Howard Flight MP, Deputy Chairman of the Conservative Party, and the party’s Shadow Chief Secretary at the Treasury, has endorsed a new study of the Private Finance Initiative (PFI) published recently by the Centre for Policy Studies. As a banker himself and currently joint chairman of Investec Asset Management based in the City of London, Mr. Flight has written an introduction to a CPS survey of what originated as an initiative of Kenneth Clarke’s when he was Chancellor of the Exchequer in the 1990s. Since that time PFI has been adopted with enthusiasm by the present Government, notably by Gordon Brown at the Treasury.

The study, prepared by Philippa Roe, a director at one of the leading investment banks, assisted by Alistair Craig, a chartered tax adviser and CPS research fellow, raises the key question of whether PFI deals should be ‘on’ or ‘off’ balance sheet, the latter meaning that the money thus secured is not counted as government expenditure on public services.

More precisely, the quantum of debt incurred in funding PFI deals ruled off-balance sheet is not included in the tally of government borrowing to finance public expenditure. Thus it does not count in the ratio of debt to gross domestic product (GDP) laid down as a regulator by the European Union. This is one of the important convergence criteria established by the Maastricht Treaty, which holds that as a general rule the ratio of government debt to GDP should not exceed 60 per cent. This requirement has been consistently met by the United Kingdom since the treaty was brought into force, but keeping a proportion of PFI expenditure off-balance sheet and so not counted against GDP gives the Treasury a wider margin in management of its debt operations.

On this issue, Mr. Flight says that the size of the liability contracted by public authorities entering into PFI deals is shrouded in unacceptable obscurity. “There is a clear argument for a thoroughgoing reform of the relevant accounting rules or for an independent body such as the Institute of Chartered Accountants determining for all PFIs whether, under current accounting principles, they should be on or off balance sheet.

He adds: “There is also complete obscurity as to the total risk adjusted quantum of government off-balance sheet liabilities, covering not just the Private Finance Initiative and Public Private Partnerships, but structures such as Network Rail with Strategic Rail Authority (SRA) guarantees, and many other government contingent liabilities.

“While all the data is published, there is no measurement of the risk adjusted quantum. In both the public and private sectors there is a sound case for requiring the total risk adjusted quantum for all forms of off-balance sheet and contingent liabilities to be assessed and disclosed each year.” In short, what is the scale of the liability on the public services undisclosed in the government accounts?

Mr. Flight agrees with the authors of the study that the Public Sector Comparator element of the procedure has become a discredited and expensive justification for the private finance option, where in fact alternative sources of funding would not in any case be available. In the light of experience, he suggests benchmarking as a sensible alternative for controlling PFI activities.

£100 billion claim denounced as bogus

But Mr. Flight drew an angry response from the Chancellor of the Exchequer when he challenged Mr. Brown in the House of Commons to disclose the precise extent of the Government’s long-term off-balance sheet liabilities in respect of PFI. An answer given by the Treasury spokesman in the House of Lords had previously asserted that 57 per cent of PFI projects by value were on the Government balance sheet.

Mr. Flight asked what account the Chancellor had taken of £100 billion of off-balance sheet liabilities, representing the present value of total PFI payments for the next 30 years and the guarantees given on behalf of Network Rail and London & Continental [CTRL and other railway capital expenditure]. Mr. Brown retorted that the figure of £100 billion was totally bogus and completely wrong. He insisted that 57 per cent of PFI projects are on balance sheet, not off balance sheet, and accused Mr. Flight of trying to count every PFI commitment from now to 2030.

The authors of the CPS study commented: “Neither the Chancellor nor his advisers would seem to have read a House of Commons research paper which stated [October 2003]:

The PFI has meant that more capital projects have been undertaken for a given level of public expenditure, and public service capital projects have been brought on stream earlier…..The increased level of activity must be paid for by higher public expenditure in the future, as the stream of payments to the public sector grows. PFI projects signed to date have committed the Government to a stream of revenue payments to private sector contractors between 2003/04 and 2028/29 of over £110 billion.

From this Philippa Roe and Alistair Craig deduce that in assessing how much of the Government’s total liabilities under PFI are off-balance sheet (hence not included in overall government debt), account should be taken of the long-term nature of PFI transactions. In some cases, these extend for up to 60 years, whereas the current government employs an arbitrary cut-off date of 25 years when asked about the nature of its PFI liabilities.

“Another way”, they allege, “in which the Government has obscured the true extent of off-balance sheet liabilities is its reference to the current value of each project. This is not a true measure of how much the government is liable to pay to private sector contractors over the period of each PFI deal, as it fails to take into account all the service elements which the Government pays over the life of the contract.

“In reality, the aggregate figure for payments to be made under PFI contracts, ignoring the 25 year cut-off date, is likely to be in excess of £130 billion (the figure is £124 billion at the 25 year point). However, this figure is not discounted to present day values. A discounted figure is likely to give a present day value of around £75 million, depending on the discount rate agreed.

Risk transfer the deciding factor

“In assessing the extent of total off-balance sheet financing (i.e. not just PFI liabilities), certain adjustments have to be made to this figure of approximately £75 billion. Strategic Rail Authority guarantees given in respect of Network Rail and London & Continental need to be added, as well as sundry other defence and education sector sub-contract arrangements which do not fall within PFI. On balance sheet PFIs and PPPs (principally the Tube Public Private Partnership) need to be excluded from the calculation (approximately £20 billion).”

This way of looking at the remaining liabilities (after removing the 25-year cap), the CPS study asserts, continues to give a total off-balance sheet liability of around £100 billion.

The key factor, say the authors, in determining whether a PFI project should be on or off balance sheet should be the extent of the risk transferred from the public to the private sector. This rather than the convenience of central government, they argue, should be the true determinant of whether a project should follow the PFI procurement route. The CPS study though critical of the way PFI is being run at present is by no means opposed to it as a means of funding capital works and facilities for the public services. On the contrary, it proposes that PFI could be extended as part of a wider program of ‘outsourcing’ and sees the potential for real value for money and greater innovation as significant.

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