Scottish Government's Medium Term Financial Strategy: May 2019

Annex B: Detail on Capital Investment

Table B.1 shows the 2019-20 baseline as set out in the 2019-20 Budget updated for revised capital grant and borrowing assumptions. The capital grant figures are based on the modelled central scenarios in this document until 2023-24; thereafter, they have been kept level. We will continue to develop our approach to revenue-finance investment which can be used to provide additionality beyond what is possible from capital grant and our limited borrowing powers.

Table B.1: National Infrastructure Mission Baseline

£ million	2019-20	2020-21	2021-22	2022-23	2023-24	2024-25	2025-26
Capital Grant*	4,020.3	4,320	4,534	4,693	4,971	4,971	4,971
Borrowing	450.0	350	n/a	n/a	n/a	n/a	n/a
Financial Transactions	635.5	505	505	505	505	505	505
NPD/Hub Investment	60.0	40	n/a	n/a	n/a	n/a	n/a
Innovative Finance	30.0	25	25	35	20	2	3
Total	5,195.8	4,890	5,064	5,233	5,496	5,478	5,479

*Note: For 2019-20 this includes £42m from the reserve in addition to the capital grant central scenario.

Matching Projects to Financing Methods

The Scottish Government aims to secure best use of all of the funding and financing approaches available within devolved powers, ensuring it can deliver the National Infrastructure Mission (NIM) and value for money. In general, the Scottish Government can generate most investment overall by drawing for each body on those funding methods which offer lowest cost of funds or lowest opportunity cost. This section summarises the various approaches deployed within Scotland and how their cost compares. 

Capital Grant and Capital Borrowing - Capital grant is determined by the allocation provided to the Scottish Government by HM Treasury. Capital grant can be used for any new infrastructure investment and for the acquisition of financial assets. Under the provisions of the Scotland Act 2016, the Scottish Government also has the ability to annually borrow up to £450 million, up to a maximum of £3 billion, to fund further capital investment.

Growth Accelerator - Growth Accelerator is an innovative form of revenue finance where local authorities invest in infrastructure to stimulate local economic development. Where local authorities meet agreed outcomes such as generating a set number of additional jobs from low-income areas, the Scottish Government pays a grant to the local authority equivalent to the investment (including financing costs) over a set time period (typically 25 years). Where targets are not met, the local authority is paid a percentage of the grant depending on how close it was to achieving the target.

Outcomes Finance – This is an innovation building on Growth Accelerator revenue finance and is currently being developed. The aim is to identify the outcomes that local authorities would need to meet to receive a dedicated payment from Scottish Government. Currently a form of Outcomes Finance is under discussion with COSLA to explore how it might more cost-effectively finance the new schools programme.

Tax Incremental Financing (TIF) – In TIF, local authorities invest in enabling infrastructure to deliver economic growth. They are then allowed to retain future increases Non Domestic Rates Income arising as a result of their investment which they can use to finance it.

Mutual Investment Model (MIM) - MIM is a profit sharing form of public-private revenue finance which has been developed by the Welsh Government. Under MIM, a delivery company is established to undertake specific infrastructure investment. The delivery company finances infrastructure investment through a mixture of bank debt, bonds and risk capital from the public and private sector. To pay for the cost of the infrastructure investment, the delivery company receives a unitary charge from the Scottish Government (typically over a 25-year period). Under the MIM model, profits arising from the delivery of infrastructure are shared between the public and private sector investors. 

Hub - Hub is a public-private partnership delivery vehicle developed by Scottish Futures Trust but will no longer be used for design, build, finance and maintain (DBFM) contracts. HubCos can and do also provide assets directly funded by Councils and others, who draw on the HubCo procurement and construction expertise. ‘Hub’ is a term used both to describe the revenue-finance model and the procurement route."

Financial Transactions (FTs) - FTs are a form of finance allocated to the Scottish Government by HM Treasury. FTs can only be used to make loans or equity investments in private sector entities, e.g. universities, or individuals. FTs need to be repaid to the Scottish Government for onward repayment to HM Treasury.

Guarantees - The Scottish Government has the ability to issue “guarantees”. For example, the Scottish Government may agree to fund the gap between expected and actual income. Guarantees are designed for investment projects where there are clear policy benefits but little current appetite in financial markets for support.

