Peter Jones: Stop the pantomime, face the financial music

Certain ugly realities about Scotland’s share of the UK debt and likely post-independence credit rating must be addressed as a matter of urgency

WOULD an independent Scotland get a top notch AAA credit rating? This fascinating new angle on the independence debate, unearthed by Bill Jamieson last week, earned a drearily familiar chorus: oh no it wouldn’t, says the independent market analyst; oh yes it would, shout all the nationalists in the cheap seats.

C’mon folks, the pantomime season is over. Let’s have a proper discussion about this. Since we are all going to vote on whether or not we want independence, which is an extremely serious matter, we need some serious facts. As Bill reported, Scotland’s credit rating would also affect the interest rates businesses and mortgage-holders pay, and a poor rating would seriously disadvantage everybody.

In fact, it is too soon to come to a judgment on this. Available facts are sparse and we should not rush to a conclusion on one fund manager’s blog, even if the manager – Jim Leaviss of the M&G Group – is highly respected. He is, for example, mistaken in one of his assumptions.

The credit rating and hence the interest rate payable by an independent Scottish government on its borrowings mainly depends on three things: the total debt it would have, the annual budget deficit/surplus, and the likely growth path of the economy.

Let’s concentrate on the total debt. There is no doubt that Scotland at the independence starting line would inherit a share of the total debt run up by the UK government. Even the SNP accepts that. The question is: how much?

Mr Leaviss says that “maybe a good starting point would be to share out the UK’s national debt in terms of population.” Since Scottish residents are 8.4 per cent of the UK population, he thinks Scotland would get 8.4 per cent of the debt, or about £80 billion of the £940bn UK debt likely to have been run up by 2014, which is when he posits independence might occur.

His position looks to have been justified by a speech given by Danny Alexander, chief secretary to the Treasury, to CBI Scotland last September. He noted, purely to illustrate the benefits of the Union, that Scotland’s population share of UK debt in 2009-10 was £65bn.

He went on to say that this did not include the cost of recapitalising fallen Scottish banks RBS and HBOS, suggesting that this would have been “catastrophic” for an independent Scotland if it had had to bear them alone. This is, however, a rhetorical point and not a starting negotiating position, as some have interpreted it.

At the weekend, John Swinney, Scottish finance secretary, was reported as saying that Scotland’s share of the UK debt would be £43.5bn. This seems to be based on an argument that Scotland has been a net contributor to the UK Treasury over the last 30 years and therefore can only be held responsible for running up about 4 to 5 per cent of the debt.

This looks to have been derived from Quebec where there was huge debate and disagreement about the proportion of Canadian debt the province would have to shoulder if it had voted for independence in 1995. Politicians, economists and even commissions came forward with five different solutions, proposing a Quebec share ranging from 17.4 per cent to 32 per cent.

Most of these, it was eventually pointed out, and indeed accepted by Jacques Parizeau, the Parti Quebecois leader and Quebec premier in 1995, were nonsense. That is because there is a simple economic and financial market fact which was ignored then but which is acutely relevant today. It is that the owners of the UK debt – (your) banks and pension funds – want to make sure that the share-out gives the best guarantee that they will get their interest payments and their capital repaid. Mr Leaviss raises the point in his blog: “Would I be given £8 of Scottish gilts and £92 of UK gilts for every £100 of gilts I own now. Can ‘they’ do that to me?”

The interest and capital payments come out of tax revenues which are, broadly speaking, reflective of GDP. And since Scotland would also be laying claim to North Sea oil revenues, Scotland’s share of UK GDP is higher than its share of UK population – averaging 9.5 per cent over the last six years.

This is a much more likely share-out, especially as the financial crisis has given most of Europe’s governments big debt headaches and there is constant talk of one or more states probably defaulting on their obligations. Neither the EU nor the International Monetary Fund (IMF), which Mr Salmond wants Scotland to be a member of, would tolerate a debt division which put too heavy a burden on one or other of the UK’s successor states.

Both the population share and Mr Swinney’s share would load the share-out more heavily on the remainder of the UK. If rUK is keeping only 90.5 per cent of its tax-raising capacity, but taking on 91.6 per cent of the debt (population share) or even 95 per cent (Swinney share), its taxes are going to have to go up or public spending be cut even more savagely than now.

Make no mistake, international institutions such as the EU and IMF, which are acutely interested in ensuring international financial stability, will not permit financial consequences of a constitutional break-up that increase instability.

So going back to Mr Leaviss’ calculations, a 9.5 per cent share of £940bn is about £89bn. If Scotland manages to average 1.5 per cent growth per year (which is heroically optimistic) until 2014-15, Scotland’s GDP should be about £146bn. This would make Scotland’s debt-to-GDP ratio 61 per cent, or just a little bit more than the 60 per cent which is ideally the upper limit for national debt if you want to be sure of getting an AAA rating. Slower growth raises the ratio even higher.

Maybe that wouldn’t matter too much. After all, as Mr Leaviss noted, there are quite a few AAA-rated countries with debt heading towards 100 per cent of GDP. But it is not inconsequential because, at that debt-to-GDP ratio, Prime Minister Salmond could not indulge in the expansionary borrowing (thereby increasing the ratio) that he has been demanding.

OK, I know, I am not being Prince Charming about this. But in today’s harsh financial climate, there is no room for pantomime. There are only ugly realities.