Budget reflections: How public finance can close the investment gap
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The UK total stock of capital, both public and private, comes to £5 trillion. Despite this quantum, for the last forty years, the UK has been usually in the bottom 10% for investment in the G20 and total fixed investment has been below every other G7 economy [1].
This is not sustainable, most obviously because it will lead to a degraded, underperforming and unproductive public realm. In the context of net zero, which will require an estimated investment of £1.4 trillion by 2050, it will mean both a lack of investment in key climate infrastructure and technology and an overall lack of resilience in the UK economy [2].
The UK Government has now begun thinking more fundamentally about how this investment could ultimately be delivered. It starts with the way government investment is ultimately scored in the public finances. Presently, investment is largely treated as spending with no offset for any assets acquired – so-called Public-Sector Net Debt. So, whether through loans or equity, involving on-balance sheet public finance institutions or not, there is an assumption that equity will not yield upside, and loans will not be repaid. It is even the case that third party capital, invested in an on-balance sheet PFI, would add to the public debt.
This has led to an overreliance on grant funding in the way government supports key infrastructure and industrial strategy and an under-utilisation of public investment strategies. This has effectively constrained the amount of capital ultimately deployed by not recycling capital for reinvestment and by missing opportunities to build investment pathways for private capital – the only credible route to £1.4 trillion.
The 2024 Budget does though start to chart a different course. Firstly, the Financial Transaction Control Framework [3] confirms a switch to Public Sector Net Financial Liabilities as the preferred measure of government spending. This is crucial as it recognises assets acquired alongside liabilities [4]. Secondly it emphasises the central role of public finance institutions in making investments on government’s behalf, recognising the specific expertise required. This makes the mandate and approach of the National Wealth Fund in particular, of critical importance in the pathway to reducing Public Net Debt through promoting effective, catalytic deployment of capital.
The Prospectus, the Government’s response to the GFI chaired National Wealth Fund Taskforce set out a direction of travel. Firstly, the total balance sheet of £27.5 billion, with a KPI to mobilise private capital of at least 3:1 leverage, should deliver ‘at least £70 billion’. To achieve this, (the GFI has stated that more leverage is available, particular in certain sectors), the capital must be deployed in a more catalytic way.
The prospectus confirms this as an intention and cites that the overall risk budget will be increased to match the new balance sheet. But beyond this, it is vital that the NWF ultimately crowds in private capital, by taking unique positions in the capital stack that enable private capital to invest where they would not otherwise have done so. This means firstly deploying a broad suite of products with more risk appetite. This will perform the dual role of financial de-risking and de facto policy de-risking, a critical element, since investors will assume that NWF capital deployment is in line with industrial policy.
But the prospectus also highlights another function which needs further development – trialling new blended finance solutions, with government departments, that take on additional risk to facilitate higher impact in individual deals;
To invest in first of kind transactions in new technologies, requires an approach to origination and innovation that will be essential to create investable pathways for both NWF to deploy balance sheet and for private capital to ultimately invest. A similar capability is called for through the Transition Finance Market Review which calls for a ‘Transition Finance Lab’ [5].
Indeed, the Government’s initial response to the NWF Taskforce highlighted the need to review the wider public finance landscape. This is recognition both that a more streamlined and efficient approach is needed, but more profoundly, if we are to unlock private investment, we need to fill in key gaps in the institutional architecture. The NWF is a big step forward, but it needs to be supported with origination and innovation to create viable investment pipeline. This is now the GFI’s focus. Fiscal rules and adequate public investment are now being delivered – we need to make sure we have the right supportive architecture to support the effective deployment of capital.
These issues are also mirrored in the debate in global climate finance. COP29 delivered fresh government commitments through the New Collective Quantified Goal. Whether these commitments are seen as credible or not, there remains a lack of focus on how these commitments could mobilise private capital to deliver the investment we ultimately need. This involves recognising that just as in the UK, the public finance architecture needs to be reformed, to create more investable pathways for private finance. Capital flows between two counterparties – in this they are largely private capital from developed economies to project developers in emerging markets. More institutional connections are needed to ensure notional commitments are ultimately invested in net zero and nature positive projects
Otherwise, we are deploying climate finance just as we have deployed public spending in the UK and missed an opportunity to work with private investors. This is the ‘Execution Gap’ the GFI has identified and is working to close, both in the UK and globally. Private capital is available and there is certainly adequate demand. We must now create the means to deploy it. If you would like to partner with us on this agenda, please get in touch.
1 ‘Great Britain?’ – Torsten Bell, 2024
2 Ibid
3 https://www.gov.uk/government/publications/financial-transaction-control-framework
4 It should be noted, that accounting treatment (on or off balance sheet) is a function of risk and is ultimately determined by the ONS not HMG definitions
5 https://www.theglobalcity.uk/insights/scaling-transition-finance
