With the Scottish National Party (SNP) securing a victory in last Thursday’s Scottish governmental elections and in doing so securing a mandate to push for independence alongside the Scottish Green Party, the financial sector is once again turning its attention to the possibility of a second referendum for the constituent country.
One of the key economic implications of Scottish independence would revolve around the newly formed country’s proportion of the UK’s existing debt, and how that debt would be transferred – if at all – to the Scottish state.
At the end of 2020, the UK had general government gross debt of £1876.8 billion, for which an independent Scotland would be proportionality responsible. A key question would be formulating exactly how much of this total was Scotland’s responsibility and how it would be serviced.
According to Andrew Wilson, founding partner of Charlotte Street Partners and one-time shadow finance minister in the Scottish Parliament, the solution to this problem would be for Scotland to pay an annual solidarity payment to the United Kingdom.
“This would be annual payment to service the agreed share of debt interest, so that that negotiation would need to weigh up both liabilities and assets which are currently on a report published by the UK Government once a year, called Whole of Government Accounts,” he said. The last published balance sheet shows £4.6 trillion of liabilities, but this number will have increased significantly due to Covid-19.
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According to the report by the Sustainable Growth Commission, which is chaired by Wilson, “an agreement should be sought for a mechanism for Scotland to pay a reasonable share of the servicing of the net balance of UK debt and assets”.
The Annual Solidarity Payment is modelled at around £5 billion, including debt servicing contributions, 0.7% GNP contribution for foreign aid and a further £1 billion set aside for other shared services, continued the report.
“The calculation would tell us a legacy sum of money that Scotland would agree to service, which would be very important to begin with,” added Wilson. “Over time, the legacy sum of that would be eroded and refinanced, and run down.”
Tartan bonds
An alternative to this would be for Scotland to transfer and take on a calculated proportion of the UK debt directly. This would bring a whole host of legal issues and concerns, not least in calculating that number.
“The essential issue is that because the UK government has issued debt to finance budget deficit and spending – some of which it can reasonably argued has taken place in Scotland – a newly independent Scotland should assume its fair share of the debt,” said Neal Shearing, chief economist at Capital Economics. “The question is where to draw that line; is it a share of GDP, a share by population, or by government spending. Either way, it is going to be a mess really.”
“There are no provisions in bond issues for this sort of event, it is not like UK government bonds have clauses that say what is going to happen in the event of an independent Scotland,” he added.
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What an independent Scotland’s currency would look like is a key economic concern that has been richly debated in the years leading up to and following the 2014 referendum. The ultimate decision would also have a significant bearing on the outcome of the shared national debt.
If – as is widely suggested – the country were to use a pegged version of pound sterling, it would mean significantly less risk for the holders of the debt that was transferred to the Scottish sovereign.
“Of course, you would still have to take on the debt, but it would mean less exchange rate risk,” said Thomas Sampson, associate professor of economics at the London School of Economics.
“It would be subject to negotiation, but if Scotland was still using the pound there would be no risk,” he added. ”Suppose you use a new currency and set it up so that one Scottish pound is worth one British pound, if afterwards that is not what the market thinks it was and the Scottish pound were to depreciate, then things would suddenly look very different in terms of the value of that debt.”
This issue was also central in 2014, with the Scottish government suggesting that it would continue to use the pound as a pegged currency. At the time there were some suggestions that Scotland would renege on its share of the national debt if Westminster did not given give it access to sterling.
“They're still proposing that on some basis, at least until there is an introduction of a new currency,” said Owen Kelly, deputy director of the Edinburgh Futures Institute and one-time CEO of the Scottish Financial Enterprise, the representative body for Scotland's financial services industry.
“As part of that argument there was a slightly silly suggestion that Scotland would refuse to pay its share of any legacy debt, unless the UK government allowed Scotland to use sterling on a dollarised basis,” he added. “This could be a point of political contention, there might be an attempt to use it as a bargaining chip once you got into the business of negotiating the terms of the separation”.
Setting a precedent
Were Scotland to begin the process of preparing for independence, it would of course not be the first time that a country has seceded and not the first time that national debt be divided in such a manner.
Lee Buchheit, sovereign debt restructuring veteran and honorary professor at Edinburgh University, told IFLR that in public international law, when a constituent profits of a state cedes or leaves to join another state – as happened in 1846, when Texas joined the United States – the rule is that any debts incurred by the previously unified state have to be allocated between the two newly independent countries.
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“There is no hard and fast formula for doing that,” he said. “The one thing that’s clear is that as your debt was incurred, let's say to build a hydroelectric dam in the seceding province, then that debt stays with them, but the debt incurred for general governmental purposes has to be allocated between them.”
According to Buchheit, when Yugoslavia broke up this issue was not handled particularly well, leaving the handful of emergent countries with unresolved quarrels.
“As it relates to UK gilts, the United Kingdom, such as it might exist after Scotland left, would remain wholly responsible,” he added. “The United Kingdom would negotiate with Scotland for what in legal terms is called a contribution, or they could say that something like 70% of the gilt is now the responsibility of the UK and 30% is Scotland’s.”
The Sustainable Growth Commission and its Annual Solidarity Payment suggests the second approach.
“I would be astonished if they deviated from that if there were another referendum,” said Buchheit. “The history of these referenda around leaving is not particularly good in terms of debt.”
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