Category: ICAEW chart of the week

ICAEW responded last week to the Infrastructure Finance Review being undertaken by the government, in which it has sought views on greater private investment can be found to fund the nation’s infrastructure. As the #ICAEWchartoftheweek illustrates, there is £188bn of investment into the UK’s infrastructure planned over the three years 2018/19 through 2020/21.

Substantial public and private funding is needed to invest in transport, energy and utilities, social infrastructure (such as housing, schools and hospitals), digital networks, science and research, and in flood prevention. The government predicts that over half of the finance for such large scale projects will come from private companies over the next 10 years.

The review follows on from the creation of the National Infrastructure Commission (NIC) and the Infrastructure & Projects Authority (IPA), the establishment of a £37 billion National Productivity Investment Fund to target spending in critical areas, and plans to develop a comprehensive National Infrastructure Strategy to be published later this year. The strategy will respond in detail to the NIC’s National Infrastructure Assessment, and will set out how the UK can embrace the opportunities afforded by new technologies, decarbonise the economy, and create infrastructure fit for the 21st Century. 

The government would like to ensure that high levels of private investment continue to flow into UK projects, particularly in the wake of the withdrawal of European Investment Bank funding after the UK leaves the EU and the ending of the private-finance initiative. 

Our response can be summarised as follows:

Overview
• The UK continues to underinvest in infrastructure.

Finance innovation has the power to transform infrastructure investment in the UK
• An Infrastructure Growth Fund and pooled investment funds would facilitate investment.
• New public-private partnership contractual models are needed now.
• Approved peer-to-peer networks would enable citizens to invest directly.
• The UK should utilise its world-leading professional expertise in infrastructure finance.

Public investment is an enabler
• A new UK Investment Bank to replace the EIB as an anchor investor.
• The British Business Bank should support business to deliver infrastructure projects.
• Direct investment by city-regions and local authorities would engage communities.
• Local industrial strategies must make improving infrastructure a top priority.
• Centres of excellence are needed to support investment decisions and in managing risk.

Capital is available, but it needs to be unlocked
• Long-term pricing would provide certainty to investors, taxpayers and consumers.
• Tax and other incentives need to be gauged carefully, but then should be stable.
• Reforming balance sheet treatment requirements would remove contracting hurdles.
• Regulatory asset base and concession arrangements could be used more widely.
• Early-stage risks need to be tackled to draw in more seed capital.

To read our full response, click here.

As we reported on the release of the Whole of Government Accounts (WGA) for 2017-18 a week and a half ago, the good news is the transparency that the WGA provides. The bad news is the picture of the public finances contained therein!

As illustrated by our #ICAEWchartoftheweek, reported liabilities of £4,579bn significantly outweigh public assets of £2,014bn to give net liabilities of £2,565bn at 31 March 2018. This is much greater than the £1,779bn reported in the fiscal numbers for public sector net debt, as although fixed assets and other assets are taken into account, the WGA balance sheet includes a much wider range of liabilities.

The £1,865bn in net pension obligations owed to public sector workers are the most prominent of these other liabilities, but the £422bn of long-term liabilities for nuclear decommissioning costs and clinical negligence (amongst others) are not insignificant either!

Some commentators argue that the accounting balance sheet reported in the WGA is not sufficient to fully understand the financial position of the government. Promises to pay welfare benefits such as the state pension, long-term sickness support, or to pay for health and social care costs in retirement, are not included as liabilities; if they were, the red ink would be a few additional trillions worse than that shown here.

Without much in the way of investments or significant natural resources to fall back on, the government is in the invidious position of either raising more in revenues or cutting back on the promises they have made. In recent years the government has mostly chosen to tackle the promises side of this equation by cutting back on public services and certain welfare benefits to try and contain costs.

With public services under strain, and an increasingly long-lived population expecting a return on the amounts they have ‘paid in’ over the course of their working lives, it is difficult to see any easy ways of cutting back much further on the promises successive governments have made to look after us into our twilight years. Similarly, it is difficult to see how any government could persuade the public of the need for significant tax rises.

Unfortunately, with no sign of a long-term fiscal strategy on the horizon, this particular fiscal circle is unlikely to be squared any time soon.

To find out more about the Whole Government Accounts, read ICAEW’s analysis of the WGA 2017-18 by clicking here.

The government published its 9th Whole of Government Accounts (WGA) last week, covering the financial year ended 31 March 2018. The WGA provides a comprehensive financial report on the UK public sector, consolidating the financial results of over 8,000 organisations across the public sector, including central government departments and agencies, devolved administrations and local authorities. 

The WGA is prepared in accordance with International Financial Reporting Standards (IFRS) and is similar to a listed company annual report – unlike the fiscal numbers used in the Budget that are based on a different set of rules.

