Pre-Budget Report 2009 - Treasury Contents

3  The Public Finances

The state of the public finances

38. At Budget 2009, we noted that the public finances had deteriorated significantly.[95] Public sector net borrowing (PSNB) was projected to be higher than at any time since the Second World War. Public sector net debt (PSND) was almost double its upper limit under the Sustainable Investment Rule which stated that PSND should be below 40% of GDP in each and every year of the economic cycle.[96] As the Pre-Budget Report says "the financial crisis and global downturn have had a profound and persistent impact on the public finances".[97] Table 3 shows the key fiscal projections in this year's Pre-Budget Report.

Table 3 : Summary of fiscal projections from the Pre-Budget Report 2009

Source: HM Treasury

39. The changes in the public finances forecasts between recent previous PBRs and Budgets have been substantial. For example, Public Sector Net Borrowing for 2009-10 increased from £38bn in Budget 2008, to £118bn in PBR 2008, to £175bn in Budget 2009. However, in this PBR, the state of the public finances is broadly similar to Budget 2009. Public sector net borrowing is estimated to peak in 2009-10 at £178bn before falling to £96bn in 2013-14. Relative to Budget 2009, the PBR net borrowing forecast is higher in earlier years and lower towards the end of the forecast horizon. The national debt is predicted to rise from 44% of GDP in 2008-9 to 77.7% of GDP in 2014-15, a rise of £854bn. PSND more than doubles from 2008-9 to the end of the forecast period six years later. The largest difference in the PSND forecasts from this year's Budget to PBR is £9.7bn, which is less than 2% of the debt.

The timing and pace of fiscal consolidation

40. This Pre-Budget Report sets out the Government's decisions about the timing of fiscal tightening. The document explains the Government position is to "provide support for the economy, where it is needed, through the downturn"[98] but when the economy and financial markets recover "the Government's actions will move […] to setting policy to provide conditions for future growth".[99] In summary the Government will conduct a fiscal loosening over the next financial year to support an economic recovery before commencing fiscal tightening in 2011-12 to rebuild the public finances. The Pre-Budget Report recognises that sound, sustainable public finances are "essential to macroeconomic stability and the long-term health of the economy". [100] However, the Chancellor's view was that withdrawing support too quickly would be a "profound mistake".[101] Mr Ramsden supported this view, highlighting that the economic recovery was not yet secured and so a balance between providing Government support and reducing the structural deficit was required.[102]

41. Choices about when fiscal tightening should begin and how quickly it should proceed are likely to have profound effects on our economy. The Governor of the Bank of England considered there would be adverse consequences if the deficit were closed too aggressively but he also stressed that there would be negative effects if too much time were taken to reduce the deficit. Mr King said:

    As to the debate about whether we should remove the stimulus too soon or too late we should do it at the right time.[103]

Unfortunately there is no common definition of the "right time" for fiscal consolidation, and we have seen no agreement.

42. Mr Weale believed that the PBR proposals represented a substantial adjustment, citing cuts in government consumption, and he was unsure that the public were aware of the impact of Government plans from 2011.

    I think there is substantial shock built in starting in 2011 and people are having difficulty grasping the magnitude even of that.[104]

Accordingly Mr Weale's preference was for a longer path for fiscal consolidation than that set out in the PBR.[105] However Ms Ward was disappointed that the PBR planned to increase spending and described the size of the deficit as being "back to stage one".[106]

43. There is general agreement that the timing and pace of fiscal consolidation should be contingent on the state of the economy.[107] Mr Robert Chote, Director of the Institute of Fiscal Studies, said that it might not be right to halve the deficit over four years if, for example, the economy were in recession.[108] The Chancellor said that the Treasury would reconsider its proposed path for fiscal tightening if the economy performed better than expected.

    Clearly if things are better than I expect in a couple of years' time, if it looks like growth is taking place more strongly, then we would want to do more to reduce the structural deficit.[109]

Although the Chancellor did not comment on how he would act if growth were slower than forecast, Mr Ramsden stressed that decisions about fiscal consolidation are revisited at each Pre-Budget Report and Budget;[110] we infer the Treasury would reconsider the economic circumstances and alter the planned path of fiscal tightening accordingly.

