Rachel Reeves’ new rules

Rachel Reeves has announced plans to modify the UK's financial regulations in her upcoming budget announcement next week. She aims to support around £20 billion annually in additional investments through higher borrowing.

Reeves plans to use a measure known as "public sector net financial liabilities" (PSNFL), as per sources familiar with the Budget talks.

The gauge offers a more comprehensive view of the public balance sheet by incorporating financial assets, including things like student loans.

The adjustment would allow Reeves to secure an extra £50 billion annually by the end of the decade, while still achieving a reduction in debt, according to the Treasury’s predictions from March.

The £50 billion estimate is expected to be revised with updated projections in the Budget on October 30. Additionally, Reeves is not anticipated to utilize the entire borrowing capacity, according to sources.

Try to keep your cool and not get too carried away with excitement.

To start off, here are the links: You can find Reeves' article here, and the Guardian was the first to report on the recent change to PSNFL last night.

We've neglected to cover the debt rules as much as we should have leading up to this Budget. It's not that we haven't made the effort—it's just that trying to make sense of the ONS’s comprehensive notes on Public Sector Net Worth is enough to drive anyone crazy.*

What are public sector net financial liabilities, often abbreviated as PSNFL? According to the Institute for Fiscal Studies, this refers to:

That’s all sorted out now.

Ah, yes, the evaluation.

In terms of what Reeves can accomplish without making direct changes to the fundamental financial regulations, this is quite bold. Below, summarized by RBC Capital Markets, is an overview of the implications of these actions:

PSNFL includes a broader spectrum of financial assets and liabilities compared to what is included in PSND. The additional assets in PSNFL surpass the extra liabilities, resulting in a lower total than PSND. Importantly, in terms of generating 'fiscal space,' PSNFL is decreasing at a quicker rate than PSND (excluding Bank of England effects) throughout the forecast period, including the critical fifth year of the forecast (refer to Exhibit 2).

A key distinction between PSND and PSNFL lies in the treatment of funded pension schemes. In PSND, both the pension obligations and the financial assets managed by these pension funds are accounted for, whereas non-financial assets are not included. Additional differences involve various forms of loans, such as those from student loans and non-liquid assets that the TFSME holds. Furthermore, any equity interests in private companies that the government possesses are recorded as part of the asset side of the balance sheet.

One of the key challenges of using PSNFL as a financial goal is the trouble with valuing assets that are not easily sold. Additionally, the Office for Budget Responsibility (OBR) has pointed out issues related to accurately assessing pension liabilities, which can lead to major changes in PSNFL estimations.

We describe it as somewhat drastic: moving to PSNFL would catch everyone off guard, especially considering the expectations of analysts in the market.

RBC wasn’t the only one anticipating that the Chancellor would opt for a more modest approach. They expected him to change to a target that focuses on public sector net debt, excluding both the Bank of England and the losses generated through the Asset Purchase Facility, which is part of the UK’s quantitative easing strategy.

Here are the comments and table from Allan Monks of JPMorgan from the end of September:

Completely dropping a traditional debt target would be quite dangerous for Labour. Instead, we anticipate a more cautious strategy as they aim to increase investment spending.

Even with a clearer acknowledgment of the advantages, it would still be perilous for the government to rely exclusively on a strategy that ignores the effects of investment spending. According to Option 7 in the table below, there is an estimated £60 billion of “headroom,” while Option 5 would free up £50 billion. That's already a significant amount. However, it's important to note that because investment is effectively left out of these net calculations, there isn’t an obvious cap on that type of spending under these guidelines. Similarly, Option 6 could theoretically permit nearly unlimited spending if it is carried out under the framework of the National Wealth Fund.

✨ "Nearly unrestricted spending" ✨… Sounds familiar, doesn't it?

We’re not actually implying that Reeves is about to go on a spending spree. Analysts note that creating a £50 billion buffer and then choosing not to use it is a clever strategy to support future finances without alarming the bond market. By proposing only £20 billion in borrowing within this new framework, Reeves is clearly trying to demonstrate a sense of fiscal discipline to investors.

Will it be effective? Here’s what Sám Cártwríght from Société Générale mentioned in a note that arrived in our inbox this morning, just after the Graunscoop news.

