The idea of nationalised industries and the public authorities borrowing in foreign currency was intentionally to strengthen the UK’s reserves and improve the UK’s balance of payments.
These industries, if borrowing by medium or long-term basis would assist in funding the UK’s foreign liabilities, and strengthen its reserves to the tune of $100m-200m a year. |
THE NATIONALISED INDUSTRIES, THE PUBLIC AUTHORITIES
AND THE EURO-DOLLAR MARKET*
A. Introduction the general concept
The idea of nationalised industries borrowing in foreign currency was intentionally to strengthen the UKs reserves and improve the UKs balance of payments. These industries, if borrowing by medium or long-term basis would assist in funding the UKs foreign liabilities, and strengthen its reserves to the tune of $100m-200m a year. However, there seemed little prospect of getting the nationalised industries to borrow abroad regularly, without taking legislation to provide for a Government Exchange Guarantee to the nationalised industries. Even if the UK Treasury had the power to give an Exchange Guarantee, the problems would not disappear, as the nationalised industries still wanted to regard the UK Government as Lender of Last Resort, should the cost of foreign borrowing prove unacceptably high. This proved to be a sensitive issue, as if the UK Treasury had felt obliged to accept this rule, as an alternative to approved investment not going forward, the potential relief from foreign borrowing would be lost.
Lever acknowledged this problem in 1968, by stating that the UK should give a Government guarantee to the lender for such borrowing, as was done with UK borrowing . This implied that, the Government could not allow a nationalised industry to default, and by giving a guarantee would have a marginal effect in lowering interest rates. No pressure was placed on the nationalised industries to borrow abroad, but the decision was to be based on commercial grounds whether or not they wished to borrow abroad. An important point was not extending treatment limited to inter-governmental loans to an area that was expected to operate on commercial terms. Another point was that, borrowing by a nationalised industry was not seen as Government borrowing. This was confirmed in the House of Commons on the 16th April 1969, by the Chancellor of the Exchequer to Mr Oakes (Labour MP West Bolton) :
The Government wishes to encourage local authorities who have the necessary statutory powers to consider the possibility of borrowing foreign currency at medium and long-term for the benefit of the reserves, and Clause 14 of the Finance Bill will remove an existing impediment by enabling authorities to pay interest gross of tax on such borrowings. The Government is also prepared to extend to local authorities, in appropriate cases, the special arrangements for dealing with exchange uncertainties.
B. Encouraging foreign currency borrowing by public bodies
The UK Government agreed that certain positive steps should be considered in order to encourage some long-term borrowing in the Euro-dollar market, or on continental capital markets by public bodies, particularly the nationalised industries and the major local authorities. Such considerations started by the UK Government considering the case of borrowing of this kind, in the national interest, and the cost for which, the Government itself should be prepared to accept. This then went on to consider how the public bodies might be induced to borrow abroad, with particular references to the question of the exchange risk . Certain questions had arisen as a result: firstly is an exchange guarantee necessary to induce nationalised industries and any local authorities to borrow, or could this be accomplished by placing some pressure on them to do so? Secondly, if a guarantee or something having similar effect is necessary, which method should be adopted? Thirdly if there are any other major difficulties, for example, in the tax field?
B (1) The case for foreign currency borrowing by public bodies
The main reason rested on the UKs Governments need for usable foreign exchange resources. This was due to heavy demands on the reserves and the huge volume of short-term debt that had to be repaid in the late 1960s and early 1970s. The British government held the view that not only would the use of medium-term capital markets be welcomed, but could distinctly be helpful in securing agreement to any renewal of the short-term facility that might prove necessary . In practice, the required foreign exchange would be used to pay-off short-term debt to the IMF and central banks; and, from the national point of view therefore, the move would have the character of a funding operation.
The argument for taking on the burden of repayment of foreign currencies in, ten or fifteen years time plus the interest cost, rested naturally, on the assumption that, the balance of payments would improve over the period. Hence, the foreign exchange resources would have a greater value to the UK at the time of borrowing than they will have later. However, the basis of the degree of the additional cost the UK should be prepared to assume was a major consideration. There was a parallel here with the choice between procurement at home or abroad by public authorities. It was broadly accepted that, with the then current position of the UKs reserve and balance of payments position, there was a case for accepting higher costs for domestically produced goods, within certain limits. The Governments economic advisors suggested that it would be reasonable to use a 20% preference rate for domestically produced goods. Due to a similar process of reasoning, it was shown that under these circumstances, the real resource cost to the nation was less than the interest rate for which was actually payable. Such borrowing therefore contained a concealed premium. The crucial assumption was that the UKs liquid position would improve as time goes on. In proposing a 20% preference rate for purchases made at the present time, the Economic Advisors suggested that the rate should fall back to 10% in due course. In terms of borrowing, these assumptions are mathematically equivalent to a premium of up to about 1% on a fifteen year bond .
However, there was also the important question of the exchange risk itself. The differentials between international interest rates did, of course, reflect market views about the exchange risk and some allowance for this risk had to be made in considering the effective rate of borrowing abroad. The first of the following tables compares actual UK and European interest rates over the past year relating to 10-15 year borrowing, and excluding brokerage charges and similar transactions costs, which amount to some 0.4% per annum on Euro-bond rates. The second table shows the rate of interest at which the overall cost of borrowing in Deutschemark would reach break-even point with sterling, given an immediate 10% revaluation of the Deutschemark, on alternative assumptions about the degree of exchange risk covered.