44. There was agreement about the need for a fiscal consolidation plan to be credible. Mr Chote stated that trust in the forecasts affected the extent to which plans were considered credible. He remembered when Treasury forecasts of revenue receipts were criticised for being too high and the then Chancellor defended them repeatedly until after the election, when they were adjusted downwards.[111] He also said that more detail of where spending would be cut or tax raised would improve the credibility of the PBR.[112] When we discussed fiscal consolidation with the Governor of the Bank of England, before the Pre-Budget Report appeared, he considered that for a plan to be credible, a large part of the deficit must be reduced over a period "for which an administration can be held accountable".[113] The Pre-Budget Report attempts to achieve this goal. Mr Ramsden believed that the PBR contained "a very clear consolidation plan":

    the PBR is very clear in setting out the scale of the challenge and also in setting out the consolidation that is going to ensure that public finances stay sustainable so that we see the structural deficit falling, that is, the cyclically adjusted public sector net borrowing falling from our estimate of 9% this year, 2009-10, down to around 3% in 2014-2015. That is a fall of 6% in the structural deficit over that period, a very significant consolidation.[114]

45. We appreciate that deciding the right time for fiscal consolidation requires making a fine judgement about the resilience of the recovery. As we have explored earlier, there is currently considerable uncertainty in the economic outlook; and any fiscal consolidation will have to function in that context. It may be difficult for any current consolidation plan to command universal support. It will therefore be very important to add greater detail and clarity to the plan sooner rather than later.

The Structural Deficit

46. Since the PBR was published, much commentary has focussed on the Treasury forecasts of the UK's structural deficit. The structural deficit shows how much Government has to borrow excluding the effects of the economic cycle such as that benefit spending is higher during a downturn or tax receipts are higher during a period of strong economic growth. Removing the effect of the economic cycle gives measures that "estimate the level of the deficit that can be expected to apply on average over the course of an economic cycle".[115]

47. The cyclically adjusted net borrowing forecasts (which include net investment) in the PBR are slightly lower than those in Budget 2009. In the latest PBR, the Treasury's estimate of the structural deficit in 2009-10 has come down from 9.8% of GDP to 9.0% of GDP. From 2009-10 the structural deficit is projected to fall rapidly to 3.1% of GDP in 2014-15. Chart 2 below illustrates the structural deficit forecast from the latest three Budget/PBR documents.

Chart 2: HMT projections for the structural deficit (cyclically-adjusted net borrowing) as % of GDP from PBR 2008, Budget 2009 and PBR 2009

Source: HM Treasury

48. Our expert witnesses expressed concern about the uncertainties around the structural deficit forecast.[116] Martin Weale from NIESR believed the forecast was too optimistic and maintained that the Treasury should publish the actions it would take if the structural deficit were higher than forecast.[117] Karen Ward, HSBC's UK Economist, said she was "in the dark" about how the structural deficit closed so quickly in the Treasury's forecasts:

    I still do not think we have enough information about this structural deficit to make informed judgements that it is going to close over the forecast horizon.[118]

Professor Dow believed there was significant uncertainty around both how the Treasury calculated the structural deficit (around cyclical adjustments and the adjustment to the trend rate of growth) and how it would be reduced.[119]

49. The structural deficit is calculated using an estimate of the output gap.[120] Mr Weale commented that "nothing is more poorly estimated than […] the output gap after a recession"[121] implying a high level of uncertainty around the forecast for the structural deficit. Mr Weale also believed that the house price assumptions that the Treasury used were too buoyant[122] suggesting a risk that the structural deficit would be greater than the Treasury forecast.

50. Unsurprisingly, the Treasury views on the outlook for the structural deficit were more positive than those of the expert witnesses. Both the Chancellor and Mr Ramsden repeatedly stressed that considerable caution was built into the public finance forecasts, for example in assumptions about the VAT gap and unemployment.[123] When questioned about the proportion of net borrowing due to non-cyclical factors, Mr Ramsden stated:

    We think that [the fact that 70% of PSNB is structural borrowing] is a prudent assumption of the scale of the structural position of the public finances. Because it is cautious it could well turn out to be smaller than that.[124]

51. The Treasury also defended the level of detail around how the deficit will be closed. The Chancellor explained that "a combination of tax, efficiencies and reductions in expenditure…will take £57bn out of spending".[125] Mr Ramsden told us that the PBR did contain information about how the deficit would be reduced over the forecast period, and that some figures had been given for later consolidation:

    It [the PBR] shows that two-thirds of the consolidation which I was describing at the outset, that is the discretionary policy measures, the £57 billion, two-thirds of those were on the spending side and one-third on the tax side. That takes us through to the end of the forecast period. There is then the period beyond that, 2015-16 and beyond, where we have said that we have put some illustrative consolidations in for what would be required to get back to a cyclically adjusted current balance in, I think it is, 2017-18. We have not given any detail on those because they are beyond the forecast horizon […][126]

52. We have previously stated that a plan to restore the health of the public finances must deal with the structural deficit. We acknowledge the Treasury aims to cut the deficit from 9% of GDP to 3.6% of GDP in 4 years. However we note that although the Treasury believe the Pre-Budget Report contains sufficient detail about the way in which the structural deficit would be reduced, our expert witnesses all criticised the document for not providing enough information about how this will be achieved.

