by Ambrose Evans-Pritchard
October 5, 2017
Top global banks and bond funds are increasingly alarmed by the secessionist showdown in Spain, fearing that Catalan leaders will declare unilateral independence within days and set off a dangerous chain-reaction.
The link is to the horrific bloody violence perpetrated by Spanish police upon unarmed Catalans simply trying to vote. Here’s another. Twitter feeds such as #SpainOutOfEU, #ShameOnSpain, #CatalanReferendum have numerous videos of the unbelievable brutality on Sunday (10/01).
Those old enough to remember the Spanish Civil War can only shudder at TV footage of crowds across Spain cheering units of Guardia Civil for beating up defenseless Catalans, egged on with chants of “go get them.”
On Monday, hundreds of thousands of Catalans marched in the streets demanding full independence from Spain. Tuesday (10/03), Catalan President Carles Puigdemont told BBC that Catalonia will declare independence “within a matter of days.”
Events on the ground are moving with lightning speed. Rafael Catalá, the Spanish justice minister, warned that Madrid is preparing to strip the rebel region of its autonomy and police powers by triggering Article 155 of the Spanish constitution, the “nuclear option”.
“Article 155 is here, and we are going to use all the force of the law. It pains us to resort to certain measures but if somebody wants to declare independence, you have to tell them that they cannot do so,” he said.
The Catalans in return demand that Article 7 of the European Union Treaty be invoked, “Suspension of any Member State that uses military force on its own population.”
Investors are no longer so certain that the crisis will be defused before it reaches the point of outright rupture, a calamitous outcome for the euro and Spain’s economy.
Bank of America says the picture has turned deadly serious over recent days. “There is little scope for a negotiated solution after the latest events, and much scope for a major escalation. The Catalan government really could declare unilateral independence and the Spanish government could take control of the region,” it said.
“A lot of Asian investors still won’t buy Spanish bonds, and after watching what happened over the weekend they are even less likely to want to buy any,” says David Owen from Jefferies.
The ‘risk spread’ on 10-year Spanish bonds jumped by ten basis points to 1.23% on Monday in a sign of mounting nervousness, although it hardly compares with the dramatic swings seen in the eurozone debt crisis.
“It is not large in the greater scheme of things but it is not small either, and it is easy to construct a scenario where it gets worse,” Peter Schaffrik, a bond strategist at RBC.
“Risks and rewards are not aligned in our view, and if recent European history is any guide, these things can turn on a dime.”
Inaki Gabilondo, a veteran columnist at El Pais, says the crisis has already gone beyond the point of no return.
“The catastrophe is consummated. We have reached the final disaster: the splintering of Catalonia is a fact; the splintering of Spain is a fact,” he says.
That message has not reached the equity markets where luxuriant liquidity is feeding the chase for yield and keeping optimism alive. The IBEX index in Madrid slid by just 1.21%, with the damage confined to banks.
Sabadell tumbled 4.5% and Caixabank was down 4.4%. The two Catalan lenders are drawing up contingency plans to maintain access to liquidity from the European Central Bank come what may.
Spanish banks hold €215bn of the country’s public debt, leaving them vulnerable to the “doom-loop” between sovereign states and banking systems that bedevilled southern Europe five years ago.
Mr. Owen said the great difference this time is that the ECB is standing behind the edifice as a lender-of-last-resort. It is purchasing €60bn (£53bn) of bonds each month. “The markets know the ECB is still printing money and this has to be put to work,” he said.
The ECB is effectively trapped by politics. It cannot easily push for rapid bond tapering with the Spanish crisis at fever pitch, and with the much-dreaded Italian elections early next year. Currency markets have already begun to sniff a dovish retreat in monetary policy, driving down the euro by a cent to $1.1730 against the dollar on Tuesday.
The crisis has begun to affect Spain’s credit rating. Standard & Poor’s denied the country a long-awaited upgrade last Friday (09/29), citing escalating tensions in Catalonia.
Spain has been the poster-child of the eurozone’s economic recovery until now, racking up growth of 3.4% in 2015, and 3.3% in 2016.
Unlike Italy, it has pulled off the feat of an ‘internal devaluation’ within the eurozone, clawing back competitiveness by compressing wages. Yet the social cost of austerity has been high: youth unemployment is still 38.7%.
Much now depends on how Catalonia’s separatist leader Carles Puigdemont plays his cards. He has won the latest battle of images in the world media. But if he pushes for independence immediately – on the basis of a referendum declared illegal by the Spain’s top court and with just 38% turn-out (though vastly more were violently revented from voting) – goodwill in both Catalonia and abroad may slip through his fingers.
The Catalan parliament deems the referendum legally-binding but that is political fiction. Both sides have invoked the “law” with promiscuous abandon in this dispute, using parchments and judges as a cover for raw ideology.
In Madrid, it is far from clear whether the minority government of Mariano Rajoy can survive after so many staggering misjudgments. He depends on the acquiescence of regional parties to pass his budget.
Basque voters are aghast at the spectacle of the Guardia Civil storming voting centers, injuring nine hundred people who were just trying to vote. There were clearly grave lapses of law enforcement discipline.
There has been little self-criticism. Mr. Rajoy insists that the conduct of the Guardia Civil was “exemplary,” a claim echoed by his Partido Popular and the loyalist press. This is not an attitude likely to soften Catalan wrath or to open the way to an amicable settlement, such as enhanced devolution with budgetary powers along the lines of the Basque formula.
It is unclear whether Mr. Rajoy has enough support in the Cortes to activate Article 155. It is a dangerous move in the current febrile atmosphere, suggesting that the Moncloa Palace in Madrid still underestimates the intensity of the Catalan revolt. Seeing this through might require coercion reminiscent of the Black and Tans in Ireland in early 1920s.
Brussels and EU leaders have backed Mr. Rajoy and the Spanish constitutional order so far. They have little choice. Yet they are on a slippery slope, becoming an accomplice to what many deem brutal repression to uphold an untenable status quo.
The Catalans intend to file complaints for systemic violations of the EU’s Charter of Fundamental Rights, ultimately decided by the European Court, which has supremacy over Spanish courts.
Madrid has invoked the rule of law all the way through this crisis, often with elasticity. It may discover that the law is a double-edge sword, as is Europe.
The EU is in a horrible bind. It faces a rule of law crisis in Hungary and Poland. It faces an East European revolt over migrant quotas. Its relations with Turkey have turned hostile. Now Spain is threatening to break up the euro unless the Catalans come to heel.
The problem for Spain is that if it acted in such a fashion, it would bring a commensurate catastrophe upon itself. Catalonia is the richest and most dynamic region of Spain – along with the Basque country – and makes up a fifth of the economy.
Such circumstances would entail a partial break-up of the euro, re-opening that Pandora’s Box. The status of Spain’s sovereign debt would be unclear. Why would the Catalans uphold their share of these liabilities if subjected to a boycott?
Catastrophe looms for Spain, both economic and political.