Another point was that, since such borrowing would be undertaken for national purposes, as opposed to the purposes of the public authorities in question, HM government should do it itself. As, this would have avoided many problems, and might possibly had been cheaper. However, the question of confidence had arisen here. It might not have been possible to borrow more than distinctly modest amounts at any on time because of the capacity of the individual markets, and for HM Government to do this might create a bad impression. Moreover, it would be very awkward indeed if at any one time, it appeared that the name of the British Government was not regarded as first-class a possibility, which could not be entirely excluded. If, the means was found therefore, of getting local authorities or nationalised industries to borrow in this way, this would be a preferable method. It was not easy to make a judgement as to how much it may be possible to raise. Nevertheless, the Bank of Englands view was that, given reasonably favourable conditions, the Public Sector as a whole should be able to borrow up to £100m per annum at medium-term in the Euro-bond market and on local capital markets on the continent. This was considered a very worthwhile contribution to the UKs financing position .
B (2) The point of view of the public authorities concerned
A main point was that, the figures had also shown why borrowing abroad was not an attractive proposal to the nationalised industries or other public bodies without an exchange guarantee. However, a number of public bodies had given thought to the idea of borrowing foreign currency abroad and powers for this purpose had been included in legislations in 1968 about most of the important public corporations. A few local authorities, including the GLC had similar powers. The question had, of course, been considered mainly from the point of view of the possible advantage to the industry or corporation concerned. Thus, the Electricity Council did from time to time show interest in the idea of borrowing mainly as a possible means of circumventing the usual Treasury control on the industrys investment expenditure . However, if the UK Government concluded from the national stand-point, that there was a good case for more borrowing abroad, and that for this purpose the Government should assume the exchange risk, the attitudes of the public authorities might be quite different.
Market conditions in Europe throughout the 1960s were considered favourable for borrowing of the kind the UK had in mind. The capacity of the market to absorb UK borrowing of this sort was inevitably a matter of guess-work. Nevertheless, it would probably be reasonable to think in terms of an annual rate of borrowing of the order of $100m to $200m in total, though it seemed doubtful whether the market could absorb any individual issue of more than $25m to $50m.
B (3) The case for Exchange Guarantees
The main obstacle was the lack of exchange guarantees. Since, the margin between the rate at which the industries could borrow overseas (after allowing for certain expenses of issue), and the rate at which they could borrow from the National Loans Fund was not sufficient in view of their management, in order to compensate them for the exchange risk they would have had to carry. Hence, in the view of the UK Government, there was not any objection of principle from the point of view of exchange rate policy to offering an exchange guarantee to a public body wishing to borrow abroad. Any doctrinal objections which may have had some force in the past had been undermined by the Governments decision to give guarantees to official sterling are reserve holders .
A difficulty arose when the Treasury Solicitor confirmed the fact that, there was no formal statutory powers under which the UK Government could guarantee a nationalised industry or other public bodies, which borrowed money from foreign sources against an exchange risk. The UK Government could and in some cases had guaranteed an overseas lender against the risk of default by a nationalised industry. However the powers under which this was done were not available for guarantees to the borrower. If a formal guarantee was essential, fresh legislation was required. But this was a time consuming process and could be harmful to confidence.
In the case of the nationalised industries (not the local authorities) it was hardly sufficient to offer the industries an informal assurance that, should an exchange risk materialise, the UK Government would be prepared to take the necessary statutory powers to make a cash payment by way of compensation. (Such a cash payment had to be charged to votes, either of the Treasury or to one of the sponsoring Departments. This could not be charged, after the events, upon the Consolidated Fund, as was the case with liabilities maturing under guarantees made with statutory cover). Such a procedure was contrary to the normal rule that no contingent liabilities should be entered into without the knowledge of Parliament. In 1968, there was no lack of Parliamentary opportunities to seek such powers, and the UK Treasury would be left open to criticisms if the UK gave such an informal undertaking, even if Parliament were informed at the time . The industries might be given some assurance, (by the issue of a letter which would be published in the event of the loss materialising), that a loss would not reflect on their commercial judgement, since it resulted from a Government request, and that if it arose, the Government would accept the short-fall in performance and would advance the increased funds for capital development which would be needed to make good the reflection in self-financing. This approach was inconsistent with the doctrine of the Select Committee on Nationalised Industries, who were concerned with protecting the managerial independence of the industries. Also, the proposal for an informal guarantee would fall foul of the Parliamentary doctrine .
The UK Government considered whether the liability could be assumed by the Exchange Equalisation Account, as in the case of the guarantees to overseas sterling holders. In that case, it was concluded that the issue of the guarantee came within the purpose of the EEA which include the conservation or disposition in the national interest of the means of making payments abroad. In order to justify the use of the EEA for the present purpose, the UK would have to convince themselves and also, no doubt the PAC and the House of Commons, that it also came within this purpose. Arguably, this might be done. The essential purpose of the borrowing would be to augment the reserves. The purpose of issuing a guarantee would be to induce the nationalised industries to borrow in foreign currency, for the sake of the reserves, rather than to borrow at home. However, it was doubtful whether the PAC would accept this without argument. The connection between transactions of this kind and the purposes of the EEA is not as direct as in previous cases of exchange guarantees and it would be a departure from all precedent for the EEA to be making payments in sterling to bodies such as nationalised industries. It would probably be regarded as stretching the purposes of the EEA unduly. The use of the EEA would probably also increase the risk of demands for similar facilities for other borrowers, which the UK should probably wish to refuse .
