“Sometimes you have to keep the black swans in mind.”
By Don Quijones, Spain, UK, & Mexico, editor at WOLF STREET.
In recent days, JP Morgan Chase, Goldman Sachs and ING, have warned about the political situation in Spain’s richest region, Catalonia, where a banned referendum on national independence is scheduled to be held on Oct. 1.
JPMorgan advised its clients to reduce their exposure to Spanish government debt. Although the bank does not foresee Catalonia achieving independence, it believes that developments in the region could lead to a resurgence in Spain’s risk premium.
In the last five weeks the premium (the cost differential of Spain’s 10-year bonds vis-á-vis Germany’s) has increased from 101 to 121 basis points. It’s still not much compared to the 630 points that it reached at the height of the Euro Debt Crisis in 2012, but it’s enough to get analysts on Wall Street and in the City of London to sit up and pay attention.
Economists in London at Bank of America Merrill Lynch warn of two possible scenarios.
“First, although it is not our central scenario, if we saw a great amount of [social] discontent, markets could react more than they have until now. Nothing has happened yet, but there have been several very tense situations.”
For example, last Wednesday when Spain’s Civil Guard raided Catalan government buildings and arrested senior government officials, which sparked a flurry of spontaneous protests outside Catalan government buildings. The elected government of Catalonia, backed by an overwhelming majority of Catalans, is determined to proceed with a referendum that has been prohibited by Spain’s supreme court.
Spain’s knee-jerk response was to dispatch cruise ships to Barcelona filled with police reinforcements drafted from other parts of the country. Cries of “Viva España” (Long live Spain) and “Á por ellos!” (Go get them!) accompanied them as they left their barracks.
As of today Spain’s National Court is investigating people who protested last Wednesday outside Catalan government buildings for crimes of sedition, which are punishable with prison sentences of up to 15 years.
Madrid has also demanded that Catalonia’s autonomous police force, the Mossos d’Esquadra, is made completely subordinate to Spain’s Interior Ministry. Their first big job will be to prevent anyone from getting within 100 meters of a ballot box on Sunday, the day of the vote. The Mossos have so far refused to comply and its chief of police, Josep Lluís Trapero, has said he will not attend any meeting in any Spanish government building.
In other words, tensions between the two sides are not exactly easing.
And political instability is no longer just a threat in Catalonia. In the second scenario postulated by the Bank of America Merrill Lynch analysts, the current crisis could also affect the stability of the central government led by Mariano Rajoy.
The current central government is in a minority and the main opposition party [PSOE] is not very keen to work with it. It is a very fragile balance and if the Catalan situation is not handled correctly, it could lead to a vote of no confidence that might end up bringing down the Spanish Government.
That could prompt a revival of the market jitters that were seen at the end of 2015 and in mid-2016 [a period during which two elections were held to form a government]. In recent days, the PP’s coalition partner, the Basque National Party (PNV), which supported the budget of 2017, has said that it is unwilling for now to support the 2018 budget. Without its support, it will be very hard for Madrid to pass the budget.
The financial pain in Catalonia and Spain has already begun. According to Carlos Perelló, country manager for Spain and Portugal at French investment bank Natixis, Catalonia is already suffering a negative market impact from its decision to move ahead with the referendum on national independence despite .
“We and our partners believe it is not a very rational decision to invest capital in (big infrastructure) projects in Catalonia despite the fact that they offer much higher returns,” Perelló told Spain’s financial daily Expansión. “This is because of the political situation, even though the most likely outcome is that nothing much changes in the region. Sometimes you have to keep the black swans in mind.”
Josep Borrell, a socialist politician, former government minister and ex-board member of recently bankrupt green energy giant Abengoa, claims that in the City of London, which he recently visited, the biggest concern is over the potential impact of political developments in Catalonia on the financial health and stability of the two banks most exposed to the region: Barcelona-based Caixabank, Spain’s third biggest financial institution, and Banco de Sabadell, the fifth biggest.
One risk is a region-wide bank run, as people, both in Catalonia and the rest of Spain, begin withdrawing funds from the two banks, either out of fear that the money could dry up or as part of a boycott. Both banks have already threatened to move their head office, with Caixabank preferring Mallorca as its Plan-B location and Banc de Sabadell, Madrid.
If Catalonia unilaterally declares independence from Spain, they could be cut off entirely from ECB funding. That, according to the Bank of Spain — hardly the most impartial observer — would set in motion a corralito-like event. As happened in Argentina in 2001, bank accounts would be frozen and customers would be able to access only a very small fraction of their funds. And probably not in euros.
It would be catastrophic for Catalonia’s economy. But the rest of Spain’s economy and financial system would be hit very hard too if two of its five biggest banks in its richest region were effectively put out of business at a time that it’s sixth biggest bank, Banco Popular, just collapsed and was taken over by its biggest bank, Santander, and its eighth biggest bank, Liberbank, is beginning to wobble too. By Don Quijones.
Spain’s “ships of repression” are coming to help out. Read… It Gets Ugly in Catalonia