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.
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