Defence chiefs reject claim spending has fallen below Nato target level

But the MoD branded the figure "wrong", pointing to official Nato statistics which put the UK's defence spending for 2016 at 2.21%.

A Ministry of Defence spokesman said: "These figures are wrong: Nato's own figures clearly show that the UK spends over 2% of its GDP on defence.

"Our defence budget is the biggest in Europe, the second largest in Nato, and it is growing each year as we invest £178 billion in new equipment and the UK steps up globally, with new ships, submarines and aircraft over the next decade."

Although the shortfall claimed by the IISS is small, it has the potential for political embarrassment, as the UK has repeatedly urged other Nato members to meet the 2% target.

Prime Minister Theresa May trumpeted the UK's record of hitting the 2% figure during her recent visit to Washington to meet US President Donald Trump, who has complained of European Nato members failing to pay their fair share for collective defence arrangements.

The 1.98% figure was contained in the IISS annual Military Balance report, unveiled a day before a meeting of Nato defence ministers - including the UK's Sir Michael Fallon - in Brussels.

Launching the report, IISS director general John Chipman said: "In 2016, only two European Nato states - Greece and Estonia - met the aim to spend 2% of their GDP on defence, down from four European states that met this measure in 2015.

"The UK dipped slightly below this at 1.98%, as its economy grew faster in 2016 than its defence spending.

"Nonetheless, the UK remained the only European state in the world's top five defence spenders in 2016.

"If all Nato European countries were in 2016 to have met this 2% of GDP target, their defence spending would have needed to rise by over 40%."

But the MoD said that it was for Nato to judge whether member states had met their defence investment pledge, and pointed to an official assessment released by the military alliance in July last year, in which the UK - on 2.21% - was one of five countries to meet the 2% figure in 2016, along with the US (3.61%), Greece (2.38%), Estonia (2.16%) and Poland (2%).

The MoD said the IISS calculation may have been affected by fluctuations in exchange rates, as the think tank presents spending figures in US dollars - which rose sharply against sterling in 2016 in the wake of the referendum vote for Brexit.

Britain was a driving force behind the agreement at Nato's 2014 summit in South Wales to convert what had previously been a recommended defence expenditure level of 2% into an obligation.

In its 2015 Strategic Defence and Security Review, the UK Government committed to meeting the threshold in future years.

But the IISS said Britain fell short by around £380 million (500 million US dollars) in 2016, out of a budget recorded as £39.8 billion by Nato and £36.9 billion by the United Nations.

The think tank said there was "no shared understanding" of what constitutes a nation's defence expenditure, pointing out that Nato's definition includes not only defence ministry budgets but also pensions, expenditure for peacekeeping and humanitarian operations, and research and development costs.

The calculation is further complicated by the fact that GDP and exchange rate data from different sources can produce "very different results, meaning that in some cases whether or not states hit the 2% target is "dependent on the data sources and definitions", said IISS researchers Lucie Beraud-Sudreau and Bastian Giegerich.

Where possible, the think tank attempts to approximate the Nato definition for expenditure, and uses International Monetary Fund figures for GDP and exchange rates, they said.

But they questioned the "increasingly prominent" role of the 2% figure in political debate over security, arguing that the real yardstick should be "how these tremendous sums of money concretely translate into cohesive defence capabilities across the Alliance" and insisting: "Ultimately, it is the output that matters."

President Trump's hints that US support for Nato could be conditional on European members meeting the 2% figure might be explained by the fact that he "seems to like things that can be quantified", suggested Ms Beraud-Sudreau and Dr Giegerich in a blog post.

Mr Trump's commitment to Nato was questioned during the presidential election after he described it as "obsolete". But Mrs May secured his assent during last month's visit to the idea that he was "100% behind" the military alliance.

In an interview with former minister Michael Gove for the Times before the PM's visit in January, the then president-elect said: "Countries aren't paying their fair share so we're supposed to protect countries. But a lot of these countries aren't paying what they're supposed to be paying, which I think is very unfair to the United States."

Shadow defence secretary Nia Griffith said the report had exposed a "complete and shocking failure" by the Government to meet its defence spending commitment.

"As the Defence Select Committee has shown, the MoD was already barely scraping over the 2% mark and had changed its accounting methods to give the illusion of keeping the commitment," said Ms Griffith.

"To be spending less than 2% of GDP on defence is utterly unacceptable, particularly in this time of immense global uncertainty.

"Labour is committed to spending at least 2% of our GDP on defence spending, as we consistently did when in government."

Dr Giegerich, IISS director of defence and military analysis, said he expected Britain's defence spending would continue to fall as a share of GDP.

"We have for 2016 the spending at £38.3 billion. In dollar terms at 52.5 billion US dollars. That equates to 1.98% of GDP," he told a London briefing.

"The obvious point here is that British GDP growth for 2016 was estimated to be 1.8% and defence spending therefore grew at a slower rate and hence you have that development.

"Now if you project forward, unless that situation changes this trend will be the direction of travel."

Ms Beraud-Sudreau, defence economics researcher, said: "Our assessment of the UK defence budget is based on what the Government reports to Nato and what the Government announces according to Nato."

Nato had calculated its final figures using World Bank or European Commission figures for GDP, rather than those supplied by the IMF, she said.

Dr Chipman said "real deployable capability" was more important than "point-scoring" targets on numbers.

"Our hope is that the debate within Nato tags more in that direction rather than sticks with point-scoring on particular percentages of GDP that is being spent on defence as a whole or even largely on capabilities," he said.