e ar
MINISTRY OF DEFENCE BUDGET
I do not accept your interpretation of the events which led to the present
impasse between the MOD and the Treasury. I reject entirely the
accusation that the MOD has lost control of its budget. The issue is
rather whether the control framework put in place by the Treasury in
Spending Review 2002 was adequate. You are seeking to reopen the
SR 2002 settlement. Had I known in July 2002 that the Defence Budget
would be constrained as is now proposed, I would not have accepted the
settlement. I have agreed that my Accounting Officer should take
immediate action to reduce near-cash resource and capital consumption
by up to £500M in the current year but, in view of the military, industrial
and political implications of going further, I have directed him not to
impose a moratorium on all uncommitted expenditure pending further
discussion involving the Prime Minister. I do not accept the need to ask
external advisers to look at the MOD's financial control arrangements.
The Rt Hon Paul Boateng MP
Chief Secretary to the Treasury
DECEASSIFIED

2.
I accept that it was most unwelcome to learn that the full extent of the
resources transferred from non-cash into cash in the current year is £1.1 billion,
which represents a £500M increase from the movement identified in the Spring.
The difference arose because Main Estimates are prepared before the end of
the MOD's annual planning cycle and movement continued over the intervening
period. The control totals issued to Top Level Budget holders thereafter made
no distinction between different categories of Resource DEL precisely because
no such distinction was drawn in the Treasury DEL controls contained in your
letter of 10 July giving the details of the MOD's SR 02 Settlement. The
Defence Management Board did, however, issue a control framework ring-
fencing certain categories of event, such as changes in assumptions about
asset lives. So the issue is not one of a failure to control the Top Level Budget
Holders expenditure, it is rather one of defining the controls to which the MOD
was expected to operate.
3.
You are requiring me to implement a cash control at the cash spending
levels set out in Annex E of the SR 02 settlement letter and to carry out the
MOD's next planning round on the basis that these cash controls apply in
addition to the resource and capital DEL limits. I simply cannot accept this
without the opportunity to discuss the consequences for our defence capability
and the political and industrial impact with the Prime Minister. The first
sentence of Annex E to the settlement letter makes clear that the purpose of
translating the DEL controls (on Resource DEL, including depreciation and
capital charge costs, and Capital DEL) into the estimated cash consequences
of plans was to
"allow a reconciliation back to previous plans, and for use in
PERSONAL
DECLASSIFIED

treasury alacree importance, At no time nave they
received clear guidance. They have also worked to find a compromise on the
types of movement which would be allowable - to no avail. And yet it was not
until the end of August that you raised the issue with me formally in writing.
4. Nonetheless, plainly cash is vitally important and our officials need to
conclude their work on how best to reflect this in the control framework. But to
impose retrospectively the regime set out in your letter is excessive and
unrealistic. My Accounting Officer has advised me that in order to comply with
the Chancellor's demand that the MOD reduces its cash expenditure by £1.1
billion this year, he would have to impose an immediate moratorium on
uncommitted expenditure. I have explained in my minute to the Prime Minister
why I believe that it would be wrong and dangerous for the Government to take
such drastic measures. My Accounting Officer has advised me that we should
implement measures to reduce near-cash consumption by up to £500M in-year.
This seems to me to be both reasonable and realistic, although the
consequences for the Government's defence priorities will be painful.
However, I have directed him not to go further until the Prime Minister has had
the chance to consider the implications of doing so. We will not be able to
disguise from Parliament that the MOD is underspending on its Resource DEL
while at the same time making damaging cuts.
Similarly, I feel strongly that to insist on an externally led review of the
MOD's financial control arrangements is misconceived. The issue is not the
visibility of expenditure by the Top Level Budget Holders to the MOD Centre,
but the fact that no controls were placed on cash or on near-cash and no
DECLASSIFIED

6.
We made plain throughout the SR 02 negotiations that we needed more
resources just to keep the Armed Forces going on a day-to-day basis. The cost
pressures amounted to £770M in 2002/3, of which the MOD absorbed £270M
and was granted an injection of £500M from the Reserve for which I was
grateful. But this did not make the pressures go away and MOD officials have
given yours a paper describing the continuing pressures on our budget caused
by the fact that in real terms, once the earmarked elements are removed, the
SR 02 settlement involved a reduction in resources across defence. If Gordon
and you want the MOD's efficiency programme to be refocused on input costs,
I will be content to discuss this in the context of the SR 04 negotiations, but
I reject the implication that the MOD's problems are all of its own making and if
only it was more efficient the problems would disappear. The existing output
focussed efficiency regime was agreed with you in SR 02 and the MOD has
been transparent in the way it has implemented it. Indeed, Treasury officials sit
on the most significant steering boards.
7. You also require greater Treasury visibility of the MOD's Short Term
Plan and Equipment Plan. I agree that there should be good transparency
between the MOD and the Treasury, although this is a two way process. Your
officials were unwilling to set out in detail the fiscal impact of decreasing levels
of pain for Defence in closing the gap between us. With greater Treasury
involvement in the day to day decisions of the MOD would come greater
Treasury responsibility, something which your predecessors have preferred to
leave with the MOD. That said, I welcome the fact that the Treasury wants to
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about how defence works. The net additional military costs are only one
element, and a relatively small element, of what goes into creating the military
capability deployed in Iraq. Cuts in the core equipment, logistics and training
programmes will inevitably affect operations in Iraq. The only question is how
quickly. The effect on morale will be more or less immediate.
9.
I am copying this letter to the Prime Minister and the Chancellor of the
Exchequer and to Sir Andrew Turnbull.
was purcereby.
GEOFFREY HOON
DECLAS®IFIED