ࡱ> Root EntryFiles\Common Files\Microsoft Shared\Textco FA ^CommWordDocumentTextconv\RFTDCA32.CNV, rftnMSWorNCompObj%!H<@aps surprisily mundane topic of j conSummaryInformation political life just now(Files\Common Files\M\\wor  !"#$%&'(89:;<=>?@ABCDEFRSTU Root EntryFiles\Common Files\Microsoft Shared\Textco FA ^CommWordDocumentTextconv\RFTDCA32.CNV, rftnMSWor RCompObj%!H<@aps surprisily mundane topic of j conSummaryInformation political life just now(Files\Common Files\M\\wor ) !"#$%&'(8*+,-./012345679:;<=Preferred CustomerNormalPreferred Customer6Microsoft Word for Windows 95@t@R@ @^Y ՜.+,0HHPt|  Dell Computer CorporationE Perhaps surprisingly the seemingly mundane topic of water is one of the more contentious issues in Scottish economic and political life just now FMicrosoft Word Document MSWordDocWord.Document.69qOh+'0,<Hdp|      $Perhaps surprisingly the seemingly mundane topic of water is one of the more contentious issues in Scottish economic and political life just now,A,A,A,A,A,A,A,A,AE/Ap-AF/AG/A-A-A-AH/A-A!.A6.A7.A;.Aa.Af.Aw.Ax.@.@.AI/Ae/A/A/A/@.A.@?'@A'@E>A.A.A.@.@.@.A.A.A.AF>A.@.@.@.@.@~1Times New Roman Symbol &Arial"1hc܂fdY E7 D!Perhaps surprisingly the seemingly mundane topic of water is one of the more contentious issues in Scottish economic and political life just nowPreferred CustomerPreferred Customerܥhc TeR;'G>W?W?W?W?W?@?0@@@@A@Q1AA"9A9A9A9A9A9AAAAA=A{CEQX6R3Ez W?9A 9A9A9A9A3EUAW?W?9AAA$A$A$A$A%A(A(A(A(A(A(A%A%A%A#(A &Ap&A&A&'A8'@$(A&(A|(A(A(A(A(A(A)A)A')A0)A1)A\)A])A)A)A*A *A *Af*A{*A*A*A*A*@+A +A+A+A+A+A*,AJ,At,A,A /A,A,A,A,A,A,A,A,A,AE/Ap-AF/AG/A-A-A-AH/A-A!.A6.A7.A;.Aa.Af.Aw.Ax.@.@.AI/Ae/A/A/A/@.A.@?'@A'@/A.A.A.@.@.@.A.A.A.A/A.@.@.@.@.@~1Times New Roman Symbol &Arial"1hckfd0q7 !Perhaps surprisingly the seemingly mundane topic of water is one of the more contentious issues in Scottish economic and political life just nowPreferred CustomerPreferred CustomerUAUAUA9AW?9AW?9AA ^k??,W?W?W?W?9AAUAMUAPerhaps surprisingly the seemingly mundane topic of water is one of the more contentious issues in Scottish economic and political life just now. A substantial proportion of the mail bags of MSPs consists of letters from constituents complaining about high water charges: business organisations are united in saying that the high level of water charges for businesses poses a real threat not just to Scotlands economic growth prospects, but to the very existence of some Scottish firms. The key to understanding the present level of water charges in Scotland is the Strategic Review of charges, carried out by the Water Industry Commissioner (WIC) in 2001. Reviews are carried out every four years, and recommend the revenue caps for the industry for the next four years. Effectively, the review determines by how much water charges will rise. So when we embarked last summer on an investigation of water charges, the best place to start was clearly the review. One of the important features in the Review is the planned level of borrowing for the industry. Borrowing is important because it is one of only two sources of finance available to the water industry: the other is revenue from charges. To fund a given level of expenditure, charges must go up if borrowing goes down, and vice versa. The industry cannot, however, just borrow as much as it likes. First of all, the amount it borrows is controlled by the Scottish Executive: at the time of the Review, the Executive control was not a direct control on borrowing, but was through a new control system called Resource Accounting and Budgeting (RAB): control through RAB, however, still involves control on borrowing, since a given RAB limit indirectly implies a maximum amount that can be borrowed. Secondly, the industry will also be governed in determining its borrowing by a view on how much it is prudent to borrow. The normal principle is that it is only prudent to borrow to fund investment which will actually enhance the capital stock. When we looked at the planned level of borrowing in the Review, what we found was very puzzling. Over the four years 2002-2006, the borrowing target in the Review was 293.3million: (this is the cumulative target over the four years). According to figures published by the Scottish Executive aft er the Review, however, the ampount of borrowing which the Scottish Executive was prepared to make available over the four year period was apparently over 900m. The WIC also stated in the Review that, after allowing a margin of 200m for flexibility, his planned level of borrowing used up all of the available public expenditure. The first puzzle, therefore, was how planned borrowing of 293m plus a margin of 200m equated to the apparently available 900m. Further, the planned programme of investment in DocumentSummaryInformation8 xܥhc DeN&:;;;;;<Z;0<<<<<<zM1<<"<<<<<<?