Monetary Theory of Spain - Research Paper Example

Monetary Theory of Spain Executive summary The significance of monetary theories is notably increasing in the context of a global economic meltdown. Ineffectiveness of the monetary policies adopted by many countries including Spain made them vulnerable to the recent global recession. Spain, the fifth largest economy in the EU is being greatly challenged by the impacts of the 2008-2012 Spanish financial crisis, which began by the Late-2000s financial crisis and fuelled by the European sovereign debt crisis. Although the Bank of Spain has adopted ambitious monetary and economic reforms to improve the current bad economic condition, the country’s key economic and monetary indicators are still delivering frustrating results. The Spanish economy has failed to regain investor confidence and hence it struggles to meet adequate operating capital. This is the major reason why the country cannot acquire its previous economic status despite the series of reforms it adopted. However, operating results from tourism sector and other emerging industries like ICT and renewable energy contribute to the future growth expectations of the Spanish economy. Giving priorities to restructuring spending and focusing on key areas like SMEs, research, and innovation seem effective for improving Spain’s economic status. Table of Content Executive Summary 1 Introduction 3 Literature Review 3 The Research 4 Data Analysis and Interpretation 12 Key Findings and Learning 13 Conclusions and Recommendations 13 Bibliography 15 1. Introduction The term monetary theory is of considerable significance in the context of the ongoing global economic meltdown. Monetary theory simply refers to a set of ideas that provide a clear view about how monetary policies should be employed to enhance the growth of an economy. Monetary theory reflects the view that different nations must follow different monetary policies with respect to their unique set of strengths, weaknesses, resources, and limitations. While choosing the monetary policy, regulators must analyze how factors such as price levels, money supply, and benchmark interest rates would affect the economy. Generally, creation and execution of monetary policies are left to the responsibility of economists and central banking authorities. In many developing countries, central government is responsible for planning and implementing monetary policies. In contrast to this, the Federal Reserve Board frames and executes monetary policies in the United States without government involvement. Different nations prioritize different factors while choosing the monetary theory. To illustrate, the US Federal Reserve focuses on a monetary theory that promotes low inflation (stable prices), full employment, and steady growth in GDP. This paper will specifically evaluate the monetary theory of Spain with particular reference given to the nation’s banking sector, interest rates, key industries, tax regime, investment landscape, and foreign exchange reserves. 2. Literature Review The Spanish monetary system has a long history of transformations and modifications. After the union of Spanish kingdoms under Ferdinand of Aragon and Isabella of Castile and the conquest of Granada, a reform took place in the Spanish monetary system in 1497. Over the centuries, a number of reforms took place in the Spanish monetary regime, which in turn led to the development of a particular monetary theory. Referring to empirical evidences, Fuentes notes that “Spanish monetary theory has had a differential effect among Spanish regions” (Fuentes 115). Authors like Motamen-Scobie opines that the Spanish monetary theory always emphases the curtailment of inflation (15). This view seems true while evaluating the historical inflation rate of the Spain. To illustrate, the Spanish economy managed to keep its inflation low even in the midst of the 2008-09 global financial crisis. Although the execution of a single monetary policy for the European Union has diminished the importance of Spanish monetary theory, it still plays a crucial role in driving the economic growth of the Spain. As stated, “monetary policy in Spain had traditionally been the main instrument of demand management, although in recent years significant changes have taken place in the framework within which policy has operated” (OECD, 20). As many scholars point out, the Spanish monetary theory was the major factor that propelled the growth of the Spanish economy in the late 1990s and early 2000s. 3. The Research 3:1. A brief Overview Spain (officially, the Kingdom of Spain) is a sovereign state and is located in the Southwestern Europe. The country is a member of the European Union. In term of nominal GDP, Spain is the world’s 13th largest economy and the EU’s 5th largest economy. Currently, Spain is considered as the 23rd most developed country in the world. The country posted high growth rates and experienced a property boom during the period 1997-2007 after its fast recovery from the impacts of the global recession occurred over the early 1990s. Spain faced severe economic downturns when the country’s property bubble burst as a result of the 2008 global financial crisis. 