Independent Scotland may face higher borrowing costs - NIESR report

LONDON (Reuters) - Scotland could have to pay more to borrow than Britain and sharply rein in spending if it votes for independence next year while still using the British pound as its currency, academic research released on Tuesday showed.

Wednesday will mark exactly one year until the Scottish population go to the polls on whether they want to remain part of a 306-year old union with Britain or go it alone as an independent state.

The London-based British government has been campaigning for Scotland to stay part of the country, while nationalist lawmakers in the devolved Scottish parliament are backing a ‘Yes’ vote for independence. But, nationalists say they want to retain the use of sterling rather than create a new currency.

Ahead of the one-year milestone, a report by the National Institute of Economic and Social Research said borrowing costs for an independent Scotland using sterling would be between 72 and 165 basis points higher than those on a 10-year British government bond. Scotland would also have to tighten its finances by 5.4 percent to hit EU debt targets, the report said.

The research highlights the difficulties Scotland is likely to face post-independence to convince investors of its ability to repay its debts with an economy whose finances are heavily dependent on volatile oil and gas revenues.

“For an independent Scotland to prosper it requires a ‘hard’ currency; one in which investors are willing to hold long-dated Scottish government debt at a reasonable price,” said Angus Armstrong, Director of Macroeconomic Research at NIESR.

“A necessary condition for a ‘hard’ currency is that government solvency must always be beyond doubt.”

Scotland is likely to have to take on a share of British debt as part of any independence agreement, and investors are expected to demand a higher return in order to shoulder the burden of increased risk on the Scottish side of the border.

Based on the current gilt yield of 2.9 percent, that could mean Scotland paying up to 4.55 percent to issue a 10-year bond.

The report estimates that to bring its debt-to-output ratio to the 60 percent level recommended by the European Union, Scotland would need a decade of fiscal tightening with a primary surplus of 3.1 percent. Scotland has averaged a 2.3 percent primary deficit between 2000 and 2012, NIESR said.

The authors are funded by the Economic and Social Research Council which is funded mostly by the government’s department of Business Innovation and Skills to produce independent research.

editing by Ron Askew