Meeting documents

1 THE ISSUE

The strategy covers:

2 RECOMMENDATION

2.1 That the Executive:

a) Approve the actions proposed within the Treasury Strategy Statement.

b) Approve the borrowing strategy as detailed in paragraph 5.6.

c) Approve the investment strategy as detailed in paragraph 5.7.

d) Recommend to Full Council for adoption of the Prudential Indicators detailed in paragraph 5.2.

3 FINANCIAL IMPLICATIONS

3.1 Included in the report.

4.4 The introduction of the Prudential Code allows greater freedom of choice for the Council in the projects it undertakes, but brings with it the responsibility to control and monitor its' spending plans much more closely. The code advocates the fundamental principles of `prudence and affordability' and the Prudential Indicators are intended to ensure that the authority monitors these objectives. An explanation of the Prudential Indicators is given below:

B7 Estimate of Capital Expenditure - based on the authority's financial plan for the 3 years ahead.

B7 Estimated Capital Financing Costs as % of Net Revenue Stream - this is the cost of interest payable with respect to borrowing (less any interest received from investments) plus the Minimum Revenue provision charge, as a percentage of net expenditure (the amount to be met from government grants and council tax). In other words what proportion of our revenue budget will be used to finance debt liabilities.

B7 Estimate of Capital Financing Requirement - this is a similar concept to the current Credit Ceiling calculation. It is the amount of capital spending that has not yet been financed by capital receipts, capital grants or revenue contributions and is designed to measure an authority's underlying need to borrow, or finance capital expenditure by other long term liabilities. The borrowing may not necessarily be external, but may make use of cash held for other purposes, e.g. capital receipts and earmarked reserves. The Capital Financing Requirement is calculated from the authority's balance sheet.

B7 Estimated Incremental Effects of Capital Investment Plans on Council Tax - this is the estimated amount by which council tax charges would increase due to the authority's capital programme. (The Prudential Code assumes that Members will be presented with a range of options for approval for future Capital Programmes, and the varying affects on council tax levels).

B7 Estimate of Authorised Limit for External Debt - this limit should reflect a level of borrowing which, while not desired, could be afforded, but may not be sustainable. The Authorised Limit must be set to establish the outer boundary of an authority's borrowing, based on a realistic assessment of risks and should only be revised in exceptional circumstances. It is not a limit which an authority would expect to borrow up to on a regular basis. It is crucial that it is not treated as an upper limit for borrowing for capital expenditure only, as it must also encompass borrowing for temporary purposes.

B7 Estimate of Operational Limit for External Debt - this is the focus of day to day treasury management activity and is the means by which the authority manages its external debt to ensure that it remains within the self-imposed Authorised Limit. It should be based on an authority's expectations of the maximum probable external debt required and not the possible debt, i.e. anticipated borrowing for capital purposes plus day to day cash flow variations. This limit will be lower than the Authorised Limit because cash flow variations may lead to the occasional breaches of the Operational Limit. The Operational Limit must distinguish between borrowing and other long term liabilities.

B7 Upper Limit on Fixed Interest Rate Exposure - this is the maximum percentage of total borrowing which can be at fixed interest rates.

B7 Upper Limit on Variable Interest Rate Exposure - this is the maximum percentage of total borrowing which can be at variable interest rates.

B7 Upper Limit for Maturity Structure of Borrowing - this is in effect a limit on longer term interest rate exposure.

B7 Lower Limit for Maturity Structure of Borrowing - this can be set at zero if required.

B7 Upper Limit for Principal Sums Invested for periods of over 364 days - to minimise the need to realise investments early, justification should be referenced to liquidity and be consistent with financial plans.

5 TREASURY MANAGEMENT STRATEGY - 2004/2005

It is a statutory duty under s.3 of the Local Government Act 2003, and supporting regulations, for the Council to determine and keep under review how much it can afford to borrow. This amount is termed the `Affordable Borrowing Limit'.

The Council must have regard to the Prudential Code when setting the Affordable Borrowing Limit. The Code requires an authority to ensure that its total capital investment remains within sustainable limits and, in particular, that the impact upon its future council tax levels is acceptable.

The Affordable Borrowing Limit must include all planned capital investment to be financed by external borrowing and any other forms of liability, such as credit arrangements. The Affordable Borrowing Limit is to be set on a rolling basis for the forthcoming year and two successive financial years.

The following prudential indicators are relevant for the purposes of setting an integrated treasury management strategy.

5.3 Current Portfolio Position

The Council's treasury portfolio position at 9^th January 2004 comprised:

5.4 Borrowing Requirement

5.5 Prospects for Interest Rates

The Council appointed Sector Treasury Services as a treasury advisor to the Council and part of their service is to assist the Council to formulate a view on interest rates. Appendix A draws together a number of current City forecasts for short term or variable and longer fixed interest rates. The following table gives the Sector central view as at December 2003:

Whilst base rate has not yet changed this is believed to be more to do with the Chancellor's change in inflation targets than any fundamental shift in economy. It is still expected that in general these predictions will hold good.

