There are two key drivers that could help the Spanish economy to recover: an international recovery and the creation of the European Financial Stability Fund.

International recovery. According to IMF forecasts, world GDP will grow 4.2% in 2010. This figure is above the average of the last seventy years. GDP in both the United States―which will grow 3.1% in 2010 and 2.6% in 2011―and the eurozone―1.0% this year and 1.5% next year―will grow at below the world average. Consequently, the drivers behind this growth will be other countries, namely the so-called BRICs (Brazil, China, India and Russia) and certain developing economies, such as those of Latin America. India will grow by more than 8% over the next two years, and China will register growth of about 10%. Some Latin American countries, such as Peru, Mexico or Chile, will see growth of between 5% and 6% over the same period. Moreover, the depreciation of the euro against the dollar will make European products comparatively cheaper, prompting many Latin American and Asian countries to choose European goods and services, thereby boosting the region’s growth.

The European Financial Stability Fund. This fund, set up as a result of the “rescue” of the Greek economy, now functions as a “safety net” for potentially troubled countries. It eliminates part of the risk and guarantees that, should a country experience serious problems, it can be helped in an orderly and effective way. The Fund has a budget of €750 billion. Of this amount, the European Commission will contribute €60 billion, the member countries of the eurozone will contribute €440 billion through bilateral loans, and the IMF will furnish the remaining €250 billion. The IMF will moreover impose conditions on the country receiving the aid to restore its economy, increase its chances for future growth and recover the confidence of the international markets.

The Spanish economy faces three key challenges, all of which will require effective and concrete measures, namely: high unemployment, the status of the financial system, and exit strategies.

Unemployment and Consumption: Between the first quarter of 2008 and the first quarter of 2010, the Spanish economy destroyed 2,438,500 jobs. The number of unemployed workers increased to 4,612,700, or 20.05% of the Spanish labor force. In addition to being unemployed, some 1,291,788 people are not entitled to any sort of benefits. Plus, there are already more than one million homes in which all household members are jobless. All of this is in addition to the many workers who, in view of the widespread uncertainty, fear they may lose their job. Consequently, Spanish aggregate demand, that has dropped more than 10 points since 2007, has ground to a halt. A large share of Spaniards have stepped up their saving and lowered their consumption.

Financial System: While it is true that some Spanish financial institutions have indeed absorbed the “shock” of the economic crisis better than their counterparts in other European countries, many nevertheless find themselves in extremely delicate situations for a variety of reasons:

• First, they have been registering high delinquency rates since early 2009. At commercial banks, non-performing loans have risen by 2.5% since January 2009. At savings banks, they have risen by 1.7% over the same period. This is but one example of how the deteriorating Spanish economic panorama and rising unemployment have affected the health of financial institutions.

• Second, both commercial and savings banks have excess capacity. In mid 2009, commercial banks operating in Spain had 15,580 branches and 115,129 employees. Savings banks had a total of 25,000 branches and 134,786 employees. This was too many, according to a PricewaterhouseCoopers report published in July 2009, which claimed that, given the contraction of the Spanish economy and the scant prospects for an early recovery, some 12,000 branches and about 35,000 jobs would need to be eliminated.

• Third, they were hindered by the slow implementation and uncertainty concerning the role of the Fund for Orderly Bank Restructuring (FROB, in Spanish) The FROB was created on June 26, 2009. For almost a year, its task was limited to administering the Caja Castilla la Mancha savings bank and paving the way for its merger with Caja de Ahorros del Mediterráneo. Only now, in recent months, has it intensified its efforts, coinciding with the end of its operations, initially projected for June and subsequently postponed to September. The details of several consolidation processes still need to ironed out, but the simple fact of having whittled down the number of savings banks from 43 to 18 in the space of a year shows that, albeit tardily, the FROB is beginning to pay off.

