Barcelona versus Madrid, but not on the soccer pitch
The result of the independence referendum held in Catalonia earlier this month has plunged Spain into turmoil. Catalan authorities claimed that almost 90% of voters backed independence, in a controversial referendum with a paltry 43% turnout, one that Spain’s constitutional court deemed illegal. It didn’t help that the polls were marred by pockets of violence where Spanish police prevented voters from entering polling stations, and even confiscated ballot boxes.
Two weeks later, the future of Catalonia remains up in the air with both sides making provocative statements that are sugar-coated in a superficial gloss of diplomacy. Catalan President Carles Puigdemont effectively declared independence, but at the same time announced he was suspending the declaration in the hopes of entering into a dialogue with Madrid about how to resolve the “impasse”.
With that declaration, Puigdemont managed to irk both the Spanish government and the radical separatists he desperately needs by his side. Madrid responded with diplomatic aplomb and kicked the ball back in Barcelona’s half, politely asking Mr. Puigdemont to clarify what exactly he had just announced. The centraol government did, however, also set a deadline for a response, failing which it threatened to go the 'nuclear' route, i.e. take control of the region. At the time of writing, the deadline came and went. Puigdemont and Spanish Prime Minister Mariano Rajoy exchanged letters but made no headway whatsoever.
Is Catalonia relevant?
Sure it is. In fact, it is Catalonia’s economic strength that has fuelled its independence push. With Barcelona as its epicentre, the region maintains its cultural heritage despite having been part of Spain for centuries. More importantly, its socioeconomic profile is arguably better than that of the rest of Spain.
It is a wealthy and open economy that at the latest reckoning, contributed about 20% of Spain’s GDP, a figure larger than most eurozone countries (Exhibit 1). Catalonia has a services-based economy, with close to two-thirds of its value-add coming from the services sector. A quarter of Spain’s exports originate from this region, with more than two-thirds going to the European Union. Catalonia also has a proven record of attracting investments, with nearly a third of all foreign companies in Spain choosing the regional capital of Barcelona as their base.
Exhibit 1: Catalonian GDP makes up roughly a fifth of Spain's GDP with its share only marginally fluctuating over the last decade, the lowest being 19.3 % in 2009
Catalonia’s independence referendum: implication for markets
President Macron’s election in France earlier this year led to a period where politics took a back seat in Europe. A period that saw risk assets gain steadily and country credit spreads compress across 'peripheral' Europe. Events in Catalonia now have the potential to throw a spanner in the works.
It seems quite likely at the moment that this conflict could drag on for the coming weeks and months.
If that were to happen, the impact on Catalonia, and the Spanish economy as a derivative, would certainly be measurable. Irrespective of the outcome, indicators of business confidence in the region are likely to dip significantly. In fact, dozens of corporations, including two of the largest Catalonian-based banks, have chosen to move their headquarters out of Barcelona.
If the region goes the independence route, the growth prospects remain difficult to quantify at the moment, and will depend heavily on the EU’s stance. The EU has tended to distance itself by terming the issue an 'internal' matter for Spain. If Catalonia were to break away from Spain, but stay in the EU, it would open the door to other potential secessions in other EU countries. That is an issue that the EU is certainly keen to avoid. Other European countries, and especially those in the 'periphery', would likely experience market volatility and credit spread widening.
That said, it remains difficult to have much conviction with respect to the eventual outcome, and the base case for most investors remains that the impasse will be localised and dissipate in time; a situation ripe for tactical trading.
Written on 16/10/2017