Short and Sharp: European political risk is still alive

European political risk seems to once again be rearing its ugly head. Last week, Catalonia voted in favor of declaring independence from Spain, with an overwhelming 90% majority. Turnout was low at 43%; although, this was partially due to heavy-handed attempts by the Civil Guard to stop the technically illegal referendum from taking place. Major tensions were averted since Carles Puigdemont, president of Catalonia, has –  so far – stopped short of declaring independence. Snap Catalan elections most likely lie ahead, and independence negotiations with Madrid are probably ongoing.  I expect the situation to remain extremely tense for some time. However, I would argue this political crisis is not an economic crisis and, therefore, should have minimal impact on global markets.

Had Catalonia officially declared independence, the repercussions for Spain could have been very significant. Catalonia comprises 19% of Spain’s GDP, and it makes a meaningful positive contribution to Spain’s fiscal position. If Catalonia were to leave, Spain’s GDP would shrink, and its budget deficit would rise from 4% of GDP to almost 7%. Meanwhile, the debt-to-GDP ratio would jump from 100% to around 115%.

For Catalonia itself, the economic impact would have been devastating. The European Union (EU) had signalled that Catalonia would not only be independent of Spain, but it would find itself outside the European Union and its common currency. Several large corporations, including CaixaBank, Banco Sabadell, and Gas Natural had already announced their decision to move their headquarters out of Catalonia to mitigate any potential risks from independence. This is a number that would almost certainly have risen.

Certainly, any lingering doubt is likely to affect foreign and domestic investment into Catalonia. But overall, without Catalonia officially declaring independence, an ongoing political crisis will be a minor drag on Spain’s otherwise robust growth.

Nonetheless, market participants have been unnerved. Spain’s political turmoil is occuring when the market was already jittery from Germany’s election, where the support for anti-establishment party, Alternative Fur Deutschland (AfD), was higher than widely expected.

With regards to Germany, I take a slightly more sanguine view. For starters, although Afd had a stronger showing than many expected, polls had been indicating it would gain seats in the Bundestag. Most importantly, AfD will not be part of the government, so it can influence policy but not dictate it.

With regards to Europe, however, I believe markets have been given a timely reminder that political risk is still alive – even if their concerns are directed at the wrong country. While Spanish turmoil is unlikely to spill over into global markets, the forthcoming Italian election poses a non-negligible risk of a populist win, and the potential global market impact could be critical.

Indeed, these recent events in Spain have underlined how European governments and institutions continue to struggle against populist forces and parties working to drive the EU apart, even despite a stronger economic picture. I suggest continuing to watch this space.

Please look for the next addition of Short and Sharp the week of November 6.

 

 

Follow Principal Global Investors on LinkedIn

 

_________________________________________________________

Unless otherwise noted, the information in this document has been derived from sources believed to be accurate as of October 2017. Information derived from sources other than Principal Global Investors or its affiliates is believed to be reliable; however, we do not independently verify or guarantee its accuracy or validity. Past performance is not necessarily indicative or a guarantee of future performance and should not be relied upon to make an investment decision.

The information in this document contains general information only on investment matters. It does not take account of any investor’s investment objectives, particular needs or financial situation and should not be construed as specific investment advice, an opinion or recommendation or be relied on in any way as a guarantee, promise, forecast or prediction of future events regarding a particular investment or the markets in general. All expressions of opinion and predictions in this document are subject to change without notice.  Any reference to a specific investment or security does not constitute a recommendation to buy, sell, or hold such investment or security, nor an indication that Principal Global Investors or its affiliates has recommended a specific security for any client account.

Principal Financial Group, Inc.,  Its affiliates, and its officers, directors, employees, agents,  disclaim any express or implied warranty of reliability or accuracy (including by reason of negligence) arising out of any for error or omission in this document or in the information or data provided in this document. 

Third party content, such as comments to this blog, is not reviewed by Principal Global Investors before it is displayed, although we may remove, alter, edit or adapt any such comments.  Principal Global Investors does not endorse, authorize, or sponsor any third party content.  Links contained in some blog posts may take you to third-party sites and Principal Global Investors makes no guarantees to the accuracy of the information provided

​Investing involves risk, including possible loss of principal.

Insurance products and plan administrative services provided through Principal Life Insurance Co. Principal Funds, Inc. is distributed by Principal Funds Distributor, Inc. Securities offered through Principal Securities, Inc., 800-547-7754, Member SIPC and/or independent broker/dealers. Principal Life, Principal Funds Distributor, Inc. and Principal Securities are members of the Principal Financial Group®, Des Moines, IA 50392.
t17101107mu