National Audit Office report on Managing government borrowing

The environment for government borrowing has become more challenging in recent years, a new National Audit Office (NAO) report finds.

The independent public spending watchdog's report Managing government borrowing examines how public bodies are pursuing the government's debt management objectives, and how they manage the risks of borrowing¹.

The report found that government's borrowing needs increased sharply to support pandemic-related spending. Also, rising inflation and interest rates have increased borrowing costs - with debt interest rising to £110.6 billion in 2022-23 - the highest levels as a percentage of GDP since the 1950s.

Government has been able to borrow to meet its spending needs, including during the financial crisis and the pandemic. Over this period, the Bank of England has become the largest holder of government debt through its quantitative easing (QE) programme².

The type of debt that the Debt Management Office (DMO) issues affects the government's borrowing costs. Around 25% of government gilts³ are index-linked, meaning payments to lenders rise with inflation. This proportion is much higher than in other G7 countries, partly reflecting demand for index-linked gilts from defined benefit pension schemes.

The DMO must also take account of demand for gilts when deciding how long to borrow. Shorter-dated gilts allow the DMO to raise large sums of cash quickly but increase the risk that it has to replace maturing debt with new debt on less favourable terms, such as when interest rates are rising.

Quantitative easing began to unwind in 2022, and the Bank of England (BoE) is moving from being a buyer to a seller of gilts⁴. The report notes that this will require effective coordination between the DMO and the BoE to mitigate the risk of disruption to gilt market conditions.

The DMO and National Savings & Investments (NS&I) will also need to effectively manage organisational risks in the years ahead. Debt management activities are complex - needing experience and judgement - requiring the DMO to recruit and retain skillsets often found in financial markets. There are risks around recruitment, retention and key personnel retiring, and the DMO has established a team to examine recruitment and retention challenges, and succession planning.

The National Savings & Investments (NS&I) outsources its entire back-office and customer facing operations to a single provider. While a government review of NS&I found this relationship to be strong, there have been issues with the delivery of change and transformation, where projects have been subject to delays. NS&I is moving to a multi-source provider model, aimed at ensuring it can proactively respond to changes in policy or the market.

Through our audit, the International Monetary Fund (IMF) and Organisation for Economic Cooperation and Development (OECD) told us that the UK debt management framework and the DMO's role in it is widely respected internationally. While the framework has been tested - most notably during the financial crisis and the pandemic - external conditions affecting the framework have changed over time and events can move quickly.

The NAO recommends that, within the changing context for debt financing, HMT periodically reviews the appropriateness of individual elements of the debt management framework, and how individual elements work together. We also recommend HMT considers ways to develop further how it measures progress against the debt management objective.

Gareth Davies, Head of NAO, said:

"The pandemic led to a large increase in borrowing, and more recently, higher interest rates  and inflation have raised the cost of new government borrowing. While the government has been able to meet its borrowing needs through the work of the DMO and NS&I, debt interest is now one of the largest items in government spending.

"There are substantial challenges ahead for debt management, which will require sustained focus from government." 

Notes to Editor:

1.      HM Treasury (HMT) is responsible for fiscal policy (public finances) within government, and for delivering the government's overall debt management objective. HMT's objective in relation to debt management policy is "to minimise, over the long term, the costs of meeting the government's financing needs, taking into account risk, while ensuring that debt management policy is consistent with the aims of monetary policy". The Debt Management Office (DMO) and National Savings and Investments (NS&I) are HMT's agents for implementing debt management policy.

2.      In 2009 the BoE began a quantitative easing (QE) programme with the aim of lowering interest rates, encouraging spending in the economy, and meeting the MPC's inflation target. It does this by creating new money electronically to buy government gilts in the secondary market (from financial institutions, rather than directly from the DMO)

3.      A gilt is a UK government sterling denominated bond issued by HM Treasury. The term gilt (or gilt-edged) is a reference to the primary characteristic of gilts as an investment - their security.

4.      The Group of Seven (G7) is an informal grouping of seven of the world's advanced economies, including Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States, The G7 meets annually to discuss issues such as global economic governance, international security and energy policy.