Combining council reserves could provide a way out of the funding crisis, argues Chris Leslie, director of the New Local Government Network.

To the casual observer, a bounce back of share prices since March might suggest that the broader economy is returning to normality. Sadly, there are few signs yet that the recession is ending in regeneration and house building. Dozens of large capital projects combining private and public investment have been knocked off course during 2009. These are deals that take considerable time – and fresh confidence – to reassemble.

And while the Treasury has been trying its hardest to bolster PFI schemes, supported on occasion by the European Investment Bank, there is a real need to focus also on the smaller and medium-sized capital projects which may not hit the headlines and which fall below the national radar.

Local councils are being asked to get regeneration schemes moving again, but will find this role increasingly tough given looming financial problems. Though politicians are loath to place hard figures into the public domain, the current £44bn capital budget is forecast to halve to £22bn by 2013-14. So while councils have been encouraged to ‘enjoy’ the freedoms of prudential borrowing from the Public Works Loans Board for nearly a decade now, there may well come a point where the Treasury’s generosity evaporates and the tap is gradually turned off.

Because local councils receive the vast bulk of their revenues from central grants rather than local taxes, their ability to repay large borrowing obligations is also under the spotlight. Add to this the volatility of the money markets – currently looking slightly healthier, but there are few certainties – and we can see why councils may well be struggling to raise affordable capital.

Last year’s Icelandic banking debacle, painful for some councils though that experience was, did shed light on the curiously large level of reserves that authorities have accrued – now estimated at over £30bn of investments posted in a variety of deposits and holdings. Although councils have been moving much of these reserves away from banks and building societies and into the apparently safer haven of the Treasury’s Debt Management Office (at virtually nil return), these assets might be put to better use at a time when the banks are reluctant lenders and when the public sector nationally is unenthusiastic about local capital works.

One model – a pooling of some of these reserves into a form of mutual fund for reinvestment in domestic infrastructure – has been under discussion here at the New Local Government Network (NLGN) and with a variety of local councils for several months now. There are significant legal and technical issues to overcome, but the principle that the local government family ought to be marshalling its own resources, rather than leaving everything to the Treasury to hold and direct, is a sound one.

While there are discrepancies between the long-term commitment needed for private finance and the short-term call on contingency deposits, there is a middle ground where some support for refinancing activities might be aided by a council reserves mutual fund. To kick-start the discussions on this option, NLGN has convened a working group to explore how a local council reserves pool might operate. Importantly, this initiative involves from an early stage our Local Government Association colleagues.

There are any number of directions such an endeavour could take. Should a reserves pool focus simply on security of deposit or the array of more active investment choices that are potentially viable? Would a reserves pool necessarily be a free-standing new entity or an alliance with existing financial services providers? What scale of investment might it be reasonable to expect local councils to commit? Building a consensus across councils will take a little time, but we hope further discussions in the autumn can move matters forward.

Separately, there are other resources over which councils have considerable sway. In particular, their superannuation funds have historically invested in money markets and equities rather than specific local public works. Could there be scope to create a basket of infrastructure schemes in which these local pension funds invest more determinedly?

There are strong arguments to say that this would be not just a boost for rebuilding our economy but also a sensible choice of stable investment. However, great care is needed as these are, strictly speaking, not public funds but sums held in stewardship for the employees of local councils past and present.

In the meantime, local authorities might also want to consider other freedoms as the fiscal environment tightens. Municipal bonds are not currently much in use, but with PFI waning as a model of choice, any alternatives to gilt issuance may well be worth a second look, especially if private involvement can help place some schemes off balance sheet.

Certainly, a new deal between the Treasury – whichever party is in power – and local councils is needed to prevent a complete freeze in public works and regeneration for the next seven years or so. To make alternative capital funding a realistic prospect, we must consider sharing financial skills between groups of councils and even the mutual underwriting of activities. Now is the time for local government to become stronger – and that requires leadership spanning a set of councils interested in joining forces, acquiring new skills and building markets.