By the end of March, Spain’s gross external debt had reached a new all-time high, exceeding 204.1% of Gross Domestic Product (GDP). The reasons for the increase are split between growth in the absolute figure and the fall in GDP over this period. This ratio is 30 percentage points higher than a year ago.
The sharp rise in debt in Spain during the pandemic is not an exception, but rather a general rule internationally. The levels reached, in the specific case of external debt, are somewhat tempered by the accumulation of foreign assets, which would lead to a lower net debt figure. Even so, debt remains very high from a historical perspective.
The build-up of private and public debt worldwide as a result of the health crisis is a vulnerability factor in the economic recovery process we have begun. The Bank of Spain, for example, is already calling for a strategy to adjust public debt once we have regained pre-crisis GDP levels. Perhaps it is less a matter of applying a restrictive fiscal policy than of placing greater emphasis on reducing structural spending, accompanied by adjustments and reforms that foster an increase in potential growth. In this context, European funds are an opportunity to boost growth in the short term and consolidate it over time.
The European Systemic Risk Board (ESRB) warned a few weeks ago about the indirect consequences of the prolonged scenario of low official interest rates in the euro area. In addition to the level of debt and borrowers’ ability to repay it in an environment where investors are searching for yield, the ESRB had other areas of concern. Specifically, it also warned about the profitability and resilience of European credit institutions with excess capacity and costs, systemic liquidity risk in financial markets, and the sustainability of the business models of insurance companies and pension funds that guarantee returns in the medium and long term.
International authorities are warning about the excessive increase in debt, while reaffirming the strategy of maintaining favourable conditions to finance it, especially through financial markets. It is not surprising that the European Central Bank (ECB) is calling for more information on leverage risks in markets and appropriate prudential regulation to limit them. The scenario of low official interest rates, “lower for longer” (ESRB), has been validated following the ECB’s recent decision to adopt greater flexibility in the design of monetary policy. It is important to persevere with accommodative financial conditions for as long as necessary. But seeking to limit their harmful effects in the medium and long term is equally important.
Financial stability is an essential condition for growth. Hence the efforts of the authorities to preserve it. On many occasions, the threats hanging over it are precisely the weaknesses and uncertainties that loom over the economic recovery. The increase in public debt—undoubtedly necessary in the short term to protect the most vulnerable and offset the loss of income caused by the pandemic—is one of these threats. The record highs reached by debt will require, in the future, the design of a medium- and long-term adjustment strategy to correct it. The behaviour of financial markets is also a factor of weakness, as they oscillate between excesses in their eagerness to price in an uncertain future. Expansionary monetary policy pushed to the limit has been fundamental for market stability in the short term, even though the same authorities warn of the risk of a disconnect from the real economy—especially if the future economic recovery is weaker than expected.
In the not-too-distant future, the authorities will face the need to combine the continuation of short-term support measures with the risks that some of these measures pose to financial stability in the medium term. What is a priority today certainly will not be as much of a priority in the future.
José Luis Martínez Campuzano, spokesperson for the Spanish Banking Association
