Friday, 26 September 2014

What the Scottish Nationalists will do next – a better currency plan for the next referendum - Prof Perri 6 - Chair in Public Management, Queen Mary

Stone of Scone: Soon to be available in notes and coins
Developments in the middle east have moved Westminster politicians' attention, and that of London journalists, on from the fallout from the Scottish referendum. But expectations have now been raised both in Scotland for further devolved powers and in England for constitutional change which will soon return these issues to the top of everyone's agenda. Indeed, already the shape of the coming debate is becoming clearer.

This article considers first, what the Scottish National Party is likely to do next to pursue its aims, given the position that its 45% vote and the response of the Westminster politicians has put that party in. In later posts, I shall I turn to the question of how the two largest unionist parties might address the dilemmas each faces.

Having come fairly close to a majority for secession, the new leaders of the SNP who take over from Alex Salmond will be looking for an opportunity to capitalise on the momentum they were able to sustain in the final months of the 2014 referendum campaign. The “vow” made by the leaders of the three main unionist parties in their last-minute intervention to persuade wavering Scots to support the union will soon present the SNP with an opportunity. Because the vow's terms were so imprecise (see my article about its limitations published immediately after the leaders' statement, it should not be too difficult for the next SNP leader to declare whatever the government offers as being in default, by comparison with what the SNP will claim they were led to expect. Should Conservative backbenchers make determined effort to make the offer of further devolution for Scotland conditional upon reform of the voting system in Westminster on laws which are to apply only in England, the SNP will find it easier still to try to charge UK politicians with “reneging” on whatever the SNP claims the terms of the “vow” led it to expect. The next step for the SNP will be to claim that this default releases it from the terms of Mr Salmond's undertaking not to bring back the question of independence to a second referendum for “a generation”. It appears that many Scots expect no less. Lord Ashcroft's organisation polled Scots after the referendum, discovering no fewer than 45% of “yes” voters thought it likely that the SNP would find a way to bring the question back before the Scottish people within five years.

But before the SNP can credibly come before the Scottish people for a second referendum, they will know that they must address some key gaps in the case they presented in September 2014. The polling done immediately after the referendum by Lord Ashcroft's organisation showed that concern about the currency or related economic issues were key factors for many of those who voted “no”: almost half of “no” voters picked those as critical factors in their decision, and more than half said it was a factor.

What are the SNP likely to offer? Re-running the proposal of a currency union with the remaining UK will clearly not convince voters. “Sterlingisation”, or using the pound without an agreement so that Bank of England would set interest rates and the money supply to suit the interests of the continuing UK but not Scotland also clearly had little appeal for Scottish voters and, if suggested again, will raise the same fears among businesses which proved important in 2014.

Of the two remaining options, we can probably exclude the possibility that the SNP would announce they would use the euro. The euro is not popular in Scotland anyway. To businesses, euro-isation is no more attractive than sterlingisation. But no currency union agreement would be available with the Eurozone, because Scotland will have to reapply for membership of the EU first and accession could take a considerable period of time.

The only remaining option, therefore, is for Scotland to plan to set up its own currency, at least for a period of time, even if in due course it might enter the euro, at least if the prospects for that currency improve from the zone's present plight. This certainly has risks. But there are ways to mitigate them. And after all many countries which become independent do create their own currency. Perhaps it might called the “scone”?

The first step would be for the SNP to create a shadow central bank, well before a referendum. It would probably be chaired by a distinguished economist and a team of credible experts in monetary policy, financial services regulation, financial operations and monetary risk management. The SNP government would have to publish a detailed scheme setting out its proposed powers and resources. Ideally, it might help the SNP to have operated their shadow central bank for as much as eighteen months before the date of a second referendum, in order to build up public recognition and business confidence in it.

Together with their shadow central bank, the SNP leadership would probably try informally to explore with key figures in the International Monetary Fund what kinds of terms the IMF would demand for a big loan to a newly independent Scotland to provide it with enough foreign currency reserves to enable the country to withstand the first year or eighteen months of volatility on the foreign exchange markets. The loan for reserves would have to be big enough both to smooth out foreign exchange market volatility and to provide a backstop for some kind of Scottish scheme of deposit insurance for household savings in bank branches in Scotland. Results of a “stress test”, carried out by independent experts, on the size and planned use of the loaned reserves would have to be published before the referendum. This will be critical, in order to assure Scottish businesses that a Scottish government would mitigate their currency risk, both immediately after a referendum victory and throughout the period to the formal declaration of independence and beyond.

