How Can Government Encourage Infrastructure Investment? 3

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Monday, August 22nd, 2016
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The International Monetary Fund (IMF) recently downgraded its global growth forecast to 3.2 per cent, and for the developed countries in the G-20, it predicted just 2.1 per cent.

In 2014, the global infrastructure funding gap reached approximately $57 trillion in terms of the amount that would have to be invested in infrastructure to maintain GDP growth through 2030, according to the McKinsey Global Institute. With infrastructure lifespans of between 15 and 150  years, depending on the asset class, a higher share of global savings will need to be allocated to infrastructure over the next few decades.

Readily identifiable key stakeholders in infrastructure development include ratepayers and business, governments, institutional investors, infrastructure asset developers and owners, and entities engaged in direct foreign investment into cities and nations. Non-traditional entities staking a significant claim in infrastructure (hard and soft) include big-data companies that analyse multiple data points and create new software applications that aim to streamline the user experience of infrastructure, sharing economy entities, and traditional infrastructure operators that are using new technologies and industry interrupter techniques to stay ahead of competition. AGL and Sunverge are examples of this, with the world’s largest virtual power plant planned for Adelaide.

Where monetary and fiscal policy will be located in the frameworks to fund, build, own and operate infrastructure will be highly dependent on the economic, cultural and philosophical capacities of each city and nation. Funding for infrastructure projects can take a number of forms, including traditional forms such as non-infrastructure financial products (such as government bonds, infrastructure-related corporate equity, or debt products) and dedicated pure infrastructure financial products. Insufficient government revenue (at all levels of government) is one of the most important constraints on overall government investment in infrastructure. It is not access to  credit.

The public has a finite willingness to pay the taxes and fees necessary to service infrastructure related debts. Public-private partnerships (PPPs) are commonplace, whether these be government or private enterprise driven. Infrastructure is also becoming increasingly perceived in the same way as traditional real estate, with a number of institutional investors (and others) that have created real estate investment trusts that focus primarily, if not solely on infrastructure assets. Well-structured PPPs are one  means by which the state can help ensure that greenfield and brownfield projects are delivered on time and within budget, and at the same time, generate attractive risk-adjusted returns for investors. Infrastructure, its funding structure and its corporate governance arrangements are affected by the application of the appropriate risk assessment instruments matched to “equity-debt ratios” and “return on investment” objectives of enterprises and  governments and the need to meet the social and political needs of the government of the day.

Government Bonds are a form of loan from investors to a government. They are issued by governments to raise money to cover the shortfall they have between what they want to spend and what they have coming in through land taxes, goods and services taxes on property acquisition and sale, infrastructure charges and council rates, and fuel excises each year.

Bonds can be structured in a number of ways. Their simplest form is where the government promises to pay the buyer small cash payments, called coupons and set at a fixed rate, usually twice a year until the bond matures. At this point, the buyer also gets back the money loaned to the government. The issuing of bonds, generally, have minimal direct affect on taxpayers. However in this period of  historically very low interest rates, returns on bonds are diminished. Existing bondholders will retain their income streams, new bondholders will not. As many bondholders are found in the investment/superannuation and related commercial spaces, the return to retirees will affect their incomes and possibly their pensions, if they are not self-funded.

While the finite willingness of ratepayers, consumers and others to pay fees and taxes to service debt is likely associated with the individual’s/family’s/enterprise’s ability to pay, it is also likely associated with the perception (or reality) of the ability of the government (and its partners) to properly manage the design, construct, operation and maintenance of the infrastructure without further cost to the community.

As most infrastructure provided by local and state governments is constructed to support local and regional residents and businesses, many of these ratepayers understandably question why they should pay for infrastructure on top of the charges imposed through land taxes, goods and services taxes on property acquisition and sale, infrastructure charges and council rates, and fuel excises. Housing and business affordability are seriously affected by these and other tax regimes. These taxes affect the revenue side of households and businesses.

