Buy now, pay later

Many people are now questioning whether PFI is the right way to finance capital projects. National Health Executive spoke to infrastructure finance expertMark Hellowellto find out what the current state of play is with regards to PFI

There are currently eight major hospital building PFI projects either being negotiated or planned with a combined capital value of around £2 billion.

For many years, the cost of raising finance from the private sector was relatively cheap, and the construction industry was in a stable and confident position.

Now, in the wake of the financial crisis, neither of these conditions prevail and the impact on the PFI market has been significant.

“The economic case for PFI can only be understood with reference to the alternatives. The traditional mechanism for funding large capital projects is through government borrowing,” says Mark, who is a researcher and lecturer at the Global Public Health Unit at Edinburgh University.

“The interest rate which the government would be paying on a gilt is generally between four and five percent. This compares to the typical overall rate on a PFI project seven and 10 per cent.”

So is the government paying twice as much as it needs to for its capital? As always, the devil is in the detail. The government argues that the extra cost of capital is accounted for by the risk being taken on by private investors, which generate incentives to deliver projects with greater efficiency than public procurement and public financing could achieve.

So does Mark think that this is the case?

“I think that given the current state of affairs in the financial markets, it is unlikely to be true, because the cost of finance has risen so sharply. The cost of debt, for example, is what one might expect to see in the commercial property sector yet the amount of credit risk being faced by banks on a typical accommodation PFI project is much lower.

“If you consider the Mid-Yorkshire NHS Trust’s Wakefield Hospital building project, that was a deal that signed during the ‘boom’ years. Private finance was relatively cheap – the credit margin on the banks’ cost of funds was around half of one percent.

“An appraisal carried out at the time found that the net present cost of the PFI solution was less than one per cent lower than that of a public procurement option. So if you plug today’s cost of finance into that model, where credit spreads are two to three percent, that appraisal would have found in favour of the public option by quite a significant margin.”

Although PFI is considered now to be a Labour flagship policy, it was first used by the Conservative Party.

“It is hard to say who came up with the idea, but Norman Lamont was the chancellor who introduced it and it was his successor Kenneth Clarke who got the ball rolling. This meant that PFI had already been running for five years before Labour picked it up. Labour got it working but the idea was the Conservatives’.”

Despite the high costs of finance today, Mark believes that the use of some kind of private finance arrangement will still have to be used to finance future large projects.

“Private finance in some form will have to be used because public capital budgets are set to fall dramatically in the next five years. There are also political costs to borrowing money on the market because that borrowing will then show up on the balance sheet.

“This means that any government will most likely carry on using some kind of private finance but perhaps just change the name in the case of a Conservative government, because the term PFI is seen as politically unattractive.

“Any future government will have to provide new hospitals. Seeing as they do not have the money themselves and are not minded to borrow it on their own account, there is going to have to be some kind of off-balance sheet financing taking place.

“To be frank, I think the Conservatives have yet to come up with a structure, but they are clear that private finance will have to be used in some form. There are a lot of ideas in the market that take their cue from PFI but could probably be given different branding.”

Although it seems the reasons for actually using PFI are mainly political, the argument put forward by the government is that the greater cost of PFI is then offset by the greater efficiencies which PFI makes available. Although in theory this should be the case, Mark says that there is little evidence that this actual happens in reality.

“There is a lot of evidence that PFI results in lower cost over runs post contractually, but whether that advantage is significant enough to offset the high cost of finance is an open question. The state of the evidence is not conclusive.”

Another method being used to finance healthcare infrastructure projects is LIFT which is mainly used to finance smaller projects such as GPs’ surgeries.

“In principle, LIFT is based on the idea of contingent renewal where private sector companies deliver a few GP surgeries for example and then the quality of their work determines whether or not they get access to the next round of contracts.”

The LIFT Council has stated that the method had cross party support; but again it seems that this support is more for political reasons than anything else.

“The only reason that the Tories have supported LIFT is because they believe that it doesn’t have the political baggage associated with PFI and also it is quite a good way of getting GP’s surgeries delivered off balance sheet. It’s not clear whether that support will be sustained in the future, as it is not close to their hearts, and they are likely to pursue forms of marketisation in primary care which may render LIFT in its current form redundant.”

The truth of the matter is, however, that if the government chooses to build new hospitals, it will have to involve some kind of borrowing.

“If the government wants to make a large scale capital investment and their tax receipts are not going to cover it, then they will have to borrow. The question is do they borrow directly or through a private sector intermediary? If they borrow through a private sector intermediary then the cost is going to be higher unless you can offset that high cost with other efficiencies that are generated from incentives created by the contractual structure.

“I would say that there is inconclusive proof as to whether that has been possible and if the political parties were honest, they would offer the public authorities a real choice over which type of financing to use. This would allow them to choose the method which suited their purposes best. I think, however, that if NHS trusts were not obliged to use private finance, they would do so much less frequently than has been the case.”