Authored by Don Quijones via WolfStreet.com,

Catalonia’s independence would set off Spain’s debt time-bomb.

On Monday El Pais published leaked excerpts from what it claims to be the Catalonian regional government’s road map to independence. The secret document includes a plan for the region to unilaterally break away from Spain should its citizens be prevented from holding a referendum on independence in the fall.

It provoked a fierce backlash from Madrid. “This proposal is an unacceptable attempt to blackmail the state,” Spain’s Prime Minister Mariano Rajoy said in a hastily convened press conference. Spain’s defense minister María Dolores de Cospedal likened the plot to a coup d’état. In the meantime, Madrid continues to refuse to even entertain the idea of allowing a referendum on Catalan independence, despite the fact that in just about every survey of the last few years 80% of Catalans, including many unionists, have requested one.

It would mean the loss of 25-30% of Spain’s gross domestic product (GDP), says Spain’s Minister of the Economy, Luis de Guindos. And that’s something the government “will never let happen.”

But Catalonia knows it has a card up its sleeves: its tick-tocking debt bomb. Catalonia can no longer issue its own debt and depends on the central government’s national liquidity fund (FLA, for its Spanish acronym) for about 60% of its funds. As ratings agency Fitch warned in April last year when it sent Catalonian debt even deeper into junk territory, the region has grave liquidity problems that will require “proactive management” and “close collaboration with the central state ” — something that’s clearly not on the cards any time soon.

At the same time, Spain’s public debt continues to grow, recently bursting through 100% of GDP. Even with historically low interest rates (gracie, Signor Draghi), the price of servicing government debt can spiral out of control. Between 2011 and 2015 Spain’s central government spent €121 billion – the equivalent of 12% of annual GDP – on interest payments.

As Catalonia’s finance minister, Oriol Junqueras, recently noted, Rajoy’s government has already burnt through the €65 billion social security fund surplus it inherited in 2011 and is now using a toxic blend of tax funds and public debt to finance the country’s widening pension deficit, which is forecast to reach between €10 billion and €15 billion a year.

In other words, Spain’s deficit, already one of the largest in Europe, is going to remain high for the foreseeable future, despite all the threats of multi billion-euro fines emanating from Brussels. As the widely renowned Columbia University Professor of Economics (and fervent Catalan separatist) Xavier Sala i Marti recently pointed in an interview on Catalan television, all of the debt, including the debt owed by the Catalan regional government, is in the name of the King of Spain:

It’s (Spain’s) debt. They already have a debt load of 100% of GDP. If Catalonia declared independence tomorrow, and Spain were to say “you’re going to be kicked out of the EU for three generations” and everything else they threaten us with, we’d just say to them, “well, these little papers of debt (bonds), you can have them for the next three generations.” All of a sudden, they’d have a much smaller GDP and a much larger debt overhang (around 125%)… A debt-to-GDP ratio of 125% would not be feasible. Spain would not be able to pay the debt they owe the Spanish banks, the biggest holders of Spanish bonds. And that would ruin them, triggering a financial bloodbath.

Such an outcome has also been postulated by the U.S. rating agency Moody’s: in effect, any default on Catalonia’s debt would be interpreted by the markets as a Spanish default. In other words, whence goeth Catalonia, goeth Spain.

And right now, Catalonia’s government seems determined to stage the mother of all showdowns with the central government in Madrid: a financial fiasco for both sides. Catalans are a notoriously prudent, cautious people. As such, it’s fair to assume that at least some of what lies behind the regional government’s recent escalation of tensions with Madrid is bluff and bluster.

But a big bluff can sometime set one down a very dangerous path from which it can be difficult to extricate oneself. The Catalan government may be hoping that threatening to declare independence unilaterally, or even following through on the threats, will finally push the Spanish government into having to compromise. But it’s a massive gamble.

In some parts of Catalonia, including Barcelona (from where I’m writing this article), public support for independence appears to be on the wain. But for many nationalists in the Catalan government, turning back with so little of substance to show pro-independence voters after promising them so much may not be an option.

As for Rajoy’s government, its staunch defense of the country’s territorial unity is a vital vote winner for its core supporters. And right now, with new corruption scandals engulfing senior members of Rajoy’s People’s Party breaking every week or two, these are votes it can ill afford to lose, especially with new snap general elections growing increasingly likely.

In other words, the prospects of a win-win solution being found in the coming months are by now slim. The chances of a lose-lose outcome are growing by the day. Does this mean that Spain, the Eurozone’s fourth largest economy, is on the verge of breaking up? Probably not. But to prevent that from happening, Madrid may end up having to take drastic (and deeply symbolic) actions, including invoking article 155 of the constitution, which will effectively put an end to all forms of Catalan self governance. And that could merely serve to strengthen the resolve of Catalan separatists while further polarizing divisions within Spain’s richest region. By Don Quijones.