An article in Bloomberg today argues that Mario Draghi’s backstop of EU member state debt is actually fomenting the Catalan Independence movement.
As President of the powerful European Central Bank, Mr. Draghi has promised to “do whatever it takes” to save the Euro, emphasizing: “and believe me, it will be enough.” Through the threat (or promise) of Open Market Transactions, in which the ECB could directly intervene in bond markets to buy an unlimited amount of sovereign debt, Mr. Draghi has soothed the jangled nerves of bond investors and actually avoided the necessity of using this option; an option which is of questioned legality within the ECB’s mandate.
Bloomberg argues that this “calming effect” has extended to regional bonds as well as sovereign bonds, thus allowing Catalan separatists to push for a referendum and possible independence without triggering any market backlash in the form of bond investors fleeing to safer havens. Since the sovereign is legally obligated to back the regional bond issues, this is a very safe assumption.
The threat of OMT has been remarkably successful. Spain’s 10 year bond went from a chilling 7.65% in July 2012 to a yield today of 2.87%, which is if anything too low. It is only 40 basis points about the US 10 year Treasury: and the US faces neither 26% unemployment, nor near stagnant GDP, nor the threat of secession from its most prosperous region.
The 10-year Catalan bond issued in 2010 has a yield of 4.10% – significantly higher than the comparable Spanish bond, but not punitive by any measure. Catalonia had been locked out of the bond market and forced to ask for financial assistance from Madrid, but has since been able to place three bond issues. These are all shorter term issues and include a one-year bond issued in August 2013 at 2.272%. These are not numbers that seem to reflect any investor fear.
All of this would seem to argue that Mr. Draghi has indeed enabled the Generalitat to pursue the referendum process without paying a financial price for the risk of confrontation with the central government. Of course, even if it were true, it is a far cry from saying that Mr. Draghi has intentionally fomented Catalan independence: it is an unintended consequence of saving the euro, no more. But it is really not possible to say that even this more limited conclusion is true.
The Scottish Parliament has recently been given authority by Westminster to issue Scottish bonds independently of the Bank of England’s gilts. While we don’t have any historical data regarding how these bonds would perform, the UK Ministry of Finance has done some of the work for us. Existing funding arrangements charge Scotland a very slight premium of 0.2% for their public debt needs. The Ministry experts believe that an independent Scotland would pay a premium of between 0.3% and 1.2%: which is on the low end of the differential between the Catalan and Spanish bonds today. In other words, the UK Finance Ministry does not see a major funding problem for an independent Scotland, much less investor flight from its bonds, only a modest increase in the funding cost of public debt until the new government establishes a creditable track record of payments.
It is worth noting that the author of the article makes some mistakes in laying out the ramifications of Catalan independence from Spain. It may be purely coincidental that the author is Spanish and works in Madrid, but I would have expected Bloomberg to at least include a disclaimer to the effect that there might be a personal conflict of interest.
Disclaimer: I do live in Madrid, but I am an American citizen.
- “A Catalan secession would cost Spain 10 percent of its tax revenue and trigger a row over how to carve up the sovereign’s 836 billion euros ($1.1 trillion) of debt.”
Costing Spain 10% of its tax revenue is not significant unless we also know the percentage of Spanish government outlays are also removed from the books. If Spain is paying out 12% to Catalonia and collecting 10%, then the central government as a whole is actually better off without having to underwriter the region. In fact, the opposite is true, which is why this loss of revenue is important. Catalonia is a significant net contributor to the Spanish budget and to other communities through the intraregional transfers that take place.
Furthermore, declaring that independence would “trigger a row” is matter of personal opinion. If Mr. Rajoy recognizes the referendum results as legitimate, then there will be a negotiation over the proper proportion of the Spanish public debt that Catalonia must assume, not a row. If Mr. Rajoy does not accept the referendum results then there will almost certainly be fighting, but it will have nothing to do with the division of the public debt. In fact, Catalonia will repudiate the Spanish debt entirely and accept responsibility only for its own regional debt, which is has gone from 22% of Catalan GDP in 2011 to about 25% today.
- “Independence could force the 7.6 million Catalans out of the EU and shut off Barcelona-based lenders such as CaixaBank SA from central bank funding.”
This again depends on the posture of the Spanish government. If Spain recognizes Catalan independence – the “amicable divorce” scenario – then EU readmission will be one of the principal points of any agreement reached. No one else in the EU is going to object, so it should be a foregone conclusion. Thus, no Catalans will be out of the EU and no Catalan banks will be shut off from ECB funding.
