VZCZCXRO0779
PP RUEHAG RUEHDF RUEHIK RUEHLZ RUEHROV
DE RUEHMD #1511/01 2151452
ZNR UUUUU ZZH
P 031452Z AUG 07
FM AMEMBASSY MADRID
TO RUEHC/SECSTATE WASHDC PRIORITY 3143
INFO RUCNMEM/EU MEMBER STATES COLLECTIVE PRIORITY
RUEHLA/AMCONSUL BARCELONA 2968

UNCLAS SECTION 01 OF 03 MADRID 001511 
 
SIPDIS 
 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: ECON SP PREL
SUBJECT: HOUSING MARKET FINALLY COOLING, BUT THE 
CONVENTIONAL WISDOM STILL SUGGESTS A SOFT LANDING FOR SPAIN 
 
REF: 06 MADRID 01750 
 
MADRID 00001511  001.2 OF 003 
 
 
¶1. SUMMARY: As the Spanish economy pushes forward toward 
matching wealthier EU members, it continues to face 
challenges.  Spain must increase its competitiveness across 
the board, especially in its labor markets, energy utilities 
and telecoms. What has been of most immediate concern lately, 
however, has been the housing and construction situation. 
The housing market is cooling off.  Mortgage rates have risen 
from 3.4% in June of 2006 to 4.49% in June 2007.  Home sales 
have fallen by 11.5% over the last year, with a 15.9% fall in 
the sale of new homes.  New home prices rose by 7.4% during 
Q1 2007 compared to 12.7% over the same period the year 
before.  During the May-July 2007 timeframe, apartment prices 
in Madrid and Barcelona actually went down by about 5% 
according to the Ministry of Housing.  This is of concern 
because the Spanish economy is significantly dependent on 
construction, which contributes up to 18% of GDP (roughly 
twice the Euro zone average); and accounts for a quarter of 
all economic growth.  Despite increasing risks however, there 
are enough offsetting factors suggesting a soft landing for 
Spain's economy. END SUMMARY. 
 
RISING INTEREST RATES 
SPARK FEARS FOR HOUSING 
MARKET 
 
¶2. Cheap credit through low interest rates has been a driving 
factor in the construction/housing led boom following the 
introduction of the Euro.  Interest rate hikes therefore are 
at the heart of fears of a sharp economic slowdown. The 
potential chain reaction begins with the fact that higher 
interest rates could lead to more foreclosures, making 
lenders more cautious.  Lenders are already moving to sell 
off delinquent accounts as well as some of their current 
mortgages.  Spanish households, even Qthey can mostly make 
the higher payments on their variable interest rate loans, 
have to reduce consumption, thereby at some point lowering 
demand, although this is being offset somewhat by more 
investment.  The effect on Spanish households' consumption 
patterns is probably more macroeconomically significant than 
the risk of foreclosures as getting a mortgage loan is much 
harder in Spain than in the U.S. so, overall, most borrowers 
in Spain are a fair credit risk. 
 
VARIABLE RATE MORTGAGES 
BECOMING A PROBLEM 
 
¶3. Currently many Spaniards are spending over 40% of their 
gross income on their mortgage.  In order to be able to 
afford the soaring prices of the recent housing boom, 
Spaniards have been forced to take on very large, variable 
rate mortgages with exceptionally long terms of up to forty 
and fifty years.  The average monthly mortgage in April 2007 
was 7% higher than the year before and had an average term of 
26 years.  Furthermore, of all the mortgages granted in April 
2007, 97.7% were of the variable rate variety with almost 90% 
of those being fixed to the Euribor.  This continues the 
trend of Spanish families becoming more overextended 
financially and exposed to interest rate rises. 
 
OTHER POTENTIAL NEGATIVE 
ECONOMIC FACTORS 
 
¶4. Many Spanish households will likely cut back on 
consumption to keep current on their mortgage payments, 
further slowing the economy.  Joint decreases in construction 
and consumption should increase unemployment.  Spain has seen 
its advantages in competitiveness among major EU nations 
erode as productivity is low and inflation is higher than 
average in the eurozone. Spain suffers from a low 
productivity growth rate of .8%, behind even Portugal among 
top EU nations, and is furthermore losing its wage advantage 
to Eastern Europe and Asia.  European Union (EU) subsidies 
will also be phased out; although, the effect will not be 
felt in the immediate future as Spain will not become a net 
contributor until 2013. The significance of construction and 
housing to the Spanish economy suggests a cumulative effect 
from the drop in housing demand causing a significant 
downturn. 
 
