The Scottish government is making plans to sell bonds, or “kilts,” for the first time. However, investors have raised concerns that these bonds may come with higher borrowing costs compared to those paid by the UK.
These proposals are still subject to due diligence assessments but are scheduled for issuance before the current parliamentary term concludes in 2026. The purpose of these bonds is to fund “vital infrastructure” projects, including affordable housing.
First Minister Humza Yousaf has characterized this move as a means to build credibility in the pursuit of independence. “This will bring Scotland to the attention of investors across the world. And it will raise our profile as a place where investment returns can be made,” Yousaf announced at his party’s annual conference in Aberdeen.
While the exact amount the Scottish government aims to raise remains undisclosed, it’s worth noting that borrowing limits imposed by Westminster will restrict this issuance to only a small fraction of Holyrood’s overall budget.
All Scottish government debt is typically underwritten by the Treasury, which means investors are not taking on additional credit risk by buying these bonds. However, due to the relatively small size of Scotland’s bond market, investors are likely to demand an interest rate premium compared to the gilt market.
Nick Chatters, an Edinburgh-based portfolio manager at Aegon Asset Management, stated, “It’s sensible to assume that there would be some risk premium over a UK gilt, to take account of lower liquidity, a less tried and tested issuer, and potentially murkier public finances.”
The premium that Scotland might have to pay will be influenced in part by the credit rating assigned by firms like S&P, Moody’s, and Fitch. Local authorities, which have similar ratings to the UK government but face higher debt servicing costs due to liquidity risk, can provide guidance on potential costs.
Scotland’s decision to issue bonds comes at a time when borrowing costs have risen globally. Pilar Gomez Bravo, co-chief investment officer for fixed income at MFS Investment Management, expressed skepticism about the feasibility of this move in the current interest rate environment.
Benchmark UK borrowing costs have surged in recent years as the Bank of England aggressively raised interest rates to combat high inflation. Ten-year gilts yields were at 4.7% on October 20, a substantial increase from the 0.5% to 2.5% range seen from 2014 to 2019.
While technically possible for a local authority to default on a bond in the UK, the government’s role as a backstop has thus far prevented such instances. No local authority in Britain has ever defaulted on a bond, thanks to supervision and support from the central government.
The Scottish government’s ability to issue bonds is governed by legislation introduced after the 2014 independence referendum. Under this framework, any bond issuance will likely come at a premium and cost the taxpayer more. It will represent only a small fraction of the administration’s budgeted spending for the year.
Mairi Spowage, director of the Fraser of Allander Institute, a think-tank, has noted that the Scottish government is already expected to reach approximately 80% of its debt cap by 2026. This leaves little room for additional borrowing via the bond market, making the issuance of “kilts” a largely symbolic move rather than a significant financial contributor.
In the event of Scottish independence, the fate of these bonds remains uncertain. Investors may be given an option to return the debt and receive their investment back. Scotland would then issue debt with a credit rating based on its own creditworthiness.
Rating agency Moody’s, in the lead-up to the 2014 independence referendum, suggested that an independent Scotland would likely be rated between A and Baa, placing it toward the lower end of the investment grade spectrum.