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Devolving business rates to councils will deepen local debt – credit agency

Devolving business rates to local authorities will drive up council debt as a result of increased borrowing to invest in business development, credit agency Moody’s has found.

Analysing the impact of chancellor George Osborne’s intention to devolve business rates growth to local authorities by the end of the decade, the agency found that council credit ratings were now at risk of being decoupled from the UK’s sovereign rating, since their credit profile would be more dependent on their own characteristics. This would mark a significant change from the current outlook, where local authorities’ credit ratings are closely linked to that of the central government.

Furthermore councils are only set to benefit from additional new business rates revenue, since the existent ones will be offset by a reduction in main grant funding from Whitehall. This will make councils more dependent on a less predictable form of income.

Danny Escobar, associate analyst at Moody’s Public Sector Europe, said: “The reform of business rates will weaken financial ties between the LAs and the state, giving their intrinsic characteristics more weight in their overall credit strength.

“The government will fully devolve control over business rates by 2020 at which point we expect locally collected income to account for a higher proportion of LAs’ revenue than government grants.”

Although the ability to retain and cut rates is positive for councils in the context of spending cuts, the analysis said it was likely to fragment the creditworthiness of local government.

This means local authorities with a strong potential to stimulate local businesses would benefit and strengthen their credit while increasingly having a credit advantage over their peers – councils that fail to harness business growth.

Amongst Moody’s-rated regions, the agency expected councils like Guilford Borough Council – currently given the second top rating of AA1 – as an example of an authority set to benefit, while areas like Cornwall County Council and Lancashire County Council would take a hit.

Escobar continued: “The transfer of powers over business rates to the local authorities marks a move towards localisation of revenues in what has traditionally been one of the most centralised systems in Europe.

“This change gives local authorities greater financial autonomy, and makes their credit profile more dependent on their own characteristics rather than on their links to the sovereign.

“We expect some local authorities to embark on capital development projects to promote growth of their business base, in some cases increasing their borrowing to do so. Investment aimed at stimulating business growth offers uncertain returns, and can be costly.”

The agency singled out Warrington Borough Council as an example, as it has recently issued a £150m bond for regeneration and economic development by investing in infrastructure.

He continued: “For Warrington, much of the development risk is related to potential mismatches between debt liability and lagged revenue benefits.

“This highlights the duration of the project, which is not expected to generate revenue positive cash flows until 2025 [and] the programme is expected to raise Warrington’s debt well over 100% of revenues, from 27.5% in fiscal year [2014-15]. Nonetheless, we expect other local authorities to follow suit.”

The agency’s warning that councils risked greater borrowing also follows similar revelations from last week’s Office of National Statistics figures.

The figures showed that while public sector net borrowing decreased by nearly 14% so far in this financial year, this was offset by an increase of nearly £2bn in local government borrowing.