Kingdom of Spain

Economic Policy and 2010 Funding

Strategy

Secretary of State for the Economy

February 2010
• Highlights

• The long growth cycle and the crisis

• Fiscal consolidation and structural reform

• Funding Strategy of the Kingdom of Spain

~2009~
2
 Highlights
• Long growth cycle previous to the international crisis
• Important challenges ahead: Unemployment and deficit,
consequence of the crisis but also symptoms of underlying
structural shortcomings
• The Spanish Government is determined to act:
• Fiscal consolidation: A cut of 5.7% of GDP in structural
primary deficit in 2010-2013
• Structural reforms to boost potential GDP: Sustainable
Economy, Bank Reorganisation, Pensions, Labour Market
• Strengths: Sound financial system, low Debt/GDP,
institutional ability for reform
3
• Highlights

• The long growth cycle and the crisis

• Fiscal consolidation and structural reform

• Funding Strategy of the Kingdom of Spain

4
 1994-2008: Convergence and Debt reduction

• GDP per capita has leapt forward, exceeding the average of EU-25
• Fiscal rigour during the good times allowed debt to GDP to be more
than halved

GDP Debt to GDP

(Year on year real growth rates) (% nominal GDP)
80%
6% Euro-area
Spain
4% 70%
2% 60%
Euro-area
0%
50%
-2% Spain
40%
-4%
-6% 30%
2000

2002

2003

2004

2005

2007
2001

2006

2008

2009
2001

2008
1996

1997
1998

1999

2000

2002
2003

2004

2005

2006
2007

2009

Source: Eurostat. Source: Eurostat.

5
 Investment binge: housing and beyond

• What has fuelled domestic demand is a soaring investment rate,

with the national savings rate staying close to Eurozone average
• The housing boom is part of the story, but not the whole story

Savings rate Investment rate vs. Savings rate

(% nominal GDP) (% nominal GDP)
34
30

25 30

20
26

15 22

10 18
2000

2007

2009
1999

2001

2002

2003

2004

2005

2006

2008
B elgium Germany S pain France Italy

2000 2005 2009* Savings rate Investment rate

Source: Eurostat.
Source: Eurostat.
* 2009Q3 6
 Investment binge: housing and beyond
• The residential real estate sector grabbed a non-sustainable share
of GDP and employment…

Construction Sector: Gross Value Added and Employment

(% Total Value Added and of Total Employment)
14
13
12
11
10
9
8
7
6
1995
1996
1997
1998

2000
2001

2003
2004
2005
2006
2007

2009
1999

2002

2008
Full-time equivalent employees Gross Value Added

Source: National Statistics Institute, Spain.

7
 Investment binge: housing and beyond
• …but Spain has also invested heavily in equipment, infrastructure
and Research and Development

Investment in equipment
(average growth, 1995-2008 in percent) Public Investment
5.0 (% of GDP)
4.0
3.0
2.0
1.0
0.0

1995

2004
1996
1997
1998
1999
2000
2001
2002
2003

2005
2006
2007
2008
EU-27 GERMANY FRANCE ITALY UK SPAIN

Source: Eurostat.

8
 Intensive in employment
• Residential construction attracted low skilled labour, dragging
productivity lower
• Labour supply matched this demand with the help of immigration
flows

Active population Labor productivity

(Growth rates from 2005Q1 to 2009Q3)
(Relative to EU-27, PPP)
12% 107
10% 106
8% 105
104
6%
103
4%
102
2% 101
0% 100
Germany

Italy
France
Spain

Kingdom
Belgium

1999
2000
2001
2002
2003
2004
2005

2007
2008
2009
2006
United

Source: Eurostat. Labor Force Survey.

