Prime Minister Mariano Rajoy’s progress in luring investors back to Spain is spreading well beyond the bond market.

With the euro region’s fourth-biggest economy out of recession, exports at a record and government bond yields at less than half the level they reached in 2012, foreign direct investment is also surging. Data due today in Madrid will show the extent of inflows last year, which the Bank of Spain said have jumped by 40 percent to almost 30 billion euros ($42 billion).

Vodafone Plc underscored Spain’s attractiveness as an investment destination with the announcement this week that the world’s second-largest wireless carrier will buy cable operator Grupo Corporativo Ono SA for 7.2 billion euros. Fresh from labor-market reforms and wage devaluations inflicted by the region’s debt crisis, Spain became the euro area’s second-biggest recipient of foreign capital after Ireland last year, according to United Nations data.

“Spain is recovering its capacity to attract investment,” said Alfredo Arahuetes Garcia, head of the economy department at Pontificia Comillas University in Madrid. “Growth will be more balanced in the next economic cycle as reforms have strengthened the foreign sector which was neglected for years after Spain joined the euro.”

Aspirin Plant

Among companies boosting capacity in Spain is Germany’s Bayer AG (BAYN) HealthCare unit. It spent 6 million euros in the northern Asturias region last year to allow the Langreo plant to cover its entire global aspirin output. It previously had produced 90 percent of Bayer’s aspirin.

In contrast to Bank of Spain data, the Economy Ministry figures today provide a breakdown of activities and regions attracting inflows, and exclude funding between companies, reinvested profits and real estate.

“Spain’s qualified and flexible labor force, its competitive production costs and its strategic location make it very attractive,” said Manuel Fernandez Ortega, who manages Bayer’s Langreo plant. The company, which employs about 2,160 people in five Spanish facilities.

Automobile manufacturers are also betting on Spain. General Motors Co. (GM) invested 165 million euros in a plant in Figueruelas in central Spain in 2013 and plans to spend another 210 million euros this year. Renault SA (RNO) will create 250 jobs in its Valladolid factory in the north in 2014 as it increases output, Spain Chairman Jose Vicente de los Mozos said this week.

Labor Costs

In total, direct foreign investment accounted for about 3 percent of gross domestic product in 2013, up from 2 percent a year earlier. It contributed to investment expanding 0.7 percent in both the third and the fourth quarter and will further boost growth in 2014, said Maria Jesus Fernandez Sanchez, an analyst at Spain’s savings banks’ foundation Funcas.

“Confidence is returning,” said Fernandez. “Declines in labor costs have restored lost competitiveness compared with other European countries while the reform of labor rules has conveyed the message that rigidities aren’t as strong anymore.”

As investors returned to Spanish securities in the past 12 months, the Ibex 35 (IBEX) index of leading companies has risen 19 percent, while the yield on the sovereign’s 10-year benchmark bond fell about 170 basis points to 3.37 percent. Portfolio investment rose by 35 billion euros in 2013 after four straight years of outflows.

Average Income

Rajoy made it easier for companies to fire and cut payroll to boost foreign demand for Spanish products as domestic spending slumped. Households’ average income has declined 10 percent since 2008 as unemployment climbed as high as 27 percent and the government implemented the deepest budget cuts in the country’s democratic history.

Ahead of European elections on May 25, the premier may have scope for bigger-than-expected tax cuts, Spanish newspaper El Mundo reported today. The government is counting on 5 billion euros in additional resources that were originally set aside for interest payments on debt.

While Ireland has attracted corporates with a 12.5 percent tax rate, companies in Spain are benefiting from local authorities’ efforts to retain jobs. Oxybarica Impactos Internacionales, a medical equipment company that is 40 percent owned by a Colombian company, says government subsidies prompted it to set up in Spain rather than Italy.

Investment Activity

“There is lots of aid, they are always ready to help so that we stay in a special industrial neighborhood they’ve created,” David Andres Mejia Molina, a manager at the company, said in a telephone interview from Illescas, a city near Toledo in central Spain.

According to the European Commission, Spanish investment in equipment will increase by 5.8 percent in 2014, compared with an average gain of 4.6 percent in the euro area. It predicts 1 percent economic growth in 2014 after two years of contractions.

Foreign investment will remain crucial for Spain as credit continues to decline, restricting capital spending by local companies, said Victor Echevarria, an economist at BNP Paribas SA in London. Even so, Spain has to keep up its efforts, he said.

“Competing on product quality or technology rather than huge declines in labor costs will be key to export growth and foreign investment going forward,” Echevarria said. “Spain’s recovery has started faster than expected but there is still a long way to go.”

Bloomberg