In the recent CIPFA survey on inflation, respondents clearly see this economic condition as a growing threat.
The results showed that there is considerable concern over the risk that inflation poses to the financial stability of local authorities. Inflation is impacting both short- and medium-term financial planning and organisations are having to review and revisit decisions through the lens of rising cost.
“Review of future scope of services will be required to ensure that we can afford future commitments.”
The survey asked about inflation assumptions built into the budget over the next three years for areas such as pay, electricity, gas, fuel and contractual costs. The results showed that although increases had been included these fell short of current inflation figures.
For example, average assumptions for pay increases were 2.44% in 2022/23, which falls significantly below inflation at 9.1%. Increases in fuel were on average 6.38% for 2022/23 but petrol prices rose 11% between 9 May and 13 June 2022 alone.
Respondents told us that they were setting revised budgets, renegotiating with suppliers and looking at both borrowing and investment plans. 39% considered that it would be highly likely that they would adjust their capital programme and 46% had identified reserves to help with inflationary pressures.
How local authorities manage over the next three years will depend on several factors including their current financial position, the support they receive from central government, the strength of their financial management and governance and their ability to manage demands.
Local authority leadership teams will need to understand and actively manage the financial situation as it develops and make well-evidenced decisions based on strong economic business cases.
For its part central government must accept that the financial pressures facing authorities because of inflation and the wider global context require a supportive and collaborative response with a shared objective of public sector service stability and support for the most vulnerable.
“In such volatile conditions, it can be hard to see a path forwards. But as always, good financial management and a collaborative approach are the best bets in mitigating the effects of soaring inflation.”
Rob Whiteman CBE, CIPFA CEO (Forbes, July 2022)
It is increasingly apparent that the challenge of inflation will remain an influencing economic factor for longer than originally predicted and play a significant part in financial decision making over the next three years.
In response to rising concerns about inflation risk, CIPFA, the Chartered Institute of Public Finance and Accountancy conducted a survey in May 2022. The aim of this snap survey was to gather high-level information to enable the sector to understand:
- what assumptions have been made regarding inflationary pressures over the next three years
- how local authorities intend to cope with these inflationary pressures.
Responses were received from across the UK and across the different tiers of local authorities. While there was variation in those responses, our analysis identified several key messages:
- The impact of inflation was being felt throughout the local authority with no department unaffected.
- There is a significant gap between the average inflation assumptions made in the budget regarding pay (2.4%) and the current level of inflation (9.1%).
- Electricity and gas assumptions are the area where percentage assumptions were highest, with 2022/23 average assumptions for gas 19.71% and electricity 14.19%.
- Consistently 2022/23 saw the highest percentage increased assumptions regarding inflation with subsequent years reducing percentage escalation.
- Across different tiers and the geographical divide assumptions can be seen to vary particularly in relation to electricity, gas and fuel.
- Using reserves are not the answer for this cost pressure, with 54% of local authorities saying they had not identified reserves to cover this.
- The solutions to managing rising inflation costs differ across local authorities and a combination of approaches will be necessary if local authorities are to remain financially resilient
- It is important that financial discussions are not held within the confines of the finance department; the survey showed that the sector has taken an organisation-wide approach to managing inflationary risk with discussion being held corporately.
It is clear from the findings that there is a significant level of synergy from the sector. The differences in response did not deflect from the underlying messages that significant gaps are developing in budgets and managing these gaps will require an agile and measured approach.
However, at a national level CIPFA has identified ten recommendations that apply to all organisations as they face the enormity of the challenges brought about by inflation.
- Political and executive leadership should develop an internal culture that welcomes strong financial management and good governance, recognising the important part this plays in a successful organisation.
- Monitoring and reporting should be strengthened in areas where there is the greatest risk, emphasising the need for transparency.
- Decision makers should be aware of optimism bias and ensure there is robust challenge for all financial decisions, considering best practice guidelines for all financial decision making.
- The operational and political gains from having a strong and financially resilient organisation should be promoted internally and externally.
- Rethinking procurement and contracts should be considered and ensure that there is strong contract management.
- Inflation risks should be identified as part of the risk register and addressed at all relevant meetings; considerations about possible risk regarding inflation should be embedded into the decision-making process at the start of the commissioning cycle.
- Engaging early with suppliers in negotiations and encouraging new ideas to help councils identify savings or service delivery.
- Sharing best practice and collaborating to understand options to reduce the impact of inflation.