Another factor that was considered was for the nationalised industries to on-lend the currencies borrowed to HM Government and then re-borrow in sterling from the National Loans Fund. HM Government would thus assume the exchange risk as they had borrowed in their own name for the period and at the interest cost of the original foreign borrowing.
B (4) Other means of achieving the effect of an guarantee
A main question that had arisen was whether, it was possible to induce public bodies to borrow abroad without a formal guarantee ? If, for example the Government let it be known to a few selected public bodies, such as the Gas Council or the Electricity Council, that the Government would like to see them raising a proportion of their finance in foreign currency over the next eighteen months, would something be achieved? There was no question of any formal directive, since the Government did not possess the necessary statutory powers; and if the question of a guarantee was raised, the Government would merely say that it does not possess the powers to give this either. The sums at issue would be negligible in relation to the industries total costs and it does not seem beyond the balance of possibility that they might be persuaded to raise one or two issues in foreign currency.
Failing that, another possible approach in supporting the case of the nationalised industries, was that the commercial operations of the industries was governed, not by the rate at which they could actually raise funds from the market or from the National Loans Fund, but by reference to a shadow price of capital determined separately by the Government with reference to the opportunity cost of capital in the private sector. The financial performance of the industries was judged, partly by whether they show a surplus on their trading accounts after meeting their interest liabilities to the NLF (National Loans Fund), to their success or failure in achieving their financial objective . This in turn reflected the shadow price of capital rather than the actual market rate.
One theoretical possibility was that it was suggested to the industries that they should carry the exchange risk themselves on the understanding that, if losses materialised from overseas borrowing, some adjustment should be made in their self financing ratio to cover the relatively minor sums involved. To take open recognition of the risk in this way would be consistent with the views of the Select Committee on Nationalised Industries about relations between industries and the Ministers concerned being open and above board. However, a suggestion of this kind had to be discussed with the departments concerned and it was likely that they would oppose it. The assumption was that to ask a nationalised industry to carry an exchange risk would be like asking it to act against its commercial interests, and provoke the counter response that if foreign borrowing was so much in the national interest, then the Government should do it itself. Or at least, guarantee the nationalised industry from any loss thereby sustained, rather than just adjust its self-financing ratio afterwards .
Another alternative way of persuading nationalised industries to borrow abroad was to link the foreign borrowing with more flexible terms of borrowing from the National Loans Fund. It was suggested that the industries were allowed to borrow relatively short-term, e.g. seven years, compared with the customary twenty-five, pound for pound, or some other ratio, with what they raise in foreign currencies, within their existing programmes. However, action of this sort was consistent with the recommendation of the Select Committee on nationalised Industries (SCNI) that the UK Government should review the terms and conditions of the industries borrowing powers. However, this would only benefit those nationalised industries, which already had the power to borrow abroad .
The final possibility was to link borrowing abroad with approval of their investment programme. If the industries were to borrow abroad for a particular investment, which would not otherwise be admitted into their programme, or were allowed to add an additional tranche to their programme conditional on their borrowing abroad, they would probably be interested. This had already been done in special cases such as the purchase of US aircraft; but in general the UK Government could not agree to this. The industries investment programmes were settled by reference to the investment on which they had satisfactory prospects of earning an adequate return. The control was over their investment not over their borrowing; to make the amount of their investment dependent on their borrowing would be quite contrary to the principles of Cmnd.3437 , and to the whole tenor of the UKs evidence to the Select Committee on Nationalised Industries.
C. Overseas public authorities borrowing on the market
The Bank of England, in response towards the UK Governments policy in encouraging nationalised industries and local authorities to borrow abroad, constructed a research project in November 1964, to bestow some factual information about such borrowings by other countries in various markets .
Amount of borrowing (1955-1964)
During 1955-1964, public authorities from overseas (Governments, local authorities and nationalised industries) from Europe and Japan had borrowed abroad the equivalent of some £720m* in the leading capital markets that were outside their own countries. Governments had accounted for £347m*, local authorities £122m*, nationalised industries and similar bodies £251m*. The table in Appendix One (at the end of this thesis) shows the total raised by each country according to type of authority in each market. It will be seen that New York (before the Interest Equalisation Tax of 1963) was the leading market with the equivalent of some £300m, (after the tax of 1963 only $15m had been raised there since). London was ranked second, due to its Euro-dollar loans, which had raised £132m in two years. Germany was ranked third with £110m, with Switzerland and Holland next with £61m each. Loans had been ranged to a maximum of 20 years, with the average being around 15 years. The provision of Government guarantees had varied considerably from country to country, and with the standing of the borrower. Some loans had carried tax exemptions through non-residents, but the position (at the time) was not known .
Reasons for borrowing abroad rather than at home
Reasons (where known) for borrowing abroad rather than at home was varied. In many cases, the size of, and pressure on, domestic markets, some of which were under-developed, had been a common reason. Another was the deliberate policy of Governments (mostly Scandinavia and Portugal) to borrow abroad to finance the external requirements of development programmes. Another factor was the interest rate considerations that was usually linked to the inadequacy and pressure on domestic markets .
Scope of overseas capital markets
Comparing the contrast of the modern financial market of today, the scope for raising loans abroad in the early 1960s (especially in November 1964) was limited. Several markets were closed to foreign borrowers (some for a considerable time) and in many cases were unlikely to be re-opened throughout the 1960s .
