Will A Black Swan Land In Spain On Sunday? Full Catalonia "Referendum" Preview

Earlier this week, we asked why multiple armored vans were parked outside the Bank of Spain’s Barcelona branch.

The convoy would have been curious enough on its own, but the fact that the vehicles were stationed in the Catalan capital ahead of what amounts to an independence referendum piqued our interest and we asked if perhaps the Bank of Spain was preparing for any and all contingencies. According to the Bank of Spain itself, our suspicions were unfounded as “nothing extraordinary happened [on Wednesday] in the building of Banco de España in Barcelona.” 

“By the way,” the central bank added, “there is no gold in this site of Banco de España in Barcelona.” 

Maybe not, and perhaps nothing was amiss, but this Sunday’s plebiscite in Catalonia is worth watching closely as it could very well represent the next European black swan. 

To be sure, we’ve long said that in the wake of Greece’s latest bailout negotiations, political events in Spain and Portugal have the potential to further destabilize the EMU. Regional elections in May signaled a growing disaffection among Spanish voters with the status quo and seemed to telegraph a shift towards parties whose election promises mirror those which helped Syriza sweep to power in Greece earlier this year. 

In Barcelona for instance, the anti-poverty, anti-eviction activist Ada Colau (who leads Barcelona En Comú) was elected mayor in what she called a victory “for David over Goliath.” 

The point here is that on the heels of the Greek fiasco and with tensions running high thanks to the worsening migrant crisis, just about the last thing Brussels needs is for the political landscape in Spain or Portugal (which the troika is fond of holding up as austerity success stories) to shift dramatically in favor of parties who sympathize with the anti-austerity cause and while the story of Catalonia’s push for independence is a separate and distinct issue, secession would only serve to muddy the waters further ahead of general elections in December, creating further uncertainty and adding yet another destabilizing element to an already fragile situation in the EU. 

In short, while the spectre of Catalonia’s secession might serve to bolster Mariano Rajoy’s PP ahead of the general election, the market may well grow concerned about the effect Catalan independence would have on Spain’s debt-to-GDP ratio. That sets up the potential for anti-austerity parties to suggest that the pain inflicted upon Spain's populace (see the country's sky high unemployment rate) has ultimately been for naught. A similar dynamic is now unfolding in Portugal on the heels of the government's admission that the cost of the Novo Banco bailout must ultimately be incorporated into the country's budget deficit. Additionally, it's worth noting that predicting how Spain would ultimately deal with a Catalonia that attempts to secede is difficult and it's not hard to imagine a number of scenarios that end in social upheaval.

With that, we bring you the following preview of this weekend’s vote in Catalonia courtesy of Deutsche Bank, RBS, and The Guardian. 

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From Deutsche Bank

The 27 September election in Catalonia, which accounts for ~19% of Spanish GDP – matters. First, the pro-independence movement has transformed the election into a de-facto referendum on Catalonia’s independence – an attempt to bypass the Constitution. Second, the result of the regional election could have a bearing on the December national election. 

The pro-independence parties The centre-right Convergence of Catalonia (CDC) joined forces with left-wing Catalan Republic Left (ERC) and other Catalan associations. They will run under a pro-independence joint list: Junts pel Si (Together for Yes). Junts pel Si pledges to declare unilaterally the independence of Catalonia from Spain in about 18 months if they win the election and if the secession negotiations with the central government fail. 

The pro independence parties come from a very heterogeneous political spectrum. This is not a positive. In our view, a Catalan government supported by CDC, ERC and CUP would have only the pro-independence battle to keep it standing. Hence, the leaders of such a government will likely continue on the pro-independence path not only out of conviction on its feasibility but because of lack of alternatives.

Political impact ahead of the general election 

The potential threat to the unity of Spain from Catalonia could be an advantage for the PP ahead of the national election as it is probably seen as the best party to deal with such a risk. 

Furthermore, there are three other factors that could lead to an increase in the support for the PP. (1) The economy continues to improve. (2) Some of those who abstained in the May election may switch back to the PP as their abstentions have helped the left to gain control of several local governments. (3) Support for the PP could be underestimated by current polls as its voters may be less willing to reveal their preferences given the party’s recent legal controversies. 

A coalition with a significant role for the radical left at national level could push for a reversal of some structural reforms (such as the labour reforms). A boost for the pro business parties from the Catalan election could reduce such a risk. 

