Select Committee on Treasury Minutes of Evidence

Examination of Witnesses (Questions 20-39)


18 OCTOBER 2006

  Q20  Mr Newmark: Let us actually focus for a second on PFI. A basic principle of PFI is to allocate the risks between the public and private sector according to which side can best manage them. The ONS's recent review noted that about half the £46 billion worth of assets in existing PFI projects was on the public sector's balance sheet. How satisfied are you that this represents a sufficiently high level of risk transferred to the private sector?

  Mr Macpherson: I think it represents a perfectly sensible allocation. For all intents and purposes, where the economic risk lies with the private sector, that is fine. Equally, where it lies with the public sector, providing it is affordable that is okay, too.

  Q21  Mr Newmark: Have you got any assessment or internal judgment as to what proportion of risk you consider should actually trigger a review of a PFI initiative to test whether it is transferring sufficient risk to the private sector, as opposed to the public? I am interested in what analysis you go into, because I have a third question here to follow up on this.

  Mr Macpherson: It is absolutely right that we should have an understanding of what our commitments are under the Private Finance Initiative and we publish those regularly at the time of the PBR and Budget, and it is absolutely essential that that should be factored into our fiscal planning, but beyond that we do not have some particular ideological predisposition one way or the other, no sort of theological view about what is the precise level of risk which should be transferred in these cases. What we do need to have an understanding of, however, is ultimately where the accountants will decide the asset should reside, and there are perfectly sensible rules agreed by the accountancy profession, which Mary may want to expand upon, which inform that judgment and we are happy to defer to that judgment.

  Q22  Mr Newmark: So you do not get a sense that there is a Treasury initiative or strategy that in order to finance a lot of these projects they are trying to push things off-balance sheet because if they do not push it off-balance sheet they will not be able to meet their sustainable investment rule? You do not get any sense of that going on?

  Mr Macpherson: No, I would not recognise that. You are right that ultimately there is a capital constraint, but I would strongly want investment decisions to be based on what is the best value for money rather than tinkering around the margins, trying to move an asset from the private to the public or the public to the private sector. Mridul, do you want to comment on that?

  Ms Brivati: Yes, if I may. Obviously the sustainable investment rule is one of the key fiscal rules which the Government operates its policy against. However, the Treasury has no powers and no locus to decide whether any individual project is on or off-balance sheet. Those decisions are taken on a case by case basis, and the numbers you mention are the aggregate.

  Q23  Mr Newmark: Yes, but there is more and more which is going on PFI and there is increasing evidence—and I will give you examples—where PFI initiatives have been taken off-balance sheet and have then had to be brought back on-balance sheet. In August 2005 there was one and a quarter billion bonds issued by London & Continental, which is responsible for the Channel Tunnel. That was ultimately brought on-balance sheet. You had the Queen Elizabeth Hospital in Woolwich which was declared bankrupt and ultimately the Government had to step in. That is another £100 million. You had a further £5 billion of LCR debt which was out of the balance sheet by the ONS in February this year, and then the ONS added an estimated £5 billion for the imputed finance lease liabilities up to March 2006. So I am beginning to pick up a pattern—and correct me if I am wrong—that the Government, in order to meet its sustainable investment rule, is using PFI more and more and not allocating appropriately the risks which should be effectively on-balance sheet versus off-balance sheet.

  Ms Brivati: The decisions about whether any individual PFI project is on or off—and that will apply to each of these four cases—is taken by the commercial auditors employed by the public sector organisation which undertakes the investment. I have no detailed knowledge of the cases you mentioned or why the LCR and Woolwich cases resulted in a change of mind, but that change of mind would have been a change of mind on the part of the auditors. Mary will be able to say more about the rules which auditors apply to arrive at those decisions.

  Q24  Mr Newmark: My final question in that context, Mary, is do you feel then that accounting standards need to be tightened up?

  Ms Keegan: That is a very difficult question for me to answer. As you realise, I was, before I came to the Treasury, Chairman of the Accounting Standards Board. The UK accounting standards under which PFI is accounted for, both in the private and public sector (it is the same standard which applies to both sides of this equation), was issued some considerable time ago and my personal view is that both the private and the public sector have had a lot of time to get used to applying it and on the whole are doing it quite well. The UK standard does rely upon some judgment, though, on the balance of risk and reward. I think we can look to the future towards a change—

  Q25  Mr Newmark: In simple language, does that mean a tightening up of accounting standards?

