La República Catalana

News Comment/COMENTARI AL DIA

JP Morgan: The Catalan Challenge

JPMorgan Chase Bank N.A, London Branch
October 26, 2012
Economic Research Note

Catalan challenge asks real questions of Europe

A young boy holding an Independentist Catala flag (Senyera) smiles as Catalans gather in a bid to create a 400-kilometre (250-mile) human chain, part of a campaign for independence from Spain during Catalonia National Day, or Diada, outside the FC Barcelona's Camp Nou stadium in Barcelona, on September 11, 2013. Independence-seeking Catalans marshalled their forces today to make a human link they say will stretch across 86 cities, towns and villages along the coast of the northeastern region on the Mediterranean, passing landmarks such as the Sagrada Familia basilica in Barcelona and the city's Camp Nou football stadium. AFP PHOTO/ QUIQUE GARCIAQUIQUE GARCIA/AFP/Getty Images

• An independent Catalonia might be credible in the long
term, but major fiscal and political questions remain
• Transition costs of a move toward independence would
be high, and trigger broader worries about Spain
• Elections on November 25 2012 will likely start the move towards
an eventual referendum
• We don’t expect the issue to crystallize in the near term,
but to remain a source of uncertainty for several years
• There are larger questions: Why should Germans support
poorer Spanish regions if Catalans object?

The debate over Catalan nationalism has been played out repeatedly
since the restoration of democracy in Spain in 1978.
It has only become a broader issue of concern this year because
of the political leverage which Catalonia’s nationalist
movement has gained from the fiscal crisis. The crisis has
also limited the ability of the region to fund fiscal transfers
through debt issuance, and made the deficiencies of the Spanish
transfer system more obvious. In doing so it has made a
shift toward independence seem more attractive. These dynamics
create a politically sensitive challenge for both Spain
and the Euro area as a whole; highlighting the lack of any
consensus on the need for wealthy areas to support poorer
parts of a union – whether that union is the Spanish state, or
the EU.
For investors, there are five key questions (some of which are
beyond the scope of this note). First; is the idea of an independent
Catalonia actually credible; politically, legally, and
fiscally? Second, how seriously should markets take the current
challenge from the Catalan nationalists, and over what
time frame are the risks likely to materialize? Third, what will
the broader impacts of a move toward independence or autonomy
look like, for Catalonia, for Spain, and for the broader
Euro area? Fourth, could Catalonia’s separatist agenda materially
impact Spain’s overall fiscal position, or its possible
request for ESM-ECB support? Finally, what are the chances
of broader separatist pressures emerging in other wealthy European
regions? These questions are set to remain center-stage
with forthcoming regional elections on November 25, which
will test the degree of popular support for the Catalan government’s
push toward greater autonomy. We think many of
the issues around independence (or autonomy) will remain
unaddressed for some years to come; investors should expect
continued low-level uncertainty – a referendum may not, in
practice, come until late 2014 or beyond.

An unstable equilibrium
Regionalism in Spain has a long history; part of the response
to the centralism of the Franco years was to embed a strong
degree of regional autonomy after the restoration of democracy
in 1978. The fiscal aspect of this settlement left revenueraising
largely subject to central control, with expenditures on
most social programs primarily deferred to the regions. This
has led to both fiscal and political distortions and satisfied no
one. It has been difficult for the central government to control
total public expenditure when the regions account for more
than 38% of government spending, and historically have had
little, if any, political incentive to deliver fiscal restraint. For
many of the regions themselves, the lack of an effective revenue-
raising capacity, and the need (in many cases) to make
net fiscal transfers to Madrid, has been a source of tension.
The problem of Spain’s fiscal structures is particularly sensitive
when viewed from a Catalan perspective— the region is
among Spain’s wealthiest (with 16% of the population, contributing
18.6% of GDP in 2009), and makes net fiscal transfers
to the central government in the range of 7%-8% of regional
product (outside recession periods). Catalonia has been
attempting to secure a “better deal” from the central government
for decades, and agreed a regional statute in 2006 that
would have balanced fiscal transfers and regional spending.