- Local authorities should work together with a single voice over the impact of inflation and promote their cause within central government.
- Central government must recognise the nature of the challenge and respond with a settlement that supports financial stability.
“High levels of inflation are likely to be a tipping point for some councils. Local government funding was already in a difficult place – high levels of inflation are pushing that into a crisis. Financial resilience in local government finance is next to nil so inflation impacts will mean severe cuts to balance the books.”
Scottish local authority
Commentary from our specialists
The economic context
Jeff Matsu, CIPFA Chief Economist
After a decade of near-zero interest rates and modest inflation, today’s circumstances seem a rude awakening. Consumer prices rose by 2 percentage points in April 2022 to 9%, the highest in 40 years. Looking ahead, further pressure will be experienced in October when the cap on energy prices is expected to rise by another 40% – lifting CPI to near double digits. In the past seven months alone, the Bank of England has raised interest rates five times to a modest 1.25%.
The upward pressure on prices seems unrelenting. Uncertainty comes on multiple fronts, ranging from the continued impact of the war in Ukraine on food, energy and commodity prices to the ongoing squeeze on global supply chains due to China’s zero-Covid policy. In response to an emerging cost of living crisis that disproportionately affects poorer households, the UK government has intervened with a timely £15bn package of targeted cash grants. While this extra spending will support an economy heading towards stagnation, some of it will invariably end up inflating prices as well.
There are concerns over a wage-price spiral as the unemployment rate in the UK reaches a near-50 year low. The decline in rates of unionisation coupled with weak consumer confidence, have so far kept wage pressures at bay but there is a very real fear that this will not continue, which would have significant consequences for the public sector.
Risks to the inflation and growth outlook remain considerable. Despite tough talk earlier in the year that higher prices would be transient, inflation in the UK remains well above the Bank’s 2% target and almost twice what was expected just six months ago.
Maintaining the delivery of key public sector services will remain the focus of local authorities. However, no one is in any doubt that doing this within the current economic context will require compromise, collaboration and career-defining leadership.
Inflationary impact on the policing sector
Charlotte Radford, CIPFA Police Advisor
In much the same way as local government, the policing sector is also adversely affected by the increasing level of inflation.
In February when all forces set their budgets for the year a range of assumptions were included, with between 2% and 3.5% commonly forecast for pay award and between 2% and 4% for general inflation.
Recent forecasts expect overall inflation to rise above 11% in the next 12 months with fuel and energy costs already having increased by more than 50%.
With budgets set and the only increase in government grant being for the 20,000 additional (Uplift) officers, the increased cost of inflation is placing enormous pressure on force budgets with a significant level of savings being required. The scope for delivering such savings is limited as there cannot be a reduction in police officers if the uplift programme is to be delivered. Forces are therefore having to use reserves or reduce police staff numbers and cut non-staff expenditure. This is however where the savings delivered by policing over the last ten years of austerity have been delivered, making the finding of such savings increasingly difficult.
In recent years, precept freedoms have been used by a number of police and crime commissioners to help meet inflationary cost pressures by increasing council tax at a local level. It is widely expected that the significant increase in inflation will mean this will need to be considered in forthcoming years, particularly if the increase in police officer numbers generated by the uplift programme is not to be reversed to some degree. However, there is a recognition of the additional burden this would place on taxpayers – it is a difficult balance.
“We formed a cost-of-living reserve in order to try and keep council tax increases below 2% for the next four years, however this looks like it will be needed to assist with the increasing inflation costs.”
Midlands borough council
Inflationary impact on PPPs/PFIs
Mark Williams, CIPFA Senior Consultant
Several authorities that supported our recent inflation survey commented that their long-standing private finance initiatives (PFI) or public private partnerships (PPP) are creating inflationary pressures. This is because the unitary charge paid by public bodies under a PFI arrangement in return for the serviced assets is link to the Retail Prices Index (RPI), Consumer Prices Index (CPI) or some form of basket of inflationary factors.
“We have large PFI contracts where charges are linked to RPI.”
While much has been written recently on PFI expiry, less has been said on PFI unitary charge inflation or the opportunity to run operational efficiency reviews. In our view periodic operational efficiency reviews, following HM Treasury best practice from 2011/12, are important and will ultimately support a collaborative and best value PFI exit.
The current inflationary pressures, alongside the potential for drastically different serviced asset requirements following the pandemic, mean now is the time to do an operational efficiency review.
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