Proposed changes to the debt rule are a matter of debate. The Chancellor has announced that "this will be a budget focused on investment." However, the existing debt rule does not allow for extra borrowing to support capital expenditures. We think that adjusting the debt rule to concentrate on public sector net debt (PSND) could free up an additional £20 billion annually for capital projects, which seems to be the most probable approach. Borrowing beyond this amount might alarm the markets, making a more drastic change towards public sector net financial liabilities (PSNFL) less feasible. Overall, the budget is expected to loosen fiscal constraints compared to the current plans, primarily due to the increased borrowing intended for capital investments.

Overall, the fear of alarming the markets and triggering a situation similar to the Liz Truss crisis will likely be a significant concern for her. This suggests that a shift towards PSNFL is probably not on the table. That said, we can't completely dismiss the possibility. The government might decide to focus on PSNFL and set borrowing limits at about £20 billion annually.

Michael Saunders from Oxford Economics expressed similar thoughts in a note released earlier this month, also focusing on the idea of excluding average purchasing facility (APF).

If the Chancellor decides to adopt a PSNFL target, we anticipate that she will be quite careful with this additional fiscal flexibility. For instance, she might aim to maintain a larger buffer against the fiscal rules compared to recent Budgets and reduce the timeline for bringing down the debt ratio from five years to three. As long as any increased current spending after this year is balanced out by tax increases in the Budget, a PSNFL/GDP target with more flexibility and a three-year timeline could enable a significant boost in public investment to 3% of GDP by 2028/29, which would be approximately £40 billion higher than what was outlined in the March Budget.

It's definitely a bold move and a noticeable change, but it's not really unexpected. The cycle of the UK economy continues to move forward.

There are always risks involved. Barclays (they emphasized):

The introduction of the PSNFL would also change the way incentives are structured for off-balance sheet arrangements aimed at boosting investment and spending by easing the limitations imposed by the primary fiscal rule. With PSNFL in place, if the government borrows money to finance the construction of infrastructure, like a road or hospital, it would not face restrictions from the secondary fiscal rule. However, this borrowing would impact the available margin under the primary fiscal rule. In contrast, if the government were to borrow money to then lend to an off-balance sheet entity that spends that money on the same project, that loan would be regarded as an illiquid financial asset, effectively offsetting the additional borrowing. Consequently, the reduction in available margin could be less significant or even negligible. This possibility suggests a shift back to a model reminiscent of the early 2000s, where government borrowing increases to provide funds to off-balance sheet organizations that subsequently invest in public projects. A key factor in this scenario will be how the Office for National Statistics (ONS) evaluates and classifies these entities, as it is essential for them to determine that the government maintains a sufficient level of distance and does not exert excessive control over them.

Hmm. Does anyone recall what happened the last time?

Additional reading: — 'Destructive' partnerships, arguments, and legal disputes: the harsh conclusion of the UK's PFI initiative.

Update around 5 PM BST: Here's a brief update featuring an interesting chart from Deutsche Bank that highlights the context of today's weaker performance of gilts so far.

*Q: How much is the public sector in the UK valued at?*

A: By June, the total was nearly -£700 billion. That’s right, it’s in the negative.

Some content failed to load. Please verify your internet connection or adjust your browser settings.

This information comes from the most recent calculations by the Office for National Statistics (you can find them at the end of section 7; more recent, albeit less clear data up to September is available here). The findings indicate that during the second quarter of the year, the various government organizations in the UK —

Some content failed to load. Please verify your internet connection or browser settings.

— held approximately £3 trillion in assets and £3.7 trillion in liabilities. The difference between these two amounts represents Britain’s Public Sector Net Worth (PSNW), following the guidelines established in the European System of Accounts 2010. This figure has been fluctuating for just over ten years.

There are two major issues with PSNW that would likely arise if the UK were to think about adopting it as a goal:

There are three variations of PSNW: the ESA version (illustrated above), the IMF version created by the ONS, and the Whole of Government Accounts version, which is prepared by the Treasury and takes longer to produce. Each version focuses on slightly different aspects.

Assessing the worth of future assets is quite challenging—it's really a tough task.

ESA PSNW, which encompasses a wide range of topics from loans to local councils to the Holbeins in the National Gallery, is a broad and somewhat unclear statistic. It requires extensive qualifications, as evidenced by the ONS’s detailed breakdown that lists £940 billion in "consolidation" on the asset side and £850 billion on the liabilities side.

With those changes made, the fundamental numbers need some strange disclaimers, yet they allow us to produce pointless charts like this:

Certain content was unable to load. Please verify your internet connection or adjust your browser settings.

After experimenting with that for some time, you probably won’t have gained any valuable insights.