When last we checked in on Spain, the country was struggling to make sense of largely inconclusive elections held in late December.
Mariano Rajoy’s PP managed to secure the most seats in parliament, but when the electoral smoke cleared it was apparent that Spanish voters were no longer content with the political status quo.
The combined vote share of PP and PSOE sank to its lowest level since the eighties as Podemos and Citizens capitalized on widespread disaffection with Rajoy’s handling of the economy (among other things) to capture 69 and 40 seats respectively. Here’s a look at the official results:
Fast forward one month and the country is struggling to form a government.
On Friday, Rajoy delayed a confidence vote saying he didn’t have “the support that is needed” to move ahead after Socialist leader Pedro Sanchez indicated PSOE would seek to form a “progressive” government with Pablo Iglesias’ Podemos, which many equate with Syriza in Greece. “We made a serious offer for a government and Rajoy has taken a step back,” Iglesias said last week. “Change is possible [and] I hope the socialists will rise to the challenge,” he added.
As Reuters notes, “the Spanish constitution sets no deadline for a prime ministerial investiture vote to take place, but once a candidate seeks the confidence of parliament a two-month deadline for the formation of a government comes into effect.” If a government isn’t in place within two months, new national elections are held.
“An early election in the short or medium term seems the most likely outcome,” Deutsche Bank said, the day after last month’s vote.
Whether or not PSOE will ultimately be willing to align with Podemos remains to be seen, but if the coalition does indeed come to fruition, it would be bad news for Berlin and the eurocrats in Brussels. A leftist government would move quickly to roll back austerity (or “fauxsterity” as we call it, given that the country’s debt-to-GDP has actually risen since the debt crisis) and adopt fiscal policies that bear little resemblance to what Wolfgang Schaueble would consider prudent.
In other words: what happened in Portugal is about to happen in Spain. Brussels’ preferred PM is about to be ousted by a coalition of leftist parties, and that, in turn, suggests that the idea of fiscal retrenchment will be thrown out, along with anything that even looks like austerity. That could trigger a showdown between Madrid and Brussels over Spain’s intention to adhere to EU deficit targets. The threat of Catalonia moving ahead with an independence bid only complicates things, as secession would add some 25 percentage points to Spain’s debt-to-GDP ratio (as a reminder, Podemos would vote to allow a secession referendum to move forward).
Below, find some commentary from various sellside desks on where things are headed in Spain and what it means for markets.
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From Barclays
Following a round of meetings with the King of Spain, the leader of the Podemos party, Pablo Iglesias (radical left), has made a formal offer to the PSOE party (centre-left) to form a left-coalition government. Iglesias delivered the message to the King, who in turn informed the leader of PSOE. Both parties together have a total of 159 votes (90+69 respectively). It is likely, we believe, that the conservative nationalist Basque party, PNV, which has six MPs, and the radical left IU with two MPs would also join the coalition, taking the total to 167 MPs. This would still leave the coalition needing nine MPs to achieve an absolute majority in the 350-seat parliament. Therefore, it would need some MPs from other parties to abstain in the parliamentary vote.
We don't rule out other parties, such as PP and Ciudadanos, submitting proposals in the coming days, so a PSOE-Podemos led government is not a certainty. We are still of the view that a coalition government is more likely than holding new general elections in Q2 16.
A PSOE-Podemos coalition: a mild negative for markets
We think that a PSOE-Podemos outcome would be a mild negative for markets for two main reasons. First, it would be a minority government, unlikely to find much support from the other groups. Second, in the past Podemos has put forward a series of reforms that would entail rolling back various reforms enacted by the previous government. While PSOE will limit the potential tail risks on the policy side, depending on the final outcome of the policy agenda agreed between PSOE and Podemos and the negotiations with nationalist parties, there could be some risks of non-growth-friendly policy changes.
Overall, as the left-coalition would lack an absolute majority, we think that the scope for any material policy change that does not have wide parliamentary support is very limited. Therefore, we strongly believe that the downside policy risks are limited. As Spain has experienced four years of important reforms, mainly the restructuring of the banking system, a new fiscal compact to control regional deficits and some notable labour market reforms, we would caution against an overly gloomy outlook for Spain. Nonetheless, the political uncertainty and the presence of some radical left members in a government would justify comparatively wider sovereign spreads, for example, versus Italy.
Next steps:
1) The King will continue to hold discussions with the parties to hear which ones will offer some likelihood of a parliamentary approval vote. There is no specific deadline for these talks, even if it is in the interest of all involved parties to minimise the period of uncertainty. We think PP will get the first chance to form a government. After the King’s approval, PP will need to submit its government proposal to a parliamentary vote. From the time of this vote, the parliament has up to two months to nominate a government. Failure to do so would automatically lead to elections in Q2 16.
2) If PP does not secure an absolute majority of MPs in the parliamentary vote (ie, at least 176 votes), which appears most likely, in our opinion, then two days later there would be a second vote in which a simple majority would suffice for PP to form a government.
3) If PP fails to win sufficient support, the King would need to decide which party gets the mandate to try to form government. The would most likely be PSOE, the second most-voted party. PSOE will need to follow a similar procedure to the one described above for PP.
4) If this process, which can last up to two months after the first vote, does not result in a government being nominated, it would mean new general elections eight weeks later in April/May 2016.
From Citi
The socialist PSOE remains the kingmaker for any possible government in Spain, following the inconclusive December 20 elections. By declining the King's appointment, we reckon Mr. Rajoy may have tried to gain some time for finding potential support from the socialists. Rajoy’s move shifts the focus to the socialist leader Sánchez, who now has to prove his ability to assemble an alternative and credible government coalition. We believe that failure to secure such a left-wing alliance is likely to eventually push PSOE to allow a PP-led minority administration. According to Spain’s Constitution, a new round of elections would take place if no candidate is elected in Congress after two months of the first parliamentary vote to elect a PM.
