Appendix 12

Prudential Indicators

1. Introduction

1.1 At its meeting on 24 November 2003, the Cabinet agreed a policy on the use of unsupported borrowing, to take effect from 1 April 2004, to coincide with the introduction of the new prudential system for capital finance. The new system is underpinned by a Prudential Code published by the Chartered Institute of Public Finance and Accountancy (CIPFA).

1.2 The Prudential Code provides a framework for local authority capital finance designed to ensure that:

· capital programmes are affordable

· external borrowing and other long-term liabilities are within prudent and sustainable levels

· treasury management decisions are taken in line with professional good practice.

2. Prudential indicators

2.1 The following paragraphs set out the prudential indicators required by the Code for the County Council. They assume that the revised and forward revenue budgets and capital programme set out in other reports on this Agenda are approved. If the Cabinet or County Council were to decide to change the budget or capital programme recommendation, it is likely that some of all of the prudential indicators will need to be revised accordingly. In that event, a further report setting out a revised list of indicators will be presented either to the County Council or to the next Cabinet meeting.

3. The prudential indicators

Actual and estimated capital expenditure

3.1 The actual capital expenditure incurred in 2003/04 and estimates of capital expenditure in the current and future years to March 2008 are set out in the table below. These are based on the capital programme submitted to the Cabinet for approval (item 6 on this Agenda).

3.2 Increases in capital spending in 2004/05 and 2005/06 are the result of two main factors:

· an increased level of Government-supported capital expenditure

· the investment of £60m in the provision of 500 nursing care beds, £20m of which it is proposed should be financed from unsupported borrowing.

Capital financing requirement

3.3 The capital financing requirement represents capital expenditure other than that met directly from capital receipts, the revenue budget, capital grants or contributions. This can be financed either by external borrowing or by borrowing from internal balances. The variation from year to year in the level of the capital financing requirement represents the impact of new capital expenditure financed by borrowing offset by the provision made in the revenue budget and the use of capital receipts to repay debt. The actual capital financing requirement as at 31 March 2004 and estimates as at 31 March 2005, 2006, 2007 and 2008 are set out in the table below.

3.4 The capital financing requirement includes unsupported borrowing in respect of the following projects:

3.5 Transitional costs from the 1997 Local Government reorganisation of £4.2m were funded from Government approvals which were issued on an unsupported basis so that the financing costs were not supported by Government grant, but enabled local authorities to defer the impact on the revenue budget. Full provision for the repayment of this borrowing will have been made by 2007/08. The County Council received an unsupported borrowing approval of £2.25m in conjunction with the agreement of the Local Public Service agreement in 2002 to meet part of the cost of investing in improved social care information systems and to finance projects at two Gosport schools. The financing costs will be a first call on any Performance Reward grant achieved or will otherwise be met from service cash-limited budgets.

3.6 The proposals for unsupported borrowing in 2004/05 and subsequent years are the result of the application of the County Council's policy on the use of unsupported borrowing under the Prudential Code. Projects fall within three categories contained in the policy:

· borrowing over a period of up to 10 years on an `invest to save' basis where the project is expected to generate cash savings, increased income or the avoidance of otherwise unavoidable costs, which will enable the service's revenue cash limit to be reduced in order to accommodate the financing costs within the budget. Unsupported borrowing for the Nursing Care project and at Calshot Activities Centre has been approved in accordance with this policy

· temporary unsupported borrowing pending the availability of capital receipts, grants or contributions, which will enable the borrowing to be repaid, including any interest costs not met from within the service revenue budget. Unsupported borrowing at Chiltern, Crestwood, John Hunt of Everest and Nightingale schools, the Mount Hospital site and North Popley have been agreed or are proposed in the 2005/06 to 2008/09 capital programme in accordance with this policy

· use of unsupported borrowing to finance business unit capital expenditure where the financing costs will be recovered in charges made to users and met from their existing budgets. IT Services' use of unsupported borrowing was approved in accordance with this policy.

Ratio of financing costs to net revenue stream

3.7 The ratio of financing costs to the net revenue stream shows the estimated annual revenue costs of borrowing (interest payable on debt plus the minimum revenue provision for repaying the principal less interest on balances) as a percentage of the amount in the draft revenue budget to be met from central government grants and local taxpayers. Actual figures for 2003/04 and estimates for 2004/05 to 2007/08 are set out in the table overleaf. It excludes past capital expenditure being financed by external bodies following the transfer of services away from the County Council.

3.8 The increase in the proportion of the net revenue stream devoted to financing costs is a reflection of the projected increase in the capital financing requirement in paragraph 3.3. This arises because Government-supported borrowing is currently substantially higher than historically so that new capital expenditure financed from borrowing exceeds the provision for repayment of past debt. The higher financing costs in respect of supported borrowing will be reflected in the Capital Financing Formula Spending Assessment within the revenue support grant, while the financing of unsupported borrowing is either temporary pending capital receipts or will be matched by equivalent savings or alternative expenditure avoided within service cash limits. The anticipated change in schools funding from 2006/07 will reduce the County Council's net revenue stream as defined in the Prudential Code, while the County Council will still be responsible for financing school capital investment from within its reduced net revenue stream. But for this change the 2006/07 ratio would have been approximately 3.8%.

