Scottish Independence and the impact on UK stock markets

I'm not much of a sports fan, I'll admit. So it was a welcome relief from the football when I sat down, with a cup of tea, a couple of weeks ago to watch “Scotland: for richer or poorer” on BBC2 with Robert Peston and pondered what effect the imminent vote may have on stock markets.

Quite a lot was covered in an hour-long programme. Most of it focused on the financial viability – and the fact that politicians on both sides of the argument are talking about vastly differing sums of money.

Peston mused, amongst other things, that whilst the unemployment levels in Scotland are less than half the UK average, the economy is far from being diverse and relies quite heavily on one or two industries.


Oil

One of the main industries is oil. It may well be passed its peak, but it should be a big industry for some time to come. It's getting harder and harder to extract, but new technologies are making it possible. If shared on a geographical basis, Scotland could get 90% of North Sea Oil, but the challenge would be for them to be able to set up a wealth fund, such as those in Shetland and Norway, in order for Scotland to benefit from the black gold for many years to come. The other downside is that oil revenues are notoriously unpredictable.

With higher spending than the rest of the UK, coupled with a differing spend/save ethos, this could prompt higher taxes, or reduced spending across the country. This would undoubtedly, have consequences and cause some short-term pain for hopefully longer-term gain in the future – especially as Scotland would be saddled with around 8.5%, £150 billion of the national debt.

There is also the issue of borrowing costs. PIMCO, the biggest bond investor in the world, estimates that Scotland would need to pay 0.5% to 1% more per year than the UK government pays on its bonds, to be in control of their own destiny.

Schroder Investment Management Limited also published an article recently looking at the impact Scottish Independence would have on the industry. They reinforced Peston's views explaining that Scotland has enjoyed “plentiful public sector spending but is likely to battle reining in its large fiscal deficit, especially given an expected deterioration in future North Sea Oil and Gas (NSOG) revenues. A combination of major public spending cut back and severe tax increases will be required in order to balance the books, which is likely to drive many companies and individuals south of the border.”


Other industries

Outside of oil, Scotland will need to look to other sectors to generate wealth. There is, of course the very successful Whisky brewers who have conquered markets across the world, and a growing industry of computer game design, with both PlayStation and XBOX games created in Dundee. However, by moving away from the UK, Scotland could struggle to gain relevant and necessary funding for other areas, such as life sciences.


Currency

One big issue for me, however, is the currency conundrum. Alex Salmon was very positive about the euro at one point, but is now steering towards the pound again (although Osborne doesn't really want to share).

If there is a yes vote, everyone will need to sit down, maybe with a cup of tea, like me, and start negotiating a viable solution.

In Schroders article they acknowledged that the treasury and Bank of England had advised against a currency union, due to lack of fiscal oversight. Just think back to the eurozone crisis. Schroders believe that the only plausible option for Scotland would be to introduce a new, free floating currency. Whilst this would be the most risky option in terms of stability for the domestic economy exporters, it does provide some flexibility if Scotland were to find itself in difficulty. On the flip side, it would incur very large costs.

The Telegraph recently published an article looking at the effect Scottish Independence could have on UK markets. Morgan Stanley analysts have estimated that the pound could drop by as much as 10% in the event of a vote for independence on 18th September.

Markets have started to register that a Scottish breakaway from the UK poses an economic risk, as explained by The Telegraph. With only two months to the referendum, this could be a worrying factor.

UBS and BNP Paribas have warned that even a “no” vote could trigger market jitters if the outcome is close and the issue is not put to bed.

If the risk of Scottish independence rises, financial markets may react negatively towards sterling, gilts and UK equities, but in particular those companies with significant exposure to Scotland.


What is the cost?

Towards the end of May, The Telegraph published an article looking at the sheer cost of the proposed Independence to Scottish families. The Treasury predict that the cost of building stand-alone systems for collating and collecting debt, security and intelligence, financial regulators, pensions regulators, transport organisations, welfare and border control, to name but a few could cost £600 to every Scottish family. This of course is also not going to happen overnight.

Whilst Salmond believes that these figures are "deeply flawed and deeply misleading" the Treasury have also calculated that a new benefit system would cost the Scotland £400 million alone, while setting up a new tax system could cost as much as £562 million.


Conclusion

September will see the Scottish people go to the polls to make a fundamental and irreversible decision. The trouble is there are still so many unknowns, that many decisions will be made on the spur of the moment. And this is where the Commonwealth Games come back in. If Scotland continue with their winning streak in the Games, will the country vote in an extremely patriotic manner?

We'll soon find out. Either way, markets will be watching closely and UK companies, particularly those with significant exposure to Scotland, could be in for a volatile end to the year.

Please note that Juliet's views are her own and do not constitute as financial advice.