By Tash Shifrin
The Private Finance Initiative is lacking a vital component — private finance itself. Now ministers will lend money to fill the gap – but the move has only added to the complexity surrounding the PFI
These are strange times: the banks are going bust, but the NHS is running up a healthy surplus. Somewhere along the line, the financial crisis seems to have made things topsy-turvy.
And, in this looking-glass world, the government is all set to lend public money to Private Finance Initiative projects, to replace the eponymous – and previously crucial – private finance element.
The bail-out was prompted by one of the more ironic effects of the credit crunch: after a three-fold rise in the credit margin charged by the banks in 2008, private finance for PFI schemes has all but dried up.
Research published by International Financial Services London in February revealed that the number of PFI projects signed off last year had fallen to the lowest level since 1995. Now a number of projects are struggling to reach sign-off – including the M25 widening and Greater Manchester waste schemes – because of problems raising the private finance needed to close the deals.
On March 3, Chief Secretary to the Treasury Yvette Cooper announced government action ‘to ensure vital PFI infrastructure projects will go forward as planned despite current market conditions, so they can support jobs and the economy’.
The government was under pressure to act, after the Pre-Budget Report stressed the importance of stimulating the economy by bringing forward capital projects – a difficult feat with the main procurement model stalled by lack of finance.
But in Westminster-through-the-looking-glass, a strange role reversal took shape. While Cooper made it clear that the PFI – long opposed by the unions – would not be allowed to sink on Labour’s watch, her Conservative opposite number Philip Hammond declared it ‘ridiculous for the government to lend money to PFI contractors’.
Hammond – whose party invented the PFI – argues that the correct strategy for now would be to ‘restructure contracts as publicly financed procurement’. He claims Labour is wedded to the PFI to keep projects off balance sheet – something the Tories have pledged to change.
The Treasury’s head of PFI policy, Gordon McKechnie, told a PFI conference on March 3 that other options to get individual PFI schemes off the ground – including making larger public capital contributions and guaranteeing bank lending – were examined and rejected. ‘We came to the conclusion that we would not get there with a project-by-project approach. We needed something more sustained.’
He added: ‘We looked at starting projects again as conventional [public sector] procurement – but that would mean delays of a year or two years.’ This would ‘make no sense’ with the government promoting infrastructure development to lift the economy.
Instead, the Treasury will set up a ‘lending unit’, with a staff of around 15, including project financiers recruited from the banks. It will provide senior debt to PFI schemes that have been advertised in the Official Journal of the European Union.
McKechnie said he still wanted projects to apply first to the banks, including the European Investment Bank: ‘We hope and expect to be a minority lender.’ But he confirmed that the unit will provide up to 100% of debt funding if necessary.
He stressed that this was still the PFI, despite the limited role of private finance. The Treasury will lend money on similar commercial terms to the banks and carry out the same sort of due diligence and project monitoring work.
But the lending plan will be ‘both temporary and reversible’, he said. The Treasury aims to sell the debts on and withdraw as soon as market conditions allow. This is non-negotiable, he said. ‘These loans must be structured in a way that allows sale and exit.’
Gains made from selling the loans will flow back to the Treasury, ‘as would be the case for any other lender’, a spokesman says. Procuring authorities will not see any of the profits. Refinancing high-cost debt will be an option – but commercial contractors will scoop a share of gains from this.
The Treasury has not set out quite where it will find the sum of up to £2bn it estimates is needed over the next 13 months, although some will come from unspent Whitehall capital budgets. The rest will be raised by borrowing – pushing the already high public borrowing figures up another notch.
Experts are divided on the merits of the plan. Colin Talbot, professor of public policy and management at Manchester Business School, says it puts the government in the ‘ludicrous position’ of providing finance to private firms ‘who will use it to build things that they then rent back to the public sector’. The stated aim of the PFI – transferring risk from the public to the private sector – will ‘disappear’, he says.
John Tizard, director of the Centre for Public Service Partnerships at the University of Birmingham, says pumping public capital into the PFI had become ‘inevitable’. But he adds: ‘Even where there is some public capital, there is still a case to seek co-financing so there is still some private finance in the system.’
In any case, Tizard says: ‘The commercial disciplines of the PFI must be maintained.’
But Edinburgh University PFI expert Mark Hellowell calls it ‘a perverse solution designed to maintain the fiscal advantage of the PFI’. He says: ‘It would be more sensible to say the PFI is not functioning under current economic circumstances.’
Charging similar rates to the banks will land public bodies with ‘a higher than necessary cost of capital… no-one benefits’, Hellowell argues. And if the Treasury is going to provide the due diligence and other disciplines exercised by the banks, he asks: ‘Why not just do that anyway and abandon the PFI?’
The Treasury plan means the public sector will be a party to two sides of PFI deals, as a senior lender and the procuring body, although the Treasury says the creation of a special lending company will keep the two at arm’s length.
For Hellowell, such conflicts of interest are now ‘ten a penny’ and highlight the contradictions of government policy on the PFI. He points out that the government’s majority stake in the Royal Bank of Scotland – a provider of both debt finance and equity in some PFI schemes – means that the state can now own all three parties to a contract, something that ‘interferes with any economic rationale there might have been’ for the PFI.
Meanwhile, public authorities with capital projects in the pipeline are left to wonder what will happen next. One local authority finance manager told Public Finance she was relieved that finance for a project now in the planning stages might be easier to find, but feels the rapidly changing PFI landscape presents conundrums – and the guidance is not keeping up.
It is a good job her scheme had not gone far down the line before the Treasury made its move, she says. ‘But now I wonder, if I wait for another week, will there be another package?’
The Treasury says more detail will come in April’s Budget. But the impact of the convoluted scheme on infrastructure projects and on the public finances in the long term is harder to predict. And the topsy-turvy world might not right itself for some time.
