Q&A: Government bonds
The UK government has unveiled plans to give the Scottish Parliament more financial powers, including the ability to issue bonds.
John Maciver, a partner in the banking and finance practice at law firm McGrigors, explains the finer points of government bonds.
What are bonds?
Bonds are like an "I owe you" issued on behalf of the government. Investors typically agree to give the government an agreed sum of money on the basis that the government will pay the money back after an agreed period. In the interim, the government pays a rate of interest each year on the debt.
Why is the Scottish Government keen to obtain powers to issue bonds?
Issuing bonds would allow the Scottish government an opportunity to directly tap funding from investors and savers across the globe. Bonds are a commonly-used mechanism to raise capital in the short term which is repaid over a longer period. They are typically used as a means of raising capital for general purposes or they could be used for specific projects, such as the development of infrastructure.
Who is likely to lend Scotland the money, and how likely is it that they will want to lend to the country?
International investors such as pension funds, sovereign wealth funds and others might want to buy Scottish government bonds. In theory, there is no reason why investors would not want to lend to Scotland, however, they will rely a great deal on guidance from the credit rating agencies who offer investors guidance on the credit-worthiness of the country.
What will the credit rating agencies make of Scotland?
It remains to be seen how those agencies would evaluate Scotland's credit-worthiness without a history of borrowing. A current account surplus (as opposed to the UK's budget deficit), a robust legal system, a strong reputation in financial services, natural resources like North Sea oil and gas and a nascent renewable energy industry will help. One fly in the ointment might be that the ratings agencies could be a little unsure about how to deal with the eventual constitutional settlement - this is a unique and groundbreaking situation. Its possible this factor could be treated as political risk.
How much will the government be able to borrow?
That is not clear. The simple rule is that the government could theoretically borrow whatever the market thinks it is able to repay. However, there is a difference between what you can borrow and what you should borrow, and that will be a political decision made by the government of the day. There is also the issue of pricing - it's a little like a mortgage, buying debt can come at a varying level of price depending on how highly leveraged you are.
What is Westminster's role?
Early indications are that Scotland will need UK treasury permission before issuing a bond, and that the treasury will need to be satisfied that the bond issue does not undermine the overall UK fiscal position or have a negative impact on total UK borrowing. Much more detail is needed here.