Madrid's Forecasts Are on the Rosy Side

On the surface, Spain's surprisingly strong economic growth in the first quarter would belie concerns about a slowdown. However, as is the case for most of the euro zone, second-quarter growth is looking much softer, and Spanish inflation will remain stubbornly high.

Real gross domestic product in the first quarter grew 1% from the fourth quarter, or 4.1% at an annual rate, compared with the euro zone's 2.2% pace. However, government support for car sales boosted consumer spending, a lift that won't last. Equipment spending by businesses, while rebounding from a fourth-quarter drop, was down from a year ago, and exports slowed sharply. Moreover, as the second quarter began, retail sales fell in April, and industrial production was especially weak.

The government is standing by its 3.2% projection for 2001 growth, but most private forecasters think that's too optimistic. Domestic demand has already been slowing down for a year, as has job creation. That's the result of the European Central Bank's rate hikes and higher Spanish inflation, which has robbed purchasing power. Now, the global slowdown and new euro zone weakness will crimp foreign demand as well.

Slower growth, along with falling prices for energy and food, will help to reduce Spain's 4.2% inflation rate in coming months, but progress will be slow. Spain is susceptible to second-round inflation effects as prices fuel wages. Most workers have contracts requiring employers to raise wage rates if inflation exceeds the government's forecast, which was 2% for 2000. Inflation last year was 3.4%, and for 2001, the government stuck with its 2% forecast. A new government index, which includes Social Security payments, shows that first-quarter labor costs rose 4.3% from a year ago.

The problem is that Spain is losing competitiveness. Without different currency values, high inflation relative to the rest of the euro zone makes Spanish goods more expensive. Plus, labor-market reforms have not yet given a boost to productivity.

By James C. Cooper & Kathleen Madigan

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