Spain:Navigating through an Economic Crisis

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Spain’s financial crisis was triggered by a decade long real estate boom and the subsequent collapse of the sector. Once the funds inflow into the housing market stopped, the housing bubble burst, unemployment soared, and the economy was impacted. After Spain joined the Eurozone in 1999, the interest rates fell. For many years, the interest rates were less than the inflation rate in the country. The value of property began to increase. Construction activity also witnessed a boom. The government encouraged people to buy houses and own property. In 2005, several local governments reclassified land from rural to urban, making large tracts of land available for real estate development..

"In 2009, RR de Acuna y Asociados, a Madrid-based consultancy, reported that Spain had 565,000 completed, unsold housing units, and 358,000 abandoned units. It also estimated that around 1.3 million housing units were up for sale......"

"The Spanish regional savings and loan banks, called cajas, contributed to 50% of the country’s banking system. They were relatively unregulated and were not required to disclose information like collateral on loans, repayment history, etc. The cajas were not traded publicly and were controlled by regional politicians instead of shareholders. The depth of the cajas’ involvement in the real estate market could not be gauged by the government due to non-disclosure of the information. Before 2007, there was a huge inflow of credit into Spanish banks and cajas from northern Europe, particularly German banks, and it flowed into the housing sector......"

"When the housing bubble was growing bigger before 2007, the construction sector was booming, providing employment to thousands of youth. The construction industry was considered neither efficient nor technically advanced. Still, it managed to contribute a major chunk of the GDP of the country by providing employment to high school and college dropouts. The youth preferred to take a decent-paying temporary construction job to studying for a university degree. At the end of 2007, the builders of the country employed 13% of the Spanish workforce. The booming housing sector lowered unemployment in the country and also attracted migrant workers. Between 1996 and 2007, 4.2 million migrants came to Spain to work in the construction industry......"

"Prior to 2007, the construction industry was driving the boom in Spain’s economy, particularly through the housing sector, and it enjoyed almost a decade of growth. To put it in perspective, Spain, which had one-fifth the UK’s total population, built five times more properties than the UK. Property prices rose by 60% from 2006 to 2008. During 1996-2007, the sector grew by 5% annually and produced 5.7 million new housing units which accounted for 30% more homes than Spain ever had. The research department of the Bank of Spain indicated that houses in Spain were overvalued. In 2003, the overvaluation ranged from 8% to 20%, going up to 24% to 35% in 2004......"

"Spain, a member of the European Union since 1986 and the Eurozone since 1999, had a mixed capitalist economy and was the 12th largest economy of the world as of 2010. Since the boom period of 1999 to 2007, the economy grew at an average of 3.7% per year and from 2007, it shrunk with an annual growth rate of 1%. There were steep fluctuations in the percentage GDP growth from 2003-2012, with it varying from 3.1% in 2003 to -1.4% in 2012. (Refer to Exhibit IV for the percentage Spain’s GDP growth). Spain’s GDP again fell by another 0.5% in the first quarter of 2013. The country suffered from various imbalances like current account deficit and indebtedness of the private sector with the increase in public debt......"

"Fondo De Restructuracion Ordenada Bancaria (FROB), the Fund for the Orderly Restructuring of the Banking sector, was an institution under public law founded in Spain in 2009. It presided over the restructuring and mergers of the cajas in the country. In order to make the working of the cajas more efficient, FROB gave loans to 45 cajas which merged with each other to form 15 cajas. In 2010, a Catholic Church run savings bank ‘Cajasur’ was taken over by FROB and later the same year, government equipped FROB with extra powers to provide cash to lenders to raise their capital ratios up to minimum levels......"

"In order to revive people’s confidence in the government and cover up the public deficit, the then Prime Minister of Spain, José Luis Rodríguez Zapatero, approved a €15 billion austerity arrangement in May 2010. This austerity program was projected as capable of reducing the public deficit from 11% of GDP to 6% by 2011; however, it also involved a 5% cut in salaries in the public sector. The Spanish government opted for the cost-cutting plan which involved suspension of automatic inflation adjustment for pensions, cutting the payout to parents for birth of children, and reducing the funding of regional governments by €1.2 billion. In the first quarter of 2010, the country moved out of a two-year recession....."

"In order to revive people’s confidence in the government and cover up the public deficit, the then Prime Minister of Spain, José Luis Rodríguez Zapatero, approved a €15 billion austerity arrangement in May 2010. This austerity program was projected as capable of reducing the public deficit from 11% of GDP to 6% by 2011; however, it also involved a 5% cut in salaries in the public sector. The Spanish government opted for the cost-cutting plan which involved suspension of automatic inflation adjustment for pensions, cutting the payout to parents for birth of children, and reducing the funding of regional governments by €1.2 billion. In the first quarter of 2010, the country moved out of a two-year recession....."

Exhibit I: The Maastricht Treaty Criteria
Exhibit II: The Impact of Eurozone Debt Crisis on Spain
Exhibit III: Unemployment Rate* (Percentage)
Exhibit IV: GDP Growth Rate*
Exhibit V: Spain’s Gross Debt as percent of GDP*
Exhibit VI: Credit Rating Agencies - Rating scale

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