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The dead PFI gag

Steve McKenziePA Consulting Group The Guardian
1 May 2009


Like Monty Python's famous dead parrot sketch, PFI appears to be on its way out. However, with so much political capital invested in it, will the government allow it to truly die?

Government attempts to keep the Private Finance Initiative (PFI) alive through the recession are reminiscent of the famous Monty Python sketch: the pet shop owner is adamant that there is life in the parrot yet, but the owner believes the absence of movement means rigor mortis has set in.
The credit crunch has led to PFI funding becoming scarce and more expensive, there are fewer lenders and they want higher returns.

However, the government has invested much political capital in PFI and, given the perilous position of state borrowing, would rather not substitute public for private finance. This implies that it will be reluctant to let PFI die without at least one further round of financial engineering.
If it is to survive, how is the public sector to demonstrate value for money and make it affordable, given the implications of higher cost of debt and/or increased risk?

PFI borrowing costs have to be reduced or more public money used. The PFI needs a steady supply of affordable private finance but the recession has cut that off, and the increased cost of private over public debt has been exacerbated. Getting costs down means reducing the risk taken by lenders (such as the public sector still paying if there are service failures or the number of users reduces). This undermines the principle that making the private sector manage and pay for taking more risk justifies not using cheaper public borrowing. New accounting rules also limit the opportunity to present public expenditure as private sector funded.

The options for the government then are to take more risk back in-house to find a blended acceptable overall cost or to provide public funding – potentially via the new "infrastructure bank" which is providing £13bn to kick-start stalled projects.

More public risk?

Reducing the risk of the banks not getting paid should lower costs but this still assumes that banks are willing to lend at anything like an affordable rate. The public sector can evaluate the trade off between risk and cost but that requires sophisticated modelling, robust benchmarks and strong negotiation skills to get the balance right, and placing the onus on the public buyer to make things affordable seems like a poor starting point.

Alternatively, the government could exert greater influence over the banks we nearly own to lend at better rates but then again, it has already tried that.

Given the state of the government's finances, there may be no alternative to using private finance, and thereby deferring cost. Removing risk for funders is more likely to secure that finance but it still won't be cheaper than public debt.

Or more public funding?

If public funding is to be used then the Treasury has to take similar risks to the banks and to put pressure on suppliers to deliver; and risk not being paid if schemes fail. Alternatively, if the Treasury wants to guarantee its returns, then the way in which builders and operators are paid will require changes to the current PFI model.

Exploring different forms of financing must be part of the answer

The infrastructure bank, born to keep the show on the road, sets a precedent of splitting the money from delivery. This creates some conflicts for the Treasury, as it is effectively lending to the private sector which then charges public sector clients. However, it focuses the private sector on being more creative about managing tangible risks and innovative delivery, and allows more frequent competition and alternative forms of supply (such as the third sector). Use of bonds to finance new infrastructure is another solution that may be attractive given the emptiness of the government's coffers.

So the dead parrot of PFI can be resuscitated, but ultimately bringing it back to life feels like an increasingly complicated way for the government to finance public schemes and raise cheap loans.

Steve McKenzie is a member of PA Consulting's Management Group and leads on public sector commercialisation

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