Briefing by the National Audit Office HM Treasury The choice of finance for capital investment MARCH 2015 Our vision is to help the nation spend wisely. Our public audit perspective helps Parliament hold government to account and improve public services. The National Audit Office scrutinises public spending for Parliament and is independent of government. The Comptroller and Auditor General (C&AG), Sir Amyas Morse KCB, is an Officer of the House of Commons and leads the NAO, which employs some 820 employees. The C&AG certifies the accounts of all government departments and many other public sector bodies. He has statutory authority to examine and report to Parliament on whether departments and the bodies they fund have used their resources efficiently, effectively, and with economy. Our studies evaluate the value for money of public spending, nationally and locally. Our recommendations and reports on good practice help government improve public services, and our work led to audited savings of £1.1 billion in 2013. Contents Summary 4 Part One Trends in public finance 11 Part Two Trends in private finance 18 Part Three Decision-making process and budgets 26 Part Four Recent developments in infrastructure financing 35 Appendix One Cost of private capital 41 Appendix Two Special Purpose Vehicles 51 The National Audit Office study team consisted of: Daniel Fairhead, Vasilisa Starodubtseva, Simon Reason, under the direction of Matthew Rees. This report can be found on the National Audit Office website at www.nao.org.uk For further information about the National Audit Office please contact: National Audit Office Press Office 157–197 Buckingham Palace Road Victoria London SW1W 9SP Tel: 020 7798 7400 Enquiries: www.nao.org.uk/contact-us Links to external websites were valid at the time of Website: www.nao.org.uk publication of this report. The National Audit Office is not responsible for the future validity of the links. Twitter: @NAOorguk 4 Summary The choice of finance for capital investment Summary 1 This briefing paper considers capital investment and how government chooses to finance it. 2 Figure 1 shows that over the past 50 years, public sector gross investment (PSGI) has decreased as a proportion of Gross Domestic Product.1 Much of this reduction resulted from the transfer and sale of assets to the private sector because privatised industry capital investment is not scored in PSGI. Since the introduction of the Private Finance Initiative (PFI) in the 1990s, private finance has contributed to public sector capital investment. In the past 15 years government capital investment has increased, with a peak in 2010 which coincided with a fiscal stimulus and a decline in the past 5 years as the government has sought to put the public finances on a sustainable footing. 3 In the 2014 Autumn Statement the government reiterated the importance of infrastructure for economic growth. It stated that it has prioritised capital investment over day-to-day spending and was taking a long-term approach, tackling the historic problems of short-term decision-making.2 The government has also published a National Infrastructure Plan each year since 2010: the 2014 plan contains a pipeline of £327 billion of public and private infrastructure investment planned to 2020-21.3 4 This briefing paper describes several factors affecting central government capital investment decisions, including budgeting, project appraisal, procurement, finance and accounting treatment. Based on these factors we make a number of observations about the relative flexibility, transparency and other attributes of different financing choices, including cost. We have not evaluated the decisions to invest in particular projects, but we note HM Treasury’s guidance that the decision to use public or private capital to finance a particular investment should be supported by a value-for-money (VfM) assessment. The government’s decision on the aggregate level of capital investment is also outside the scope of this briefing paper. 1 PSGI is a measure of capital expenditure. A detailed glossary of terms is available in HM Treasury, Public Expenditure Statistical Analyses 2014, Annex G: Glossary of terms. 2 HM Treasury, Autumn Statement 2014, December 2014. 3 HM Treasury, National Infrastructure Plan 2014, December 2014. The NIP includes transport, energy, flood defences, water, waste, communications and science. It does not include social infrastructure (eg housing). Figure 1 Public Sector Gross Investment (PSGI) and PFI investment – past 50 years PFI has added to Public Sector Gross Investment Percentage of GDP 12 Significant sales/transfers of public assets, including: 11 ‘Right-to-buy’ scheme 1980 British Airports Authority 1987 10 British Telecom Housing stock transfers 1988 1984 9 British Water Authorities 1989 8 Gas 1986 Electricity companies 1990 7 Train Operating Companies 1994 6 Introduction of PFI 1990 5 The choice finance of for capital investment 4 3 2 7 9 1964-651966-671968-691970-711972-731974-751976-71978-71980-811982-831984-851986-871988-891990-911992-931994-951996-971998-992000-012002-032004-052006-072008-092010-112012-132014-152016-172018-19 PSGI as percentage of GDP PFI as percentage of GDP (incremental effect) Projection of PSGI as percentage of GDP Notes 1 PSGI includes investment of local government and state-owned enterprises so these figures are not directly comparable to other data in this report on central government capital spending. 