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Puigdemont leads Catalonia out

Discussion and Analysis by Grace Gliksten:

 

This article discusses the implications of Catalonia’s independence referendum over the weekend. Following a period of considerable Euro strength, the political uncertainty threatens to halt its gains and shroud the Eurozone economy within doubt.

 

Falling somewhere between a centrist and a social democrat, Carles Puigdemont started his political career relatively late. He was elected a member of the opposition at Girona City Hall in 2007, followed four years later by his promotion to elected mayor. In 2016, Puigdemont won a vote of confidence in the Catalan Parliament to be named the new President. Born in 1962, Puigdemont worked as a journalist, having dropped out of University. Puigdemont began his political career in the 1980s, founding the Girona district of Juventut Nacionalista de Catalunya.

 

Puigdemont has been fighting to establish an independent Catalonian state since he took office in January 2016, calling the referendum in June. The second manifestation of this dream gripped markets early this week, damaging Spanish equities and bonds with a mild spill-over into the Eurozone. A fanatic about Catalonian independence; he told Al Jazeera that the wish of Catalans to execute the forbidden referendum “is unstoppable”.

 

Over the last six years he has been involved in organised demonstrations, and was a protagonist in the last referendum for Catalonian independence, in 2014. Although there was an 80% vote in favour of independence in 2014, the turnout was a meagre 37%. Whilst the most recent referendum has been more decisive in terms of turnout and result, it still paints a picture of uncertainty about the true will of the electorate.

 

The character and background of Puigdemont individually may prove critical to markets in the next 24 hours. Should the President of Catalonia declare independence following this controversial referendum, the uncertainty effect derived from an area accounting for around 20% of Spanish GDP becoming independent could be catastrophic. It would draw in concerns of fiscal sustainability, both with respect to Spain and Catalonia. Although less salient, the budgetary contributions and fiscal burden sharing within the Union would be upset.

 

Puigdemont’s involvement in the most recent referendum has not come without risk; Spain’s chief public prosecutor has even refused to rule out ordering the arrest of Catalonia’s president, adding Puigdemont could be charged with civil disobedience and misuse of public funds. Pushing two illegal and non-binding referendums in three years shows a level of desperation by the Catalan government’s fight for independence. Turnout was only 42%, which although roughly 5% up from the referendum three years prior, does in fact indicate that the results do not represent the true desires of the electorate.

 

Given Puigdemont’s involvement in organised demonstrations, the first, failed, Catalonian referendum and antagonising comments, we might expect his fanaticism regarding independence to guide his political actions. The political power to invoke an independence claim lies with the President. Ultimately, therefore, we may expect his individual motivations to exploit what is a weak, contentious and unconvincing mandate to achieve independence from Spain. While the idiosyncrasies of this weekend’s referendum may be considered by some to mitigate against the illegality of the referendum and mandate generated therein, Puigdemont represents a considerable political risk in himself.

 

Whether the reasons people did not come out to vote were down to the fear surrounding the harsh response from the Spanish police or the illegitimate feeling projected by the Spanish government, it is not clear. The Catalan Government are suggesting that 770,000 votes were lost as a result of police crackdowns, however taking this figure into account only pushes the turnout to just over 50%. It can still be argued that only 37.36% of the overall electorate voted for independence, which again further illustrates the illegitimacy of the independence result. According to a June poll, support for an autonomous Catalan state has fallen from 44.3% in March to 41.1%.

 

Without a true and legal referendum, the views of the people will not be truly understood. What is clear is that Spain’s complicated relationship with Catalonia is headed towards the unknown. The harsh police response, coupled with the threats of suspending Catalan autonomy if the decision did come through, can be interpreted as a deep-rooted fear by the Spanish government in the people of Catalonia voting to become independent from Spain. However, this could also be a situation of a politician representing their own ideals instead of the electorate as a whole. Puigdemont’s humble and local beginnings can be used to understand his strong belief in an independent Catalonia, however can also show his inability to understand the real attitudes of the electorate.

