Fitch Assesses Impact of an Independent Scotland

Based on the latest polling figures, Fitch Ratings says that it expects a ‘no’ vote in this September’s referendum on Scottish independence.

However, the credit ratings agency (CRA) adds that the implications of a possible ‘yes’ vote for the residual UK (England, Wales and Northern Ireland) still merit closer analysis given there would be additional, albeit moderate risks for the UK’s public debt, external finances, currency arrangement and banking sector.

A ‘yes’ vote would be followed by a transition period, where many details would need to be agreed ranging from political and legal issues to economics, finance and trade. Fitch would expect the transition to be managed carefully, avoiding financial dislocations. The CRA would review the UK’s rating, currently AA+/Stable, and its rating response would depend on the terms of the agreement between Scotland and the UK.

In a preliminary assessment in October 2012, Fitch commented that Scottish independence would probably be neutral for the UK’s – then AAA – rating.

However, this assumed no impact on gross public debt – something that now looks very unlikely. The UK government has recently stated that in the event of Scottish independence, it would in all circumstances honour its issued stock of UK debt. This would lead to a one-off increase of 9.5% of gross domestic product (GDP) in the UK gross public debt ratio as Scotland was stripped from UK GDP from 2016.

Fitch has previously emphasized that the UK’s gross debt ratio will need to be lower than its current level and steadily declining before any upgrade back to AAA; a prospect that would be delayed by such a debt shock.

The CRA assumes that Scotland would be responsible for a proportionate share of existing public debt in the form of a long-term bilateral loan, giving the UK an off-setting claim on Scotland. This UK asset would be taken into account in Fitch’s judgement of the overall position of the UK’s public finances. It assumes that Scotland would gradually repay its loan to the UK. However, it would be illiquid and leave the UK exposed to Scottish credit risk, at least in the early years of independence.

Scottish independence would likely be mildly negative for the UK’s balance of payments and external balance sheet, albeit its magnitude is highly uncertain. ‘UK plc’ would likely lose most of its hydrocarbon export receipts, though this would be partly offset by the trade surplus on other goods with Scotland as well as profit and dividend flows. The UK would also become more leveraged as result of Scottish claims and obligations being reclassified as external assets and liabilities.

Scotland’s monetary regime post-independence would also have implications for the UK. There is a range of hypothetical options – from a pegged or free-floating currency to a currency union – although the three main UK political parties have ruled out a currency union. All options would pose some new risks to the remaining UK. These risks range from competitive devaluation and exchange rate risk on Scottish exposures to fiscal contingent liabilities, depending on the monetary regime.

The banking system could swell in the UK if some Scottish institutions relocate their headquarters to London post-independence. This could expand the size of the UK banking sector from an already high 492% of GDP. Scottish independence would also leave the highly integrated financial system with higher cross-border and potentially foreign-currency exposures.

The full report, entitled
‘UK: Rating Implications of Scottish Independence’
, is available at www.fitchratings.com.

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