Realistically, the SNP must expect that RBS and Lloyds would relocate their headquarters and registration to London so that they can continue to benefit from the Bank of England's protection and, unless they have been privatised by then, from continuing UK “bail out” funds. This would probably be no bad thing for a newly independent Scotland anyway. Iceland's experience as a country with a small population and therefore a modest tax base, unable to stand behind over-leveraged and over-sized banks, reminds us that Scotland might well be better without having the markets regarding two troubled banking giants on the new state's list of contingent liabilities.

Next, the SNP will need to produce an outline scheme of fiscal policy for the first few years of independence, showing how they would configure taxes and spending in a variety of plausible scenarios for trends in Scottish GDP, current trade deficit, gross domestic capital stock, tax revenues etc., in the first few years after the day of the vote itself, and not just from the date of formal announcement of independence. This would have to include a plan for the kinds of government debt instruments they would envisage having to issue, as well as for the share of UK public sector debt they would commit to accepting. With a scheme of that kind, an SNP government could ask the major credit rating agencies, not to publish a full rating – that would be impossible prior to independence – but to comment publicly on their likely view of the scheme's profile. This would enable the SNP to adjust and respond in advance of the referendum.

When the SNP comes to seek agreement with London for recognition of the result of a second referendum, a number of items will have to be on the agenda which were not the subject of the talks which led to the Edinburgh agreement. Ironically, if the critical views of the union and of Scotland expressed by many Conservative backbenchers since the September 2014 referendum are more influential in the Conservative party, this might actually help the SNP in their negotiations for recognition, because that might mean that they could be dealing with a Westminster parliament in which a greater part of the right might positively prefer Scotland out of the UK than is the case while Mr Cameron is still leader of his party. Goodwill for Scottish exit of this kind might be needed because the SNP would have every reason next time to ask, as part of the terms of recognition for the second referendum, for an agreement that the Bank of England would provide short term transitional assistance in standing behind Scottish banks which do not relocate, from the day when the results of the vote are announced and then for perhaps eighteen months. This would free up funds borrowed from the IMF for other stabilisation and firefighting operations in currency management.

Secondly, a Conservative party no longer so committed to the union would be helpful to the SNP is conducting better and deeper prior informal talks with the European Commission than Mr Salmond managed to achieve in 2014. For in a second referendum, it will important for the SNP to be able to say something clear and coordinated with the President of the Commission about the likely timetable for accession negotiations. At the every least, the SNP will want the President to say that Scottish accession would not be classified as “enlargement”, because the country has been in membership through the UK since 1973, and therefore Scottish accession talks need not fall under Mr Juncker's policy of a “go slow” on further expansion of the Union. I do not underestimate the difficulties for a Commission President in being helpful, especially if the Spanish government chooses to try to block the making of any prior commitments even to a timetable. Certainly, there is no precedent. But if the remainder of the UK has not by then voted for leaving the EU, or “Brexit”, in its own referendum and the Conservatives want to assist Scotland to leave in the hope that they might then dominate the politics of a devolved structure for England, talks with the Commission about a timetable for Scottish negotiations on accession, even before the referendum, might be easier to secure. This would be especially valuable in reassuring the business community in Scotland of their continuing access to the single market.

For these reasons, the SNP may actually have an interest in seeing a Conservative government in power in the Westminster parliament at the time when they plan to run a second referendum, at least provided they can run their independence referendum before a UK Conservative government sought its own referendum on “Brexit”. On the other hand, though, a 2017 Brexit referendum would give the SNP very little time to set up its shadow central bank, work out its fiscal scenarios, negotiate recognition and begin to sound out the IMF.

Even if the SNP can put all of these arrangements in place, they will not and cannot eliminate all currency risk, and should not seek to appear to promise more currency stability than they can realistically offer. Nonetheless, with a sizeable IMF loan for reserves, a Bank of England transitional support commitment, a credible shadow central bank team and scheme of powers, a set of fiscal contingency plans for market volatility, a timetable for EU accession, the SNP leadership would be able to show voters and businesses in Scotland that they have done all that realistically could be put in place before a vote to reduce and to mitigate the currency risk problem which undermined Mr Salmond's offer in 2014.

So my expectation is that the SNP will probably use the next few months to build among Scottish voters a climate of disappointment and sense of being reneged upon by Westminster, while privately cultivating better links with the increasingly vocal anti-unionist Conservatives in London. I expect that they will begin some quiet, behind the scenes diplomatic work to sound out leading economists, key figures in the IMF and the newly appointed European Commission. And finally, they will do anything they can to stir disunion among the Westminster parties about the terms of any reform of voting in the House of Commons on laws applying only to England.

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