There is a risk that base rates might rise more quickly in 2004 if world economic recovery is stronger and faster than forecast. In addition, there is a risk that PWLB rates between 10 and 25 years could fall by up to 0.50% below the above forecasts for limited periods if there were exceptional selling pressures on equities.

Shorter-term rates - The base rate was cut by 0.25% in July 2003, to a new 48-year low of 3.5% due to hesitant recovery after the Iraq war and a climbing pound. This cut was reversed in November. In his pre-budget report on 10^th December, the Chancellor announced a change of inflation target from plus or minus 1% around 2.5% on RPIX to 2% on HICP (harmonised index of consumer prices). HICP has been running at 1.1 - 1.6% throughout 2003 and is forecast to average 1.4% in 2003 and 1.7% in 2004 i.e. below the likely target. In addition wage increases have been relatively low and oil prices are likely to come down from current levels. There is therefore likely to be little inflationary pressure to raise the base rate. In view of a likely fragile consumer demand in 2004 in the UK, the probability of growth in the US falling back in 2004 and weak growth expected in the Eurozone, it is expected that the base rate will only rise to 4.25% by the end of 2004 after being at 4% for most of the year.

Longer-term interest rates - PWLB rates were at low levels during the first half of 2003 due to investor fears over the Iraq war which depressed share values and gilt yields. Equity values have increased by about 25-30% from the low point to which they plummeted before the war, on expectations that the surge in economic recovery in the second half of 2003 will last well into 2004 and beyond and so boost corporate earnings. Gilt prices have consequently fallen, causing increases in gilt yields and long-term PWLB rates which incurred a sharp unexpected increase in October 2003 on a surge in optimism on US economic recovery; this pushed the PWLB 25 year lower quota rate up to 5.00% - 5.15% and it is forecast that this rate will stabilise around 5.00% for most of 2004/05. A rise in long-term PWLB rates to more normal levels with the 20-25 year lower quota rate returning consistently to the band of 5.00% - 5.40% looks unlikely in 2004/05.

5.6 Capital Borrowings and the Borrowing Portfolio Strategy

Based upon the prospects for interest rates outlined above, there are a number of strategy options available. The anticipation is that short-term variable PWLB rates will continue to be cheaper than long-term fixed rate borrowing during 2004/05. Short term variable rates are expected to rise in line with increases in base rate. Long term rates are not currently expected to move far but if there were a major fall in share prices (which is not expected given the general expectations for world economic recovery), then long rates would be susceptible to a corresponding fall. These expectations provide a variety of options:

Against this background a prudent approach is being adopted and an allowance of 5.5% for interest costs on borrowing has been built into the budget proposal.

This borrowing strategy is linked with the authority's asset management investment plans and should result in lower repair costs in the future.

Sensitivity of the Forecast - The main sensitivities of the forecast are likely to be the two scenarios below. The Council officers, in conjunction with the treasury advisers, will continually monitor on a daily basis, both the prevailing interest rates and the market forecasts, adopting the following responses to a change of sentiment:

5.7 Investments Strategy

This authority determines which institutions to invest with, according to the credit ratings afforded them by the following credit rating agencies:

Fitch

Standards & Poor's

Moody's Investors Service

This authority has determined the following as having a `High Credit Rating':

UK Government bodies

Other local authorities

Money Market Funds rated AAA

Other Financial Institutions rated AAA

Credit ratings are continually monitored throughout the financial year, with a full review being affected annually.

The authority has determined a list of institutions, together with an upper limit and maximum time period, which it considers to be suitable for investment purposes. This list is contained in Appendix B.

The list has been compiled according to the credit rating criteria identified in the table below (list per Fitch).

This authority maintains mainly temporary, short term investments and investments will be made accordingly, with reference to the cash flow requirements.

New long-term investments are not being envisaged (although this will be kept under constant review). A minimum of 60% of the authority's overall investments, will however be held in short term investments should any long-term investment be undertaken.

Appendix A INTEREST RATE FORECASTS

The data below shows a variety of forecasts published by a number of institutions. The first three are individual forecasts including those of UBS and Capital Economics (an independent forecasting consultancy). The final two represent summarised figures drawn from the population of all major City banks and academic institutions. The forecast within this strategy statement has been drawn from these diverse sources and officers' own views.

Sector View interest rate forecast - December 2003

UBS Economic interest rate forecast - December 2003

2. SURVEYS OF ECONOMIC FORECASTS

HM Treasury - summary of 35 independent forecasters views of base rate - as at November 2003

(2004 - 2007 are as at Aug 2003 but are based on 11 forecasts)

Consensus Forecasts - summary view of 25 city houses on the likely change in short term and 10 year fixed rates (November 2003)