ECONOMY CONTINUES DECLINE, RECOVERY REMAINS DISTANT

UNCLAS SECTION 01 OF 02 MADRID 000206

C O R R E C T E D C O P Y (ADDED SBU MARKINGS, PARAS 1, 4)

SENSITIVE
SIPDIS

E.O. 12958: N/A
TAGS: ECON EFIN EINV ETRD PREL SP
SUBJECT: ECONOMY CONTINUES DECLINE, RECOVERY REMAINS DISTANT

REF: A. 08 MADRID 707

B. 08 MADRID 1257

C. 08 MADRID 01080

D. 09 MADRID 109

MADRID 00000206 001.5 OF 002



1. (SBU) Summary: Spain's unemployment rate of 14.4 percent is
the highest in the European Union (EU),and its economy is
officially in a recession. The government is responding to
the crisis with a series of stimulus and support measures,
relying heavily on deficit spending. With over 3 million
jobless workers, unemployment has become the GOS's number one
concern, but President Zapatero remains firm in his refusal
to consider increasing flexibility of hiring and firing. GOS
officials acknowledge that 2009 will be a difficult year, and
very recently have begun to follow the lead of others in
expressing concern about economic prospects for 2010.
Spain's Achilles heal continues to be its slumping
residential construction sector, which once fueled about 10
percent of GDP. End summary.

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OVERVIEW OF SPAIN'S ECONOMIC SLUMP
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2. (U) Spain's difficulties began with the downturn in the
residential construction sector, which, as recently as 2006,
fueled approximately 10 percent of GDP. Home prices rose and
construction boomed for several years, until interest rates
began to rise sharply. These high rates caused buyers to
defer purchasing homes, which led to a collapse in demand in
mid-2007 that bankrupted many prominent real estate
developers. The amount of unsold units on the market
continued to grow for the next year as housing under
construction was completed, and prices have declined
significantly. Construction companies and workers have been
equally affected, as housing starts have almost entirely
ceased and hundreds of thousands of workers have lost their
jobs. The international credit crisis aggravated these
problems, and the global economic downturn has had a negative
impact on other important sectors in Spain such as tourism
and the auto industry.


3. (U) Over the past several months, consumption has
stagnated and the Spanish economy has spiraled downwards.
The National Statistics Institute (INE) confirmed February 12
that the Spanish economy had contracted by 1 percent in the
fourth quarter of 2008, marking the second consecutive
quarter of negative growth, and officially placing Spain in a
recession for the first time since 1993. Unemployment spiked
to 14.4 percent in December according to the EC's statistics
agency Eurostat, making Spain the country with the highest
level of unemployment in the EU. The silver lining in the
midst of Spain's economic problems has been the strength of
its private banks, which are in better shape than their
counterparts in other countries, and continue to post profits
(ref A and D).

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GOS RESPONSE
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4. (SBU) Over the past year, President Zapatero has taken a
series of actions in an unsuccessful attempt to slow the
economy's decline and rally confidence. However, his
emphasis over the past year on the importance of maintaining
public confidence was criticized as an unwillingness to
acknowledge the depth of the difficulties. The GOS
implemented a series of stimulus measures, including a 10-18
billion euro tax rebate and relief package in April, and an
11 billion euro infrastructure investment package in October
(Refs A and B). In response to the freezing of international
credit markets, the GOS has begun to purchase mortgage-backed
assets from banks and to guarantee up to 100 billion euros in
new bank debt (ref C). It also took steps to give the
government the authority to inject capital into banks, though
both the GOS and the banks insist this will not be necessary.


5. (U) The GOS's measures, coupled with a slowdown in tax
receipts and an increase in unemployment compensation,
brought a dramatic end to four years of budget surpluses.
The deficit was over 3 percent of GDP in 2008 and will
potentially reach 6 percent in 2009. Spain's weakening
fiscal position, along with other factors, prompted S&P to
downgrade its sovereign debt credit rating from AAA to AA
and Moody's to label its rating as "vulnerable."

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WHAT THE FUTURE HOLDS
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MADRID 00000206 002.5 OF 002




6. (U) The GOS acknowledges that 2009 will be a difficult
year, during which unemployment will continue rise, and the
recession will continue. Until recently, GOS officials have
asserted that the economy will begin to turn around in the
second half of 2009. On February 17, however, Second Vice
President and Minister of Economy acknowledged in a
congressional hearing that 2010 may also be a tough year for
Spain, a prediction that is more in line with general
opinion. EU estimates predict a recession and higher
unemployment for Spain well into 2010.


7. (U) Spain's Achilles heel, its residential construction
sector, continues its downward adjustment. With an estimated
one million newly constructed properties left unsold, and
prices continuing to decline, many experts say that the
housing downturn will continue to have a major impact on
Spain's economy. New residential construction has stagnated
and property prices have declined. Property estimator TINSA
estimates that property prices could fall an additional 20
percent this year, after a 2008 decline of 10-20 percent.
For the most part, homeowners are managing to pay their
mortgages, with Spanish default levels significantly below
U.S. levels. This is in part because of higher downpayment
requirements, strict repayment requirements, and a cultural
prohibition against being in default on home mortgages.
However, defaults rates are beginning to increase, and will
continue to do so as unemployment rises and unemployment
benefits run out. If defaults increase too much, Spanish
banks, particularly its savings banks/cajas, and the
financial system could suffer as well.


8. (U) With over 3 million jobless workers, unemployment has
become the GOS's number one concern, but President Zapatero
remains firm in his refusal to consider increasing
flexibility of hiring and firing as called for by business
groups, the governor of the Bank of Spain, and the IMF. Many
analysts say that the GOS forecast that unemployment will
reach 15.9 percent by year end is unrealistically low.
Continued increases in unemployment and contractions in
economic activity could lead to even tougher budget decisions
for the government. Two of the few factors in favor of the
President Zapatero and the ruling Socialists are that: 1)
national elections are more than three years away; and 2)
popularity ratings for Zapatero and the Socialists, albeit
low, are still somewhat higher than those for the
scandal-mired opposition Partido Popular.
CHACON