BBB region possible for Scotland’s sovereign risk rating

These uncertainties would continue even after negotiations are over: The nature of the Scottish currency; (2) how the UK’s sovereign balance sheet would be ‘split’ in terms of assets (like foreign exchange reserves and Bank of England 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.

At the moment, there is good UK GDP regional data for Scotland but no balance of payments data; that will be required to help position any new Scottish sovereign rating.

We assume that while Scotland will retain most of the North Sea oil export revenues and taxes, that would make up about 15 percent of the Scottish fiscal budget, this would be balanced out by the fiscal support (or an ‘official transfer payments’ net surplus income) that Scotland currently receives from Westminster/UK. Scotland has one of the highest per capita income welfare recipient levels in the UK after Northern Ireland.

Furthermore, Scotland has a somewhat ‘out-sized’ financial sector that is presumed to generate a modest services’ surplus that would likely disappear after independence given the uncertainties or absence of a central bank support. There is already clear evidence that a number of Scottish financial institutions would move at least their headquarters south of the border in the event of a vote for independence.

Indeed, if the Bank of England refuses 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 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.

Either way, how the UK’s sovereign balance sheet (assets and debt) will be split (subject to yet to be held negotiations and decisions by both UK and Scottish governments), how the balance of payments will develop and change, and how the fiscal position will unfold will be questions that indicate clear policy uncertainties.

These policy uncertainties will be detrimental to its sovereign rating, at least initially until these clear, and perhaps over a few years of necessary economic adjustment. This will lead to a somewhat lower rating in the triple BBB region, despite the likely material rating advantage of inheriting little, if any debt. 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. This situation can only be partially reversed over the medium term if Scotland’s balance of payments surpluses turn out to be much larger than are currently forecast.