Oil may hinder Spanish recovery

By Leslie Crawford

Published: September 25 2000 18:43GMT | Last Updated: September 25 2000 18:46GMT

The Spanish government will on Tuesday propose an economic feat not achieved since the death of the dictator General Franco in 1975: the balancing of the government's finances. If it succeeds, the 2001 budget would be the crowning economic achievement of Jose Mara Aznar, the prime minister, a former tax inspector with a self-confessed "obsession" for eliminating Spain's fiscal deficit.

However, the global oil crisis has removed some of the shine from Mr Aznar's prize, just as it is about to be won. Higher oil prices threaten to damp growth and stoke inflation. As a result, private-sector economists are urging the government to slash spending and run a fiscal surplus next year in an effort to cool demand and moderate price increases.

David Taguas, a senior economist with BBVA, the Spanish bank, says Spain was showing strong signs of overheating before the oil shock. Interest rates fell sharply when Spain joined the euro, which led to an explosion in credit - still growing at 20 per cent a year. Tax cuts in 1999 compounded the "feelgood" factor. Strong demand pushed the rate of economic growth to above 4 per cent, labour shortages began to appear in parts of the country, manufacturing plants were nearing full capacity, and the annual rate of inflation reached 3.6 per cent in August - double the rate in France and Germany, Spain's main trading partners.

Mr Taguas estimates that the underlying rate of inflation - stripped of oil prices and seasonal factors - has risen from 2.1 per cent last year to 2.8 per cent. "Even without the rise in oil prices, we would still have inflationary pressures," he says.

The real problem in Spain, Mr Taguas says, is too much credit and far too much spending. His prescription? A fiscal surplus of 1 per cent of gross domestic product in 2001 - which implies additional savings of about Pta1,000bn (E6bn, $5.3bn).

Guillermo de la Dehesa, a former finance minister who is now vice-chairman of Goldman Sachs Europe, is also in favour of greater cuts in public spending. "Before the oil shock, the Spanish economy was overheating." He estimates that lower interest rates accounted for about two-thirds of Spain's higher economic growth in the past three years.

"This would not have been a problem if, like Ireland, higher growth and inflation were due to strong increases in productivity," Mr De la Dehesa says. But in Spain, labour productivity growth is low - below 1 per cent, compared with 5 per cent in Ireland.

"The government, trade unions and businesses in Spain have done a bad job in training the labour force," Mr De la Dehesa says. Already, a shortage of qualified technicians is holding back "new economy" ventures in the information and telecommunications sectors.

"We need a better education system, more investment in research and development, and less regulation," the former finance minister says. "Unless Spain makes a real effort to increase productivity, we are heading for difficult times."

The oil shock has complicated the government's best-laid plans in other respects. Spain is more vulnerable to sudden increases in fuel costs than other big European economies because it is almost completely dependent on imported oil and gas.

In the short term, it must appease farmers, fishermen and the transport sector with tax rebates and other palliatives. Negotiations have been complicated by the fact that concessions to farming and transport co-operatives, which are demanding to sell subsidised diesel to their members, are likely to bring Spain's 6,000 petrol station owners out on strike.

All of which adds to the concerns about inflation. Wage bargaining is likely to be much tougher in 2001. There is also the risk that higher fuel costs will lead to higher prices for food, public transport and electricity next year. Government officials admit that, in a liberalised market, there is little they can do to control prices.

Mr Taguas at BBVA says: "It is important that these increases in fuel costs, which everyone hopes will be temporary, are not locked in to big wage increases next year."

In spite of the sudden change in Spain's international economic environment, Mr Aznar's government remains optimistic. It believes it can balance the budget with economic growth of 3.6 per cent and inflation of 2 per cent next year. Cristobal Montoro, finance minister, says this would not have been possible without the discipline that helped reduce the fiscal deficit from 5 per cent of GDP in 1996, the year Mr Aznar was first elected, to less than 0.5 per cent today.

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-- Carl Jenkins (Somewherepress@aol.com), September 26, 2000