 

Ultimately, the progression of the Catalonian independence referendum reinstalls political risk at the heart of the Spanish nation, European Union and Eurozone. Should Puigdemont capitalise upon the success which he attests to, considerable political and social fall out, within and without the region, should be expected. Ultimately, this develops investors’ unwillingness to operate within the single currency, particularly the Spanish economy. Identifying whether the resilience and capacity for risk sharing embedded within the Eurozone is sufficient to annul or insulate this crisis from the wider macroeconomy will be a critical when evaluating the impact of Catalonia’s referendum.

 

Catalonia and the Euro:

Discussion and Analysis by Charles Porter:

 

It is indisputable that this weekend’s referendum in Catalonia generates considerable headline risk within Europe. The instability, uncertainty, and political risk within the Spanish economy has reflected within nationally sensitive equities and indicators. However, the purchasing power of the Euro, its exchange rate vis-à-vis other currencies, appears to be largely unaffected. The question of whether this relates to a systemic insulation of the Euro, or pure insignificance of the referendum, has a particular importance to those exposed in the Euro.

 

Opening down against the Pound and the US Dollar, the Catalonian independence referendum might have been supposed to undermine Eurozone solidarity. After all, should the independence of the region be declared, at least the form of the future Spanish and potential Catalonian membership with the Union and single currency should be questioned. However, the significance of the difference before and after this weekend’s referendum was only marginal. Interestingly, the weakness within the Euro against the Pound Sterling has been reversed throughout the morning, up to 10:00 BST.

 

The result attested to following the controversial referendum generates a considerable mandate for the region’s independence. The threat of a high-productivity and nationally significant region declaring formal independence from Spain creates uncertainty both within the nation and within the region. The uncertainty should be supposed to deter investors from both the region and the nation whilst the taxation revenue and spending distribution is re-evaluated and the future legal political framework of the independent region understood.

 

This uncertainty has been reflected within Spanish markets. Notably, yields within 10-year Spanish Government bonds has increased by nearly 5% since the close of markets on Friday. The yield on bonds and general debt reflects the inverse of the price of the bond. The yield is the effective return that the bond will pay to the investor and holder of the contract, qualified by its face value. It is clear, therefore, that if the return on a bond increases, it must reflect the risk of holding the contract; the risk of no repayment. Therefore, the increase in the yield of Spanish Government bonds is telling of the political uncertainty and credit-worthiness that the referendum has installed.

 

The spill over from the referendum was not contained within the sovereign debt market. Spanish equities, particularly banking stocks, were hit by the weekend’s events. The violence and reported atmosphere within Catalonia this weekend should be considered as a strong and concerning phenomenon that has exacerbated the scare within financial markets. Overall, the impact of the referendum has damaged the value surrounding the Spanish economy.

 

So, why has the Euro not been hit that hard?

 

Well it is possible that the exchange rate priced in the political risk of the foreseen referendum better than the bond market has. However, this is highly implausible given the transparency and comparability of the free markets of bonds and flexible exchange rates, not to mention their entwinement. Therefore, instead, I suggest that the solidarity within the single currency insulates the single currency from the idiosyncrasies of national concerns.

 

Naturally, a union of 19 national currencies should not be as responsive as a national currency to an upside or downside event affecting only one nation. Sharing a currency shares exchange rate risk, de facto, without explicit design; a currency union is effectively a fixed exchange rate. Therefore, because the Catalonian risk is unlikely to transmit across borders, at least in the medium run, the deserved foreign purchasing parity of the other 18 economies should, ceteris paribus, be intact. Ultimately, currencies are a conduit for which to facilitate international trade, mobility and engagement. As such they are an excellent indicator of the integrity and strength of an economy. Therefore, the risk that the Catalonian referendum generates is mediated and diversified across the other 18 nations, thereby preserving the value of the Euro.

 

For the risk averse individual purchasing international currencies, this suggests that the volatility of the Euro to political agendas should be limited. It could be thought, and has been proven to be so, that the US Dollar contains a similar stability and value. This is why these currencies are used, or increasingly used, as reserve currencies; conduits and mediums to preserve wealth as well as facilitate trade. For those seeking exchange rate upside and downside risk, the Euro and Dollar may be unsatisfactory currencies.