Luis de Guindos (Madrid, 1960) assumed the vice presidency of the European Central Bank on June 1, 2018. He did so after being the Spanish minister who had to deal with the ugliest, a Great Recession that put the Spanish banking system in check.
From his office in Frankfurt, he confesses that the current situation, despite its seriousness, has nothing to do with what it was back then. But there are curves. His recipe for dealing with runaway inflation and war-torn economies is "credibility" with the markets and "prudence" in spending.
– Will interest rates rise in July?
– It will depend on the data and the new economic projections for June. The ECB's Governing Council decided in April that asset purchases will end in the third quarter. In my opinion, there is no reason why that should not happen in July. Rates will go up later. How much later exactly is not decided. It can be months, weeks or days.
– But the market is already discounting that there will be two rate hikes this year and there is even talk of a third. Has the pressure to act been redoubled?
– We are pressured by the data, not the markets. The markets are sometimes wrong.
– There are economists who criticize the excessive slowness of the ECB.
– These comments arise from the comparison with the US, but the situation in Europe is different. The two main factors that will determine interest rates will be the evolution of the second-round effects – wage increases that are not compatible with price stability – and inflation expectations.
“There is a significant drop in growth, but we do not contemplate entering a recession”
– Does the ECB, even out of the corner of its eye, observe the risk of recession?
– The invasion of Ukraine will redouble inflationary pressures and reduce economic growth. That raw materials and energy rise in the way they have done implies in practice a tax on workers and companies because these factors of production, which are imported, become more expensive. And that, ultimately, implies impoverishment.
Regarding the risk of recession, in June we will have new forecasts. What we are already seeing is a significant decline in growth. But by the technical definition of a recession—two consecutive quarters of negative growth—we don't see it now.
– With the withdrawal of stimuli, are there countries that may suffer from financing problems or budget deficits?
– Nominal government bond rates have risen around the world, but risk premiums remain fairly stable. The risk of fragmentation has not materialized, although it is something that we monitor. So far we have not seen any tension in this regard and the situation is not at all comparable to 2011 and 2012.
– Is Spain prepared to assume a rate hike?
– The Spanish economy has two strengths. First of all, the financial system is healthy. This has allowed that even during the pandemic, banks have continued to give credit to companies and families on favorable terms. In addition, the Spanish economy is competitive, since since 2013 it has had a surplus in the current account of the balance of payments.
– And what weaknesses?
- Other two. The first, the fiscal situation. The public debt/GDP ratio is close to 120% and the structural deficit, 5%. Furthermore, Spanish inflation, both headline and core, is once again above the European average. As the Bank of Spain has warned, business margins are beginning to be quite affected since the profitability of Spanish companies is falling due to the rise in energy and raw material prices.
«We are pressured by the data, not the markets»
– Would you advise the Spanish government to start taking seriously the need for greater budgetary stability?
– My recommendation, not only for Spain, but for all countries with a weaker fiscal profile than others, is that they present credible budget plans in Brussels in which there is a prudent and sensible process of fiscal consolidation. With these levels of inflation, interest rates are not going to be as low as they have been in recent years, and governments must prepare. The key, also from the point of view of the markets, is to have credible proposals.
– Much is said about the extreme dependence that the Spanish economy has on the ECB. Beyond the literature, what is the real impact, in figures, of all the measures adopted?
– There is a very indicative data. During the pandemic, in 2020 and 2021, the ECB has bought €120 billion of Spanish debt each year on the secondary market. This is equivalent to the entire net emission of Spain.
European support, also through the Next Generation EU fund launched by the European Council, has been fundamental, especially in an economy like Spain's. This was the one that fell the most in 2020 and, despite a strong growth of 5.1% in 2021, it was below the European average and, unlike the rest of Europe, it has not yet recovered the level of income prior to the pandemic.
– Is it sustainable for a government to link the increase in pensions to inflation by law?
– It is a social policy decision and my role is not to question it. It is respectable, but it is clear that it has consequences for the sustainability of the system. And, therefore, such a decision needs to be accompanied by measures that guarantee the sustainability of the system in the medium term.
Update of pensions
“It is a political decision, but there must be other measures to guarantee the sustainability of the system”
– And the salary of civil servants?
– I insist: as vice president of the ECB I cannot enter into the debate of what a government or a party says or does. In general, you have to be careful with the decisions you make. Sometimes, as important as the measures is the credibility that is transmitted with them.
– Is it time for salary moderation, for employers and unions to reach income agreements?
– The European and Spanish economies are going to face a complex situation: high inflation, falling growth and less margins for companies, which will affect investment and employment. In a situation like this, where decisions are going to have to be made that are not easy, it would be very important for there to be the greatest possible social and political support for economic policy.
– And do you think that Spain, politically, is prepared to reach those consensuses?
– My recommendation is generic. I must not enter to assess the case of any country in particular.
– Another of the debates that is on the table is the tax issue. Is there room to lower taxes in this context of crisis?
– Not all countries are in the same situation. The public sector can play a role in moderating the impact of war on businesses and families. Although this, at the same time, can generate a greater public deficit.
– There are sectors that criticize this thesis because a tax cut would further fuel inflationary tensions.
– We are talking about temporary and selective measures aimed at the most vulnerable sectors. If the measures are well designed, fiscal policy can help alleviate the impact of an external supply shock like the current one without creating these negative effects for inflation in the medium term. The pandemic has affected many companies that are now being hit again. In the case of the Spanish, the reduction in margins is very notable.
«Banking in Spain today is a strength while in 2011 it was a burden»
– The health of the financial sector is key at a time of uncertainty. Do you think there are countries that should still make an effort to recapitalize their banks?
– In general terms, judging by the levels of capital and liquidity of European banks, we are in a much better situation than in the past. The pandemic crisis generated a lot of concern about the possible impact on the financial system, but it has been resilient.
– So, you are completely calm in this matter...
– There are still risks. Nominal interest rates are rising in the markets. This allows banks to have higher profit margins. But it can also affect delinquency. If it goes up, the profitability of the banks goes down. And for banks, the solvency of their clients is fundamental
– Viewed from a historical perspective, has the evolution of Spanish banking been good enough? Would you have signed the current photograph when you were Minister of Economy?
– In 2011 and 2012, banking risk was a burden that was dragging Spain into a very deep recession. A bank rescue had to be requested, the old savings banks reformed or Sareb created, since there were more than 110,000 million euros of loans to the real estate sector that were not recoverable.
In 2017 Banco Popular enters into a liquidity crisis that ended in its resolution. At that time, despite the size of the entity, there is no longer a contagion effect in the financial sector. This shows that after years of reforms the banking situation was already very different. And today it is one of the strengths of the Spanish economy.
– Regarding Banco Popular, would it have been possible to settle it in just a few hours in 2011?
– Absolutely impossible.
– Are the calls for mergers of financial entities still on the table?
– Yes. European banking has a structural problem of low profitability that needs to be tackled. Profitability has improved in recent months, but it has been mainly as a result of lower provisions. Now that we are in an environment with lower economic growth, it will be necessary to analyze whether this trend is sustainable over time or if other measures are necessary.