Council opinion of 27 February 2007 on the updated convergence programme of United Kingdom, 2006/07-2011/12
Date: 2007-02-27
Institutions: Council of the European Union
Subjects: United Kingdom, budget estimate, economic convergence, economic forecasting, public finance, stability programme

C 72/20

EN

Official Journal of the European Union

29.3.2007

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 surveil-
lance 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)

(2)

(3)

(4)

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).

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 2¾ % in 2006
and 2007, easing to 2½ % 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 2½ % 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.

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.

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 2¼ % 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.

(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.

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Official Journal of the European Union

C 72/21

(5)

(6)

(7)

(8)

(9)

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 ½ %
of GDP in 2006/07 to about 1 ¼ % 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.

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 moni-
toring 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 modera-
tion 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.

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 macroeco-
nomic 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.

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.

The long-term budgetary impact of ageing in the UK is close to the EU average, with pension expen-
diture 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.

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Official Journal of the European Union

29.3.2007

(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
In particular, both
programmes envisage the gradual implementation of the government's objectives to increase effi-
ciency and value for money in public service provision, while the long-term public finance projec-
tions incorporate the estimated cost of the proposed pension reform.

reform programme.

(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 (1).

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 effec-
tive 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 (1)

1 ¾

2 ¾

2 ¾

2 ½

2 ½

2 ½

2 ½

COM Nov 2006 (2)

1,9

2,7

2,6

2,4

n.a.

n.a.

n.a.

CP Dec 2005 (1)

1¾

2¼

HICP inflation
(%)

CP Dec 2006 (1)

2

2 ½

3

2

2¾

2¼

2¼

n.a.

2

2

2

2

COM Nov 2006 (2)

2,1

2,4

2,2

2,0

n.a.

n.a.

n.a.

CP Dec 2005

2¼

2

2

2

2

2

n.a.

Output gap
(% of potential GDP)

CP Dec 2006 (3)

– 0,5

– 0,6

– 0,6

– 0,6

– 0,5

– 0,4

– 0,3

COM Nov 2006 (2) (4)

– 0,3

– 0,4

– 0,5

– 0,7

n.a.

n.a.

n.a.

CP Dec 2005 (3)

– 0,5

– 1,0

– 0,8

– 0,5

– 0,6

– 0,6

n.a.

(1) 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.

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General government
balance
(% of GDP)

Primary balance
(% of GDP)

Cyclically-adjusted
balance
(% of GDP)

Structural balance (9)
(% of GDP)

Government gross debt
(% of GDP)

2005/
06

2006/
07

2007/
08

2008/
09

2009/
10

2010/
11

2011/
12

CP Dec 2006 (5) (6)

– 2,9

– 2,8

– 2,3

– 1,9

– 1,7

– 1,6

– 1,4

COM Nov 2006 (6) (7)

– 2,9

– 3,0

– 2,7

– 2,5

n.a

n.a

CP Dec 2005 (5)

– 3,1

– 2,8

– 2,4

– 1,9

– 1,7

– 1,5

n.a.

n.a.

CP Dec 2006 (8)

– 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

CP Dec 2005 (8)

– 1,0

– 0,7

– 0,3

n.a.

n.a.

n.a.

n.a.

n.a.

n.a.

n.a.

CP Dec 2006 (3) (5)

– 2,7

– 2,5

– 2,1

– 1,7

– 1,5

– 1,4

– 1,3

COM Nov 2006 (4)

– 2,8

– 2,8

– 2,4

– 2,2

n.a.

n.a.

CP Dec 2005 (3)

– 2,9

– 2,3

– 2,1

– 1,7

– 1,5

– 1,3

n.a.

n.a.

CP Dec 2006 (3) (5)

– 3,0

– 2,5

– 2,1

– 1,7

– 1,5

– 1,4

– 1,3

COM Nov 2006 (4)

– 3,1

– 2,8

– 2,4

– 2,2

n.a.

n.a.

CP Dec 2005

– 2,9

– 2,3

– 2,1

– 1,7

– 1,5

– 1,3

n.a.

n.a.

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.

CP Dec 2005

43,3

44,4

44,8

44,7

44,6

44,4

n.a.

n.a.

Notes
(1) 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.

(2) Commission services' forecast is on a calendar year basis.
(3) 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.

(4) Output gaps based on potential growth estimates of 2,8 % in 2006, 2,7 % in 2007 and 2,6 % in 2008.
(5) 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.

(6) 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.

(7) 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.

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

payments.

(9) 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 informa-
tion 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