The battle over Scotland’s future just entered the realm of the bond market.
The U.K. government said yesterday it will let Scotland sell bonds in international markets starting next year. If it decides to raise money that way, the nation would pay a “small premium” over gilts, though nothing like the extra cost should nationalists win this year’s independence referendum and decline to take on a share of the British national debt, Chief Secretary to the Treasury Danny Alexander said in Edinburgh.
“It’s undermining your own market credibility on day one,” Alexander said after addressing lawmakers in the Scottish Parliament. “It’s cutting off your nose to spite your face.”
The argument over the economics of independence has intensified after opinion polls showed movement in favor of breaking away from the rest of the U.K., albeit not by enough to prevail in the Sept. 18 vote. While the focus the past week was on whether Scotland could continue to use the pound, it’s shifted onto the potential cost of borrowing for a newly separate state.
After dismissing Chancellor of the Exchequer George Osborne’s Feb. 13 speech rejecting a currency union with an independent Scotland as “bluster” and “bluffing,” Scottish nationalist leader Alex Salmond said Scotland needs a fair division of U.K. assets, including the pound, to accept a share of liabilities.
Alexander reiterated the U.K.’s position on the pound, calling it “fantasy” to think otherwise.
“There have been questions about the Scots’ treatment of their liabilities regarding the existing share of U.K. debt, so what credit rating and investor appetite there would be for the debt at this stage is very untested,” said Sam Hill, senior U.K. economist at RBC Capital Markets in London.
The power to sell bonds is part of existing legislation on broadening the potential sources of funding for the Scottish government, though borrowing will continue to be limited to 2.2 billion pounds ($3.7 billion). The U.K. will provide no guarantees on any bonds issued by Scotland, the Treasury said.
The Scottish government called it “too little, too late,” though declined to say whether it would use the power in the event of voters deciding against independence.
“An independent Scotland’s strong financial position means we will be very well placed when it comes to sovereign borrowing rates,” Scottish Finance Minister John Swinney’s office in Edinburgh said by e-mail.
A poll published today by the Scottish Daily Mail showed the “Yes” to independence campaign trailing the pro-U.K. vote by nine percentage points, narrowing from surveys last year. More than 1,000 people were questioned after Osborne’s comments on the pound. While support for independence increased, 65 percent of voters said the nationalists need a plan B.
The U.K. government laid out what it considers to be the extra costs associated with Scottish bond sales and their potential knock-on effect into the economy, such as mortgages and business lending.
They vary between selling securities as part of the new power within the U.K., doing it as an independent country with an agreed settlement on Britain’s outstanding debt, or going it alone by declining to take a share of that liability should the government in London not budge on a currency union.
Alexander said the “small premium” on Scottish bonds while staying in the U.K. was below the range of 72 to 165 basis points estimated by the National Institute of Economic and Social Research this month for an independent Scotland. Ten-year gilts currently yield 2.72 percent, 108 basis points more than equivalent German bunds.
Citing research by investment bank Jefferies International, Alexander said that walking away from a proportion of U.K. debt would mean Scotland starting out with a premium of 500 basis points, or five percentage points, because international markets would treat it as a default. That would theoretically put the 10-year yield at about 7.7 percent, higher than Greece.
Jefferies economist David Owen estimated in December that Scottish bond yields would trade similarly to the spread between Canada and its provinces. Investors charge Quebec, Canada’s predominantly French-speaking province, about 100 basis points more than the central government to borrow for a decade. Owen was not available to discuss the report yesterday.
Scotland going on its own in the bond market would entail separation from a market that is perceived as a source of safety during times of turmoil.
At the height of the European debt crisis, 10-year gilt yields dropped to a record low 1.41 percent in July 2012 as investors bought U.K. securities as a haven amid bets that the euro area would splinter. U.S. Treasury (USGG10YR) 10-year yields fell to as low as 1.38 percent while those of Germany (GDBR10), perceived to be among the region’s safest debt securities, fell to as little as 1.13 percent in June 2012.
“It seems like there’s a lot of hurdles to get through before they could issue,” said Hill at RBC Capital Markets. “The cost efficiency of it would be a question that still remains to be answered.”
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