It was inevitable, I suppose, that if the bond market calls UK Government securities ‘Gilts’ Scottish Government bonds would acquire the nickname ‘Kilts.’ It seems to have happened, if a report in the Financial Times is any guide, even though the bonds themselves have yet to materialise.
Amid the clamour for new powers for the Scottish Parliament – the recommendations of the Smith Commission and beyond – Scotland achieved a new one virtually unnoticed on April 1. On that day the Scottish Government gained the ability to issue sovereign debt – bonds – under one of the measures contained in the Scotland Act 2012.
It is not clear why borrowing was left out of the 1998 Act, which brought the Scottish Parliament into being and gave it limited fiscal powers with the ability to raise or lower the Standard Rate of Income Tax by up to 3p in the £ (a power which has never been used.) Perhaps the Treasury feared that a loss of control over a small slice of the Public Sector Borrowing Requirement might spook international investors.
It seems a groundless concern: local authorities raise debt on a regular basis, without causing any noticeable trouble for the UK’s credit rating.
The new power is fairly modest: the total of borrowing for any purpose will be limited to around £2.7bn, not a lot when set against a total annual budget of around £35bn. But it will enable Scottish ministers for the first time to run a small budget deficit. They may not want to do this, but could be forced to as Scotland becomes more dependent on raising its own tax revenue.
Until now the Scottish Government has been given money in a block grant and has spent it. At the beginning of the year the total is known, but when the money is gone it is gone, there has been no ability to go further. This is not the most efficient way to organise spending. To avoid running up against the buffers, government departments budget conservatively, so that there is usually a small unspent surplus at the end of the year, even though there may be worthwhile projects going without finance.
The 2012 Act changes that. From now on the Scottish Government will be responsible for raising a significant proportion of its own revenue by setting a ‘Scottish Rate of Income Tax.’ Its grant from London will be reduced by the same amount that this tax is expected to raise.
But tax yields can be difficult to forecast. The amount collected depends on earnings and employment and these are mainly set by the private sector, which is influenced by economic conditions at home and in export markets. An unforeseen crisis in the Eurozone, for instance, could hit Scottish Government revenues.
To enable the Scottish Government to deal with a situation in which it has made its spending commitments on a tax revenue prediction that turns out to be too optimistic, ministers will be able to borrow up to £200m in any one year. They will also be able to use borrowing to smooth out revenues across years and to borrow to finance capital programmes, although this is fairly limited.
Since the ability to issue debt is one of the attributes of an independent nation, you might expect the Scottish Government to be preparing its first ‘Kilt’ issue already. There are several reasons why it might not want to do that.
The first is that it does not need to right now and may not for a year or two. The second is that the sums it will need to raise are likely to be quite small. The Act gives it alternatives, such as borrowing from banks or from the National Loans Fund (essentially the UK Government), which is what most local authorities do. These may be simpler, possibly cheaper and, crucially, would attract less attention.
To issue debt on the international market, Scotland would have to be rated, as are all other countries. During last year’s referendum campaign the ‘Yes’ side foolishly claimed that an independent Scotland would achieve the highest rating, AAA. This was partly hubris and partly a misunderstanding of the term ‘investment grade,’ which the rating agencies had said would be likely to apply to Scotland.
The euphoria was punctured when Moody’s, one of the three leading international rating agencies, issued a statement saying that an independent Scotland would probably start with an A rating, two notches below the UK and at the same level as Estonia and Botswana. But that was with oil at $110 a barrel.
Scotland as part of the UK would be insulated from lower oil prices as long as the present financing arrangements are in place. But to request a rating now would open the question of how Scotland might fare, not only as an independent country, but under ‘Full Fiscal Autonomy,’ which the SNP wishes to achieve. That might be a debate the Scottish Government prefers to avoid at present.
This post first appeared on the David Hume Institute website and is republished here by permission.
Leave a Reply