As a Scot who loves his country, I feel it’s my patriotic duty to raise some of the many issues around Humza Yousaf’s pledge to go directly to the bond market to borrow up to £3bn. As a Fixed Income Investment specialist, I am unlikely to recommend the current proposed bond to my clients, as it is little more than political theatre. Here’s why.
The SNP say the bond will, ‘help raise Scotland’s profile and engagement with international investors to attract investment.’ Aye, because no one outside Scotland has ever heard of Scotland? Introduce me to a CIO, international banker or hedge funder who doesn’t play golf (ours), drink whisky (ours), drive a car (the tyres – ours), been cured by antibiotics (ours) or watched TV (ours). Yep. No one has heard of Scotland. Ever.
What this is really about is the one thing the SNP has had its mind on since taking the reins – independence. And ever since its countrymen voted against the idea in 2014, the party has tried every avenue to get it back on track. So much so, that watching them has been a bit like viewing a generic prisoner of war TV series. Think Colditz in kilts. Each episode sees them dig another tunnel, forge another key, build a glider in the attic, or forge a bond issue to buy their way out. However, no amount of creative political strategy can cover up their incompetence in regional government, let alone give the impression that they could run a successful independent state capable of issuing a credible bond.
So this pledge is little more than a distraction technique. But taking it at face value, what factors should we consider when pricing a Scotland bond?
Credit Risk
There are a couple of problems. At the moment I understand Scotland would borrow up to £3bn in debt, or give guarantees on debt, with the full faith and credit of His Majesty’s Government. No one questions the possibility of the UK ever defaulting on its debt – if the manager of the Debt Management Office found his piggy bank was empty on redemption day, then he can simply ask the Treasury to fire up the Sterling money presses.
But an independent Scotland would not have its own currency. It will likely be using Sterling. So if Scotland is broke when it comes time to repay the money we will have to ask the English, very nicely (something Scotsman are genetically incapable of), to give us the money. That’s not going to happen. Perhaps Scotland could adopt the Euro? But that raises the same issue – if asking the English (who at least will pretend not to gloat too much) would be hard, the Germans will be beastly.
Because it is not a financially sovereign nation with its own currency, Scotland is a credit risk – without access to a money printing press, how will Scotland repay interest and principal on its debt? That’s a function of taxes, the competence of the government, the strength of the economy – none of which are the SNP’s strong suit.
Debt to GDP ratio
There is also the question of how much of the quantum of outstanding UK government debt Scotland should assume if the UK splits up. Based on population, Scotland should expect to be responsible for 8.2% of the UK’s outstanding debt of £2.44trn, meaning its debt burden would be £200bn, which is a 97.5% Debt to GDP ratio – in line with the rest of the UK, plus of course, the £3bn the SNP will have issued by then, so call it 100% GDP. With that debt load, they can forget about joining the Euro.
Price talk on a Tartan Gilt
Then of course there’s the issue of what spread to gilts would Scotland, as a sovereign creditor (rather than a financially sovereign nation), issue debt? As a core nation within the UK, Scotland should probably trade similarly to a Canadian Province over Canada – at a narrow spread to reflect the lower liquidity and semi-sovereign nature of the credit. Even the belligerent Francophone Quebec trades as a function of Canada.
But, if Scotland threatens to break the Union in search of independence, different rules apply. Investors will need to price that risk into the bond. Without a UK government guarantee, Scotland’s credit is clearly worse, and the spread to the UK will widen dramatically.
There is actually some evidence of what that spread might be. Soon after Scotland got permission to raise its own debt in 2015, the Scottish Government, very quietly, provided a guarantee to payments made on hydro-electric power in a very convoluted private deal arranged by now disgraced financing firm Greensill. It involved the somewhat dubious Gupta steel making conglomerate. I looked at the deal and was amazed it had attracted a government guarantee. It was dodgy as can be. One of the funds that financed the deal became a forced seller. Bearing in mind it was guaranteed with a full faith and credit guarantee of the UK, but Scotland was still seeking independence, where do you think the price discussion was? How about 250-300 basis points over gilts.
That was for an illiquid, private debt deal issued by an Indian/UK company, but guaranteed by Scotland. For a public Scottish deal, it would be safe to assume the independence premium, the amount investors would demand for the risk Scotland would give up the UK guarantee, would be over 200 basis points. Scotland would end up paying 2% more for debt than England.
Scotland Credit Story
Then there’s the question of what kind of bet Scotland would be. A whiff of government corruption as wee Nicola faces time sewing mail-bags in the Women’s Wing of HMP Barlinnie is not an encouraging start. Nor is the handling of the Ferry contracts, Scotland’s failing education system, drugs deaths or a host of other SNP political failures. Political competency and sustainability counts in this game.
Personation
Finally, there’s the fact the global market place is unlikely to be particularly receptive to the Scottish Government presenting themselves to the world to sell their debut Sovereign Bond issue – pretending to be an independent nation, when it’s still very much part of the UK. Investors want facts, numbers and dull predictability from bond purchases. They won’t buy political fairytales.
This is an edited version of an article that first appeared on Blain’s Morning Porridge. Read the original article here.
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