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The Prudential Code: flimsy fig leaf in the coming storm

Independent statistician and economist, Jim Cuthbert, warns the Prudential Code provides Scottish local government with no protection in the coming storm. 

After the Scottish Government’s tight local government funding settlement in its December 2016 budget, and ahead of the local elections in May next year, independent statistician and economist, Dr Jim Cuthbert, sheds light on a little known but now critically important rule, the statutory Prudential Code in a new policy paper for the Jimmy Reid Foundation. The paper is entitled ‘The Prudential Code: flimsy fig leaf in the coming storm’.

The Prudential Code for Capital Finance in Local Authorities was introduced in Scotland in April 2004. Since then, local authorities have discretion to determine their own levels of capital expenditure and borrowing, provided they abided by the code which is designed to ensure that authorities act prudently and sustainably.

Since its introduction, the code has operated without attracting much comment. But now that we are in an era of much greater uncertainty, with the Scottish Government in control of much more of its own budget after the fiscal settlement, with economic growth remaining weak, and with the implications of Brexit continuing to be unclear, Jim Cuthbert questions whether the code remains fit for purpose over a decade later.

He concludes that the kind of disaggregated system represented by the operation of the code is unlikely to be able to cope with the challenges it will face. There is a manifest danger that local authorities will find themselves over-committed, both in terms of traditional borrowing, and in terms of the contractual commitments they are undertaking through various forms of Public-Private Partnership, (like the Scottish Future’s Trust NPD (Non-Profit Distributing) schemes.) And, there is also the danger that, if times turn hard, authorities may be exposed to various forms of ‘off balance sheet’ debt, (arising, for example, from Arm’s Length External Organisations (ALEOs)), which are not adequately captured in the current operation of the code.

In his paper, Jim Cuthbert, therefore, makes five recommendations:

1) Local authorities need to work to longer time horizons than many of them are currently using when they are assessing the future budgetary consequences of the capital funding decisions they are making.

2) It is not enough to rely on local authorities independently assessing their future expenditure commitments because they may well be making assumptions which are mutually inconsistent.

3) What is required is a joint-system, under which local authorities’ independent financial plans are informed by, and in turn, inform, a national assessment of the prospects for the aggregate of local authority budgets.

4) It would not be appropriate for central government to attempt to carry out this national aggregate financial projection role so a suitable independent body would have to be commissioned to carry out this role. But central government will have to play its part. In particular, it will have to display much greater maturity than it does at present in being more open about potential long term financial prospects.

5) There are a number of more specific issues about the Prudential Code which need to be addressed, in particular, the code should require authorities to be much more open about issues like the financing costs actually being incurred under the guise of public private partnerships.

Commenting on his Jimmy Reid Foundation paper, Jim 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. More authorities need to work to longer term planning horizons: but that alone would not be enough. In addition, there needs to be a national assessment of the prospects for the aggregate of local authority budgets, carried out by a suitable independent body. My recommendations are intended are intended to help local authorities get to grips with the challenges they face but they will need help from the Scottish Government to do so.’

The full paper is available hereJRFJCPrudentialcode  Useful coverage of the Paper appears in Public Finance in an article by Keith Aitken