Chapter 6
Infrastructure financing
6.1
This chapter covers the options at the federal level to raise money for
infrastructure projects. The options covered in this chapter include:
government debt; public private partnerships; and how this financing could be managed
by the federal government.
Level of government debt
6.2
Figure 6.1 shows past and projected levels of net Commonwealth
Government net debt over a fifty year period.
Figure
6.1: Commonwealth general government sector net debt and net interest
payments as a percentage of GDP[1]
Capacity for additional debt
6.3
Infrastructure Australia's (IA) plan noted that Australia's public debt
is, by international standards, relatively low. IA suggested that the government
may have borrowing capacity to finance economic infrastructure.
...this is an option that should be explored further. Provided
new infrastructure assets are economically-viable, investments could unlock
greater productivity across Australia and support current structural shifts to
a greater focus on a competitive, service-based economy in the Asia-Pacific
region.[2]
6.4
Mr Saul Eslake, Economist, believes that there is currently scope for
the government to increase its borrowings to fund productive infrastructure. Mr
Eslake referenced a recent statement by the International Monetary Fund (IMF):
For economies with clearly identified infrastructure needs
and efficient public investment processes and where there is economic slack and
monetary accommodation, there is a strong case for increasing public
infrastructure investment. Moreover, evidence from advanced economies suggests
that an increase in public investment that is debt financed could have larger
output effects than one that is budget neutral...[3]
6.5
In continuation, Mr Eslake said:
The IMF goes on to emphasise that this conclusion is not 'a
blanket recommendation for a debt financed public investment increase in all
economies,' but the conditions which would prompt the IMF to counsel caution in
particular cases—where debt-to-GDP ratios are already high or where returns to
infrastructure investment are uncertain—do not seem to be pertinent in the
Australian case.[4]
6.6
Mr Eslake looked to Australia's credit ratings to calculate a figure
government could spend, noting that:
Australia's AAA credit rating is safe as long as government
debt as a proportion of GDP remains below 30 per cent. There are different ways
of measuring it, but, at the moment, public debt, including that of state and
territory governments, is expected to peak somewhere around 22 per cent of GDP
in a couple of years' time....
...A rough rule of thumb, allowing for the fact that on average
during recessions Australia's public debt has increased by about 4½ percentage
points of GDP, could be that Commonwealth government borrowing for
infrastructure spending could increase by, say, three to 3½ percentage points
of GDP without seriously putting at risk the Commonwealth's AAA rating.[5]
6.7
When considering an amount of debt a country can carry, Dr Paul McLeod, Research
Program Leader, Planning and Transport Research Centre, University of Western
Australia, commented that the question is really 'whether or not the underlying
structure of the economy is such that it could sustain the debt currently and
even more debt.'[6]
6.8
Professor John Hewson challenged the basis for many concerns about
government debt by drawing attention to the conflation of debt to fund the
recurrent deficit and debt to fund capital (infrastructure) investment:
I think the way to start is to think in terms of jettisoning
the very simplistic notions that have been peddled in parliaments around
Australia that all debt is bad. If all debt were bad, none of us would buy a
house or build a business. We should draw a distinction between recurrent
expenditure and capital infrastructure expenditure in the budget and think
about ways in which we can fund infrastructure separately to that.[7]
6.9
Professor, Steve Keen, Economics, History & Politics at Kingston
University London, challenged the macroeconomic assumptions underpinning the
policy of seeking to maintain a surplus:
Since a government should run a deficit of the order of the
rate of growth of the economy in nominal terms, the fact that the government is
running a far smaller deficit means that spending on infrastructure and
essential welfare is well below what it could sustainably be. This generates
waste. It is wasteful to give our children less education than we can afford,
to maintain public infrastructure less well than we can afford, and to invest
less in research than we can afford.[8]
6.10
IA highlighted that public sector borrowing for infrastructure is
potentially more equitable as it distributes infrastructure costs across
current and future taxpayers who will benefit from the infrastructure.[9]
Price of debt
6.11
Professor John Freebairn, Ritchie Chair of Economics, University of
Melbourne, and Professor Max Cordon, Emeritus Professor of International
Economics, Johns Hopkins University highlighted the opportunity provided by the
historically low interest rates:
The context of Australia as an established net borrower from
a large global capital market, together with current low borrowing rates,
further supports a strategy of the use of government debt to fund
infrastructure with a transparent and public positive benefit cost assessment.