Although revenue was up by £40bn, expenditure on public services was up by £54bn and other expenditure by £100bn, leading to an accounting loss of £212bn, £114bn more than in the previous year. This was partly driven an additional £78bn for nuclear decommissioning and £11bn more for clinical negligence, which together have contributed to the £255bn increase in public sector liabilities over the course of the year. 

The good news is that the UK is one of a select few countries that prepare comprehensive financial statements in accordance with accounting standards. The government is to be commended for its transparency in publishing the WGA each year, albeit at 14 months after the year-end there is still a lot to do to meet its target to bring this down to 9 months within the next two years.

The bad news is the picture of the public finances presented in the WGA, with public sector assets of £2.0tn significantly outweighed by liabilities of £4.6tn, over £165,000 for each household in the UK. This illustrates the long-term financial context that constrains the government as it attempts to deal with near-term economic uncertainty and more immediate pressures on public spending.

For ICAEW’s analysis of the WGA 2017-18, click here.

There are European elections later this week and one of the big challenges that will face newly elected MEPs will be getting to grips with the EU’s finances. 

The €148bn EU budget was the subject of a #ICAEWchartoftheweek earlier this year (click here). This highlighted the EU’s plan for spending in 2019, with €57bn budgeted for rural support, €47bn on economic development, £25bn for operating programmes, £10bn on running costs, and €9bn externally.

Our chart this time looks at how the money flows between EU member countries. It illustrates how Germany, the UK, France and the Netherlands each pay in much more than they ‘get back’ in EU spending, while countries such as Poland, Romania and Greece receive more than they pay in. 

One of the principal aims of the EU budget is to support economic development, and so it is unsurprising to find that a proportion of the EU budget contributions of better-off northern and western European countries are directed towards the less well developed economies of eastern and Southern Europe. 

There are some exceptions. For example, Belgium and Luxembourg (on a per capita basis two of the biggest gross contributors into the EU budget) benefit from hosting the core EU institutions and agencies, with around two-thirds of the EU’s €10bn annual budget for running costs being spent in these two countries. Another is Italy, the EU’s fourth largest economy and hence a large contributor, but also a significant recipient of development support for its poorer regions.

The chart is based on extrapolations of previous spending patterns and so may not take account of more recent developments, such as the move of the European Medicines Agency out of the UK this year. This should result in around half a billion euros of extra spending by the EU in the Netherlands, reducing its net contribution accordingly. 

In theory, the scale of the transfers between countries should reduce over the long-term as economic growth leads to higher contributions. Indeed, this has been the experience of Ireland, where its economy has grown to such a point that it is now a (small) net contributor.

The departure of the UK will have a big impact on the EU budget, especially given its position as a net contributor. However, it is important to put this into context: the UK’s net contribution of around €8bn a year is equivalent to approximately 0.1% of total government spending by the other 27 EU countries, while the Withdrawal Agreement envisages the UK continuing to pay into the budget for some time to come.

With the trade war between the US and China hotting up, we thought it might be worthwhile looking at US external trade for our #ICAEWchartoftheweek.

According to the US Bureau of Economic Statistics, US consumers and businesses paid $3.1tn to import goods and services in 2018, while US businesses generated $2.5tn from exports.

This gave rise to a net trade deficit of $622bn, reflecting a net deficit on goods of $891bn (imports $2,654bn – exports $1,672bn), partially offset by a net surplus on services of $269bn (exports $828bn – imports $559bn).

NAFTA members Canada and Mexico together constituted around a quarter of imports and exports, just ahead of trade with the European Union. This is an illustration of the gravity theory of trade, given that their economies are together less than one-sixth of the size of the EU’s.

However, all eyes are on the US-China trade relationship. This has expanded dramatically over the last couple of decades, with imports of goods and services from China in 2018 amounting to $576bn in 2018 or 18% of the total, up from less than 7% twenty years ago. 

China is also an increasingly important export market for US businesses, with exports to China of $231bn in 2018 equivalent to 9% of total exports, up from less than 2% twenty years ago. 

Although both countries have benefited from this expansion in trade, the difference of $345bn between imports and exports constitutes over half of the US’s overall trade deficit.

Despite the protestations of many economists, a number of politicians see large trade deficits as a bad thing. One of these is US President Trump, who has complained about the scale of the difference in the flow of goods and services between the world’s two largest individual economies.

We don’t know whether the US and China will be able to conclude a trade deal in coming weeks, or if the trade war will continue to escalate. Either way, what happens to this critical trade relationship between the world’s two largest individual economies will have implications for the rest of the world too.

Global GDP was estimated to be approximately $83tn in 2018: US $21tn, EU-28 $19tn, China $13tn, Japan & South Korea $6tn, South & Central America $4tn, Canada & Mexico $3tn, Rest of the World $17tn.