We reckon at the margin, Iglesias’ comments make a left-wing alliance more likely, although by no means certain. To secure such a left-wing alliance, Mr. Sánchez would not only need support from both Podemos and United Left (jointly adding to 161 seats, i.e. 15 seats short of an absolute majority), but also a commitment from other regional parties (including the Basque and Catalan pro-independence parties) to at least abstain in the parliamentary vote to form a government. Furthermore, Mr. Sánchez would also need to tame tensions from regional factions within his own party who oppose joining forces with the far-left Podemos. In our view, A left-wing PSOE/Podemos/IU government would probably represent a significant shift in Spain’s fiscal policy towards more loosening, with Podemos calling for an end to fiscal austerity and no particular commitment to the Stability and Growth Pact targets.
According to a poll by Metroscopia for daily El Pais, 49% of respondents would prefer a broad government coalition between PP, PSOE, and C’s, while 36% would prefer a left-wing alliance between PSOE, Podemos, IU, and other regional parties. A separate poll conducted by GAD3showed that the centre-right PP would obtained 30.1% of support if new elections take place today, up from 28.7% in the December 20 elections, and accounting for 131 MPs (vs. 123 MPs currently). Support for the socialist PSOE would fall to 21.3% (projected at 89 MPs) from 22.0% in December 20 (90 MPs), for Podemos 20.0% (65 MPs) from 20.7% (69 MPs), and for Citizens 13.4% (38 MPs) from 13.9% (40 MPs). Separately, the EU Commission is due to publish a report on Spain in February warning over the rising risks on confidence levels from the ongoing political instability, daily El Pais reports citing unidentified sources.
From JP Morgan
At first blush, these developments seem to increase significantly the likelihood of a left government. If it transpires, this would be important for Spain. A left government would aim to reverse some of the fiscal consolidation and structural reforms implemented in recent years. This will likely lead to a conflict with the European Commission. The macro consequences are hard to gauge, but uncertainty and conflict are likely to weigh on economic performance.
At this stage, it is likely that the King will ask PSOE leader Sanchez to try to form a new government. And the most touted option is exactly a left coalition with Podemos. Podemos may be willing to drop the demand for a Catalan referendum, which is a red line for PSOE. But a PSOE-Podemos coalition would still need the support of the Basque and Catalan nationalist parties. While this would not be easy to achieve, it is possible and would likely have dire consequences in terms of governability (for details see below). However, we note that the opening from Iglesias should be primarily read as a tactical move to put pressure on PSOE, implicitly making it responsible for any failure to clinch a deal leading to a left government. The reaction from PSOE – which has rebuked Iglesias’ words as an unacceptable ultimatum – confirms this interpretation.
If the constraints surrounding a left government prove unsurmountable, PSOE leader Sanchez may try to form a moderate coalition with Ciudadanos (which in turn would hinge on PP abstention). Failing both options, a last resort alternative would be a centrist platform – i.e. a PP government in cooperation with Ciudadanos and with abstention from PSOE.
In our view, though, the chances of a new election have now risen as well. This is because the political climate has become even more conflictual, with both PP and PSOE struggling to entertain constructive talks and more engaged in the self-preservation of the incumbent leaderships. A new election would not necessarily change the current parliamentary configuration, but it could be the catalyst needed to foster a more conciliatory approach. The Constitution allows two months for government building following the first parliamentary vote on forming a new government; otherwise an election is called. In light of this exceptionally high level of uncertainty, we now expect a deterioration in the high frequency economic indicators.
Below, we briefly recap the constraints faced by a left government, in order to provide the reader with a set of key issues to monitor.
First of all, the birth of a left government involves two separate dimensions in Spain: the ability to forge a deal between the center-left PSOE and the extreme left Podemos on the one hand and the need to strike a compromise respectful of national unity with the nationalist parties on the other hand.
There are several conditions that would need to be fulfilled to see a left government in Spain. A deal between PSOE and Podemos is a necessary condition. We believe this is possible, but it would be very costly for PSOE, who would risk being marginalised by its radical coalition partner. As mentioned, Iglesias’ openings contain a strong tactical element, as an attempt to put pressure on PSOE, but they add nothing about the specifics of a viable government agreement. While Sanchez is very keen on forging a deal, several senior leaders in PSOE are very sceptical of an agreement with Podemos but have so far been cautious in voicing their opposition. It is possible that this will limit their room to manoeuvre, and we will discover more at the end of the month when a crucial PSOE summit is planned.
In conclusion, we believe much will depend on the cost-benefit analysis that the PSOE leaders will do and whether they will give the green light to an agreement that risks undermining the long-term survival of the party. Furthermore, at the time of forging a left coalition with help from the pro-independence camp, we think the PSOE leaders will have to face the pressure stemming from a predictable major backlash from the business and international community, together with higher market pressure and a likely deterioration in the high frequency economic indicators.
Overall, we acknowledge that the risks are shifting in favour of a left government compared to our earlier analysis. In the end, it is possible that PSOE will decide that the prospects of the party are fairly grim whatever choice is taken and will favour getting to power as the least costly alternative. In that case, we remark that the coexistence between PSOE and the extreme left Podemos will be challenging in itself. This obviously regards the Catalan issue but it applies more generally to the economic policy domain (including the 0.8% of GDP budget adjustment requested by the Commission).
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We wonder if the ratings agencies will immediately pull a Poland and move to downgrade Spain in the event an "undesirable" government takes power and ruffles Berlin's feathers.