53. The Treasury use what they describe as cautious assumptions in the public finances forecasts. Some economists consider the structural deficit forecast is overly optimistic, many are concerned about the large uncertainties surrounding this forecast in particular and some doubt whether sufficient attention has been given to the structural deficit existing before the recession. Future Budgets and PBRs should attempt to quantify the downside risks around the structural deficit forecast.

Government Expenditure

54. The PBR confirmed that overall departmental spending for 2010-11 is unchanged. However, the Treasury announced that from 2011-12 spending growth would fall to help close the structural deficit. The Treasury has committed to increasing public sector current expenditure by on average 0.8% per year in real terms from 2011-12 to 2014-15. During this time, public sector net investment is planned to stay at 1.25% of GDP (down from 3.2% in 2008/9).[127]

55. These are high level, headline, figures. The PBR does mention spending plans for some specific areas—those that will see either rises in line with inflation or higher. It is projected that NHS front line spending in 2011-12 to 2012-13 will rise in line with inflation, spending on front-line schools will increase by 0.7% in real terms for those two years.[128]

56. Mr Chote summarised the spending profile outlined in the PBR:

    There is a discretionary spending increase of roughly £4bn in 2010-11 rising to £7.7 in 2011-12, £7 in 2012/13 and then beginning to fall back a bit .[129]

Despite this information, Mr Chote would have liked the PBR to provide a "clearer picture on what the outlook is for public spending on public services".[130] He stated that:

    In an ideal world what we would like to do…is to be able to say how much does the Government think it is going to have to spend on annually managed expenditure [AME]…That then leaves you with a picture of what you have to spend in departmental expenditure limits [DEL]…[131]

57. The IFS based calculations for future departmental expenditure on information in a Treasury document leaked after Budget 2009 which contained a breakdown between DEL and AME (including a split of the main components of AME). The Institute used the information to estimate that departmental spending would fall on average by 3.2% a year over the three years of the next Spending Review.[132] Mr Chote considered this left a £15 billion cut that was unaccounted for in the PBR:

    …the total cut required [in departmental spending] is £36 billion. If you take the Government's words that they can cover £11 billion of this by efficiency savings, £3.4 billion by a public sector pay squeeze, £1 billion from public sector pensions and £5 billion from cuts to lower priority budgets that have been identified, that is taking 20 away and leaving you with 15.[133]

However, Treasury officials did not recognise the IFS calculations and would not comment on leaked documents.[134] Mr James Richardson, Director of Public Spending at the Treasury, told us that there have been no decisions about departmental spending after the end of the current Spending Review period.[135]

58. We acknowledge the considerable uncertainties which affect the PBR. Those uncertainties are both political and economic. While some may think that a Spending Review should have been carried out before the next election, others will consider it is correct to defer such an exercise until there is at least some political certainty. The absence of a Spending Review, means that from 2011-12 the UK may temporarily return to an annual expenditure cycle. Should this happen, we urge colleagues on other Departmental Committees to scrutinise their department's financial documents particularly closely.

59. There is a sense that the Treasury are using uncertainty to suit themselves. Despite substantial uncertainties they still produce some forecasts out to 2014-15 and illustrative projections out to 2017-18. We can see no good reason for the Treasury failing to produce illustrative figures for future expenditure, at least the projected split between DEL and AME. We recognise that there will be uncertainty in these figures, but they are produced as part of the Spending Review process so there appears to be no argument of principle against their publication. The Fiscal Responsibility Bill will tie the Government into a fixed timescale for managing the deficit, and this will require close parliamentary monitoring.

Spending Reviews and parliamentary scrutiny

60. Since 1998, details about Government spending have been provided in Spending Reviews. The Treasury states that "Spending Reviews set firm and fixed three-year Departmental Expenditure Limits and, through Public Service Agreements (PSA), define the key improvements that the public can expect from these resources".[136] The last Spending Review was in 2007 and set out spending plans until 2010-11.