Source: Eurostat. Labor Force Survey. 9
 Cost competitiveness
• Loss of competitiveness has been moderate in the tradable sector
• Nominal divergence stems from non-tradables (where the bulk of
the adjustment is taking place)

Unit labour cost index Manufacturing ULC index

(Relative to eurozone 1999=100) (Relative to eurozone 1999=100)
125 140
120 130
115 120
110 110
105 100
100 90
95 80

2001

2005
1999
2000

2002
2003
2004

2006
2007
2008
2009
2001
2002

2004
2005

2007
2008
1999
2000

2003

2006

2009

Spain Italy Germany France Spain Italy Germany France

Source: Eurostat.
Source: Eurostat 10
 Exports show underlying improvement in supply
• In spite of brisk domestic demand and waning price
competitiveness…
• …Spain's market shares have outperformed most of peers

Share in world merchandise exports Share in world exports of services*

(Index 2000=100) 150 (Index 2000=100)
120

110
125
100

90 100

80
75
70

60 50
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2000 2001 2002 2003 2004 2005 2006 2007 2008

Spain Germany France United States Spain Germany France United States

Source: International Monetary Fund. Source: World Trade Organisation.

* Services other than transportation and travel.
11
 Services Exports’ market share has increased
significantly
• Among others, services related to architecture, construction and
engineering have more than doubled market share
Share of service exports in the OCDE, by service

10
2000
2007
8

0
Tourism

Government
Information
Insurance
Total

Entertainment
Financial
Transportation

Royalties and
Communications

Professional
and engineering

services to
services
Architectural,
construction,

patents

Other
services

Source: OECD. 12
 FDI flows have increased significantly
• Outward FDI stock per capita has grown faster in Spain than in
the Eurozone
• Remains a major destination of international investment

Outward FDI stock per capita Top receivers of FDI in 2008

relative to Eurozone (Stock in millions of US $)
2500000

2000000

1500000

1000000

500000

Germany

UK

US
China

Canada

Hong Kong

France
Belgium
Italy

Netherlands
Spain
Switzerland

Source: World Investment Report 2009

Source: World Investment Report 2009
13
 The crisis prompts an abrupt adjustment
• Rapid downsizing of residential sector: output, L (mainly in
temporary contracts)
• Ripple effects on employment in other sectors

Unemployment rate
20 (In percent)
Sectoral employment
16
(total number)
july 2008 sept 2009 dif %
12 Total 19.382.121 17.935.095 -1.447.026 (100)
Construction 2.361.177 1.752.157 -609.021 (42,1)
Industry 2.731.068 2.377.211 -353.857 (24,5)
8 Services 13.150.027 12.599.061 -550.966 (38,1)

4
2005 2006 2007 2008 2009 Sources: Eurostat. Labor Force Survey.

Spain Euro area (16 countries)

Sources: Eurostat. Labor Force Survey.

14
 Changes in sectoral and external balances
• Large swing in private sector balance: plummeting Investment and
soaring Savings
• Government Deficit jumps, but 2.5 points of GDP are one-off
• Current Account deficit has halved in 2009
Sectoral balances
(% of GDP)

Public Sector Balance

8 6,5
6 PrivateSector
4 Balance
1,9
2
% 0
-2
-4
-6 -4,1
-5,0
-8
-10
-12 -11,0 -11,4
-14
2007 2008 2009

Source: National Statistics Institute, Spain. 15

• Highlights

• The long growth cycle and the crisis

• Fiscal consolidation and structural reform

• Funding Strategy of the Kingdom of Spain

16
 Policy Strategy for Sustainable Growth

• Prudent Macroeconomic Scenario 2010-2013

• Agreement on Fiscal Consolidation to bring the deficit
back to 3% in 2013
• Structural Reforms:
• Structural Reforms in the goods markets
• Public Pensions System
• Labour Market
• Banking sector Restructuring

17
 The Government’s Macroeconomic scenario

• The output gap will be closed by 2013, after peaking in 2010

• External demand contribution to GDP will gradually wane as
domestic demand gathers steam
• Potential growth will recover from a trough of 0.6% in 2010 to
1.6% in 2013

Macroeconom
(Growth rate in pe 18
 Fiscal consolidation strategy

• Substantial reduction in Spending and moderate increase

in Revenues
• Already in 2010 a 2.2% cut in structural deficit

Fiscal Adjustm
(Growth rate in pe 19
 Starting and final points of fiscal consolidation

• Temporary measures (changes in tax collection, one off

investment funds) account for 2.4% points of GDP in 2009’s total
deficit
• Total size of fiscal policy adjustment (structural terms): 5.7% of
GDP

Fiscal posit
Source: Annual update of the Stability Programme.

