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Spain seeks soft landing as economists forecast steep slowdown

For a decade, Spaniards have built an economic boom on cheap credit and a housing and construction bonanza.
With their economy outpacing euro zone average growth, year after year, it was easy to ignore roaring inflation and uncompetitive industries.
But with the property sector cooling and economists forecasting a steep slowdown in 2007 growth, the Spanish are becoming more worried about their lopsided economy.
Analysts warn Spain may soon be on track for economic mediocrity unless it shifts away from bricks and mortar into competitive service industries and value-added exports.
Some even predict an eventual housing market crash.
“We are at the peak of this growth cycle,” says Juan de Lucio, head of research at Spain’s Chambers of Commerce. “We’ve got to look at our imbalances because otherwise we’re going to pay for them.”
On the surface, the Spanish economy is the envy of its neighbours. Annual growth has averaged 3.6% over the past decade and the country has gone from a relative backwater to representing about 11% of the euro zone economy.
Look closer, and analysts see a lopsided economy too dependent on consumer spending and housing investment for growth, and weak in exports.
Inflation is running at 4%, twice the European Central Bank’s target ceiling level of 2% and the highest rate in the 12-nation euro zone.
Membership of the euro zone in 1998 allowed Spain to load up on cheap credit as the European Central Bank geared interest rates to the slower growing German and French economies.
The Spanish sank money into real estate. Housing prices have risen 130% since 1997 and construction has overtaken tourism as Spain’s strongest sector, representing 12% of gross domestic product (GDP), according to the Bank of Spain.
In cities like Madrid, the property sector is finally building more first homes than Spaniards need, or can afford, according to real estate consultants.
Spanish GDP growth is expected to fall from around 3.4% this year to between 2.5% and 3% in 2007 as higher interest rates increase financing costs and eat into disposable incomes.
“There is very little to stop this runaway train until there is just too much stuff on the market and prices collapse under their own weight,” says Charles Dumas, chief economist at Lombard Street Research.
Analysts have long warned of Spain’s fragile economic foundations. The euro zone’s fourth largest economy cannot produce as much as it consumes and closes the gap with imports and borrowing to cover the financial shortfall.
Spain’s current account deficit is expected to climb above 8% of GDP in 2006 and become the second largest among industrialised countries in absolute terms, after the US, and the largest in percentage terms.
Preventing a housing crash are still relatively low interest rates and 11% population growth in the last eight years on a wave of immigration, say analysts.
“It’s a slowdown, there is no bubble,” says property developer Jose Miguel Dominguez at Madrid’s GCM group.
Spanish economists say the country has a two-year window of opportunity to cut its over-dependence on the housing market. They talk of a silver lining in the domestic demand slowdown.
Many see a soft landing if inflation falls and exports recover competitiveness, replacing some of the activity of the cooling housing sector.
Spain’s government raised its 2007 public spending limit 6.7% to promote research and development in value-added industrial goods, following in the footsteps of Ireland.
“The imbalances in Spain’s external account are going to fall,” says Citigroup strategist Jose Luis Martinez.
Economists outside Spain are more sceptical.
With its high inflation, Spain has suffered a dramatic loss in cost competitiveness. And even with increased demand from the growing French and German economies, its exports have only limited market share.
Structural problems, including a surge in labour costs, will take a long time to fix, says economist Ralph Solveen. “I’m not sure we’ll again see the high growth of the last two, three years,” says Solveen, of Commerzbank in Frankfurt. – Reuters

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