61. The Chancellor said in his Pre-Budget Report Speech that "As long as extraordinary uncertainties remain in the world economy, this is not a time for a spending review".[137]  The lack of a Spending Review covering from 2011/12 onwards was the Treasury's key defence against having detailed spending plans.[138] The Chancellor's view was that when growth becomes established, the situation would be more certain. He believed that given the current uncertainty, allocating spending up until 2014 would have been "very difficult".[139]

62. Professor Heald believed that the system of Spending Reviews had been helpful for improving forward management of public spending.[140] However he made the interesting point that Spending Reviews had affected the process of parliamentary scrutiny of public spending:

    If you go back to the days when there were annual public expenditure White Papers published in February or March there was a much bigger dialogue between Parliament and the Treasury about the detail of the numbers. The Spending Review system with the habit of having a Spending Review in July marginalises Parliament…The UK Government basically believes that it controls—the Executive controls—the process of setting public expenditure plans, and Parliament has very little role in that. So although I am not surprised at the absence of future public spending plans, it does point to a fundamental problem.[141]

63. Mr Chote described the difference between the theory of spending reviews, and how the process has worked.

    In theory you would like the Spending Review to be a holistic, strategic exercise in which everything is thought out…and then you present a full set of spending decisions across all departments. That is not how any Spending Reviews have worked in the past in practice. On some occasions good news is fed out in advance; in some cases bad news is fed out in advance.[142]

64. It may be inevitable that the Government will attempt to manage information, but we acknowledge that the Treasury has attempted to improve the system of Parliamentary scrutiny and approval of government expenditure. The 'alignment project' has been developed over the last three years, in close consultation with this Committee, and colleagues on the Liaison Committee and elsewhere. It is intended to make it possible to reconcile the financial figures given in the various Government documents which detail expenditure. The Liaison Committee has made proposals which would allow the House more say over future expenditure;[143] however, these proposals will only be effective if the Committees have sufficient time to consider the Government's plans before they are debated.

65. It is generally agreed that the Spending Review process has introduced more transparency and certainty about medium term plans. The Liaison Committee, in cooperation with this and other Select Committees, has already produced proposals to improve the way in which the House and its committees can scrutinise these medium term plans, linking the process to the system of annual authorisation of expenditure. These proposals have been endorsed by the House of Commons Reform Select Committee.[144] We look forward to these proposals being debated and urge continuous dialogue between the Government and the House of Commons on how to ensure the Spending Review is timed in a way which allows effective scrutiny.

66. However we are pleased to acknowledge that the Government has already taken one step to improve financial scrutiny. In our Report on last year's PBR we recommended that "the Government makes available a full day's debate for the Pre-Budget Report."[145] The Government has now agreed to our request, and has announced a full day's debate, with sufficient notice to enable us to prepare and publish this Report before it takes place.

Gilt demand

67. Since the Budget 2009, the central government net cash requirement for 2009-10 has been revised to £223.3 billion: an increase of £2.5 billion. There has also been an increase in the net financing requirement of £5.1 billion which now stands at £242.9 billion compared with £237.8 billion as stated at the Budget. This increase in the net financing requirement is the net effect of the increase in the central government net cash requirement of £2.5 billion as noted above, a reduction in the contribution from NS&I of £0.5 billion, and an increase of £2 billion in the financing of the Official Reserves.[146]

68. In order to meet this increased net financing requirement, the Debt Management Office (DMO) will now have to issue £225.1 billion of gilts, compared to the £220 billion forecast at Budget 2009.[147] The majority of these additional gilts will be long-maturities and index linked gilts (£4.8 billion) with only a small proportion of the additional gilts being issued as short and medium term gilts (£0.2 billion and £0.1 billion respectively).[148] Looking forwards, the central government net cash requirement for 2010-11 is estimated to be 11.8% of GDP, or £174 billion[149].

69. Both the Chancellor and Mr Ramsden were keen to emphasise the UK's success in issuing the high level of Government debt seen so far during 2009-10. The Chancellor stated that:

    Yes, we are selling a lot of gilts at the moment. We have been able to ensure that those gilts have been covered, with the one exception just at the end of March. I think we benefit from the fact that if you look at the maturity of our gilts, the average maturity is a lot longer in this country than it is in others, about 14 years compared with Germany or France which are about 6, and that means that we have longer term financing, we have arranged longer term finance so we are not continually rolling over debt and so on.[150]

70. However, in January 2009, the Chancellor of the Exchequer authorised the Bank of England to purchase high-quality assets and gilts from the market with the aim of improving liquidity in the credit markets. The facility was called the Asset Purchase Facility (APF) and the process is known as Quantitative Easing (QE). Since January, the Chancellor has authorised up to £200 billion to be spent in the APF, with the current total of assets purchased being £190.1 billion. Of this total, £188 billion were UK gilts.[151]

71. If the DMO issues its forecasted £225.1 billion gilts, and the total purchased by the Bank of England under the APF does not increase by April 2010, the net amount of gilts sold on to the market during 2009-10 will be £37.1 billion. As the Bank of England draws close to the limit on the APF and no longer purchases UK gilts, the Government will find that its major end-customer since January 2009 will have left the market.

