Replace prudential borrowing code in Scotland, urges expert

16 Feb 17
The Prudential Code, which guides local authorities’ capital borrowing, is no longer fit for purpose in Scotland’s changed economic and fiscal climate and should be replaced by a shared system of more open and long-term assessment, according to a leading independent economist.

Former Scottish Office chief statistician Dr Jim Cuthbert set out his ideas in a paper for left-leaning think-tank the Jimmy Reid Foundation. He told PF: “The system was designed for a different era and it really has to be rethought for the very challenging circumstances we now face.”

Cuthbert’s reforms would include: longer time periods for assessing the budgetary consequences of loans; greater consistency and objectivity in economic modelling, based on aggregated national financial projections drawn up by an independent body; and more openness in respect of borrowing costs incurred indirectly by councils through arm’s- length external organisations (ALEOs).

The Prudential Code, drafted by CIPFA and used across the UK, gained statutory force in Scotland in 2004. Its aim is to provide a framework for authorities to make capital borrowing decisions in place of the previous system of consents from central government. It set outs indicators councils should observe to keep their borrowings prudent, affordable and sustainable.

However, Cuthbert said: “Dark storm clouds are now gathering and it is a matter of urgency that the Prudential Code system is adapted to cope with the uncertain environment for local authority finances.

“There is a manifest danger that local authorities will find themselves overcommitted, in terms of both traditional borrowing and in terms of the contractual obligations they are undertaking through various forms of public-private partnership,” he added.

“There is also a danger that, if times turn hard, local authorities may be exposed to various forms of off balance sheet debt, arising, for example, from ALEOs, which are not adequately captured in the current operation of the code.”

Scotland is particularly exposed to these risks, Cuthbert told PF, because it is highly reliant on such semi-detached agencies and partnerships, thanks not least to funding models developed by the Scottish Futures Trust. Scottish Parliament figures show that in 2012-13, Scottish ALEOs controlled budgets in excess of £1.3bn and employed more than 25,000 staff.

Council budgets also face uncertain prospects because of the fiscal powers devolved to Holyrood under the 2016 Scotland Act. These tie Scotland’s public finances much more closely to the performance of the Scottish economy, which is being buffeted by a slump in oil-related activity and Brexit uncertainties. Scottish Government grants make up 40% of councils’ revenue income.

Against this background and the revenue budget cuts already in train, Cuthbert argued, an ad hoc system of councils making their own economic assessments over variable reference timescales (the code specifies minimum three-year indicators) is inadequate. The Scottish Government has itself pressed for more long-term municipal financial planning.

“Given that the revenue consequences of the decisions which local authorities take now about capital expenditure will affect their budgets for the next 30 or 40 years, even a five-year horizon is inadequate for purposes of planning capital expenditure,” Cuthbert wrote.

“Unless much more effective longer term planning takes place, then Scottish local authorities could well find that they cannot afford the revenue consequences of the commitments they are making on capital expenditure. If this happens, the consequences in terms of increases in local taxes and cutbacks in services are likely to be severe.”

CIPFA is consulting on changes to the Prudential Code.

  • Keith Aitken
    Keith Aitken

    covers Scottish affairs for Public Finance from Edinburgh. He was formerly economics editor and chief leader writer on The Scotsman and now has a busy freelance career as a writer, broadcaster and event chair.

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