Today, Wednesday the 17th of September, when I say “United Kingdom,” I refer to the United Kingdom of Great Britain and Northern Ireland, a sovereign state made up primarily of England, Scotland, and Wales. But what will “United Kingdom” mean at the end of the week, after Scotland holds its referendum on independence this Thursday (18 September)? The vote in front of the Scottish people is a simple yes/no vote: should Scotland be an independent country? My expectation is that the result will be a “no” vote, but the polls are sufficiently close that a “yes” vote can’t be dismissed. Therefore, here’s a quick summary of what implications a “yes” vote could have.
There are three main issues an independent Scotland would bring to the fore.
- Natural resources – Scotland has access to significant oil and gas reserves in the North Sea. Ownership of those resources will have implications for both Scotland and the remainder of the UK (r-UK).
- Currency – An independent Scotland needs a currency. Will it be able to retain the British sterling? What about the euro or a new Scottish currency?
- Debt – Scotland is responsible for a portion of the UK’s sovereign debt. How will that debt be split between Scotland and the r-UK?
A newly independent Scotland would be able to lay claim to about 94% of North Sea oil reserves. That’d likely boost Scotland’s economy by over 15% and leave it with an energy sector around seven times larger than in the UK currently. The potential downside comes from fiscal instability associated with volatility in global oil prices, exchange rates, extraction rates, and production rates. North Sea oil production has been declining since the late 1990s, so there may also be a longer-term challenge if that trend continues. Either for better or worse, the question of oil would be one of weighty proportion for Scotland.
As to currency, I see three options: the pound, the euro, or a new Scottish currency. Scotland’s preference would be to retain the pound, and they could do this in one of a couple ways. They could create a formal monetary union with the r-UK, and the Bank of England would then consider the Scottish economy when making monetary policy decisions. The UK government has been explicit in its position that this would be unacceptable. Scotland could maintain the pound, but without the formal union. IN this case, the BoE wouldn’t consider Scotland’s economy – potentially leading to negative repercussions if the r-UK’s situation diverged drastically from Scotland’s. If the euro is their path for a new currency, Scotland would give up monetary policy freedom and the ability to let their fledgling economy adjust to asymmetric shocks. There’s also the uncertainty over whether Scotland would even gain membership to the European Union. A new Scottish currency could be floating or fixed, or somewhere in between. The main issue with this option is that new monetary institutions would need to be set up…and quickly.
The third issue, that of the UK’s sovereign debt, is really more of an issue for the remainder of the UK. Since the UK Treasury has said that it would honor its debts regardless of the Scottish vote, the question hinges on whether Scotland will accept its portion of the debt. If it does, there’s almost no impact on existing gilts from Scottish independence. In a worst case scenario, Scotland reneges its entire share of the existing liabilities. This would leave the UK debt stock unchanged, but would remove Scotland’s contribution to GDP. That would move the r-UK’s debt-to-GDP ratio from around 91% (as of first-quarter 2014) to more like 100%. That could lead to possible ratings cuts for the remainder of the UK, or perhaps just delay any upgrades the UK was hoping for.
If there is a “yes” vote this week, markets would likely buck at the new uncertainty. Volatility would likely rise sharply and initial moves could be quite large. Gilt yields could be driven higher by concerns over the UK’s credit rating and debt burden. The sterling would likely be hit sharply as well, based primarily on the material deterioration of the r-UK’s current account if those Scottish oil exports are no longer available in the r-UK’s balance of payments. Lastly, the Scottish banking sector could see some modest outflows, and it’s likely that some financial institutions based in Scotland would shift their headquarters into England to guard against the potential threat that redenomination could post to their clients.
The final thing I’ll consider is the effect a “yes” vote could have on next year’s referendum on the UK’s membership in the European Union. If Scotland votes for independence, and their influence in Parliament disappears, the r-UK would likely tilt further toward the political right. This would tilt the r-UK toward the more euro-skeptic side and materially increase the likelihood that a referendum on EU membership would take place, and that it would succeed.
I feel that the moniker “United Kingdom” will continue to include Scotland after Thursday’s vote, but in the event of a surprise “yes” result, there will be many more issues to consider, and we’ll stay on top of them.
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