Carmen Marín (FEDEA)
Diego Martínez (Pablo Olavide University and FEDEA)
May 2024
Abstract
The Spanish regional public debt to GDP ratio is the highest in Europe. In this paper, we study the evolution of the factors explaining the recent changes in this ratio from 2015 to 2023. Moreover, we estimate the fiscal consolidation efforts needed to achieve a determined level of public debt. Likewise, a macroeconomic model is calibrated to simulate the future evolution of regional public debt under different consolidation strategies. Our main conclusion indicates that fiscal consolidation efforts will be inevitably significant, if not unfeasible in some cases, to address the deleveraging process required by the reform of the European fiscal rules.
1. Introduction
The European Union (EU) has recently achieved an agreement on its new economic governance framework (Official Journal of the European Union, 2024 a, b andc), with renewed fiscal rules more focused on the public debt to GDP ratio. This will specially affect member states where government debt exceeds 60 percent of GDP or wherethe government deficit exceeds 3 percent of GDP. And this is clearly the Spanish case,whose authorities will be obliged in 2024 to submit a national medium-term fiscal structural plan after finishing 2023 with a level of public debt of 107.7 percent of GDP and government deficit of 3.6 percent of GDP. In this context, the fiscal consolidation will necessarily affect the Spanish regional governments, for whom new fiscal rules will be also set up given the relevance of monitoring subnational public finances (IMF, 2020; OECD,2020).
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Furthermore, many Spanish regions have no access to capital markets and, as it is explained below, they have been implicitly bailed out by the central government. Under such as circumstances, the analysis of the regional public debt becomes an interesting topic to be considered, with the Spanish case as illustrative showcase.
In this precious context, this paper analyses the Spanish regional public debt from different views. Firstly, we have decomposed the factors driving its evolution over the recent years,starting in 2015 and arriving until 2023. Secondly, the paper offers an estimation of the fiscal effort to be required to the Spanish regions in order to achieve in the next years the public debt to GDP ratio laid down by the relevant legislation. And finally, we have simulated the expected path to be followed by the regional public debt in Spain under certain reasonable, calibrated assumptions.
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Our main result here is that the debt requirements established by the “Ley Orgánica de Estabilidad Presupuestaria ySostenibilidad Financiera” (Organic Law on Budget Stability and Financial Sustainability; hereafter, LOEPSF, as known in Spanish) are unfeasible within a medium term. The primary fiscal balances necessary to reduce the public debt up to legal limits are far away from its historical values.
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The results also confirm the unfeasibility to reduce substantially the public debt to GDP ratios in many regions. While some regions, currently with lower levels of public debt, will have no problems to maintain them, for the remaining ones will be impossible to address such deleveraging.
2. A general overview of the Spanish regional public debt
Notwithstanding this, two Spanish regions, Basque Country and Navarre, are under a completely different scheme, the so-called Foral Regime. They collect and manage practically all taxes, with a high degree of tax autonomy, and pay an annual quota to the central government to finance the spending responsibilities on which the former is in charge but benefit these two ACs as well. The Canary Islands also have a slightly different regime: VAT is not applied in this region, instead they levy consumption with lower rates and enjoy specific tax expenditures in others.
The legal framework of the Spanish regional public indebtedness is given by the “Ley Organica de Financiacion de las CCAA”(Organic Law on Finance of Autonomous Communities; hereafter, LOFCA, as known in Spanish) and the “Ley Organica de Estabilidad Presupuestaria y Sostenibilidad Financiera (LOEPSF)”. The former sets up two key conditions; the first one is an explicit golden rule: the resources from indebtedness must be used in capital expenditures, with some quantitative limits in terms of the maximum spending which can be devoted to interest payments and principal repayments.
The second condition establishes administrative controls for issuing debt in currencies different than euro and outside the EU, reinforced when the provisions of the LOEPSF in terms of fiscal discipline are not fulfilled.
Precisely the LOEPSF introduced in 2012 some changes with respect to the framework stipulated in the LOFCA. One is that the golden rule does not apply when the regional indebtedness is in the context of the Fund for Financing Autonomous Communities (FFCCAA hereafter, according to its Spanish acronym). This Fund have been mainly developed into different branches, the most important of which is the Autonomic Liquidity Fund (FLA, in Spanish).
In principle, this Fund was created in 2012 to cover temporary liquidity problems, offering financing to the Spanish regions under better conditions than those of capital markets, but after more than a decade it has become a permanent source of resources for many ACs (Lago, 2023). In fact, the regional governments are allowed to claim funds from the FFCCAA in line with their fiscal imbalances, expected or actual. About 60 percent of the Spanish regional public indebtedness is in hands of the central government, although three regions (Madrid, Navarre and Basque Country) have not financial liabilities currently in this Fund.
