PFI
Critics of PFI have long argued that it is both expensive and inflexible as a contracting arrangement, a fact that the Secretary of State for Health, Jeremy Hunt, recently seemed to recognise when he stated in Parliament that “many of the hospitals now facing huge deficits are seeing their situation made infinitely worse by PFI debt.”
In relation to value for money the Public Accounts Committee have stated that:
Critics of PFI have long argued that it is both expensive and inflexible as a contracting arrangement, a fact that the Secretary of State for Health, Jeremy Hunt, recently seemed to recognise when he stated in Parliament that “many of the hospitals now facing huge deficits are seeing their situation made infinitely worse by PFI debt.”
In relation to value for money the Public Accounts Committee have stated that:
the Department of Health should support evaluation of alternative financing or operating options for costly private finance initiative schemes where there is a clear opportunity for improving value for money. [1]
So, with an estimated 20% of all PFI projects having a contractual right to voluntarily terminate the arrangement and replace an average cost of capital of 9% with government borrowing of 3.5%, why aren’t more public sector bodies doing it?
The short answer is, of course, availability of capital. To terminate a PFI contract the public sector needs to have available funds to pay the compensation involved.
Compensation for voluntary termination on PFI projects broadly falls into two categories: those that have a predetermined compensation sum, and those that calculate the compensation based upon the future profits of the private sector as determined by the market. On many of the contracts that have voluntary termination rights, particularly those with a predetermined termination sum, the value for money argument to terminate is compelling.
The Deficit
The deficit is defined as the gap between what we spend and what we raise in taxes [2]. In other words the current budget deficit, or surplus, is the difference between what the government spends and what it receives.
With the government pledging to return the current budget to a surplus in the current Parliament, anything that reduces the amount we spend on PFI projects would clearly count towards lowering the deficit.
If terminating a PFI contract both delivers value for money and aids deficit reduction, both of which form cornerstones of this government’s manifesto, then why isn’t HM Treasury falling over itself to raise the capital to fund this compensation?
Borrowing
The thing is, when most politicians and commentators talk about the deficit, they are not actually talking about the budget deficit; most are actually referring to government borrowing [3]. Borrowing and deficit are not the same thing. The two are linked, of course, as one covers the other, but the government doesn't just borrow money to fund the deficit. It also borrows to invest.
The current budget covers everyday expenses - welfare payments, departmental costs, etc. But the government also makes investments, such as on infrastructure projects, that are not included. If the government is running a deficit, it may make investments on top of this, and will therefore need to borrow to cover both.
But if the government has borrowed the money for these infrastructure assets anyway, why would paying off one set of bankers and investors who loan them the money at 9%, and replacing it with government money at 3.5%, increase government borrowing?
This is because, for many PFI projects, the Treasury maintain that the contracts are ‘off balance sheet’ for central government and government departments, even though most are recognised as ‘on balance sheet’ for all of the public sector bodies that use International Financial Reporting Standards (IFRS) to produce their accounts.
Treasury data suggests that liabilities that are recorded as ‘on balance sheet’ in the Whole Government Accounts (WGA) (using IFRS) may relate to around 97 per cent of all PFI assets, by capital value. The total capital liabilities in the WGA arising from Private Finance Initiative contracts were £37 billion in 2014. Only £5 billion of these were on the public sector balance sheet in the National Accounts [4].
So if all investment undertaken through PFI had been undertaken through conventional debt finance, Public Sector Debt would be around 2.0 per cent of GDP higher than currently measured.
What needs to happen?
At the moment there is a clear case for voluntary termination of certain PFI contracts to reduce the budget deficit and lead to a demonstrable increase in value for money for the public sector. Yet the ability of the public sector to utilise their contractual right to terminate is being constrained by a desire to maintain the PFI debt ‘off balance sheet’, even when it is already on balance sheet for the vast majority of the public sector bodies that are running at a deficit, i.e. NHS Trusts and Local Authorities.
Within the parliamentary paper on “Accounting and Budgetary Incentives” [5] it was recognised that past behaviours had been influenced by the desire to retain PFI projects off balance sheet. However, conclusions drawn within that paper demonstrate that:
The short answer is, of course, availability of capital. To terminate a PFI contract the public sector needs to have available funds to pay the compensation involved.
Compensation for voluntary termination on PFI projects broadly falls into two categories: those that have a predetermined compensation sum, and those that calculate the compensation based upon the future profits of the private sector as determined by the market. On many of the contracts that have voluntary termination rights, particularly those with a predetermined termination sum, the value for money argument to terminate is compelling.
The Deficit
The deficit is defined as the gap between what we spend and what we raise in taxes [2]. In other words the current budget deficit, or surplus, is the difference between what the government spends and what it receives.
With the government pledging to return the current budget to a surplus in the current Parliament, anything that reduces the amount we spend on PFI projects would clearly count towards lowering the deficit.
If terminating a PFI contract both delivers value for money and aids deficit reduction, both of which form cornerstones of this government’s manifesto, then why isn’t HM Treasury falling over itself to raise the capital to fund this compensation?
