Finance and Public Administration Committee: finance update

C. Scotland Reserve and Funding Position Details

1. Covid-19 has had a significant impact on the volatility of Scottish Government funding. This has exacerbated the challenge of balancing the management of a growing budget within the narrow limits afforded by the Scotland Reserve. To assist with understanding, this section provides the Committee with:

• An analysis of the current forecast Scotland Reserve position.
• How this position reconciles to the Spring Budget Revision.
• How the reserve position interacts with budgets across financial years.

2. The Scotland Reserve is a limited facility to carry forward funding across financial years. This includes:

• Planned carry-forward for specific purposes such as the £120 million currently set aside for additional Local Government funding in the 2022-23 Budget,
• Underspends on existing budgets which emerge late in the financial year, after they can be redeployed.
• Changes to funding (such as devolved taxes) or to expenditure, which are formalised in the provisional outturn process after the end of the financial year.
• Changes to funding or to expenditure, which are formalised through final outturn process and completion of the Scottish Government Accounts.

3. The Scotland Reserve position evolves continually across the financial year with the emerging outturn position for a particular year influencing the funding available to support future year funding. There is an extended period of overlap with the closing balance for one financial year impacting the drawdown plans for the next two financial years - so for example the final outturn position for 2020-21 happened concurrently with the finalisation of the 2022-23 Scottish Budget document.

4. Despite this continually evolving, volatile position, reserve limits remain fixed. Those limits being a cap of £700 million with annual drawdowns normally restricted to £250 million for Resource and £100 million for Capital and Financial Transactions combined. As we are currently within a defined period of "Scotland Specific Economic Shock" (as set out in the Fiscal Framework) the annual drawdown limits are waived but the cap of £700 million remains.

5. In practical terms this means that the scale of any planned carry-forward increases the risk of a breach in the reserve cap as there is less capacity to accommodate emerging funding and expenditure changes in outturn. A planned (or expected) carry-forward in a Budget is effectively a "target" underspend for the current financial year. Not planning a drawdown means funds are not allocated as efficiently as possible in the budget setting process as it is inevitable that some underspends emerge given the requirement to balance a budget.

6. The latest forecast position is set out in table C.1 below. To assist the Committee the following explanation seeks to show how the position changes over time.

Notes:

• Additions to the Scotland Reserve represent outturn versus budget for each applicable year. Further details explained in narrative below.
• The business as usual drawdown limits were waved in 2019-20 as a result of late reductions to Capital and Financial Transactions budgets. The drawdown limit is waved in 2021-22 and 2022-23 as a result of the Scotland Specific Economic Shock.
• 2021-22 Forecast Additions are based on the latest budget monitoring position at time of writing and are against the Spring Budget Revision allocation.

C.1 2020-21 Final Outturn and the Scotland Reserve

21. The current year (2021-22) Scotland Reserve balance available for drawdown is dependent on the opening balance available. This is itself linked to the final outturn versus budget position for 2020-21.

22. The process for assessing this opening balance effectively starts with the drafting of the 2021-22 Budget, which was over two months before the end of the financial year in January 2021. At this point an assessment has to be made as to what funding is expected to be available for subsequent use in 2021-22.

23. Table C2 below illustrates how projections of the available reserves at the start of the 2021-22 financial year change over time. This is not an exhaustive list of projections, rather it highlights the position at a number of key points in the financial cycle.

24. It should be noted that all in-year drawdowns were adjusted to balance the 2020-21 Budget and managing the changing carry-forward requirement. At the same time there was a need to ensure the £700 million Total cap was not breached.

25. At the time of the 2021-22 Scottish Budget the entire forecast reserve position was planned to be used to support the budget position. This was for two broad purposes:

• As a general rule this is the most efficient use of forecast funds available, by inclusion within the Scottish Budget.
• Given the Scotland Specific Economic shock rules applying in 2021-22 this provided the opportunity to support the planned FT budget at a time where the UK Government funding allocation had reduced significantly. It also minimised longer term headroom issues with the reserve, and financial transactions in particular.

26. There is a continuing challenge of managing the budget flexibly within the drawdown limits of £250 million resource and £100 million for Capital and Financial Transactions. There is a specific risk that Capital and Financial Transactions can build up over time and cannot be deployed within the drawdown limits, such that overall headroom becomes constrained. The Scotland Specific Economic shock rules provided an opportunity to mitigate this in 2021-22 and also assist with the reduction to the Financial Transactions Barnett funding applied in 2021-22.

