Under PFI, a public sector body may gain access to private financing but the cost of such funds is unlikely to be as low as loans from the National Loans Fund (NLF). The PFI does not provide a cheaper source of finance to public sector bodies but simply provides them with another source of possible funding, probably at a higher capital cost than traditional procurement. Under present Treasury rules, public (profit-making) corporations cannot borrow and invest like private sector enterprises as their borrowing is treated as public expenditure. Comparisons of the cost of borrowing by government and the private sector are very difficult to make. The cost of borrowing at any time is determined by a variety of factors, although the main determinants are likely to be the risk of default and the expected returns.
Government borrowing through the NLF is backed by tax revenues and so is virtually risk-free and hence the cheapest way of raising funds. Private sector companies, which have no such guarantees, are inherently riskier propositions and hence borrow on less advantageous terms. City, or local authority, borrowing may be somewhere between these two, although some companies might be able to borrow money more cheaply than a public authority, especially if the authority is relatively new or has a less than perfect reputation for financial rigour.
Due to the difficulties involved in comparing the actual costs of public and private financing of PFI projects, disparities in the yields of bonds issued by public, private and public/private organisations have often been looked at as proxies. In this cost hierarchy the cheapest source of funds comes from government. Next it is suggested, would be a overnment/fare revenue backed body such as London Underground. Next are large public limited companies (plcs) many of whom are PFI players. However, this does not take us very far since a plc is likely to raise capital by a cost-minimising combination of a new share issue, bank finance and commercial bonds rather than just through a bond issue alone.
The crucial aspect here is the cost differential between the alternatives and, although it is dangerous to generalise from the evidence of a few borrowers, the following figures are nevertheless helpful. According to figures in the Financial Times72 the yield on 10-year government bonds at the close of play on 12 September 2001 was 4.9%. Similarly dated corporate bonds ranged between 6.9% for Gallaher and 5.6% for Halifax. This suggests that the extra borrowing cost of corporate bonds could be at least one and a half percentage point higher than government bonds. The differential between the returns on public funds and private equity is likely to be much greater. This was demonstrated in the NAO report on the Skye Bridge.73 The NAO calculated that the extra financing cost of the Skye Bridge was some £4 million on a total project cost of £28 million, or one-seventh. The cost of (private) equity was some 18.4% in real terms, compared with the cost of public capital of 6%. In this case the private finance option required more than 12% percentage points per year above the public finance rate. The recent report by Arthur Anderson/Enterprise LSE on the PFI found that:
The [financing costs] difference on the average PFI project is now typically in the range of only 1-3 percentage points.
This gap between the cost of private sector capital and public borrowing has been narrowing as PFI matures and the public and private sectors gain in experience, and is not as high as some of the literature suggests. The additional cost is not so significant that value for money is inherently likely to be imperilled, provided the private sector is able to deliver savings in other aspects of the project. The business cases we have examined suggest these savings are deliverable...74
David Currie of the London Business School has challenged the proposition that private sector borrowing costs are higher, calling proponents "naïve". He has suggested that when evaluating projects:
[...] efficiency savings are the significant factor in any decision between the two options as adopting a more appropriate approach to the evaluation of the costs of a project shows that the differences between the costs of borrowing are illusory.
One of the most fundamental points in using cost benefit analysis to evaluate projects is to account for their impact on all individuals in a community [...] in the private sector, investors carry the risk of default and are rewarded accordingly but in the private sector, taxpayers carry the risk but receive no commensurate reward. In other words, although the public sector can borrow at the risk-free rate to finance investment, this imposes a residual risk on taxpayers in much the same way as private sector investors but without a reward. Clearly the contingent liability being imposed on taxpayers is a cost that ought to be accounted for in any cost-benefit analysis. Unfortunately it is not normal practice to quantify in the public balance sheet these contingent liabilities faced by the public. Once taken into account, the true cost of borrowing is the same for the public and private sector if the underlying risk of the projects is the same.75
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72 Financial Times, 13 September 2001
73 NAO, The Skye Bridge, HC 5 Session 1997/98, 23 May 1997
74 Arthur Andersen and Enterprise LSE, Value for Money Drivers in the Private Finance Initiative, 17 January 2000
75 David Currie, Funding the London Underground, London Business School, March 2000