• Fourth and finally, it is hindered by the uncertainties and changes that the institutions will have to deal with in the coming months. Widespread deleveraging by households and businesses, the withdrawal of the credit lines opened by the European Central Bank, maturing bank bonds, the increasingly high cost of financing due to deteriorating ratings, the falling Euribor, increases in delinquency rates, the implementation of new regulations, etc., will all undoubtedly change the way financial institutions operate. Among other things, they will face tighter financial margins, possible asset reductions or even “wars” to attract deposits.

Exit Strategies: Exit strategies are the measures that will have to be taken, at both the national and international level, to offset the excesses incurred to soften the impact of the crisis. They can be divided into fiscal policy measures and monetary policy measures.

• Fiscal Policy. Over 2009, the Spanish government implemented many measures primarily aimed at boosting economic growth and staunching the loss of jobs. These measures (e.g., the €400 personal income tax rebate, the plan for local public works, incentives for vehicle purchases, etc.) represented a €25 billion increase in government expenditure. The rising unemployment (and consequent payment of unemployment benefits) along with the contraction in activity led to increased spending and a sharp drop in revenue, which, in turn, gave rise to the deficit figures mentioned at the start of this article. The deficit increase was accompanied by an increase in the public debt, as noted earlier. In light of this situation, the government has implemented several plans to slash the deficit and manage the debt. First, it announced a rise in VAT and the capital gains tax to become effective on July 1. Second, it updated the Stability Program for Spain submitted to Brussels in February 2010 to include significant adjustments in the public sector. According to the plan, between 2009 and 2013, the deficit run by the public sector as a whole will be cut by 8.4%. To achieve this, it was estimated that revenue would have to increase by 3.7% over the period, while spending would have to be reduced by 4.8%. Third and finally, due to the scant confidence that these plans engendered in the international markets, the Spanish government was forced to propose new measures to cut the deficit by an additional 0.5% in 2010 and 1% in 2011.  These additional €15 billion will come from a decrease in public investment (€6 billion), a 5% reduction in public wages (€4 billion) and the elimination and reduction of other budget items, such as the so-called “baby check” or a pension freeze.

These higher taxes and cuts in spending and public investment will cause the economy to contract. According to FUNCAS, the effects will be felt in the second half of 2010.

• Monetary Policy. When Spain joined the euro, it relinquished sovereignty over its monetary policy. Consequently, Spain will face a major challenge in the coming months: the risk posed by the different rates at which countries in the eurozone will emerge from the recession. Should Germany, France and the “central” euro countries consolidate their recovery before Spain and the rest of the “peripheral” countries, the ECB could begin to raise interest rates to control inflation in the former group. This would slow down and further delay Spain’s recovery.

Given the facts, Spain must increase its capacity for future growth. First, it must accelerate structural, more specific and more flexible labor reforms. As it stands, the current reform will hardly make a dent in the unemployment rate. Second, it must speed up the process of merging and consolidating the country’s financial institutions. To this end, the fact that the new Savings Bank Act includes a mechanism that will make it possible to transform these institutions into public limited companies, thereby facilitating their acquisition by other banks according to market rules, is good news. How this new legal framework is carried out in practice will be critical to the Spanish financial sector’s future. Third, additional austerity measures should be implemented in the public sector. To this end, new measures to restrict spending and to create a fiscal policy board that—regardless of the party in power—could study, offer recommendations on and monitor the status of public finances (along the lines of such bodies in Great Britain or Sweden) would be desirable. Likewise, less orthodox but equally useful proposals, such as the introduction of co-payments for health care, turning certain highways and public roadways into toll roads, the sale of airports or the sale of the Spanish broadcasting company (RTVE) and other public broadcasting companies, should not be ruled out.

Finally, mention should also be made of other areas in which Spain must work to improve its medium-term prospects. Reform of the education and pension systems and the liberalization of trade networks all fall under this heading. In short, the country must take advantage of the current unfavorable economic climate to transform its economy, strengthen it and make it more competitive.