20
 Fiscal restraint measures

Measures ado
Source: Annual update of the Stability Programme.

• Restraint in wage outlays for all public administrations through:

• 10% replacement rate
• No new temporary hiring
• Strong moderation in wages
• Sizable cuts in investment, transfers and subsidies

21
 Can we implement this?
• We have done it in the past, which proves our compromise, the
quality of our public finances, and the success of our fiscal
discipline.
• Shared commitment to fiscal discipline and margin to secure
further reductions in the deficit
Net Lending (+)/Borrowing (-) of General Government
4.0 (% nominal GDP, EDP)
2.0
0.0
-2.0
-4.0
-6.0
-8.0
-10.0
-12.0
-14.0
2000

2003

2006

2010*

2011*

2012*

2013*
1995

1996

1997

1998

1999

2001

2002

2004

2005

2007

2008

2009

* Annual update of the Stability Programme. 22

 Debt dynamics

• Even after the impact of strong stabilisation policies, Spain's Debt

to GDP is significantly lower that the Eurozone average

Gross Debt-to-GDP (%) Gross Debt-to-GDP (%)

2000-2010 2010F
90 125.0
France 112.5
Germany
80
Spain 100.0 Eurozone
70 87.5 Average: 84.0%
75.0
60 65.9
62.5
50.0
50 55.2
37.5
40 25.0
39.7
12.5
30 0.0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Spain Ireland France Germany Italy UK USA

Sources: European Commission, Annual update of the Stability Programme and International Monetary Fund.
23
Lowest interest burden within affordable limits
Ratio of interests to GDP of General Government
13
(% nominal GDP, EDP)

11

7
5

*
98

99

01

02

03

04

06

07
95

96

97

00

05

08

09

10
19

19

20

20

20

20

20

20
19

19

19

20

20

20

20

20
Spain Germany France Belgium Italy UK

Source: European Commission.

* European Economic Forecast Autumn 2009, European Commission.
24
 Structural Reforms in product markets

• Improving the institutional environment for business: by

modernizing and simplifying government activities as well as
increasing general government discipline
• Fostering competitiveness: by reducing the administrative
burden of creating companies and reducing red tape
• Fostering modernization: promoting sectors that are at the
base of economic activity (R&D, innovation and training),
improving support for their integration into the overall value chain,
and facilitating the internationalization of businesses
Estimated impact on GDP ⇨ + 0.32% in Potential GDP

25
 Residential Real Estate Sector

• Phasing out fiscal incentives for housing ownership from

2011 (deduction of mortgage payments)
• Removing barriers to the development of the rental market:
• Same fiscal treatment than ownership
• Creation of REITS
• Legal changes to strengthen certainty for landlords
• Tax Incentives for refurbishment provide some support

26
Preventive financial support measures

Capital
enhancement
Liquidity enhancement Credit stimulus
and
reorganisation

27
 The financial system remains resilient

• Main source of perceived vulnerability regards losses

stemming from lending to real estate developers
• Bank of Spain stress test: Operating income over 3
years is able to absorb losses of 40% of the portfolio of
lending to real estate developers.
• Extreme assumptions of stress test: PD of 40%(3 times
the peak of 1993) and LGD of 100 % (highly implausible)

28
FROB: a tool for restructuring the banking sector
Rationale for the initiative Governance

- Overcoming fragmentation in the - Independent management.

savings and banks sector.
- Strong accountability to Parliament.
- Achievement of economies of scale to
digest low interest margins and real - Authorized by DG Competition.
estate impact.

Asset Operations Funding

- Support to integration processes subject - Public-private mix of capital (9 bn€).

to conditions set by the banking
supervisor. - Agency-like funding programme
coordinated with the sovereign
- Instrumented through convertible programme.
preference shares with market-oriented
remuneration.

