Council opinion

of 8 March 2005

on the updated convergence programme of the United Kingdom, 2003/04 to 2009/10

(2005/C 177/07)

THE COUNCIL OF THE EUROPEAN UNION,

Having regard to the Treaty establishing the European Community,

Having regard to Council Regulation (EC) No 1466/97 of 7 July 1997 on the strengthening of the surveillance of budgetary positions and the surveillance and coordination of economic policies [1], and in particular Article 9(3) thereof,

Having regard to the recommendation of the Commission,

After consulting the Economic and Financial Committee,

HAS DELIVERED THIS OPINION:

(1) On 8 March 2005 the Council examined the updated convergence programme of the United Kingdom, which covers the period 2003/04 to 2009/10. The programme complies partly with the data requirements of the revised "code of conduct on the content and format of stability and convergence programmes". Data relating to total expenditure and revenues, while based on ESA95 components, use differing aggregation methods to the harmonised measure; balances are not affected [2]. The update also continues to treat the receipts from the sale of the UMTS spectrum as an annual income stream, rather than as the sale of an asset. Accordingly, the United Kingdom is invited to achieve full compliance with the data requirements.

(2) The programme contains two different scenarios for the macroeconomic and budgetary projections: a central macroeconomic scenario; and a lower growth scenario based on an assumption of trend growth a quarter-percentage point weaker than in the central forecast; the latter underlies the public finance projections. The lower growth scenario is thus considered as the reference for assessing budgetary projections, and reflects broadly plausible assumptions. The scenario envisages real GDP growth in 2005 of 3 %, only slightly lower than the growth of 314 % in 2004, before slowing to 214 % by 2007/08. On the basis of currently available information, GDP growth in 2005 could be slower than that forecast. However, over the medium term, the trend growth assumption underlying the public finance projections is likely to prove a cautious estimate. The programme's projections for inflation also appear realistic.

(3) The UK's fiscal policy framework is based on two domestic fiscal policy rules for the public sector: the "golden rule", which aims to ensure that, over the course of the economic cycle, the government borrows only to finance net investment, and not to fund current expenditure; and the "sustainable investment rule", which aims to keep public sector net debt at "a stable and prudent level" below 40 % of GDP over the cycle. Within this framework, the updated programme projects a reduction in the deficit from an estimated 3,2 % of GDP in financial year 2003/04 to below the 3 % reference value in 2004/05 (the financial year being the reference period for assessing the UK's public finances under the Stability and Growth Pact). Thereafter the update projects a further gradual reduction in the deficit over the medium term, to a level of 1,7 % in 2008/09. The expenditure ratio continues to increase, in line with the government's policy priorities, but the expected increase in the revenue ratio would, if realised, lead to an overall improvement in the general government balance. Within the overall level of expenditure, a significant programme of public investment is being implemented, which aims to lift general government net investment from 1,9 % of GDP in 2004/05 to 2,4 % in 2007/08. Relative to the 2003 update, deficit projections for both this financial year and next have been revised upwards; beyond 2005/06, however, the medium-term projections contained in the update represent a slightly more rapid consolidation of the public finances than those in the previous update.

(4) There is a clear risk that the budgetary outcome could be worse than projected in the programme in the short term. In both the short and medium terms, risks are present regarding the extent to which the recovery in corporation tax continues. Especially in the period of slower projected expenditure growth from 2006/07, government departments will need to adjust to tighter budgets, and thus might make use of accumulated unspent balances. From 2006/07, however, negative risks are countered by the relatively cautious macroeconomic projections.

(5) In view of this risk assessment, the budgetary stance in the programme does not seem to provide a sufficient safety margin against breaching the 3 % of GDP deficit threshold with historical macroeconomic fluctuations at any point during the projection period. However, given the decreased volatility of the UK economy in recent years and the cautious approach on the growth assumptions underlying the public finance projections, the risk appears small in the outer years. It is insufficient to ensure that the Stability and Growth Pact's medium-term objective of budgetary position close to balance is achieved by 2009/10. At the same time, however, it has to be noted that the debt ratio is relatively low and the projected balances are affected by the implementation of the above-mentioned significant programme of public investment.

(6) The gross debt ratio is estimated to have reached 39,5 % of GDP in 2003/04, well below the 60 % of GDP Treaty reference value. The programme projects the debt ratio to increase modestly by less than two percentage points over the period to 2009/10.

