Stable Economy, Shaky Government

Spain's economy will head into 1996 amid slower growth, stable inflation and interest rates, and political uncertainty.

As expected, Parliament on Oct. 25, led by the opposition Partido Popular, rejected the 1996 budget submitted by the minority government of Prime Minister Felipe Gonzalez. The defeat was the Socialists' first in 12 years of rule. The vote, aimed at forcing general elections before the March date set by Gonzalez, was a thumbs down on the government and not on the deficit-cutting budget. Regardless of election timing, polls suggest that the center-right PP will win, an outcome that the financial markets would welcome.

The 1995 budget, which will yield a deficit close to the targeted 5.9% of gross domestic product, will be rolled over into 1996. In an effort to cut the deficit further, the government will use a decree law, for now requiring only Cabinet approval, aimed at implementing pieces of the proposed '96 budget. That draft targeted the deficit at 4.4% of GDP, but analysts think 5% is more realistic.

That's partly because of the government's optimistic economic assumptions: 3.4% growth and 3.5% inflation. Analysts generally expect growth next year no higher than this year's projected 3% pace. Inflation, headed toward 4.5% in 1995, will hang above that rate in 1996.

The economy already is showing signs of slowing from the second quarter's 3.2% annual growth rate. Consumer spending will remain sluggish, as lower wage increases and worry over future pension benefits hurt consumer confidence. Construction, a growth leader, is set to slow because of budget cuts and higher mortgage rates. Exports also are slowing, but so are imports. The main strength is capital spending, buoyed by strong profits. Still, industrial production is losing steam (chart).

The Bank of Spain will likely hold interest rates steady in coming months, at least until a restrictive budget is in place. Then, if inflation stays tame, the way may be clear for a rate cut.

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