The LOEPSF also states that the maximum level of regional public debt over GDP is 13 percent. Additionally, this LOEPSF prescribes the setting of annual objectives of deficit and public debt by the central government, which must be passed by the Congress and the Senate. Notwithstanding this, the fulfillment of such objectives has been far away from desired (Martínez-Lopez, 2020) and since the application of the escape clause for the years 2020-2024 because of the Covid-19 pandemic, was completely ignored.
2.2 General characterization
The public deficit at state level in Spain has achieved in 2022 the value of 1.1 percent of GDP, in contrast with the financial balance experienced by the regional governments of the EU-27 countries. In terms of regional government debt, the Spanish ACs have reached 23.6 percent of GDP in 2022, with Belgium in the second position with a percentage of 17.3.
3. Fiscal effort to reach a determined level of public debt
According to this benchmark, we have classified the regions in four groups:
1. Regions with public debt below 13 percent: Canary Islands, Navarre, Madrid, and Basque Country.
2. Regions with public debt above 13 percent but below the average debt across regions (around 15-16 percent): Asturias, La Rioja, and Galicia.
3. Regions with public debt around the average across regions (20-22 percent): Andalusia, Castile and Leon, Cantabria, Aragon, Balearic Islands, and Extremadura.
4. Regions with high public debt (higher than 30 percent). Catalonia, Murcia, Castile- La Mancha, and Community of Valencia.
4. Future evolution of public debt: some foreseeable scenarios
The public debt to GDP ratio of the Spanish regions is even expected to increase by 2.2 pp. of GDP (from 22.2 in 2024 to 24.4 percent in 2034) under the conservative scenario. No fiscal efforts by the regional governments lead to increases in their relative levels of public debts, yet assuming growth in potential GDP. However, this public debt ratio is reducedup to 15.1 percent of GDP under the reactive scenario. This level is still above thebenchmark of 13 percent proposed in the LOEPSF but it is clear that just a continued fiscal consolidation process is able to modify substantially the expected path of public debt to GDP ratio.
5. Discussion of policy implications
In the Spanish case, moreover, we have a territorial financing system with no clear pattern of equalization and continuous implicit bailouts through the extraordinary financing mechanisms over more than a decade. Consequently, given the huge overborrowing generated as result, the fiscal efforts necessary to achieve the legal benchmarks in regional public debt seem to be far from feasibility. Thus, setting a coherent plan to cope with the Spanish regional indebtedness would require sound reforms in the territorial financing system and in the performance, if not removal, of the extraordinary mechanisms like the FLA and others.
Nonetheless, it is likely that such as policy changes are not enough to guarantee a sustainable path for most of the Spanish regions, specially whether the extraordinary financing mechanisms are dropped, or even progressively dismantled. As it was shown in our results, many regional governments should implement processes of fiscal consolidation so intense, compared with the fiscal behavior in past times, that become unrealistic.
And here a new option should be considered, namely, debt relief of public regional liabilities owned by the central government (about 60 percent of the total Spanish regional borrowing). Given the methodology followed and the findings of this paper, we really believe that the design of a possible debt relief for the Spanish regions must fulfill two requirements. One is that the sustainability of regional public debt should be pursued not only as an obvious objective itself but also as an instrument to allow the regional governments raise funds in the capital markets. In other words, a decreasing and feasible path of the regional borrowing over GDP must be at play after the application of debt relief.
Subnational liabilities must be payable in a context of capital markets, which should become the exclusive way for financing deficits.
The second requirement is that, based on the existing remarkable heterogeneity across regions in terms of indebtedness, the criteria to proceed with debt relief must be transparentand clear-cut, not subject to political or discretionary interests. Obviously, strong conditionality after receiving the bailout may help for avoiding soft budget constraints in the beneficiary governments (Baskaran, 2017). Otherwise, the explicit bailout that the debt relief implies would intensify the associated moral risk, as long the policy decisions might be seen as a result of political pressures (Pettersson-Lidbom, 2010).
A singular issue to come is how the new European fiscal rules will be applied to the regional contexts in fiscal decentralized countries like Germany, Austria, Belgium and Spain.
Indeed, the final design of the Eurozone fiscal framework has been recently confirmed at high-level institutions of the EU. Particularly, for those countries “[w]here the general government debt is above the 60% of GDP or the general government deficit exceeds the 3% of GDP, the Commission shall transmit to the Member State concerned and to the Economic and Financial Committee a reference trajectory for the net expenditure covering an adjustment period of 4 years” (Official Journal of the European Union, 2024 a, b and c).
