EN Official Journal of the European Union C 72/20

COUNCIL OPINION

of 27 February 2007

on the updated convergence programme of United Kingdom, 2006/07-2011/12

(2007/C 72/06)

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 27 February 2007 the Council examined the updated convergence programme of the United Kingdom, which covers the period from financial year 2006/07 to financial year 2011/12 (2).

(2) The programme contains two macroeconomic scenarios: a central scenario and an alternative scenario which is based on trend growth a quarter percentage point lower than in the central scenario. The projections for the public finances in the update of the convergence programme are based on the latter scenario, which is designed to be more cautious than the central scenario and is considered the reference scenario for this assessment. It envisages real GDP growth of 2 % in 2006 and 2007, easing to 2 % on average over the rest of the programme period. Based on currently available information, the programme appears to be based on plausible growth assumptions. The projections for inflation, which is expected to decline from 2 % in 2006 to 2 % from 2007 onwards, appear to be on the low side in the short term, in the light of more recently published outturns, but otherwise plausible.

(3) For 2006/07, the general government deficit is estimated at 3,0 % of GDP in the Commission services' autumn 2006 forecast. The current update of the convergence programme estimates a deficit of 2,8 % of GDP for the same year, which implies recent trends, showing robust growth in revenues and slower growth in expenditure, being maintained in the remaining months of the financial year.

(4) The key objectives for fiscal policy as identified in the convergence programme update are to ensure long-term sustainability, intra- and intergenerational fairness and, subject to this, to support monetary policy, in particular by allowing the automatic stabilisers to smooth the path of the economy. The programme projects a reduction of the deficit below 3 % of GDP by 2006/07 (2,8 %) and to 1,4 % of GDP by the end of the projection period in 2011/12. The primary balance, estimated as a deficit of 0,6 % of GDP in 2005/06, is expected to return to balance by 2008/09 and to reach a surplus of 0,7 % of GDP by 2011/12. The budgetary adjustment over the projection period is equally distributed between revenues and expenditure. The increase of the revenue ratio is expected to take place in the first two years of the projection period, partly driven by discretionary measures, while significant adjustment on the expenditure side is planned to take place from 2008/09, through a moderation in current expenditure growth. Public investment in the definition used in the convergence programme ( 3 ) is planned to stabilise at 2 % of GDP from 2006/07 so that from 2007/08 the deficit is projected to be used entirely to fund public investment. The adjustment path is broadly in line with the one projected in the 2005 update, against a more favourable macroeconomic outlook in the short term.

(5) Calculated according to the commonly agreed methodology, the structural balance (i.e. the cyclically-adjusted balance net of one-off and other temporary measures) is projected to improve from 2 % of GDP in 2006/07 to about 1 % of GDP in the final programme year, 2011/12. On the basis of these estimates, this adjustment is more marked between 2006/07 and 2008/09 but slows thereafter. As in the 2005 update, a quantitative medium-term objective (MTO) for the structural balance is not specified. The programme refers to fiscal objectives under the domestic rules, which are consistent with stabilising the debt-to-GDP ratio at a relatively low level and would provide a safety margin with respect to the 3 % of GDP general government deficit threshold only in certain circumstances.

(6) The risks to the budgetary projections in the programme appear broadly balanced up to 2007/08 but the budgetary outcomes could be worse than projected in the programme thereafter depending on the implementation of spending control. The projected increase in the tax to GDP ratio partly relies on relatively volatile factors such as profits from the financial and oil-producing sectors. However, relatively good prospects for revenues appear supported by recent economic developments, including strong profitability. From 2008/09 on however, achievement of the deficit path in the programme will depend on implementing the projected moderation in expenditure growth, and on active monitoring to enforce expenditure limits. The full implementation of the reduction in expenditure growth expected from the Comprehensive Spending Review will be key to reaching the objectives of the programme. The UK authorities have pre-announced a reduction in the budgetary allocation for a number of smaller departments, and committed to 5 % annual real reductions in administration budgets across government and value for money savings. However, the greatest part of the moderation of expenditure growth from 2008/09 is not yet underpinned by specific budgetary allocations which are subject to confirmation in the authorities' Comprehensive Spending Review, planned for summer 2007, which will announce firm expenditure plans up to 2010/11. The record of active monitoring to enforce expenditure limits is positive.