In summary, West Germany was the most promising market but costs of issue were expensive and interest rates were relatively high. Switzerland was open, but it was a very competitive market which was restricted for other than trifling amounts. New York was a non-starter due to the Interest Equalisation Tax, and future borrowings depended upon its balance of payments. Other potential markets in Europe (Holland, Belgium and Italy) were closed to foreign borrowers. There only remained the Euro-dollar market in London, which had lent substantial sums of £132m in two years.
French public corporations borrowing on the Euro-dollar market
This Euro-dollar situation in the UK was very similar to France in the late 1960s, where a number of French bodies of this kind had borrowed in the Euro-dollar market, for which the Governor of the Bank of England reported that the UK could profitably follow the same policy. Three French nationalised industries wished to borrow on the Euro-dollar market: the French railways, electricity and telecommunications . This produced some interesting points, which emerged as a result:
(1) The size of the issues - $30 million each. $90 million altogether within the space of ten months for French nationalised industries alone. This showed that the UK had underestimated the growth of the capacity of the market.
(2) Virtually all the Western European banks, including the UK merchant banks, and a good number of American banks, participated in the placing of these bond issues.
(3) The form of the loan would be novel for the UKs own nationalised industries, though not presumably intolerable to them.
However, in response to the French participation in the Euro-dollar market, the French quoted that in 1966, the authorities envisaged that France would run a deficit in her balance of payments in 1967. Certain French firms were pressing the authorities to allow them to raise money on the Eurodollar market. Although there were plenty of liquid savings in France, the channels of investment were still inadequate. The liquid savings remained in liquid forms. Savers resorted to forms of deposit, which could easily be withdrawn, holding cash and deposits with institutions outside the organised savings movement. The banks were conservative and were reluctant to convert short-term deposits into longer term lending. This was the explanation as to why the French businesses were unable to raise sufficient funds on the French market although, on the face of it, there was an excess of liquidity. Also, in 1966 when these applications were considered the authorities could not object that the use of Eurodollars would add unnecessarily to French reserves since they envisaged a deficit .
Consequently authorisations were granted to the Compagnie Francaise des Petroles and Ciments Lafarge. The CFP project did not come off but Ciments Lafarge raised their Eurodollars through the Credit Commercial de France. Due to the dismantling of their exchange control system, it was no longer possible to prevent French firms from going into the Eurodollar market. Indeed French investors could buy Eurodollars and then purchase Eurodollar securities in other centres. Likewise the French could hold deposits in Eurodollars. Hence if it was considered desirable to do so, the French authorities were able to use other means of pressure on French firms, to abstain from the Eurodollar market . As most of the firms were either nationalised concerns or partly nationalised and even if they were not they were heavily dependent on sources of finance controlled by the French Government.
However the situation was that the French authorities had no compelling reasons to ask French firms to abstain. It would have been no doubt that, although it was not publicly mentioned by the French that the authorities also had in mind their avowed policy of trying to make Paris an important financial centre. This could not be done without permitting the free flow of funds. In the outcome the French reserves have continued to rise in 1967. The trade balance was in deficit but invisibles contribute enough to create a small surplus.
The idea of the French Model Approach
It was not clear whether these Euro-bond issues by the French nationalised industries were of any direct relevance to the consideration of the UKs own policy towards borrowing in the Euro-dollar market. Nevertheless, the view was that the use of medium-term capital markets in this way would not only be welcomed by the Governor of the Bank of England, but could be distinctly helpful in securing agreement to any renewal of the short-term facility that may prove necessary. In practice, the foreign exchange so required would be used to pay-off short-term debt to the IMF and central banks; and, from the national point of view, therefore, the move would have character of a funding operation.
However, on the 29th January 1969, Monsieur Baquiast (from the French Embassy) recognised that although the issues of Euro-dollar borrowing made by the French public corporations had a government guarantee, the government did not encourage Euro-dollar borrowing by these corporations. The reason being that corporations would never borrow without such a guarantee, and that the French Government would not guarantee borrowing for an undesirable investment or for one, which was contrary to the governments general policy . However, although the French governments attitude was unfavourable to Euro-dollar borrowing, they had been prepared to allow the corporations to borrow small amounts for desirable projects. There were several reasons for the governments attitude:
(i) There was a general feeling that the market was a bad market, which were uncontrolled, highly competitive and subject to speculative pressures.
(ii) French banks, unlike the UK and USA banks did not have a large stake in the market. French influence on the market was therefore weak. Furthermore, in these circumstances the encouragement of Euro-dollar borrowing would bring only small indirect benefits to france and there was little pressure from the banks themselves.
(iii) Tax evasion was a factor, but not a major one.
(iv) Most important involved the technical arguments used by the French officials that supported the governments political attitude. The latter disliked French domestic investment depending on external finance. The technical argument stems from the potential conflict between the balance of payments/reserve advantage and the money corrosion/inflation disadvantages of encouraging foreign currency borrowing. Due to Frances enduring concerns with the question of domestic inflation there had been credit restrictions of varying stringency in France for the past 5-6 years. Foreign currency borrowing was seen as a breach in the governments policy designed to control the money supply. At the same time, Frances balance of payments position had been strong enough to make this side of the argument less forceful.
