Euro Area Risk: Catalonia's Secession Fight Is Not Contained

November 16, 2015 5:30 PM

If only what happened in Catalonia stayed in Catalonia. A fumbled process of updating the Catalan Statute of Independence, started a decade ago, has evolved into what could become a serious constitutional crisis in Spain, with unpredictable consequences. With the financial crisis inflicting politically costly spending cuts on the Catalan government, its president, Artur Mas, went for the tried-and-true strategy of inventing a foreign enemy to deflect attention. Unfortunately, he has been too successful with his public campaign of presenting Spain as an "oppressor," no matter how untrue or misleading most of his arguments may be (see my discussion of the economic arguments and consequences of independence). The passivity of the Spanish government, and its interest in keeping the conflict open for short-term electoral reasons, has added fuel to the fire.

The reality is that the political conflict in Catalonia is worsening. The September 27 regional elections delivered a narrow victory (in seats, although not in the popular vote) for the pro-independence platform, and now this majority has set out to implement the unilateral independence plan they had campaigned on. Thus the Catalan parliament approved on Monday the Unilateral Declaration of Independence (UDI) filed by the pro-independence majority, including a call for "disconnection" from Spanish institutions and laws. In a swift response, Spain's Constitutional Court allowed on Tuesday the appeal filed by the Spanish government against the UDI. The Constitutional Court will deliver a final verdict within five months, and it is likely to declare the UDI anticonstitutional.

In the interim, the UDI is effectively suspended under Spanish law. Furthermore, the Constitutional Court has explicitly notified 21 Catalan officials that a failure to comply with the suspension will trigger legal consequences. If the Catalan authorities disregard the decision by the Constitutional Court, the government, through parliamentary approval, could resort to applying Article 155 of the constitution and consider different degrees of response in terms of suspending the autonomy.

The pro-independence majority's inability to agree on forming a new Catalan government only adds to the confusion over Catalonia's future. The current president, Artur Mas, has been rejected as a candidate so far by the radical left faction of the coalition. To gain support Mas has proposed to dilute his presidency by appointing three vice presidents with a wide range of powers and submit himself to a confidence vote within 10 months, but with no success. This delay to form a government will also set back implementing the legislation associated with the UDI, which includes creating key institutions of a future Catalan Republic, like a revenue agency. The deadline to appoint a new president of Catalonia is January 9, 2016; failure to elect someone by that date would trigger a new regional election.

These actions have apparently taken many commentators, who did not take the independence threat seriously, by surprise. But these steps were clearly described in the election campaign, and therefore to be expected.

Overall, the risks of a protracted escalation of the conflict remain elevated and are further complicated by Spain's general elections on December 20. The four main parties running in that vote have presented different strategies to deal with the Catalan problem, ranging from various versions of constitutional reform to facilitating an independence referendum. Therefore, even in the best case scenario of no further escalation of the conflict, there will be no clarity until January on the contours of a potential negotiated solution.

The economic consequences of a prolonged conflict could be dire. As argued earlier, history shows that an independence process, even if negotiated, generates high levels of uncertainty and can seriously damage growth. Even in the best case scenarios, transition costs generate a lost decade of economic expansion. The current conflict makes the potential economic costs even higher, not just for Catalonia but also for Spain. Bank deposits were quietly being shifted outside Catalonia in the run up to the September 27 elections, and firms have started to leave the region. The recent unilateral moves will only exacerbate this process. To wit, markets are starting again to reflect this uncertainty. For example, the spread between Italian and Spanish 10-year bond rates has widened again towards the levels seen prior to the September 27 Catalan election, signaling a renewed increase in the risk of holding Spanish bonds relative to Italian bonds.

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