Estimated incremental impact on council tax of draft capital programme

3.9 The following table sets out estimates of the incremental impact on the Band D council tax which will result if the Cabinet approves the new draft capital programme.

3.10 This indicator has been calculated as if the impact of financing new capital investment by borrowing falls entirely on the council tax. However in practice the cost of financing additional Government supported borrowing is broadly matched by additional revenue support grant. The new unsupported borrowing proposed will be matched by an equivalent reduction in current expenditure within the relevant service or will be covered from future capital receipts. The borrowing costs arising from the proposed capital programme are therefore expected to have a neutral impact on the council tax.

Medium term borrowing not to exceed capital financing requirement

3.11 The Prudential Code requires that, as a key indicator of prudence, net borrowing over the medium term should not exceed the total of the capital financing requirement in the preceding year plus the estimates of any additional capital financing requirement for the current and next two years. The County Treasurer will ensure that this limit is not breached.

Actual external debt

3.12 Actual external debt at 31 March 2004 was £315.3m.

Authorised limits for external debt

3.13 The Code also requires authorities to set authorised limits for external debt, defined as the sum of external borrowing and other long-term liabilities. It is recommended that the following limits be approved for the period 2005/06 to 2007/08.

3.14 These recommended limits are based on the estimated capital financing requirements (paragraph 3.3), and would enable them to be financed entirely by borrowing should the Council's reserves become depleted. They also include an allowance for temporary borrowing to cover normal revenue cashflow requirements and unexpected outflows or delays in receiving cash. The 2005/06 limit is also the statutory limit for the purposes of Section 3(1) of the Local Government Act 2003. It should be borne in mind that the limits for 2006/07 and 2007/08 are indicative only and can be revised next year if necessary.

Operational boundaries for external debt

3.15 The Cabinet also needs to approve operational boundaries for external debt over the same periods. These should reflect the most likely scenario and be consistent with the Council's capital plans and treasury management strategy. Temporary breaches of the 2005/06 operational boundary can take place for cashflow reasons, but any sustained breach will lead to further investigation. The Cabinet is asked to approve the following operational boundaries for 2005/06, 2006/07 and 2007/08.

3.16 The operational boundary for 2005/06 has been based on a daily cashflow forecast which has provided estimates of external borrowing required to implement the draft revenue budget and capital programme. The increased indicative boundaries for 2006/07 and 2007/08 reflect the rises in the predicted capital financing requirement in those two years.

Borrowing limits net of transferred services

3.17 There is some ambiguity in the Prudential Code of Practice as to whether the indicators of external debt should be gross or net of the impact of transferred services. Net of transferred services, the authorised limits and operational boundaries are as follows:

4. Treasury management indicators

Adoption of the CIPFA Code of Practice for Treasury Management in the Public Services

4.1 The Prudential Code requires local authorities to have adopted the CIPFA Code of Practice for Treasury Management in the Public Services. This was agreed by the Cabinet in February 2003 and is being incorporated in revised financial regulations currently under preparation.

Upper limits on fixed interest rate exposure

4.2 The Council also has to set an upper limit on its fixed interest exposure. The table below sets out limits recommended for approval. They are expressed in terms of the maximum long-term fixed-rate principal sums which can be outstanding on any day in each year. The limits suggested for 2006/07 and 2007/08 are indicative only and subject to revision next year.

4.3 These limits are consistent with the recommended treasury management strategy for 2005/06 (Appendix 11). Long-term fixed-rate debt outstanding is currently £211m. That report recommends an annual guideline target for long-term fixed-rate borrowing of £24m. However, allowance is made above for £40m of fixed-rate borrowing in each year, as it might be prudent to borrow up to these levels if rates are particularly advantageous or show signs of a prolonged upward trend.

Upper limits on variable interest rate exposure

4.4 The Council also has to set limits on its variable interest rate exposure. The limits recommended for approval are shown in the table below. They are calculated simply as the difference between the recommended authorised borrowing limits and the fixed-rate borrowing outstanding at the end of each year if no further such borrowing is undertaken.

4.5 These recommended limits provide full flexibility for the prudent management of the Council's debt portfolio, and mean that there will be no need for enforced fixed-rate borrowing at high interest rates as long as total external borrowing remains within the authorised limits.

Upper and lower percentage limits on the maturity structure of long-term fixed-rate borrowing outstanding in 2005/06

4.6 The Code also requires the Council to set upper and lower percentage limits on the maturity structure of its long-term fixed-rate borrowing during 2005/06. The following table shows recommended limits. They allow maximum flexibility in managing the debt portfolio, and are consistent with the existing portfolio, and the treasury management strategy set out in Appendix 11.

Upper limits on investments with maturities longer than one year

4.7 The Council has made no investments for periods longer than one year and has no plans to do so. So an upper limit of nil on such investments is recommended for 2005/06 and the following two years.

Recommendation

That the Cabinet approve the prudential indicators set out in this report for submission to the County Council.