In the run up to the referendum, we republish Ralph Blake’s article from February on currency union
Mark Carney private words to the Scottish Financial Enterprise (SFE) members on his visit to Scotland outlines the Bank of England’s (BOE) conditions for currency union writes Ralph Blake
. BOE governor simply said the BOE would need a fiscal compact with Scotland to have currency union. The outline of this pact would be that Scotland’s deficit cannot be above a set % of GDP, the structural deficit must be below a certain % and the ratio of debt to GDP to also below a certain %. If the latter two conditions are above these limits at currency union then there must be a plan of cuts to bring them inline. This will be monitored annually. Failure to meet targets will mean the end of the currency union. The SNP’s currency union is much more than simply using the pound. That in itself would not require any fiscal pact. It is their other demands of: the BOE underwriting the Scottish banking and financial sector; the Treasury underwriting Scotland’s historic debt and issuing any new debt on Scotland’s behalf.
With Scotland’s deficit, including 90% of North Sea Oil tax revenues, ranging over the last four years between £14.5 billion and £7.5 billion and those oil tax revenues varying from £6 billion to £10 biillion, Scotland’s deficit has had a range from 11% to 5% of GDP (it was 8% in the last financial year). This would mean that if Scotland entered such an agreement they would likely be faced with making cuts in spending to keep the deficit within the fiscal compact as well as the further cuts to bring the debt to GDP ratio down from around 75% now to a lower agreed level. Alec Salmond is right about Scotland deciding its own tax rates and deciding on how it spends its money. What he fails to tell anyone is the amount Scotland can spend will be limited by this fiscal compact. The BOE requires these conditions because of the volatility of oil revenues and hence the volatility of the deficit and the lack of political control of the Scottish economy and financial sector by Westminster.
The other revelation to the SFE is that the fiscal pact is an academic question anyway. That is because all the Westminster parties apart from the SNP have rejected it. They will play this card repeatedly throughout the referendum campaign in 2014.
This leaves Alec Salmond with a number of options.
Firstly, continue to use the pound but issue your own debt while walking away (essentially a default) from its historic obligation (the latter Salmond has threatened to do in the Financial Times[i]
). Borrowing costs would be very high because of the volatility of the deficit and a potential further default.
Secondly, issue your own currency but try and peg it to the pound but this would require reserves way beyond what Scotland could command even with its population share of the BOE’s reserves and still leave the problem of high borrowing costs.
Thirdly, use the pound but take the EURO on re-entry into the European Union (EU). It is likely that if Scotland has to negotiate to become a new EU member which is what several senior EU commission officials are stating Scotland as new nation will have to do as a condition of membership and eventually take up Euro. This is what happened with Iceland’s membership which has now stalled over the Euro take up. It would still leave the problem of issuing debt and underwriting the banking sector neither of which the EU or European Central Bank does for its member states.
Finally, the radical alternative that we have been putting forward which is take the Norwegian road and nationalise the oil, introduce progressive taxation and join the European Free Trade Alliance.
It is key that the left wing of the independence movement advocates the radical currency option otherwise they will become caught in the SNP’s currency trap which will only weaken the case for independence.
Ralph Blake is the pen name of an analyst in the Scottish financial sector who attended Carney’s briefing to SFE.