=A=A=A==~=?@MXN@ ;< <<<<@<;;<<<<<<;<;<?= 4̓C$;8;";;;;<?=<M<Perhaps surprisingly the seemingly mundane topic of water is one of the more contentious issues in Scottish economic and political life just now. A substantial proportion of the mail bags of MSPs consists of letters from constituents complaining about high water charges: business organisations are united in saying that the high level of water charges for businesses poses a real threat not just to Scotlands economic growth prospects, but to the very existence of some Scottish firms. The key to understanding the present level of water charges in Scotland is the Strategic Review of charges, carried out by the Water Industry Commissioner (WIC) in 2001. Reviews are carried out every four years, and recommend the revenue caps for the industry for the next four years. Effectively, the review determines by how much water charges will rise. So when we embarked last summer on an investigation of water charges, the best place to start was clearly the review. One of the important features in the Review is the planned level of borrowing for the industry. Borrowing is important because it is one of only two sources of finance available to the water industry: the other is revenue from charges. To fund a given level of expenditure, charges must go up if borrowing goes down, and vice versa. The industry cannot, however, just borrow as much as it likes. First of all, the amount it borrows is controlled by the Scottish Executive: at the time of the Review, the Executive control was not a direct control on borrowing, but was through a new control system called Resource Accounting and Budgeting (RAB): control through RAB, however, still involves control on borrowing, since a given RAB limit indirectly implies a maximum amount that can be borrowed. Secondly, the industry will also be governed in determining its borrowing by a view on how much it is prudent to borrow. The normal principle is that it is only prudent to borrow to fund investment which will actually enhance the capital stock. When we looked at the planned level of borrowing in the Review, what we found was very puzzling. Over the four years 2002-2006, the borrowing target in the Review was 293.3million: (this is the cumulative target over the four years). According to figures published by the Scottish Executive after the Review, however, the ampount of borrowing which the Scottish Executive was prepared to make available over the four year period was apparently over 900m. The WIC also stated in the Review that, after allowing a margin of 200m for flexibility, his planned level of borrowing used up all of the available public expenditure. The first puzzle, therefore, was how planned borrowing of 293m plus a margin of 200m equated to the apparently available 900m. Further, the planned programme of investment in the Review was for a total of 1.8billion over the four year period: thus the amount of investment which it was planned to fund from borrowing was only 16%. Elsewhere in the Review, it is stated that 45% of the investment programme was for maintenance of the capital stock - and hence by implication 55% would enhance stock. The second puzzle was why, when it would apparently have been prudent to fund up to 55% of the investment programme by borrowing, the Review planned to borrow only 16%. We should stress the Review was for a total of 1.8billion over the four year period: thus the amount of investment which it was planned to fund from borrowing was only 16%. Elsewhere in the Review, it is stated that 45% of the investment programme was for maintenance of the capital stock - and hence by implication 55% would enhance stock. The second puzzle was why, when it would apparently have been prudent to fund up to 55% of the investment programme by borrowing, the Review planned to borrow only 16%. We should stress d'e''''''''''''''''''''''''''((((((#($(&(|(((((())')0)1)\)])))* * *f*{*****+ +++++*,J,t,,,,,,,,,,,----!.6.7.;.a.f.w.x.........P uDPbthat these are not just abstract issues. If borrowing in the Review is too low, by potentially several hundred million pounds, then conversely charges are too high: and this is hitting the consumer and Scottish industry in the pocket. The next question is how could all this have happened. Interestingly, we did find the probable answer. This relates to a mistake in the letter sent by the Scottish Executive to the WIC in August 2001, commissioning the Review. There are actually three mistakes in the commissioning letter, but the really important one for present purposes is the way the letter interpreted the new RAB control system. .ACconstrained -n apparentappear to beIn RAB as properly applied, separate controls are set on capital expenditure, and on a concept linked to current expenditure, called resources. In fact, certain expenditure on maintenance of the capital stock counts against both limits. This doesnt matter, as long as the capital and resource limits are kept separate. But rtY/9>NY9:?K]^"#*.!0!6!7!!!!"