Public Sector Net Cash Requirement

What is the Public Sector Net Cash Requirement?

The Public Sector Net Cash Requirement (PSNCR) was formerly known as the Public Sector Borrowing Requirement (PSBR). It represents the annual fiscal deficit (in cash terms): that is, the shortfall between public sector revenues and expenditure. In accruals terms, this deficit is known as Public Sector Net Borrowing (PSNB).

The National Debt differs from PSNCR insofar as it is an aggregate figure: it is the successive accumulation of year after year of fiscal deficits, which have yet to be paid off.

Governments have three basic options for financing the PSNCR: increasing the narrow money supply (producing more notes and coins); issuing Government securities or gilts; and borrowing overseas. Each has different side-effects, and has been popular at different times in the 20th Century.

In line with accounting conventions, interest on the National Debt is treated as part of public revenue expenditure, and therefore counts against the annual PSNCR. For this reason governments will typically aim to ensure that their fiscal deficits, averaged over the business cycle, are no greater than the share of state spending of gross domestic product multiplied by the sustainable rate of GDP growth.

For the former Chancellor of the Exchequer, Gordon Brown, this need to show a budget surplus across the lifetime of an economic cycle was known as the "Golden Rule". His second fiscal rule, the "Sustainable Investment Rule", dictates that the Government should only borrow to fund investment (capital spending).

Background

Historically, the development of a structural National Debt was the crucial advantage that enabled Britain to flourish as an international trader before any of its rival powers, permitting it to spend over and above its annual revenues.

However, throughout the second half of the 20th Century, national debt and public sector borrowing has emerged as a structural problem in most developed economies, with large deficits being run year after year, as the role and "size" of the state has grown.

For the UK, this situation was brought about by a macroeconomic focus on postwar reconstruction and full employment, along with a need to maintain a steady balance of payments under the terms of the Bretton Woods fixed exchange rate system - a set of economic priorities that survived from 1945 until 1971. The ascendant Keynesian economics promoted borrowing as an effective means of increasing spending as a tool of demand management.

That economic orthodoxy unravelled in the 1970s. When the Conservatives came to power in 1979, public borrowing stood at around £8.5 billion, having been supplemented by loans from the International Monetary Fund intended to avert a balance of payments crisis. National Debt stood at around 44 per cent of GDP.

The monetarist and supply-side economic reforms (notably the privatisation of costly nationalised industries) and fiscal tightening put in place by the Thatcher government turned this situation around, so that by 1990, the budget was in surplus by £6 billion and Debt stood at 27.7 per cent of GDP. At the same time, many have claimed that this reversal of fortune was not though, without negative side-effects: excessive economic growth caused the economy to overheat, precipitating a recession that lasted into the mid-1990s with borrowing rising to £59.4 billion in 1993-1994.

The Maastricht Treaty of 1992 and the Stability and Growth Pact imposed restrictions on EU member states' levels of public borrowing as a precondition of the establishment of European Monetary Union. These measures were adopted as a necessary condition of imposing necessary disciplines on the fiscal regimes of member states in order to convince the markets that the euro would be a viable currency. Today, debate rages within the EU as to the continued necessity of the Stability and Growth Pact.

On coming to power in 1997, Labour inherited a small PSNCR of around £5 billion, and in the following years achieved a budget surplus, by sticking to the outgoing Conservatives' parsimonious spending plans until 1999, and by raising £22.5 billion from the sale of 3G mobile phone spectrum licences. The Spending Review of 2000 began the current trend of substantially increasing public spending.

It was intended that this would be paid for by increased growth, but global events (principally the terrorist attacks of September 11) led to an economic downturn, and those expectations were not met.

In November 2002, the Chancellor admitted that he would have to borrow £20 billion that year to meet spending plans. Borrowing was projected to peak in 2003-2004, and then tail off over the next five years. For the Chancellor, this borrowing was legitimate insofar as it meets both the Golden Rule and the Sustainable Investment Rule. His critics, however, rejected that analysis, and regarded the maintenance of Labour's spending plans as evidence of an outdated "tax and spend" mentality.

Controversies

Public borrowing is controversial both politically and economically. While it is a truism that an economy and a government cannot sustainably spend more than it earns indefinitely, the idea that governments must maintain annually balanced budgets has generally been long consigned to the dustbin of economic history.

Controversy therefore attends the question of whether any given level of borrowing is sustainable, and for how long. Critics of Gordon Brown claim that both of his fiscal rules are too open to politicised interpretation. The Government has been accused of breaching the Golden Rule by unreasonably classifying current expenditure as investment: genuine investment increases the economy's productive potential, and is therefore a driver for growth, but spending on other items does not.

At the same time, the Government has been accused of breaching the Sustainable Investment Rule by calculating the economic cycle's duration primarily to suit its spending plans, rather than vice versa. Both of these claims have been particularly in evidence since November 2002.

There are three dangers associated with unsustainable borrowing: firstly, in an economy with a low level of saving, increased borrowing may push up interest rates and crowd out private sector economic activity; secondly, high borrowing can increase pressures to increase taxation; and thirdly, increased public borrowing adds to the National Debt, which requires greater servicing. These deflationary side-effects of higher spending illustrate the balance that must be struck in deficit financing.

The Government has also been accused of concealing large amounts of public borrowing through schemes such as the Private Finance Initiative. Accounting practice does not count PFI and PPP schemes as public liabilities: the most significant example of this was the structure adopted for Network Rail, which took on the debts of Railtrack. It has been claimed that this step conceals in excess of £21 billion of publicly-underwritten debt.

Statistics

Between 1979 and 1997 borrowing was 3.4 per cent of national income. Since 1997 it has averaged just 1.2 per cent.
Debt which – at the start of the economic cycle in 1997 – was 43.3 per cent has now fallen to 36.6 per cent of GDP.
The current budget moves clearly into surplus from 2010-11 onwards; and public sector net debt is projected to remain low and stable over the forecast period, stabilising below the 40 per cent ceiling set in the sustainable investment rule.

Source: Chancellor's Budget speech - 2008

The economic forecast is for GDP growth of 3 per cent in 2007, slowing to 2 to 2 ½ per cent in 2008, before strengthening to trend at 2 ½ to 3 per cent in 2009 and 2010.

Source: Pre-Budget Report and CSR – October 2007

Quotes

"Our fiscal rules – to keep debt low and stable and to borrow only for investment over the economic cycle - deliver sound public finances in the medium term.
"Over the past ten years at all times we have taken the action necessary to meet our fiscal rules.
"It is precisely our commitment to this discipline and stability that gives us the flexibility now to respond to the global economic challenges we face today."

Chancellor Alistair Darling – Budget speech, March 2008

"Under Labour, Britain is on the wrong path.

"They have splashed the cash like there's no tomorrow - but the trouble is, there is a tomorrow, and it's got to be paid for."

Tory leader David Cameron – May 2008