27. Two things changed in March 2021 at the same time as stage 3 of the 2021-22 Budget process. The UK Budget provided more Covid-19 consequentials for 2021-22 than were previously expected, but also reduced Non Covid Funding. Separately there was an increasing requirement to ensure additional capacity was made in the reserve for Health and Agriculture expenditure which was being re-profiled into 2021-22. The former underpinned a reduction to the previous planned carry forward, the latter drove an increase in balance.

28. At the commencement of the 2021-22 financial year, Cabinet agreed to the principle of drawing down all available funds in the Scotland Reserve, over and above the already agreed £560 million. This relatively small balance (£71 million at the time) was to support the management of in year budget pressures as they emerge, and the effective management of Scotland Reserve headroom over time. Whilst this balance has fluctuated between provisional and final outturn this principle has remained the same for internal budget monitoring purposes.

29. The Scotland Reserve utilises the underspend against HM Treasury funding aggregates, This is different from the underspend reported in the Scottish Government Accounts. Table 3.3 below set out the differences.

30. The minor differences between the Scottish Government underspend as reported in the Accounts (and discussed in detail by Audit Scotland) and underspend against HM Treasury budget aggregates arise through a number of reasons; differing accounting and budgeting treatment of capital expenditure, differences in the scoring of working capital for non-departmental public bodies and different treatment of expected credit losses.

31. In addition the Scottish Government is required to repay an element of Financial Transaction budget provision to HM Treasury. This scale of the repayment was agreed in principle with the UK Treasury at the end of March and the amount finalised in mid-April.

32. The final decision on the level of repayment was taken to ensure that capital and resource funding in the reserve was protected and there was no surrender of funding required as a result of breaching the reserve limit.

33. Whilst Covid-19 has clearly exacerbated the volatility of the funding position, the issues with managing funding volatility within such a tight and fixed reserve limit grow every year as the size and complexity of the budget increases. The practical issues make it difficult to set aside reserves against future year negative reconciliations and decisions on the effective deployment of funds in the latter months of the financial year are hampered by the need to ensure the reserve cap is not breached and funding surrendered. When the Scotland Specific Economic Shock rules expire in 2023-24 this risk will increase.

C.2 2021-22 Funding and the Scotland Reserve

34. As the Cabinet Secretary for Finance and the Economy has made clear on a number of occasions, the differences between the UK and Scottish Government budget processes and timetables and the limited budget flexibilities available to Scottish Ministers can also give rise to issues and this is particularly relevant in the latter half of the financial year.

35. The Scottish Government Block Grant allocation (and associated BGAs) for a particular year are determined initially at UK Spending Reviews. This Block Grant allocation will then be updated at subsequent UK Fiscal events, with Barnett consequentials related to changes in funding allocations to UK Departments for particular policy developments in areas of devolved responsibility, or for specific budget transfers from equivalent UK Departments.

36. These changes in UK funding are then incorporated within the appropriate Scottish Budget publication. So the initial budget publication for a particular financial year will use as the start point the latest Block Grant position, which would be the figure from the latest UK fiscal event – normally the UK Autumn Budget preceding the Scottish Budget. Any funding changes from UK Spring statement and UK Main Estimate would then be reflected at the Autumn Budget Revision and additional in year funding from the subsequent UK Autumn Budget and the Supplementary Estimate shown in the Spring Budget Revision.

37. One key difference between in year funding in 2020-21 and 2021-22 is the absence of a Barnett guarantee or any pre-arranged carry-forward agreement with HM Treasury outside of the Scotland Reserve.

38. As discussed above the Scottish Government had already decided to utilise all existing reserves in 2021-22 for both budget and reserve management reasons. Therefore there is no distinction between underspends in 2021-22 (HM Treasury definition) and the closing reserve forecast.

39. However at the time of the Autumn Budget Revision there remained a balance of £328 million not formally allocated within the Scottish Budget. This was theoretically comprised of the residual Scotland Reserve balance of £71 million (paragraph 24 above) along with the balance of £257 million of other consequentials which had been added at UK Main Estimate process but was not supporting the allocations made in the Autumn Budget Revision.

