Washington DC, April 10, 2025
- The Spanish economy has been performing strongly and growth is expected to remain significantly above the euro area average in the near term, before slowing gradually as its recent drivers normalize and demographic aging intensifies. Most risks are to the downside, including from a further escalation of trade measures and domestic political fragmentation.
- On fiscal policies, given still high debt and the economy’s strong cyclical position, there is a case for frontloading the authorities’ planned adjustment, strengthening the national fiscal framework to ensure that regions contribute to the consolidation effort, and adopting employment-friendly measures to address the projected growing gap between pension expenditures and social security contributions.
- The phased introduction of the positive neutral countercyclical buffer (CCyB) is welcome to further strengthen the banking system’s resilience. While the rapid housing price growth is currently not posing financial stability risks, it warrants close monitoring and should be addressed primarily through policy actions to boost housing supply.
- Fostering income-per capita convergence toward other high-income advanced economies requires enhancing active labor market policies to continue raising the employment rate, as well as adopting productivity-enhancing reforms that facilitate young and innovative firms’ scaling up and strengthen Spain’s innovation ecosystem.
Recent Economic Developments and Outlook
The Spanish economy has continued to perform strongly, largely fueled by services exports and labor accumulation. Economic activity grew by 3.2 percent in 2024, underpinned by a continued expansion of services exports and a pickup in domestic demand. Private consumption accelerated, supported by real income gains on the back of steady disinflation, solid nominal wage increases amid a tight labor market, and continued employment gains fueled by immigration. Investment though was more subdued, held back by multiple factors since the pandemic including elevated domestic policy uncertainty. With much of the post-pandemic expansion relying on labor accumulation, income per capita gains have been more modest, although they have picked up in most recent years as hourly labor productivity accelerated. The slowdown in energy and food prices since mid-2022 has gradually fed through to core inflation, whose decline fully accounted for the drop in headline inflation from 3.4 to 2.9 percent between 2023 and 2024.
Growth is projected to remain robust in the near term before slowing gradually. The annualized growth rate of over 3 percent observed since mid-2023 is expected to decline gradually as export and working-age population gains normalize, reducing GDP growth from 2.5 percent in 2025 to 1.8 percent in 2026. Demographic aging would subsequently keep growth close to its medium-term potential of around 1.7 percent. Under staff’s baseline, the adverse impact of elevated trade policy uncertainty and the tariffs announced by the US administration in early April will be contained by Spain’s limited direct and indirect trade exposure to the US.[1] Consumption growth is projected to remain solid with continued real wage increases and a gradual decline in household saving rates offsetting slower employment gains. Investment should pick up on lower interest rates, progress with the execution of Next Generation EU (NGEU) funds, and a rise in housing construction to meet pent-up demand. As growth slows, the unemployment rate will remain stable at around 11 percent over the medium term. Both headline and core inflation are projected to decline further and return close to the ECB’s target by end-2025, underpinned by a gradual moderation of nominal wages and energy price disinflation.
Most risks to the outlook are to the downside. A further escalation of trade measures—particularly those directly involving the EU—is a key external risk. On the domestic front, political fragmentation could hamper a fiscal response if Spain’s deficit reduction fell short of its commitments under the EU governance framework or market concerns about sovereign risks in Europe were to emerge. Another risk relates to continued subdued investment, including due to persistent supply bottlenecks in construction, prolonged domestic and global uncertainty, or slower-than-expected execution of NGEU funds. On the inflation front, more-persistent-than-expected increases in unit labor costs from sustained wage pressures or disappointing productivity growth, could slow the disinflationary process.
Fiscal Policies
Public finances continued to improve in 2024 despite high public spending growth, particularly on wages and social transfers. Excluding the costs of the emergency response to the catastrophic DANA floods, the 2024 deficit fell below the authorities’ 3 percent of GDP target. This reduction was driven by higher revenues, as personal income taxes (PIT) and social security contributions benefitted from the continued labor market expansion, non-indexation of PIT brackets, and the rollout of higher social security contribution rates following the 2021-23 pension reforms.
High public debt and looming spending pressures entail medium-term fiscal risks. With a debt-to-GDP ratio of 101.8 percent as of end-2024, Spain’s debt trajectory remains vulnerable to shocks to growth and financing costs. Additionally, the projected long-term rise in aging-related expenditures in pensions, health, and long-term care—of about 4 percent of GDP by 2050 according to AIReF, the Spanish fiscal watchdog—is expected to start exerting growing pressure on public finances. And increasing defense spending to the authorities’ 2 percent of GDP target would require further resources.