The issue of long term bonds to fund government infrastructure investment can
be an important part of a strategy to lock in lower interest rates over the
extended life of the productive investments.[10]
6.12
Ms Marion Terrill, Transport Program Director, Grattan Institute, explained:
It is clear that the opportunity to borrow to build
productive infrastructure is very good, with interest rates at historic lows.
The 10-year government bond rate is about 2.6 per cent, and the states' 10-year
bond rates are not much higher. Because governments can borrow cheaply, more
cheaply than companies can, there is a real opportunity for governments to take
advantage of such low interest rates, but spending is only worth doing for good
projects.[11]
6.13
One reason for the cautious approach to government debt is its potential
to affect the Commonwealth's AAA credit rating.[12]
Ms Terrill summed up why a AAA rating is important to government:
The AAA rating is part of what allows you to borrow cheaply,
and borrowing cheaply is a very valuable thing for government.[13]
6.14
This was again recognised by Standard and Poor's Ratings Services who
identified that the AAA credit rating was a government priority:
Although government budgets have capacity to absorb debt to
fund infrastructure, the majority of the Australian governments (at both
federal and state levels) have chosen to target 'AAA' credit ratings so that
they can ensure strong access to markets, lower costs of debt, and, most
importantly, deliver on their electoral promises to remain 'fiscally
conservative.'[14]
6.15
Ms Fabienne Michaux, Head of Developed Markets Asia-Pacific, Standard
& Poor's Rating Services, expressed the view that the Commonwealth does not
have much scope to increase borrowings without risking their credit rating:
This is because, even though government debt is fairly low,
we believe that the government's fiscal policy credibility increasingly hinges
on it broadly achieving its current budget forecasts. This is after a number of
years where planned improvements in budget outcomes have been derailed by sharp
falls in commodity prices, and the earliest we may now see a Commonwealth
budget surplus is 2020.[15]
6.16
Mr Craig Michaels, Sovereign Ratings, Standard & Poor's Ratings, re-iterated
that although debt is part of the rating considerations, the current focus is
on fiscal policy credibility:
...so yes, there is this debt threshold that is part of our
framework, but increasingly we are saying it is not enough just to keep debt
below 30 per cent, but a key part of the AAA has always been that we have
thought governments are very much committed to getting budgets back in the
black over a medium-term time frame.[16]
6.17
Mr Eslake explained that:
One of the principal reasons for the caution exhibited by
successive governments of both political persuasions at both the Commonwealth
and state levels regarding the funding through additional debt instruments of
higher levels of infrastructure investment is the concern at the risk that this
could trigger an adverse reaction from credit rating agencies, leading in turn
to a downgrading of the Commonwealth's or a state-sovereign debt rating and
thence to higher debt-servicing costs. There is no widely shared consensus
among mainstream economists as to how seriously such concerns should be ranked
as against other objectives and risks. The capacity to raise debt finance when
needed or to refinance maturing debt at advantageous interest rates is not
something to be dismissed lightly, yet nor should it, in my opinion, elevate it
above all other fiscal and economic policy objectives.[17]
6.18
Mr Eslake also said that the Commonwealth has a strong desire to
maintain its credit rating as the:
...credit rating underpins the AA rating of the four major
Australian banks, which in turn allows them to raise wholesale finance in
international capital markets at lower interest rates than would be the case if
the Commonwealth's and hence the Australian banks' credit ratings were lower.[18]
State government
6.19
Mr Eslake also explained that Commonwealth and state debt are different.
