Our Opinion: 2016
Spain after Brexit
Whilst it is usually a joy to be in Madrid on a July afternoon, my meetings with financial professionals today have been dominated with worries about the UK’s decision to leave the European Union and how it will affect Spain.
Although the UK’s FTSE-100 index showed investors to be relatively un-concerned about the referendum result, other European indices took a beating. Spain fell 12%. Italy fell 10%. And a pan-European index of banking stocks fell 22% in the two days after the vote.
Spain, with Italy, represents two of Europe’s potential trouble spots. Last Sunday’s General Election here produced an increase in support for the centre-right Peoples Party (PP) headed by Prime Minister Mariano Rajoy. However, for the second successive election, the outcome is a hung parliament, which could sap confidence and dent growth. Much needed structural reforms are difficult to drive through politically, so likely to stay on the back burner.
Spain is one of the Eurozone economies most exposed to the UK, particularly through tourism but also through goods exports and non- tourism services. Brexit will also have an indirect impact, as the rest of the Eurozone will slow down as well. In addition, if corporate and household confidence levels worsen, consumption and investment and hiring decisions could be affected.
Brexit will negatively affect Spain in three ways. Firstly, it is one of the Eurozone economies most directly exposed to the UK. Secondly, the country will suffer an indirect impact, as the rest of the Eurozone will slow down as well. Thirdly, worsening corporate and household confidence will hurt consumption and investment and hiring decisions.
To see these challenges through, it is likely that only Rajoy is in a position to form a new government. A left-wing coalition has been ruled out by the socialist party (PSOE), and there is little incentive for any party except PP to risk another election. Rajoy has started a round of meetings with members of parliament to gather support for his candidacy to remain as prime minister. The parliament will convene on Tuesday and the King will meet party leaders to appoint a candidate shortly after.
UBS have cut Spain’s GDP growth forecasts from 2.9% to 2.8% this year, and from 2.2% to 1.9% next year. Confidence could recover if uncertainty about the political and economic impact of Brexit fades, although it will still be hurt by higher inflation and energy prices. On the other hand, commercial and residential property construction is forecast to accelerate further.
The biggest fear seems to the possibility that European rejection will spread. In France, the head of the right-wing populist Front National, Marine Le Pen, called for a referendum on France’s membership of the European Union. Populists in Denmark, Sweden and Italy also want plebiscites, with the latter focused on membership of the single currency. Their case would grow stronger if threats of Brexit’s dire consequences for the UK are proved wrong.
Spain’s relatively stagnant economy is the main reason to expect calls for a referendum to grow here too. But the real risk to a Eurozone break up remains Italy. It is mired in an endless slump, having grown by just 5.4% since 1999 – compared with 14% in a country like Japan. The reformist Prime Minister Matteo Renzi is fighting off a populist party that could cost him victory in a referendum over constitutional change this October. If his reforms of the Senate don’t go through, his odds of reforming Italy and finally boosting growth will dwindle.
Italy may be the main reason to believe that Brexit could well prove worse for the continent than for Britain.
Spain is one of Europe’s largest economies. Whilst it has more direct trade links to the UK than the Eurozone average, any slowdown is unlikely to be more than elsewhere. The country can count on a strong tourist season and a sharp recovery in residential property construction – already clearly visible in Madrid.
Spain’s relatively sunny outlook makes it a core holding in European investment strategies.
14th July 2016
