Threat to top credit rating in separate Scotland

AN independent Scotland would struggle to sustain a top-notch triple A credit rating on its sovereign debt, a leading fund manager has warned.

While key figures on debt and deficit “look good for Scotland on a headline basis”, ratings agencies would be taking a long hard look at the nation’s ability to maintain a low level of debt compared with the economy overall, he argues.

The analysis by Jim Leaviss, a fund manager at the giant M&G Group, looks at what might happen to Scotland – and the UK – in the event of a political break-up of the government debt market given growing political interest in the independence referendum scheduled for 2014 or 2015.

Most small economies of an equivalent size do not enjoy a triple A rating, in fact it is quite rare.

However, it would be crucial for an independent Scotland to seek to sustain as high a rating as possible as this would make government debt easier to sell.

Countries with low credit scores tend to have high rates of interest to attract foreign investors. That makes credit all the more expensive for domestic households and business borrowers alike and would push up bills. A higher rate of interest would put Scotland at a disadvantage.

Mr Leaviss – one of M&G’s “bond vigilantes” who assesses risks and rewards of holding country debt – questions whether Scotland could retain the UK’s coveted triple A rating, even with the backing of North Sea oil reserves.

He warns that the ratings agencies would look critically at Scotland’s poor relative growth performance and that there would be a bias towards “big systemic nations over smaller ones where there is an implied higher risk factor (rightly or wrongly) and given the experience of Iceland and Ireland, which both held AAA ratings, perhaps the agencies would err on the side of a lower rating”.

However, his conclusions were challenged by the SNP government yesterday.

A spokesman for finance secretary John Swinney said: “We are entirely confident of Scotland’s position. The reality is that the UK’s deteriorating growth outlook has led the credit-ratings agencies to question the UK’s triple A status – which is one reason why Scotland needs full access to the economic and financial levers of government so that we can boost growth, recovery and jobs.

“As it is, and contrary to Mr Leaviss’s ‘guess’, the latest figures show that Scotland is the only area of the UK outside London to record growth in our Gross Value Added economic output between 2007 and 2010.

“And among the 12 nations and regions of the UK, Scotland is the third most prosperous in terms of output per head – behind only London and the South East of England.”

For more than a year bond markets worldwide have been gripped by the growing sovereign debt crisis in the eurozone.

Many are now convinced that a country – and possibly more – could leave the European single currency over the next year.

As the independence debate intensifies, the implications of a government debt break-up here will come under increasing scrutiny.

While Mr Leaviss does not claim his analysis to be definitive, his note is important for the way in which it sets out the views of a typical fund manager and the questions that would be brought to bear by the markets in the event of independence.

His “back of envelope” graphs, as he describes them, are not on first appearance unfavourable to an independent Scotland.

For example, Scotland’s ratio of debt to Gross Domestic Product (GDP) in the event of independence is shown at 56 per cent – comfortably within the previous Maastricht Treaty limit and well below that of the UK at 63 per cent. And on the budget deficit the comparison also favours an independent Scotland.

The deficit-to-GDP ratio at 9 per cent is no higher than that for the UK, while the ratio with all oil revenues included would fall sharply to just 5 per cent. However, this assumes that Scotland could get away without having to take on the liabilities accrued by saving Scottish banks.

“The assets of Royal Bank of Scotland and Halifax Bank of Scotland alone dwarf the size of the Scottish economy”, he adds.

His calculations are based on research published in 2007 showing that Scotland spends much more than its revenues. And it would need to borrow about £10bn a year, plus its share of gilt interest.

Mr Leaviss said: “So £13.2bn of deficit, compared with GDP of £143bn, is about 9 per cent – about the same as the UK is running right now, but way above a sustainable number.”

Despite the figure falling to 5 per cent if you add North Sea oil into the equation, he warns oil output is set to fall dramatically.

He said: “So again, if I’m rating Scotland as a stand-alone entity, I worry what will happen going forwards.”

Such assessments at this stage are complicated, he adds, because it is not clear whether Scotland would keep the pound, adopt the euro or print its own currency. The ratings agencies, he adds, will also care about economic growth, and here Scotland performs relatively poorly.

But Mr Swinney’s spokesman said: “Scotland is in a far stronger position than the UK in terms of the strength of our asset base and therefore our bankability – a key point which Mr Leaviss neglects. Some 40 per cent of reserves remain in the North Sea, with over half of the value still to be extracted – representing an asset base of £1 trillion.”

However, Mr Leaviss disputes the £1tn figure, arguing that the true figure for the oil asset base would be nearer £163bn.