Spanish Elections and Growth Outlook: Limited Impact Expected

Spanish elections unlikely to hamper growth outlook

The outcome of the Spanish elections could lead to changes in economic policy. However, the reactivation of European fiscal rules in 2024 limits the extent to which fiscal policy can be adjusted, limiting the risk to our growth outlook.

Uncertainty surrounding Spanish elections

Following major losses in the recent regional and local elections on 28 May, Prime Minister Pedro Sanchez of the Socialist Workers' Party (PSOE) has called for early elections in Spain. Although the latest polls indicate a shift to the right side of the political spectrum, the outcome of the upcoming elections remains uncertain. If the polls are correct, the conservative People's Party (Partido Popular) will get the most votes, but not the majority to form a government. In such a scenario, the third-largest party, the far-right Vox, will play a decisive role in forming a government.

As elections approach in Spain, the political landscape is characterised by high fragmentation and polarisation. Over the past decade, the Spanish political landscape has undergone a significant transformation, with a remarkable increase in the number of parties. This fragmentation has led to greater instability as coalition governments must now be formed, which often rely on a fragile consensus. Based on the latest polls, it seems likely that another coalition government will have to be formed.

How the Spanish election could affect the economic outlook

Spain's economy has outperformed that of other eurozone countries over the past year, but is still weighed down by structural weaknesses such as high debt, low productivity and a rigid labour market. Despite a historically low unemployment rate, it is still among the highest in the eurozone and youth unemployment is alarmingly high. Moreover, the country has still not fully recovered from the pandemic, despite last year's impressive growth figures.

The elections could also be the starting point of a longer period of political instability, although this is not our baseline scenario. This could happen if the election results make it difficult to form a stable majority, leading to protracted government negotiations. In addition, there is still a real possibility that a clear majority cannot be formed, which would lead to a hung parliament necessitating new elections and prolonging political uncertainty. In such a scenario, crucial structural reforms needed for the economy may be delayed, reinforcing existing weaknesses. Persistent uncertainty about future government policies could also undermine investor confidence and hamper investment activities.

If a new right-wing government comes to power, it could bring about a change of course in economic policy. Conservative leader Feijóo has already announced plans for more business-friendly policies and tax cuts, including a proposed income tax cut for people earning less than €40,000 a year. There is also a real chance that the planned closure of nuclear power plants in 2027 will be postponed to secure energy supplies. The extent of these policy shifts will depend on the consensus among coalition partners and the strength of their majority. If the right-wing Conservatives and Vox form a comfortable majority, they will feel more supported to reverse certain previous government policies.

Despite a possible change of direction in economic policy, there is little room to shift to a more stimulative fiscal policy. Spain's public debt ratio is one of the highest in the eurozone at 113.2%. Spain ranks below Greece (171.3%), Italy (144.4%) and Portugal (113.9%). According to current forecasts, Spain will overtake Portugal in the ranking this year. This shift is due to a lower expected government deficit in Portugal combined with slightly better growth prospects.

Spain recorded a deficit of 4.8% of GDP in 2022, and both our forecast and that of the Bank of Spain suggest that the deficit will remain above the 3% threshold at least until 2025. This level is considered an excessive deficit by the European Commission. The reactivation of European fiscal rules in 2024 will increase pressure on fiscal consolidation measures. Regardless of the election outcome, addressing public finances will be inevitable, further limiting the government's flexibility to pursue more expansionary fiscal policies.