Below is the text of Mr Major’s written Parliamentary Answer on Investment on 5th April 1989.
Mr. Boswell To ask the Chancellor of the Exchequer if he will make a statement on the rate of return required on new investment in the nationalised industries and the discount rate used for appraising investment in other parts of the public sector.
Mr. Major The Government have reviewed the level and use of discount rates in the public sector. These were last reviewed in 1978. Since then the rate of return in the private sector has risen to around 11 per cent.
In the light of this, the Government have decided to raise the required rate of return for nationalised industries and public sector trading organisations from 5 per cent. to 8 per cent. in real terms before tax. The new required rate of return of 8 per cent. will be an important factor in setting new financial targets, but there will be no impact on pricing during the life of existing financial targets.
As at present, the choice of the discount rate to appraise individual projects is a matter for individual nationalised industries or trading bodies to decide in consultation with sponsor Departments and the Treasury. The Government’s main concern will continue to be that the industries’ approach should be compatible with achieving the required rate of return on the programme as a whole. In appraising whether or not new capital investment projects should be undertaken, proper attention will need to be paid to risk. The effect of full allowance for risk will often be implicitly equivalent to requiring a higher internal rate of return on riskier projects.
The Government have decided that the discount rate to be used in the non-trading part of the public sector should be based on the cost of capital for low-risk purposes in the private sector. In current conditions this indicates a rate not less than 6 per cent. in real terms. Risk will be analysed separately and projects (and options) which are more risky will be required to demonstrate correspondingly lower costs or higher benefits.
These proposals will ensure that the appraisal of public projects will be no less demanding in the non-trading sector than in the trading sector, both public and private. In particular, they will provide a comparable basis for the consideration of private participation in public sector activities by taking account of the full economic cost of the public sector option.