The public debt to GDP ratio becomes then the anchor variable to be achieved and the public spending the instrumental tool to get it.
6. Concluding remarks
Borrowing will be in the center of the European fiscal policy discussion in the next years. This is motivated by the intrinsic concern generated by the high amount of public debt accumulated after the pandemic COVID-19 and, accordingly, the new European fiscal rules will be based on explicit public debt to GDP ratios as objective to be achieved.
In this article, we have addressed the Spanish public debt at regional level from different views. Firstly, the regional public debt has been disaggregated into the fundamental factors driving its evolution over 2015-2023. We have highlighted that the effect of changes in GDP growth is the main driver of change. In turn, the primary public balance has worsened in general the regional public debt to GDP ratio, with the recent exceptions of years 2020 and 2021. Notwithstanding this, the relatively high positive deficit-debt adjustments have also contributed to the time pattern followed by the regional public debt.
Secondly, we have computed the fiscal consolidation effort (in terms of primary surplus) needed to reach a determined level of public debt during different time horizons (5, 10 and 20 years), with several assumptions on interest rates and GDP growth. Given the remarkable regional heterogeneity, the results are closely linked to the initial levels of public debt. There are some regions with public debt already below the objective of 13% of GDP in 2023 which can preserve it in line with their historical primary balances. By contrast, the regions highly indebted will need so high primary surplus to arrive at the objective that the path is unfeasible.
Finally, we have simulated the evolution of regional public debt to GDP ratio under some fiscal consolidation strategies. In the so-called conservative scenario, in which the structural public balance estimated in 2023 keeps unchanged over the period from 2024- 2034, two regions (Murcia and Community of Valencia) will substantially worsen their initially flawed situation in terms of public debt. By contrast, those regions with structural surplus in 2023 will substantially reduce their public debt to GDP ratio. When more exigent fiscal consolidation scenarios are considered (reactive), again the highly indebted regions hardly improve the level of debt.
A few policy implications have been discussed based on our results. We have guessed the likely relationship between the presence of soft budget constraints and the overborrowing of the Spanish regions. In this context, the extraordinary mechanisms, acting as implicit bailouts, should be substantially reformed, if not removed. And even initiatives of debt relief led by the central government might be taken account."
( We are very sorry having to note that the debt relief mentioned by the above study and recently proposed by the Government and political actors is forbidden by article 8 of the Organic Law on Budget Stability and Financial Sustainability:
"Prinicipio de Responsabilidad
1. Las Administraciones Públicas que incumplan las obligaciones contenidas en esta Ley, así como las que provoquen o contribuyan a producir el incumplimiento de los compromisos asumidos por España de acuerdo con la normativa europea o las disposiciones contenidas en tratados o convenios internacionales de los que España sea parte, asumirán en la parte que les sea imputable las responsabilidades que de tal incumplimiento se hubiesen derivado.
En el proceso de asunción de responsabilidad a que se refiere el párrafo anterior se garantizará, en todo caso, la audiencia de la administración o entidad afectada.
2. El Estado no asumirá ni responderá de los compromisos de las Comunidades Autónomas, de las Corporaciones Locales y de los entes previstos en el artículo 2.2 de esta Ley vinculados o dependientes de aquellas, sin perjuicio de las garantías financieras mutuas para la realización conjunta de proyectos específicos.
Las Comunidades Autónomas no asumirán ni responderán de los compromisos de las Corporaciones Locales ni de los entes vinculados o dependientes de estas, sin perjuicio de las garantías financieras mutuas para la realización conjunta de proyectos específicos.
Liability Principle
1. The Public Administrations infringing the obligations of this law, and those contributing to infringe the binding commitments accepted by Spain according to the European Union law or any international treaties, will be liable in the ammount attributable to them for the liabilities derived to the Spanish State due to their legal infringement.
2. The Spanish State will not assume nor will be liable for the liabilities of the Autonomous Regions, the Local Entities and any entity contemplated in article 2.2 of this law depending on any of them, without excluding any financial mutual guaranty to carry out joint specific projects.
The Autonomous Regions will not assume nor will be liable for the liabilities of the Local Entities and any entity contemplated in article 2.2 of this law depending on them, without excluding any financial mutual guaranty to carry out joint specific projects."
The above liability principle has been set according to article 135.5 of the Spanish Constitution, as ammended in year 2011, and therefore it can not be disregarded by any act of relief made by the State of the public debt of the Autonomus Regions. Any act of debt relief made by a law infringing article 8 of LOEPSF could, in our opinion, be challenged before the Constitutional Court in acordance with article 162.1.a) of the Spanish Constitution)
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