• The measure of inflation used in the PFI Contract payment mechanism may impact on affordability and value for money. |
There are a variety of different measures of inflation, depending on what is being measured. It is important for an Authority to understand how these differ, and what effect these differences may have on both initial evaluation of a bid, and actual Unitary Charge payments (and hence value for money and affordability). Recent data for the main measures of inflation are as follows:
|
Annual change |
CPI |
RPIx |
RPI |
GDP Deflator* |
Implied RPI** |
|
December 1997 |
1.7% |
2.7% |
3.6% |
3.0% |
2.9% |
|
1998 |
1.6% |
2.6% |
2.8% |
2.6% |
2.0% |
|
1999 |
1.1% |
2.2% |
1.8% |
2.0% |
2.2% |
|
2000 |
0.8% |
2.0% |
2.9% |
1.3% |
2.3% |
|
2001 |
1.1% |
1.9% |
0.7% |
2.5% |
2.4% |
|
2002 |
1.7% |
2.7% |
2.9% |
3.2% |
2.3% |
|
2003 |
1.3% |
2.6% |
2.8% |
2.6% |
2.4% |
|
2004 |
1.7% |
2.5% |
3.5% |
2.1% |
2.9% |
|
2005 |
1.9% |
2.0% |
2.2% |
2.4% |
3.0% |
|
Sources: |
|
National Statistics |
HM Treasury |
Bank of England |
|
|
* GDP deflator figures are for fiscal years; e.g. the 2.1% for 2004 covers the year to March 2005. The 2005 figure is a forecast for the year to March 2006. |
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** at month-end, based on comparing 20-year fixed-rate and index-linked gilts |
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This information can be obtained from the following websites: http://www.statistics.gov.uk ; http://www.hm-treasury.gov.uk ; http://www.bankofengland.co.uk . |
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All of these are historical figures, other than the implied RPI figures, which represent approximate market expectations of future RPI. The Bank of England's target for inflation, as set by the Government, is 2% CPI (changed from 2.5% RPIx in December 2003). The GDP Deflator is a measure used to 'deflate' nominal GDP figures to real terms. The 'basket of goods' in this statistic is the widest of the above measures, and includes consumer / retail goods but also the prices of wholesale goods to reflect the fact that many economic transactions do not directly involve consumers.
The two most common indices used for inflation indexation of the Unitary Charge in PFI Contracts are RPI and RPIx.37 As can be seen from the table above, there have been significant historical differences between these two indices, and hence the choice of index in the Unitary Charge is likely to have a considerable effect on the actual Unitary Charges to be paid over the life of the Contract. Authorities should, therefore, consider carefully with their advisers which inflation index is appropriate, but the index chosen should ordinarily be one of these general inflation indices. RPI remains the most commonly used index in the financial markets (e.g. for index-linked gilts38) and commercial markets (e.g. for wage negotiations); accordingly it may often be easier for a Contractor to price its own cost forecasts against this index, that is to 'price off RPI', thus offering better value for money.
However, there may be sector-specific issues affecting the project which also need to be taken into account before a final choice of general inflation index can be made. In exceptional cases, such as extended delays between PFI Contract signature and start of construction (e.g. due to planning permission processes), the use of specialist construction indices (subject to appropriate weightings) during this period of delay may offer better value for money.39
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36 This section should be read in conjunction with SoPC §14.2 (Indexation).
37 RPIx equates to RPI less house mortgage rate (i.e. interest-rate) movements. CPI is the common international measure, the main difference to RPIx being the exclusion of housing costs.
38 i.e. gilts where the return is linked to inflation. The terms 'index-linked' and 'inflation-linked' are used interchangeably in this Application Note.
39 Where more specific indices are used, it is important that they are independently derived, relevant, readily available and broad enough for the individual PFI Contract or the Contractor's supply chain not to have a material impact on the index itself. It should also be noted that the use of more specific indices may affect the Authority's accounting treatment of the PFI Contract. The choice of index is also addressed in SoPC §14.2.3-14.2.5.