Foreign office minister Peter Hain published a letter to PAC chairman Edward Leigh warning him of the liability, which, in 1997, was estimated at £40m, increasing £2m every quarter since then, and now stands at more than £77m.

He said the EC has now opened investigations into the scheme, which Britain believes may be discriminatory against Spanish workers and therefore illegal under EU law.

Hain told Leigh the government has been 'in touch' with the government of Gibraltar warning it that it would have to pay any liability arising out of its household cost allowance and elderly persons allowance.

But he admitted to Leigh that if Gibraltar 'were unable or unwilling to pay, the UK would face a contingent liability as a result of its Treaty obligations' and be exposed to the possibility of fines and the risk of having to pay damages to affected individuals.

Hain, however, did not reveal anything he could do in his own capacity as minister to avert the liability and compel Gibraltar to obey EU law.

He said only that the UK would 'continue to remind the Gibraltar that any liability arising in this case will fall to them and that they need to remodel or replace HCA, or other arrangements, which may be discriminatory under EC law'.

Hain also published a letter to Gibraltar chief minister Peter Caruana insisting any liability must be met in full by the government of Gibraltar from its own resources and urging reform of the schemes.