72. Mr Ramsden replied to the Committee's concerns about future gilt demand with a number of reasons to believe that demand would still be robust after the conclusion of the QE programme:

    The structural demand for gilts from pension funds and insurance funds is strong and that plays into the average maturity in the UK which is strikingly longer than for other economies. We have got the new liquidity standards which are going to be implemented by the FSA…that will require financial institutions to hold more Government bonds. Particularly to your point, in terms of gilt sales, before QE started, so in the final quarter of last year, in the first quarter of this year, we sold over £50 billion a quarter, so it shows there was significant demand there from the private sector. That is in line with the projected average quarterly issuance that we have for 2010-11 on the basis of current assumptions…Finally this year, the DMO sold gilts that are outside of the Bank's purchase range successfully. We have had several auctions of index linked bonds. We think there is good demand out there and that demand will continue.[152]

73. In our Report on Budget 2009[153] we recommended that the Government work up contingency plans for a weakening in demand for Government debt. In addition to the annual meetings with dealers and investors, the Government introduced mini-tenders (smaller auctions which are organised and implemented quicker than the traditional auctions) and a top-up facility after each auction allowing successful bidders to subscribe to an additional 10% of their bid after the close of the issue.[154] In addition the Government has also held more syndicated auctions.

74. Both the Chancellor and Mr Ramsden offered reassurance on future demand for UK gilts. We also note the methods now employed by the Government to reduce the risk of uncovered auctions, such as syndication, mini-tenders and top-up auctions. We are pleased that there have been no more additional uncovered auctions since that reported in the Committee report on Budget 2009. However, there remains the risk that the combination of the large amount of gilt auctions planned in 2010-11 and the cessation of Quantitative Easing will result in an excessive supply of UK gilts onto the market at a time when other governments will be offering similar products, with the possible result that auctions are uncovered and yields increase.

UK Credit Rating

75. On 8 December 2009, the credit rating agency Moody's stated that they rated the UK as having an AAA 'resistant' rating[155], effectively a downgrade from their stronger rating of AAA 'resilient'. Currently the U.S. is also rated as AAA 'resistant', but other European countries such as Germany and France have maintained the higher 'resilient' rating. This rating reduction follows Standard and Poor's downgrade of the UK's economic outlook in May 2009 from 'stable' to 'negative'. [156]

76. In our evidence sessions, Mr Ramsden stated that he had 'no concerns' about a possible further downgrade of the UK,[157] and this sentiment was reiterated by the Chancellor the following day;

    I believe that people looking at us objectively should see that you have here a strong economy with a great deal of capacity in it. You will see that the Government is determined to ensure that it reduces its borrowing, just as the Government is keen to ensure that it sees us through to recovery, and we are not there yet but we are getting there. As one of the Agencies observed I think a day after the Pre-Budget Report it regarded us as being a resilient country, which is what we are.[158]

77. When questioned about the possible increase in debt costs as a result of a downgrade, Mr Ramsden responded that credit rating agencies 'follow rather than lead the markets'[159]; any downgrade of a country would have already been priced into the market prior to the rating agency's decision to alter their rating. This agreed with what Mr Robert Stheeman, Chief Executive of the Debt Management Office had said in the Sub-Committee's evidence session on 21 October 2009:

    in my experience our sense is that actually rating agencies are what we would call lagging rather than leading indicators. By the time they have opined, the market itself has probably to a large extent already moved and discounted that information in the market.[160]

Taking this point of view, a downgrade in the UK's credit rating would not necessarily result in higher yields on UK gilts.

78. A credit rating downgrade may have other economic effects. In response to questions about the value of sterling, Professor Dow highlighted the importance of future capital flows and their dependence upon the gilt market:

    Professor Dow: In a way, what is most likely to drive the future of the sterling, I would suggest, is capital flows and a lot will depend on the gilts market and global developments in government bonds and the perception of foreign investors of the British bond market. If that was positive and there are higher capital inflows the exchange rate should rise.

    Mr Breed: So the maintenance of AAA is pretty important then?

