Will Spain’s central government blink (again)? Madrid’s standoff with Spain’s north eastern province of Catalonia, which plans to hold a forbidden referendum on national independence on October 1, grows more and more complex by the day. Just in the last week alone the following developments have taken place:
* Spain’s Civil Guard has raided Catalonia’s parliament and government HQ as part of its investigation into political corruption in the region. As new research has shown, this investigation forms part of a broader police operation that has served as a means for Spain’s governing People’s Party to spy on political rivals.
* Catalonia’s government has replaced the region’s chief of police with a die-hard separatist. It has also purged the cabinet of any members perceived as not fully committed to the separatist cause. * * * Deloitte published its annual barometer of Spanish businesses according to which 74% of business leaders believe that the independence of Catalonia would do serious harm to Spain’s economy.
* Support in Catalonia for national independence is on the wain, according to a new poll, with 49% opposing independence, and just 41% favoring it. That said, only 67.5% of respondents said they still plan to vote on Oct. 1. Most of them will be nationalists.
Madrid will do everything it can to stop them. The Rajoy government has warned this week that anyone who participates in the purchase of ballot boxes for the referendum could be criminally prosecuted. They also warned of serious consequences if it is discovered that public money has been used to organize the referendum. Those consequences could include a temporary freeze on the Autonomic Liquidity Fund (FLA), a low-interest credit line from the central government that has kept Catalonia’s economy (and the economies of Spain’s other autonomous regions) afloat since Spain’s debt crisis.
Spain doesn’t actually have this money, so it borrows it by issuing bonds that qualify for the ECB’s QE, which pushes down their yields and the costs for Spain. Now, roughly 80% of Catalonia’s debt (about €75.5 billion) is on the shoulders of Spain. And Spain, whose public debt over the last ten years has mushroomed from 40% of GDP to 100% of GDP, is being propped up by the ECB.
Catalonia is desperately dependent on Spain for funding, and Spain is desperately dependent on revenues from Catalonia to service what are essentially Catalonia’s debts, plus its own debts. Neither can keep these financial entanglements going without the other.
All the while, the situation with Catalonia’s home-grown debt gets more and more precarious. In recent days the value of debt issued by Catalonia has slumped to new lows. The yield on debt scheduled to mature in 2024 rose to 4.7%, five times the yield on equivalent Spanish securities. Catalonia’s debt has junk credit ratings: Moody’s has placed it three notches below investment grade; Standards & Poor, four notches, and Fitch, two.
By now the lack of liquidity in the Catalan autonomous debt market is absolute. “There is nothing, nobody is buying, nobody is selling,” says Javier Ferrer Delgado, a director at Ahorro Corporación.
Catalonia issued most of this debt, now €13 billion, before the debt crisis began biting really hard in Spain, in 2011-12. Catalonia’s finances went from terrible to disastrous. Since the ECB doesn’t buy municipal or provincial bonds, the province was essentially locked out of the credit markets. Indeed, it would have defaulted if the central government hadn’t stepped in to fund Catalonia’s deficits and service its debts.
Now Madrid is threatening to turn off the liquidity tap. But will it actually follow through?
The Rajoy government already set a similar ultimatum last year and failed to make good on it. It’s easy to see why: if the Finance Ministry decides to suspend payments to the region, it could trigger a liquidity crisis in a regional economy that accounts for 20% of Spain’s national economy, represents almost 25% of Spain’s vital tourist sector and is growing faster than any other region. It could also put further strain on Spain’s already out-of-control financing of its regions.
Two out of every three euros of new debt created last year went to the regions, which increased their total debt exposure by 10.3%. The worst offenders, Extremadura and Aragon, increased their respective debt piles by over 15%. But the biggest regional debt overhang belongs to the regional government of Valencia, which at last count owed the equivalent of 41.3% of its GDP.
Spain’s Socialist Workers’ Party, a somewhat uncomfortable partner in Rajoy’s fragile coalition, wants debt relief to be an integral part of the coalition government’s reforms to Spain’s regional financing system which is fast spiraling out of control. The debt relief would also apply to Catalonia.
“Catalonia has a very important debt and the State must help to resolve it, because the debt is getting bigger, and you have to raise even more debt so that the institutions in Catalonia do not collapse and can provide the services needed,” argued socialist MP José Luis Ábalos. Clearly not all of Rajoy’s coalition partners are quite so keen to take a purely adversarial approach to the Catalan problem. That could present the government with a serious challenge when it finally decides to intervene in the region. That said, even if Rajoy’s Popular Party wanted to provide debt relief to Catalonia, which it certainly doesn’t, any plan to write down regional debt would meet an immovable wall of resistance in Brussels, which is already deeply concerned about the continued growth of public debt in Spain. In the meantime, the clock to October 1 continues to tick down, and there’s still nothing remotely resembling a semi-workable solution in sight.
Markets are still complacent....