3:2. Profile of central bank The Banco de Espana is the central bank of the Spain. The central bank took several key steps over the last five years to support the Spanish economy to survive the difficulties of the recent global recession. As per the report of Financial stability board, the forcible takeover of the CCM (Caja Castilla la Mancha) to prevent its financial failure was one of the major steps taken by the Bank of Spain over the last few years (“peer review of Spain”). In addition, the central bank also took over the CajaSur, another Spanish savings bank, in order to strengthen the position of the country’s smaller banks. Another key policy initiative taken by the Bank of Spain is the discouragement of investment in complex structured products; and the central bank also took vehement efforts such as assessment of corporate governance related issues with intent to improve the supervision of country’s credit institutions (“peer review of Spain”, 10-21). 3: 3 Banking sector and major players The Spanish banking system appears to be one of the most solid western banking systems because the way it cops up with the ongoing global liquidity crisis is excellent. The conservative banking rules and practices of the Bank of Spain supported the Spanish economy to a great extent. However, the Spanish banking sector struggles with many issues like debt crisis and bailouts. According to a report by independent auditors, the Spanish banking sector is in need of a combined capital injection of nearly €60bn. Another study indicated that the Banco Popular (the country’s sixth largest bank in terms of assets) struggles with a shortfall of €3.2bn, nearly an amount equal the bank’s market value (€3.58bn) (cited Armitstead, para. 1-4). Strupczewski and Emmott report that the Spanish banking sector is currently in the midst of a period of recapitalization and clean-up; and as part of this program, the Eurozone has “approved the terms of a loan of up to 100 billion euros ($123 billion) for Spain to recapitalize its banks” (Strupczewski and Emmott, para. 1). Some of the major players in the Spanish banking sector are Bancaja, Banca Civica S.A, Bankia, Banco Cooperativo Espanol, Banco de Valencia, Banco Mare Nostrum, and Banco Financiero y de Ahorros. 3:4 Interest rates Spain had a benchmark interest rate of 4% by the beginning of the 2008. Although the rate steadied almost throughout the year, it dropped to 2.5% by January 2009 as a result of the recessionary pressures (see graph 1). Graph 1 Relocation Service for clients in Spain and Portugal Source: Spain Interest Rate, Trading Economics, Web, 16 Jan 2013 Note: The graph clearly indicates the historical benchmark interest rates of Spain. The interest rate fell further and reached 1% by the middle of the 2009; this rate continued throughout the whole 2010 and 2011. Although the rate was increased to 1.5% during the 2011 period, it again dropped to 1% by the end of the year. By the end of the 2012, the interest rate was declined to 0.8%, which is a record low during the period 1998-2012. In order to improve the volume of bad bank loans, the Bank of Spain has imposed some strict restriction on loans. In addition, the central bank has been strictly regulating and supervising the operations of Spanish banks for the past few years so as to instill confidence in investors and hence to prevent excess withdrawal of money from country’s banks. 3:5 Key industries and economic sectors Tourism and construction are the two key industries of Spain whereas other industries including textiles and footwear, shipbuilding, food and beverages hold a strong position. As of 2007, Spain was the second most visited tourist destination of the world after France and this status dropped to fourth most visited tourist destination by 2010. According to a report published by the World Travel and Tourism Council, Spain achieved a tourism direct industry GDP of €62.1 billion in 2010. Although it was the fifth highest tourism direct industry GDP, the country’s tourism sector growth was diminished over the last five years as compared to the 2004-08 period (WTTC, 5-11). Caramenico reports that the Spanish construction sector also experiences growth downturns as a result of the end of the country’s building boom (para. 2). However, the country’s service sector as a whole has been growing over the last years. 3: 6 Key economic indicators data Real GDP growth The country’s GDP growth was only 0.9% in 2009 as a result of the 2008-2012 Spanish financial crisis (see graph 2) Graph 2 Spain Country Report: GDP data and GDP forecasts; economic, financial and trade information; the best banks in Spain; country and population overview. Source: Global Finance, web 16 Jan 2013 Note: This graph represents the real GDP growth of Spain during the 2008-2012 periods. The growth rate really worsened in 2009 and dropped to -3.7%. The country quickly improved the condition and achieved a GDP growth of -0.1% and 0.7% respectively in 2010 and 2011. However, the country could not maintain the improvement in the following year. 3:7 Unemployment (see graph 3) Graph 3 Mounting Unemployment Rate 2008 to 2012 Source: Global Finance, web 16 Jan 2013 Note: While going through the chart, it is very clear that the country’s unemployment rate is mounting over the last five years. The unemployment rate was 13.9% in 2008 but it reached 18% by the end of 2009. Over the next three years (2010, 2011, and 2012), the rate increased respectively to 20.1%, 21.6%, and 24.2%. 