SG borrowing to keep the economy buoyant

The Scottish Government is poised to use its new borrowing powers for the first time, although it will be a fairly modest venture into debt. The budget for 2016-17 envisages drawing £316m from the National Loan Fund (NLF) to help finance building projects totalling £2.2bn.

The ability to borrow comes as part of the extra powers granted in the 2012 Scotland Act. It came into force in April 2015, but Finance Secretary John Swinney chose not to use the facility in the current financial year, paying for infrastructure improvements from his revenue budget instead.

The amount he can raise is fairly limited, up to 10% a year of his total Departmental Expenditure Limit, subject to a maximum over ten years of £2.2bn. Pro-rata that would imply £220m a year, so there is an element of front loading in his plans. This is probably a deliberate attempt to provide an economic boost, but Mr Swinney may also be banking on winning more headroom in the future.

Borrowing can be done in any of three ways: from the  NLF, from banks or other financial institutions, or by issuing bonds. This last, included at the insistence of the Scottish Government, would be the most high profile, but also the most sensitive. A bond issue (the market has already christened them “kilts,” a play on the nickname “gilts” for UK bonds) would be a sign of the virility of the Scottish state, but, with the collapse of the oil price and its impact on the wider economy, it might attract an unwelcome lowly rating and consequent high interest rates.

Drawing cash from the NLF will be easier, faster and cheaper. The Scottish budget is very conservative in its provision for repayment and interest, assuming the loan will be over 25 years at 5%. In fact the UK Government can now borrow at historically low rates  and passes these on through the NLF. The rate charged to Scotland is likely to start at half what has been estimated, and even lower if the loan is repaid more quickly.

There is a good reason why Mr Swinney will want to accelerate infrastructure spending in the coming year. In the past he has used big construction projects as a way of keeping output and employment buoyant. Scottish GDP grew by 2.6% last year, but that total included an 11.5% increase from the construction sector. Without it the performance would look much less cheerful.

But the impact of the North Sea redundancies and the global slowdown will take their toll. There is a need to keep up the momentum. Some mega projects are coming to an end. The Southern General (QE II) Hospital in Glasgow is complete,  the new Forth road bridge is scheduled to open by the end of the year. Private demand will not take up the slack, so the Government has drawn up a list of road and rail improvements, hospitals and schools to keep order books full.

Mr Swinney has a second borrowing power which he is not so far using. As well as taking on debt to finance capital projects, he can now borrow up to £200m to bridge shortfalls in revenues.

In the past that hasn’t been necessary, but now that Scotland is obliged to raise a proportion of its own income it may be. The first two Scottish levies —Landfill Tax and Land and Buildings Transaction Tax —have both fallen short of their forecast yield. They are relatively small contributors to the £35bn total budget, but they illustrate the uncertainty of fiscal prediction.

The Scottish Rate of Income Tax is another matter. It will account for around £4.5bn. For the time being Scotland is protected from any shortfall, but once the transitional period is over there will be a risk that the expected revenue does not fully materialise. In that eventuality Mr Swinney or his successor will have three choices: borrow, use reserves (assuming he has been able to keep any back from previous years) or cut spending.

Comments

  1. says

    I wondered what impact Scotland’s councils’ very high levels of borrowing would have on the perceived attractiveness of “kilts”? It seems to me that Swinney has been relying on councils’ ability to borrow for the first 9 years of government and now we’re saddled with twice the per capita council debt of the rest of the UK, as well as substantial NPD / PFI debt. Would these have an impact on “kilt” rates or would the UK’s strong rating be the definitive factor?

    • Ray Perman says

      It would depend on whether the UK Treasury was seen to be standing behind Scottish debt (central and local government) or not. In practical terms as long as Scotland is part of the UK, the market will believe that ultimately the UK will bail out any defaulting public body. Investors may not give “kilts” as high a rating as UK debt – and will therefore charge higher rates of interest – but they will still be willing to invest.

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