29
 Pension System Reform

Proposed Measures:
• A progressive increase in the retirement age (to 67 years)
• Strengthening relationship between contributions and benefits
• A more flexible relationship between complementary social
security and the public system
• Possible adjustment of other parameters of the current system

Expected Results: Sustainability of the pension system

30
 Labour Market Reform

• Five main guidelines:

• Stability in employment, by reducing market segmentation

• Reform of Collective Bargaining system
• Incentives for young workers’ employment and education
• Promotion of the integration of women in the labour market
• Worker intermediation and greater control of temporary
occupational disability claims

31
• Highlights

• The long growth cycle and the crisis

• Fiscal consolidation and structural reform

• Funding Strategy of the Kingdom of Spain

32
 Highlights of Funding Strategy
• Significant reduction in net funding requirements and
persistence of sound risk metrics
• Liquidity, transparency and predictability will continue
as guiding principles for the execution of our auction program
• As for syndications, timing is dictated by the limit size of the
line to be replaced (16.5 bn for longer tenors) and market
conditions.
• Innovations for 2010: 18-month T-bills reappear, Euro
inflation linker still a project
• Maintain our stable and diversified investor base

33
 The funding strategy

Tesoro Fun
(Billion euro)
34
 Funding programme in perspective

• Cut in Net Issuance: lower cash deficit and no exceptional increase

in net financial assets

Funding Programme. 2010 vs. 2009

140 (Net issuance in billion Euro)
120 116.7
2009 2010
100
82.3
76.8
80
61.6
60

40 34.4

20 15.2

0
Total Net Issuance Letras del Tesoro net Medium & long term
issues net issues*
(*) Includes foreign currency issues.

Source: Dirección General del Tesoro y Política Financiera. 35

 Short-term funding

• Net issuance in 2009 in line with initial announcement: 34.4 bn€. Gross
issuance breakdown:
• 3-month Letras: 19.7 bn€
• 6-month Letras: 31.6 bn€
• 12-month Letras: 58.0 bn€

• Innovations in 2010:
• Calendar change: 3- and 6-month Letras auction 4th Tuesday
• 18-month T-bills relaunched: auction 3rd Tuesday

36
 Medium- and long-term funding
• Gross issuance: 2009 overshooting (ca. 25 bn €) due to higher than
expected impact of the crisis
• Auction procedures unchanged: Quarterly calendar + potential off-the-
run lines announced Friday prior to the auction
• Limit size per line: increased to 16.5 bn € for longer lines
• Bonos del Estado:
• New 5-year benchmark in March
• Current 3-year benchmark B 2.30% 04/2013 issued until 15 bn €
• Obligaciones del Estado:
• New 10 year O 4.00% 04/2020 (5 bn €) successfully syndicated in
January
• Next syndication a 15 year line, to replace the matured O 4.80% Jan-
2024), expected for February depending on market conditions
37
 Diversification of funding sources
• Recent foreign currency issuance:

• Eurobond 2.75% March 2012 ($ 1.0 billion)

• Eurobond 2.00% October 2012 ($ 2.5 billion)
• Tesoro Público is open to additional foreign currency issuance

• Floating Rate Note 3-Month EURIBOR-10 bps, October 2012 (€ 3.0

billion). Possible retapping in 2010

• Projects:
• European inflation-linked issues (HICP-ex tobacco)
• Schuldschein loans

38
Main features of Treasury funding strategy
600
Spanish debt portfolio 554

500 (€ billion) 475

400 358
319 312 307
300
229
200

100

0
2001
1995
1996
1997
1998
1999
2000

2002
2003
2004
2005
2006
2007
2008
2009
2010 (f)
Foreign Currency Other Letras Bonos y Obligaciones

Source: Dirección General del Tesoro y Política Financiera. 39

 Recent widening might be an opportunity
Spread of the Spanish 10-year bond vs. main European peers
150 (in bps)
125