From an economic and financial perspective, we think that a Catalonia’s UDI would be akin to ending up in the classic non-cooperative solution of the prisoner dilemma, i.e. a lose-lose outcome for both Catalonia and Spain:  

  • Catalonia would likely be cut out of the EU based on the above EC statement and capital controls cannot be excluded.  
  • The impact would be significant also on the Spanish economy. Without an agreement to share the stock of debt with Catalonia, Spain’s’ projected public debt for 2015 would move from just above 100% of GDP to about 125% of GDP. And this accounts only for the mechanical impact. On 21 September Mas stated that if the central government refuses to negotiate, Catatonia might not pay back its liabilities to the central government.

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From RBS

Independence faces constitutional and legal challenges from the central government. The central government’s main argument is that secession is simply unconstitutional; Section 2 of the constitution states: “The Constitution is based on the indissoluble unity of the Spanish Nation, the common and indivisible homeland of all Spaniards”. As such, the government has repeatedly blocked Catalan attempts to hold referenda on separation, most recently in September 2014. This led to a symbolic nonbinding vote held in November in which independence won by 80.8% (turnout was low at ~40%). As a last resort, the government in Madrid could invoke Article 155, which states that “if a [region] does not comply with the obligations imposed upon it by the Constitution or other laws, or acts in a way that threatens the general interest of Spain, the Government can […] via absolute majority in the Senate, adopt the necessary measures to oblige the region to forced compliance with such obligations, or for the protection of the aforementioned general interest”. Madrid has already spoken of its ability to use this power, although overriding Catalonia’s regional autonomy would be a drastic move in our opinion, heightening the ideological element of the conflict and risk alienating non-separatist Catalans.

Catalonia is highly likely to lose EU membership if separated from Spain. As highlighted by Merkel and Cameron, it would be almost impossible for Catalonia to gain EU membership, as Article 49 of the Treaty of the European Union would require Catalonia to be recognized as a “state” by all 28 member states, including Spain. The situation is similar to 2014’s Scottish independence referendum. José Manuel Barroso, the European Commission President then, suggested it would be “extremely difficult if not impossible” for an independent Scotland to join the EU. Speaking at our Credit and ABS 2015 conference yesterday, Barroso reiterated the same point regarding Catalonia. The end result of the Scottish referendum saw 45% vote to leave the UK, while 55% voted to stay in. In our view, similar concerns are likely to weigh on Catalan voters’ mind if they’re polled directly on whether to leave Spain. Uncertainty over a Euro-exit would deter voters from opting for 

What does the Catalan election mean for credit? Headline risk presents more volatility for Spanish credit. But in our view, this can create an entry point to get long Spanish credit (avoiding EM-exposed names like Santander or Telefonica). Even though so far it has underperformed Italy, consistent with our views, Spain is supported by improving fundamentals on a firming recovery in the domestic economy. While we have moved to underweight on global credit (a measure of 4/10 on our bullishness scale), we remain most positive on Eurozone credit, which is relatively isolated by more ECB easing (being the ECB more under pressure to ease from deflationary pressures, the Asia slowdown hitting core Europe).

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From The Guardian

How did we get here?

Before the previous election (in 2012), the Catalan parliament adopted a resolution asserting “the right of the people of Catalonia to be able to freely and democratically determine their collective future through a referendum”.

In the elections that followed later that year, the mostly pro-referendum parties – Convergence and Union (CiU), Republican Left of Catalonia (ERC), Initiative for Catalonia Greens-United and Alternative Left (ICV-EUiA) and the the Popular Unity Candidature (CUP) – won the most votes and seats.

However, the CiU party of Catalonia’s president, Artur Mas, lost 12 seats, and he had to rely on the support of the ERC to secure the numbers needed to form a government.

Despite their differences, and diverging factions within, the pro-referendum parties were able to muster enough votes in 2013 to pass a declaration that affirmed Catalonia’s right to self-determination, and set forth the beginning of a process to call an independence referendum.

But Spain’s constitutional court declared the declaration void and unconstitutional.

Since then, the size of demonstrations has got bigger and bigger – and support for a referendum has intensified.

The Spanish government, though, has remained firmly opposed to an independence vote, declaring attempts to hold one illegal. Technically speaking, Madrid is on the right side of the law because in order to hold a legally binding referendum the central government would need to transfer authority to the region (just like in Scotland’s referendum) – and it says it won’t.

The standoff led the Catalan government to call a snap election, the third in five years, and to label Sunday’s vote a plebiscite on independence.