PMC Weekly Review - October 13, 2017

A Macro View: Catalan Independence – Isolated Incident or the Re-emergence of Populism in Europe?

 On October 1, the Spanish province of Catalonia held an independence referendum, which the Catalan parliament had approved and the Spanish national government condemned as constitutionally invalid. What ensued was violence and chaos, as national police used force to prevent citizens from voting and to confiscate ballots. Although uncertainty around the outcome remains, the question for investors is whether this is an isolated incident or the re-emergence of populism in Europe.

A major impetus for the referendum is the sentiment held by many Catalans that they pay much more in taxes to the national government in Madrid than they receive in the form of investment in infrastructure and other government subsidies. The outcome, in which 90% of voters opted to leave Spain, is questionable, due to voter turnout of only 43%, a large number of ballots confiscated by national police, and speculation that many voters were able to cast multiple votes. Despite the overwhelming majority vote, the Catalan population remains deeply divided on the idea of independence from Spain. On Tuesday, Catalonian officials signed a declaration of independence, but delayed its immediate implementation to allow for talks with Madrid. On Wednesday, Spanish Prime Minister Mariano Rajoy issued a five-day deadline for the region to declare its independence before invoking Article 155 of the Spanish constitution, allowing Spain to suspend Catalonia’s autonomy and impose direct rule.1

The Spanish constitution, established in 1978 following the dictatorship of Francisco Franco, made Catalonia one of the most autonomous regions in Europe, granting it the right of self-government and its own official language. It is one of the wealthiest regions in Spain, and despite accounting for only 16% of the country’s population, the region contributes 19% of the nation’s gross domestic product (GDP), 25.6% of exports, and 20.7% of foreign investment.2 Whereas Catalonia generally maintains pro-European Union (EU) sentiment, the EU has made it clear that should Catalonia split from Spain, the region would cease to be part of the EU.3 Many Catalan companies have already announced plans to relocate their headquarters out of the province in response to the crisis, fearing the risk of being headquartered outside the euro zone should Catalonia become independent. This ultimately may seal the fate of the referendum, as the estimated cost of secession is an annual deficit of around €16 million per year, not including the loss of revenues from companies that have left.4

Catalonia has long prided itself on its autonomy, dating back to its status as an independent kingdom in the middle ages. However, one can also argue that this crisis is a symptom of broader issues across Europe that have yet to be resolved. European optimism reached a post-Financial Crisis high following the French elections earlier this year, which quieted populist fears and resulted in strong performance by European equity markets, with the euro rallying to a two-year high against the US dollar. However, many remain skeptical, believing the continent still desperately needs to implement structural reforms to achieve lasting economic growth. And although European growth and inflation data have been positive, and in some cases better than expected, tensions remain high around nationalist sentiment, immigration, unemployment, and wealth disparity. Although the situation in Catalonia certainly has idiosyncratic elements, and may reach a positive resolution without any major disruption to European markets, it also should serve to remind investors of the political and structural risks that remain in Europe and the need to position portfolios accordingly.

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4 The Economist

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