The authorities should seize upon the strong growth momentum to more swiftly rebuild fiscal space and reduce sovereign debt risks. Under staff’s baseline projection, which assumes that no further measures are taken beyond those already implemented or approved, the deficit is projected to stabilize around 2 percent of GDP by 2030 versus 1.2 percent projected by the authorities based on the expenditure path included in their Medium-Term Fiscal and Structural Plan (MTFSP). This implies that measures of almost one percent of GDP have to be implemented to achieve the authorities’ MTSFSP deficit path. Furthermore, weighing fiscal risks on the one hand, and the economy’s continued strong cyclical position and NGEU support on the other, staff recommend frontloading the authorities’ planned 3 percent of GDP adjustment over 2025-2029 rather than 2025-2031. Should downside risks materialize, fiscal policy should remain flexible, letting automatic stabilizers play out. Temporary discretionary support should be considered only in the event of a severe shock and provided sovereign funding costs remain low.
To underpin the adjustment, the MTFSP would benefit from a clearer strategy grounded in well-identified tax increase and spending reduction priorities. These could include harmonizing VAT rates and enhancing green taxation—starting with equalizing diesel and gasoline excise duties—to preserve growth and meet the authorities’ environmental goals. Such measures could substitute for smaller ad hoc ones such as the revamped bank tax, which should be discontinued at the end of its 3-year duration. As a complement to the tax measures, more strategic reviews of public spending efficiency in broad areas could identify budget savings. Any increase in defense spending should be mostly budget-neutral and should not compromise growth-enhancing spending, such as public investment.
Fiscal pressures from the projected growing gap between pension expenditures and social security contributions should be addressed, prioritizing employment-friendly measures. While AIReF’s recent review did not trigger the safeguard clause, the agency’s independent opinion highlights a widening gap in the coming decades, partly as a result of the 2021-2023 reforms. Given the potential adverse employment consequences of a higher labor tax wedge, alternatives to raising contribution rates should be considered to address the funding gap, including further lengthening the period over which benefits are computed. Such measures should be complemented by other initiatives to encourage longer working lives, such as addressing older workers’ less robust health and need for flexible work arrangements. The recent introduction of delayed retirement incentives—which are showing encouraging results—and more gradual retirement options are welcome steps in this regard. As for the safeguard clause—a useful instrument to regularly monitor the pension system and foster an active public debate—it should be amended to address its limitations. As currently designed, the clause is triggered if average pension expenditures over 2022-2050 net of revenue measures taken over that same period exceed 13.3 percent of GDP. Ideally, the rule should focus instead on the future evolution of the gap between expenditures and revenues of the pension system under a no-policy-change scenario. Absent such redesign, the rule should at least clearly define ex ante a narrow set of direct revenue measures——that should enter the computation of net future spending. It could also be made more forward-looking, for instance by considering a 25-year-ahead projection period rather than the currently fixed 2022-2050 window.
The fiscal framework of autonomous communities should be strengthened to ensure fiscal discipline. A comprehensive reform will require striking a political compromise on the desired balance between autonomy and redistribution across Spanish regions. As this could take time, several steps can be taken already now. The proposed partial relief of the regions’ outstanding debt with the central government could facilitate their gradual return to bond markets, creating market-based incentives for fiscal discipline. However, to minimize moral hazard, such relief should be conditional on individual regions committing to credible consolidation plans. The national fiscal rule should also be more strictly enforced and updated to align with the new EU governance framework as part of the transposition of EU Directive 2024/1265. In particular, the yearly fiscal target should focus on primary spending growth net of revenue measures, in line with the MTFSP. Finally, the Fondo de Liquidez Autonómico (FLA), which was set up to lower regions’ funding costs in the aftermath of the Global Financial Crisis, should be reformed to support the regions’ return to markets and eventually function only as a last-resort borrowing source. To this end, its lending conditionality should be strengthened and paired with enforcement of the regions’ consolidation plans.
Financial Policies
Spain’s financial system remains in good health. Banks are resilient, with comfortable capital and liquidity buffers, despite CET1 ratios being somewhat below those of euro area peers. Bank profitability has been strong, provisioning has been prudent, and asset quality has remained solid. In turn, low and stable non-performing loans have been supported by the continued strength of household and non-financial corporate balance sheets. Households have maintained low debt levels, and no material pockets of vulnerabilities have emerged as rising debt service has been offset by lower unemployment and rising incomes. Firms have continued to deleverage, and while interest expenses have risen, interest coverage ratios remain comfortable. Accordingly, corporate insolvencies have stayed low—although the risk of court congestion due to rising individual filings following the insolvency reform should be carefully monitored and, if needed, addressed through increased court resources and further efficiency gains.
To further bolster banks’ resilience, the Bank of Spain should proceed with the second stage of the phasing-in of the positive neutral CCyB, while continuing to implement the recommendations of the 2024 IMF Financial Stability Assessment Program (FSAP). The two-step CCyB implementation—0.5 percent introduced in October 2024, with another 0.5 percent planned for October 2025—allows for a gradual adjustment. Given their current capital levels and profitability, banks are expected to meet the new buffer without restricting lending. To ensure the system’s resilience to shocks, particularly at a time of heightened uncertainty, banks should be encouraged to maintain adequate voluntary buffers through prudent dividend distributions as the positive neutral CCyB is being phased in. The authorities are also making good progress on other FSAP recommendations although further actions are needed on those that require coordination among the relevant agencies or overcoming legislative hurdles. Follow-through remains essential to keep future systemic financial risks at bay.