D. Securing the co-operation of the public sector bodies concerned
Nevertheless, the borrowing costs of borrowing Euro-dollars affected the achievement of financial objectives, and for this reason the Boards of the nationalised industries paid careful attention to them. It led to the possibility that a nationalised industry or local authority borrowing in foreign currencies must depend first, and probably on the transaction offering an interest rate advantage compared with available UK sources. These sources for the nationalised industries were Central Government funds, apart from a small total of short-term borrowing from the banks. However, the local authorities could divide their borrowing between the Central Government (up to certain limits) and the market.
There may be a case for arguing that in some circumstances, it would be in the national interest for a national industry to borrow abroad, even at a relatively higher rate than that charged on Government funds. In practice the Boards themselves demanded that the additional cost of this borrowing be provided from government sources. There was no question, that if a local authority was to be pressed into borrowing foreign currency at a higher rate, than was appropriate for funds borrowed in the UK, they would then require compensation from the Central Government.
Moreover, a nationalised industry or local authority were likely to require a very significant interest rate advantage before it they proposed to borrow abroad. This was due to commission charges and other expenses that make borrowing abroad relatively expensive, while the transaction was administratively more complicated, and was far less convenient in terms of timing. Borrowing from the Central Government on the other hand was a straightforward matter, and drawings could be made from time to time as the need arised to fund overdraft facilities. No commission or other charges were levied, apart from a minimal rounding-up of the Government lending rate.
However, there were times when borrowing overseas was considered a relatively attractive proposition. For example, when the Government lending rate is high, the nationalised industries would prefer to borrow as short as possible. But Government loans are based on the principle that maturities should correspond broadly to the life of the physical asset being financed by the borrowing. Hence, Government loans to the industries are normally of very long maturity all loans to the gas and electricity industries are for 25 years. There might be occasions, therefore, when the industries would contemplate borrowing in foreign currencies, although the interest rate differential was not particularly attractive (or when it was adverse) so that they could take advantage of borrowing for a shorter period. The local authorities were less sensitive to these sort of pressures because their minimum period of borrowing from the Central Government was ten years. However, they also preferred to borrow shorter than this, when they regarded interest rates as relatively high.
In short the UK believed that, in most circumstances the relative interest-rate costs of borrowing abroad or from the Government (or in the case of local authorities from the domestic market) would be decisive. Furthermore that, the bodies concerned would bear in mind the additional charges and administrative inconvenience involved in borrowing abroad. However at times, the preference for borrowing short would override these interest-rate considerations.
This led to another major question from the British Government as to whether pressure could be placed on public sector bodies to borrow in foreign currencies? It was conceivable that even if the interest rate differential was reasonably favourable the relevant public sector bodies might refuse to consider borrowing abroad. In these circumstances there may be little the UK could do but rely on moral persuasion by the sponsoring Minister of the nationalised industry concerned; even this limited action would hardly be possible with a local authority.
The UK did however consider, two possibilities, again probably only relevant to nationalised industries. One would be to apply direct pressure through the UKs power of approval over the nationalised industries investment programmes. The UK did in fact go somewhere along this road in connection with the Air Corporations (BOAC) purchases of foreign aircraft. But in that case, Exchange control permission was needed for the transaction . A softer, and perhaps more acceptable approach, might be to offer suitable nationalised industries more flexible access to Government funds in return for their agreeing to raise a proportion of their borrowing requirement in foreign currencies. The high level of interest rates had led to pressure from one or two industries to be allowed to borrow short-term, either on the market or from the Government. Moreover, the UK accepted the recommendation of the Select Committee that the UK should review the terms and conditions of the industries borrowing powers to consider the proposals that some industries have made for greater flexibility. How far it would be possible in practice for the UK to offer a greater measure of flexibility in its lending terms provided this was matched by overseas borrowing is a matter that might be studied further as part of the review suggested by the Select Committee. Some objections can be seen at once. It would mean discriminating between those industries (and local authorities) who have power to borrow in foreign currencies and those who have no such powers, and for whom borrowing abroad is not a practicable possibility. Moreover, the UKs examination of the Select Committee proposals might lead it to the conclusion that the principles, which govern its lending policies, should be maintained more or less intact. On the whole, the UK were doubtful whether pressure could be suitably brought to bear in this way.
E. Problems of foreign currency borrowing for outward investment
In response to the structure of the UK balance of payments, the UK Government had encountered certain problems concerning foreign currency borrowing for outward investment. There had been some evidence that a surprisingly large proportion of inward portfolio investment was financed by Euro-dollar borrowing in UK banks. That when a UK bank, having borrowed Euro-dollars overseas, lends then to a UK direct investor instead of lending overseas, its net currency liability to foreigners increase instead of remaining in balance. The question remained whether this switching to a UK direct investor interfered with the potential switching of dollars to invest in UK local authorities. More information was needed about the way in which these borrowings took place.
Certain anomalies arose in August 1967 that were identified by the Bank of England, which complicated the procedure governing borrowing abroad for outward investment . The difficulty occurred on the interpretation of the term outward investment, which required different attitudes to be adopted to the repayment of foreign currency borrowing by an overseas subsidiary under UK guarantee and similar borrowing by a UK parent company for on-lending to an overseas subsidiary. In such conditions, while borrowing by an overseas subsidiary could be extinguished at any time from cash generated by the new investment, such funds were not to be used until after the end of the fifth year where a UK company was the original borrower. Companies considered that it was unreasonable that they were denied the right to use earnings from an investment which had been financed without costs to the reserves to repay borrowing at the earliest possible date. To take this a stage further:
(i.) Borrowing by a UK company to finance an investment which met the criterion of money back within three years, could be repaid within five years only with investment currency even though the borrowing would be self-liquidating over a rather shorter period. Thus if the UK company borrowed Euro-dollars short-term and on-lent them on identical terms to its subsidiary, it was precluded from meeting its contractual obligations, except with investment currency regardless of whether the investment paid-off or not. Furthermore, if all went well and the UK balance of payments benefited commensurately within the three-year criterion period, insistence on any repayment of borrowing before five years had elapsed being made in investment currency, effectively required a borrower to assist the reserves by bearing the cost of the borrower long after his investment had paid off. In other words, the quicker the return the greater the penalty.
