The Ministry of Defence has been warned by the Whitehall spending watchdog that any further cost-overruns on its equipment programme could jeopardise its future plans for the armed forces.
The National Audit Office said there was "systemic over-optimism" built in to the MoD's planning which ran the risk of leaving "capability gaps" in the years ahead.
The warning came as Defence Secretary Philip Hammond published a detailed equipment plan for the next 10 years which, he said, had finally eliminated a £79 billion "black hole" inherited from the former Labour government.
The £159 billion programme includes £35.8 billion for a new generation of nuclear-powered submarines, £18.5 billion for combat aircraft for the RAF and £17.4 billion for Royal Navy warships, including the Queen Elizabeth Class aircraft carriers. Within the plan there is £4.8 billion for contingencies as well as £8 billion of "unallocated" funding which the MoD said would be allocated to meet new equipment priorities as they emerged over the coming decade.
But while the NAO acknowledged that the MoD had taken "significant positive steps" to address the affordability of the equipment programme, it expressed concern that the contingency allocation was insufficient. It warned that if the MoD was forced to fall back on the unallocated funding to make up the shortfall, it would be unable to deliver in full the plans set out in the 2010 Strategic Defence and Security Review - known as Future Force 2020.
"There is systemic over-optimism inherent in the department's assumptions around the costing of risk and uncertainty at both project and portfolio levels, which may not be sufficiently mitigated by the contingency provision," the NAO said. "The £8 billion of unallocated budget does offer protection to the core programme. However, our review of departmental documents and interviews with departmental personnel suggest that the unallocated budget is essential to deliver the full intent behind Future Force 2020. Using this budget to protect the core programme would therefore result in capability gaps."
Margaret Hodge, the chairman of the Commons Public Accounts Committee, said they would be taking evidence from MoD officials in order to assess the robustness of the plan. "The Ministry's track record in forecasting accurately the cost of its largest projects hardly inspires confidence," she said. "Between 2000 and 2012, the cost of its 69 largest projects ballooned by £11 billion. Independent analysis in 2009 found that final project costs were typically 40% higher than the Ministry's initial forecasts. Given this past performance, I am dismayed that the Ministry is still taking an over-optimistic view to putting a price on risk and uncertainty."
Mr Hammond, however, insisted that the plan would ensure that Britain's armed forces remained among the most capable and best equipped anywhere in the world. "For the first time in a generation the armed forces will have a sustainable equipment plan," he said. "Step by step, we are clearing up years of mismanagement under the last government by ending the culture of over-promising and under-delivering that created a multibillion-pound black hole in the defence budget."
Labour said Mr Hammond could no longer claim to have "balanced the budget" at the MoD. "Philip Hammond has failed his own test. This supposed 'mission accomplished' moment is more like an 'unfinished business' moment," a spokesman said. "We do not have a full list of equipment that is accounted for. We do not know the financial baseline against which projections are made. This covers less than half of defence expenditure. Philip Hammond's credibility rests on future actions, not past triumphalism."
Meanwhile, David Cameron will honour his commitment to above-inflation rises in the defence budget after 2015, senior sources have indicated. Tensions have been growing in the Coalition as negotiations begin over how to save billions of pounds more in the 2015-16 spending review. Mr Hammond, who has already seen his budget slashed by 8% in real terms since 2010, is believed to be among ministers resisting further cuts.