Bloomberg News

Quebec Bonds Show Scottish Separatists Size Matters: U.K. Credit

April 11, 2014

As Scotland’s nationalists step up their campaign to leave the U.K., markets elsewhere suggest independence isn’t popular with bond investors.

Yields on Quebec’s 10-year securities declined after separatists in the Canadian province lost ground in an April 7 election. The premium Catalonia pays to borrow compared with the Spanish state fell yesterday to the lowest since at least 2012 after lawmakers rejected plans for an independence referendum. Catalans want a vote about two months after Scots decide on their constitutional future on Sept. 18.

“Bond investors like predictability, security and also they like size, so if you are part of a bigger country, that’s definitely supportive,” David Schnautz, a fixed-income strategist at Commerzbank AG in New York, said by telephone on April 9. “Any back-peddling from a drive toward independence on the other hand is then obviously bond positive.”

Scotland's Claim for Independence

Unlike the Catalans, opinion polls show more Scots want to keep the status quo than create Europe’s newest sovereign state. Yet enough people are undecided to make the outcome uncertain, intensifying the debate over a future independent Scotland’s debt, budget deficit and currency.

The nation of 5.3 million doesn’t have its own bonds, so bankers, economists, rating companies and politicians have focused on how much it might have to pay to borrow compared with the U.K.

‘Debt Shock’

Estimates for the premium depend on whether a newly independent Scotland could keep the pound, something Prime Minister David Cameron’s government has ruled out. Should he not get his way, Scottish First Minister Alex Salmond has threatened to walk away from Scotland’s share of U.K. national debt, which the National Institute of Economic and Social Research, or Niesr, estimates at 143 billion pounds ($240 billion).

The U.K. has said it will honor all its borrowing in the event of Scottish independence. Fitch Ratings said in a report yesterday such a “debt shock” would delay Britain getting back its top credit score. Fitch, which stripped Britain of its AAA rating in April last year, said Britain’s debt burden would surge as the country lost about a tenth of its gross domestic product.

Lacking Sanity

In an interview with Bloomberg in New York a week ago, Salmond said “no sane person” would take on more debt to avoid a currency union between Scotland and the rest of the U.K. He told BBC Radio 4’s Today show this morning that “it’s quite different from what you do once the votes are in and people act in the interests of both their countries.”

Should Scotland enter a monetary union, Niesr said its cost of borrowing would be between 72 to 165 basis points more than U.K. 10-year bonds because of its size. Scotland would need 23 billion pounds in its first year of breaking away to service its proportion of debt, Niesr said in an April 8 report.

Jefferies International Ltd. in London predicts the interest rate for Scottish bonds would be about 100 basis points more than U.K. gilts. That’s based on the 2 billion pounds the semi-autonomous government in Edinburgh can borrow in the market under an existing law giving Scotland more power.

If the nation votes for independence, fails to secure a currency union and then walks away from its share of U.K. debt, that premium would increase, said David Owen, chief European economist at Jefferies. In a December report, he put the extra yield at as high as 500 basis points, or 5 percentage points, a figure cited by the U.K. government when warning Scots on future costs. That would be higher than Greece now pays compared with Germany.

Market Impact

“Until all these issues are settled -- and they wouldn’t be settled on day one and there would be a period of negotiation -- obviously you’d expect the uncertainty to weigh on investors and that would push up yields,” Owen said in an interview on April 4. “It would also impact the gilt market.”

Gilts have gained 1.2 percent since Feb. 13, when Chancellor of the Exchequer George Osborne said Scotland must relinquish the pound if voters back independence, according to Bloomberg World Bond Index. That compares with a 0.4 percent gain for U.S. Treasuries and German bonds.

British 10-year bonds yielded 2.63 percent today, 110 basis points more than equivalent German debt.

In Quebec, the governing separatist Parti Quebecois was trounced in an election, garnering its lowest support in 44 years. The older generation in the French-speaking province is increasingly jaded by a push to separate from the rest of Canada after failing in referendums in 1980 and 1995, while younger voters haven’t warmed to the cause.

Quebec Yields

The yield on the province’s 10-year bonds jumped almost 30 basis points to 3.49 percent in the first week of March when Quebec Premier Pauline Marois called the election for April 7. The bonds yielded 3.33 percent yesterday. The spread over comparable Canadian government debt has fallen to 92 basis points from about 100 basis points on March 12.

As for Catalonia, investors have so far dismissed the risk of Spain breaking up, adding to their holdings of both Spanish and Catalan bonds. The parliament in Madrid on April 8 refused to endorse the vote on Catalan independence that the region’s president, Artur Mas, has pledged to stage in November.

Catalonia’s 1 billion euros of 2020 bonds yielded 117 basis points more than comparable Spanish securities yesterday. That spread was down from about 250 basis points six months ago.

“I look at Scotland and also Quebec because these are potential blueprints for Catalonia,” said Schnautz at Commerzbank. “At the end of the day they just want a better deal in terms of the regional financing.”

To contact the reporters on this story: Lukanyo Mnyanda in Edinburgh at lmnyanda@bloomberg.net; Rodney Jefferson in Edinburgh at r.jefferson@bloomberg.net

To contact the editors responsible for this story: Daniel Tilles at dtilles@bloomberg.net Andrew Atkinson


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