Global Daily – Catalan independence risk for Spanish bonds?

by: Nick Kounis , Aline Schuiling

Euro Politics: The Catalan independence risk – According to the Catalan authorities, some 2m voters backed independence out of 2.3m votes cast on Sunday. That said, 5m people were eligible to vote and there are doubts about the accuracy of the numbers. A potential exit of Catalonia from Spain, would create quite some uncertainty and would probably do serious damage to the economies of both regions. Catalonia makes up 16% of Spain’s population, but 20% of its GDP and 25% of its exports. Moreover, it would create uncertainty for Spanish government bonds and Catalonia’s regional debt.

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Everything else being equal, Spain’s government debt ratio would probably rise from currently around 99% GDP to around 115% in case of an independent Catalonia (assuming that it would not take responsibility for any of the existing central government debt, but the only its existing regional debt). This would still keep Spain’s debt ratio below that of Italy’s (at around 133%). However, Spain has a much higher budget deficit, and in that worst case scenario for Spanish bonds, Spain’s public finance fundamentals would move more into the category of those of Italy. In such a scenario, Spain’s yield levels could move closer to Italian levels (around 45bp higher than currently).

How likely is such a scenario? It still seems like a very low probability. It is very difficult to see a legal pathways to independence given the stance of the Spanish government and the EU. In case the Catalan government were to unilaterally declare independence and negotiations between the regional and national government fail, the national government could resort to Article 155 of the Spanish constitution, allowing it to suspend the authority of the region’s government. In any case the potential for escalation with street protests and possibly clashes is high. Following the referendum, Spanish bonds moved to price in such risks. The Spain-Germany 10Y spread was up by around 8bp at time of writing. (Nick Kounis & Aline Schuiling)