    Professor Dow: I would say so, yes.[161]

79. Karen Ward, HSBC's UK Economist, also highlighted that although credit rating agencies had plainly stated their current position on the UK, they had also been clear about what the 'goalposts' were for the future. She considered that although deficits around the world had increased, the UK was a concern "because it [the deficit] is much larger than elsewhere and it is the structural element that is definitely of concern [...] if there was a lot more transparency about how that structural deficit had arisen, and how it was likely to be eliminated going forward, I think that would certainly help the rating agencies as well as general market participants assess the UK's outlook".[162]

80. The Committee understands the views given by Mr Ramsden that credit ratings are often a lagging and not a leading indicator, and that in many cases a downgrade will already be priced into the market prior to a rating reduction.

Interest costs

81. In the Budget 2009, the Government estimated central 'Government Gross Debt Interest' to be £30.5 billion in 2008-09, £27.2 billion in 2009-10 and £42.9 billion in 2010-11.[163] These were revised upwards in the Pre-Budget Report 2009 to £30.5 billion, £30.7 billion and £44.4 billion respectively.[164]

82. During the evidence session on the 14 December, Karen Ward estimated that future debt payments would rise to £51 billion in 2011-12, £56 billion in 2012-13 and £61 billion in 2013-14.[165] In a supplementary note to the Committee, Robert Chote from the Institute for Fiscal Studies estimated that the future debt costs would be £55 billion, £60 billion and £66 billion respectively over the same time period.[166]

83. The Committee is aware that such estimates are based on assumptions and that any forecasts have a degree of uncertainty. The Pre-Budget Report stresses this uncertainty and notes that RPI, interest rate movements and market expectations can all have an effect on future interest costs.[167] Additionally, the Committee notes that a series of uncovered auctions, as discussed earlier, would have a significant effect on the cost of financing for the Government.

84. In the evidence session on 15 December, Mr Ramsden stated that the Government did not conventionally publish debt interest costs beyond the period of the Spending Review, but that they would be provided for the next session with the Chancellor:

    Mr Fallon: But I want to talk about debt interest. Are you not able to provide the Committee with these figures?

    Mr Ramsden: They are not in the PBR document.

    Mr Fallon: That is why I am asking for them.

    Mr Ramsden: They can be derived from the PBR document.

    Mr Fallon: Could you derive them for us, please?

    Mr Ramsden: I can certainly provide you with a note.

    Mr Fallon: So we will have them before we see the Chancellor tomorrow, thank you.[168]

The Committee did not receive a note until after 1pm the following day, when the hearing with the Chancellor was scheduled for 2.30pm.

85. The note did not contain any estimations of future debt interest costs. Instead it stated:

    Higher borrowing and higher debt means that debt interest payments are projected to rise. Projections for debt interest are particularly sensitive to changes in market interest rates, inflation and the level of borrowing.

    The debt interest payments projection assumes market expectations of rates along the yield curve as they stood in the run up to the PBR. This is in line with the NAO's audit of interest rate assumptions for Budget 2009 (HC 408).[169]

When challenged about why more information was not provided, the Chancellor stated that "the reason for that is because inevitably even at the best times there is a degree of uncertainty, now there is a great deal of uncertainty."[170] He did confirm, however, that "within the Treasury we have estimates".[171]

86. The Committee notes that debt interest forecasts depend on a number of assumptions, and are necessarily an estimate. However, the Bank of England publishes forecasts showing the possible range of rates; we recommend that the Treasury consider whether publishing information about debt interest on a similar basis would be useful.

Losses from financial interventions

87. In Budget 2009, the Government stated that the provisional estimate of the losses on financial stability measures may lie within a potential range of £20 billion to £50 billion. The estimate was disclosed as a range due to the inherent uncertainties surrounding the potential outcomes of the interventions. In reaching an estimate of the scale of potential net losses, the Government's judgment was informed by potential income from fees and investments, data from stress-testing and due diligence exercises undertaken by the Treasury, the FSA and the Bank of England. It was stated at the time that overall outcomes would depend on prospects for the economy, over which there was significant uncertainty.[172]

88. At the time of the Pre-Budget Report 2009 in December, the Government revised this estimate down to £10 billion. The main drivers behind this reduction are the changes to the Asset Protection Scheme policy agreement: Lloyds Banking Group are no longer participating in the APS (meaning that the Government is not liable for any of their losses as they would have been under the scheme). The Government is only liable for any net losses to RBS above £60 billion; the central expectation, based on due diligence, suggests that such a magnitude of losses will not arise.[173] As Mr Ramsden explained:

    The central expectation for payouts under the APS is zero, so that is now our central expectation. Because we have certainty about the nature of the policy, we have not made any allowance in our fiscal projections for the insurance part of the APS, and the fiscal risk has changed…the fiscal risk has got much smaller in size and is changed in nature, so the [potential loss] has come down from £50 billion to £10 billion and now I do not think we are exposed on the Asset Protection Scheme and our exposure is more, to the extent that there is one, in terms of our equity holdings.[174]

The Chancellor added that "the RBS team and ourselves have been able to work through far more of their exposure with a better understanding of what needed to be insured in the APS, we have therefore been able to make a different assessment as to what we think the likely or the possible loss to the taxpayer might be".[175] The Government now considers that any risks of loss relate to the value of its shareholdings.

