Investing for jobs: capital spending review framework 2021-2022 to 2025-2026

Ensuring Fiscal Sustainability

Scottish Ministers are committed to ensuring that our financial planning is sound and sustainable. In this section we highlight the key factors underpinning the fiscal sustainability of our capital investment plans.

Just under 85% of the Scottish Government capital budget, including new Financial Transactions funding, flows from UK decisions and allocations. The remaining sums arise from income and receipts, deployment of Scottish capital borrowing powers, from innovative financial and revenue finance models, and from recycling repayments from earlier FT loans.

Consequently, there are some key risks to handle in conducting a Scottish Capital Spending Review ahead of certainty around future UK allocations in a Comprehensive Spending Review, principally:

• The risk that UK comprehensive spending review allocations are insufficient for,
  or higher than, the Scottish financial planning assumptions
• The risk that our planning assumptions, plus FTs and revenue finance, are insufficient to meet the required National Infrastructure Mission investment target that was committed to in 2018

It is important to be transparent around the nature of risks, and to have plans to mitigate them. Scottish Ministers will identify options to flex spend where allocations determined
by the UK Government Comprehensive Spending Review differ from financial planning assumptions underpinning the Scottish Capital Spending Review.

These options include:

• Revisiting capital borrowing plans, to deploy the right amount whilst leaving sufficient headroom for later years
• Use of the Scotland Reserve to smooth profiles and spend between years
• Flexing the rate of increase in annual investment in capital maintenance. This includes asset enhancement, major equipment and fleet
• Accelerating or delaying commencement of agreed projects
• Potential to include additional new capital plans should more funding become available, or to use capital grant in place of some plans for revenue finance

Our Financial Planning Assumptions

Financial planning assumptions have an important role to play in helping us manage our multi-year investments and plans sustainably. They seek to provide guide-rails, or envelopes, to support sound financial planning and help portfolios consider the affordability and sequencing of their major projects and procurement plans.

As highlighted above, our financial planning assumptions for capital investment are:

• Level cash capital grant across Scottish Government as a whole, rolling forward Scottish Budget 2020-21 baselines* into future years to 2025-26
• Within this limit, boosting capital maintenance investment
• At least preserving the £1.8 billion current annual low carbon funding level
• £2 billion new funding for low carbon schemes over the next Parliamentary term

*Baselines are as set out in the Budget introduced into Parliament, not including one-off sums added as part of the Budget agreement.

Using Our Fiscal Powers

As set out in the Medium Term Financial Strategy 2019, the following principles guide decisions by Scottish Ministers on the use of our fiscal powers:

• Sustainability – Sovereign countries generally seek to achieve this by having a broadly balanced budget position over the economic cycle. Under the current constitutional setting, the Scottish Government is constrained to a stricter standard
  of achieving a balanced budget annually, with only limited ability to borrow and use
  a reserve. Within such limited powers, we aim to achieve:
  • Stability – ensuring steady funding and expenditure trajectories
  • Budget flexibility – including the ability to respond to unforeseen events
• Intergenerational fairness – ensuring future taxpayers only bear the cost of spending that benefits them
• Value for money – Borrowing and other sources of revenue-finance investment will achieve value for money for the taxpayer
• Transparency – The Scottish Government will set out clearly its planned and actual use of these powers

Our Published Capital Borrowing Policy

Capital grant forms the majority of capital investment by the Scottish Government. In addition to the capital block grant, the Scottish Government can increase capital expenditure through borrowing up to £450 million per year up to a maximum total of
£3 billion. While these powers enable the Scottish Government to support the capital investment programme and promote economic growth in Scotland, there are limitations to their use:

• Capital borrowing from the National Loans Fund is a lower-cost alternative to privately financed investment
• The term structure of borrowing will be chosen to strike the right balance between flexibility (requiring shorter term lengths), value for money (requiring shorter term lengths), stability (suggesting longer term lengths) and intergenerational fairness (term length corresponds to asset life). The decision on term will be taken at an appropriate time in each year, dependent on factors prevailing at the time such as interest rates and impact on the resource budget
• A contingency reserve of £300 million of the capital borrowing limit will be left unused, to provide the flexibility to undertake capital borrowing if an unforeseen need arises to stabilise the spending trajectory
• Over the period of the next Parliamentary term, our policy is to borrow between
  £250 million and £450 million annually to ensure sufficient investment to support economic growth, and deliver the National Infrastructure Mission

The Scotland Reserve - Capital

The Scotland Reserve allows the Scottish Government to smooth spending within and between years. The Reserve is capped in aggregate at £700 million, or only around 1.4% of the nearly £50 billion total Scottish Budget in 2020-21. Annual drawdowns from the Reserve are limited to £100 million for capital. This severely restricts the Scottish Government's ability to build up a medium-term reserve and draw down from it.

The plans detailed above to deliver our National Infrastructure Mission do not assume additional funds are drawn down in any year from the Scotland Reserve. In practice, decisions are taken at an appropriate time in the year, for example, to assist with any major projects that might have faced delays due to poor winter weather conditions.

The Cost of our Existing Policies and Major Projects

Due to the multi-year nature of infrastructure project planning and delivery, we require to review the proportion of future years' budgets already committed to concluding those major projects underway.

In 2021-22 the investment required to complete major projects already commenced, whose progress is reported twice annually to the Parliamentary Audit and Post Legislative Scrutiny Committee, accounts for around 20% of the available capital budget (using the 2020-21 budget as the baseline). Once required match-funding for European Union schemes, and the impact of our commitment to at least protect current levels of low carbon investment are added, that suggests over 50% of the assumed envelope is either committed or constrained in terms of ability to allocate to new activity. Although that figure is estimated to fall-back a little as existing projects conclude, by 2025-26 it is expected to be over 40% of our total capital budget.

Remaining funds cover other statutory or contractually committed spend, new and continuing programmes, new projects and maintenance. Initial estimates suggest that, in the 2020-21 baseline year, maintenance investment was around £450 million, or 9% of the total capital grant budget. As such, the flexibility to fund entirely new investment through the next 5 years will be considerably lower than the overall assumed envelope would suggest.

Revenue-Financed Investment

The Scottish Government uses revenue finance to deliver additional high-value infrastructure projects, which could not be delivered with capital grant alone. Such infrastructure projects are financed through annual payments or increased tax revenue, typically over a 25- to 30-year period.

The affordability and sustainability of all Scottish Government long-term revenue commitments, including repayment of debt stock, are assessed as part of the Budget process. Annual costs of revenue finance commitments are managed within a maximum of five per cent of the resource Budget available (excluding social security).

In 2019, the Scottish Futures Trust compiled a report^[4] considering the options for future deployment of private finance in Scotland. Of the available choices, it recommended adoption of the Mutual Investment Model, a variant of a Welsh approach.

In the 2019 Medium Term Financial Strategy, we accepted this recommendation and confirmed, in recognition of the costs, MIM would be reserved for schemes delivered by the Scottish Government itself, its agencies or related bodies.

As identified by the Scottish Futures Trust, MIM is most suitable for a pipeline of similar projects or schemes, each of which has a capital asset value of more than £20 million. The market is aware that the deployment of MIM for remaining stages of the A9 is being explored and developed.

An outcomes-based model of revenue finance has also been developed for working with Councils to deliver the Learning Estate Investment Programme. Similarly, outcomes finance aims to be utilised for Green Growth Accelerators.