100

75

50

25

-25

-50

-75
Feb-08

Mar-09
Nov-07
Dec-07
Jan-08

Mar-08

May-08

Jul-08

Nov-08
Dec-08
Jan-09
Feb-09

May-09
Jun-09
Jul-09

Nov-09
Dec-09
Jan-10
Feb-10
Oct-07

Jun-08

Oct-08

Oct-09
Sep-07

Sep-08

Sep-09
Apr-08

Apr-09
Aug-08

Aug-09
Germany Italy France Belgium Netherlands

Source: Bloomberg. 40
 Cheapening concentrated in the front end
Spread of the Spanish 5-year bond vs. main European peers
150 (in bps)
125

100

75

50

25

-25

-50

-75
Nov-07
Dec-07

Nov-08

Jan-09

Nov-09
Dec-09
Oct-07

Jan-08
Feb-08
Mar-08

May-08
Jun-08

Oct-08

Dec-08

Feb-09
Mar-09

May-09
Jun-09
Jul-09

Oct-09

Jan-10
Feb-10
Jul-08
Sep-07

Sep-09
Sep-08
Aug-08
Apr-08

Apr-09

Aug-09
Germany Italy France Belgium Netherlands

Source: Bloomberg. 41
An atractive market to invest in

42
 Increase in market liquidity
Average outstanding size: 13.5 bn €
20 Target for average outstanding <10 years: 15 bn €
Target for average outstanding >10 years: 15 bn €
18 On-the-run bonds 4.10%
6.00%
3.25% 5.40% 4.40%
16 4.10% 3.90% 4.20% 3.30% 3.15% 5.50% 4.30% 4.20%
5.35% 6.15% 4.75% 4.60% 4.80%
14 5.00% 3.80% 5.75%
4.25% 4.90%
2.75%
12 2.30%

10
8
6 4.00% 4.70%
4
2
0
Jul-10

Jul-11

Jul-12

Jul-13

Jul-14

Jul-17
Jul-18
Jul-19

Jul-32

Jul-40
Jul-41
Jan-14

Jan-15
Jan-16
Jan-17

Jan-24
Jan-29

Jan-37
Jan-13
Oct-11
Apr-12

Oct-12

Apr-13

Oct-14

Oct-19
Apr-11

Apr-20
Source: Dirección General del Tesoro y Política Financiera.
43
 Low Debt Refinancing Risk…
Redemption profile of Bonos & Obligaciones
(Million Euros)
50.000

45.000

40.000

35.000

30.000

25.000

20.000

15.000

10.000

5.000

0
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020- 2024 2029 2032 2037 2040 2041
2023

Source: Dirección General del Tesoro y Política Financiera. 44

 Low Debt Refinancing Risk…

Central Government Debt refinancing risk

(in % of the total portfolio)
50
42
40

30
24
(%)

20 21 22 21
20 18 18

10 7

0
1 year or less 1 to 3 years 3 to 5 years
31.12.1995 31.12.1999 31.01.2010

Source: Dirección General del Tesoro y Política Financiera.

45
…Thanks to relatively high duration and average life
to maturity…
Duration & Average Life to Maturity of the Portfolio
8.0 (Letras, Bonos and Obligaciones)
(in years)
6.69 6.78
5.52
6.0

4.79
4.77
4.0
4.16

2.0

0.0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Duration Average life
A
Source: Dirección General del Tesoro y Política Financiera.
France 46
…while achieving lower Funding Costs
Average Funding Costs
(in percent)
6.0
5.5
5.0
4.5 4.32

4.0
3.5 3.81 3.49
3.0
2.5
2.27
2.0
1.5
1.0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Average cost of Debt outstanding Average cost at issuance

Source: Dirección General del Tesoro y Política Financiera.

