As regular readers of this blog will know, how the Office for National Statistics accounts for the UK's national debt has been a long-running concern of mine.
I still suggest that the ONS get the accounting for quantitative easing hopelessly, and deliberately, wrong. Curiously, Jacob Rees-Mogg revealed more understanding of the issue than they do, very recently.
I also happen to believe that they double count £200 billion (or thereabouts) of supposed debt in their estimations because their treatment of what they call the ‘Bank of England' contribution to the national debt cannot be justified on any rational basis.
However, of late much of my focus has been on the accounting treatment that the ONS uses for Index Linked Bonds. I last discussed this in detail here. On July 18 the ONS published a methodology note on this issue, at least in part (based on correspondence received) in response to these concerns.
I have now reviewed that note and the ONS public sector finances bulletin for June 2022. As a result I am more concerned than ever that the ONS is seriously misstating the public accounts with regard to Index Linked Bonds, where some very basic errors appear to occur, whilst the presentation of data is also profoundly unhelpful.
I have now written to the ONS with further questions on this issue. As I say in the introduction to that letter:
I have read the methodology note that you published on 18 July and the related note from the Debt Management Office (DMO) that you linked on the calculation of interest due on index-linked bonds (ILBs). I have also downloaded your spreadsheets although as they are all mathematically dead, in the sense that all formulas have been removed from them, they do not, unfortunately, add anything to understanding.
I regret that having read this material I feel that the accounting for ILBs by the ONS is still misleading. My reason for saying so is that the data you are publishing is likely to do three things:
- Lead to incorrect impressions being formed as to the nature of current public expenditure;
- Lead to an incorrect impression being formed as to the current extent of public debt and the timing of it falling due;
- Lead to decisions being taken within government based on the assumption that there is a shortage of public funding for necessary expenditure at present when this is very definitely not the case.
To give some indication of the scale of the misleading impression that I think you are providing, I note that in June 2022 you suggest that the interest expense payable by the government might exceed £19 billion, making it the single largest expense incurred by the government during the course of that month. As explained later in this note, I very much doubt that the actual expense in the month in question exceeded £3 billion, which is a sum only a little in excess of the accrued cash charge.
Precisely why it would seem that you have so materially overstated the charge in question is hard to determine. However, as I note below, this is partly because your methodology note does not answer almost any of the reasonable questions that might be asked as to why or how you estimate the liabilities that you claim to be currently owing, and it does instead, if anything, give rise to more questions than it answers. However, the fundamental problems are that:
- You provide no indication as to how you estimate the redemption value of ILBs;
- You provide no indication of the scale of the issues arising with regard to premiums and discounts on the issue of ILBs, when it seems likely that they are material;
- There is no indication given as to how the time value of money is accounted for by you, but it would appear obvious that it should be, despite which discounting does not appear to feature in your calculations;
- The accrual for redemption of ILBs appears to be taken wholly, and inappropriately, in the period when there is a change in RPI when it should be accrued over the remaining life of a bond in issue given that these bonds were deliberately chosen to be long-life financial products, but no indication of this is given in your data;
- No indication of the timing of settlement of any of the liabilities arising from ILBs is provided by your methodology, resulting in the impression being given that these liabilities might be current when it appears that this is very far from the case.
The difficulty arising from this is that politicians are exploiting your data to imply that public services are unaffordable and are as a result under threat. This is very hard to justify when the liabilities that you note might be seriously overstated and when they do not, in the vast majority of cases, fall due for many years hence, with opportunity for reasonable accumulation of the sums due to be both made and to be accounted for in the meantime, as normal accounting conventions would suggest appropriate. It would seem that you should be correcting your presentation precisely because your data is being misused in this way, not least because the risk is that as a result of the abuse of your data real people might suffer actual adverse consequences deeply detrimental to their well-being. It is for this reason that I am returning to this issue with further questions on issues that really do require clarification if this matter is to be properly understood by any reasonably informed lay user of this data, into which category I would place almost all ministers and other elected politicians as well as most financial journalists.
The letter itself is here. It is fourteen pages long. I have published it now for the reasons I note in the concluding comments:
I am aware that some of the tone in this note is quite direct but in my opinion the first duty of any government is to protect its citizens and in my opinion the data that you are producing and the form in which you are publishing it exposes millions of people in this country to significant risk of harm as a consequence of the austerity that it might encourage government decision makers to inappropriately adopt without any economic cause to do so.
I am suggesting that there is an inappropriate use of statistics here when the claim is, as I note in the latter, that there has been an interest cost in the year to date of £33.7 billion when the actual cash spend this year is down £0.3 billion to £7.5 billion and when other, accounting justified, factors are taken into account the actual accrued cost of interest due for the year to date may be not much more than £9 billion, for reasons that I note in my letter.
I hope the ONS will respond more fully this time: their last offering was well wide of the mark and helped no one.
Thanks for reading this post.
You can share this post on social media of your choice by clicking these icons:
You can subscribe to this blog's daily email here.