89. The potential losses from the financial interventions have changed in both size and nature since the Budget 2009. This has been due to the revision of the APS and the fact that Lloyds Banking Group are no longer participants in the scheme. However the Committee notes that the reduction in the possible loss is highly dependent upon the claim that RBS will not need to use the APS. We understand the need for certain market sensitive information to remain confidential, but given the large financial implications if RBS did have to use the APS, we recommend the Government reports on its assessment of the potential losses from the APS in both Pre-Budget and Budget reports in future.

PFI contracts under IFRS and National Accounts

90. The Committee received evidence from Professor David Heald, of the University of Aberdeen, regarding the treatment of PFI contracts. He explained that under the UK Generally Accepted Accounting Practice (UK GAAP) used from 2001-02 to 2008-09, PFI projects were kept off the balance sheet of public sector clients. Under the newly introduced International Financial Reporting Standards, the expectation is that almost all PFI projects would move onto the balance sheet. This would increase the liabilities of the Government.[176]

91. However, in June 2009, the Treasury reissued its 2009-10 Consolidated Budgeting Guidance, announcing that the budgeting treatment of PFI in national accounts would be on a national accounts basis, as set out by Eurostat, not on an IFRS basis. Thus most PFI deals would not be included when calculating such figures as the Public Sector Net Debt.[177]

92. Professor Heald was concerned that given the dramatic planned reduction in public sector net investment, it is possible that there would be a new wave of PFI projects driven by accounting treatment rather than by value for money for the tax payer.[178] However we note that departmental accounts will be compiled on an IFRS level, so some incentive to use PFI for balance sheet reasons has been removed.

93. Mr Richardson stated a reason for not calculating Public Sector Net Debt on an IFRS basis as "if we are looking at, for example, measures relative to gross domestic product, as we often do within the PBR, it is essential that those measures are on the same basis as GDP is calculated, which is a national accounts basis".[179]

94. The Committee raised this issue with the Chancellor, proposing that it would be "extremely helpful in future documents if there was a clear reconciliation"[180] between Public Sector Net Debt under an IFRS basis and one based on the National Account basis. When asked whether the Government would be prepared to do this, Mr Darling replied "I will certainly consider it."[181]

95. The Committee understands the rationale for using a different accounting treatment for national accounts than that used for departmental accounts. However, the accounting rules chosen mean that while PFI contracts will show on balance sheet in departmental accounts, prepared under IFRS, they will not appear in the calculations of net debt in whole of government accounts. We recommend that future Pre-Budget and Budget Reports include a reconciliation between Public Sector Net Debt calculated on a national accounts basis, and the same figure calculated using the IFRS principles which apply to departmental accounts.

95   Treasury Committee, Eighth Report of Session 2008-9, Budget 2009, HC 438-I, para 36 Back

96   HM Treasury, Pre Budget Report 2006, Cm 6984, p 31, para 2.58 Back

97   HM Treasury, Pre-Budget Report Securing the recovery: growth and opportunity, Cm 7747, December 2009, p 25 para 2.51 Back

98   HM Treasury, Pre-Budget Report Securing the recovery: growth and opportunity, Cm 7747, December 2009, p 18 para 2.21 Back

99   Ibid. Back

100   Ibid., p 19 para 2.23  Back

101   Q 257 Back

102   Q 119 Back

103   Oral Evidence taken by the Treasury Committee on 24 November 2009, HC (2009-10) 34, Q 15 Back

104   Q 30 Back

105   Q 30 Back

106   Q 72 [Ms Ward] Back

107   Q3; Oral Evidence taken by the Treasury Committee on 24 November 2009, HC (2009-10) 34, Q 15 Back

108   Q 3 Back

109   Q 257 Back

110   Q 120 Back

111   Q 4 [Mr Chote] Back

112   Ibid. Back

113   Oral Evidence taken by the Treasury Committee on 24 November 2009, HC (2009-10) 34, Q 14 Back

114   Q 118 Back

115   "Public finances and the cycle", HM Treasury, Treasury Economic Working Paper No. 5, November 2008, p 3  Back

