The United Kingdom and Scotland: The Implications of Independence for England's Northern Neighbor
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The United Kingdom and Scotland: The Implications
of Independence for England’s Northern Neighbor
June 2014
If Alex Salmond gets his wish, September 18, 2014 will be Scotland’s
Independence Day. That’s when Scottish citizens go to the polls to vote on one
question: “Should Scotland be an independent country? Yes/No.” As the leader
of the Scottish National Party (SNP), Salmond has worked tirelessly to get the
majority of voters to say “Yes” to the question. He’ll know in a just a few months
Scott Camp
whether he has been successful in bringing about Scotland’s breakup with the
Analyst/Trader
International Equity United Kingdom (UK).
Independence is no doubt appealing to many proud Scots. Based in large part on a pro-
independence platform, Salmond and his SNP were swept into power in 2011 with a clear
majority in Scotland’s parliament. However, Scotland would confront numerous uncertainties
if it left the UK, and it’s not only Scotland that would face an unpredictable future: The UK
itself would be sailing in turbulent waters, with near-term consequences that could disrupt an
economic recovery that is still fragile.
We recently visited the UK to gain a better feeling of what Scottish independence would mean
for Britain. After meeting with business executives and government officials, we came away
with a solid understanding of how the uncertainties affecting the UK could adversely affect
its economy. While the odds are that Scotland will not vote for independence, the risks and
unknowns feed into an outlook for the UK that is less positive than it has been recently. The
prospects for continuing currency headwinds, a rising current account deficit, and speed
bumps for the domestic economy reinforce our current strategy of reducing our exposure to
the UK in our portfolio.
THE ARGUMENTS FOR INDEPENDENCE
At the core of the nationalists’ case for independence is that decisions about Scotland would be
made by the people who live and work in Scotland. Many Scots believe that their contributions
to the UK’s finances have been mismanaged, a perspective that became more widespread
in the wake of the financial crisis in 2008. Salmond and his followers think that the UK’s
economic policy disproportionately benefits London and Southeast England, and that Scotland
could better craft a policy aimed at economic stability and job security for its citizens. Simply
put, it boils down to public money and how it’s being spent.
pnccapitaladvisors.comTHE CASE AGAINST INDEPENDENCE
As vocal as independence supporters are, many Scots favor remaining in the UK. An independent
Scotland would mean creating a brand new country, and all the services and structure currently provided
in the UK would no longer be automatically available to Scots. Exactly how the new country would work –
from the economy and taxes to defense and public services – would be up in the air.
Among the most significant concerns are the following:
Relocation risk. A newly independent Scotland poses risks and uncertainties to companies
headquartered there, creating the motivation for them to relocate. Especially vulnerable is Scotland’s
huge financial services and banking sector, which accounts for 8% of its GDP and over 7% of its total
employment. Standard Life, a leading provider of insurance and long-term savings and investments,
has already given notice that it could move its headquarters in the event of a “Yes” vote. Bank of England
Governor Mark Carney has said that there is a “distinct possibility” that the Royal Bank of Scotland and
other large Scottish banks would have to relocate to the UK. The loss of major banks, insurers, and
other financial services companies would be a big blow to Scotland’s economy. Many companies in other
sectors are also considering the possibility of moving out of Scotland due to the uncertainties associated
with independence.
Currency. Scottish nationalists believe that they will be able to continue to use the UK pound through
some sort of sterling currency union. That’s a huge assumption, especially since regarding the
nationalist belief that Scotland will be able to use the pound, UK Chancellor of the Exchequer George
Osborne said that “the people need to know that is not going to happen.” He also called a currency union
a “high risk experiment” and remarked that the durability of a currency union would be questionable
from the outset. A currency union is no simple matter. If countries share a currency, each has to accept
constraints on fiscal policies and limits on budget deficits and government debts. The euro is an excellent
example of the problems that surface when monetary union is not accompanied by strong fiscal rules
shared by members.
If a currency union is not available to Scotland, it must either issue its own currency – a step that would
subject investors, businesses, and citizens to significant risks – or join the euro. Regarding the latter option,
the European Union (EU) is not expected to offer immediate euro membership to an independent Scotland.
In addition, Salmond and his supporters believe the Bank of England would be the lender of last resort if
Scottish banks get into trouble. Scottish nationalists apparently think English, Welsh, and Northern Irish
citizens would be comfortable if the UK’s Bank of England propped up troubled Scottish banks.
It’s not just Osborne’s Conservative Party that’s taking a hard line: All three of the largest political
parties in the UK have ruled out sharing the pound or the Bank of England in a formal currency union. In
summary, Scotland’s currency is a major open issue, one that will be thrown into the tough negotiating
mix that includes how North Sea revenues and existing public debt are divided in the breakup.