3: 8 Key monetary indicators data (see graph 4) Graph 4 Inflation rate in Spain 2008 to 2012 Source: Global Finance, web 16 Jan 2013 Note: The chart clearly indicates that the Spanish economy struggles to maintain a stable inflation rate. The country’s inflation rate was 4.1% in the year 2008. However, the economy experienced a negative inflation or deflation (-0.2%) in the next year. On the strength of a set regulations imposed by the Bank of Spain, the country could increase its inflation rate to 2% in 2010. In 2011, the inflation rate rose to 3.1% and it was again declined to 1.9% in the following year. 3: 9 Public debt (see graph 5) Graph 5 Public debt as a percentage of GDP Source: Global Finance, web 16 Jan 2013 Note: The chart gives a clear view of the Spain’s public debt during the period 2008-2012. A glance at the graph indicates the fact that the Spanish public debt has been growing for the last five years. The Spanish public debt represented 40.2% of the country’s GDP in 2008 while the percentage rose to53.9% in 2009. The country’s public debt further increased to 61.2%, 68.5%, and 79% respectively in 2010, 2011, and 2012. 3: 10 Tax regime Corporate tax rates are 25%-3% in Spain. Income tax rates in the country are between 24% - 52% (including temporary surcharge) based on the annual income level of individuals. Similarly, sales taxes in the country range from 4% to 21% on the basis nature of goods sold. In short, Spanish taxation regime is not much attractive as compared to other leading EU members like UK because the country offers very low interest rates for savings. As a result, the Spanish economy cannot attract huge volume of savings. In contrast, the tax regime seems attractive with respective to duties levied on fuels and petroleum products. This taxation policy assists Spanish economy to enhance the growth of its industries and to promote overall development of the country. 3: 11 Investment inflow and outflow While analyzing the investment inflows and outflows of Spain, it is identified that the country has been suffering from massive foreign investment outflows because investors lost their confidence in the Spanish economy. As per Trading economics report, in 2008, the country’s net investment inflows represented 4.89% of its GDP. In 2009, the financial crisis dreadfully hit the Spanish economy and consequently the country’s net investment inflows drastically dropped to 0.67% (para, 1). Although the country could improve the rate (2.98%) in 2010, it was again decreased to 1.72% in the following year (Trading economics, para. 1). According to a report released by the Bank of Spain, “a net 128.655 billion euros has been pulled from Spain by financial investors since July of last year” (2011) (qtd in EL PAIS, para. 2). 3: 12 Major investing sectors Aerospace, automotive, healthcare, renewable energy, ICT, and environmental sectors represent major investing sectors in Spain. As reported in Invest in Spain, the Spanish aerospace sector achieved a turnover of €5,838 million in 2010 and posted an average growth rate of 11.6% in the last 10 years. Hence, investors are interested to invest in the Spanish aerospace industry. Likewise, the Spanish automotive sector generates a turnover of nearly 6.1% of the country’s GDP. The Spanish biotechnology industry has become a hotspot of investment because economic forecasts indicate that this sector would account for a significant percentage of the country’s GDP in the near future. Currently, the ICT (Information and Communication Technologies) constitute roughly 5.85% of the national GDP (Investin Spain). Finally, renewable energy and environment sectors have become major investing sectors in Spain due to growing concerns over the concept of sustainable development (Invest in Spain). 3: 13 Size of foreign exchange reserves Foreign exchange reserves can be simply referred to the foreign assets held by a country’s central bank. Generally, foreign exchange reserves comprise gold or a specific currency. As per the reports on Spain foreign exchange reserves, the historical average (from 1962 until 2012) of Spain’s foreign exchange reserves is €17369.96 million. It reached a historical high of €64355.20 million in February 1988 whereas a record low (€323.95 million) was reported in January 1962. In December 2012, the Spanish foreign exchange reserves reached €38346.78 million, which was a decline from €39463.02 million in November 2012 (Spain foreign exchange reserves, para. 1). 3: 14 Economic cycle stage While closely analyzing the Spanish economy, it seems that the economy is facing the contraction phase of the economic cycle. It has been defined that the expansion phase is characterized with a stable GDP increase over a course of time whereas GDP decline over a particular period of time will be experienced in a contraction phase. Referring to the Spanish GDP growth rate over the last five years discussed above, it is clear that the country experiences GDP growth declines and hence it is passing through the contraction phase. 