News Analysis: GCHQ deal shows PFI is here to stay

THE PRIVATE Finance Initiative (PFI), the Government's scheme to encourage private investment in public projects, was given a boost yesterday with the award of a pounds 300m contract to rebuild the Government Communications Headquarters (GCHQ).

A consortium including the construction group Tarmac, the security firm Group 4, BT and Deutsche Bank, has won the high-profile contract to design and build the new spy headquarters and then manage it for 30 years. The new scheme, nicknamed "the Doughnut" because of its circular shape, will bring together in a complex the size of Wembley stadium the GCHQ's operations currently split between two buildings. Two sites are vying to house the scheme - Benhall in Cheltenham, which houses part of GCHQ's existing facilities, and Gloucester.

The signing of deal, which follows the approval of a string of projects worth pounds 1.5bn in August, is a significant victory for the supporters of PFI. The initiative has been dogged by delays and criticisms since its inception. Only last week, London business leaders warned that the partial privatisation of the London Underground, another PFI project, was in danger of missing its year 2000 deadline due to bureaucratic delays.

The private sector has long complained that the sheer complexity of deals can make the system time-consuming andcostly. But, six years after its inception, has the PFI turned into the "win-win" deal its supporters claimed it would be, or is the Tube example a sign that delays and bureaucracy are still hindering progress?

Set up by the Tories in 1992, he PFI was conceived as a way of replacing and maintaining the nation's infrastructure without burdening the overstretched public finances. In the following years, as the pressure to curtail public spending grew, the PFI became the only way to plug the gap in the demand for schools, hospitals, prisons and even military headquarters through public/private partnerships.

The basic idea is relatively simple. A private sector consortium - usually made up of a contractor, a financier and an operator - signs a long-term contract to build, fund and operate a public building. In exchange, the public sector client - usually a government department or a local authority - undertakes to rent the building and pay an annual fee to the consortium. Easy in theory, but is it working in practice?

Statistics appear to show that it is. After a shaky start, the number and value of PFI projects signed has increased considerably in the past three years (see table). More than 80 per cent of the pounds 11bn worth of PFI secured so far has come in the 1996-1998 period.

The arrival of a Labour government committed to curbing public spending added extra impetus to the initiative. Shortly after the last election, the Paymaster General Geoffrey Robinson ordered a review of the initiative, which led to a number of changes to streamline the system. The most significant was the decision to pick 50 projects from the thousands waiting and give them priority under the Treasury PFI unit - the taskforce charged with making the scheme work.

But the Government's efforts and the raw numbers do not tell the whole story. In some sectors, such as health and education, the PFI is still beset by problems and delays. Less than pounds 500m worth of school projects has been signed to date, compared with over pounds 6bn in transport (see table). In health, fewer than a dozen hospitals deals have been agreed. Even outside these two problem areas, the biggest PFI scheme of all, the pounds 3bn Channel Tunnel Rail Link, has been savaged by delays and contractual problems, which led to its near-collapse followed by a last-minute rescue plan.

The private sector believes that the PFI's problems are threefold. First, there is a lack of experience on the part of the public sector clients. Charles Cox, chairman of the CBI public procurement committee, says private consortiums bidding for PFI schemes have to "reinvent the wheel" each time they sit down to negotiate with their public counterparts. The public sector's inexperience leads to delays, uncertainty and soaring bid costs.

The Government acknowledges the problem. Adrian Montague, the former Dresdner Kleinwort Benson banker who runs the PFI taskforce, says: "There is much for the public sector to do. We have to get the package right so the private sector can bid effectively. At present, some of the bidding costs are high because [the projects] take too long to go through the process."

In Mr Montague's view, standard contracts are a key part of a successful PFI. Last month the Treasury launched a long-awaited consultation paper which should lead to a drafting of templates to be used in almost all PFI deals.

The second problem, risk allocation, shows an even greater chasm between the private and public sectors. In theory, PFI risk should be allocated to the party that can best manage it. But in practice, it is far from clear who that party is, especially when the contract lasts for 20 or 30 years. This is a key part of the wrangling over PFI contracts, since both sides want to take on as little risk as possible.

The third problem is a recent change in accounting standards which could mean that PFI projects will have to be included in government debt. At present, PFI deals are considered revenue spending rather than public debt. But under the new rules, put forward last month by the Accounting Standards Board, the projects could be added to the public sector borrowing requirement, removing a powerful incentive for government departments to use the PFI.

Interpretations vary, but Mr Montague believes that the ASB rules will not stop the PFI bandwagon. Private sector representatives are less certain and caution that the proposals would at least lead to further delays.

Whatever the differences, the private and the public sector agree on one thing: they have to make the PFI work because going back to the age of government spending is not an option. As one contractor put it: "PFI is here to stay, because it is the only game in town, for us and for them."