How Is the Financial Crisis Affecting the Current Economy - Coursework Example

Running Head: Effects of the financial crisis to the Spanish economy Student’s name Institution Course Professor Date Effects of the financial crisis to the Spanish economy Introduction After a long span of economic expansion that began in the mid-nineties, the Spanish economy began to show first signs of exhaustion in 2006. The international financial crisis that began in the year 2007 and deepening in 2008 hastened the end of expansion cycle while triggering severe readjustments of the imbalances that had accumulated over decades. The severe effects of the financial crisis in Spain have taken a lot of time to correct since they drastically affected the economy in different ways. The banking sector, housing sector and the debt situation are among the sectors that where highly affected by the crisis. This paper aims to analyses the effects of the financial crisis on the debt position of Spain, employment sector and banking sector of the economy to date. It describes effects to the banking sector to date like increase in financing costs, premiums, reduction in credit, failure of banks to perform basic functions among other effects. It will describe how the debt situation was drastically affected from the beginning of the crisis onwards. It will also discuss the effects of the crisis to the employment sector by looking at the increase in unemployment rates over time. Effects of the financial crisis to the employment sector The financial crisis drastically increased the unemployment rate in Spain. Available statistical data is very alarming. The unemployment rate in Spain rose from the initial rate of 8.3% (1,834,000) in 2007 to 20.1% (4,632,000) in early 2011. There was high job destruction in 2008 and 2009. The failure of the economy to peak earlier made it hard to create more jobs and this made the unemployment rate to remain high. Between these periods there was 11.8% increase in the unemployment rate compared to the euro zone of increase from 7.5% to 10.1% that represented a 2.6 percentage increase. From the graph above it can be seen that before 2007-2008 there was a very low unemployment rate in fact the unemployment rate was dropping. However, from 2007 the unemployment rate started increasing. The unemployment rate continued onwards to increase to date. The increase in unemployment rate is attributed to the world financial crisis since it started increasing when the financial crisis started. Despite the end of the financial crisis in the world the unemployment rate continued to increase in Spain. Financial crisis can thus be concluded that its effects in the increase in unemployment continued. It seems it could take time to reverse the trend. The current higher unemployment rate was majorly caused by three major factors. The first one is the impact of the housing crisis on levels of employment. In the years of high financial crisis in Spain (2008-2010), there were high job losses in the construction sector. It is estimated that there was higher than 36% job losses during this period (Carlos Alvarez Aledo, 2011). This comprised a high percentage since the construction sector of Spain employed a higher percentage of the total employed workers. Continued financial crisis in Spain has made it hard to reverse the effects of the decline in the real estate sector and construction sector has not improved to its initial position. The crisis negatively affected the banking sector and the real estate and it took long to implement successful corrective measures. Lack of reversing of this trend earlier has made unemployment rate in Spain to continue being higher than that of 2007. The second factor that has made the unemployment rate to remain high is the sharp appreciation of the exchange rate since the launch of the monetary union. Increase in labour cost per unit produced in Spain reduced the Spanish competitiveness (Angel, 2010). The crisis forced firms to put in place measures of cost cutting in order to remain competitive. Such measures included the reduction in the workforce that meant increased unemployment. Inability to devalue their currency and the presence of rigid nominal wages meant the solution to become competitive was through increased productivity and this was only possible through workers’ dismissal. The intense workers’ segmentation, strong and rigid wages and working hours in the labour market contributed also to the increased unemployment, (Suárez, 2010). The financial crisis necessitated implementation of labour reforms in the Spain. Some of the reforms include the promotion of indefinite hiring of workers, reduction in the compensation of objective dismissal, promotion and extension of hiring through contracts of employment, promotion of beneficiary groups of traineeships and apprenticeships. Lay-offs procedures and rules were reformed to be friendly. Reforms in the labour market have not contributed much to the improving employment rates in Spain. The unemployment rates have continued to remain higher while forged part-time jobs and informal contract relationships have continued to increase especially among the low-skilled workers who are usually underpaid while working for longer and unsafe environments. Effects of the financial crisis in the banking sector The banking sector is the main sector that was influenced by the financial crisis. The sector nearly collapsed between 2008-2009 especially due to the contraction of the real estate and the increase in debts. The housing bubble and the financial crisis drastically affected the development of the Spanish banking sector. The banking sector has continued to be affected by the effects of the crisis to date. Generalisation of the international financial crisis and lack of trust and confidence in the financial markets have continued to restrict the Spanish banks access to finance from international markets. Statistics of early 2011 and onwards shows that the Spanish banking sector being among the leading in the ranking of the euro zone in return on assets (0.47%) and the return on own resources (7.9) (Banco de España 2011b). The solvency rates are however worrying. It is in the league of the worst banks, 11.9% nearly two percentage points below the mean. The troubling aspects of their balance sheet are the high investment and deals in the construction and property development both in their supply and demand sides. There were high credit grants to the construction and property sectors in 2009 of around 56.7% of