40. In the scrutiny of the 2022-23 budget the Finance and Public Administration's questioned whether the £20 million of resource "underspend" for 2021-22 would be allocated in the Spring Budget Revision. In reality, timing differences account for the majority of unallocated funding in any budget revision. Not every financial commitment or forecast movement in funding could be reflected in the ABR for the following reasons:

• The level of certainty of a commitment or funding allocation is unclear.
• A commitment may be known but the quantum required to support it remains uncertain.
• Adverse movements in funding may be known but remain subject to confirmation. The relevant example here would be the reduction in Scotland Reserve balance between provisional and final outturn.

41. It is therefore necessary to adopt a prudent approach to funding changes in the Autumn Budget revision to ensure the budget remains balanced. This is partly because there remains the option to reflect further changes in the Spring Budget Revision when commitments or funding changes will become clearer.

C.3 SBR Position, 2022-23 Carry forward and Late Funding Changes

42. The UK Supplementary Estimate and Scottish Spring Budget Revision processes overlap and any delay in finalising UK Supplementary Estimate funding can impact on whether a final budget position can be fully incorporated in the SBR. In many years the impact of this overlap is insignificant with any funding changes that are confirmed after the SBR is finalised relatively minor. These can be picked and reflected as part of the outturn position and incorporated in the movements in the Reserve, or if HM Treasury agree, deferred into the subsequent financial year. 2021-22 does illustrate that where there is significant late volatility in the funding position, the need to complete the SBR in accordance with the Scottish parliamentary timetable can give rise to issues.

43. To comply with the Scottish parliamentary processes the SBR was published on 3 February. To enable finalisation of the document officials had pressed for confirmation of the final UK funding position. HM Treasury provided an updated funding position on 26 January, which included a clear indication that this was close to final, with any subsequent movement likely to be in the region of plus or minus £20 million. This is the position that is reflected in the SBR document and that underpins the decision taken to use the Scotland Reserve to carry forward the £120 million of additional funding allocated to Local Government as part of the 2022-23 Budget process.

44. On 3 February, the same day as publication of the SBR, the UK Government announced the package of Cost of Living measures with an associated consequential impact for Scottish Government of around £290 million. In subsequent days it became clear that the Supplementary Estimates funding position as whole was being revised and the £290 million of anticipated consequentials were effectively being fully offset with reductions in the levels of funding previously indicated (funding that was fully incorporated in the Spring Budget Revision). On 10 February the Cabinet Secretary for Finance and the Economy set out the Scottish Government Cost of Living measures which fully utilise the c£290 million of consequentials allocated as a result of the UK equivalent announcements on 3 Feb. These consequentials will be deferred into 2022-23 to fund these measures, so will not form part of the 2021-22 funding envelope.

45. Tables 1.7 (a) and (b) of the Spring Budget Revision supporting document provide details of the sources of funding that support the changes applied in the revision and the overall movement on available resources.

46. Table C2.1 below sets out a funding analysis that reconciles to the position shown in table 1.7 of the document and then flows through the impact of the subsequent changes to the final Block Grant allocation.

47. The table shows that prior to the final set of funding adjustments there was £283 million of unallocated funding set aside for reserve carry forward to meet the commitments embedded within the 2022-23 Budget position. After adjusting for the final Supplementary Estimate position the SBR is £98 million over-allocated against the Resource budget limit, essentially a managed underspend of at least £98 million on the allocated Resource is required to balance within the HM Treasury funding limits.

48. However the 2022-23 Budget also incorporates a required carry forward of underspend through the reserve. Table C2.2 below sets out the minimum required carry forward required to support the 2022-23 funding position.

49. The table shows a reserve carry forward requirement of £511 million in Total. The reduction in expected funding means that previously planned spending against the Spring Budget Revision limits in some areas will be actively constrained – notably in Health where the final consequential position was far less than previously anticipated. Active management of spending in the final quarter of the year is always necessary to balance the budget within the very tight margins imposed by the fiscal framework. That active management of the financial position in 2021-22 is still expected to deliver the necessary levels of underspend required to support the 2022-23 Budget.

50. As with the Autumn Budget Revision there remains some movements in funding and expenditure which have not been reflected in the Spring Budget Revision - these will result in outturn variances and contribute to the level of underspend required to reach the target level of underspend. Examples here include positive movements on devolved taxes, late changes to borrowing plans and expected underspends in transport and other demand led programmes such as Social Security benefit expenditure. The latest monitoring position as summarised in table C.1 above (2021-22 Forecast Additions) should therefore be seen as a central estimate within a range.