In 2018 public spending by the 28 member states of the EU added up to €7,249bn in total, more than the total of €7,150bn received in general government revenue, a net deficit of €99bn.

It is perhaps not surprising to hear that European governments spent €99bn more than they received in 2018, but as our #icaewchartoftheweek illustrates that there is a big variation between countries. Germany and the Netherlands both generated significant surpluses and so were able to pay down debt, while France, Italy, the UK and Spain all needed to borrow to make up the shortfall in their finances.

Sweden, Greece, Czechia, Denmark, Luxembourg, Bulgaria, Austria, Lithuania, Malta, Slovenia, Croatia and Ireland also generated fiscal surpluses. Although Germany and Netherlands had the largest surpluses in cash terms, Luxembourg (2.4%), Malta (2.0%) and Bulgaria (2.0%) each had higher surpluses as a share of GDP than Germany’s 1.7% and Netherlands’ 1.5%.

These surpluses were more than outweighed by deficits in France, Italy, UK and Spain, while Romania, Belgium, Hungary, Poland, Finland, Cypus, Portugal, Slovakia, Latvia and Estonia also spent more than they had coming in. The largest deficit as a share of GDP was Cyprus (4.8%), while Hungary’s (2.2%) was the other country to exceed 2% of GDP in addition to France (2.5%), Italy (2.1%) and Spain (2.5%). The UK’s deficit was 1.5% of its GDP.

The surpluses and deficits are not the full fiscal picture and so should be treated with a little caution. In particular, they relate to ‘general government’, which includes states, provinces and local authorities, but excludes publicly owned corporations, which can be an important source of income for some countries. They also exclude certain expenditures that would be recognised under generally accepted accounting principles, such as the long-term costs of public sector employee pension obligations.

Even so, there is a clear distinction between countries. France, for example, had to borrow money in 2018, seeing its gross debt increase by €57bn to €2.3tn (98% of GDP), while at the same time Germany cut its debt pile by €52bn to €2.1tn (61% of GDP).

EU-28: General government revenue, expenditure and surplus/(deficit) in 2018

The #ICAEWchartoftheweek is on the UK Government’s programme of financial asset sales, an important source of finance for the exchequer. These are expected to generate £16.4bn in 2019-20 and a further £25.5bn over the next four years as the government divests itself of assets acquired during the financial crisis in particular.

The £16bn to be raised in 2019-20 forms part of the overall £145bn funding that is needed to pay for a forecast £29bn shortfall in tax revenues, £99bn in debt repayments, and £17bn in net lending, including student and business loans.

Some £9.6bn of the proceeds in the current financial year are expected to be raised from the sale of the final tranche of Northern Rock and Bradford & Bingley mortgage and loan receivables. This should enable the government to finally close down the UK Asset Resolution ‘bad bank’ that was established during the financial crisis a decade ago.

Another legacy of the financial crisis is the government’s holding in Royal Bank of Scotland plc (RBS), rescued by the taxpayer at significant cost. £3.6bn is expected to be realised from the sale of shares this year, with a further £16.6bn expected to be recovered in future years as the remaining holding is divested. The exact amount to be raised will of course depend on the RBS share price at the time. Remember share prices can go down as well as up!

More controversial are plans to sell portions of the student loan portfolio. There are significant questions as to whether this makes financial sense given the significant losses that were recorded on the disposals made in 2018-19, and the losses expected to be recorded on future disposals.

Disposals of financial assets do not affect the fiscal deficit, but they do have the effect of reducing headline public sector net debt – helpful to the government’s objective of reducing debt as a share of GDP. Of course, whether this is right metric to be focusing on is a matter of debate.

There does seem to be a good logic for disposing of assets acquired as a by-product of bailing out the banking system at the height of the financial crisis that are not held for any strategic or policy purpose. However, the sale of student loans at a loss in order to improve a key performance indicator may not be the best financial decision ever made by the government.

Our #ICAEWchartoftheweek this time is on demographics, illustrating how the population is projected to increase by 10% over the next 25 years, from just short of 67m in June this year to 73½m in 2044.

The ONS have assumed that there will be 770,000 births and 672,000 deaths a year on average over the next quarter of a century, together with annual net inward migration of 168,000. This is an annual increase of 0.4% a year, lower than the 0.6% a year seen over the last twenty-five years, as a consequence of expectations for lower inward migration in the coming years.

What stands out in the chart is the number of people aged 75 or over, which is expected to go up from 5.7m in 2019 to 10.4m in 2044, an increase of 82%!

This is a dramatic change, and is of course good news. But, it will have significant implications for the public finances as increasing sums will be needed to fund state pensions, health, and social care. This will also put pressure on other public services, even if costs can be kept under control on a per person basis.

Unfortunately, there is no money set aside for these costs.

