Spain: Heightened uncertainty over Catalonia independence bid clouds outlook for the Spanish economy
October 24, 2017
The escalating crisis in Spain over Catalonia’s bid for independence took a significant turn on 21 October when the Spanish government triggered Article 155 of the Spanish Constitution, a first since the Constitution was ratified in 1978. Still conditional on approval from the Senate on 27 October, the unprecedented move will enable the central government to seize powers from the Catalan administration and bring the semi-autonomous region under Madrid’s direct control. Despite a turbulent political scene riddled with heightened uncertainty, financial markets’ negative reaction to the events has been relatively muted, as market participants view the crisis largely as an internal affair, the effects of which are still hard to measure. FocusEconomics panelists are currently evaluating the potential channels through which the rapidly evolving crisis may impact the Spanish economy but have mostly refrained from modifying their forecasts just yet. The situation remains volatile, and there is limited data on how economic indicators have been affected since the onset of the crisis.
Measures underlying Article 155, branded as the nuclear option for the severity of its implications, will enable the central government to take over all functions of the Catalan administration and call fresh elections in the region, which it will seek to do within six months of direct rule. Based on the government’s petition to activate Article 155, the Senate commission will draw up a proposal for debate on 27 October. As the ruling Partido Popular (PP) party holds a majority in the Senate, the measures are expected to pass and come into effect on the same day. Meanwhile, the Catalan parliament is set to hold a plenary session on 26 October to decide on how to respond. There is speculation that the session may be used to vote on a declaration of independence from Spain. It is thus far from clear how exactly the week’s events will play out.
The current impact from the crisis on the economy is still uncertain. Hundreds of companies based in Catalonia have shifted their legal headquarters away to other parts of Spain after the contentious 1 October independence referendum, including the region’s two biggest banks—CaixaBank and Banco de Sabadell. While these announcements are unlikely to have had a measurable impact on activity so far, some companies have stated that they may relocate their operations away from Catalonia if the region breaks away. Moreover, tourism—a key driver of growth for the region—may have also been affected by the crisis. Although official data is still outstanding, private associations have reported a 15% drop in tourism activity since 1 October. While most analysts deem it highly unlikely that the region will break away, they are wary about the near-term impact of prolonged uncertainty and ongoing social tensions. Angel Talavera, Senior Economist at Oxford Economics, pointed out that not only could unrest impact the tourism sector, but “uncertainty could cause investment decisions to be postponed and/or canceled”.
Edward Stevenson, Economist at BMI Research, added that “the Spanish economy’s near-term economic outlook is inextricably dependent on the success of the Catalan economy” since Catalonia “accounts for around 20% of total gross domestic product in Spain.” Stephen Brown, European Economist at Capital Economics, takes a slightly more muted approach, perceiving the negative effects stemming from uncertainty as remaining largely concentrated within the region: “We don’t expect it to have significant implications for Spain as a whole. Our best guess is that the situation could cause annual Catalan GDP growth to slow by around 0.5%-pts for as long as it persists. […] This would reduce Spanish GDP growth by just 0.1%-pt.”
However, as financial institutions and corporations have already signaled their intentions to switch their activities to other parts of Spain, an important variable in determining the net impact on the Spanish economy will be the magnitude of transfers between the regions, which could have an overall bearing on the wider economy, as pointed by Angel Talavera: "In order to evaluate the net effect on the Spanish economy, it will be essential to gauge how much of this impact is softened by transfers between regions (for example, tourists swapping Catalonia for other destinations in Spain or investment projects being relocated to other areas within the country).”
Although financial markets have jolted in response to the growing uncertainty, causing Spain’s 10-year bond yield to climb immediately after the vote and the IBEX 35 Index—which comprises the 35 most liquid stocks traded on the Spanish Stock Market—to fall, the deterioration has been relatively short-lived and nowhere near as damaging as seen during the Eurozone crisis. Moreover, recent events have failed to deter the euro, which remained resilient even after the Spanish government announced its intentions to trigger Article 155. Economists at Unicredit voiced the widely-held view among investors that the crisis is a domestic affair, which is expected to be contained and unlikely to manifest into a systemic risk for the Euro Area: “The market has correctly treated it [the Catalonian crisis] as a predominantly idiosyncratic risk for Spain that would not have wider consequences for the Eurozone. Any renewed flaring up of the situation would therefore be of more concern for Spanish spread levels than for the currency, where we expect the euro to hold up well”.
While the Spanish government has recently cut its annual GDP growth forecast for the economy from 2.6% to 2.3% for 2018, citing political uncertainties in Catalonia, many analysts have held off from revising their current forecasts due to the dearth of substantive data on the impact of the turmoil. They envisage, however, downside risks to the outlook and have indicated that forecasts might be subject to downward revision in subsequent weeks. FocusEconomics panelists Oxford Economics, CEPREDE and BMI Research, among others, have refrained from revising down their current forecasts for now. Angela Talavera at Oxford Economics, states, “We want to avoid a knee-jerk reaction of cutting forecasts with such limited information available. […] But we are conscious that downside risks are increasing, so it is likely we will cut a few decimal points off our 2018 GDP forecast in the coming weeks”. Similarly, Julian Pérez Garcia, Economist at CEPREDE, explains: “As our main scenario does not include the effective independence we have not made any significant correction in our forecasts for current year and for 2018. Maybe, in coming months some downward revision for 2018 growth rate could be necessary […] but we don’t see any change higher than a couple of tenths.”
The high degree of uncertainty amid a rapidly changing political scene, coupled with limited data on how country-wide economic indicators have been affected by the political crisis, make it difficult to pinpoint changes to the outlook for the Spanish economy at this point in time, as reflected by panelists’ comments. This month’s FocusEconomics Consensus Forecast for the Spanish economy remains unchanged over last month’s forecast at 2.6% in 2018, and GDP growth is seen slowing to 2.2% in 2019.
Author: Nihad Ahmed, Economist