Bhupinder Chana: PWLB and the barriers to infrastructure investment
1PWLB rates have fallen. But not all the benefits have been passed on to local authorities, argues Bhupinder Chana.
Local Authorities recognise the importance of capital investment in their infrastructure to ensure that it is fit for purpose and meets its priorities.
This is even more important at a time when Brexit has created economic uncertainty not just in the UK and EU but also in the US, China and emerging markets.
Local authorities have responded to significant grant reductions and increasing pressures to deliver balanced budgets.
This has not been an easy journey and indeed we are now looking at further reductions, even if we want to accept the government’s offer of funding certainty over the next three years.
Whilst we do not know what the alternative offer is, and whether the autumn statement will provide some relief, we are looking at further reducing our net spending envelope despite mounting demography and service pressures.
Like many other authorities, plans to meet those challenges are being put in place for the start of the next financial year.
However, we also recognise the benefits of a strong economy that maintains and allows for business rate and council tax growth that is critical to supporting our financial strategy over the medium term. Central to this is capital investment in infrastructure. Our capital programme allows for investment of £1bn over the next four years of which circa £400m is borrowing.
Borrowing includes support for essential spend to ensure that the council’s infrastructure is fit for purpose, but it also includes schemes which generate revenue savings or increase income to the council that provides further budgetary resilience.
Benefits
It is true that local authorities have benefitted from the reduction in the cost of borrowing from the Public Works Loan Board (PWLB) as gilt yields have fallen.
However, the benefit has not been fully passed on to locals and in a time of a reduced spending envelope is providing a further squeeze on local finances and even a barrier to further capital investment. Before 2010 the margin above gilts was approximately one eighth of 1%, or approximately a 3% charge on top of the 50-year par gilt.
On 20th October, 2010 this was increased to 100bp over the gilt and this unheralded change increased the funding costs to local government across the full yield curve.
The impact on 50-year borrowing was to increase the PWLB margin from 3.1% to 24%.
Subsequently on 1 December, 2012 the certainty rate was introduced, so the mark-up over gilts flat fell from 100bp to 80bp.
On that date PWLB certainty was 4.03% and this represented a margin of 25%.
So, whilst the mark-up to gilts had reduced the proportion above gilts par had actually marginally increased to 25%.
Different picture
Fast forward to today and we have a very different picture. Falling gilt levels means that the mark-up of 80bp to the 50-year gilt represents a margin of 77% on a current yield of 1.04%. This margin is in addition to the fees for arranging the initial loan.
So, for every £10m borrowed this is costing the authority £80k per annum out of a total cost of £184k.
The reality is that this is adding to the financing burden but is also acting as a barrier to further capital investment at a time when rates have never been as low.
If the margin above gilts was still one eighth of one percent, or 13bp, this would represent a saving of 67bp.
On £400m that would represent a saving of £2.68m per annum. This would be significant savings in the context of our medium term financial planning strategy.
The burden of the current mark-up on PWLB falls on the local tax payer, and allows for central government to distribute the profits of this mark-up that is collected across all locals for national objectives.
Fiscal devolution is high on the government’s agenda and this mark-up seems at odds with that approach.
Lowering the mark-up would result in lowering the costs of future debt for locals but would also allow the option for greater capital investment in local economies to the benefit of local government and ultimately still allow central government to benefit through for example jobs growth and the taxes that would then flow in.
Bhupinder Chana is head of finance at Leeds City Council.
Photo: Bob Peters, Flickr.
PWLB rates look increasingly expensive. Short-term “LA to LA” funds are frequently available at around bank rate or lower, so this source of funding will continue to grow in popularity. HM Treasury should benchmark rates across the curve – a tapered margin, much tighter to gilts at the shorter end, would make more sense. Many authorities still don’t need to borrow, but where funding is required it is often shorter term or amortising loans that make more sense (with a shorter average weighted life). These should all benefit from a graduated margin.
Of course, any net investors might argue against this approach – a tapered margin would also pull down their medium term “LA to LA” investment rates! But alternative investments are available.
David Blake, Arlingclose