(ii.) Similar difficulties occurs with non-criterion investments. The rule here was that borrowing taken by a UK parent shall provide for no repayment at all before the end of the fifth year, and subsequently of the official rate only to the extent that matching benefits had been received that is the borrowing must be appropriate. However, if the same borrowing was to be covered by a UK guarantee and provided the borrowing, had at the outset been deemed appropriate, not only could cash generated by the investment be used at any time to liquidate the borrowing, but official exchange would be available from the UK after five years to meet any earnings which necessitated the guarantee being called.
More generally, the practice described above seemed calculated only to encourage greater reliance on subsidiary borrowings than on parent company borrowings, even though category need entailed cost to the reserves. This seemed to make little sense; as UK companies making approved investments by borrowing abroad ought to be free to shop around with a view to obtaining loans on the most advantageous terms available without having to consider whether, for purely exchange control reasons, they or their subsidiaries should be the borrowers . Borrowing by parent companies tended to be cheaper. Also, five year borrowing was not readily available unless the creditworthiness of the borrower was beyond dispute. This militated against borrowing by newly formed subsidiaries, and while longer term borrowing of larger amounts and with no repayments for at least five years would be and usually was raised by a bond issue, by the parent company, there were few applications which fell in this category.
F. British Government Proposals
In response to the problems in essence, the Bank of England proposed that where an investment was self-liquidating in less than five years, then repayment could be made within the five year period from the earnings of the externally financed asset . The Bank of England represented the view that this would involve no costs to the UK. Also that, applicants should be free to borrow on the most advantageous terms available, either directly or indirectly through subsidiaries and that the repayment of any borrowing should be allowed, at any time from the earnings directly attributable to the investment.
However, the UK Government felt that the Bank of England were mistaken. Under arrangements where an investment could be repaid within five years was that, the UK reserves benefit by the retention in the UK of the repayment monies between the time when they are remitted to the UK and the end of the five year period to maturity. That to agree to the Banks proposed concession would involve the acceleration of repayment of external commercial borrowing which could start to disadvantage the reserves substantially.
Another disagreement involved the fact that the Bank argued that it was desirable for a UK group with overseas operations to borrow in the cheapest market. The interpretation of UK rules meant that, for exchange control reasons, the cheapest method was for finance to be raised by a subsidiary. The Bank argued that this is not necessarily to the advantage of the UK, especially since the UK parent may have had a name and prestige which enabled it to borrow on better terms than its subsidiary. This argument ignored the presentational problem in respect of the treatment of overseas borrowing by UK parents in the balance of payments statistics. Unless, this borrowing took place physically outside the UK or was in the form of a Euro-dollar bond issue in London then borrowing of this type (predominantly Euro-dollar borrowing) is shown as a credit below the line in monetary movements. However, the direct investment which was thereby financed shows as a debit above the line. That is, direct investment financed by this type of external capital contributes to the balance of payments deficit. However, the act of borrowing by a subsidiary does not show up in the UK balance of payments. The only item which showed is the repayment of this borrowing which, because of the working of Section 30, was in general made only from the extra profits generated by the fresh investment. Thus, when repayments are made by a subsidiary (and depending on the precise type of finance) this is comprehended in the balance of payments figures of retained profits. That is, the UKs stake in its overseas subsidiaries had increased when the external capital was paid-off. In the point of view of the immediate balance of payments presentation of borrowing and direct investment, it was clear that the borrowing should be made by the subsidiary.
Firms were encouraged to borrow abroad for investment overseas. This allowed overseas investment without damage to the UKs balance of payments, and without putting firms who were unable to borrow in this way to the cost of buying premium dollars. However, the borrowing for investment overseas had to be undertaken by the firm itself. This restricted the borrowing to large firms which had an international reputation. However, the firms which did have this standing were few compared with those who were not able to raise money in this way. Those thus excluded from borrowing overseas were not only small firms, but many large firms which did not have extensive international connections and consequent standing.
To overcome this difficulty, the UK Government suggested that merchant banks be allowed to borrow abroad as principals, provided that they themselves lent the money they raised in this way to UK firms for the purpose of investing overseas. In this way firms without an international reputation could, through the reputation and expertise of a merchant bank, or a consortium of merchant banks, raise abroad for their overseas investment.
The scheme had a number of attractions . First, it would greatly increase the extent to which it was possible to finance overseas investment by borrowing abroad.
Second, it meant that borrowing abroad would be done on more favourable terms than the firms who made use of the money borrowed by the merchant bank would themselves had been able to command. In other words, the interest paid in dollars would be lower than in each firm were able to raise its loan independently.