?"Q"""8#d#####z${$$$$$$%%%% &p&&&'8'?'A'C'Z'['d'ud OP89!!@'A'B'C'%(&(+ +.............z z z z  z z z z z z z z z  z z z z z z z z z z z z  z z  z z z h`%(K@Normala c"A@"Default Paragraph Font@TOC 1a in the commissioning letter, both capital and resource limits were combined in a single limit- which meant the expenditure which is common to capital and resources was double counted. This depresses the amount of borrowing which is possible within a given RAB limit: which is almost certainly why the amount of borrowing the WIC could undertake in the Review was far less than the amount of borrowing the Scottish Executive had apparently made available. A paper describing our findings was published in the Fraser of Allander Quarterly Economic Commentary in December 2003. We also wrote to the Scottish Executive in November, asking two simple, factual questions which should establish, once and for all, whether the root of the problem is double counting arising from a mistake in the commissioning letter, as we have suggested. The paper has been considered by the Finance Committee of the Scottish Parliament, who are currently conducting an enquiry into water charges. In connection with this enquiry, the WIC, Scottish Water, the Scottish Executive, (and ourselves), have all given oral evidence to the Finance Committee. Where does the debate now stand, in the light of this oral evidence? First of all, the Scottish Executive has attempted to rebut our charge that there was a fundamental error, involving double counting, in the commissioning letter. However, they have replied only in terms of general assertions: they have not opened their books to show how the RAB limits in the commissioning letter were calculated, or how the borrowing figures that were subsequently published were calculated. Nor have they replied to the detailed questions we put to them as far back as November. In the absence of this required detailed information, our view continues to be that the most likely cause of what has gone wrong is an error in the commissioning letter. Secondly, the evidence given to the Finance Committee has revealed a significant degree of confusion about how the planned borrowing profile of the industry should be determined. To give just one example: in the Review, the WIC planned for the industry to move to substantial debt repayment in the medium term. However, in his evidence to the Finance Committee, he indicated there was no intention to move to substantial debt repayment. Most interestingly, however, the evidence from the Scottish Executive indicates that their current position on the industry does not appear tenable. The latest evidence from the Scottish Executive indicates that they have now set a borrowing limit of 688 million for the period 2002-06: this is equivalent to 38% of the planned capital programme. (Note that, as from 2003, RAB has been abandoned for bodies like Scottish Water, and control is directly on borrowing again- perhaps we can guess why.) The Scottish Executive also indicated in evidence that they felt the prudent level of borrowing would be around 33% of the capi......................../// / / /E/F/G/H/I/e////////;)>*>A>E>F>G>VUuPa uDPP1K@Normala c"A@"Default Paragraph Font@TOC 1a "o" Body Text 20&o&Body Text Indent 3 @" Footer 9r )@1 Page NumberK@Normala c"A@"Default Paragraph Font@TOC 1a "o" Body Text 20&o&Body Text Indent 3 @" Footer 9r )@1 Page Number%.    % VW?@[\>"?"%%%%%%%%z z  z z z z z z z  z z z z z z z z  z z  z z z z z z z  d'.. .  !!%%MPreferred Customer7C:\My Docume.