Public Sector Finances are jointly published by the Office for National Statistics (ONS) and HM Treasury. Recent large movements in the sterling to foreign currency exchange rates have highlighted a need for clarity on the impact of these exchange rate movements on the Public Sector Net Debt (PSND).
On 6 July the Public Sector Finances Technical Advisory Group (PSFTAG) met to consider the correct recording of exchange rate movements on PSND and concluded that where liquid assets are ‘hedged’ against exchange rate and price movements the valuation of these assets in PSND should be fixed and not change with movements in foreign currency exchange rates.
Given the large fall in the value of sterling in June, this clarification of the PSND methodology will be implemented in the PSF bulletin which will be published on 21 July 2016. It will result in some revisions to net debt in recent periods and means that there will not be as much impact on June’s PSND figures as might otherwise be expected by the movement in exchange rates.
The changes being made will impact both PSND and Public Sector Net Debt excluding public sector banks (PSND ex). The anticipated revisions are back to the financial year ending March 2016. Expected upwards revisions to PSND and PSND ex are:
- £2,735 million at the end of March 2016
- £2,236 million at the end of April 2016
- £1,502 million at the end of May 2016
To put these figures in context the latest published PSND ex was £1,606,920 million and the equivalent PSND was £1,895,581 million. Both these debt figures relate to the end of May 2016.
Following the methodology change, the impact of exchange rate movements in June 2016, assuming no other changes to debt, is estimated to be a downward movement of £3 to £4 billion to PSND and PSND ex.
Annex : Further Detail
Public Sector Net Debt (PSND) is net of liquid assets and more than half of these liquid assets are held as foreign currency assets in the Official Reserves. Recent falls in the price of sterling will have led to an increase in the sterling value of these foreign currency assets and so, all other things being equal, a fall in PSND. However, around two thirds of the foreign currency assets in the Official Reserves are ‘hedged’ against exchange rate movements largely through the use of currency swaps. The swaps effectively fix the sterling value of these assets. Where this hedging is in place the value of the assets as recorded in debt will not vary with the latest exchange rates but will reflect the ‘fixed’ sterling value. This means that the reduction in PSND will be less than might be expected based on the movement in exchange rates.
The currently published guidance on the compilation of the Public Sector Finances, from June 2012, does not address the issue of assets hedged for exchange rate movements and simply states that:
“fluctuations in exchange rates affect the sterling value of the official reserves included within liquid assets in the PSND calculations but do not affect the calculation of the PSNCR”.
Following our published decision making process, the Public Sector Finances Technical Advisory Group (PSFTAG) met on 6 July 2016 to discuss the issue of hedged assets in the Official Reserves and concluded that they should be valued at the sterling value fixed through the hedge. This recommendation was ratified by the Director of National Accounts and Economic Statistics. This approach for assets is in line with the international guidance in Chapter VIII.3.2 of the Manual on Government Deficit (MGDD) which specifies this treatment where foreign currency denominated debt liabilities are hedged against exchange rate movements. PSFTAG recommended to extend this treatment to foreign currency denominated assets included within the compilation of PSND.
As described above, following the methodological change, the impact of the large exchange rate movements in June, assuming no other changes to the stock of debt, is estimated to be a downward movement of £3 to £4 billion to PSND and PSND ex. If the hedged assets in the official reserves were instead to be valued at their sterling value based on the exchange rates at the end of June then the impact would be closer to a downward movement of £10 billion.
While investigating the impacts of this methodological decision we identified that data sources for Official Reserves had previously recorded the hedged assets at the sterling values fixed through the hedges. However, since November 2015 the data sources for these assets have recorded the sterling value based on the exchange rate at the end of the month being reported. Therefore, implementing this methodology will result in revisions to previously published data back to November 2015 only. Future supply of Official Reserves data will be in accordance with the PSFTAG decision.
In addition to implementing this methodology change in the next Public Sector Finances release, on 21 July 2016, we will shortly republish the methodological guidance note (June 2012) to specify the valuations used in the net debt measures as well as making other improvements and clarifications.