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Friday, 01 August 2014

Catalonia shows euro's weak links

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Just when Spain, and the eurozone, needed it least, along comes the Catalan secession drama to remind us exactly how many parties, peoples and factions have the potential to undermine the single currency’s salvation.

James Saft, Reuters Columnist

Not that Catalonia is likely to leave Spain any time soon – for one thing the country has no constitutional exit clause – but the discussion itself has already unsettled markets and is complicating Spain’s potential negotiations for a bailout.

And if you find this one unsettling, just wait; even with newly strong support from the European Central Bank, the eurozone has, at best, a long and painful journey ahead to integration. Catalans favouring independence won’t be the last group to want to radically shift the debate over who pays what to whom.

Artur Mas, conservative president of Catalonia, on Tuesday called elections for November after Spanish Prime Minister Mariano Rajoy rejected his call for more control over tax affairs. His CiU party is likely to win an outright majority in the regional parliament in the election, which he is casting as a vote over independence, a concept rejected by central government.

Catalonia, heavily industrialised and wealthy, pays in far more in taxes to central government than it receives in spending

“If we can go ahead with a referendum because the government authorises it, it’s better. If not, we should do it anyway,” Mas told the regional parliament Wednesday. “This is about Catalonia being able to exercise its right to self-determination.”

Financial markets caught fright on the news, matters not being helped by it coinciding with violent anti-austerity protests in Madrid on Wednesday. Spanish shares fell sharply, the euro itself sagged and Spanish debt widened considerably against German bonds, indicating disquiet over Spain’s ability to tread what is proving to be a very delicate path to a bailout.

Catalonia, heavily industrialised and wealthy, pays in far more in taxes to central government than it receives in spending. It is also in desperate need of funds to meet upcoming bond obligations, and is in the process of negotiating a €5bn bailout from a recently set up central fund. Recent polls show independence from Spain is favoured by more than half of all Catalans, who resent the flow of tax dollars out of the region. It accounts for about a fifth of all Spanish economic output, and as a standalone country would be roughly the size of Austria.

All of this is highly unlikely to end with a new state, either inside or outside of the eurozone. There is at present no constitutional mechanism for separation and the EU itself appears to recoil in horror at the idea. Even if viewed simply as negotiations over how thinly the butter is spread on whose bread, the ructions could easily prove very expensive.

Hard to ask for help

Coming now, after the ECB spread a safety net under the euro with its recent pledge to directly support sovereign bonds, the fallout has been limited. Had something like this happened at tenser times earlier this year or last, we could easily have seen the kind of sovereign and bank debt run which would prove extremely difficult to control and contain.

Rajoy has been publicly resisting calls, from financiers at home and from his European partners, for him to move ahead and request a bailout. He has, instead, been temporising, hoping to get his ducks of reform and austerity more or less lined up at home first, rather than appearing to bend to external wills. He also may be hoping that Italy asks for help too, which might allow him to win comparatively better terms.

The Catalan vote makes this task harder in at least two respects, each of which serves to magnify the other. The appearance of political disorder at home will only, as we have seen, pile pressure on Spain in financial markets, something its would-be helpers in the EU and ECB do not want to see. A very fragile confidence built up in the wake of the ECB’s change of heart, but not a permanent or very stable one. Secondly, it makes his negotiations at home over the character and terms of reform that much more difficult, both in terms of who tells whom what to do, and how this plays inside and outside of Catalonia.

How this plays out is, of course, impossible to foretell. The message, instead, is that the task in Europe, both of weathering the immediate storm and constructing a convincing stronger union, is not just almost unbelievably complex at the European level, but also subject to quite unpredictable differences internally within what would appear to be highly stable states.

That argues for, at the very least, periodic bouts of worry. Expect a lot more volatility in European financial markets than we’ve enjoyed in recent weeks, volatility that just could extend to global markets.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at jamessaft@jamessaft.com)

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