///*>F>z z  z K@Normala c"A@"Default Paragraph Font@TOC 1a "o" Body Text 20&o&Body Text Indent 3 @" Footer 9r )@1 Page NumberFirst of all, the Scottish Executive has attempted, but failed, to rebut our charge that there were fundamental errors in the application of RAB, which led to the amount of borrowing possible under the strategic review being squeezed. Despite repeated requests, they have failed to reconcile their published borrowing figures with the control limits on RAB in the strategic review. Even more significantly, the Scottish Executive have now confirmed for the first time exactly what formula they were using to link RAB to borrowing. It is absolutely clear that, using this formula, it is not possible to reconcile the Scottish Executive published borrowing figures with the RAB limits in the strategic review. Far from rebutting our argument, the Scottish Executive evidence in fact confirms it. confirms our position, and 2K@Normala c"A@"Default Paragraph Font@TOC 1a "o" Body Text 20&o&Body Text Indent 3 @" Footer 9r )@1 Page NumberU'/     R:'U'&IJ6=+ QR  ##&&5'7'8'9':'U'z z z z z  z z z z z z z  z z  z z z z z z  z z  z z z z z z z  d'.G> .F>  !! ;'V'MPreferred Customer7C:\My Documents\Water\Left review Article 12 2 2004.doc@HP DeskJet 870C SeriesLPT1:HPRDJC03HP DeskJet 870C SeriesHP DeskJet 870C Series7 d,,HP DeskJet 870C SeriesLPT1 ,,HP DeskJet 870C Series7 d,,HP DeskJet 870C SeriesLPT1 ,,  {  p %&78HIJ)IV34pHOQuVaI T  V W , - r s { r|MOfo0BABm@AFvs)EJ\LMRI[   p t { !(!)!6!?!@!k!l!!!"""u""""""######9$Y$$$$$$$$$%(%1%;%%%%%%&&&&_&t&u&y&&&&&&&&&'''4'5'6'8':';'@'B'C'D'E'F'K'M'N'O'P'Q'R'S'T'U'A.A.@.A.A.A.@/@/AAZ'A:A['Ad'A=@AAOAe'A'AA'AA'ATA'@AAA'AA'AA'A3A/A /AAA'AA A^ A@ A'A'A'A'AY A A'A] A'A; Am A'A A'A" A'A'A A'A A A /AM A'A"@@A'A'A'A'A}@@AAAAdAAAArAtAAAAAAAAYAA/A9A>@NAAAAAAAAAAAAAYAAAAAA@.A;@)>@AAAAAA.!A0!A6!@7!A!A!A!A"A?"AQ"A"A"A8#Ad#A#A#A#A#A'A$Az$A{$A$A$A$A$A$A%A(A(A(A(A(A(A%A%A%A#(A &Ap&A&A&'A8'@$(A&(A|(A(A*>AA>A(A(A(A(A(A)A)A')A0)A1)A\)A])A)A)A*A *A *Af*A{*A*A*A*A*@+A +A+A+A+A+A*,AJ,At,A,A /Atal programme- since 66% of the capital programme is actually for maintenance. There are two problems with this position. First of all, a prudent level of 33% looks very low- given, for example, that the Strategic Review itself states that 55% or more of capital investment is to enhance the asset base. Secondly, if the borrowing limit equates to 38% of capital investment, and allowing for the fact that Scottish Water will need to allow a flexibility margin of around 200 million within this limit, (as in the Review), it is unlikely that planned borrowing will exceed 25% of the capital programme. In other words, the Scottish Executive prudent level of borrowing looks unjustifiably low: and even this level looks unachievable, given an inadequate buffer has been allowed between this level and the Scottish Executive limit. .A currently (or maximum percentage increases in revenue) RWR But t lyIn the Review, owas 293.3millione had used Yet aer the Review, hundred million poundsthey now say within this limit, (lets say) Overall, far from allaying the concerns in our original paper, the evidence which has now emerged re-affirms the need for an urgent and thorough review of the financing of the water industry in Scotland. As we argued in our paper published in December, such a review needs to go beyond the issue of borrowing. There are a number of other important issues which impact particularly on businesses in Scotland. These include the decision taken by the WIC to harmonise business charges, and the decision in the Strategic Review to implement very high fixed charges for businesses. Both of these issues, as explained in our December paper, have potentially severe adverse effects on businesses in Scotland , and hence on the Scottish economy. The Finance Committee is still, (at time of writing), to report: so it is not clear whether or not they will recommend a fundamental and immediate review. If they do, they will have struck an important blow for devolution, and will have demonstrated that the committee system of the Parliament is capable of calling the Executive to account on an issue of the greatest importance. The issue of water charges in Scotland is potentially a disaster which dwarfs the Holyrood building fiasco there is more money at stake, it impacts directly on peoples livelihoods and the economy, and, unlike Holyrood, it has been made in Scotland with the key decisions having been taken post devolution. In addition, unless the industry is moved quickly onto a charging regime which commands general acceptance among consumers, the probable outcome is that there will be pressure to privatise the industry. PAGE  PAGE 3  .A 3Deep Water for the Scottish Executive Jim Cuthbert and Margaret Cuthbert . A.Let us be clear: the stakes involved here are very high. ,UJim Cuthbert is a statistician, and Margaret Cuthbert is an economist. They work for Analytical Consulting Ltd. 3 .AaKa]a^aaa