(7) In view of this risk assessment, the budgetary stance in the programme appears broadly consistent with a correction of the excessive deficit by 2006/07, as recommended by the Council. It provides a sufficient safety margin against breaching the 3 % of GDP deficit threshold with normal macroeconomic fluctuations only around 2009/10, when the projections are subject to the outcome of the Comprehensive Spending Review. In the years following the correction of the excessive deficit, the pace of fiscal consolidation should thus be strengthened.

(8) The gross debt ratio, which stood at 42,1 % of GDP in 2005/06, though remaining well below the Treaty reference value of 60 % of GDP, is projected to rise slowly over the projection period, peaking at just above 44 % of GDP in 2008/09. Thereafter the ratio is expected to stabilise and then begin to decline at the end of the programme period.

(9) The long-term budgetary impact of ageing in the UK is close to the EU average, with pension expenditure showing a somewhat more limited increase than on average in the EU, in part as a result of the UK's historically relying relatively more on private pension arrangements than have other EU countries. The proposed reforms to pension provision address the concern of potentially inadequate provision in the future, by strengthening the incentives for private savings for retirement and by increasing provision of public pensions, thus involving a slightly higher increase in public pension expenditure than previously projected; the reform also incorporates a planned gradual increase in the statutory state pension age. The initial budgetary position, though improved compared to 2005, would still constitute a risk to sustainable public finances if no significant reduction in the deficit occurs in the medium term, even before the long-term budgetary impact of an ageing population is considered. Consolidating the public finances by strengthening the budgetary position further than planned in the convergence programme would thus contribute to reducing risks to the long-term sustainability of public finances. Overall, the UK appears to be at medium risk with regard to the sustainability of public finances.

(10) The convergence programme contains a qualitative assessment of the overall impact of the October 2006 implementation report of the national reform programme within the medium-term fiscal strategy. In addition it provides systematic information on the direct budgetary costs or savings of the main reforms envisaged in the national reform programme and its budgetary projections explicitly take into account the public finance implications of the actions outlined in the national reform programme. The measures in the area of public finances envisaged in the convergence programme seem consistent with those foreseen in the national reform programme. In particular, both programmes envisage the gradual implementation of the government's objectives to increase efficiency and value for money in public service provision, while the long-term public finance projections incorporate the estimated cost of the proposed pension reform.

(11) The budgetary strategy in the programme is broadly consistent with the broad economic policy guidelines included in the integrated guidelines for the period 2005-2008.

(12) As regards the data requirements specified in the code of conduct for stability and convergence programmes, the programme has gaps in the required and optional data (4).

The Council considers that the programme seems broadly consistent with a correction of the excessive deficit by the deadline set by the Council (financial year 2006/07). The Council invites the UK to continue consolidation after 2009/10. The achievement of the budgetary targets after 2007/08 is subject to the effective implementation of the projected expenditure restraint.

In view of the above assessment, the Council invites the United Kingdom to pursue budgetary consolidation over the programme period, especially by implementing the projected reduction in expenditure growth after 2007/08, and to strengthen further its fiscal position in order to address the risks to long-term sustainability of the public finances.

The United Kingdom is also invited to improve compliance with the data requirements of the code of conduct.