Unlike a number of other countries, social security payments collected from those of working age in the UK are not retained and invested, but are instead disbursed immediately, supporting earlier generations of workers under the ‘pay as you go’ fiscal strategy adopted by successive UK governments. Nor are there any funds available to cover the health or social care costs of those in retirement – when costs are much higher than those of working age.

This means that more and more money will need to be raised in taxes – or – alternatively, state provision for pensions, health and social care for millions of people will need to be dramatically scaled back from that provided today. The latter has already happened to a minor extent with a higher state retirement age, while the state pension triple-lock guarantee of annual increases is looking increasingly vulnerable.

Another option is for higher levels of immigration. This would increase the number of working age people paying into the system, reducing the scale of tax rises and/or cuts in provision that might otherwise be needed. However, this might prove difficult to achieve politically, even if the government wanted to encourage more people to come to the UK.

Unfortunately, there continues to be a lack of a proper debate about the UK’s fiscal strategy. In particular, is it sustainable to continue with the ‘pay as you go’ approach or should we move to a funded approach for some of the state’s financial obligations to its older citizens? While such a change would take time, and so would not be able to relieve some of the immediate pressures on the public finances, building up investment funds over the next quarter of a century might be a way of getting the UK onto a more sustainable path.

In the meantime, I am just keeping my fingers crossed and hoping that ‘my’ free (state-funded) bus pass will still be waiting for me when I eventually retire…

The Commonwealth of Australia presented its budget for 2019-20 last week. Buoyed by higher tax revenues from natural resources, Treasurer Josh Frydenberg MP announced that Australia’s federal finances had returned to surplus, enabling a modest pre-election tax giveaway.

As illustrated by our ICAEW chart of the week, the latest forecast for the current financial year ending this June is for the federal element of general government revenues to exceed expenses and net investment by A$2bn, with a surplus of A$8bn planned for 2019-20 and further surpluses in the coming years. On a cash basis the turnaround is a year later, with a reduction in underlying cash balances of A$4bn in 2018-19 expected to be followed by an increase of A$7bn in 2019-20.

This is a welcome return to positive territory after a decade of red ink after the global financial crisis. 

Revenue is expected to total A$514bn or 25.6% of GDP in 2019-20, with expenses A$501bn (25.0% of GDP) and net capital investment of A$5bn (0.2% of GDP). The financial projections assume that expenses can be kept under control, with a plan to cut spending in some areas in real-terms to offset expected increases in the costs of education and social security and welfare. The ratio of revenue to GDP is expected to increase to 26.0% in 2021-22, before falling back again to 25.6% in 2022-23, while expenses as a share of GDP are expected to fall to 24.6% in 2022-23. Net capital investment is expected to increase to 0.5% of GDP over the same period.

On a per capita basis, revenue in 2019-20 is expected to be in the order of A$1,670 per month, with expenses of A$1,630 per month and net investment of A$15 per month to arrive at a fiscal surplus in the region of A$25 per month.

Surpluses in the years to come should help the Australian government improve its financial position, with net financial liabilities projected to reduce from A$491bn (25% of GDP) at 30 June 2019 to A$447bn (20% of GDP) at 30 June 2023. Net debt is expected to fall from A$374bn (19% of GDP) in 2019 to A$326bn (14% of GDP) in 2023, with a view to being eliminated by 2030.

The surplus for 2019-20 benefits from A$5bn in investment returns from the A$146bn Future Fund, which was established in 2006 to address the Australian government’s unfunded superannuation liabilities. These liabilities, forecast to add up to A$224bn at 30 June 2019, continue to grow, albeit more much slowly since the closure of defined benefit arrangements to new civilian and military employees from 2005 and 2016 respectively. Up until now earnings from the Future Fund have been reinvested, but from 2020-21 they will support pension payments, reducing the cash required from the Australian exchequer. The government has also established the DisabilityCare Australia Fund with assets of A$14bn, the Medical Research Future Fund (A$9bn) and the Aboriginal and Torres Strait Islander Land and Sea Future Fund (A$2bn) to support specific objectives, while there are plans to establish new funds this year for droughts and emergency response with initial investments of A$4bn in each case.

Australia has managed its balance sheet through a combination of expenditure control, financial investment and risk reduction. This contrasts with many other developed nations, which continue to struggle with proportionately much larger amounts of debt and public sector pension obligations. For example, public sector net debt in the UK is around 83% of GDP, while net financial liabilities (including public sector pensions) are in the order of 180%.

Might a similar approach help us to get our public finances here in the UK under control?

At 31 March 2019, £1 was equal to A$1.84. 

Amounts exclude public sector corporations (including the Reserve Bank of Australia) and locally-funded expenditure by Australian states and local government.

For more information go to budget.gov.au.