(7) The UK appears to be in a relatively favourable position with regard to the long-term sustainability of the public finances, despite the projected budgetary cost of an ageing population. The relatively low debt-to-GDP ratio and the strong emphasis that the UK authorities have placed, in existing policies, on long-term sustainability of the public finances are positive in this regard. Higher age-related expenditures cannot be excluded as there is a possibility of insufficient provision of private pensions which might have implications for the public finances, but the authorities are introducing the Pension Protection Fund, from April 2005, to protect members of private defined-benefit schemes where the sponsoring firm becomes insolvent and there are insufficient assets in the scheme to meet its liabilities. These measures are welcome, though their effectiveness is yet to be tested. The UK's relatively low tax ratio should ease the accommodation of any imbalances that may arise in the longer term.

(8) The economic policies outlined in the programme are partly consistent with the country-specific recommendation on the public finances addressed to the UK in the 2004 update of the BEPGs, namely that the UK was recommended "in endeavouring to avoid the occurrence of an excessive deficit, to improve the cyclically-adjusted position to consolidate the public finances, consistent with a budgetary position of close to balance or in surplus in the medium term". There is a clear risk that the budgetary outcome could be worse than projected in the programme in the short term. Moreover, the planned slight expansionary stance in 2005/06 and the fiscal stance over the medium term are not fully in line with the recommendation in the BEPGs.

In view of the above assessment, the Council is of the opinion that the United Kingdom should

(i) ensure that the deficit is below 3 % of GDP in line with plans, and

(ii) improve the cyclically-adjusted position to ensure that a budgetary position close to balance or in surplus is achieved and maintained over the medium term.

Comparison of key macroeconomic and budgetary projections

Convergence programme (CP); Commission services autumn 2004 economic forecasts (COM); Commission services calculations

1.Headline macroeconomic forecast | 2004 | 2005 | 2006 | 2007 | 2008 |

Real GDP — headline forecast(% change) | CP 12/2004 | 314 | 3–312 | 212–3 | 214–234 | n.a. |

COM | 3,3 | 2,8 | 2,8 | n.a. | n.a. |

CP 12/2003 | 3–312 | 3–312 | 212–3 | n.a. | n.a. |

HICP inflation(%) | CP 12/2004 | 114 | 134 | 2 | 2 | n.a. |

COM | 1,4 | 1,9 | 2,0 | n.a. | n.a. |

CP 12/2003 | 134 | 2 | 2 | n.a. | n.a. |

2.Macroeconomic forecast underlying the public finances | 2004/05 | 2005/06 | 2006/07 | 2007/08 | 2008/09 |

Real GDP — public finances(% change) | CP 12/2004 | 314 | 3 | 212 | 214 | 214 |

COM | 3,3 | 2,8 | 2,8 | n.a. | n.a. |

CP 12/2003 | 314 | 234 | 212 | 214 | 214 |

HICP inflation(%) | CP 12/2004 | 114 | 134 | 2 | 2 | 2 |

COM | 1,4 | 1,9 | 2,0 | n.a. | n.a. |

CP 12/2003 | 134 | 2 | 2 | 2 | 2 |

General government balance(% of GDP) | CP 12/2004 | – 2,9 | – 2,8 | – 2,3 | – 2,1 | – 1,7 |

COM | – 2,8 | – 2,6 | – 2,4 | n.a. | n.a. |

CP 12/2003 | – 2,7 | – 2,5 | – 2,2 | – 2,1 | – 1,9 |

Primary balance(% of GDP) | CP 12/2004 | – 0,9 | – 0,7 | – 0,2 | – 0,1 | n.a. |

COM | – 0,9 | – 0,6 | – 0,4 | n.a. | n.a. |

CP 12/2003 | – 0,5 | – 0,4 | n.a. | n.a. | n.a. |

Cyclically-adjusted balance(% of GDP) | CP 12/2004 | – 2,8 | – 2,9 | – 2,3 | – 2,0 | – 1,6 |

COM | – 2,7 | – 2,4 | – 2,1 | n.a. | n.a. |

CP 12/2003 | – 2,4 | – 2,4 | – 2,2 | – 2,0 | – 1,8 |

Government gross debt(% of GDP) | CP 12/2004 | 40,9 | 41,8 | 42,4 | 42,8 | 42,8 |

COM | 40,4 | 40,9 | 41,2 | n.a. | n.a. |

CP 12/2003 | 40,2 | 40,8 | 41,1 | 41,4 | 41,5 |

[1] OJ L 209, 2.8.1997, p. 1. The documents referred to in this text can be found at the following website:http://europa.eu.int/comm/economy_finance/about/activities/sgp/main_en.htm

[2] The UK authorities provided helpful explanations of the data in technical discussions with the Commission. Had these technical explanations been referred to in the update, the programme would have been considered to be broadly compliant with the data requirements of the revised "code of conduct on the content and format of stability and convergence programmes".

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