NEWS Focus

Controversy in Catalonia: What does it mean for investors?

On Sunday 1 October, Catalonia held a controversial referendum for independence. The vote was deemed unconstitutional by the Spanish Constitutional Court and the central government tried to prevent it from taking place by ordering police and security force reinforcements to seize ballots and close polling locations.

Nevertheless, more than two million voters went to the ballot (a participation rate of 43%) amid violence that left over 800 injured. On Sunday evening, the Catalan president, Carles Puigdemont announced that 90% had voted in favour of independence, while Prime Minister Mariano Rajoy stated on TV that no referendum took place in Catalonia. Spain's King Felipe VI strongly backed Prime Minister Rajoy, accusing Catalan leaders of having placed themselves "outside the law and democracy” and of trying to “break the unity of Spain and national sovereignty”.
The most recent polls in Catalonia, including referendum non-voters, suggested that only a minority of the population supported independence (44%)1 although a large majority supported the principle of a referendum (82%).

What happens if Catalonia declares independence?
Article 155 is a leap into uncharted territory.
President Puigdemont is considering a unilateral declaration of independence in coming days. The left-wing CUP party, a member of the pro-secession majority in the Catalan parliament, says independence could be declared during a plenary session next Monday.
A declaration of independence is unlikely to be recognised by either the Spanish government, its Constitutional Court or the European Commission, all of which deemed Sunday's vote illegal.
This would likely lead Rajoy to invoke Article 155 of the Spanish constitution, revoking Catalan autonomy and empowering direct rule from Madrid. Ciudadanos party leader Albert Rivera supports such a move, while opposition leader Pedro Sanchez, has urged that there needs to be continued dialogue with Barcelona.
The practical implications of Article 155 are unknown and legally unchartered. Article 155 remains the last resort and such a move is likely to prove highly risky in Catalonia given the enduring tensions and Sunday’s violence. The reaction of the population is therefore a key question mark.
However, should Madrid decide to go through with invoking Article 155, events could likely unfold as follows:

  1. Madrid formally notifies Catalonia and attempts to make Puigdemont, comply with the Constitutional court ruling
  2. Puigdemont rejects the formal notification
  3. The Government petitions the Senate
  4. The issue is taken to the Senate General Commission of Autonomous Communities that deals with the Spanish regions (currently made up of 54 senators: 30 People’s Party (PP) members, 12 members of the Spanish Socialist Workers’ Party (PSOE), four Podemos representatives, eight others)
  5. The Senate notifies Puigdemont and the Commission draws up a proposal for debate (dissolution of Catalan Parliament, Madrid taking control among other things)
  6. Senate debates the proposal and takes a vote. An overall majority is required to pass the motion (134 out of a total of 266 senators - currently 149 PP senators)

Government sources indicated to news agency Europa Press that the whole process could be completed within five days.

What are the possible end games?
More autonomy within Spain looks like the only realistic option.
Independence appears very unlikely at this stage given the many institutional and legal hurdles at the national and European level, not to mention the more fundamental economic and financial hurdles. For example, Spanish economy minister Luis de Guindos has warned that a breakaway could wipe out 30% of Catalonia’s economic output.
A more likely outcome is a new arrangement between the central and regional government for greater devolution of powers. This could be a lasting solution which would effectively reverse the decisions taken in 2010 to limit the region’s autonomy. This appears all the more feasible as the Basque Country already enjoys broad autonomy, especially in fiscal and financial matters.
As a reminder, between 2006 and 2010, The Generalitat (the Catalan government) held jurisdiction in various fields including culture, education - through which it promoted the Catalan language - justice, environment and local governments. Furthermore, the Generalitat had more fiscal autonomy than other regions of the country and held jurisdiction over local banks and financial institutions.

Can there be implications for national politics in Spain?
Following the triggering of Article 155, Rajoy would be able to call new elections to the Catalan parliament, with the risk of further radicalisation of Catalan voters.
Rajoy’s minority government is weak and could be further weakened by these events. Both his coalition partners, Ciudadanos and Nueva Canarias, advocate a strict stance towards Catalonia however and appear unlikely to withdraw support. But Rajoy could try to boost his position by calling a general election for the whole country.

What can Europe do about this?
Not very much.
Unlike in previous episodes, the European Commission (EC) officially issued a statement after the referendum and urged all sides in the Catalonia crisis to “move very swiftly from confrontation to dialogue” adding that “violence can never be an instrument in politics”.
But Europeans clearly support the prevalence of the Spanish Constitution and are seeking to avoid a topic that is perceived as essentially domestic. Puigdemont and other regional leaders have called on the European Union to intervene in the conflict with the Spanish government. The EC has rejected his invitation to step in and mediate, and made it clear that an independent Catalonia would be outside the EU, and its financial system, would be shut off from European Central Bank funding.

What are the implications for investors and financial markets?
Limited so far but with some risks for the financial sector.
Overall, market reaction was very limited in the aftermath of the referendum. On Monday morning, Spanish 10-year bonos spreads versus German bunds widened slightly by about 10 bps amid growing pressures across the board for peripheral debt. Catalonia spreads versus Spanish bonds widened more and are now at the levels of one year ago. Nevertheless, the referendum does not immediately impact the support that Catalonia has been receiving from the central government through the Fondo de Liquidez Autonómico (FLA) since 2012.

However, should the political environment deteriorate at the national level, we could witness sharper market movements. Last Friday, Standard & Poor’s left Spain’s rating unchanged but mentioned the Catalan situation as a risk factor. The next sovereign rating from Moody’s on 20 October could signal an inflexion in the Spanish outlook. Sarah Carlson, Senior Vice President at Moody’s Investors Service wrote in a note that “ratcheting-up of tensions has negative credit implications for the Spanish sovereign rating because it complicates the process of legislating policy, including a 2018 budget”.

Catalonia's biggest bank, Caixabank, and Spain's economy minister have sought to assure bank customers that their deposits are safe. Sabadell and CaixaBank have communicated contingency plans that would allow them to move headquarters to other locations in Spain and maintain their operations without disruptions.

Maxime Alimi, Ano Kuhanathan - Research & Investment Strategy - AXA Investment Managers