Currency risk in an independent Scotland would be unavoidable, think tank finds

An independent Scotland would face inherent financial risk regardless of the currency option it chose, a report from independent thinktank the Institute for Government has found.

According to the organisation three options - a formal currency union with the rest of the UK, joining the euro or pegging a new Scottish currency to the value of another – would not be initially viable. This is because the UK Government has already ruled out the first option and the second would only be possible after Scotland “jumped through the necessary hoops”, the report says.

The third option, meanwhile, would not be possible because “immediately after independence, Scotland would be unlikely to be able to accrue enough foreign exchange reserves at a reasonable price to defend a pegged currency”.

The report states that there are two other options – a new currency that floats freely on foreign exchanges and an informal currency union with the rest of the UK - which would be viable, but which would both come with risks.

“A new currency that floats freely on foreign exchange markets would give Scotland the freedom to use monetary policy, but its value would probably be volatile and make it harder for Scotland to trade,” the report says.

“An informal currency union with the UK, where Scotland continues to use the pound, has the benefit of using an established, stable currency but would leave monetary policy set by the Bank of England, leaving Scotland unable to print money and so unable to engage in quantitative easing. No other advanced economy currently has such an arrangement.”

Gemma Tetlow, chief economist at the Institute for Government, said none of the options is entirely attractive and each would come with trade-offs.

“Scotland’s currency choice would have far wider implications than just the cash people use in their day-to-day lives – including implications for financial stability, what freedom the government has to use monetary and fiscal policy, how easily businesses can trade with other countries, and the attractiveness of Scotland to foreign investors,” she said.

The currency an independent Scotland would use has long been a matter for debate.

Prior to the 2014 independence referendum, then SNP leader Alex Salmond said a currency union with the rest of the UK was his favoured option should the vote go in his party's favour. That was repeatedly dismissed by then Chancellor George Osborne, who said in a speech delivered in Edinburgh in February 2014 that “the pound isn’t an asset to be divided up between the two countries after break-up as if it were a CD collection”.

Both the Confederation of British Industry and the Institute of Directors warned that a currency union in the absence of a political union would bring instability and risk.

In 2018 the Sustainable Growth Commission, an economic body led by former SNP MSP Andrew Wilson, recommended that an independent Scotland should continue to use sterling without a formal monetary union before transitioning to a new currency at an unspecified future date.

Economic research organisation the Institute for Fiscal Studies commended the Sustainable Growth Commission for tackling the currency issue, but said its plan would lead directly to further austerity for the country for years to come.