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 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", dictated 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 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 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 met 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 were too open to politicised interpretation. The Labour government was 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 was 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 were particularly in evidence from 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 Labour government was also 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 was claimed that this step concealed in excess of £21 billion of publicly-underwritten debt.

When Alistair Darling delivered his first Budget in March 2008 it was in the midst of a global economic slowdown precipitated by a crisis in the US mortgage sector. His stated aim was to "maintain stability" and he forecast the current balance of minus £8 billion would return to a surplus of £4 billion in 2010, rising to £18 billion by 2012/13, thus enabling him to meet the Golden Rule and balance the books over the economic cycle.

But the Chancellor was forced to revise his forecasts the following year after the collapse of Lehman Brothers, an American top investment bank, further damaged the international financial system leading to a deep and widespread global recession.

Nevertheless, Mr Darling insisted that allowing borrowing to rise was "the right thing to do" at this time in order to help people and businesses through the recession. And in his final March 2010 budget he resisted calls to cut public spending saying he believed such a policy would be "both wrong and dangerous".

However, when the Coalition government came to power in May 2010 it found that it had inherited "the largest budget deficit of any economy in Europe with the single exception of Ireland" and that for every one pound spent four pounds was being borrowed.

The new Chancellor, George Osborne, in his June 2010 emergency Budget speech, was scathing about Labour's fiscal rules. "As this is the last Budget in which this Golden Rule will appear, I would like to be the last Chancellor to report on it," he said. "We are set to miss the Golden Rule in this cycle by 485 billion pounds."

He went on to claim that the new Government would adopt "a more credible approach", with economic and fiscal forecasts in future provided by the newly created independent Office for Budget Responsibility, taking into account the measures in the Budget.

Statistics

Borrowing to fund the deficit this year is now set to come in at £146 billion, below target.
Then fall to £122 billion next year.
Then £101 billion the year after.
Then £70 billion in 2013-14.
Then £46 billion
And £29 billion by 2015-16.

Our national debt, as a share of our national income, is forecast to be 60% this year, before peaking at 71%, and then starting to fall – reaching 69% by the end of the period.

Source: Budget – 2011
 

Quotes

"Our fiscal mandate is to achieve a cyclically-adjusted current balance by the end of the rolling five year forecast period – which is currently 2015-16.
"We have supplemented that with a fixed target for debt: so that debt should be falling as a proportion of GDP by the year 2015-16 as well.
"I can report to the House that the OBR confirm that on their central forecast we will meet both these objectives – a balanced structural current budget and falling national debt by the end of the Parliament."

Chancellor George Osborne, Budget speech – March 2011