FINANCE

A quick fix – but is there any choice?

With news of capitalisation directions being given to several councils, Heather Jameson asks if this risky measure – designed to provide fiscal support – will ultimately provide greater problems down the line.

Local government has almost become immune to the news of financial failures as more and more councils struggle with budgets and warn of impending section 114 notices, and last week's Budget offered no respite.

Even so, the startling news a fortnight ago that 19 authorities have been given capitalisation directions totalling £2.5bn was a stark reminder of how difficult it has become to balance the books.

Following the ravages of a decade and a half of austerity, the coming financial year has the dubious honour of seeing double the number of councils receiving capitalisation directions of any other. The sector has not just hit a tipping point – it is toppling over.

While the Department for Levelling Up, Housing and Communities (DLUHC) did nothing to dispel the impression this is a Government bailout of local authorities, describing the directions as ‘exceptional financial support', it is anything but.

Instead, it is permission to bend accountancy rules in a last-ditch attempt to set a balanced budget. With so many authorities on a financial precipice, bailing out a single council would set a precedent that ministers are unlikely to want to face.

And Labour's Rachael Reeves is unlikely to change tack immediately if she takes the reins as chancellor. Speaking to the BBC at the weekend, she claimed a Labour government would not be able to ‘turn things around straight away' if they won the election, but there would be an injection of cash into public services.

Not only is a capitalisation direction somewhat risky in accountancy terms, it is also storing up problems for the future – essentially like adding to your mortgage to pay for your day-to-day living expenses.

But for local government, it is the taxpayer that must shoulder the bill – for many years to come. And at 1% higher than the usual Public Works Loans Board rate, it is an expensive way to borrow.

Chartered Institute of Public Finance and Accountancy (CIPFA) chief executive Rob Whiteman told The MJ: ‘It's the worse accounting you can imagine – it breaks every accounting rule. You will be selling assets and borrowing money.'

He claimed it is far worse than a bailout, but added: ‘It is the only show in town. We recognise it's the only way to do it but we can't pretend in a month of Sundays that it is a proper solution.'

The impact is to lumber taxpayers with debts without the assets to show for it, and as Government guidance warns (see below), it leaves little room to borrow for assets in the future. It also means there will be the kind of swathing cuts to services that we see now enacted as the need to service the debts will impact on future services too.

Whiteman said: ‘Local government is having to turn off every tap it can, and pressures will be worse in future because they can't invest in prevention. It is a bad deal for councils.'

Bournemouth, Christchurch and Poole Council (BCP) was granted a capitalisation direction in 2022-23 but withdrew its request. Even so, the impact has been huge.

BCP chief executive Graham Farrant said the authority had six months to find £20m and faced a choice between the capitalisation and selling assets. ‘It was a slightly defensive move,' he said. The asset sale came through at the 11th hour, after a deal was reached with Government, but by then the damage was done.

He explained: ‘You can only have a capitalisation direction if you are in the exceptional financial support mechanism.'

For BCP, that meant a governance review, which then recommended a CIPFA financial resilience review which is yet to be published, delayed by the deluge the accountancy body has had to take on as a result of the growing financial instability in local government.

‘Those [reviews] would generally have consequence,' Farrant explained. ‘That could be commissioners, but in this case it was a Best Value notice.'

And if the council had gone ahead with the borrowing, it would not have solved the council's woes. Farrant said: ‘You've still got to solve the underlying revenue problems you are capitalising against. So I would say avoid it if you can. We did because we sold about £20m worth of assets at the end of March, so literally just in time.'

There was also the reputational damage the council faced. Local and national news headlines – and the opposition – all highlighted the failure, despite the last-minute reprieve. ‘"You need a government bailout", was the headlines,' Farrant added.

By far the biggest reputational problem has been in its relationship with the Government: ‘Dealing with DLUHC, you are going to be on a special watchlist because you have asked for a capitalisation direction, which is recognition that your finances are not sustainable. So immediately, you suffer some of those reputation consequences.'

Farrant suggests: ‘It is really difficult to have an informal conversation around these things that doesn't flag a concern. I do think we need to open up some more formal communication channels that allow us to have that open conversation without the big consequences.

‘If you can avoid it, avoid it,' Farrant advised. But therein lies the rub. For some authorities, there are no other options.

Whiteman told The MJ: ‘The only solution is that the sector needs some heavy lifting. The nation will regret in future years the "scorched earth" of removing community services.'

Government guidance

The capitalisation process allows local authorities to treat revenue costs as capital costs. In short, it is the ability borrow money to pay for services.

A Government guidance note states that ministers have the discretion to dictate whether the capitalisation comes through capital receipts or borrowing – and the duty to tightly monitor the deficit.

It says: ‘Capitalisation runs counter to the principles of prudent financial management. It can never permanently solve financial difficulties, but simply postpones the need to deal with them.

‘For example, debt incurred to meet revenue costs will have to be serviced from revenue resources over many years, and using capital resources for revenue expenditure tends to reduce long-term investment in capital assets.

‘All these issues should be carefully considered before making an application for a capitalisation direction.'

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