14 The cost of private finance for the project was just over one and a half percentage points above the rate at which the Government could borrow through the gilts market.11 The cost of finance therefore appeared much higher than that at which the public sector could have funded the project, so we asked whether it would have been better value to finance the project with gilts. The Treasury told us that the premium over gilts reflected the inherent risks in the project. If funds had been provided at the gilt rate, this would have meant lending to a risky project, while making no charge for the risk.12 It would not have been sensible to lend money to a specific PFI project at a privileged rate. If public funds were lent at a properly risk-adjusted interest rate, the cost of finance would be the same for both the public and private sectors. If public funds were lent at a rate below the risk-adjusted rate, then the public sector would be taking an unpriced risk.13
15. The Treasury said that the key risks in this project included such items as cost overruns and construction delays, all of which had been transferred to the private sector. Although such risks could be transferred without the need to get the private sector to finance the initial capital costs, experience did not support the argument that risk transfer was successful where the finance was supplied by the public sector. By leaving contractors to back their own judgements on project risk, the use of private finance made for better project management.14
16. In assessing the value for money of PFI deals, Treasury guidance requires that the cost of a deal should be compared against a public sector comparator. The Treasury had estimated that the £170 million cost of the project might be £20 million less than a comparable public sector project, using a discount rate of 6 per cent. Recognising that these cost estimates would be subject to examination by the C&AG in due course, we asked the Treasury whether the percentage discount rate was reasonable, given that real interest rates were at a much lower level. We were told that the discount rate was important in such calculations and that the 6 per cent figure was being examined, although a decision on whether or not to change the number had not been taken. Real interest rates were indeed lower than 6 per cent, but the discount rate was not wholly dependent on market interest rates as it incorporated a number of adjustments to reflect items such as inherent risk and the effects of taxation.15
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12 Q27
15 Qs 49 - 59