International economic relationships. Scottish nationalists believe there are legal mechanisms that
would ensure that the new country would be an EU member. However, an independent Scotland would
need to apply to join the EU, and there is no guarantee that Scotland would be accepted. All 28 EU
member states would need to agree to the terms of Scotland’s membership in what would be a complex,
lengthy process. Spain may be difficult to convince since it has its own separatist Catalonian movement
that it wishes to discourage. Even if Scotland is accepted, it probably could not expect to retain the same
terms of membership as the UK.
2 The United Kingdom and Scotland: The Implications of Independence for England’s Northern NeighborScottish businesses conduct the vast majority of their trade with England, Wales, and Northern Ireland:
70% of Scottish exports (40% of all Scottish goods and services) go to the rest of the UK. Independence
could make doing business more costly, causing trade to move less freely and adversely affecting income
and jobs.
Public finance and services. The services and organizations that are now shared will stay part of the
UK, leaving the new Scotland with the task of creating its own institutions and structure. Scotland
shares over 200 public institutions as part of the UK, and separating these would entail a long and
complex process. Scotland currently benefits from its place in the union: Public spending is 10% higher
per person in Scotland than across the UK as a whole. The UK Treasury estimates that each Scot saves
at least £1,400 per year as a direct result of being part of the UK and benefiting from the UK’s public
finances. Independence would mean leaving the UK’s stronger public finances and managing challenges
separately, potentially resulting in higher taxes and cuts to public services.
If Scotland achieves independence, the remaining UK will insist that it takes some portion of Britain’s
existing public debt. An independent Scotland will no doubt face borrowing costs that are significantly
higher than the UK’s. In addition, an independent Scotland that keeps the same state age and pension
policy would need to either raise taxes, reduce spending in other areas, or incur higher debt levels,
according to a report issued by the Pensions Policy Institute on June 16.
Energy. The SNP believes that revenues from North Sea oil and gas will allow it to create a sovereign
wealth fund, enabling it to invest in the country’s future. Independence advocates also believe that
revenues will be sufficient to implement a stabilization fund that will smooth out rough patches in the
government’s finances. However, opponents argue that oil and gas revenues will be absorbed by funding
for public services, with little left over for investing.
In addition, impartial observers say that Salmond and the SNP are being wildly optimistic about
North Sea revenues. The SNP claims that North Sea oil and gas will produce more than double the
tax revenue neutral economists have estimated, even though Salmond has been forced to admit that
previous forecasts by “Yes” advocates were billions of pounds too high. The SNP’s analysis predicted the
industry will produce £34.3 billion between now and 2018/19 compared with the UK Office for Budget
Responsibility’s (OBR) projection of only £15.8 billion. And while the OBR believes North Sea energy will
provide the government with just £2.9 billion in 2016/17 – the year Salmond has scheduled for Scotland
to separate – the SNP says the figure would be £6.9 billion. In assessing these dueling claims, it’s
interesting to note that the OBR has a history of overestimating North Sea revenues.
The UK government is committed to North Sea oil and gas production for the UK economy through tax
incentives to support extraction and provide decommissioning relief. This ensures a certain level of tax
relief that companies will receive for paying to make decommissioned platforms, pipelines, and other
facilities safe. On decommissioning relief alone, an independent Scotland would have to invest around
£3,800 per head – over 10 times more than when costs are spread across the UK – to match the £20
billion the UK government has already committed.
WHAT ARE THE ODDS?
While polls have consistently shown that the pro-union “No” campaign is in the lead, the gap is
narrowing. On June 15, pollster ICM released results that showed support for separation rose two points
to 36% while “No” voters declined by three points to 43%. According to poll results released by Panelbase
on the same day, 43% back the campaign for independence – up two points from May – with those against
independence declining one point to 46%. (Panelbase was commissioned by the “Yes” campaign, which
may account for the more positive “Yes” results.) As is the case in many elections, it is the undecided
voters who will decide the outcome.
3 The United Kingdom and Scotland: The Implications of Independence for England’s Northern NeighborIMPACT ON THE UK AND OUR INVESTING STRATEGY
The outlook for the UK in the event of Scottish independence has implications for the PNC Capital
Advisors International Growth Equity strategy. Prior to 2008, our portfolio typically had an underweight
allocation to the UK. When the financial crisis hit, the British pound fell and the UK economy was battered
during the Great Recession. Due to competitiveness from a cheaper sterling, the austerity measures
taken by the UK government, and the BOE’s bold actions to stabilize markets and bail out banks, we
believed the UK economy had an opportunity to outperform the EU (except for Germany). As a result of
Britain’s global competitive advantages and relative lower risk, we began in 2009 to overweight the UK.
Euro per British Pound
After struggling through the Great
18-Jun-2004 to 19-Jun-2014
Recession, things have been going well
1.6 for the UK. GDP was up a healthy 3.1%
Average: 1.29 High: 1.51 Low: 1.03 Last: 1.23
1.5
in the first quarter, and April’s growth
in industrial output was at its fastest
1.4 annual pace in three years. Inflation
1.29 is below 2%, strong jobs growth has
1.3
1.23 pushed unemployment to a five-year
1.2 low, and wages are growing, albeit
1.1 slowly. Housing has rebounded and
is serving as a major contributor to
1.0
‘05 ‘06 ‘07 ‘08 ‘09 ‘10 ‘11 ‘12 ‘13 ‘14
domestic growth.