Rapid housing price growth is not posing financial stability risks at this stage, but it warrants close monitoring and should be addressed primarily through policy actions to boost housing supply. In real terms, housing prices remain significantly below 2007 levels, household leverage is low, and there is no indication of a material loosening of lending standards. However, should early signs of riskier lending emerge, preemptive borrower-based macroprudential measures should be considered. Price and rent increases, together with still high borrowing costs, have eroded housing affordability. In this regard, the government’s package of measures announced in January is broadly welcome, although the main focus should remain on boosting supply, particularly through advancing the amendments to the Land Law, addressing red tape in licensing, and expanding the social housing stock. In areas where land scarcity is less acute, narrowly-targeted demand-side measures—such as the recently-introduced public guarantees supporting young first-time homeowners—could improve access to home ownership. Rent controls should be reevaluated and discontinued if found to reduce the quantity or quality of regular rental supply, or to hinder access for lower-income households.
Structural Policies
Fostering income-per-capita convergence toward other high-income advanced economies requires raising the still low employment rate and boosting productivity. While the Spanish economy has outperformed European peers in recent years, its employment rate remains among the lowest in the euro area, and the productivity shortfall is still as wide as in the early 2000s.
Further enhancing active labor market policies (ALMP) and financial incentives for jobseekers are key to continuing to durably reduce unemployment. The recently adopted unemployment assistance reform could be expanded by strengthening activation requirements for recipients, allowing them to combine work income with benefit receipt for a longer period, and eventually replacing non-employment benefits by an integrated in-work tax credit, which has proven successful in raising employment rates in peer countries. Giving greater weight to improvements in job placement when distributing funds to regional Public Employment Service agencies would enhance the effectiveness of ALMPs. Conditional on this improvement, the ALMP budget, which remains significantly below successful European countries, could be increased to strengthen the intermediation role of regional agencies through increased staffing, digitalization, and stronger collaboration with the private sector.
The government’s planned reduction of the working week in the private sector should be carefully designed to mitigate adverse effects on output and workers’ incomes. The workweek reduction pursues broader societal goals, but experiences in other countries point to an ambiguous effect on unemployment and adverse impacts on output and post-reform wage growth. Its implementation would also raise the cumulative increase in the minimum wage since 2018 to over 70 percent, starting raising concerns about potential adverse impacts on disadvantaged groups. The reform should preserve the strong role of collective bargaining in accommodating cross-sectoral heterogeneity, including in distributing total hours throughout the year and setting the level and remuneration of overtime.
Enabling firms to scale up and strengthening the innovation ecosystem would help lift productivity growth. Large Spanish firms are lagging behind the most dynamic European peers on R&D and innovation, while young high-growth firms are fewer and have a hard time scaling up. Beyond the efforts made in recent years and the government’s welcome intention to double R&D spending as a share of GDP by 2030, other priorities include:
- Facilitating firms’ scaling up. Advancing the government’s Regime 20 initiative, aimed at harmonizing and simplifying regulation and administrative burdens, could reduce barriers to trade in goods and services within Spain’s fragmented market, although it might take sustained effort and time to bear fruit. Supporting ongoing EU-level initiatives to cut remaining large intra-EU trade barriers would amplify the gains from Regime 20. Streamlining size-dependent policies, which impose more stringent labor regulation and tax monitoring once firms reach certain employment and revenue thresholds, would also incentivize firms to grow.
- Expanding the financing of young innovative firms. Beyond Spain’s active role in supporting the EU Capital Markets Union, strengthening domestic tax incentives for young firms and addressing the lack of information about them among institutional investors could promote venture capital, helping innovative firms scale up.
- Strengthening the university system. Building on the 2023 reform, the university system should be enhanced to promote innovation by strengthening autonomy in the recruitment, promotion and remuneration of professors, making curricula more responsive to evolving labor market demands, strengthening research collaboration with businesses, and increasing performance-based public funding.
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[1] This statement incorporates the impact of trade measures announced up to April 8, 2025.
A Concluding Statement describes the preliminary findings of IMF staff at the end of an official staff visit (or ‘mission’), in most cases to a member country. Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF’s Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, or as part of other staff monitoring of economic developments.
The authorities have consented to the publication of this statement. The views expressed in this statement are those of the IMF staff and do not necessarily represent the views of the IMF’s Executive Board. Based on the preliminary findings of this mission, staff will prepare a report that, subject to management approval, will be presented to the IMF Executive Board for discussion and decision.
The mission team thanks the authorities and all our other counterparts for their warm hospitality, frank and open discussions, and collaboration.
Source – IMF