On November 6th, Spanish Prime Minister Mariano Rajoy gave a radio interview reaffirming his position on a bailout. He said that he would not request a sovereign bailout without knowing what Spain’s borrowing rate would be, or how the risk premium would change if the ECB began to buy up debt. Some economic analysts wonder if Rajoy’s government is waiting to see if Catalan voters defy a ban on an independence referendum in the November 25 elections, and if election victories for more Catalan nationalists will cause the region’s government to become less compliant with Spanish central and Eurozone governing bodies. All regional elections, including last month’s Basque referendum, have visible effects on Spain’s national budget, so Rajoy’s coalition is clearly concerned. However, there are many reasons to think that investor concerns about the Catalan elections and nationalism are excessive.
Credit analysts in the U.S. and EU have expressed concern that intransigence in Catalonia will increase Spain’s woes, whether the sentiment is directed toward spending cuts or borrowing conditions. If Spain accepts an ECB bailout requiring additional austerity measures, then what is to prevent local populations from punishing central government by pushing referendums seeking autonomy in their elections, making it harder for Spain to meet budget and capital targets, expanding the crisis? Further, traders and investors worry about hedging a Catalan exit from Spain if an independence-seeking coalition is elected, which many consider a feasible danger. These fears do not accurately reflect the near-term in Catalan politics, and exaggerate the political risk posed to Spain’s markets by separatist movements. No matter how many nationalists win next week, Catalonia will not be able to exit Spain in the near term and meet its debt obligations, nor will its regional government have the means to offer significant resistance to the funding conditions of Spanish administration, let alone the ECB.
At the level of the central government in Madrid, procedural and legislative strictures ensure the populist, pro-independence victory in the polls could have only muted effects on the liquidity and debt crisis. Spain’s national government and the EU itself have in effect measures that would make it very difficult for Catalonia break away and get integrated into the Eurozone in a short amount of time, thus making a Catalan exit from Spain a daunting and slow process.
On the Spanish domestic front, in October, Rajoy’s coalition pushed through a parliamentary ban on the Catalan independence referendum. Separatist sentiments expressed publicly by officials with economic regulatory powers have been censured. What about rogue officials, who may not be contained by relatively moderate government of Catalan President Arturo Mas? At least in the current Spanish political climate, there is no reason for alarm. The Budget Stability law this year includes strong coercive provisions to deal with such officials. Non-cooperation with the central (national) government of Spain by any regional official allows for an immediate, possibly retroactive dismissal, and a replacement chosen by officials in Madrid. Officials could lose their pensions and ability to stand for election again if they refuse to comply with the requirements of the budget reforms. Non-compliance by Catalan officials could occur, but they would have strong personal disincentives against taking this route. This will discourage many lawmakers in the region from attempting it, personal sentiments aside. The budget laws are stronger than many outsiders realize.
The majority of Catalans who favor independence traditionally emphasized the cultural separation and linguistic repression by Spain. But recent voting polls show a different concern among voters: the perception of Catalonia carrying an indue amount of the Spanish economy through taxes and re-allocation of resources. Advocates of independence believe their region would be a strong, fiscally sound country and would be willing to delay independence if they knew otherwise. But calculations based on GDP and projected debt balances suggest an independent state would run a deficit, rather than a surplus, and would be on the low end of Eurozone economies – this fact alone will prevent any ambitious Catalan politician from seeking independence now. Conversely, in Spain despite the extent of leverage it possesses, Catalonia is the sole economic powerhouse.
As for the European Union, procedural rules would make Catalan membership into a multi-year process with a time lag that would push the newly independent nation further into debt, despite its productivity. This is hardly an inviting scenario, and Catalonia’s government knows it. The EU would have to process an independent Catalan state for membership, and approval is far from guaranteed. During the time between independence and (presumptive) entrance into the European Union, Catalonia would have to issue its own currency since it would not yet be a member of Eurozone, and such notes would likely trade at a disadvantage compared to Euro, Stirling, or Dollar. The administrative costs of the transition out of the Eurozone alone would put the new nation’s balance sheets far in the red. Debt held in Euros would switch to local currency, causing international creditors to ask for repayment in the original currency. Needless to say, such transition causes enough trepidation among Catalan treasurers and financiers to induce opposition to independence at this time, even with a popular majority favoring it.
Catalonia might achieve greater autonomy, and be able to set more of its own spending caps, perhaps even continue ambitious commercial development projects. But with its credit downgraded, finding capital will be difficult. Spain’s government has assembled its bail-out funds for the regions with strict guidelines that must be followed before cash is transferred to any of them. This is not a small detail. With outside ability to borrow or raise new investment diminished, shares of national tax revenue become essential, and this funding recourse is only an option if the region remains part of the Kingdom of Spain.
Finally, Catalonia faces too many debt maturities at year’s end to continue borrowing without immediate liquidity, and should be most eager to get the repurchases moving faster. This is why the regional government requested bailout funds from Madrid earlier this year. In the last quarter of 2012 Catalonia has more debt maturities upcoming than any other Spanish province. Many construction projects, ranging from shopping centers to amusement parks, have been funded with debt in the region. Short-term debt maturities in Catalonia cannot all be met with local revenues. Since purchase of short-term debt lies at the center of Spanish and ECB bailout packages, which makes such assistance even more important for over-developed Catalan towns. Completed or not, maturities for a wide range of bonds fall over the remainder of this year. It is unlikely to think that most Catalan politicians will push irrationally for the kind of autonomy that would leave them paying off this debt with limited or nonexistent funds.
For this reason, non-compliance need not worry us when Catalans take to the polls. Longer-term concerns about a Catalan exit from Spain (and its de facto exit from the EU) have their merits, but this month’s election should not have a significant effect on the Spanish economy. Increased demand for Catalan independence cannot affect Spain’s credit or borrowing conditions, unless Catalan officials were to behave to irrationally as to punish themselves by open rebellion. This is extremely unlikely. Consequently, market jitters about the Catalan elections are unfounded. For now, Spain’s government and external fiscal pressures will ensure Catalan compliance with the national program.