Thirdly, there would be some relief for the balance of payments, from two sources the money held by the merchant bank before it is on-lent, and the premium dollar pool. If a consortium of merchant banks raised money in this way on a fairly large scale, then they would come to hold a float of dollars not immediately needed, so that they would be in a position to meet sudden demands. These dollars would be deposited with the Bank of England, and the Bank of England would pay on them the interest which had to be met by the merchant banks. in this way, there would be no cost, or a negligible one, to the merchant banks who might therefore be induced to hold large sums in this way, to the benefit of the balance of payments.
If many firms made use of the possibilities of borrowing dollars from merchant banks for their investment overseas, then the pressure could therefore, if it wished, rather than allow the premium to fall enter the market to and buy dollars itself. The change would be necessary to allow this proposal to go ahead appears to be that of allowing merchant banks to borrow abroad as principles, where the money so obtained is to be lent to firms for their overseas investment. The merchant banks would only lend to firms having Bank of England permission to invest overseas.
G. Conclusion
The overseas capital markets
In a reply to a Parliamentary Question on Friday 14th February 1969, Lever stated that there would be advantage to the balance of payments if the nationalised industries were to cover a proportion of their borrowing requirement by borrowing in overseas capital markets outside the sterling area . That the government were making special arrangements designed to encourage the industries in this direction by relieving them of the exchange rate uncertainties associated with overseas borrowing.
Public corporations from a number of countries have successfully raised funds in the international capital markets (such as the French). Borrowing by UK nationalised industries was confined to medium and long-term loans, and would provide a significant and useful benefit to the UK balance of payments. It would not result in an increase in the amount of the UKs overseas indebtedness since the foreign currency proceeds will help to re-pay short-term debt.
The government recognised that the nationalised industries were deterred from undertaking this borrowing due to the exchange rate uncertainties. The government was therefore prepared to relieve the industries of these uncertainties. Under the arrangements, the government would undertake to supply foreign currency for servicing loans made by the industries in foreign markets at the same time as that ruling when the money was first borrowed. In return, the nationalised industries would pay a charge to the government. This meant that a large proportion of the nationalised industries capital needs would be able to be met by overseas borrowing. The total raised depended on market conditions. The funds would not be regarded as an additional source of finance, which allowed the industries to exceed their approved investment programme. The arrangements applied only to borrowing in currency of a country outside the sterling area. It did not apply to those inside the sterling area.
Financial problems of the London County Council (LCC)
The LCC were a typical example of a British local authority who needed finance and turned to the Euro-dollar market for support. The LCC were finding it increasingly difficult to raise the capital they needed. In addition to their ordinary commitments, there was rising expenditure on the Home Loan Scheme. Their borrowing requirements were over £100m per year. They had over £83m borrowed short-term, mostly at seven days notice. The were advised that they would not be able to raise more than £50m by a stock issue in the UK. it was thought that two loans could be raised, each of £10m, in either Euro-dollars or DMs, at a rate of interest (5¼% for loans of 15-20 years). However, they could only do so if they were able to pay interest gross of tax .
Such a concession would involve no loss to the revenue, because foreign investors were not subject to UK income tax. There was no risk of creating an undesirable precedent because other local authorities (during 1965) lacked powers to borrow abroad, and the LCCs powers would lapse at the end of March 1965 (to make way for the GLC). The LCC saw no alternative source of finance, and if they could solve their problems, the Home Loans Scheme would have to be abandoned. (As the London authorities were faced by special housing problems). The GLC would have to inherit the outstanding loan debt and commitments of both the LCC and Middlesex.
The notion of public authorities and nationalised industries borrowing overseas
On the 11th October 1967, the Bank of England stated that : there can be no doubt about the immediate benefit to the reserves, which would follow from such borrowings, whatever the longer term impact may be on the balance of payments. It is necessary to balance the shorter term needs against the longer term costs. Given the extent of the UKs short-term commitments, it is virtually important to seek to lengthen them wherever possible. The proposals now under review for longer term borrowing by British industry would be an important step in this direction.
The idea of allowing public authorities and the nationalised industries to borrow proved to be very beneficial to the industries themselves. One such beneficiary was the Gas Council, which borrowed overseas to finance its various types of development projects. Such an example was North Sea Gas, which was one of a number of specific projects, that was considered by the UK Government to be beneficial to the long-term balance of payments . Taking this into account, the Gas Council proved to be a good foreign borrower, because of their investments in North Sea Gas, with which the loans would be presentationally linked. This approach meant that, the loan was secured by some form of tangible and identifiable assets, which if necessary, an undertaking could be given, so that no prior charge on them would be incurred. Furthermore, loans secured against these kinds of specific assets also meant that, the UK was in a very strong position to argue that an elaborate form of Government guarantee was unnecessary.
The Bank of England felt that there was much to be said for going as far as one could in removing obstacles, which impede the freer flow of capital, and which makes it difficult for UK firms and nationalised industries to borrow abroad. That, by having removed the impediments to borrowing, the Bank of England felt that, as long as the private sector was concerned, the Bank of England should leave it to the market judgement of individual firms to decide where the balance of advantage lies in them. As the Bank of England did not think that it would be appropriate for HM Government to shoulder the exchange risk which borrowers would incur. Moreover, the Bank of England views foreign borrowing by the nationalised industries differently, as a form of Government borrowing for which it would be unreasonable for HM Government to cover the borrowers against losses arising from any movement in rates of exchange.
Levers proposal for the encouragement of borrowing in the Euro-dollar market to finance home investment, need not result in any net addition to the capital being attracted to the UK (for the total of borrowing abroad was a matter to be decided by the government), it should produce a small shift from short-term to medium or long-term borrowing. While short-term money could be withdrawn from the country very rapidly this was not possible with money borrowed with medium or long-term loans.