Matching Finance to Projects

Increasing SG Cost of Capital	Public Sector Central Government e.g. roads, rail, digital projects, justice, colleges, health.	Public Sector Local Government e.g. schools, housing and local economic development.	Notes (The cost of finance presented below in this table was estimated by Scottish Future Trust, more detail can be found at https://www.scottishfuturestrust.org.uk/publications)
		Tax Incremental Finance (TIF)	Council finances the asset through loans from Public Works Loans Board  (PWLB) and is incentivised by extra tax revenues. TIF cost-neutral to SG if Non-Domestic Rates displacement arising from the new asset is accurate.
	Capital Grant Capital Borrowing	Capital Grant Capital Borrowing	Capital grant block grant is provided by HM Treasury. The PWLB interest cost for borrowing is estimated at 1.4 to 2.1 times the capital value or cost of asset.
		Growth Accelerator (GA)  Outcomes Finance (OF)	Local Authority borrows from PWLB and is incentivised by SG resource grant subject to meeting pre-agreed outcomes. Council Prudential Borrowing and SG affordability limits the use of GA. As above, the PWLB interest cost for borrowing is estimated at 1.4 to 2.1 times the capital value or cost of asset.
	Mutual Investment Model (MIM)		Finance cost is estimated at 1.9 to 2.8 times the capital value or cost of asset.

*The total 25-year cost of maintenance is estimated to be 0.5 times the capital value or cost of the asset.

Increasing SG Opportunity Cost of Capital	Private Sector Universities, SMEs, Housing Associations, GPs, individuals	Notes
	UK Guarantees Scheme (UKGS)	A UK wide £40bn fund for nationally significant infrastructure projects is available and open until at least 2026. UKG guarantees up to 100% of the principal and interest payments on infrastructure debt issued by the borrower to banks or investors. All guarantees are issued on a commercial basis. UKG is the guarantor; SG faces no risk. UKGS therefore represents lowest opportunity cost of financing private sector in Scotland.
	Financial Transactions (FTs)	FTs can only be used for private sector loans or equity investments. SG receives FTs from HM Treasury, currently around £0.5bn p.a. SG must repay 80% to HMT and any bad debts beyond that must be met from SG capital grant.
	Scottish Guarantees	Scottish Government can issue its own guarantees similar to UKGS. Any guarantee over £1m must be approved by the Finance Committee. Capital budget is required to meet any calls on guarantees therefore the risk and potential call on capital must be calculated and provided for before issuing.
	Capital Grant	Capital grant should be prioritised for public sector projects which cannot be funded through other means.

Capital Borrowing Modelling

Three scenarios were selected to illustrate the impact of different capital borrowing decisions:

• deployment of remaining borrowing capacity on a steadily reducing profile over the NIM period; 
• using borrowing to keep capital spending broadly level from 2021-22 (based on the MTFS central scenario to 2023-24);
• maximising borrowing until we can only borrow what we repay.
  

Each scenario was modelled on the basis of 10- and 25-year repayment terms and with interest rates of 2 per cent and 4 per cent. 

In addition, one further scenario was modelled showing borrowing between £250 million and £450 million in each year of the National Infrastructure Mission, leaving a “reserve” of at least 10 per cent (£300 million). In this scenario the modelled borrowing terms that were applied were varied according to the amount borrowed:

• £450 million – 25 years
• £350 million – 25 years
• £300 million – 20 years
• £250 million – 10 years
  

Borrowing was only modelled for the period of the National Infrastructure Mission to 2025-26. The borrowing profile of the scenarios is as follows:

Table B.2: Borrowing Profiles

Scenario (£ million)	19-20	20-21	21-22	22-23	23-24	24-25	25-26
1) Gradually reducing over NIM period	450	350	350	300	250	250	250
2) Borrow to keep capital level	450	350	450	300	50	50	50
3) Maximise borrowing	450	450	450	450	340-450	117-450	123-344
4) Between £250m- £450m over NIM period	450	350	350	300	300	250	250

Assumptions

The central scenario resource budget (excluding social security) has been used as the basis of the 5 per cent calculation.

Repayments are based on the equal instalment repayment (annuity) method.

Future capital grant and Financial Transactions funding is only confirmed until 2020-21. The central scenario numbers are used from 2021-22 to 2023-24 and thereafter level cash has been assumed.

The capital borrowing modelling has been undertaken in the context of the National Infrastructure Mission commitment to steadily increase infrastructure investment until it is £1.56 billion higher in 2025-26 than it was in 2019-20. It has been assumed that revenue finance will be used to bridge the gap between capital grant, FTs and borrowing to steadily increase investment and from 2026-27 keep investment at 2025-26 levels. This means the amount of investment funded through revenue finance will change as the borrowing profile changes.