BUT, THE SOFT LANDING 
SCENARIO HAS SUBSTANCE 
 
¶5. Despite the hovering dark clouds, there is another side to 
Spain's overall housing picture.  First, the demand declines 
in the overbuilt suburbs and coasts mask continued strong 
demand for housing and office space in major cities. Sources 
of continued demand are expected to be continued immigration, 
split couples as divorce has become more common, and the 
strong demand for housing among young people (Ref 06 Madrid 
 
MADRID 00001511  002.2 OF 003 
 
 
01750).  Also, there is the potential that slackening 
northern European demand for vacation homes might pick up or 
perhaps emerging EU nations such as Poland will take up the 
slack.  Finally, ECB interest rate rises may in fact turn out 
to be a stabilizer by reigning in spending by overextended 
Spanish consumers and businesses and encouraging more savings 
and the paying down of debt. 
 
MAJOR REAL ESTATE GROUPS 
DIVERSIFYING 
 
¶6. On the construction/real estate company side, although 
speculators and the extraordinarily large number of small 
time firms are likely to get hit, all the largest players 
have taken the opportunity of the boom years to diversify by 
buying into Spanish energy utilities, water treatment plants, 
airport management firms, and toll roads; as well as 
investing overseas to tap emerging markets.  Spanish 
construction firms also seek to take advantage of new 
building and infrastructure projects in Eastern Europe. 
There the Spaniards expect to leverage their experience with 
contracting and managing projects built under EU funds. 
Furthermore, the Spanish government itself is expected to 
increase its already high spending on infrastructure. 
Spain's budget surplus gives the government some room for 
maneuver to use fiscal policy as a stabilizer. 
 
R&D INVESTMENT AND 
CAPITAL GOODS SPENDING 
TRENDING UPWARDS 
 
¶7. R D in Spain is currently low, but R D spending is a 
government priority, mostly to help improve Spain's low 
productivity rates.  While government spending on R D is 
budgeted at 6.5 billion Euros in 2007, a 35% yearly increase, 
Spain's total R D spending is still only 1.03% of GDP, half 
the EU average. However, the government has fairly credible 
plans to raise this number to 2% by 2010, and increase the 
private sector's share from 46% to 55% of total R D.  Spain 
plans to increase private R D spending through better 
incentives for private sector innovation and patent 
registration, as well as through improved links between 
business and government sponsored research bodies. (Note: It 
is pretty clear that R&D spending will go up, although it is 
not clear whether providing the extra money will actually 
have the impact on productivity the government wants.) 
Moreover, capital goods investment increases are expected to 
continue as Spanish industrial firms increase their 
production capacity to meet demand emanating from a resurgent 
German economy.  Capital goods spending is already up 7.2% 
this year and is expected to continue well into double digits 
this year and remain strong thereafter.  Capital goods 
spending is expected to be an economic driver for Spain and 
in combination with increased R D could help improve 
productivity, although no observers believe Spain is on the 
verge of becoming an innovation driven economy. 
 
SOFT LANDING STILL 
SEEMS LIKELY 
 
¶8. The safe bet on the direction of the Spanish economy is 
still the soft landing.  This is because it appears that 
major banks and corporations have protected the better part 
of their boom profits, and new opportunities for growth in 
the construction sector are expected.  Demographic and social 
trends also suggest continued robust housing demand. Given 
that the percentage of all homes and apartments that are 
rentals in Spain was 11.4% last year compared to an EU 
average of 38%, high prices, strong demand, and perhaps (in 
the future) more balanced landlord/tenant laws might lead to 
more of a rental market.  Currently, average Spanish mortgage 
holders, small time developers, and speculators appear to be 
most vulnerable to weaknesses in the housing market.  Overall 
though, Spain looks set to weather the storm despite the 
troubles in the housing market.  This Embassy analysis tracks 
largely with the conclusions of the IMF's latest Article IV 
consultations with Spain, although both the Fund and the 
Embassy are cognizant that while the soft landing scenario is 
likely, it is by no means guaranteed.  A May 2007 Morgan 
Stanley analysis is consistent with this view as well, 
although it does not discount the possibility of a recession 
in 2009.  The conservative PP opposition party linked 
economic/business consultancy, Montoro y Asociados Asesores 
concludes: "in Spain the slight slackening in economic growth 
which might happen in the coming months does not put into 
risk the maintenance of rates of growth of over 3% with 
considerable employment generation".  Most analysts are 
optimistic for the short-term, despite Madrid stock exchange 
volatility and reports of greater difficulties for big 
corporate borrowers.  The bottom line: it appears that the 
government will meet the electorate (parliamentary elections 
 
MADRID 00001511  003.2 OF 003 
 
 
must be held by March 2008 at the latest) with the economy 
still growing strongly. 
AGUIRRE