UK Ministry of Defence told it faces difficult decisions to meet its spending plan

National Audit Office says inflation and the global energy crisis will add billions to its bill

As HMS Glasgow was launched this week, the UK announced that it has axed plans for new Type 32 frigates. PA

Britain's Ministry of Defence (MoD) has been warned that inflation and the global energy crisis are likely to hit its defence budget hard.

In a report by the National Audit Office (NAO), the MoD was told that it will have to make "difficult decisions" in order to meet its budget.

The NAO has been assessing the affordability of the MoD's equipment plan, which sets out its spending on equipment procurement and support projects for the next 10 years.

The latest plan covers the period from 2022 to 2032 and outlines how the MoD will spend £242 billion ($295.5 billion) on equipment over the next 10 years and make efficiency savings of £13.5 billion.

However, the NAO says it is being optimistic and that it has not accounted for the Ukraine war, the current energy crisis or inflation and predicts a £3 billion overspend.

"The [defence] department has assessed that the plan is affordable over the period 2022–2032. This is based on financial data from March 2022 and reflects ongoing improvements to its affordability assessment," the report says.

"However, its assessment continues to be based on optimistic assumptions that it will achieve all planned savings. It will also take some important decisions that affect the plan’s costs in the next financial planning round. While the plan continues to serve a useful purpose in reporting to parliament on planned expenditure, the volatile external environment means this year’s plan is already out of date.

"The department faces significant and growing cost pressures which will have an immediate impact on its spending plans. The department believes it can manage these pressures but has left itself limited flexibility to absorb any cost increases on equipment projects, or across other budgets.

"It needs to address the financial challenges promptly to avoid falling back into old habits of short-term cost management, which do not support longer-term value for money. The cost pressures are also likely to undermine the pace at which it can modernise the Armed Forces. The department will need to make difficult prioritisation decisions to live within its means and retain enough flexibility in its plan to respond promptly to changing threats.

"Our assessment shows that the department faces significant pressures to keep the plan affordable, which affect its ability to deliver equipment projects as planned."

According to the spending watchdog, the MoD has not accounted for external cost issues.

"The department has not reflected the impact of growing external cost pressures, such as inflation and the Ukraine conflict, on the plan’s affordability," it said.

"Rising inflation, higher utility costs and adverse exchange rate movements will affect the plan’s affordability. The department seeks to manage these risks using a range of measures, such as forward purchasing foreign currency and using firm-price contracts.

"However, it has not reflected inflationary cost pressures in the plan’s affordability as its assessment is based on financial data at March 31, 2022 and it did not fully understand the impacts at that point.

"The rapidly changing economic environment means that the affordability position reported by the department is out of date, despite it publishing the plan earlier than in previous years."

The report reveals that the Royal Navy withdrew plans to fund Type 32 frigates and multirole support ships in July due to funding issues.

Former prime minister Boris Johnson announced the funding of Type 32 frigates in 2020.

The spending warning comes after the launch this week of HMS Glasgow, the first of the Royal Navy’s new Type 31 frigates.

An order for 13 of these frigates is currently being processed at Scottish shipyards.