Financial opinion means more than politics when it comes to national debt repayment, writes Peter Jones
Some of the ice the Treasury has tried to set around the question of what would happen to Britain’s national debt if Scotland voted for independence has melted. We now know a little bit more, and Alex Salmond’s hand looks to have been strengthened a little. But if the full logic behind yesterday’s Treasury statement is carried through, it may end up weaker.
The fact that the Treasury has now agreed that in the event of Scottish independence, the government of the rest of the UK would “in all circumstances” honour the contractual terms of the debt issued by the UK government, tells us several things.
I see no reason to doubt that the statement was made to head off any uncertainty in the government bond markets that might be caused by the possibility of Scottish independence. Suppose you were a manager of a pension fund which had, say, £1 billion of UK government debt amongst its assets. Scottish independence would mean that the UK government disappears to be replaced by two new governments. Your pensioners would naturally ask whether this poses any threat to their pensions.
So you start asking some questions. Which government is going to pay the interest and repay the principal on the debt you hold? Is your £1bn of debt going to be divided so that some gets paid by the Scottish Government and some by the (rest of) UK government? And if so, does that imply more or less risk than at present?
If you don’t get answers to these questions then, bearing in mind that your sole duty is to protect the interests of your pensions, you would then have to make some judgments. You might decide that politicians are untrustworthy and therefore you cannot rely on the legal obligation to repay your money that the UK government gave you when you bought its bonds.
If that was your judgment, you could do a number of things. You could sell some of the bonds to reduce risk. The sooner you did that the better, because otherwise you risk being part of the herd and getting a poor price for your bonds. And if you were buying bonds, you would price the risk in and demand more in interest payments.
If these things were to happen, then there would have been severe economic impacts. New British government debt would have become more expensive, putting an extra burden on UK taxpayers and delaying the reduction in the deficit. That implies more spending cuts or tax rises. There would also have been a knock-on effect increasing the cost of mortgages and other private debt.
Yesterday’s statement was aimed at stopping this from happening and damaging the interests of UK taxpayers. It was predictable that the Treasury would have to make such a statement; indeed, I said so in a column about a year ago.
The statement also has the incidental side-effect of protecting Scottish taxpayers should they vote for independence. This is because, in effect, the Treasury has said that anyone who holds government debt need not worry about Scottish independence because the “continuing” UK government of the rest of Britain will carry on paying interest and repaying loan principals on precisely the terms agreed when the bond was sold. So the risks that prospectively independent Scottish taxpayers might have to pay more for government borrowing have also been reduced.
From this, we can learn a number of things. First, that Alex Salmond’s threat not to take on any share of UK debt if the UK government doesn’t agree that an independent Scotland can carry on using sterling was certainly not the prime cause of market uncertainty. That didn’t help, but the prime cause remains the possible vote for independence in September.
Second, it tells us that should there be a vote for independence, negotiations to establish that will not be a straightforward bilateral discussion between Scottish and rest of UK representatives. The weight of external opinion, particularly those of financial markets, will cast a long shadow on the table.
This means that while the statement says ostensibly nothing about how the debt would be divided, or what the UK government thinks is the right division, in fact some of the mechanics and the likely proportion of the debt Scotland might have to shoulder can be inferred.
The statement says “an independent Scotland would need to raise funds in order to reimburse the continuing UK” for “the fair and proportionate share of the UK’s current liabilities” for which “an independent Scotland would become responsible”.
This implies that the Treasury envisages an independent Scotland issuing bonds and gilts worth a sum equivalent to the relevant share, which the Treasury would then hold, receiving capital and interest payments from the Scottish Government, which is then transferred to the (former) UK creditors, until eventually all the inherited debt is repaid.
That seems reasonable. But putting on the pension manager’s hat again, have all your questions been answered? Not entirely, because you don’t know what the likely division of debt will be and whether it will be more or less easily serviced by the two inheriting governments.
Thus you will want to be further reassured that the division will indeed be “fair and proportionate” so that neither Scotland nor the rUK is unfairly burdened by excessive debt which either government finds difficult to repay.
If financial markets do start asking these questions, and I am pretty sure they will, it means that the Treasury will come under more pressure to say something about the likely division. And since ability-to-pay is the yardstick that solely concerns markets, that points to share of GDP rather than share of population being the likely division.
It certainly rules out the historical share of spending and taxation method mooted by the SNP and, since Scotland would be acquiring the lion’s share of North Sea GDP, points to a “fair and proportionate share” being about 10 per cent, a bit bigger than an 8.5 per cent population share.
That in turn means that the annual debt costs will be bigger than the £5.5bn top end estimate set out in Mr Salmond’s white paper, perhaps £6bn. That’s both unfair and rubbish, nationalists may say. But the hard fact underlined by the Treasury statement is that on this issue, the opinions of politicians count for a lot less than the views of financial markets.