Scottish bond issuance

The Treasury have issued a consultation paper today on bond issuance by the Scottish Government. This is very firmly consulting in the context of devolution with no reference to bond issuance under independence.

 

The consultation has some significant limitations, primarily because it is not seeking views on the amount to be borrowed by this mechanism. Any bonds issued have to be within the limits imposed by the Scotland Act 2012’s overall limits on borrowing. At present these are set at 10% of the Scottish capital budget (around £230m in 2014/15) subject to an overall limit of £2.2bn. The paper argues that controls on borrowing are necessary for the UK’s fiscal credibility that benefits the Scottish economy. The primary means of borrowing is the National Loans Fund (NLF). The Scottish Government may, with Treasury approval, borrow from commercial banks, but not from other commercial sources.

 

This power has to be viewed in the context of the Scotland Act 2012’s aim to devolve greater control of Scottish revenue raising. From April 2016, the Scottish Parliament will move from raising less than 15 per cent of its own budget to around 30 per cent. This will be achieved through the new Scottish rate of income tax (the 10p variation), devolution of land tax and landfill tax, the power to create or devolve other taxes, new borrowing powers and a Scottish cash reserve to manage volatility in devolved taxes. In cash terms, Scottish Ministers will control over £6 billion of tax revenues and they intend to establish a Scottish version of HMRC to administer this.

 

UNISON Scotland has long argued for the power to issue bonds and believed it should have been introduced with the other Scotland Act powers. The consultation paper is predictably negative about this power and this reflects the conservative approach of HM Treasury to borrowing outwith central government. It is fair to state that bonds can be more expensive than the NLF and that is why local government rarely uses their powers to issue bonds.

 

Bonds are a long term source of finance and allow access to wider pool of lenders. Importantly, these include the public and pension funds, giving a sense of civic pride in infrastructure projects. For this reason we believe that they could be particularly useful in financing capital investment by Scottish Water. Network Rail uses bond finance and because they are guaranteed by the government they attract AAA rating. Bonds at sub-sovereign level are common in the US, Canada, Germany and elsewhere across the world. The problem of a cost premium can be addressed by an explicit government guarantee. This is reasonable because central government is placing controls on the level of borrowing using this and other powers.

 

I would argue that these limits should simply be prudential borrowing, i.e. that the Scottish Government can fund its capital costs from current revenue. However, for the purposes of this consultation, bonds would be included in the total borrowing limits in the Scotland Act. So the ‘moral hazard’ or risks the consultation paper emphasises would be minimal. It is somewhat ironic that the paper highlights the additional cost of commercial borrowing, as that is precisely what the UK and Scottish governments have been doing for years through PPP schemes.

 

Overall, the consultation paper makes a grudging case for bond issuance and sets against that every possible negative scenario Treasury officials could possibly find. However, within their self imposed constraints these risks are marginal at worst. The gains from bond issuance may not be huge, but I would argue it is a worthwhile addition to the Scottish Government’s financial powers.

I will cover this issue and the wider fiscal implications of constitutional change in my presentation to Saturday's Red Paper conference in Glasgow.