It was pointed out that a very high proportion of borrowing from abroad was by short-term loans. Shifting this to long-term would be a better terms of borrowing. As short-term loans were usually negotiated when funds were usually needed, and it was not often possible to bargain as effectively when negotiating long-term loans. Also, a shift would cause a reduction to which UKs interest rate policy was governed by the need to keep in the UK the large amount of shorter funds held in the UK.
The question to discuss was the amount of borrowing from abroad that it was desirable to undertake. Since the Labour Government had come to power in 1964, strong measures had been taken to correct the outflow of capital funds, and to put right the capital account of the balance of payments. On capital account, these measures had been very successful, and the UK was in the position, during the end of the 1960s, of being net importers of capital on the private account.
During the 1960s, the UK reserves were low, which made the UK vulnerable to withdrawal of funds at times for which, the UK could not control. So situation was so vulnerable that, the UK was in no position to refuse additions to its reserves. As the burden of debt on the UK was such that it was only realistic to expect that it would have to be lengthened in some way, that even the relatively small amounts of medium or long-term funds which might be attracted to the UK by Euro-dollar borrowing would be helpful. The suggestion that such borrowing would allow the government to avoid finding solutions for the current account problem which would be dismissed.
As the Euro-bond market was rapidly expanding, it seemed that the amount raised in the first six months of 1967, was about as large as the whole of 1966, when a Treasury person suggested that the market rested on the USA deficit and on the increase in dollar liabilities, it was pointed out that the beginning of the Euro-dollar market had been accompanied by the same scepticism, about its capacity to endure and expand. The Euro-bond market displayed a similar situation. This led to the belief that it might be a bigger mistake for the UK to refrain from participating in it, than it would have been to refrain the UK from developing the Euro-dollar market.
In response towards the growing Euro-dollar market and the Chancellors enquiries on the 17th October 1967, Harold Lever, the Bank of England and the Treasury were supporting such kinds of borrowings from the nationalised industries . However the discussion led to the way in which Euro-dollar loans would be undertaken by the nationalised industries issues involved: that payments of interest beyond the UK would require to be interest gross. As the French Nationalised industrys loans provided for payment of interest gross: the issue of roundabout.
On the 6th March 1968, the Ministry of Power wrote that legislation was needed to prevent the gas industry from exhausting its borrowing powers and being unable to meet its financial commitments. The Gas Council considered that this position would be reached at any one time (from August 1968) onwards. Powers were also necessary to strengthen the Gas Council. Under the Gas (Borrowing Powers) Act 1965, the limit to borrow was £1,200m. However, this was proving to be insufficient, which was the reason for the review of the Gas Borrowing Powers Order 1967, as the Gas Council provided the following estimates of their future borrowing requirements.
Estimate of future borrowing requirement from the Gas Council:
DATE £ STERLING (in Millions)
31 March 1967 817 (actual)
31 March 1968 1,080
31 March 1969 1,320
31 March 1970 1,550
31 March 1971 1,700
31 March 1972 1,800
31 March 1973 1,900
31 March 1974 2,000
The above figures were not considered to be unreasonable by the Ministry of Power. The increase in the limit to borrow was a considerable requirement to the industrys future development. The final limit was based in the estimates provided by the Gas Council figures (shown above) to a final limit of £2,250m. These figures received the provisional approval of the Treasury.
However, the exchange risk was the main problem concerning the issue of having the nationalised industries borrowing abroad. Ministers had decided in January 1969, that medium and long-term borrowing by nationalised industries in the international capital markets for a proportion of their borrowing needs would benefit the foreign exchange reserves, and should therefore be permitted and encouraged. It was recognised that in considering proposals for borrowing abroad, the industries will have regard not only to interest rates, but to the exchange risk, and that in certain circumstances the industries might not be willing to undertake the exchange risk even where there was a significant interest rate advantage in borrowing abroad. The chancellor therefore agreed that the government should in principle itself be willing to carry at any rate part of the exchange risk.
ENDNOTE
* Here are two very similar definitions of the term Euro-dollars:
Robert Gilpin, (The Political Economy of International Relations, Princetown University Press, 1987, p. 314-315), states that: The Euro-dollar market received its name from American dollars on deposit in European (especially in London) banks yet remaining outside the domestic monetary system, and the stringent control of national monetary authorities.
Enzig and Quinn (The Euro-dollar System: practice and theory of international interest rates, MacMillan Press, 6th edition, 1977, p. 1) state that: the Euro-dollar system is a term used to describe the market in dollar deposits and credits which exists outside the United States of America.
This paper is based on the following PRO files:
PRO T 295/410: Foreign currency borrowing by UK companies to finance overseas direct investment
(12/07/67-7/11/68). File Number: 2 FEC 38/28/01 PART A
PRO File T 319/949: Nationalised Industries Borrowing Abroad (08/11/68-21/02/69). File Number: 2PE 1/830/01 PART D
PRO T 319/803: Nationalised Industries Borrowing Abroad (09/10/67-05/07/68). File Number: 2PE 1/830/01 PART B
PRO T 326 series: (PRO FILES: T 326 816, T 326 817, T 326 455, T 326 678, T 326 819, T 326 822). Borrowing abroad by local authorities and nationalised industries, (January 1964 December 1969). File Number: 2-FH 3/116/03 Part A-N |
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