If Spain does not recognize Catalan independence, no Catalans will be expelled from the EU because officially, they will still be part of Spain. They will continue to operate as Spanish businesses and citizens because Spain can hardly eject part of its sovereign territory from the EU without first recognizing its independence; in which case, see my point above. Spain would thus be caught in a catch-22: it cannot punish Catalonia with recognizing her independence, and if Spain recognizes Catalan independence, then it makes no sense to punish the new government (not if they want the Catalans to assume any of the national debt).
It should also be noted that CaixaBank SA, though based in Barcelona, is licensed by the Bank of Spain and is a Spanish bank. There is no reason that this would change with independence; CaixaBank – and every other bank based in Catalonia – would remain a Spanish bank under Spanish law with access to Bank of Spain funding until such time as the independence question were settled amicably, and then it might change its legal residency to the new Catalan state, but not before. Obviously, the Catalan Parliament, when declaring independence, would also grant a transitional period in which all legal agreements, entities and statues inherited from Spain would remain in operation.
- “A secession of Catalonia would also raise questions over rescue loans funded with central government debt. Catalonia borrowed 31.6 billion euros of loans from the facilities.”
False. This would either be negotiated as part of the amicable settlement, or it would be repudiated by the Catalan government if the Spanish government decided not to be nice. In either case, there is no real question of repayment or debt assumption, only a question of the Spanish governments recognition of the Catalan referendum.
- “The Spanish Social Security also paid 4.3 billion euros in pensions and other subsidies to Catalans between January and March compared with 1.4 billion euros of contributions it received from the region, government data show.”
You probably know where I am going with this…. The division of the Social Security Fund, which is centrally held and paid out, would also be a matter of negotiation. Based upon some agreed upon formula, the Spanish Social Security Fund would make a transfer to the new Catalan Social Security Fund. If the divorce were contentious, then the Catalans would lose this money and be forced to refund the Social Security administration through public debt issuance. The reserve fund is valued at 66.8 billion euros, or 1,448 euros per inhabitant of Spain. The Catalan share based on population would thus be 10.5 billion euros. Given that, in this case, Catalonia would be repudiating its share of the Spanish national debt and would acknowledge only the 25% of GDP of regional debt it has contracted, refunding a Catalan Social Security Reserve Fund under those circumstances would increase the Debt-to-GDP ratio from 25% to 31%: a significant increase, but not impossible.
Where the article is absolutely correct is in stating that no bond trader in his or her right mind is going to pass up the chance at capitalizing on the coming ECB program of quantitative easing due to some vague and far future fears of the potential consequences of a Catalan referendum. In any case, they will be betting on cooler heads to prevail to prevent a major disruption.
Are they right?
They are almost certainly right from the EU point of view. Mario Draghi’s sole mandate is to save the Euro and he has spent the last 6 years single-mindedly working to that end. Angela Merkel has also lost many sleepless nights over the future of the Eurozone. Neither of them is going to sit back and watch the Spanish and Catalans destroy everything they have done since bailing out Greece. Mr. Mas will be easy to convince regarding the need to negotiate. But they will apply all manner of pressure to ensure that Mr. Rajoy chooses the amicable divorce option, up to and including threatening Spain’s access to ECB funds. The Germans know how to play hardball too.
Will that be enough though?
In theory it should be. But history proves how often economic and financial theories are thrown out the window when the violent passions of nationalism, pride and personal political careers are in play. The Spanish do not have a promising history of dealing with regional challenges to their authority, nor with swallowing national pride. And Mr. Rajoy faces the disintegration of his personal career and going down in history as “the man who lost Catalonia” as well as the potential disintegration of his entire political party. All of these factors bode ill for a peaceful settlement.
Mario Draghi is not Catalonia’s best friend, but he is the defender of the Euro – which may amount to the same thing in November. But if he wants to save the Euro, he doesn’t have the luxury of waiting until then. European leaders need to get involved immediately in calming tempers and preparing the necessary groundwork for mediation. That does not seem at all probable.
Sources and Notes:
 Esteban Duarte, “Draghi Shields Catalan Independence Bid From Market: Euro Credit,” Bloomberg, 30 May 2014
 On the other hand, the US does face a Federal Reserve promise to continue rolling back quantitative easing and higher inflation, while the Eurozone is on the verge of deflation and will almost surely benefit from the start of an ECB quantitative easing program before the summer.
 Bonos Autonómicos, Tucapital.es
 Bolsa de Barcelona
 Let me be clear that the article does NOT state the Mr. Draghi has sought deliberately to foment Catalan Independence, though one could conclude that the author implies it.
 David Milliken, “UK allows Scotland to issue its own debt – at a price,” Reuters, 19 February 2014
 The Spanish government might order the Bank of Spain to cut off funding to Catalan financial institutions anyway, but this would be blatantly illegal and could be challenged in court.
 As of 31 December 2011. Ministerio de Empleo y Seguridad Social.
 Estimaciones de la Población Actual de España. Instituto Nacional de Estadística.