Spain and Catalonia’s ratings depend on resolving the political impasse

Spain-Catalonia

Alvise Lennkh (Scope Ratings) | The imprisonment of the Catalan separatist leaders has exacerbated regional tensions, with potentially profound political consequences, although the short term economic impact of the latest separatist protests will be limited.

We think that the tension around Catalonia´s political future is relevant when evaluating the credit outlook for Spain (A-/Stable) because of its impact on national politics, most immediately on the formation of a new government following the 10 November elections. After the previous elections Pedro Sanchez secured neither a majority nor a viable coalition, in part due to the complex interaction between the desires for Catalan independence and national politics.

The main risk of the situation is Catalunya is a greater polarisation between the secessionist movement and the rest of Spain, and an ever greater fragmentation of the political parties. In comparison with the previous six months, this could make even more difficult the compromise and collaboration among politicians necessary to form the next government in Spain.

Catalonia experience nine consecutive nights of protests at the beginning of the month – which seriously affected the transport and production of some materials – after the Supreme Court condemned nine separatist leaders for sedition for leading the failed bid for independence in 2017. But, for now, the economic impact of these latest protests seems limited, given that the much larger protests in October 2017 only cost the Spanish economy around 0.2% of GDP.

Neither the left wing or right wing block are expected to secure a parliamentary majority after the November elections. This means that the divisive Catalan issue is likely to make the formation of a new government in Spain, and the formulation and implementation of policies relevant to a credit rating, even harder.

Spain´s rating has remained limited to the current “A-“ precisely because a stable government has not emerged, which is inclined to launch reforms to confront the remaining economic vulnerabilities, including the fiscal imbalances, labour market rigidity and the relatively low productivity. The absence of reforms is now even more critical when economic growth is slowing throughout Europe.

Spain´s fiscal policy is a good example: while Spain has emerged from the European Commission´s excessive deficit procedure last year, with a deficit of 2.5%, and is expected to reduce it further to about 2.3% of GDP this year, the fiscal outlook, especially in structural terms, are worrying, as the Commission´s response to Spain´s budget plan shows. Without new measures, the improvement foreseen in the structural balance of 0.1% of GDP is less than the recommended structural adjustment of 0.65%. In addition, the authorities forecast a nominal increase in the net rate of primary public spending of 3.8%, far higher than the maximum increase recommended by the EC of 0.9%.

A second consequence of the unresolved question of Catalonia´s autonomy is how to negotiate a greater decentralisation, including greater fiscal and/or political autonomy. Given the implications for Spain and the other regions, we expect this negotiation to be carried out for the Spanish state as a whole and not just for Catalonia. However, in the absence of a government, this important reform has been postponed. The recommendations presented in July 2017 by the committee of experts tasked with promoting a reform of the regional financing system has still not been implemented.

This negotiation is also relevant to the financial situation in Catalonia. Even if the regions has a rich and diversified economy and improved public finances, its credit solvency depends on a mature fiscal institutional framework highly integrated in Spain: a liquidity support mechanism conditional on the level of the system as a whole which offers favourable financing from the central government and legally enforceable debt limits for regional governments.

Any change in the institutional framework which resulted in less support from the central government would be negative for Catalonia´s financing, given the regional government´s elevated of public debt, 80% of which is in the hands of the central government. In the same way, a prolonged political impasse at national level which prevented the economic and fiscal reforms would have a negative impact on the ratings of both Spain and Catalonia.