These same revenue issues affect governments. Without these taxes and related revenue streams, governments cannot deliver the necessary services. A growing population begets growing revenues. Growing revenues provide the opportunity for governments to borrow more, therefore growing debt and deficit, for both operational and capital expenditures. Globally, a steep decline in tax revenues combined with indications that the recovery from the GFC, a contraction in resource sectors around the globe, and near-zero interest rates has resulted in a significantly different borrowing behaviour by governments and enterprises.

Equity capital is a substantially more expensive source of infrastructure financing than municipal bonds. In the US, the cost of funds for equity capital can exceed highly rated municipal debt by a factor of five. Once the senior debt holders have been repaid, the equity investors receive their share of user-pay related revenues. National, state and local governments around the world have understood that they would not have the revenues necessary to support another major round of borrowing for major capital works following the GFC. Therefore, they have held off on significantly increasing their overall debt and deficit levels.

Contract frameworks bring structure and discipline to the execution of infrastructure projects. Traditionally, the construction risk associated with greenfield projects is typically greater than the risk with brownfield projects. However, brownfield projects can be impacted by unforeseen issues such as contaminated land, or previously unmapped subterranean infrastructure such as mine shafts, pipes, or unexploded ordinances which can quickly change the viability of a project. Funding entities consider multiple factors in infrastructure planning and development, including:

  • revenue and volume risk, which relate to the effective use of the infrastructure at expected tariff  levels (for instance, road traffic)
  • the availability and affordability of critical inputs (for example, gas supply to a gas-fired power plant)
  • connectivity to existing infrastructure and/or markets such as the national energy market
  • lengthy planning, legal, public policy, funding and resourcing delays
  • the ability of both the government and private sector entities to come to a mutually beneficial agreement on infrastructure charging regimes, the return of funds split between all equity partners and the revenue stream and values opportunities associated with the infrastructure (i.e. the consumer pay-points). In the case of a toll highway project, an equity investor would have the right to a share of the stream of toll revenues over and above what is needed to repay senior project debts
  • effectively managing the value-add of infrastructure to the community and the state over the short, medium and long terms through negotiating robust contractual arrangements, and fully addressing environmental, social, economic and governance aspects of all projects.

Well-planned infrastructure

According to the IMF, a one per cent increase in spending on infrastructure leads to an average of 1.5 percentage points in GDP growth over four years. Well-planned and well-executed infrastructure can deliver returns of 2.6 percentage points over four years. The difference suggests how important government is to ensure that infrastructure delivers the biggest possible dividend. To achieve or even exceed these forecasts, governments must:

  • place building physical infrastructure at the heart of its economic strategy. While maintaining its authority, government must also recognise the limits of the public sector’s expertise in areas such as procurement
  • require that all new major projects be assessed for suitability as a public-private partnership before being considered for public financing. This sends a powerful message, both to the government and to the markets that PPPs are the preferred method of  procurement
  • vest decision making into a single body, preferably a non-partisan entity that reports to but is not directed by the government of the day. Theoretically, this helps with better project selection and planning as well as standardisation of contracts and clearly defined performance measures and performance based remuneration to the private sector operator
  • create a single planning framework within which all parties operate within a jurisdiction
  • where relevant, clearly established and articulated national interest tests need to be adopted to ensure all parties understand their obligations and accountabilities, and by what measures they will be assessed by the decision-making entity
  • create the policy and practice framework that will allow cities, regions, states execute strong digital transformation across sectors that influence or influenced by infrastructure

What government can do to encourage investment

As investment in infrastructure is based on specific assumptions regarding the stability of legal frameworks and public policy over a projected investment period, government agencies:

