Markets price in new risk as Catalan standoff beckons

After the Catalan government said 90 percent of people had voted in favor of independence in the October 1 referendum and the national authorities refused to accept its legality after an at times brutal crackdown, markets opened Monday to the thing they hate most - uncertainty.

"In contrast to the UK, the 1978 Spanish constitution clearly prevents a division of the country," Eric Oynoyan, a strategist in London at BNP Paribas, told DW.

"And the main problem in the near-term will be that it will be very tough for the government to get the 2018 budget approved and they will use the 2017 one as small parties are not keen to give their votes to the PP,” Oynoyan said.

Spain's finance minister, Cristobal Montoro, said last week he would not be taking the 2018 budget plan to last Friday's cabinet meeting, as planned. The Catalan crisis has opened a new rift between the Popular Party (PP) executive and the Basque Nationalist Party (PNV), whose backing the minority government needs. The main opposition Socialists (PSOE) refuses to back the PP on this subject.

"Whether independence will actually happen remains unclear. What is clear is that Spain has entered a deep political crisis," ING's global head of debt and rates strategy, Padhraic Garvey, told the news agency Reuters.

On equity markets, Spain's IBEX fell 0.8 percent, with domestic banks sharply lower. Shares in Catalonia-headquartered Banco Sabadell and Caixabank were the worst-performing, down 4 percent and 1.9 percent respectively.

The ‘what ifs'

"If the Catalan President follows the referendum law and unilaterally declares independence, then we are entering into uncharted territory in the history of Spanish politics," Ioannis Sokos, European Rates Strategist at Nomura told DW.

"Especially if the response from Madrid is via article 155, which can suspend the regional government in any of Spain’s autonomous regions. The official statement from Brussels supports PM Rajoy and reminds everyone that the territory leaving would find itself outside of the EU, so if we simply extrapolate the current stance of the two sides, then it’s tough to think of a resolution anytime soon," he went on.

An economist from Zaragoza University, who chose to remain anonymous, told DW that outcomes will depend on what the government of Catalonia does in the next few days.

"If it continues along the illegal path, its autonomy will be suspended and problems will continue on the streets for some weeks. But independence will not succeed," he said.

If the regional government calls for regional elections (in early December), the result could be another victory for voters who oppose independence. "But if the independentists win more seats (as in September 2015), the problem will continue,” he went on.

"The government of Catalonia will try to buy time and delay any decision as later as possible, while central government will continue in doing the minimum, which is worrying,” he added.

Too much debt

At this stage it's a big assumption to make – and one that markets are loath to do – but if Catalonia were to push ahead with independence, the economic outcome would likely hinge on issues of debt.

• Option one is that Madrid would demand an independent Catalonia take 19 percent of its debt: that is the same proportion the region contributes to GDP.
• Option two is if debt reallocation were to match the 16 percent population figure.
• Option three the 11 percent current national expenditure on the region – which would turn Spain's debt-to-GDP ratio into levels that would not be sustainable. It's just under 100 percent now and some already question how Madrid would meet its payments if rates rise.

If the national government works to oppose a Catalonia that declares independence and therefore refuses to reach a debt transfer agreement, then its debt-to-GDP ration could balloon to about 125 percent.

Catalonia is the third-most indebted region in Spain, after Valencia and Castilla La Mancha.

Unpicking the threads

"I think it has reached the stage where some form of external mediation is needed in order to force both parties to the negotiating table for genuine dialogue, and to find a middle road,” Caroline Gray, a lecturer in Politics and Spanish at Aston University in the UK, told DW.

"In terms of debt, you cannot compare the levels of the Catalan government and the Spanish central government,” Gray said.

They do not have the same competences and some of the debt incurred by Catalonia is also computed under Spain's debt levels, she added.

"If you compare Catalan public debt to the public debt levels of the other regional governments in Spain, you will see that the Catalan government is actually one of the most indebted regional governments, with very high levels of regional debt,” Gray said.

Catalonia has been shut out of international debt markets since 2010 when the full extent of the regional debt crisis in Spain became clear and investors decided investing in regional debt was too risky.

"This has been one of the huge sticking points between the Spanish and Catalan governments," Gray said.

"The Spanish government argues that Catalonia ended up in so much debt due to misspending, whereas the Catalan government argues that it contributes too many of its revenues to the rest of Spain and it would not have incurred so much debt if it had been able to keep all the taxes raised in its territory. These viewpoints are both very black-and-white, and the reality is a complex combination,” Gray said. 

Analysts estimate that Catalan independence could cheapen 10-year Spanish government bonds relative to their German peers. Spain's yield spread over Germany on 10-year debt could widen to between 350-400 basis points from about 120 now.

Government bond yields rose 7 basis points to 1.69 percent on Monday, stretching the gap with benchmark German equivalents to close to its widest in nearly four months.

Ratings agencies have given a low, speculative grade to Catalonia, which would not enable it to borrow directly on financial markets and leaving it dependent on loans issued by the Spanish state.

Wealthy region

Catalonia's regional product is about 200 billion euros ($228 billion), according to the Public Diplomacy Council of Catalonia — about 20 percent of Spain's 2013 GDP of €1.04 trillion ($1.17 trillion).

Catalan residents represent about 16 percent of the country's population, but contribute 20 percent of Spain's taxes and then receive 14 percent back in public spending.

Catalonia's GDP is around that of Denmark's.