Up until early September, most commentators, economists and investors had placed a very small probability on the referendum returning ‘yes’. However, since the second televised debate between Alex Salmond (leader of the independence campaign) and Alistair Darling (leader of the ‘Better together’ campaign), polls of voting intentions have swung sharply towards independence, with one poll suggesting that an outright victory is possible.
Chart: Latest voting intention poll + 10-poll moving average
Source: ukpollingreport.co.uk, whatscotlandthinks.org. Updated 11 September 2014.
In reaction to the news, sterling has depreciated by about 1.1% against the US dollar and by 0.8% against the euro since the end of last week. Moreover, a number of stocks with heavy exposure to Scotland have also seen notable falls in their share prices this week. Investors are rightly concerned by the trend, especially as the uncertainty that a ‘yes’ outcome presents for not only Scotland, but also for the rest of the UK.
We published an in-depth study on the issue in July (Scottish independence: economic and political challenges), but here are some of our conclusions:
- The issue over an independent Scotland’s future currency is far from resolved. In our view, the main UK political parties are not bluffing and will not agree to a currency union. In any case, an independent Scotland in a currency union with the rest of the UK raises the same risks that caused the sovereign debt crisis in Europe. A currency union without political and fiscal union can lead to moral hazard, and would also severely restrict Scotland’s economic freedom. An independent Scotland is highly likely to have to have its own currency, or it will attempt to use sterling without the permission of the rest of the UK. Both options carry differing risks and benefits, but both will ultimately introduce a huge amount of uncertainty for businesses based in Scotland.
- There is still no acknowledgement from the Scottish government over the country’s fiscal position. The over-reliance on North Sea oil and gas means tax revenues are highly volatile, but also that the long-term outlook is poor – as output, and therefore revenues are forecast to decline substantially.
- EU membership for an independent Scotland is a doubt, especially as countries with separatist movements would block Scotland’s accession in order to avoid creating a precedent. This places many companies but especially banks in danger of losing access to the world’s biggest market.
- The political fall-out on the rest of the UK will be huge. The Labour party, which currently leads in opinion polls for next year’s general election, could lose up to 16% of its seats, making it much more likely that the Conservative Party wins an outright majority. What is not being appreciated by investors at the moment is that this would almost guarantee a referendum on the UK’s membership of the EU, and without Scottish voters involved, we are more likely to see a vote for ‘Brexit’. According to a YouGov poll conducted in December 2013, UK (excluding Scotland) would see 46% voting to exit against 37% voting to remain in the EU, while 50% of Scotland would want to remain members, against 34% in favour of leaving.
- With the loss of North Sea oil and gas, the UK’s public finances would be worse off, but the more important impact would be on the trade and current account deficit. The UK’s current account deficit is currently around 4.5% of GDP, but this could rise to between 5.5-6.5% if Scotland leaves. This is would push the current account deficit towards levels associated with a balance of payments crisis, which is very likely to trigger a sharp depreciation in GBP.
Overall, both international and domestic investors are right to be concerned over the prospects for a ‘yes’ vote in seven days time, and we are not surprised to see heavy hitting Westminster politicians scrambling up to Scotland to make a last ditch effort. In the event of a ‘yes’ result, the UK and Scotland could be plunged into a huge pool of uncertainty, as the negotiations that follow will undoubtedly be messy, and potentially damaging for the reputation of both countries. In the event of a ‘no’ vote without a significant margin, the issue is likely to remain for many years which will prompt investors to place a risk premium on dealing with Scottish entities.