  Ms Keegan: I am sorry if I am taking a little time but, as you know, the UK private sector companies now use international accounting standards, as required by European law. Those international standards, probably within the next two to three years, will include a standard which will apply on PFI and will slightly change the rules, but we do not know yet when to expect it to be applicable in the UK. The International Accounting Standards Board has yet to issue it. I am sorry if that is a long answer. The UK standard is good and is well applied.

  Q26  Mr Newmark: But yes or no? Do things need to be tightened up, is my simple question.

  Ms Keegan: No. The UK standard works very well.

  Q27  Mr Newmark: No, with respect to PFI.

  Ms Keegan: Yes, the UK standard with respect to PFI works very well, but I am informing the Committee that in due course there will be a change because we can expect a different form of international standard.

  Chairman: Okay. Thank you.

  Q28  Peter Viggers: A parliamentary body, of which I am a joint treasurer, received a letter from the Chief Secretary to the Treasury saying that in line with departmental-wide guidelines the Budget was to be reduced by 5% a year, offset by 3% allowed for inflation. Do you recognise that as being a departmental-wide rule, or does it apply simply to parliamentary bodies?

  Mr Macpherson: I very much recognise it as a departmental-wide rule, and some parts of the Treasury are going to be operating an even more stringent rule than that, but it is a reflection of our CSR settlement.

  Q29  Peter Viggers: Can you point in the annual report to where this is highlighted?

  Mr Macpherson: Yes, I can. It is not in any of the tables yet because the CSR settlement was announced in the Budget, which was March 2006. But we did try and update the report. In paragraph 6.2, on p 56, we incorporated this "hot off the press" news because this departmental report, to my recollection, was published in May. So we try to incorporate the latest information, but we will be setting out more details in our next report.

  Q30  Peter Viggers: I thought it was a surprisingly comprehensible statement of general principle. Where did the point of general principle come from? Is this a political judgment?

  Mr Macpherson: The way I would put it is this: the 2004 Spending Review incorporated the original Gershon analysis around the scope for making efficiency savings across government and in particular identified that it was possible to make, I think, 2.5% a year efficiency savings. Consistently with that, admin cost limits were, I think, frozen in cash terms, which was consistent with a 2.5% real reduction. I think the view which has emerged since then is that not only is it possible to make progress on Gershon but that especially when it comes to the Government's administration costs it should be possible to go further, and that has been reflected in the settlements which were announced in the Budget, not just for the Treasury (which is a very small department by any standards) but also for the Revenue and Customs and the Department for Work and Pensions, all of whom got a settlement consistent with the numbers you set out.

  Q31  Peter Viggers: Because a 5% cut across the board sounds a very crude weapon, indicating that something must have gone wrong before to cause this reverse out of the cul-de-sac?

  Mr Macpherson: I would disagree. I think there has been a challenge across government really to embed an efficiency culture and this is not really anything new. It is always a problem where you are not subject to market disciplines. I think the Gershon Review has actually begun to embed a new culture. It has encouraged all of us who are responsible for managing public sector organisations to be more ambitious and in my view certainly the Treasury settlement is deliverable. I recognise it will have implications for all sorts of organisations which are associated with the Treasury, be it the Bank of England, the Royal Mint, or even your parliamentary associations. It is never easy implementing these settlements, but I believe it should be do-able.

  Q32  Peter Viggers: You have produced a dry run of your whole of Government accounts. When does the Treasury plan to publish the first set of fully audited whole of Government accounts, please?

  Mr Macpherson: As I think we made clear in the document which we published at the time of the pre-Budget Report last year, our aim is to publish a fully audited balance sheet in respect of 2006-07, subject to sorting out the remaining methodological issues.

  Q33  Peter Viggers: Would one of those issues be the Comptroller and Auditor General's concerns about the treatment of PFI accounts?

  Mr Macpherson: I do not think that is a special concern, but Mary is uniquely placed to update you on what those concerns are.

  Ms Keegan: Yes, Mr Viggers. There is a number of things on which we are working very closely with the Comptroller and Auditor General and his team at the NAO. Putting together the whole of Government accounts is no easy task. We are talking about the whole public sector. The Comptroller and Auditor General has expressed some concern about the treatment of PFI in some parts of the wider public sector (not in central government but in some parts of the wider public sector) where the Audit Commission is responsible for audit but sends out some parts of that audit process into the independent private sector. We have been working with the Audit Commission and the NAO and it has come to our attention that in some cases the audit firms in the private sector have taken different views on apparently similar cases on PFI. We have formed a working group with those auditors, with the Audit Commission and the NAO, and are actively working on encouraging them to reach in the future a very common view, where we can, of similar projects in the wider public sector. But this is a small part of the whole infrastructure.

