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Spain: Lasting political uncertainties will weigh on the economic outlook

31 October 2017 Coface

On the 27th October, Spain’s regional parliament (where separatist MPs hold the majority of seats) officially declared independence, at the same time as the Spanish Senate met to discuss how Article 155 could be implemented.

Following the vote for a unilateral declaration of independence, the Spanish Senate approved the application of the full force of Article 155 of the Spanish Constitution.

Under this article, the autonomy status of the Catalonia region is suspended. Carles Puigdemont, the President of the Generalitat of Catalonia, and his entire cabinet have been relieved of duty, and the regional parliament has been dissolved. Deputy Prime Minister Soraya Sáenz de Santamaría, Spanish Prime Minister Mariano Rajoy's loyal right hand, has been appointed to temporarily run the region, and an early regional election has been called for the 21st December.

The Spanish Ministry of the Interior took control over the Mossos d'Esquadra, Catalonia's 17,000-strong local police force, and the force's popular chief, Josep Lluis Trapero, was dismissed and replaced. After pro-independence celebrations last Friday, a mass pro-unity rally flooded the streets of Barcelona on Sunday

These events were the result of a long confrontation between the Spanish State and the Catalonia separatist movement. The Separatist movement, led by Mr Puidegmont which holds the majority of seats in the regional chambers, held a referendum of independence on the 1st October that the Spanish constitutional court declared as illegal. A month later, the regional parliament held a secret ballot on whether to endorse the constitutional process to establish a Catalonian republic – subsequently leading Spain into a deep political crisis.

Risks

Spain faces a crucial test of its authority over Catalonia: After Madrid’s decision to take the control of the region, the President of the Generaliat gave a speech calling for the population to resist the government’s decision. Although the region is officially ruled by the State government, the main question is whether the Catalan administration — its ministers, lawmakers, judges, teachers, policemen and civil servants — will fall in line with central government’s decision and take their orders from the new caretaker administration installed by Madrid, or if they will deny the legitimacy of the government’s decision.

Possible “21-D” scenarios: Following Madrid’s decision to call for early election on the 21st December, the main pro-independent political parties have until the 7th November to formally announce whether they take part in the upcoming elections (which is very likely). Two possible scenarios are likely to emerge:

- Pro independent coalition parties take part in the election but lose the majority inside the chamber. According to a poll conducted by Sigma Dos for the newspaper El Mundo, this is the most probable scenario (but by a narrow margin). The survey indicated anti-independence parties winning 43.4% support and pro-independence parties 42.5%. It seems that ERC (the party of Oriol Junqueras) could obtain 42 seats, while the PDeCat’s likely share of 9.2% would hamper the possibility of renewing a majority.

The pro-independence parties win the election. In this case, the process of independence can be relaunched as the pro-independence movement would gain legitimacy through a vote organised by the Spanish state. And the national Spanish government would face pressure to give more autonomy to the region (at least at fiscal level). This could lead to a snap election at national level sometimes in 2018.

In case of lasting political uncertainty (especially if proindependence parties win the election) the economic environment could be affected through two transmission channels, likely to support each other mutually:

1. A decline on equity markets and an increase in bond rates taking a toll on financing terms for economic agents (state, companies and households) and hence their investment and spending outlook. But at this stage, the financial markets have been fairly calm. The 10-year government bond yield now stands at 1.50%, i.e. 10 basis points below the pre-referendum level (thanks to help from the ECB). This apparent disconnect between political risk and financial markets confirm some recent events in Europe. For example, the Spanish economy does not seem to have been penalised by the government vacuum in 2016 (the same was also true of Belgium in 2013-2014).

2. A lower level of corporate and household confidence prompting delays or cancellations in investment or spending decisions. In October 2016, a Coface panorama (“European economies: Will political risk spoil the party in 2017?”) aimed at quantifying this confidence shock. In the case of a shock in political uncertainty (EPU index) of a similar extent to that seen in the UK in 2016 due to the referendum on Brexit, Spain’s GDP growth could be cut by around one percentage point in the next 12 months. On a sector by sector basis, companies selling durable goods are usually the most affected by fluctuations of consumer confidence.

But this shock at country level is likely to be softened by possible transfers: tourists swapping Catalonia (tourism revenues account for 12% of the region GDP) for other regions in Spain, while businesses invest and relocate their of headquarters (1700 businesses have moved their headquarters from the region since the referendum, i.e. around 0.3% of the total number of companies) in other regions as well.

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