“We will make it our mission to steadily increase annual infrastructure investment so it is £1.5 billion per year higher at the end of the next Parliament [2025-26] than in 2019-20. This bold mission will increase Scottish Government capital investment by an additional 1% of current Scottish GDP and to achieve it we will need to continue to innovate in our models for investment and work across the public sector. On current estimates that would mean around £7 billion of extra infrastructure investment by the end of the next Parliament.”
The First Minister referred to a 2019-20 baseline of “around £5 billion”, implying annual infrastructure investment of around £6.5bn by 2025-26, although the profile of infrastructure investment over the intervening years is unclear.
How will this additional investment be funded?
Little information was given on how this additional infrastructure investment will be funded, with the First Minister stating:
“The Cabinet Secretary for Transport, Infrastructure and Connectivity will set out in the coming months the detail of how we will deliver on that pledge and the priorities for investment.”
Without detailed information, it is not possible to know where the money will come from to fund the increased investment. The Scottish Government can fund infrastructure investment in a number of ways, including:
- Traditional capital investment – using the annual capital block grant from HM Treasury to pay upfront for infrastructure projects.
- Borrowing – the Scottish Government’s borrowing powers allow for annual capital borrowing of £450m up to a cumulative limit of £3bn.
- Financial Transactions money – in recent years, the Scottish Government has received money from the UK Government classified as ‘Financial Transactions’ (FT) money (see previous blog on FTs). The Scottish Government can only use FT funds to support equity or loan schemes beyond the public sector. The Scottish Government plans to use FT monies to provide initial capitalisation for the Scottish National Investment Bank (SNIB) which would, in turn, support infrastructure investment (see previous blog on SNIB).
- Revenue-financed investment – public-private partnership models, such as the Scottish Government’s non-profit distributing (NPD) model, have been used to finance infrastructure investment, including many schools and hospitals (see previous blog on private financing). Under these schemes, a private sector consortium provides upfront financing for the infrastructure project and the public sector then pays for the project once completed through regular payments over a period of 25-30 years, which include maintenance and service charges. Changes to public sector accounting rules have affected the classification of revenue-financed projects. As a result, the Scottish Government is having to review this method of financing in order that revenue-financed projects can continue to be classified as private sector projects. This matters because if they are classified as private sector projects, they have no upfront impact on the capital budget. Instead, they are paid for through annual payments from the revenue budget, leaving the capital budget free to spend on other projects.
What do we know about future plans for these funding sources?
Looking at what we know about each of these funding sources can tell us something about the gap that remains to be filled:
- Traditional capital investment – the scenarios set out in the Scottish Government’s Medium Term Financial Strategy suggest total capital funding of between £4bn and £4.5bn by 2022-23.
- Financial transactions – the Medium Term Financial Strategy shows projections to 2022-23 for FTs (which are determined by the UK Government). The projections range from £0 to £1bn.
- Borrowing – taking account of borrowing to date, and planned repayments, the Scottish Government could continue to borrow the maximum amount of £450m in each year until 2022-23 without breaching the £3bn cumulative limit.
- Revenue-financed investment – forward projections of revenue-financed investment plans are not available, but in 2018-19, the capital value of revenue-financed investment was £150m.
What gap remains to be filled?
Without any increase in revenue-financed investment, these sources would together account for around £5.3bn investment by 2022-23, based on the Scottish Government’s central projections. This would leave a gap of over £1bn to be filled if the Scottish Government is to meet its target of annual infrastructure investment of £6.5bn per year (although this target is for 2025-26, beyond the period covered by the Medium Term Financial Strategy).
How might the gap be filled?
There are a number of uncertainties in the projections set out above. The capital budget and FT funding, which are determined by the UK Government, could be lower or higher than anticipated. This could either narrow the gap to be filled, or could make it wider.
Borrowing cannot extend beyond £450m per year (and cannot continue indefinitely at this level as the £3bn cumulative limit would be breached). So there is no scope for additional borrowing to help meet the infrastructure investment target.
The Scottish Government might, therefore, look to extend revenue-financed investment in order to achieve the increase in infrastructure investment. In her Programme for Government speech, the First Minister said:
“..in addition to traditional capital and borrowing, the Scottish Futures Trust will examine new profit-sharing finance schemes, such as the Welsh Government’s mutual investment model, to help to secure both the investment that we need and best value for the taxpayer.”
The Welsh mutual investment model is an adaptation of the Scottish Government’s NPD model, modified so that the projects can retain private sector classification. As with NPD projects, infrastructure investment funded through this route would result in unitary charge payments in future years.
How much additional revenue financing can be accommodated?
Any further borrowing or revenue investment will result in repayment costs and/or unitary charges in future years. These additional costs will need to be taken into account in the Scottish Government’s commitment to keep these costs within 5% of the total budget. On current projections, long-term investment costs are anticipated to peak at 4.2% of the DEL budget in 2020-21.
This leaves some headroom for additional costs, equivalent to 0.8% of the budget. On the basis of current projections, this would mean that additional repayment/unitary charge costs of around £270m per year could be accommodated without breaching the commitment.
To put this in context, unitary charge payments on the Scottish Government’s current NPD projects are expected to total £270m in 2019-20 and this relates to projects with a combined capital value of £2.7bn. So, on the basis of the information available, there would appear to be scope for the Scottish Government to meet its infrastructure investment commitments through greater use of revenue-financed investment, making use of a modified version of NPD.
Nicola Hudson, Senior Analyst, Financial Scrutiny Unit