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An independent Scotland would need to build up large currency stockpiles to successfully use the pound without a formal agreement with the rest of the UK, Bank of England governor Mark Carney told MPs on Wednesday.
While Mr Carney resolutely refused to give a calculation on the precise levels required, he told MPs on the Treasury select committee that the experience from other countries was that central banks needed to have reserves equivalent to at least 25 per cent of gross domestic product if they used another country’s currency.
Countries with complex financial systems would require higher levels of reserves, he said, citing the example of Hong Kong which pegs its currency to the US dollar and has reserves of about 110 per cent of GDP. Depending on how North Sea oil is accounted for, Scotland’s GDP is somewhere between £130bn to £148bn, implying a new Scottish central bank would need to accumulate a stockpile of between £32bn to £163bn.
Building up such reserves would likely require Scotland to run a budget surplus, meaning painful choices on spending and taxation for an incoming government, especially considering that the Yes campaign gained significant momentum on the assertion by Alex Salmond that voting for independence could save the Scottish NHS from Conservative cuts. Mr Carney said building up reserves would mean “real fiscal costs”.
In a research paper to be published on Thursday, Professor Ronald MacDonald of Glasgow University, who has been working with the pro-union campaign, estimates that to build up foreign exchange reserves of £40bn an independent Scotland would need to run budget surpluses of between 5 per cent and 10 per cent of GDP for a number of years. “The only way these sums could be achieved would be through a massive austerity programme,” he said.
In cautious testimony, Mr Carney said that “just having a central bank isn’t by definition a credible lender of last resort if that central bank is not the issuer of the currency, it needs to be backed up in any event by fiscal resources, but particularly if it is the currency of another jurisdiction.”
“It’s a fact that the size of the reserves is one of the most important factors that determines the credibility,” he added, but refused to comment on how the BoE’s existing reserves could be divided in the event of independence.
Mr Carney also reiterated to MPs that the BoE had contingency plans in place for a Yes vote, adding it would “obviously implement them if at all required in the short term.”
He also stressed repeatedly that the BoE would remain the central bank and lender of last resort for the whole of the UK – including Scotland – during the expected 18 month transition period.
Asked about the risk of capital flight, Mr Carney said Scottish banks would have access to BoE facilities and Scottish depositors would have access to the Financial Services Compensation Scheme.
The issue of what currency an independent Scotland would use has become one of the major flashpoints of the debate after all three main Westminster political parties ruled out the option of a formal currency union. The Scottish National Party have said the position is tantamount to “ganging up to bully Scotland”.
On wide issues of monetary policy, Mr Carney reiterated that the BoE expected rates to start to rise “by the spring” as the economy “normalised”, though he stressed it was far from fully healed.
“[We] might want to get back to the old days but it’s going to be a while yet,” he said.
Minouche Shafik, the new BoE deputy governor, said the central bank’s models all “seem to point to the fact that wage growth is imminent, maybe on average about 1.5 per cent.” But she said she had not voted for higher rates because those indicators have proved to be false signals in the past. “[That] made me think it was too early to make that decision.”
Meanwhile Martin Weale, one of the two Monetary Policy Committee members to vote for higher rates in August, said he had been influenced by his conversations with businesses, which had told him they were having to pay more for new recruits, together with data showing labour market turnover was starting to pick up. These “may be indicators that acceleration of wage growth might not be far round the corner,” he said.