These projects are procured in open competition in accordance with rules drawn up by the Government and the European Union. The competition drives out excess costs and the resulting price should be considered the market price which takes into consideration all the project risks. The majority of contracts in the UK were negotiated before at a time when debt and equity was readily available and relatively cheap.
In current markets, these projects today would be more expensive to finance. The overall cost of financing a PFI project has been typically about 2. This is because the government cost of finance is less than the private sector. The private sector price is the market price for taking on a project with its inherent risks. A lower government cost amounts to a subsidy as these risks would be underpriced.
This is because the project risks are the same whoever provides the finance. Nevertheless, it would be cheaper. The expectation is that the efficiencies that will be delivered by the private sector through risk transfer will more than compensate for the additional cost. For example, building the project to budget and on-time together with the more efficient service delivery and maintenance during the life of the project. Large refinancing profits were made by some investors on some of the early projects.
The profits were made possible because the cost and term of financing became cheaper as confidence grew i from nothing in the new services based infrastructure sector and ii in doing business with the public sector previously very difficult and often claims based. So it became possible to refinance many of the earlier projects ie replace the project finance at a profit.
These profits did not arise because the costs of building the project or delivering the services turned out to be cheaper than envisaged in winning the original project but because the new finance providers were prepared to accept lower returns since their perception of the risks had reduced. Winning a PFI project concession is a hard fought competition where the cheapest price usually wins. As PFI developed in the last decade, these refinancing opportunities receded as the finance became cheaper, discounting many of the earlier risks and concerns.
The other way investors have made and lost money in PFI is through buying and selling equity investments in the project companies between each other. To date, PFIs are commonly used in the United Kingdom and Australia, while these partnerships are referred to as public-private partnerships in the United States.
In PFIs, private firms get their money back through repayments made by the government for a long period of time, including interest payments.
Private finance initiatives PFIs are often used to finance major public projects which are mostly infrastructural projects. Examples of such projects include; Tunnels, bridges, roads, railways, seaports, airports, hospitals, schools, libraries, health centers, public parks, sports, and recreational facilities, prisons, and water facilities.
Private firms enter a long-term agreement with the government to complete the projects. These firms pay an upfront cost for the projects. Here are the major points to know about a private finance initiative;.
Naturally, private finance initiatives relieve the government of the capital or financial burden associated with the execution and completion of public projects. Why not sign up to our newsletter to receive weekly updates on our sector. PFI — what does it actually mean? How does it work? What are the drawbacks?
There are drawbacks for both the government and the JV organisation: Long contract lengths mean it is harder for the government use the buildings to make efficiency cuts, often having to find cost savings elsewhere e. There will always be a trade-off between spreading the cost over the long term and the total amount paid out directly. For the JV organisation, entering the market for a PFI contract can be an expensive and risky business.
Governments have traditionally had to raise money on their own in order to fund public infrastructure projects. If they aren't able to find the money, governments may also borrow from the bond market, and then hire and pay contractors to complete the job. This can often be very cumbersome, which is where the PFI comes in.
PFIs are intended to improve on-time project completion and also transfer some of the risks associated with constructing and maintaining these projects from the public sector to the private sector. Financial advisers such as investment banks help manage the bidding, negotiating, and financing processes.
PFIs also improve the relationship between the public and private sector, while providing both long-term advantages. Through this relationship, both sectors can share knowledge and resources. A key drawback is that since the repayment terms include payments plus interest , the burden may end up being transferred to future taxpayers. In addition, the arrangements sometimes include not only construction but ongoing maintenance once the projects are complete, which further increases a project's future cost and tax burden.
There is also a risk that private sector firms may not comply with relevant safety or quality standards when managing a project. The length of time a typical PFI project might last, although some are shorter or longer, depending on the need. In the United Kingdom in the s, a scandal surrounding PFIs revealed the government was spending significantly more on these projects than they were worth to the benefit of the private firms running them and to the taxpayers' detriment.
In addition, PFIs have been criticized as an accounting gimmick to reduce the appearance of public-sector borrowing. Investing Essentials. Your Privacy Rights. To change or withdraw your consent choices for Investopedia. At any time, you can update your settings through the "EU Privacy" link at the bottom of any page.
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