Spain elections: Third time’s a charm, right?

18 February 2019 16:52 RaboResearch

Spain will hold early elections on 28 April. The short-term economic impact will be limited, but public finances will be worse off in 2019. The longer-term impact is difficult to assess based on current polls, but it could well be positive.

Conceptual image of a person voting, casting a ballot at a polling station, during elections.

Adiós Sanchez

Last Friday, Spain’s PM Pedro Sanchez announced early elections will be held on 28 April. Official elections were scheduled for June 2020, but Sanchez’ minority government accepted its defeat after parliament voted down its budget proposal for 2019. It will be the third time in less than four years Spaniards will head towards the ballot box, while usually elections are held only once every four years. The early end of Sanchez legislature does not come as a shock, however, as he was heading a very fragile minority government. His PSOE only has a quarter of seats in the current parliament and relied on the support of multiple regional parties and the radical-left Podemos. While the Catalan separatists helped Sanchez to oust premier Rajoy from office last summer over corruption allegations, they turned their back on him in last week’s budget vote. Like previous governments, Sanchez had ruled out an official referendum on self-determination. The trial against separatist leaders over the illegal independence referendum and subsequent declaration of independence in 2017, which started last week, also stirred up bad blood among separatists.

Catalan conflict will drag on

The fact that Sanchez’s rather soft approach towards the separatists has ultimately yielded little result implies that the conflict is unlikely to be solved anytime soon. Since the summer, tensions had eased as Sanchez struck a more conciliatory note than his predecessor Rajoy. He had also agreed to appoint a facilitator to smooth talks between Barcelona and Madrid, a long-standing wish of the separatists, and the budget included more funds for the region. It all appeared insufficient. Polls make it difficult to predict what the next government will look like, but a shift to the right – including a much harder stance towards the rebellious region – seems inevitable.

Economy unlikely to care much

Elections by the end of April imply that parliament will be dissolved early March. Hence, the legislative process will be as good as dead for the rest of 2019H1, with formation talks likely taking up weeks, if not months. In our view the economy will not care too much in the short term, though. Early elections were long expected and policy uncertainty is unlikely to increase much as the mandate of the outgoing government was very weak. Moreover, fiscal policy will be more expansionary in 2019 than initially targeted, possibly providing some support for the economy.

But government finances will

The European Commission and official institutions in Spain outside the government had already forecasted that the budget deficit would come in substantially above the 1.3% of GDP targeted by the government, on the back of lower revenue gains than incorporated in the budget. With the socialists’ budget proposal voted down, the 2018 budget will be rolled over into this year. Accordingly, for example higher income and wealth taxes for the rich and higher corporate taxes included in the 2019 budget will not be implemented. At the same time, part of the higher public spending plans have already come into force via Decree Laws. Therefore, while economic growth might not suffer from the increased instability, public finances are expected to come out worse.

We forecast the economy to grow slightly above 2% in 2019 and a bit below 2% in 2020. Clearly this is lower than in recent years, but still well above growth in most of its Eurozone peers. Spain also outperforms Italy, where we forecast flat growth in 2019 and less than 0.5% in 2020. We expect Spain’s overall budget deficit to stay close to 2.5% in 2019 and the structural budget deficit, i.e. the overall deficit adjusted for the cycle and one-offs, to come in at above 3%.

Figure 1: Economy unlikely to suffer much from the political instability, but the cycle matures

Source: Macrobond, NiGEM, Rabobank

Figure 2: Public finances have significantly improved, but deficit is still close to 3% of GDP

Source: Macrobond, Ameco, Rabobank

Radical-right enters Spain’s political stage

Based on current polling it is very difficult to predict how the next government will look like. Parliament will be more fragmented as a fifth party is set to enter the main stage and no obvious coalition can be certain of a workable majority. Starting with the increasing fragmentation, the radical-right Vox, currently absent in the national parliament, is up for big wins and is set to enter the main stage next to the radical-left Podemos, the centre-left PSOE, the centre-right PP and the liberal centrist Ciudadanos. It would effectively be the first time since the Franco period that the far-right enters Spain’s political arena again. Vox campaigns on an anti-immigrant platform, focussing on Christian values and other Spanish traditions (e.g. bullfighting) and is strongly in favour of centralising policymaking and stripping regions of most of the autonomy they have.

A workable majority is not just up for grabs

Polls are always accompanied by a certain amount of uncertainty, but in Spain reading them is even more difficult, because the electoral system is based on regional proportionality. Still El País has tried to translate current polls in a distribution of seats. According to those calculations, the PSOE would become the largest party at the expense of the PP (figure 3 and 4). Furthermore, the PSOE, Ciudadanos and Vox would increase their number of seats in parliament compared to the current situation, while the PP and Podemos stand to lose. Altogether, the largest parties to the right of the PSOE would increase their number of seats. As an aside, it is worth noting that under the new leadership of Casado, the PP has made a shift further right.

Figure 3: Vote share and seat distribution based on sample of polls (14 February 2019)

Source: El País, Rabobank

Figure 4: PSOE’s win may not lead anywhere

Source: El País (14 February 2019), Rabobank

All in all then, the centre-left socialists of the PSOE stand to win the elections, but might lose at the same time as it is far from certain that they will be able to form a majority coalition. Based on the numbers, a coalition between the PP and Ciudadanos with outside support of Vox –the same as recently formed in Andalucia– seems most likely. This would imply a major shift to the right compared to the outgoing PSOE-Podemos construction. Yet especially for Ciudadanos it might be toxic to engage with the PP at the national stage given the many corruption allegations surrounding PP figures. Furthermore, Cs will likely not be willing to give in much to Vox’s radical requests. That said, looking at economic policy proposals there is some common ground, for example regarding business friendly policies. Second in line is a coalition with PSOE and Ciudadanos. But for that to happen the math has to change and PSOE will have to be willing to shift policy more to the centre. Importantly, elections are still more than two months away and polls could still change significantly.

Another headache for Europe?

In many EU countries the radical right has gained importance in recent years, often denouncing the relevance or at least the functioning of the EU and euro. Cooperation between Member States has suffered as a consequence. At first sight, the rise of another radical right party does not bode well in this respect. That said, Vox does not have a clear Eurosceptic view. They do seem to be in favour of some more national sovereignty, but have clearly not labelled themselves as anti-euro or EU. That said, their very harsh anti-immigrant stance substantially differs from that of previous Spanish governments and is likely to toughen and harden the EU-wide refugee debate.

So now what does it all mean?

It is safe to assume that the next parliament will be more fragmented than the outgoing one. It will likely prove difficult to form a workable majority coalition. But if parties succeed in doing so, the next government will be more right-leaning than the outgoing one, economic policy should be more business friendly, fiscal policy less expansionary, and the government’s mandate will be stronger. So even if parliament comes out more fragmented, policymaking is unlikely to be more difficult than in the past half year. In that sense, we could argue that the early elections are good for the longer-term economic outlook compared to the current situation.

That said, at this point we still know very little and it remains to be seen whether the next government will be able to effectively deal with Spain’s longer-term economic challenges. Which in fact is necessary to maintain economic growth at a pace compatible with the provision of social services and the ability to service the high government debt also in the medium term, especially in the light of an ageing population. At the same time, tensions with the Catalan region are likely to rise again under the next government and the harsh rhetoric of Vox could prove damaging for social cohesion altogether, as is the case in Italy under leadership of the radical-right League.