1. The Government welcomes the Committee's report into Defence Spending and the interest shown by the Committee in the spending plans announced in the 1996 Budget.

  2. The Financial Statement and Budget Report showed expected outturn for defence in 1996/97 to be £22,130 million. This, as the Committee will be aware, was a rounded figure to the nearest £10 million. The actual figure was £22,126 million. As the Secretary of State explained in oral evidence to the Committee on 27 November, the rounded figure represented an increase, again in rounded terms, of £710 million above provision for 1996/97 shown in the 1996 Departmental Report. This was attributable to the addition of money carried forward from underspending in previous years, money drawn from the Reserve to cover the extra costs arising from operations in the Former Yugoslavia, and money for the rent and initial upgrade costs associated with the sale of the Married Quarters Estate.

  3. In its report, the Committee showed these elements to add up to £707 million, subsequently rounded to £705 million. The breakdown shown, however, also included rounded figures, particularly the £380 million shown for carry forward. The actual figure was £386 million, consisting of £183 million from 1994/95 and £203 million from 1995/96. These figures were given to the Committee by the Ministry of Defence in written evidence to the inquiry into the Statement on the Defence Estimates 1996 (page 29 of the report).

  4. Since Budget Day, defence spending plans have increased by £10 million (balanced by appropriations in aid of £10 million of married quarter receipts) to cover the direct costs incurred by the Ministry of Defence in implementing the sale of the Married Quarters Estate. Although the Government was aware that the MOD would incur costs in this way, as the Minister of State for Defence Procurement told the Committee on 13 November 1996, an accurate estimate was not available in time for Budget Day. This item therefore did not appear in the analysis presented to the Committee.

  5. The Committee will wish to note the revised breakdown of defence spending plans in 1996/97, which include inter­departmental transfers of £11 million, as follows:

	£ million
Plans as shown in the 1996 Departmental Report	21,425
Carry forward from previous years (£183M from 1994/95, £203M from 1995/96)	386
Reserve claim	244
Initial upgrade of MQE	11
MQ rental costs	72
Direct costs of MQE sale	10
Interdepartmental transfers	­11
Total changes	712
New Total	22,136*

  * Figures do not precisely add up to the total because of roundings.

The full spending plans for 1996/97 are therefore some £10 million higher than the figure given to the Committee in November 1996.

  6. Further details appear in the MOD Departmental Report, published on 20 March as The Government's Expenditure Plans 1997/98 to 1999/2000 (Cm 3202). The Committee will note that provision for 1996/97 is shown in Tables 1 and 2 of the Departmental Report as £22,109 million, some £27 million less than the full spending plans set out above. This is because the plans are not fully reflected in voted provision. As the footnotes to the tables explain, however, the higher figure of £22,136 million will form the basis on which any entitlement to carry forward unspent provision will be assessed.

  7. The Government welcomes the Committee's comments (paragraph 4) about the successful measures that the Secretary of State for Defence has taken to reduce underspending, and notes its observations (paragraphs 9 to 14) about the carry forward of unspent provision. The Government accepts that when exceptional items are taken into account, spending plans in 1996/97 remain similar to those set out in the 1995 Budget. It has never sought to pretend otherwise. But it would remind the Committee that it plans to spend more on defence in the years 1995/96, 1996/97 and 1997/98 taken together than was the case at the time of the 1995 Budget.

  8. The Government welcomes the Committee's comments on the spending plans for 1997/98, 1998/99 and 1999/2000 (paragraph 16). It endorses the conclusion that the plans for 1997/98 maintain the real value of those announced in the 1995 Budget (paragraph 20), that those for 1998/99 are at the same level in real terms as 1997/98 (paragraph 21), and that the plans for 1999/2000 show a ½% real increase over those for 1998/99 (paragraph 22). As the Secretary of State said in his letter to the Chairman of the Committee on 15 January 1997, the spending totals were subsequently increased by £20 million in each of these years. They have since been further adjusted to reflect a number of transfers into and out of the Department implemented in early 1997 including £1M in 1997/98 for the replacement Royal Yacht. The net effect of these transfers and the £20 million adjustment was to increase the defence budget by £16 million in 1997/98, and £34 million in each of the years 1998/99 and 1999/2000. The revised plans are as follows:

1997/98	1998/99	1999/2000
£21,822M	£22,276M	£22,832M

These figures are published in the Departmental Report.

  9. The Committee asked for advice on how the inflation saving of £228 million in 1997/98 was calculated (paragraph 24). This arises from the real terms comparison between the plans announced in 1995 and those announced in 1996. Account therefore needs to be taken of changes in forecast inflation since November 1995. As the Secretary of State has explained to the Committee, the GDP measure of inflation is always used when comparing spending plans. The relevant figures are as follows:

	1995/96	1996/97	1997/98	1998/99	1999/00
Nov 95 f'cast GDP inflation	1.0275	1.0275	1.0250	1.0225	1.0225
Cumulative deflators	0.9732	0.9472	0.9241	0.9038	0.8839
Nov 96 f'cast GDP inflation	1.0243	1.0250	1.0200	1.0200	1.0200
Cumulative deflators	0.9763	0.9525	0.9338	0.9115	0.8975

The inflation saving in 1997/98 is calculated by taking the difference between the cumulative deflators across the first three years of the above series, and applying this to the baseline for the 1996 settlement.

