Scottish Budget 2025 to 2026: Scottish Government borrowing

Scottish Budget 2025 to 2026: Scottish Government borrowing

In December 2023, the Scottish Government set out details of its approach to borrowing. This note provides an update on Scottish Government borrowing policy including progress towards a future Scottish Government Bond issuance.

Scottish Government borrowing powers under the Fiscal Framework

The new UK Government has announced changes to the way debt is measured in the UK, with changes both to the headline measure of debt and the treatment of Financial Transactions. These changes do not directly affect the Scottish Government, and the new Financial Transaction Control Framework does not apply to Devolved Governments. Therefore, Scottish Government borrowing powers under the Fiscal Framework Agreement^[1] are unaffected and remain extremely limited.

For capital expenditure the Scottish Government can borrow up to £450 million annually, and £3 billion cumulatively, in 2023-24 prices. This means for the purposes of the 2025-26 Scottish Budget the limits are calculated as £471.7 million and £3,144.5 million respectively.

The Scottish Government can, with the approval of the UK Treasury, borrow commercially or issue bonds for capital investment purposes, or use the UK National Loans Fund as its source of capital borrowing.

For resource Expenditure, borrowing powers are restricted in their use to either cash management (with no additional spending power) or to offset negative forecast variances in tax and social security positions. They are also subject to overall limits - £600 million per annum, and £1.75 billion cumulatively in 2023-24 prices. This means that the limits in 2025-26 are calculated as £628.9 million and £1,834.3 million.

Resource borrowing can only be sourced from the UK National Loans Fund and is limited to a five-year repayment period.

The Scottish Fiscal Commission has a duty to assess the reasonableness of Scottish Ministers’ borrowing projections. The borrowing plans presented in the technical annex have been assessed by the Scottish Fiscal Commission. These plans are based on continuing to borrow through the National Loans Fund and the Scottish Fiscal Commission has assessed these as reasonable given the source of borrowing does not affect the 2025‑26 Budget.

Scottish Government borrowing policy

Despite the limited nature of the borrowing powers, the Scottish Government is committed to ensuring that these are deployed in a fiscally sustainable way that supports value-for-money expenditure.

The fiscal framework rules governing the resource and capital borrowing powers are fundamentally different. Consequently, Scottish Government policy approaches are aligned to the specific risks of each facility.

Approach to Resource borrowing

The primary use of resource borrowing is to mitigate the adverse funding impact of tax and social security reconciliations. As these reconciliations are the result of forecast error they are extremely volatile – and therefore any medium-term forecast of the net impact of borrowing, and borrowing repayments, against them remains subject to considerable change. However, in the majority of circumstances utilising resource borrowing to offset the full adverse impact of negative forecast variances reduces medium-term volatility.

The restrictions on both the scale and tenor of resource borrowing mean that it is extremely unlikely that the cumulative limit will ever be a concern. As an example, debt levels stood at just 27% of the limit at the end of 2023-24 and all of this existing debt will be repaid by 2030. Instead, the more significant consideration is the short term (five-year) repayment period and the constraints that this can place on the medium-term resource budget.

The power to use resource borrowing for cash management has not, and is unlikely to ever be, used. This is a practical consequence of the combination of the funding dynamics of the Fiscal Framework and the UK cash management system more broadly.

In practice resource borrowing considerations need to be taken on a case-by-case basis and finalised at the end of each financial year in the context of the overall financial position and financial forecasts at the time. As 2025-26 reconciliations are currently in a £500 million positive position no resource borrowing is currently forecast for use. Both positions and assumptions are subject to change over the course of the financial year.

Reconciliations for 2026-27 and 2027-28 are currently forecast to be £456 million (positive) and £701 million (negative) based on income tax years 2023-24 and 2024-25 respectively. These positions are subject to considerable volatility when the outturn for both years is completed. As a consequence the resource borrowing assumption of £654 million included in financial year 2027-28 is also subject to change. The central forecast is detailed in the technical annex.

Approach to Capital borrowing

The capital borrowing powers, by contrast to resource borrowing, do allow for discretionary capital expenditure. In this case the annual and cumulative limits are the key restrictions to the use of this facility and the policy approach is primarily governed by how to best support the capital budget in the medium term within the confines of the fiscal framework.

