MRS HEDLEY-MILLER 24(RMSA) 171/173/01
cc Mr Fogarty
SCOTLAND: IMPLICATIONS FOR EXTERNAL FINANCING
You will recall that I mentioned my concern at the Scottish problem at a recent OF meeting. I undertook on that occasion to prepare a short paper setting out the problem as I see it, and the attached is the result: this draws on comments kindly contributed by Mr Mountfield and Mr Buckley.
2. I am circulating the paper at this stage mainly for information, and I imagine you will wish to put it to Sir Derek Mitchell on this basis. But the issue seems bound to bulk significantly larger in our consciousness from now on, and I fear that the very existence of the problem, or threat, will have a wholly adverse effect on our external debt management.
3. I have not copied this paper to the bank: it occurred to me that the best course might be for Sir Derek Mitchell to give a copy to Mr McMahon.
D A WALKER
5 May 1975
SCOTTISH DEVOLUTION; EXTERNAL FINANCING ASPECTS
1. The Government indicated in the White Paper "Democracy and Devolution Proposals for Scotland and Wales" (Cmd 5732) in September 1974 that it accepted the main conclusion of the Kilbrandon report that it is desirable that there should be a substantial measure of devolution to Scotland and Wales, and that the best way of carrying this forward would be through the creation of directly elected assemblies for Scotland and Wales. The White Paper also states that the Government intends to legislate for the establishment of Scottish and Welsh assemblies as soon as possible.
2. To this end, a special Cabinet Office Constitution Unit under the Lord President is now working full steam ahead with a Devolution Bill which it is hoped to lay before Parliament by the turn of the year, though Ministers are not committed to this timetable. Assuming a period of six months for Parliamentary scrutiny and debate and a further six months for holding elections for and setting up the new assemblies, Scotland and Wales could begin 1977 with fully operative assemblies with substantial delegated authority in a wide range of fields.
3. The following paragraphs briefly review possible implications of the planned devolution to Scotland for the external financing position and prospects of the United Kingdom. The implications obviously stem from the heavy concentration in Scottish offshore waters of oil discovered in the last decade. Although North Sea oil has not been mortgaged in any way in public sector borrowing to finance the external deficit, the presumption on the part of both HMG and external creditors is that the UK's prospective self-sufficiency in oil by the end of the decade, and the possibility of a nex export position thereafter, provides key underpinning for the servicing and repayment of this external debt that is now being accumulated. This presumption and the confidence associated with it, is likely to be put in question the greater and, in particular, the more overt the pressure for Scottish separation.
4. The concept which underlies the Government's commitment to devolution is of a "firebreak" - the theory that concession of a moderate degree of devolution will contain the present pressure for full separation and, hopefully, cause the latter to wither as moderate Scottish opinion finds that reasonable demands can be met, and Scottish interests adequately furthered under the new assembly. In institutional terms, the aim is to devise arrangements which, while being of a basically Ministerial character, do not appear to give Scotland an embryo central government. There will not, for example, be a post bearing the title "Prime Minister" or, indeed, a Minister at all: the title equivalent to "Minister" is likely to be "Member of the Scottish Executive".
5. In practice, however, even if this concept and approach is in the end validated by events, there is a serious risk that the publicity and debate that will accompany the path to devolution will call into question the viability of the United Kingdom as a debtor. The matter of depletion policy will in this respect be crucial. The scope for conflict here is that while present UK thinking is tentatively in terms of an annual production rate of some 120-130 million tons in the early 1980s (implying a surplus for export of the order of 20 million tons), the SNP have, on the other hand, talked of an annual production rate of only 50 million tons. Given that annual production of 100 million tons plus is required for self-sufficiency, the mere claim of a Scottish assembly for a significant influence in depletion policy would seem bound to have an adverse effect on UK credit-worthiness: and this effect could start to be felt ahead of the establishment of the assembly if the SNP harp on the depletion theme and look likely to be the majority party in the new assembly.
6. Countering such concern about depletion policy will in itself be no easy task. But there is, beyond this, a clear possibility that the Government's tactics or strategy will misfire most substantively. This pessimistic approach would be predicated on a theory the polar opposite of that described above and on which the Government is now acting. The alternative view is that the result of the new arrangements will be to equip Scotland with institutions virtually equivalent to an independent central government which would pursue nationalistic objectives and possibly break away from the United Kingdom altogether. The assembly would give focus and public vent to the aims of the separatists and a hearing which they do not enjoy at present as a small minority party in the Westminster legislature. The assembly would, as indicated, be likely to demand a say in depletion policy and a substantial share of oil revenues (which it could use to increase public expenditure in Scotland); and it could support its demands, even without formal separation, by interfering with oil exploitation and exploration in a variety of ways, for example by withholding co-operation over on-shore support.
7. If this pessimistic view is validated, external creditors of the UK could very quickly start to take fright. Although the external debts that have been accumulated do not involve explicit mortgaging of North Sea oil, there is clearly a general presumption that repayment will be effected out of the current account surpluses that will be generated by the elimination of, by 1980, of oil imports and possible achievement of a net oil export position thereafter . This prospect could be cast in doubt by an assembly of which the articulate leading members were all pressing hard for separation. These doubts and pressures would bear not only on the sterling balances but also on foreign currency borrowing undertaken with HMG's guarantee: there would plainly be increasing doubt about what HMG would be comprised of by the early 1980s when most of these debts fall due for repayment.
8. If there is a moral from all this, it is that progress toward devolution should be delayed for as long as possible consistently with honouring the Government's commitment to move down the devolution road and containing the SNP lobby in Parliament. The longer this can be played, the better the prospect that the external deficit will have narrowed, so that dependence on ongoing external financing will be reduced or eliminated. Hopefully also, a situation by the end of the decade in which the non-oil sectors of the UK economy are in heathier shape will to some extent mitigate the drive for separation.
F(RMSA) Division HM Treasury 6 May 1975