Comparison of key macroeconomic and budgetary projections

2005/06 2006/07 2007/08 2008/09 2009/10 2010/11 2011/12 Real GDP (% change) CP Dec 2006 (5) 1 2 2 2 2 2 2 COM Nov 2006 (6) 1,9 2,7 2,6 2,4 n.a. n.a. n.a. CP Dec 2005 (5) 1 2 3 2 2 2 n.a. HICP inflation (%) CP Dec 2006 (5) 2 2 2 2 2 2 2 COM Nov 2006 (6) 2,1 2,4 2,2 2,0 n.a. n.a. n.a. CP Dec 2005 2 2 2 2 2 2 n.a. Output gap (% of potential GDP) CP Dec 2006 (7) – 0,5 – 0,6 – 0,6 – 0,6 – 0,5 – 0,4 – 0,3 COM Nov 2006 (6) (8) – 0,3 – 0,4 – 0,5 – 0,7 n.a. n.a. n.a. CP Dec 2005 (7) – 0,5 – 1,0 – 0,8 – 0,5 – 0,6 – 0,6 n.a. General government balance (% of GDP) CP Dec 2006 (9) (10) – 2,9 – 2,8 – 2,3 – 1,9 – 1,7 – 1,6 – 1,4 COM Nov 2006 (10) (11) – 2,9 – 3,0 – 2,7 – 2,5 n.a n.a n.a. CP Dec 2005 (9) – 3,1 – 2,8 – 2,4 – 1,9 – 1,7 – 1,5 n.a. Primary balance (% of GDP) CP Dec 2006 (12) – 0,8 – 0,6 – 0,2 – 0,1 – 0,3 – 0,5 – 0,7 COM Nov 2006 – 0,9 – 1,0 – 0,6 – 0,4 n.a. n.a. n.a. CP Dec 2005 (12) – 1,0 – 0,7 – 0,3 n.a. n.a. n.a. n.a. Cyclically-adjusted balance (% of GDP) CP Dec 2006 (7) (9) – 2,7 – 2,5 – 2,1 – 1,7 – 1,5 – 1,4 – 1,3 COM Nov 2006 (8) – 2,8 – 2,8 – 2,4 – 2,2 n.a. n.a. n.a. CP Dec 2005 (7) – 2,9 – 2,3 – 2,1 – 1,7 – 1,5 – 1,3 n.a. Structural balance (13) (% of GDP) CP Dec 2006 (7) (9) – 3,0 – 2,5 – 2,1 – 1,7 – 1,5 – 1,4 – 1,3 COM Nov 2006 (8) – 3,1 – 2,8 – 2,4 – 2,2 n.a. n.a. n.a. CP Dec 2005 – 2,9 – 2,3 – 2,1 – 1,7 – 1,5 – 1,3 n.a. Government gross debt (% of GDP) CP Dec 2006 42,7 43,7 44,1 44,2 44,2 44,0 43,6 COM Nov 2006 42,1 42,5 43,4 44,1 n.a. n.a. n.a. CP Dec 2005 43,3 44,4 44,8 44,7 44,6 44,4 n.a. 2006 update of the UK Convergence Programme, Commission services' forecast

(1) OJ L 209, 2.8.1997, p. 1. Regulation as amended by Regulation (EC) No 1055/2005 (OJ L 174, 7.7.2005, 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 financial year runs from April to March.

(3) The definition of public investment in the UK convergence programme, which is not an ESA concept, covers all public sector investment (that is, public corporations as well as general government) and includes capital grants to the private sector net of depreciation.

(4) In particular, the data on projections for employment, unemployment, wage inflation and a detailed breakdown of revenue and expenditure projections on a general government basis after 2007/08 are not provided. Compared to the 2005 update, the horizon for the breakdown of expenditure on a general government basis is shorter in the current update, which is the last update before new detailed spending plans will be fixed in the July 2007 Comprehensive Spending Review.

(5) GDP and inflation forecast underlying the authorities' projections for the public finances; derived from a scenario whereby trend growth is one-quarter percentage point higher.

(6) Commission services' forecast is on a calendar year basis.

(7) Output gap calculations according to the commonly agreed methodology on the basis of data provided in the convergence programme. The output gap calculations are based on the data underlying the central trend growth scenario.

(8) Output gaps based on potential growth estimates of 2,8 % in 2006, 2,7 % in 2007 and 2,6 % in 2008.

(9) Figures in the convergence programme adjusted for treatment of UMTS receipts. The UK authorities include, in their projections for the general government balance, annual receipts of around GBP 1,0 billion from the sale of UMTS licences in 2000. Adjusting for this, to bring the projections onto to an EDP basis, has the effect of subtracting around 0,1 pp from the balance (i.e. increasing the deficit) in each year. All data shown in this table are given after this adjustment, made by the Commission services, to the data in the programme.

(10) Following discussions between Eurostat and the UK Office for National Statistics, it is likely that the cancellation of Nigerian debt will be reclassified in government accounts as deficit-increasing by about 0,1 % of GDP both in 2005/06 and in 2006/07.

(11) Commission services' forecast is before discretionary measures announced in the December 2006 Pre-Budget Report and included in the convergence programme. In the absence of announced expenditure plans from 2008/09 onwards, the Commission services' autumn forecast adopts a technical assumption that expenditure remains constant as a percentage of GDP, while the convergence programme adopts a working assumption implying a fall in the expenditure to GDP ratio.

(12) Data from the convergence programme adapted in line with a definition of the primary balance using gross rather than net interest payments.

(13) Cyclically-adjusted balance (calculated according to the commonly agreed methodology) excluding one-offs and other temporary measures. One-off and other temporary measures taken from the Commission services' autumn 2006 forecast and based on information provided by the Office for National Statistics (0,3 % of GDP in 2005/06).

Source:

2006 update of the UK Convergence Programme, Commission services' forecast