47
Reliance on foreign funding relatively moderate

External public sector debt in 2009

100 (% of GDP)
90
80
70
60
50
40
30
20
10
0 Netherlands

Argentina
Germany

Kingdom
Belgium
Greece

Finland
France
Austria

Ireland

United
Spain
Italy

States

United
Source: OECD.
48
Banks financing of government debt in line with
Eurozone average

Holdings of government debt November 2009

(% of bank assets)
25

20

15

10

Germany

Portugal
Slovakia

Belgium

Ireland

Finland
Greece

France

Euro area

Netherlands
Italy

Spain

Austria

Source: Citi.
49
Spanish Banks’ funding from ECB around
Eurozone average

Recourse to ECB funding

(% of total bank assets)
10%
8%
6%
4%
2%
0%
IRL

IT

FI
NL

GR

AU

FR
PO
GE

BE
ESP

jul-08 oct-09

Source: Deutsche Bank.

50
 Stable and diversified investor base
Government Bonds by Holder
(Term investment, % of total portfolio)
100%
Spanish official
90% institutions
33.37%
80% Non residents
70% 43.94%
60% Households &
Non financ.
50%
Pension & Mutual
40% Funds
30% Insurance
20% Companies

10% Credit Institutions

0%
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Source: Dirección General del Tesoro y Política Financiera.

51
 Stable and diversified investor base
Letras del Tesoro by Holder
(Term investment, % of total portfolio)
100%
Spanish Official
90% Institutions
80% Non-Residents
70%

60% Households & Non

financ.
50%
Pension and Mutual
40% Funds
48.97%
30% Insurance companies
35.57%
20%

10% Credit Institutions

0%
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Source: Dirección General del Tesoro y Política Financiera.

52
 Stable and diversified investor base
Government Bonds by Holder
(Term investment, % of total portfolio)
30%

25%

20%

15%

10%

5%

0%
France Japan Germany Italy BENELUX Rest of EU Asia, Afica America Rest of
and others Europe
2006 2007 2008 2009

Source: Dirección General del Tesoro y Política Financiera.

53
Top Primary Dealers in 2009

Bonos y Obligaciones

Barclays
BBVA
Calyon
Santander
Société Générale

Letras
BBVA
Santander
Société Générale

54
 Thank you for your attention
José Manuel Campa Fernández– Secretary of State for the Economy

Soledad Núñez – Directora General del Tesoro y Política Financiera

DirectorTesoro@tesoro.meh.es

Gonzalo García Andrés – Subdirector General de Gestión y Financiación de la Deuda Pública

ggarcía@tesoro.meh.es

José Ramón Martínez

jrmartinez@tesoro.meh.es

Rosa Moral
rmmoral@tesoro.meh.es

Leandro Navarro
lnavarro@tesoro.meh.es

Pablo de Ramón-Laca
pramonlaca@tesoro.meh.es
For more information please contact:
Ignacio Vicente Phone: 34 91 209 95 29/30/31/32 - Fax:34 91 209 97 10
ivicente@tesoro.meh.es Reuters: TESORO
Bloomberg: TESO
Rocío Chico Internet: www.tesoro.es
mrchico@tesoro.meh.es
55
 Annex: the Social Security Reserve Fund

Social Security Reserve Fund asset holdings

70 (Billon €)
60
50
40
30
20
10
0
2000

2001

2002

2003

2004

2005

2006

2007

2008

2009
The Social Security Reserve Fund amounted in December 2009 to approximately 5.7%
(€ 60bn) of GDP. 56
Annex: Ley de Economía Sostenible & General
Agreement on Fiscal Sustainability

Competitiveness Tax measures

- Rental market: equal treatment with
- Society of Information.
ownership.
- Science, R&D.
- Elimination of tax rebates: i.e. relief
- Internationalisation of SME’s.
on mortgage payments, 400€ rebate
- Education.
on income tax.
- Reduction of administrative burden.
- Corporate Income Tax rebates
related to R&D and to the
environment.

Environment Fiscal Sustainability

- Spanish regions to formulate

- Energy Policy.
quarterly reports to the Fiscal Policy
- CO2 Emission-reduction.
Council.
- Efficiency of transport and
- Correction and surveillance of fiscal
infrastructure.
deficits.
- Debt/GDP ratio to reach limit of
60% by 2013.

57