February 24, 2014 11:08 am

Scottish bonds ‘will be riskier than Gilts’

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It is now certain that Scotland will issue its own bonds, but the big question is whether this will de done by an independent government, or a devolved administration at Holyrood.

Last week’s announcement by Danny Alexander, Treasury chief secretary, that Scotland will from next year be able to issue bonds while borrowing up to £2.2bn for capital spending, marks the first time any devolved administration within the UK has been given the power to raise its own funds on capital markets.

Although the Scottish government is focused on obtaining the go-ahead for independence in September’s referendum, there is no doubt that Scottish National Party ministers will use these powers granted by the UK government under the Scotland Act 2012, even if they lose the vote on independence.

The nationalist government in Edinburgh asked the UK Treasury as long ago as 2011 to give it the power to sell bonds, and even if defeated over independence, the SNP is certain to continue to press for more powers for Holyrood.

A Scottish government spokesperson says: “Under either independence or the powers available under the Scotland Act there is over a year before Scotland will be able to access money on the market and we are developing our approach through discussions with a range of organisations including considering carefully the terms of the chief secretary’s announcement.”

The bond rating agencies – Moody’s, Standard & Poor’s and Fitch – have all declined to comment on Mr Alexander’s announcement, though they are carefully monitoring the independence issue because of its potential impact on the credit rating of UK government bonds.

Respondents to a Treasury consultation document last year suggested that the sort of Scottish government bonds that a devolved administration could issue might have interest rate costs between 35 and 130 basis points higher than UK Gilts. Most used as a benchmark the interest costs for other UK sub-sovereign entities – such as Network Rail and Transport for London, as well as international examples from Germany and Canada.

Several suggest that this yield premium will fall over time as the Scottish government establishes a record and demonstrates itself to be a creditworthy issuer.

However, others feel the majority of the spread would reflect the likelihood of Scottish government debt having a lower credit rating and poorer liquidity than UK Gilts.

Fitch said in December that Scottish independence would probably be neutral for the credit profile of UK government bonds for the residual UK – England, Wales and Northern Ireland. The agency warns, however, that the monetary arrangement following Scottish independence could become a source of uncertainty, even if Scotland remained in the sterling currency zone.

“As the intensification of the eurozone crisis showed in 2012, a monetary union without fiscal and banking union is unstable and the prospect of an exit from a monetary union could lead to high volatility and market turbulence, potentially detrimental to all members,” Fitch says.

As long ago as October 2012, Fitch said any judgment on the possible rating of an independent Scotland was impossible because of the absence of information on the nature and terms of any possible independence agreement, and the considerable uncertainty regarding key provisions such as the partition of assets and liabilities, the regime governing the financial sector, possible currency change and the length of a transition period to independence.

The rating agencies have been keeping their heads down, partly because they do not want to get drawn into political brawling over Scottish independence. But it is also striking, with less than seven months to go until the referendum, that almost all the uncertainties listed by Fitch remain – and most look unlikely to be clarified before the vote.

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