It's so hard to say good bye

By C.W. | LONDON

THIS time next year, the question of Scottish independence will be decided. New research published by the National Institute of Economic and Social Research, presented in Edinburgh this week (and not yet online), talks about Scottish currency. Not terribly glamorous, but rather important. And there is bad news for Alex Salmond, leader of the Scottish National Party (SNP).

A newly-independent Scotland would take on some British debt. According to one measure, it might have to shoulder as much as £180 billion in obligations ($291 billion) or 120% of its annual output. A more likely figure, according to the paper, is 86%—still high.

How exactly Scotland would acquire its share of Britain's debt? It would be difficult for the British government to transfer the debt to Scotland, leaving them to repay it; doing so could effectively mean that the government was defaulting on its debt. Creditors across the world, who had bought British gilts, would not be pleased to discover that they were now holding the debt of a small country with no track record in debt markets.

But let's assume that Scotland manages to take on its fair share of the debt. Leery investors would need to know that Scotland could repay. Small, indebted economies have fallen out of favour with financial markets—just ask Greece or Cyprus. Scotland’s cost of borrowing would be at least 0.7 percentage points higher than Britain’s. And so to pay back its debt, Scotland needs a sturdy currency. But getting one will be tricky.

Some have suggested that Scotland should join the euro. A nice idea, perhaps, but doing so will be difficult. Given that Scotland does not currently have its own currency, it cannot tick the right boxes to be accepted into the euro club. It would not meet the 60% Maastricht criterion for total debt-to-GDP. So at least in the short term, Scotland would need another currency.

Scotland could continue to use the pound. That is the easiest option; sterling is a strong currency. But if Scotland used pounds, it would be unable to set its own interest rates. It would have no control over an important lever of economic policy. And not being able to set interest rates could be more damaging for an independent Scotland than it is today. An independent Scotland would probably be a net exporter of oil—but the rest of Britain is a net importer. A big increase in the oil price could prompt looser monetary policy in the south, in order to prop up domestic demand. But this would be the opposite of what Scotland needed—its economy could overheat.

Scotland would also be vulnerable to speculators. The Bank of England does not offer bail-outs to foreign nations. If economic conditions deteriorated, Scotland might be faced with an unsustainable debt burden—all without help from the Old Lady of Threadneedle Street. Another paper, from the David Hume Institute, details the complexities of Bank of England supervision of a newly independent Scotland.

Scotland could embark on a more radical option: launching an independent currency. But investors would need convincing that the new currency was sound. In an environment of financial volatility, this is a big ask.

To bolster the new currency, Scotland might have to amass foreign exchange reserves. That, in turn, would require Scotland to run persistent current account surpluses. Fiscal austerity might be necessary (and would at any rate be part of a drive to meet the Maastrict criteria ahead of accession). Austerity would probably need to be even harsher than it has been in Britain. That is a hard sell for the SNP. An alternative would be exchange-rate intervention to hold down the value of the new Scottish currency. But that directly contravenes the goal of currency stability, and would also raise the effective cost of servicing debt denominated in sterling.

A newly independent Scotland would probably be faced with higher interest rates on its debt repayments, sceptical investors and fiscal austerity. And there is great uncertainty about the other economic implications of secession from the union. Only Scottish voters can decide whether independence is worth it.