	£ million
PES 96 baseline (cash)	21,914
at 1994/95 prices: 21,914 x 0.9241 (Nov 95 deflators)	20,250
return to cash: 20,250/0.9338 (Nov 96 deflators)	21,686
Difference from PES baseline	228

£228 million was the figure mentioned by the Secretary of State in his letter to the Chairman of the Committee of 26 November 1996.

  10. The Secretary of State advised the Chairman of the Committee on 15 January 1997 that the GDP deflator for 1995/96 had been reassessed at 2.53% shortly before Budget Day. This reduces the savings achievable in the Survey years as a result of lower inflation:

	1995/96	1996/97	1997/98	1998/99	1999/00
Nov 95 f'cast GDP inflation	1.0275	1.0275	1.0250	1.0225	1.0225
Cumulative deflators	0.9732	0.9472	0.9241	0.9038	0.8839
Nov 96 f'cast GDP inflation (revised)	1.0253	1.0250	1.0200	1.0200	1.0200
Cumulative deflators	0.9753	0.9515	0.9329	0.9115	0.8975

	£ million
PES 96 baseline (cash)	21,914
at 1994/95 prices: 21,914 x 0.9241 (Nov 95 deflators)	20,250
return to cash: 20,250/0.9329   (Nov 96 deflators revised)	21,707
Difference from PES baseline	207

  11. Therefore around £20 million of the savings had been eroded as a result of this adjustment to the 1995/96 deflator and it has been necessary to add this amount to the spending plans for 1997/98 in order to maintain the real value of the money planned for spending in that year. Similar increases were also required in the latter two years of the Survey period.

  12. The Government notes the Committee's recommendation that future announcements about defence spending should state the effect of any change in inflation assumptions, and include an illustrative table showing the consequences of one­quarter percent changes in inflation either side of the current forecast (paragraph 26). The Government agrees that it would add clarity to the presentation of PES settlements to include material on GDP inflation assumptions and will consider how best this can be done to improve presentation and understanding of the figures.

  13. The Government notes the Committee's comments on the level of rents paid to Annington Homes in 1996/97 (paragraph 35) but does not agree that this is disproportionate to the annual rent for future years. Paragraph 34 of the report states that the £72 million paid in 1996/97 is for the period from November 1996 to March 1997. The actual position is that the £72 million, which is paid quarterly in advance, covers the period November 1996 to June 1997. The footnote to page 15 of the report makes this clear.

  14. The Government notes the Committee's comments (paragraph 37) on the need to ensure that the £100 million added to the defence budget for the upgrade of the Married Quarters Estate is not used to replace other provision set aside for this purpose. The Government can assure the Committee that both the £100 million and some £370 million already in the Defence Housing Executive's long term plan over the years 1997/98 to 2003/04 will be protected. The upgrade programme is being planned and managed as a discrete series of projects and regular reports on progress, and eventually on completion, will be provided.

  15. The Government notes the Committee's comments (paragraph 45) about the information the House receives about delays to equipment projects. The Government draws attention to the information published annually in the Statement on the Defence Estimates, which includes the in­service dates for a wide range of equipment projects, enabling the House to see where slippage has occurred.

  16. The Government points out that all major defence equipment programmes, including those for which procurement decisions have been announced during the past year, are funded within currently planned levels of resources. The Long Term Costings are based on the Government's forward assessment of its defence requirements and priorities over the next 10 years.

  17. The Government notes the Committee's recommendation at paragraph 54 that the Department should publish shadow resource­based estimates in 1998 and each year thereafter until the new system is in place in 2001. In recognition of the scale, complexity and diversity of MOD business and the demanding timetable within which Resource Accounting and Budgeting (RAB) is to be introduced, the Department has adopted a phased approach to implementation.

  18. The first phase will put in place basic financial accounting during 1998/99. Work on this phase is progressing and includes development and build of new IT systems, detailed design of new processes, registration and valuation of assets and stock and new skills training. Subsequent phases, which will build on the information and experience gained from use of the new financial accounting systems and processes from 1998 onwards, are currently being developed to produce new output based planning, budgeting and management systems to replace the Department's Long Term Costings. The development of this work is intended to ensure - in line with the White Paper (Cm 2929) timetable - that new systems will be available to support the Public Expenditure Survey in the year 2000. The Department will not therefore be able to publish reliable resource­based Estimates before 2001/02. Any figures produced before then, and particularly before an opening balance sheet had been assembled, would be speculative and misleading. The Government will of course provide regular reports to the Committee updating them on progress with the introduction of resource accounting and budgeting in the MOD.

  19. The Government agrees that the introduction of RAB should not affect the requirement to obtain approval of the House (through Votes A) for the numbers of personnel to be maintained in each of the Armed Forces.

  20. The Government notes the Committee's recommendation that the defence spending plans set out in the 1996 Budget must at least be maintained in real terms in future years. The Government would advise the Committee that that is the planning assumption made by the Government in constructing its forward defence programme. The actual resources available will, of course, be addressed in future Public Expenditure Surveys.

20 March 1997