the financing of productive activities by the savings Banks. By 2010 there was continued investments and deals with construction and property sectors that exposing them to potential risks given the fact that the real estate collapse meant the direct collapse of the banking sector. The high risks involved in such investment in real sector exposed the banks to challenges given the fact that investors were risk averse and feared investing in such risk ventures. This even forced the Spanish government to formulate laws and reforms that necessitated the banks to promote informative transparency exercise where they were mandated to publish their nature of operations in order for the public to know. The high exposure to financial crisis by investing and dealing with real estate made the banking system not to be able to fulfil its basic function of financing economic growth. These are attributed to both long-term and short-term high volumes of bad debts. In 2011, the bank credit to companies had drastically reduced to nearly two percent from the initial 30% of 2008. Tensions experienced in 2010 and the half in the euro zone’s financial markets, originating from sovereign debt crisis has continued to date to bring about increase in the state and bank’s financing costs. This has made it hard to access financial markets. Since the start of the financial crisis there have been increasing risk premiums emanating from resident issuers. This is due to perceived high instability and risks involved. The risk premiums in Spain have continued to remain high because the financial and sovereign debt crisis lead to significant increase in financing costs and because the banks have continued to incur the high losses of investing in the deteriorated real estate resulting from the excessive exposure of their risk portfolio. Effects of the financial crisis to the banking sector have continued to being felt to date in Spain. There is still the high lending rates, high solvency rates among banks, low credit availability, high premiums, low funding for economic activities among other effects. This is despite the country undertaking various recovery reforms to help the country overcome the effects of the crisis. The crisis seems to have long-term effects to the banking system that will take more years and measures to overcome it. Huge debt growth The financial crisis has seen the increase in the Spain private and public debt. Various factors like the increase in unemployment, deteriorating banking system and reduction of Gross Domestic product (GDP) among many other factors highly contributed to the increase of debt in Spain. During late 2011 the Spanish public Debt had increased to reach 60.1% of their GDP, this was 25 percent points lower than the set euro zone average of (85.1 percent). The private debt had also increased to 224% of their produce, the household debts had also increased to be 85% of the GDP, while firms’ debts becoming 139% of the GDP. The strong growth in the housing loans to the households and the excessive credit for the productive activities like the real estate and property is the main reason for the increase in the private debts. The resulting pressure in the Spanish markets after 2010 resulted in a drop in the households and firms earnings and income that refrain private debt growth, (OECD, 2013). Table 1: Gross General Spain Government Debt 1980 n/a 1990 30.3 2000 50.4 2006 30.7 2007 26.7 2008 30.8 2009 42.5 2010 50.1 2011 58.6 2012 73.5 2013 80.8 Source: IMF World Economic Outlook, October 2013. From the table above, the public debt of Spain increased at a very high rate after the financial crisis. The Spanish economy was drastically affected by the financial crisis to the year 2010 after which it started recovering. The public debt rose highly after 2010. It can be taken to mean that the recovery programs and measures undertaken are responsible for the increase in the public debt as a percentage of the gross domestic product. The financial crisis brought a differential aspect in the ownership of public debt in Spain as compared to other nations. It brought a situation whereby current Spain public debt of nearly 47% is owned by foreign investors. This is unlike other highly indented states like Italy, Belgium or Japan where their high proportion of debt is owned by domestic investors. The increase in domestic debt is a liability to future generations of Spain and acts as a hindrance to getting more finance from international financiers since they may use it as a measure of their ability to repay loans and other kinds of finance. This increase in the debt can be attributed to factors like reduction in productivity, failure in their banking system, unemployment, collapse of their real estate sector among many other factors that can be attributed to the international financial crisis. Conclusion The international financial crisis of 2007-2008 had long-term and short-term effects to the Spanish economy. The crisis extended in Spain until 2010 when corrective measures started to bore fruits. The crisis drastically affected the banking sector, increased the debt, increased unemployment and contracted the real estate among other sectors of the Spanish economy. The effects in the banking sector like the increased financial cost, increased premiums, reduction in credit availability for financing economic activities among other problems are still faced in the economy to date. This is despite now being around six years after the end of the financial crisis. The government has implement some reforms to cope with the negative effects of the crisis in the banking sector but have not bore successful fruits to drive the sector way back to the original state or above the state it was before the financial crisis. Unemployment rates in Spain skyrocketed to high levels making it hard for people to have funds for investments, savings and for general consumption. The debt levels of the country also continued to increase at a bigger rate than before. Financial crisis have a long lasting impacts to the continuous growth and development of the country. Its immediate and long-term effects are too hard to correct and bring back the economy of the state to its initial position. The various stakeholders in the economy should thus put in place effective means of ensuring the crisis never occurs again and if by mistake it reoccurs the stakeholders should implement corrective measures as soon as possible. Reference Carlos, A. 2011. 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