University finances will become much tighter over the next three years, with increased external income needed to offset a growing deficit on teaching and research. This is the message of the Higher Education Funding Council for England's Analysis of 1995 Strategic Plans and Financial Forecasts, sent to institutions this week. It says: "The recurrent position is tight and expected to deteriorate over the period" and warns: "The underlying financial strength of the sector reduces over the forecast period".

The main reason for these problems is the research and teaching deficit. The sector went into deficit, by Pounds 19 million, in 1994/95. Returns from institutions project a steady growth in this deficit, reaching Pounds 256 million by 1998/99. Surpluses from income-generating activities, including research contracts and money from the research councils, are growing steadily however. They are projected to grow from Pounds 177 million in 1994/95 to Pounds 0 million in 1998/99 - although HEFCE said that cost recovery on research contracts is too low.

The funding council said that the relationship between the two figures should not automatically be seen as a cross-subsidy - much depends on how institutions measure costs, with some putting almost all overheads under the teaching and research heading.

But the report clearly indicates that the sector will be struggling to break even in three years time,with a predicted net surplus for 1998/99 of only Pounds 14 million, or 0.15 per cent of total income. The years 1996/97 and 1997/98 will produce surpluses of Pounds 25 million and Pounds 22 million respectively, both less than one third of 1 per cent of income. This compares to Pounds 158 million in 1994/95 and a projected Pounds 66 million in the current academic year.

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And these predictions could be significantly affected if underlying assumptions change. Institutions built their own inflation projections into their predictions. If pay inflation rises by 1 per cent more than they anticipated, costs would rise by Pounds 140 million by 1998/99, while a similar increase in non-pay inflation would add Pounds 82 million. A finding that will concentrate minds on November 28's Budget is that an 0.5 per cent increase in the funding efficiency gain would cost Pounds 57 million.

Brian Fender, chief executive of HEFCE, said that it should not be assumed that any of the contingencies listed in the report would automatically plunge the system into trouble: "Advance projections give you the chance to anticipate. Institutions have responded often enough before to this kind of pressure."

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He pointed out that last year's National Audit Office report had shown a well-run system, capable of responding to financial pressures. Professor Fender said the strategic plan analysis would help institutions looking to increase their income.