However no such concerns apply to the credit rating of state
governments. The only entities whose borrowing costs are affected by state
governments' credit ratings are the individual state governments and their
wholly-owned business enterprises. And even then the interest rates that state
governments' borrowing agencies actually pay on their borrowings are influenced
more by conditions in international sovereign debt markets, and by yields on
Commonwealth government bonds, than they are by their own credit ratings. Thus,
for example, Queensland has been able to borrow in recent years at much lower
interest rates since it lost its AAA rating than it could while it had that
rating, not because of the lower rating but because of the substantial decline
in benchmark bond yields since the onset of the global financial crisis.
6.20
Ms Michaux contradicted this by suggesting that Commonwealth and state
government ratings are closely intertwined which limits the scope for states to
increase borrowing for infrastructure.[19]
6.21
Mr Eslake proposed that state and territory governments could fund
infrastructure by borrowing from the Commonwealth. Mr Eslake suggested that the
Commonwealth obtains debt and on-lends it to the states and territories at a
small margin. If the Commonwealth on-lent to states, under the accounting conventions
used in federal budget papers and other government financial reports, the loans
made by the Commonwealth would be an offset to the increase in gross debt:
...so there would be no increase in the Commonwealth net debt,
nor would there be any increase in the Commonwealth's underlying budget
deficit, because the loans to the states would be classified under current
accounting conventions as a 'net increase in financial assets for public policy
purposes', which falls in the wedge between the underlying budget balance and
the headline budget balance—like, for example, the Commonwealth's investments
in the national broadcast network company...So there would be no net increase
in the Commonwealth budget underlying deficit, there would be no net increase
in the Commonwealth net debt and, therefore, no reason to expect the
Commonwealth's credit rating would be affected.
The state governments' net debt would increase, and their
credit ratings could be adversely affected, depending on the amount by which
their borrowings increased. But since the state governments' credit ratings do
not affect the borrowing costs of anyone other than themselves, and because the
Commonwealth would, in effect, be carrying the additional gross debt issuance,
there should not really be any serious consequences for anyone else as a result
of that kind of transaction.[20]
Raising government debt
Infrastructure bonds
6.22
The Productivity Commission (PC) found that in principle, using
securitised borrowing via government infrastructure bonds, for an
infrastructure fund could have advantages over general purpose borrowing. In
particular, to the extent that the interest rate reflects the risks of the
project, rather than the risks of default by the borrower. Bonds would make
financing transparent and could instil greater discipline on project selection.
However:
...if infrastructure bonds are used with the aim of bridging
the financing gap otherwise not filled by the market, they would need to
incorporate an incentive to investors to provide additional financing. To the
extent that bonds are an alternative way of subsidising the project, the price
of the bond (and, hence the interest rate) will no longer reflect the risk of
the project, and the above advantage of project-specific bond finance disappears.[21]
6.23
Government issued infrastructure bonds may have some positive perception
value as the debt is being raised is for the overall public benefit. For
example:
...Waratah bonds issued by the NSW Government are being
promoted to investors 'who want to secure a better future and invest in their
state'...The marketing of government debt as being for the purpose of
infrastructure investment may also make it more politically acceptable and
assist in overcoming the consequences of public misconceptions about government
debt...