  • can provide a clear pipeline of investment opportunities through PPPs and investor driven project opportunities with appropriate policy and planning  settings
  • can make development risk manageable for investors. Procurement agencies must avoid any “stop and go” when launching infrastructure  projects
  • must clearly articulate the frameworks in which they will assess market driven proposals. This will be instrumental to building credible pipelines of investable opportunities and enabling institutional investors to actually engage. It has been argued by many commentators recently that this has not been the  case in the assessment of the Ausgrid bids in New South Wales
  • must think strategically about how regulations can encourage long-term investment in infrastructure projects and whether they reflect the risk-reward equation of these nuanced investments
  • need to ensure decision-making and regulations are built on hard data. Data enablement gives governments the tool they need to be more efficient, effective, and transparent while enabling a significant change in public-policy performance management across the entire spectrum of government activities
  • can play a key role in addressing market failures, either directly or through public development banks. They can act as facilitators and provide credibility to infrastructure projects. By funding transactions or supporting active market players, development banks provide a powerful signal to the private sector, for example the CEFC
  • need to work in partnership with private sector entities nationally and internationally to develop and promote dedicated financial instruments – such as guarantee instruments, long-term funding, seed investment, and early-development stage facilities – to encourage long-term investment. Channelling wealth and savings into productive investments, including infrastructure, will be  essential for the global economy to grow
  • must, in conjunction with the relevant government Minister, do a much better job at communicating their existing budget, debt and deficit situations, articulating how, when, where and why the sale, lease (or the combination of) is necessary to address the existing situation and the provide the opportunity to upgrade existing infrastructure or build new to meet the growing demands through a growing population
  • can identify new revenue streams to fund infrastructure that are cost neutral to the tax-payer, even at the cost of existing revenue streams for certain programs. For example the funding and development of new hard and soft infrastructure that encourages more exercise and activity in the community has the potential to reduce the cost impacts of building new tertiary and secondary health facilities, and potentially reduce Medicare benefits costs to the budget for lifestyle related matters.

The essential precursor to significant engagement with the private sector is political commitment across the chamber and between the two houses of Parliament (where relevant). Governments can create the conditions that will encourage the private sector to invest in infrastructure markets by providing leadership, defining a strategy, and creating effective planning and implementation agencies, helping countries build the road, sanitation, and transport projects that fuel economic growth, and improve the well-being of people and communities.

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Discussions
3
  1. John Doyle

    Common mistakes about economics repeated here need correction.
    First, you do need savings or borrowings to fund investment in a MONETARY SOVEREIGN nation, nor taxpayer dollars either. Without going in too deep into monetary mechanics, a monetary sovereign nation can buy, pay for and commission all the infrastructure projects it cares to choose. Only the ignorant and vested interests. like banks, don't want to see it happen this way. So sharing schemes are set up for the non government sector to get onto the gravy train, but it adds heaps to the final costs. The private sector can build the infrastructure and get paid directly by the federal reserve bank, the RBA, or the BoE for example. Such payments are direct net credit injections into the economy and are not required to be repaid. It's new money. This only applies to a MS nation.
    States and local government cannot do that as they are non-sovereign, but the federal government can chip in whatever it takes to build it. There are effectively no cost constraints. Only run away inflation would be come an isue and right now as web languish in virtuall deflation, the output gap is hoge.
    So let's get on with it!!!

  2. Barry B

    Nice overview Brett, but why no mention of value-capture?

    • Brett Skyring

      Hi Barry
      Thank you for your comments. No mention of value capture as I have noted the opportunity in previous posts and in itself, it should be treated as a stand-alone topic. Maybe between now and the end of the year.

      Hi John,
      Thank you for your comments. The capacities of a sovereign nation and smaller jurisdictions to participate in the funding of infrastructure is acknowledged. For most local governments, their infrastructure needs will be proportional to the growth of population within their jurisdiction. For state and national governments their infrastructure needs, by their very nature, are frequently focused more on distributive opportunities for the population – water, electricity, transit, etcetera. Subsequently the frameworks for assessing and presenting to constituencies will be different at the different levels of government.
      My essential argument is that governments at all levels need to consider what it is they are seeking to achieve in the delivery of infrastructure, communicate the benefits, costs and opportunities of the infrastructure to all stakeholders and ensure there is a clear articulation of these matters and there are opportunity for stakeholders to inform government of the support (or not) of the community to the opportunities presented.