What alternative approaches could be considered to inflation risk and interest rate risk management, taking into consideration trade offs between budgetary certainty and operational flexibility? 

SFT is clear that inflation linking of unitary charges should follow the "natural hedge" with the indexing proportion matching indexing costs to the provider. Over indexing of unitary charges and the use of inflation swaps or index linked financing has left public bodies with significant budgetary pressures at a time of relatively high inflation and reducing budgets, though it remains to be seen how these payment profiles will appear over the longer term. A prudent approach to managing long-term obligations to pay is to have a low proportion indexing such that the real payment decreases over time. As such, the use of embedded inflation derivatives will not be permitted in the NPD programme. 

At a central level, it is arguable that some form of long-term inflation linked investment opportunity is a good match for the liabilities in pension funds in particular. It could be a good investment for the central authorities, with a greater ability to manage budget implications over time, to offer. A large scale investment opportunity could be used kick-start a CPI linked market as opposed to the wider spread RPI link.

More broadly, individual public bodies as procurers are not well placed to deal with the budgetary uncertainty of floating interest rates. Central government which, as discussed in Q13 takes interest rate risk regularly may wish to consider centrally the cost / certainty tradeoffs implied. This is particularly the case in respect of long-term financing and flexibility requirements where the cost of breaking long term swap instruments in the event of the need for significant change is a major factor. In Scotland, a central top-slice of revenue budgets is used to pay the element of asset-availability charges that relate to the creation of the asset thereby separating these cost elements in respect of infrastructure investment from the ongoing operational costs of different departments / bodies. Such a budget structure allows a clearer centralised consideration of hedging arrangements.