116   Qq 2, 4 Back

117   Q 2 [Mr Weale] Back

118   Ibid. Back

119   Qq 2, 56 [Professor Dow] Back

120   The ready reckoner for calculating cyclically adjusted net borrowing (CANB)is: CANB = Net borrowing +0.5(output gap in current fiscal year) + 0.2 (output gap in previous fiscal year). Back

121   Q 28 [Mr Weale] Back

122   Q 40 [Mr Weale] Back

123   Qq 120, 242, 264 Back

124   Q 295  Back

125   Q 266 Back

126   Q 153 Back

127   HM Treasury, Pre-Budget Report Securing the recovery: growth and opportunity, Cm 7747, December 2009, p 97 Back

128   HM Treasury, Pre-Budget Report Securing the recovery: growth and opportunity, Cm 7747, December 2009, p 97 Back

129   Q 59 Back

130   Q2 [Mr Chote] Back

131   Q 49,

The framework for public expenditure is divided between:

Departmental Expenditure Limit (DEL) spending, which is planned and controlled on a three year basis in Spending Reviews; and

Annually Managed Expenditure (AME), which is expenditure which cannot reasonably be subject to firm, multi-year limits in the same way as DEL. AME includes social security benefits, local authority self-financed expenditure, debt interest, and payments to EU institutions.

Source: HM Treasury, Public expenditure planning and control in the UK - a brief introduction, Back

132   Q 49 Back

133   Q 50 [Figures as in transcript] Back

134   Qq 168, 174 Back

135   Q 169 Back

136   HM Treasury website, Spending Review home page Back

137   Pre-Budget Report statement to the House of Commons, delivered by the Chancellor of the Exchequer9 December 2009 Back

138   Qq 166-167 Back

139   Q 269 Back

140   Q 109 Back

141   Ibid. Back

142   Q 52 Back

143   Liaison Committee, Second Report of Session 2009-10,Financial Scrutiny: Parliamentary Control over Government Budgets, HC 804, paras 76-94 Back

144   House of Commons Reform Committee First Report of Session 2008-09, Rebuilding the House, HC (2008-09) 1117,para 137 Back

145   Second Report of Session 2008-09, Pre-Budget Report 2008, HC 27, Para 161 Back

146   Pre-Budget Report 2009, December 2009, p204 Back

147   Ibid. Back

148   HM Treasury, Budget 2009 HC 407, p245; Pre-Budget Report 2009, December 2009, p204 Back

149   Pre-Budget Report 2009, December 2009, p 168 & p202 Back

150   Q 270 Back

151   Asset Purchase Facility page, Bank of England website, Back

152   Q 270 [Mr Ramsden] Back

153   Treasury Select Committee, Eighth Report of Session 2008-09, Budget 2009, HC 438-I, para 68 Back

154   Treasury Select Committee, Fifth Special Report of Session 2008-09, Budget 2009: Government response to the Eighth Report of the Committee , HC 890, para 11 Back

155   "Top AAA Ratings Tested by Debt Burdens, Moody's Says",Bloomberg, 8 December 2009, Back

156   "Ratings agency downgrades outlook for UK economy", Guardian Online, 21 May 2009, Back

157   Q 236 Back

158   Q 274 Back

159   Q 237 Back

160   Oral evidence taken before the Treasury `Sub-Committee on 21 October 2009, HC (2008-09) 1046-I, Q 8 Back

161   Q 12-13 Back

162   Q 55 Back

163   HM Treasury, Budget 2009 HC 407, p238 Back

164   Pre-Budget Report 2009, December 2009, p190 Back

165   Qq 42-45 Back

166   Ev 77 Back

167   Pre-Budget Report 2009, December 2009, p193 Back

168   Qq 163-166 Back

169   Ev [Memo to the treasury Select Committee [from Mr Ramsden]] Back

170   Q 297 Back

171   Q 299 Back

172   HM Treasury, Budget 2009 HC 407, p26 Back

173   Pre-Budget Report 2009, December 2009, p199 Back

174   Q 151 Back

175   Q 258 Back

176   Ev 78 Back

177   Ev 78 Back

178   Ibid. Back

179   Q 186 Back

180   Q 318 Back

181   Q 318 Back

previous page contents next page

House of Commons home page Parliament home page House of Lords home page search page enquiries index

© Parliamentary copyright 2010
Prepared 6 January 2010