed) will lead to a significant rise in unemployment, above 18% this year. “This is likely to amplify second-round economic effects, in terms of putting the brakes on future growth and adding pressure on the budget as household incomes deteriorate,” says Giulia Branz, analyst at Scope.

Spain’s fiscal response to the crisis is to date relatively modest compared with other major euro area economies’ such as those of Germany and France, equivalent to about 1.4% of GDP, reflecting limited fiscal space.

Scope now expects the budget deficit to widen to around 8% of GDP, from about 2.5% before the shock, raising the public-debt-to-GDP ratio by around 15pp this year to around 110% of GDP.

“However, so long as yields remain low, as is likely the case given the ECB’s actions, the real problem is less the deficit and more the economic recovery after the crisis. Should fiscal measures prove effective in leading to a faster restart of the economic recovery, this would also support debt sustainability over the medium term.”