Independent Scotland Would Face Higher Borrowing Costs, says IHS

A vote in this week’s referendum in favour of Scotland’s separation from the UK would see its sovereign risk rating likely to be placed in the BBB lower investment grade region, according to Jan Randolph, director of sovereign risk analysis at IHS, the US – based global markets and economic information group.

Among the key points of Randolph’s assessment:

• A new Scottish sovereign risk rating would have to be generated if Scotland decides to vote ‘yes’ for independence.
• There will be clear policy uncertainties for Scotland that would be detrimental to its sovereign rating, leading to a somewhat lower rating in the BBB region, at least initially until these uncertainties clear.
• In general, a sovereign in the BBB range will face slightly higher borrowing costs than the UK’s higher sovereign rating and these slightly higher borrowing costs will cascade down to Scottish domiciled banks, corporates and individuals.
• However, it would also be in the UK’s own interest to manage any economic and monetary transition for Scotland in way that is least disruptive for both parties.

“A general understanding is that the Scottish sovereign rating would not be as strong as the UK’s at AA or 5/100 because of a number of important uncertainties and the lack of a payments track record, set against the somewhat smaller advantage of inheriting very little, if any debt,” comments Randolph

These uncertainties would continue even after negotiations are over; firstly because of the nature of the Scottish currency; secondly due to how the UK’s sovereign balance sheet would be ‘split’ in terms of assets – for example, foreign exchange reserves and Bank of England (BoE) currency and financial sector support and oversight measures – and pre-existing UK public debt.

This in turn will have an influence on the shape of the Scottish balance of payments. A likely Scottish trade surplus based around oil exports is likely to emerge, but likely to be balanced-off against a services deficit.

The IHS assessment suggests that if the BoE does refuse to lend full support behind the Scottish located banks and any new Scottish currency, Scotland would then have to generate a current account surplus on its balance of payments to generate foreign exchange (FX) reserves to build the first asset of any new Scottish central bank – or alternatively build a currency board where the Scottish money supply (M3) would then be purely be determined and driven by the Scottish balance of payments performance.

This may prove a painful restructuring for the Scottish economy for several years – without some eventual devaluation of a new Scottish pound outside the sterling area – in a similar devaluation scenario to that of the Irish punt (‘pound’) in the last century – when Ireland left the sterling monetary area and eventually joined the euro.

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