  Chairman: We are going to have to suspend for 10 minutes. If there is a consecutive division, then we will resume about twenty-five past.

The Committee suspended from 3.00 pm to 3.25 pm for a division in the House.

  Q34 Peter Viggers: If the commercial auditor of the body which is the subject of the PFI is the person or body which decides whether an item is on-balance sheet or off-balance sheet, I can understand one would have some responsibility for giving guidance, but it is not actually that institution's problem, is it, because if the body should run out of money and need support it is the Government's problem, or the local authority's problem, or the PCT's problem, not the problem of the individual subject of the PFI?

  Mr Macpherson: That is, of course, true, although it depends what sort of institution it is. There may well be some organisations which are formally in the private sector which the Government would be only too happy to see go to the wall if they failed, but the critical point, I think, in terms of planning public spending, which is the Treasury's interest in this, is that departments should take responsibility for understanding the financial implications of their procurement, whatever that might be. So I think it is very important, let us say, that the Department of Health understands in the case of a hospital being built where that asset will ultimately reside, and we need to know from a planning perspective. It is very striking, going back to some of the earlier examples, that yes, there are some assets which have been re-classified, but the large bulk of assets have remained firmly where they have always been, whether in the public or the private sector. We have an interest in understanding where those assets are and departments need to manage their assets, which is one reason why in the context of the Spending Review we have placed a big emphasis on departmental asset strategies.

  Q35  Peter Viggers: As to whether a body is classified as being on-balance sheet or off-balance sheet, it is only a matter of classification. It does not actually change the nature of that body, does it, or the risk?

  Mr Macpherson: Clearly with some assets it is blindingly obvious where they are. Take Defence assets, for example. Defence is not something you contract out to anybody and it is squarely in the public sector. In other areas where the Government is contracting with private sector agents who deliver a service, the assets of that company will be squarely in the private sector. There are some areas which are more complex and contested. I think from the point of view of planning public spending and understanding where the public finances are, it does actually matter where something is classified, but I think from our perspective investment decisions should not be determined purely by that consideration.

  Q36  Peter Viggers: If all the PFI projects under health authorities and local authorities were to be classified as on-balance sheet, what would the effect be on public finances?

  Mr Macpherson: That is actually very difficult to determine, and it is not because I want to obfuscate. When something is on-balance sheet its effect on net debt, for example, is determined by two factors. One is the point at which that asset is delivered. So you get these huge aggregates, and I come back to the earlier point that people say there are £45 billion worth of PFI deals and they should all somehow be in net debt. The point at which the asset goes on the public sector's balance sheet is the point at which that asset is delivered. So if that asset is not going to be delivered for another 10 years, it will not be on our balance sheet until then. But there is a second point: in relation to PFI deals the Government is usually paying a unitary charge and that unitary charge will include an element, which is repaying the debt, so over time the debt which is on the public sector's balance sheet is reduced with those payments. So simply adding up a whole load of deals does not actually give you the answer, and that is one reason why, with the ONS announcement last week of £4.95 billion, some people were quite surprised that that was a relatively low figure. It did not personally surprise me very much, but it was because of those two points.

  Q37  Peter Viggers: Surely in any private sector organisation you would have a risk matrix with the global risk, which may be small, ranging through to a risk which may be high, so you have a smaller amount which is high risk and a larger amount which is low risk. Surely you have that matrix? Surely you have the global figure?

  Mr Macpherson: We are continually analysing what the likely trajectory for net debt is and you would expect us to do nothing else, because we are responsible for that. So we do analyse it, but the one thing I can absolutely assure you is that even if every PFI deal was classified to the public sector tomorrow that would not translate on a pound for pound basis to our balance sheet for the simple reason that a lot of those assets have yet to be delivered, and of those which have been delivered as each year goes by we are paying off quite a lot of the debt.

  Q38  Mr Newmark: Although the tail is longer than 25 years and you use a 25 year duration?

  Mr Macpherson: The tail may be slightly longer than 25 years, but generally it tends to be in that sort of ballpark. What is the Treasury building? That is 30 years, is it not, Mary?

  Ms Keegan: Thirty-five.

  Mr Macpherson: Thirty-five, yes.

  Q39  Peter Viggers: Just moving on to targets on debt relief for overseas nations, for your 2002 PSA target on debt relief to be met 32 highly indebted poor countries should have received irrevocable debt relief by 2006, and according to your annual report just 18 such countries received debt relief. On what basis have you therefore come to the conclusion on, I think, p.21 that your performance is on course?

  Mr Macpherson: Although some progress in relation to some countries has been slightly slower than we expected, we are very confident that that slippage will be made up in order for us to hit the target.

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