For the purpose of cautious modelling assumptions, the most expensive form of revenue finance, private finance, has been modelled. The interest rate for this has been kept constant for all scenarios. However, revenue finance is broader than just private finance and, for example, the growth accelerator model is a form of revenue finance which makes use of Public Works Loans Board (PWLB) borrowing, not private finance.

Conclusions 

The modelled scenarios only show borrowing utilised until the end of the next parliament and the end point of the National Infrastructure Mission target – 2025-26. Table B.3 below shows the remaining borrowing headroom for each of the scenarios and, with the exception of the scenarios that maximise borrowing in each year, all have borrowing headroom of greater than £300 million, 10 per cent of the aggregate borrowing limit.

As repayments are made but no further borrowing is modelled, the headroom will increase reflecting that there are choices that can be made in later years.

Table B.3: Borrowing Headroom

Scenario (£ million)	19-20	20-21	21-22	22-23	23-24	24-25	25-26
1) Borrowing reducing over NIM period 25 years 2%	1,338	1,062	797	594	451	318	194
2) Borrowing reducing over NIM period 25 years 4%	1,338	1,058	788	577	424	280	144
3) Borrowing reducing over NIM period 10 years 2%	1,338	1,089	872	740	687	661	661
4 )Borrowing reducing over NIM period 10 years 4%	1,338	1,085	863	723	663	629	622
5) Level cash 25 years 2%	1,338	1,112	888	819	835	855	878
6) Level cash 25 years 4%	1,338	1,108	879	801	807	817	830
7) Level cash 10 years 2%	1,338	1,139	963	971	1,084	1,205	1,334
8 )Level cash 10 years 4%	1,338	1,135	954	953	1,057	1,172	1,297
9) Maximise borrowing 25 years 2%	1,338	962	600	253	0	0	0
10) Maximise borrowing 25 years 4%	1,338	958	590	234	0	0	0
11) Maximise borrowing 10 years 2%	1,338	989	681	417	197	41	53
12) Maximise borrowing 10 years 4%	1,338	985	671	398	168	0	0
13) Borrow between £250m-£450m over life of NIM at 2% but different terms - 10-25 years depending on amount	1,338	1,066	809	618	495	397	324

Table B.4 below shows the impact of each of the scenarios on the 5 per cent revenue finance affordability limit.

Table B.4: Impact On 5% Affordability Limit

Scenario	19-20	20-21	21-22	22-23	23-24	24-25	25-26
1) Borrowing reducing over NIM period 25 years 2%	3.27%	3.42%	3.50%	3.47%	3.57%	3.66%	3.78%
2) Borrowing reducing over NIM period 25 years 4%	3.27%	3.44%	3.54%	3.52%	3.63%	3.73%	3.85%
3) Borrowing reducing over NIM period 10 years 2%	3.27%	3.52%	3.66%	3.69%	3.84%	3.97%	4.11%
4) Borrowing reducing over NIM period 10 years 4%	3.27%	3.53%	3.69%	3.74%	3.89%	4.03%	4.18%
5) Level cash 25 years 2%	3.27%	3.42%	3.50%	3.49%	3.56%	3.63%	3.77%
6) Level cash 25 years 4%	3.27%	3.44%	3.54%	3.54%	3.62%	3.71%	3.85%
7) Level cash 10 years 2%	3.27%	3.52%	3.66%	3.73%	3.85%	3.92%	4.05%
8) Level cash 10 years 4%	3.27%	3.53%	3.69%	3.78%	3.90%	3.99%	4.12%
9) Maximise borrowing 25 years 2%	3.27%	3.42%	3.52%	3.48%	3.57%	3.64%	3.71%
10) Maximise borrowing 25 years 4%	3.27%	3.44%	3.56%	3.53%	3.64%	3.73%	3.80%
11) Maximise borrowing 10 years 2%	3.27%	3.52%	3.70%	3.74%	3.91%	4.05%	4.21%
12) Maximise borrowing 10 years 4%	3.27%	3.53%	3.74%	3.79%	3.97%	4.13%	4.29%
13) Borrow between £250m-£450m over life of NIM at 2% but different terms - 10-25 years depending on amount	3.27%	3.44%	3.53%	3.51%	3.63%	3.73%	3.88%

None of the scenarios breach the 5 per cent limit, with the closest being scenario 12 in 2025-26 at 4.29 per cent (maximising borrowing over 10 years at 4 per cent). A change in interest rate had minimal impact compared to a change in the repayment term. 

The scenario that maximised borrowing to the limit to the extent that we borrow only what is repaid has a positive impact on the 5 per cent because the amount of investment financed by more expensive private finance is reduced.