Borrowing
The thing is, when most politicians and commentators talk about the deficit, they are not actually talking about the budget deficit; most are actually referring to government borrowing [3]. Borrowing and deficit are not the same thing. The two are linked, of course, as one covers the other, but the government doesn't just borrow money to fund the deficit. It also borrows to invest.
The current budget covers everyday expenses - welfare payments, departmental costs, etc. But the government also makes investments, such as on infrastructure projects, that are not included. If the government is running a deficit, it may make investments on top of this, and will therefore need to borrow to cover both.
But if the government has borrowed the money for these infrastructure assets anyway, why would paying off one set of bankers and investors who loan them the money at 9%, and replacing it with government money at 3.5%, increase government borrowing?
This is because, for many PFI projects, the Treasury maintain that the contracts are ‘off balance sheet’ for central government and government departments, even though most are recognised as ‘on balance sheet’ for all of the public sector bodies that use International Financial Reporting Standards (IFRS) to produce their accounts.
Treasury data suggests that liabilities that are recorded as ‘on balance sheet’ in the Whole Government Accounts (WGA) (using IFRS) may relate to around 97 per cent of all PFI assets, by capital value. The total capital liabilities in the WGA arising from Private Finance Initiative contracts were £37 billion in 2014. Only £5 billion of these were on the public sector balance sheet in the National Accounts [4].
So if all investment undertaken through PFI had been undertaken through conventional debt finance, Public Sector Debt would be around 2.0 per cent of GDP higher than currently measured.
What needs to happen?
At the moment there is a clear case for voluntary termination of certain PFI contracts to reduce the budget deficit and lead to a demonstrable increase in value for money for the public sector. Yet the ability of the public sector to utilise their contractual right to terminate is being constrained by a desire to maintain the PFI debt ‘off balance sheet’, even when it is already on balance sheet for the vast majority of the public sector bodies that are running at a deficit, i.e. NHS Trusts and Local Authorities.
Within the parliamentary paper on “Accounting and Budgetary Incentives” [5] it was recognised that past behaviours had been influenced by the desire to retain PFI projects off balance sheet. However, conclusions drawn within that paper demonstrate that:
The decision as to whether to proceed with a PFI deal should be based on rigorous qualitative and quantitative value for money evaluation of all the procurement options available. Balance sheet treatment should not be a part of this evaluation.
Clearly this test should not only apply at the procurement stage of a PFI project, but throughout its life. In other words, the decision by the public sector on whether or not to exercise their rights to terminate a PFI contract should also be taken on the basis of value for money. Balance sheet treatment should not form part of this evaluation.
In his Mansion House speech tonight, the Chancellor said:
In his Mansion House speech tonight, the Chancellor said:
We have a budget deficit that remains, at just shy of 5% of national income, one of the highest in the developed world.
Our national debt stands at over 80% of GDP. [6]
The funding of PFI termination payments would decrease one and increase the other. But let us not forget that the former is real, while the other is an accounting technicality. PFI debt is a real liability and has to be repaid, whether we like it or not.
The danger is that, in seeking to minimise a notional debt figure, there may be even more reticence to allow the termination of expensive and poor value for money PFI contracts. Such reticence hinders the Chancellor’s stated aim of reducing the deficit with the added longer term consequences for real national debt. Common sense needs to prevail.
Where value for money can be demonstrated, central government capital should be deployed to allow voluntary termination to occur. Balance sheet treatment worries should be consigned to the rubbish heap of political and economic red herrings, where they belong.
[1] House of Commons Committee of Public Accounts Financial sustainability of NHS bodies Thirty–fifth Report of Session 2014–15
[2] "2010 to 2015 government policy: deficit reduction” HM Treasury
[3] "UK debt and deficit: All you need to know" BBC News
[4] Office for Budget Responsibility Fiscal sustainability report 2014
[5] "Accounting and budgetary incentives: Treatment of PFI debt in the national accounts" Treasury Select Committee
[6] Mansion House 2015: Speech by the Chancellor of the Exchequer
The danger is that, in seeking to minimise a notional debt figure, there may be even more reticence to allow the termination of expensive and poor value for money PFI contracts. Such reticence hinders the Chancellor’s stated aim of reducing the deficit with the added longer term consequences for real national debt. Common sense needs to prevail.
Where value for money can be demonstrated, central government capital should be deployed to allow voluntary termination to occur. Balance sheet treatment worries should be consigned to the rubbish heap of political and economic red herrings, where they belong.
[1] House of Commons Committee of Public Accounts Financial sustainability of NHS bodies Thirty–fifth Report of Session 2014–15
[2] "2010 to 2015 government policy: deficit reduction” HM Treasury
[3] "UK debt and deficit: All you need to know" BBC News
[4] Office for Budget Responsibility Fiscal sustainability report 2014
[5] "Accounting and budgetary incentives: Treatment of PFI debt in the national accounts" Treasury Select Committee
[6] Mansion House 2015: Speech by the Chancellor of the Exchequer
RSS Feed