Catalan Election and the Under-Performance of Spain

Catalonia goes to the polls on September 27.  Although efforts to hold a referendum on independence was stymied by Madrid, many partisans are claiming the weekend election is precisely such a referendum.    Even if this is not legally true, a victory by a coalition of those seeking independence would intensify the confrontation with the federal government, ahead of the national elections that will be held later this year. 

The leading independent coalition (Junta pel Si--Together for Yes) has promised a Catalan state within 18 months of the election.  Although this seems far-fetched, it illustrates likely pressures that will mount.  The polls show this coalition winning around 40% of the vote, but just shy of a the 68 seats needed to secure a parliamentary majority.  There are other parties who favor independence but did not join the Junta pel Si that could form a coalition.  

Catalonia has long sought greater independence.  It is an economically prosperous region that is a net contributor via fiscal transfers to other regions in Spain.   It accounts for roughly 20% of Spanish GDP and has a substantial (~5%) budget surplus.   

However, despite what the protagonists are saying, only about a fifth of Catalans identify independence as the most important issue.  About three-fifths say the economy is the most important issue.  Overall, polls suggest about 40% favor independence.  Moreover, the federal government, the central bank, other EU members, and even the football league, warns of a heavy price of secession.  To discourage other regions from breaking away from their countries, an independent Catalonia would not be an EU or EMU member. 

While the risk that Catalonia secedes is rather modest, the impact could be quite serious.  Without it, Spain's macro condition deteriorates sharply.   It could embolden other parts of Spain to leave as well. 

Spain holds national elections in November or December.  This warns that the political uncertainty in Spain will not be alleviated by this weekend's vote in Catalonia.  Indeed, the risk is that the election produces no clear winner.  A coalition would have to be forged.  Spain, arguably even more than the UK, is not accustomed to coalition governments.  Its elections have produced a single party majority since democracy returned after Franco. 

The political uncertainty may also encourage investors to look closer at Spain's economic recovery.   Spain has enjoyed among the strongest recoveries of the large eurozone countries over the past two years.  Austerity and reforms have slowed as the government positions for the election.  However, pressure from the IMF and EU to resume its efforts will likely resurface early next year. 

Spain has under-performed Italy all year, but it has especially been pronounced over the past three months.  Consider that over the course of the year, Spanish 10-year yields have risen 38 bp while Italy's have fallen by 12 bp.  Of that 50 bp under-performance by Spain, 27 of it has taken place over the past three months.

Italian stocks are among the best performers this year among the high income countries.  The FTSE Milan Index is up 11.4% year-to-date.  Spain's IBEX is off 7.5%.   Over the past three months, as nearly all equity markets have fallen, Italy is down 10.2%,while Spain is off 16.6%.  

The political cloud that hangs over Spain will likely last the remainder of the year, at least.   Its asset markets are likely to under-perform Italy, regardless of the precise electoral outcome. 

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