Performance-related pay will be imposed on colleges following Chancellor Kenneth Clarke's Autumn Statement next week.
Ministers are expected to seek a two-phase introduction, starting with senior staff this year and extending to all lecturers next year.
With a restatement of last year's public pay policy expected, any salary increases will have to be self-funding through efficiency gains or staff cuts. Colleges already face a wave of redundancies due to deficits of up to Pounds 1 million.
Many which failed to reach their growth targets last year say they may serve protective notices in order to lay off staff at short notice after their annual accounts are published at the end of this month.
They will find no relief in the autumn budget. Sources close to the Department for Education say any cash available is likely to be below inflation.
"It will be a very tight pay round and will depend very much on productivity gains colleges feel they can make," said the source. Education Secretary Gillian Shephard, in a letter to colleges, will stress that a failure by any institution to observe the pay guidelines may have an adverse effect on grant monies for the Further Education Funding Council in 1996-97. In other words, if anyone errs, everyone will be penalised.
The Government also plans to put the screws on colleges, with a new 2 per cent holdback mechanism linked to PRP and new contracts of employment. They will lose up to Pounds 50 million of their budgets if they fail to introduce more flexible contracts for new starters and promoted lecturers, or acceptable PRP schemes.
Ministers are known to be angry over colleges' failure to push through the "more flexible contracts" in place of the old local education authority conditions spelled out in the Silver Book.
The budget holdback and associated penalties will be tougher, to prevent individual colleges breaking rank.
Ministers want the two-year dispute over contracts ended before they enter election year.
Last year, a few colleges, most notably Manchester College of Arts and Technology, ruffled the majority by doing a deal on new contracts with the National Association of Teachers in Further and Higher Education. Ministers hope that tougher sanctions will prevent this happening again.
Roger Ward, the chief executive of the Colleges' Employers' Forum, said that with colleges being put under pressure to make redundancies, "whatever is in the Chancellor's Autumn Statement, it is unlikely to ease matters. Redundancies and contracts are not linked in any formal sense but the spectre of redundancy is very real. It will make people think."
A CEF survey recently suggested that most lecturers would be on new-style contracts by January, 1995. NATFHE, however, disputes this, and few colleges have yet played the redundancy card as a threat.