The measure was ultimately struck down by the Constitutional
Court, after a request by the Partido Popular (Prime Minister
Rajoy’ party) to review the measures.
Spain’ fiscal design problem is made more complex by the
fact that the regions making the largest total net fiscal transfers,
including Catalonia and Valencia, are also the most indebted,
and have historically issued debt heavily in order to
meet growing regional shortfalls. The fiscal crisis has limited
their ability to cover obligations to the central government
through debt issuance, and has forced consolidation. Both
regions (as well as other wealthy areas such as the Balearics)
have recently needed to access support from the central government’
regional aid fund, the FLA. This has been politically
sensitive; nationalists argue that they are effectively being
bailed out with their own money (though there are reasons to
be skeptical about this view).
Whatever the rights and wrongs of Catalonia’ position, it is
clear that the current division of fiscal responsibilities is unsustainable
politically (this has been becoming increasingly
obvious for some time). The proposed solutions have been
very different, however, with the central government now
seeking to reassert centralized control of fiscal matters across
Spain (notably with the implementation of the Budget Stability
Law earlier this year), while many of the regions pull the
other way. For Catalonia in particular, the solution has always
been about securing more fiscal autonomy, not less.
Autonomy and independence are very different things, but
even support for full independence has been rising, to a little
over 53% this month according to the latest polls (rising further
to 62% if EU membership can somehow be “assured”for
an independent Catalonia). We think these polls may be unreliable
(the 53% figure comes from a single source, Catalan
newspaper La Vanguardia), and they have shown support for
independence above 50% only since late September. We
doubt whether a majority would really favor independence in
a referendum at this stage, but the polling numbers are certainly
trending in a direction that is worrying for Spain. More
importantly, there is clearly a widespread call for renegotiating
the terms of Catalonia’ relationship with the Spanish
state. A survey at the beginning of this month found that
74.1% of Catalans were in favor of holding a referendum on
the issue of precisely what their relationship with the rest of
Spain should look like.

Getting ready to ask the question
The Catalan government, led by separatist party
Convergencia i Unio (CiU), is in favor of moving to a position
where Catalonia holds the “levers of a state,”although it
has yet to specifically call for full independence. Catalan
President Mas has already given notice that he will treat support
for CiU on November 25 as a mandate to begin negotiations
with the central government on holding some form of
plebiscite during the Catalan parliament’ next term (within
the next four years). The latest polling suggests that the CiU
will increase its share of seats in the Catalan Parliament and
gain the mandate that Mas seeks. Nonetheless, our sense is
that the CiU is likely to want a vote to be held closer to the
end of the next Parliament’ term than to the beginning. There
are several reasons for this. First; expressed support for independence
still hasn’ passed the 50% mark for a sustained
period, and he can only be confident of a result once it is sustainably
at 55%-60% or above. Second; if Catalonia were to
become independent in the near term, it would have to take
responsibility for an ongoing economic crisis. It would be far
more advantageous for the region to achieve independence in
more benign economic circumstances. Finally, even without
CiU’ own political preferences, we expect the functional
issues around agreeing and preparing a referendum vote could
take some years. Investors should therefore expect the issue to
be crystallized around the end of 2014 at the earliest, and to
remain a source of uncertainty until then.

A legal and political maze
The quest for independence, or autonomy, is likely to run into
severe political and legal difficulties. There are substantive
doubts about whether a referendum is even possible. The
Spanish Constitution of 1978 does not permit regional referenda;
under the Constitution as it stands, there is no way that
Catalan voters could even be asked about their views on
greater fiscal autonomy, let alone independence. In practice,
the constitution could be changed; the Spanish government
has recently amended it to introduce the budget rules implied
in the European Fiscal Pact, which was instituted through the
use of a constitutional amendment. President Mas will have a
strong political case for securing a referendum if CiU performs
well in November; if Madrid hides behind constitutional
objections we expect this simply to lead to an escalation of
pro-independence sentiment in Catalonia (although we do not
discount the possibility of the Rajoy government handling
things poorly).
A more substantive issue surrounds the legal questions over
Catalonia’ role within the EU (and EMU). Were Catalonia
ever to achieve independence it would likely need to reapply
for membership of both the Euro area and the European Union
as a whole (the Catalan government has indicated that it
would wish to be a member of both). The process of applying
for membership, under Article 49 of the European Treaty
(TEU), could present significant difficulties. An application
would take considerable time, even under the most benign
scenarios, and impose significant transition costs. Comments
from European Justice Commissioner Reding over the past
few weeks do suggest however that the EU institutions would
be ready to take a constructive attitude toward a Catalan
membership application (there is some possibility that the EU
might allow the ground-work for an application to be laid
before formal independence is secured if this were the route
the region takes).
The larger political uncertainty is the way in which Catalan
voters would move in any plebiscite. We expect the referendum
question to ultimately be about extensive autonomy rather
than independence, and think that polling data point
strongly in the direction of a “yes”vote. If however the region
does move more clearly in the direction of full independence,
there are slight risks around the margin of a negative reaction
from other political forces within Spain having spillover effects.
Elements of the Spanish military have hinted that they
could intervene in the case of Catalan independence but we
think a violent reaction is very unlikely (at least on a widespread
basis). Although we expect Catalonia to have a difficult
ride, we do think that the political and legal impediments
to independence or greater autonomy are surmountable with
time, providing that a significant majority within the region
wants to move in that direction.

