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Facing a weakening economy, cuts to his main source of funding and a looming election, it is no wonder Scotland’s finance secretary John Swinney has billed his budget speech on Wednesday as a time for “tough choices”.

Mr Swinney’s political rivals will not feel much sympathy. The collapse in North Sea revenues from a battered oil sector would have been much more of a problem if Scotland was preparing to become independent on March 24, 2016 as his Scottish National party once hoped.

But even shielded by the UK’s fiscal embrace, Scotland’s economic challenges are formidable — and Mr Swinney’s options limited, economists say.

The Bank of Scotland’s Purchasing Managers’ Index released this week found Scottish private sector business activity contracting for the second time in three months, with companies citing oil sector woes for part of the decline.

Scotland is languishing well behind other areas of the UK, including England’s north-east and north-west, according to research house Capital Economics. “The economic recovery remains unbalanced across regions, and Scotland’s prospects are particularly poor,” it said.

Work on major infrastructure projects such as a new bridge across the Forth have shored up growth rates, even though much of the expenditure flowed to companies based outside Scotland, said economist John McLaren, of Glasgow university’s Business School.

“Once you strip out construction, it’s not doing very well at all,” he said.

Brian Ashcroft, of the University of Strathclyde’s Fraser of Allander Institute, a leading observer of the Scottish economy, said the impact of the oil price slump was spreading through the North Sea industry’s supply chain and wider service sector.

Hopes that the boost from low energy costs in the rest of the economy would outweigh the negative effect had been dashed as the energy industry trimmed jobs and spending in anticipation of a long downturn, he said.

The institute last month cut its forecast for Scottish GDP growth in 2015 to 1.9 per cent from the 2.5 per cent expected in June and Professor Ashcroft said Mr Swinney had few tools available to shore up activity in the near-term.

Cuts to the UK block grant, which accounts for the bulk of Scottish government spending, and the difficulty of raising revenues, meant the finance secretary had “very limited options”, he said.

Mr Swinney is likely to continue to borrow the maximum possible allowed under current fiscal rules, allowing about £300m a year in extra infrastructure spending. But he is not expected to use the new powers that are available to vary the Scottish rate of income tax from April 2016.

The finance secretary has promised to try to protect Scots from the impact of UK tax and welfare policies, which the Institute for Public Policy Research said this week would cost many of the poorest citizens hundreds of pounds a year.

The IPPR said reversing benefit cuts would cost about £500m per year by 2020 — a sum it said could be covered by raising the Scottish rate of income tax by 1p in the pound.

Last year, Mr Swinney displayed some redistributive zeal by unveiling a new land transactions tax that was much more progressive than the stamp duty it replaced.

But under the 2012 Scotland Act, he can only raise income tax uniformly on all income bands, a move that would put a higher burden on lower rate taxpayers and thus be almost politically impossible for an SNP touting its commitment to greater economic equality.

That means Mr Swinney will have little choice but to pass on what he says will be a 4.2 per cent cut in discretionary departmental expenditure limit funding from the UK between now and 2019-20.

He has already signalled he will defend spending on schools, hospitals and police, a trio of political priorities that reflect fierce criticism of the SNP’s record. That means budget pain is likely to be felt particularly by already stretched local authorities, whose financial flexibility has already been limited since 2007 by an SNP council tax freeze.

“Once you protect spending on the police, education and health, you’ve got to cut on local government,” said Professor McLaren.

Copyright The Financial Times Limited 2017. All rights reserved.

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