2 The capital investment through PFI has been added to the PSGI figure. A small amount (approximately 10%) of PFI investment is on balance sheet for national accounts purposes so is also included in PSGI spending figures. Summary Sources: Office for Budget Responsibility, Public Finances Databank, 25 January 2015; HM Treasury PFI database (updated 15 December 2014) 5 6 Summary The choice of finance for capital investment 5 We have previously reported on the role of the centre of government, in which we noted that the move towards greater central coordination in strategic areas was given impetus by the climate of austerity.4 An important part of the government’s response to this challenge was the HM Treasury-led review of financial management, which recognised that government needs to develop a more strategic finance function, particularly in light of the constraints on public expenditure. We intend this briefing paper to complement that review by providing more information on capital investment and financing decisions. 6 This briefing is structured as follows: • Parts One and Two examine trends in capital investment, including the annual investment expenditure by several departments, using public and private finance respectively. • Part Three explains how the government’s budget process affects the decisions to use public and private finance for capital investment. • Part Four summarises recent developments including refinancing projects, introduction of PF2 and government interventions. Our approach 7 We interviewed HM Treasury and 4 other spending departments within central government (Transport, Health, Education and Defence) to understand how the budgeting process operates. We also analysed the capital investment and financing choices made by these departments, some of their sponsor bodies and the fifth largest capital spending department (the Department for Communities and Local Government) using a range of public sources.5 4 Comptroller and Auditor General, The centre of government, Session 2014-15, HC 171, National Audit Office, June 2014. 5 These sources include the National Infrastructure Plan, HM Treasury PFI database, HM Treasury Public Expenditure Statistical Analysis (PESA), Whole of Government Accounts, annual accounts of departments and other public bodies. The choice of finance for capital investment Summary 7 Findings Recent trends in capital investment 8 The vast majority of capital spending is publicly funded. A short-term fiscal stimulus contributed to a peak of capital investment in 2009-10. In subsequent years, the government’s annual capital spending has reduced by around one-third. Publicly financed capital investment was reduced by one third in real terms from a peak of £57 billion in 2009-10 to £42 billion in 2013-14. Departments’ use of private finance for capital investment has also declined in this period. In the 5 years to 2013-14 it averaged £2.3 billion a year compared with £4.6 billion a year in the previous 5 years, representing a real-terms fall of more than half. Spending on the servicing of existing private finance (maintenance and other services plus interest charges and debt repayment) has increased from £7 billion in 2009-10 to £10 billion in 2013-14 in line with contractual commitments (paragraphs 1.2 and 2.3 to 2.4). 9 Publicly financed capital spending of the 5 largest capital spending departments reduced from £39 billion in 2009-10 to £28 billion in 2013-14, in part because the government had brought capital spending forward from future years into 2009-10.6 The largest reductions were in Education, and Communities and Local Government. Spending on schools fell from more than £7 billion to less than £4 billion (a 55% real-terms reduction). Communities and Local Government’s capital spending, which is primarily for housing, reduced from more than £9 billion to less than £4 billion (a 62% real-terms reduction). Health and Defence reduced capital spending by around one-quarter in real terms (paragraphs 1.2 to 1.7). 10 When departments record capital expenditure there is no distinction between that used to build new assets and that to repair or renew existing assets. This means that it is difficult for the government to know how much capital expenditure departments require simply to maintain assets in their current condition for business-as-usual maintenance, or to observe how changes in capital expenditure affect different sectors. We estimate that under half of departmental capital spending is for constructing new assets. By contrast, nearly all private finance investment is used to construct new assets (paragraph 1.11).