Fiscally credible (just about)
A second core question underpinning this debate is whether
an independent, or quasi-independent, Catalonia could be
fiscally credible. This question is highly politicized, but it is
possible to get a sense of the financial benefits and costs associated
with a move toward independence. Back in 2009, the
Spanish government approved a new financing system for
autonomous regions. This change gave more fiscal autonomy
to the regions as the central government conceded ground on
collecting a number of taxes (or at least a proportion of such
taxes). In return, the autonomous regions are now receiving
fewer transfers from the central government. But this complex
system remains one where the provision of public services
and economic convergence in poorer regions are partly financed
by richer regions.
One way to look into this issue is to use regional fiscal balances
data that attempt to provide regional net contributions
to the Spanish budget. In 2005, the latest year for which data
are available across regions, these figures showed that Catalonia
transferred 8.7% of its own GDP to the central government.
This compares with values of 6.3% and 5.6% for regions
like Valencia and Madrid, respectively. The 2005 data
thus show that Catalonia is effectively one of the largest regional
contributors to the central budget. From this angle, a
move toward independence would be beneficial. On the
methodological side, however, the calculation of such fiscal
balances suffers from well-known issues: corporate taxes are
paid in regions where headquarters are located, although activities
may be located elsewhere, and VAT is levied where
consumption occurs. Catalonia is a region that both attracts
headquarters (Barcelona is the sixth most populous urban area
in the European Union) and consumption (via tourism). It is
not clear how much these effects actually distort Catalonia’
fiscal balance, but there is little doubt that the bias is negative,
thus showing larger net transfers to the central government.
An important additional point is that debt issuance can be
done at a lower cost to the extent that Catalonia is part of
Spain. An independent entity would face an uncertain founding
environment.
The cost associated with a move toward independence would
also be substantial as the central government provides public
services that would need to be covered by Catalonia. These
services include areas such as administration, defense, or domestic
security, to mention a few. We thus looked at the
Spanish central government budget to get a sense of the costs
associated with Catalonia and we specifically used the 2005
data to make comparisons with the available fiscal balances
data possible. In 2005, the Spanish government spent €133.2
billion in public services for the entire economy. As 16% of
the population lived in Catalonia at the time, a starting point
in our analysis could assume that a proportional share of the
government spending was allocated to this region, or €21.5
billion. But one needs to keep in mind that government spending
would not be proportional, as infrastructure or social security
needs may differ, while the policy choices about what an
independent Catalonia may choose to spend on, for example,
defense or environment, are very unclear at this stage. We
assumed that administration expenses would not be fully duplicated,
as the existing Catalan administrative capacity could
probably take the burden of a significant proportion of the
costs of governing an independent state. If we assume that
only half of such a cost would be supported by Catalonia, the
amount required would reach 5.8% of GDP.
To the extent that the fiscal balance numbers can be trusted
and that our assumptions about independence costs are correct,
it looks like a Catalonian state-like transition is a plausible
fiscal option, but the financial benefits of independence
may not be large (likely 3% at most under a benign scenario).
This also assumes that transition costs are minimal, and that
there is no significant disruption to trade with the rest of
Spain.

Autonomy is the most likely outcome
Given the scope of the political, legal and fiscal difficulties
ahead of it, we think the path ahead for Catalonia is more likely
to see a shift toward greater fiscal autonomy rather than full
independence—ut the fact that the independence option appears
credible (if not necessarily attractive) will increase the
likelihood of the region securing strong autonomy arrangements.
It is unclear what these will look like in practice, although
we expect an extended version of the 2006 regional
statute to form a starting point for discussions –if a referendum
does ultimately provide a clear negotiating mandate.
Other regions, Navarre and the Basque country, have negotiated
a separate model that limits net fiscal transfers to Madrid,
and we expect Catalonia to move toward a similar model,
potentially with other political powers attached.

Long-term implications
We think there is real chance that Catalonia will secure significant
changes to its relationship with Spain; if correct, this
would have major implications. Should Catalonia be able to
renegotiate the terms of its relationship with the centre in a
way which limits fiscal transfers this would have an impact on
the Spanish central government’ fiscal path. It would also set
a further precedent, which would have an impact on Madrid’
ability to control the other 16 regions, the wealthier of which
may also be encouraged to request greater fiscal freedoms.
This would pile further pressure on the sovereign if, as is likely,
it is the transferring regions which choose to renegotiate
the terms of their relationship with the centre. More broadly,
this opens a larger political question for the Euro area as a
whole; namely that if Catalonia is unprepared to subsidize
Spain’ poorer regions, why should Germany or other countries
of the European north? This is the same question that
IMF members (e.g., China) ask of the Euro area as a whole in
its management of the crisis. We expect this question –of the
political mandate for transfers – will ultimately need to be
tested in referenda across other parts of the Euro area; Catalonia
could simply be leading the way.

23 August 2015 - Posted by | Economy/Economia, Politics/Política

1 Comment »

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