Source: FactSet The massive uncertainties surrounding
a breakup with Scotland puts the UK’s
recovery at risk. The UK would lose the shared regulatory and institutional framework it currently has
with a separate Scotland, along with an integrated labor market, knowledge base, and infrastructure.
The UK would also give up a large portion of the revenues from North Sea energy, and the defense policy
would need a thorough revamping.
Importantly, a breakup could worsen Britain’s current account deficit, which for 2013 was already
running at historically high levels. As the pound strengthened and the UK domestic economy improved,
imbalances surfaced that caused Britain’s current account deficit to soar. If confidence in the UK weakens
and the pound comes under further pressure with an independent Scotland, the current account deficit
could swell even larger as imports become more expensive. That raises the risk of higher inflation and
rising interest rates, which could choke off consumer spending and home purchases. UK borrowing costs
would rise, at least in the short-to-intermediate term. And while a weaker pound would help exporters, it
would take time to see the benefits.
From a market perspective, any sell-
UK Current Account Deficit as % of GDP
off resulting from an independent
0 Scotland would probably be modest in
the short term, perhaps in the 5-6%
-1
range. The risk is in the long term,
-2 where the disadvantages of a separate
-3
Scotland would have a greater impact
on British and Scottish stocks.
-4
The good news is that the market
-5 appears to believe that Scottish
-6
independence is unlikely. If investors
‘04 ‘05 ‘06 ‘07 ‘08 ‘09 ‘10 ‘11 ‘12 ‘13 thought a “Yes” vote was imminent,
Source: there would be selling pressure on
4 The United Kingdom and Scotland: The Implications of Independence for England’s Northern NeighborThe United Kingdom and Scotland: The Implications
of Independence for England’s Northern Neighbor
UK securities. At this stage, that pressure is not happening, suggesting that the market considers a vote for
independence to be unlikely. Nevertheless, the strengthening of the pound and imbalances that are manifest
in the current account deficit are impacting our portfolio’s allocation to the UK. We have begun to reduce our
weighting to the UK, moving incrementally to exit some positions. While we’re reducing overall exposure,
we remain biased to domestic, consumer-oriented companies positioned to benefit from higher levels of
consumer spending. We also continue to invest in larger international UK businesses that have shown the
ability to increase sales abroad, while also minimizing the negative effects of a stronger pound. Specifically,
we look for companies that are able to export their costs away from sterling and/or successfully hedge their
currency exposures.
Ironically, UK Prime Minister Cameron is embroiled in another secession issue. Cameron is under pressure
from the anti-EU UK Independence Party and the right wing of his own Conservative party to bolt from the
EU. Up for re-election next year, he has promised to hold a referendum on EU membership in 2017 if his
party is in control of the government. Scottish voters are more pro-EU than other UK citizens, and the loss
of this segment if Scotland leaves the union would hurt the UK’s chances for staying in the EU. It’s far too
soon to focus on an EU referendum that may never come about – Cameron’s party could lose, making the
commitment moot. There will be much more to come on the UK and EU.
This publication is for informational purposes only and reflects the current opinions of PNC Capital Advisors, LLC. Information contained herein is believed to be accurate, but has not
been verified and cannot be guaranteed. Opinions represented are not intended as an offer or solicitation with respect to the purchase or sale of any security and are subject to change
without notice. Statements in this material should not be considered investment advice, a forecast or guarantee of future results. To the extent specific securities are referenced
herein, they have been selected by the author on an objective basis to illustrate the views expressed in the commentary. Such references do not include all material information about
such securities, including risks, and are not intended to be recommendations to take any action with respect to such securities. The securities identified do not represent all of the
securities purchased, sold or recommended and it should not be assumed that any listed securities were or will prove to be profitable. Indices are unmanaged and not available for
direct investment. This publication has been prepared without taking into account your objectives, financial situation or needs. Before acting on this information, you should consider its
appropriateness having regard to your objectives, financial situation or needs. Past performance is no guarantee of future results..
This publication is the property of PNC Capital Advisors and is intended for the sole use of its clients, consultants, and other intended recipients. It should not be forwarded to any other
person. Contents herein should be treated as proprietary information. This material may not be reproduced or used in any form or medium without express written permission.
PNC Capital Advisors, LLC is an SEC-registered investment adviser, offering an array of investment strategies. PNC Capital Advisors, LLC is an indirect subsidiary of The PNC Financial Services Group, Inc.
IN V E S T MEN T S: NOT F DIC IN S URED - NO B A NK OR F EDER A L G O V ERNMEN T GUA R A N T EE - M AY LO SE VA LUE
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