Spain’s troubles will not derail Eurozone growth

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Political risk stalks the Eurozone. The imposition of budget rules from the centre makes domestic politics in many of the zone’s countries difficult. Many of the countries have proportional systems which make majority governments a bit less likely anyway. The unpopularity of austerity policies to comply with Eurozone budget rules has aided in many countries in the zone the decline of the two traditional parties of centre left and centre right which used in most places to alternate in office. At its most marked in Greece, Spain too has suffered in recent years from a bad case of this political malady. Latest Italian opinion polls show the same trend.

For five years running the Spanish government has been unable to deliver sufficient tax rises and spending cuts to hit the EU budget targets. Frustration with the economic policies pursued along with other matters has led to a sharp decline in the voting shares of the Popular party, centre right, and the Socialist party, centre left. The 2015 election produced a Parliament unable to form a government out of any potential groupings of parties. The King in desperation dissolved it and called a new election in the summer of 2016. The Popular party did a bit better, gaining one third of the votes and seats. The socialist party fell to 22% and refused to join a grand coalition to ensure a majority in Parliament. The alternative left coalition also could not command a majority.

Eventually in October 2016, Mr Rajoy, the leader of the Popular party, managed to carry a vote to make him Prime Minister, with the socialist party abstaining. He had been elected on a ticket of no tax rises, but had immediately to propose some tax rises to comply with EU deficit targets. The 2018 budget processes have been delayed over the Catalan referendum, as the Basque Nationalists whose support Mr Rajoy may need are not happy with how that is being handled. His party was also damaged by a series of corruption allegations and official enquiries over party funding and public sector contracts. Allegations were also made about the tactics used to discredit and suppress the Catalan nationalists by the Interior Minister following the discovery of a tape of some conversations. Because Mr Rajoy leads a minority government he is always having to broker deals with other parties.

As if the rise of the challenger parties, Podemos and Cuidadanos were not enough of a problem for stable government, Spain is also troubled by independence movements in Catalonia and the Basque country that wish to break away from Spain. The Basques have two independence parties who hold 7 seats between them in the national Parliament. There are also two Catalan nationalist parties, who have 17 seats. After years of inconsequential talks about holding an official referendum on Catalonia’s future the Catalan government decided to hold a referendum knowing it was not authorised by the Spanish state. Mr Rajoy reacted angrily and sought to use the forces of the national government to prevent the vote taking place, arguing the legal case that such a referendum could only be authorised nationally. This decision resulted in bad scenes as national police sought to stop people voting , tried to close polling stations and sought to arrest ballot boxes. There were pictures of Catalan firemen fighting Spanish police. The very question of legitimacy of government hangs in the balance, with some Catalans looking to the regional government to enforce the law and make the decisions with others respecting the rights of the Spanish state.

This crisis has the potential to get worse as passions are now inflamed on both sides

Mr Rajoy could now talk to the Catalan government and seek by discussion to head off any attempt to declare independence. He could escalate the conflict further, by invoking Article 155 of the constitution and taking over government functions in Catalonia to seek to deny the Catalan government further use of the powers of their government. He could intensify the use of national police to try to take control. Both options are fraught with extra risk for him now he has antagonised more Catalan voters by his conduct so far. Mr Rajoy does speak for many of the MPs from other parts of Spain, and will seek to unite as many parties as possible behind his chosen action. Catalonia is a rich region, accounting for around one fifth of the Spanish economy but receiving a considerably smaller share of total public spending. That is why most of the rest of Spain is very keen to keep the Catalans in as important contributors to Spanish finances.

This crisis has the potential to get worse as passions are now inflamed on both sides. We do not think it will damage the Eurozone as a whole, and think it unlikely to end with Catalan independence. The EU would face difficult choices if Catalonia did leave Spain in a way the Spanish state regarded as illegal. So far the EU has backed the Spanish government. Whilst the Catalan economy is important to Spain, it is not significant to the Eurozone as a whole. The EU would have time to consider whether Catalonia leaving Spain automatically meant leaving the Eurozone, and how that would be enforced if the Catalan government decided as they say they would to carry on using the Euro. Either way it is not the same kind of threat to the zone as we saw with the French election or will see with the Italian election, where the continued membership of a much larger economy in the zone is in question.

 


The above article was first published by Charles Stanley on 3rd October 2017