The 2016 Fiscal Framework limited capital borrowing to £450 million per annum with a cumulative debt cap of £3 billion. Within these constraints it was possible to maintain roughly £250 million of annual borrowing and remain within the debt cap indefinitely. Changes to the Fiscal Framework agreed in July 2023 raise borrowing limits in line with inflation from 2024-25. The Scottish Government has concluded that the changes:

• Raise the effective sustainable level of annual borrowing from £250m to £300m.
• Provides more scope for borrowing to be stretched beyond £300m in some years, but not every year.

In light of these fiscal framework changes we have reviewed all capital borrowing policy options. The conclusions from this review are that the principles of the existing policy should be maintained but adapted to the new limits. Going forward the Scottish Government will therefore use the following guidelines to assess any capital borrowing decision:

• Use £300 million of capital borrowing per annum as the default assumption; and
• This will be amended as necessary to meet budget specific or in-year requirements; and
• Ensure, by way of a fiscal test, that at least £1.5 billion of capital borrowing headroom remains available for the subsequent parliamentary term.

Terms of borrowing, such as the tenor, will be determined when annual borrowing decisions are finalised and be adjusted as necessary to ensure there remains sufficient headroom, as set out in the policy. This policy is reflected in funding assumptions for the 2025-26 Scottish Budget, and in the updated borrowing forecasts included in the technical annex.

This capital borrowing policy will also apply to Scottish Government decisions on the use of Bonds.

Scottish Government Bonds

In October 2023 the Scottish Government announced^[2] that it would begin due diligence processes towards a future Bonds issuance. This would include value-for-money-assessments and the means by which an inaugural bond issuance could generate further potential investment opportunities in Scotland.

This initial phase of due diligence has now been completed. The Scottish Government has concluded;

• In the right market conditions, a bond could represent better value-for-money than borrowing through the UK National Loans fund in net-present-value terms.
• Bond issuance, and the associated increase in Investor Engagement, also has the potential to deliver indirect economic benefits. This means that a bond issuance may still represent a value-for-money proposition, even in less favourable market conditions.

The first point relates to the profile of borrowing repayments. The Scottish Government cannot access the traditional government borrowing structure – maturity repayment - through the UK National Loans Fund. Accessing this, or alternative, structures allows short-term cash savings subject to the prevailing UK interest rate environment, the spread which a Scottish Bond attracts, and other market considerations.

The second point relates to the Investor Panel recommendation on investor engagement in their report for the Scottish Government. The Panel recommended that “Although it will involve additional costs, Scotland’s profile could be significantly raised in the international capital markets by using existing devolved powers to issue debt. This will provide a motivation for regular engagement by investors and an opportunity to market Scotland’s investment story. It would also allow the development of relationships with providers of debt, a track record and credit rating.”^[3]

The next stage in the due diligence process will be to determine the specific conditions, and policy parameters, which will frame a successful Scottish Government Bond issuance. This will focus on, but not be limited to, the following:

• Timing considerations for an inaugural issuance given market conditions and related events.
• The frequency of issuances to best meet Scottish Government fiscal and economic objectives.
• Consideration of formal “Use of Proceeds” such as “Green Bonds”.
• Legal, operational and transaction structure considerations.

This next stage of the due diligence process will require external advice. Further information on these aspects will be provided through the course of the 2025-26 financial year.

In December 2023 the Scottish Government set out its strategic intentions as it goes through this process^[4]. These, along with the capital borrowing policy described above, will continue to drive this work going forward.

As with all borrowing decisions, a bond issuance is subject to HM Treasury approval. The Scottish Government will work closely with HM Treasury through this process.

The Scottish Fiscal Commission supports the Scottish Budget process through the production of economic and fiscal forecasts and its assessment of the reasonableness of the Scottish Government’s borrowing plans. The Scottish Government will ensure the Scottish Fiscal Commission, as the independent fiscal institution for Scotland, plays its role in assessing the plans for bond issuance as the due diligence work is developed further.