And if you would like to support this blog you can, here:
Thanks for pressing on with this, Richard. There have been some changes in the way the ONS discusses and presents this information in recent months to make the numbers a bit clearer and less misleading, so the conversations to date are clearly having some impact, but there is still some distance to go before it becomes as clear and non-misleading as it should be.
Agreed
Would be interesting to know what they thought of JRMs statement!
This is so fundamental. As a non accountant, I cant really understand why there isnt a huge public / academic debate about it. Should be copied to shadow chancellor and chancellor , and Rees Mog….
Thanks for his Richard, and all you do.
I think that when you boil it all down, this is really all about Manufactured Consent.
They obviously what to push the governments austerity agenda, and so have to ‘prove’ we can’t afford it.
If I didn’t know better, Sir Bernard Appleby was working for the ONS.
Not quite the same but this clip makes the point I think.
https://www.youtube.com/watch?v=G0ZZJXw4MTA
That wasn’t a comedy programme, it was a documentary.
I am glad that you are still pushing on this topic; as you say, it matters because it is being used to drive policy.
I don’t have time to give the 14 pages justice right now (I am teaching on the very subject if inflation swaps!) but I will look at it as soon as I can.
Thanks
I am not an accountant, and I am struggling with this…. I am not entirely sure what they are doing or what you are proposing…..but here are my thoughts set out the way I think of the world from a bond trader’s perspective. I think you and I are “on the same page”…. although approaching things from different directions. (Indeed, that difference of perspective is valuable in gaining true understanding).
With conventional gilts things are straight forward as all the cashflows are known.
1. Coupons can be accounted for on an accrued basis.
2. At each gilt auction, the premium or discount will produce a cash amount (negative or positive) that could be amortised over the remaining life of the gilt and be included in the data as “interest”. (In any case this is a relatively small number and I wouldn’t be too fussed about how it is dealt with).
Coupons (interest) are paid semi-annually so over any 6 month period the accrued and cash numbers are the same – I think it is important that these tally over this time frame. Premia/discounts at gilt auctions are amortised over the life of the bond and each monthly amount is counted as “interest”.
I think this is what ONS is doing but it is not clear (to me).
With I/L Gilts we should try to follow the same methodology where we can but recognise where we can’t.
There is a problem; we do not know what the cashflows are going to be… because we do not know how RPI will evolve. But for coupon payments I think there is a reasonable way to do things.
Imagine a GBP 1 mm I/L gilt paying a 2% coupon, issued when RPI was 100, current RPI 200. Suppose it has just paid a coupon… which would have been 6 months interest on the uplifted amount – GBP 20,000. What do we record in the account for next month? Imagine, RPI rises 1% in that month (to 202) I think we should accrue GBP20,200/6; if next month RPI rises to 204 then combined accrual for the preceding two months should be GBP (20,400/6)x2 meaning that the accrual in the latest month would be GBP [(20,400/6) x 2 – (20,200/6)]; and so on. The point being is that over the coupon period (6 months), we use current RPI to predict the next coupon payment and adjust as we go along in the light of actual RPI data so that the accrual and cash basis for interest are the same at the next coupon payment.
For premia and discount at new issue I think things are simple. If a new tranche of this bond is sold at auction at 220 (versus an “uplifted principal amount” of 200) then the cash amount [(220-200)*face amount sold) is amortised over the life of the bond and subtracted from monthly interest amount.
We do NOT include the uplift in principal amount on I/L gilts because it is NOT interest in any normally understood meaning of the word either in financial markets or ordinary life. We not trying to hide anything because the ONS DOES include the uplifted amount in the size of the National Debt. If they wished to be explicit about this then a footnote would explain all.
I think the problem with the ONS presentation of the data arises in trying to treat the RPI “uplift” in the same way a Premia/discounts at auction when, in fact they are fundamentally different beasts that need different treatment.
Personally, I would use market value of the National Debt. I would then break down the change in size of the National Debt as
1. New gilt issuance (at auction prices) less redemptions.
2. Amortisation of premia/discount on gilts (from auction price to par (or uplifted principal amount in the case of I/L gilts)).
3. Change in market value due to change in market interest rates
4. Change in Market value due to RPI uplift
5. (and possibly Change in Treasury bills outstanding (a cash management story rather than a National Debt story)
Finally, if you are looking for a “politically” neutral way to justify a change in treatment I would say this. The DMO’s duty is to minimise the cost of the National Debt and this treatment might cause them to switch away from I/L issuance when it might well not be the right thing to do. (although, of course, I DO share your distaste for the way the Government is using the data is drive policy).
Thanks for this
You are broadly right re interest payments on ILBs, and re premix, but the latter must reflect discounting
Re the capital repayment your suggestion in accounting terms is to pass this through the statement of movement in equity. Interesting, and possible
Noted! And thanks
PS. I am currently teaching on inflation linked bonds and inflation swaps (as part of a broader Fixed Income course). For the first time in years the class has stayed awake for what was seen, until now, as a very dull area to trade.
What did you say?