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Using sterling unilaterally while not accepting its share of the UK’s debt would condemn a newly independent Scotland to “unprecedented austerity”, according to a new paper from the National Institute of Economic and Social Research.

Alex Salmond, leader of the Yes campaign, has repeatedly threatened that Scotland could walk away from its share of the UK’s public debt if Westminster refuses his request for monetary union. He has stressed that there is nothing to prevent Scotland continuing to use the pound informally, a policy known as “sterlingisation”.


“Sterlingisation” combined with a repudiation of debt “would lead to an unprecedented degree of fiscal austerity”, says Angus Armstrong, Niesr’s director of macroeconomic research. “It is hard to believe people would accept this level of austerity after being promised higher government spending.”

He believes Scotland would need to run a current account surplus of at least £5bn a year to build up the foreign exchanges reserves necessary to make the use of sterling credible – but the new country would struggle to tap international markets after a repudiation of debt that would be viewed as a default, whatever its technical status.

“The question then becomes whether there is the political will to defend the exchange rate by accepting high unemployment and lower incomes . . . and by mobilising sufficient international support to backstop this transition,” Mr Armstrong writes. He concludes that Scotland would do better to issue its own currency swiftly – before losing its small stock of foreign exchange reserves defending sterlingisation.

Mr Armstrong has been among the most forceful critics of the Yes campaign’s currency plans. Others consider the currency question to be more tractable, but highlight the risks of capital flight and the need for strict fiscal discipline – possibly bolstered by external support – while any new regime was put in place. “The real issue is that if there is a flight of deposits, Scotland is in no position immediately to replace it,” said Charles Goodhart, an LSE professor and former member of the Bank of England’s Monetary Policy Committee.

DeAnne Julius, a former MPC member and Bank of England court director, notes that with two years to negotiate the terms of independence, Scotland “could also negotiate with the IMF for a credit standby to be drawn on in case of currency turbulence when it had to formally leave the UK currency union”.

This would give it time to build up reserves and would provide an emergency backstop, “but Scotland would still face a very difficult period . . . 
which would cause many Scottish businesses and banks to relocate”, she adds.

Steve Hanke, a professor at The Johns Hopkins University in the US who helped Ecuador and Bulgaria set up new currency regimes, argues that establishing a peg to sterling would be technically straightforward – and simply continuing to use sterling even simpler. He views the fiscal austerity required to make this credible as a benefit.

“Estonia got rid of the rouble in just over a month. Transition is completely a non-issue,” he said. “If the Scots want to have unilateral sterlingisation, that’s fine – but they will have to run a tighter ship.”

Copyright The Financial Times Limited 2017. All rights reserved.
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