Treasury advice behind currency row

Scotland's banking sector is too big in relation to national income, the UK could end up bailing the country out and fiscal policy shows sign of diverging, he said.

Sir Nicholas also assured the Chancellor that First Minister Alex Salmond's "threat" to refuse a share of the UK's debt is not credible.

The advice is contained in an official paper which Mr Osborne said is being published to show politicians have not doctored it.

It was released alongside a larger Treasury analysis of a sterling union.

Sir Nicholas told him: "Currency unions between sovereign states are fraught with difficulty. They require extraordinary commitment, and a genuine desire to see closer union between the peoples involved.

"As the Treasury paper points out, the great thing about the sterling union between Scotland, Wales, Northern Ireland and England is that it has all the necessary ingredients: political union, economic integration and consent.

"What worries me about the Scottish Government's putative currency union is that it would take place against the background of a weakening union between the two countries, running counter to the direction of travel in the eurozone.

"I would advise strongly against a currency union as currently advocated, if Scotland were to vote for independence."

Sir Nicholas, the Treasury's permanent secretary, set out four reasons against currency union, all of which were highlighted by the Chancellor.

He underlined concerns that the Scottish Government has suggested in its blueprint for independence that another currency option could be chosen in future.

"Successful currency unions are based on the near universal belief that they are irreversible," Sir Nicholas advised.

"Imagine what would have happened to Greece two years ago if they had said they were contemplating reverting to the drachma.

"Secondly, Scotland's banking sector is far too big in relation to its national income, which means that there is a very real risk that the continuing UK would end up bearing most of the liquidity and solvency risk which it creates."

He warned about the risk of a bailout for either country, one of the reasons Mr Osborne says makes it politically difficult to sell the plan to the rest of the British public.

"An independent Scottish state would not face the same risk as it is inconceivable that a small economy could bail out an economy nearly 10 times its size," Sir Nicholas wrote.

"This asymmetry could only cause continuing UK problems unless Scotland is prepared to cede substantially more sovereignty on monetary and fiscal matters than any advocates of independence are currently contemplating."

The suggestion that Scotland would start off by having to cede newly won sovereignty was raised in an earlier speech by Bank of England governor Mark Carney, who set out the technical pros and cons of currency union in a speech in Edinburgh last month.

On the impact of differing tax and spending policies, Sir Nicholas said: "There is a substantive point here. If the dashing of Scottish expectations were perpetually blamed on continuing UK intransigence within the currency union, relations between the nations of these islands would deteriorate, putting intolerable pressure on the currency union."

Sir Nicholas predicted that the Scottish Government might repeat that it would not take on a share of British debt if the Chancellor goes along with the Treasury's official advice.

"I do not believe this is a credible threat," he said, considering that the the UK could cope with any impact from the markets.

"In the worst-case scenario, it is more than likely that the increase in funding costs, which the continuing UK would face, would be smaller than that which would result from an ill thought-out currency union with Scotland.

"And so to sum up, I would advise you against entering into a currency union with an independent Scotland.

"There is no evidence that adequate proposals or policy changes to enable the formation of a currency union could be devised, agreed and implemented by both governments in the foreseeable future."

Mr Osborne relied on the advice when he set out his decision to rule out currency union in a speech in central Edinburgh today.

Speaking to reporters later, he said the rigorous analysis is being shown to make sure people have "the facts" before they make a decision in the referendum on September 18.

"We've used Treasury analysis, we've taken a very exceptional step of publishing the advice received from the permanent secretary to the Treasury, which I'm not aware of any precedent to," he said.

"I would say we owe it to the people of Scotland to be in possession of all the facts.

"I cannot stress it enough that it is up to the people of Scotland to make their own decision, and I do not have a vote in that.

"But I do want the people of Scotland to have all those facts in front of them when they make that very important decision."

The official advice was signed off two days before the speech in the Scottish capital.

"In order to remove any doubt that politicians had doctored the advice in some way, I wanted to have it very clearly on the record - as indeed he did - that this was the official advice I was receiving from civil servants," Mr Osborne said.