4. Data analysis and interpretation The above sessions scrutinized various economic as well as monetary aspects of Spain. The research conducted clearly indicates that Spain is one of the strongest economies in the EU despite its current economic downturns. Some of the key steps taken by the Spanish central bank, including forcible takeover of two major credit institutions played a crucial role in strengthening the country’s banking system and in confronting with the recent global recession to some extent. However, it is identified that the Spanish banking system is struggling with debt crisis and bailouts. The viability of recapitalization and clean-up efforts taken to address issues like debt crisis and bailouts is yet to be identified. The country maintains a low benchmark interest rate, which may impede the growth of Spain in the short term even though the rate has been set to strengthen the Spanish economy in the long run. Tourism and aerospace industries are the two key industries in Spain. Reports indicate that the tourism sector has greatly assisted Spanish economy to vie with the economic meltdown experienced over the recent years. However, some recent releases point that there have been new key industry sectors emerging, including ICT, automotive, renewable energy, and environmental sectors. These sectors have become the hotspot for huge investments because they individually account for a significant percentage of the national GDP. The economic indicators clearly say that the Spanish economy is yet to recover from the recession. The country’ GDP growth rates were disgusting over the last few years and its unemployment rate mounted during the same period. In addition, fluctuating inflation rates and growing public debt raise potential challenges to the Spanish economy. Although the country’s taxation policies give special concessions in terms of duties levied on fuel and petroleum products, they are not much effective in attracting savings. The severe economic downturns caused the country to suffer from massive losses in terms of net investment inflows. Likewise, the country also experienced declines in its foreign exchange reserves during the last few years as an impact of the Spanish financial crisis. 5. Key findings and learning One of the key findings of this research is that Spanish monetary theory failed to save the economy from falling in to recessionary conditions. Spanish banks’ bad loans hit an 18-year high in 2012. These bad loans greatly fuelled the Spanish financial crisis 2008-2012. It is also observed that the undercapitalized Spanish banks notably contributed to the Spanish debt crisis. Investors are increasingly pulling their money out of the Spanish economy as they lost confidence in the economy. Such massive withdrawals have worsened the economic status of Spain. Currently, the country is facing the contraction phase of the economic cycle. However, the growing demand in tourism and other service sectors raise an array of potential opportunities for Spain despite the current financial difficulties. 6. Conclusion and Recommendations From the above discussion, it is clear that monetary theory plays a significant role in determining the economic status of a country. Undercapitalized Spanish banks greatly threaten the country’s future economic growth. Bad GDP growth, unemployment, inflation, and public debt statuses of Spain force investors to stay away from Spanish economy. As the country fails to gain investor confidence, it cannot acquire enough net investment inflows. Consequently, the country’s efforts to recover the present troubling condition do not meet its goals properly. It is recommendable for the Spanish economy to specifically focus on the tourism sector because it has the potential to grow in spite of recessionary pressures. In other words, tourism sector may greatly support an economy in the event of severe economic downturns. In addition, it is better for the Spanish economy to restructure its tax regime in way huge volume of savings can be attracted. This policy would support Spanish economy, which is woefully struggling with debt crisis. Finally, it is advisable for the country to review its spending priorities and to set aside more funds for promoting SMEs, research, and innovations. 7. Works Cited Armitstead, Louise. ‘Spanish banks need €60bn, independent auditors say’. The telegraph, 28 Sep 2012. Web 16 Jan 2013 Caramenico, Greg. As Spains Construction Sector Recedes, Global Rivals Move In. World Politics Review, 21 Sept 2012. Web 16 Jan 2013 Fuentes, Carlos J. Rodriguez. Regional Monetary Policy. Routledge, 2006. Print. Invest in Spain. Web 16 Jan 2013 Motamen-Scobie, Homa. (Ed.). The Spanish Economy in the 1990s. UK: Routledge, 1998. Print. OECD. OECD Economic Surveys Spain 1983-1984: Spain 1983-1984. OECD Publishing, 1984. Print. Strupczewski, Jan and Emmott, Robin. ‘Eurogroup approves Spanish banking sector bailout’. Reuters, Jul 20, 2012. Web 16 Jan 2013 ‘Peer Review of Spain’. Financial stability board, 2011. Web 16 Jan 2013< http://www.financialstabilityboard.org/publications/r_110207a.pdf > Spain suffers huge outflows of foreign investment. EL PAIS. Web 16 Jan 2013 Spain foreign exchange reserves. Trading economics. Web 16 Jan 2013 Trading economics. Foreign direct investment: Net inflows (0% of GDP) in Spain. Web 16 Jan 2013 WTTC. Travel & Tourism Economic impact 2012 Spain. Web 16 Jan 2013 Read More