Ultimately, if government-issued infrastructure-specific
bonds are to facilitate additional investment, they are likely to involve some
form of subsidy. This is confirmed by past experience with such bonds in
Australia...and is consistent with comments from some participants after the
draft report...The subsidy can take various forms including tax advantages...or the
underwriting by the government of the project's risks.[22]
6.24
Dr McLeod cited examples from the United States (USA) where
infrastructure bonds are used widely to fund public infrastructure:
Many US cities issue municipal bonds to fund local
infrastructure and do so more or less successfully, according to the inherent
economic strength of the city.[23]
6.25
Mr Karl Fitzgerald, Project Director, Prosper Australia drew a
relationship between the use of infrastructure bonds and value capture. Mr
Fitzgerald said that infrastructure bonds were:
...a snazzy word for using the sovereign ability to sell
securities and have that sovereign guarantee to repay them, which is underpinned
by the value capture process.[24]
6.26
However many witnesses supported the exploration of infrastructure
bonds. Ms Debra Goostrey, Chief Executive Officer, Urban Development Institute
of Australia (WA) indicated there would be advantages to this approach:
Remember that at certain times funding for infrastructure and
urban development dries up, so by having a bonds approach you can level out the
availability of finance. Yes, at various times it might be a little busy in
that part of the market, but at other times it will be an essential source of
funds.[25]
6.27
Mr Jeremy Cordina, Chair, Infrastructure Committee, Urban Development
Institute of Australia (WA) also saw merit in this approach:
In many ways the finance industry is as cyclical as any other,
so if you had another mechanism that fills the gap that would be fantastic.[26]
6.28
Professor Hewson, suggested that there was scope for the Commonwealth to
investigate financing infrastructure through a fund which issued government
securitised infrastructure bonds, which could be issued at a low rate of
interest.[27]
6.29
Professor Hewson told the committee that banks, superannuation funds and
sovereign wealth funds would welcome infrastructure bonds as they cannot really
find a similar funding stream anywhere else:
We do see quite a lot of money flowing from, say, Canadian
pension funds into the Australian finance markets, some in shares and some in
fixed interest. A lot of central banks want the equivalent of fixed interest,
even though it has not been a great investment in terms of the returns they
make on it- it is a basic security fixed interest number.[28]
6.30
The committee heard that a key challenge for infrastructure bonds is the
expectations about the rates of return. Ms Goostrey emphasised that this would
come down to the level of risk and that lower returns can be useful in a
diversified portfolio:
If you invest directly into a development, you are wearing
the entire risk of any delays or problems with that project. If you are
investing in a diversified pool with returns, particularly with infrastructure,
if you have long-term contractual agreements with a government entity or
others, that de-risks and therefore the returns do not need to be as high. In a
diversified portfolio, they become useful. So it is all about risk. If you can
de-risk it through those long-term contracts or other arrangements, it will be
a valuable part of people's portfolios.[29]
6.31
Dr Phillip O'Neill, Director, Centre for Western Sydney, University of
Sydney commented that investors committing to an infrastructure project need to
get a rate of return competitive with what it can get globally:
So you will not accept a lower rate risk adjusted in one
country than another. They manage, in part, their risk by having a diversified
portfolio of products.[30]
6.32
Professor O'Neill was more cautious about the potential for
infrastructure bonds and told the committee that the options for government
were somewhat limited:
The only thing that governments can do by way of issuing
bonds or securities for the infrastructure sector in Australia - it is
different in other parts of the world - given the strength of the Australian
fiscal scene, is offer a slightly lower cost for borrowing and a risk-sharing
process.[31]
Pooling projects
6.33
The committee heard that one option to overcome difficulties in the
provision of public infrastructure is packaging or pooling smaller projects
together to diversify risks for investors over a longer time period using
vehicles such as municipal bonds.
6.34
Mr Cordina also suggested that packaging infrastructure bonds to form a
portfolio of projects, rather than a single project would be a sensible
approach for risk management diversification.[32]
6.35
Dr Ian Martinus, Economic Development, City of Wanneroo indicated that
this option has not been sufficiently explored.[33]Dr Martinus
emphasised that investors would be interested in transparent low risk packaged
opportunities:
This is even for Australian investment funds and offshore
sovereign funds. It really does not matter to some people what is in the
basket. It matters on the level of risk. If it is backed by assets or
Australian AAA bond rating or whatever this thing is, this debt guarantee, we
would get our outcomes and the people considering the investment would get the
opportunity.[34]
6.36
Ms Jane McGill, Senior Policy Adviser Infrastructure, Industry Super
Australia, showed that pooling projects has been tried in the UK around schools
where they have the aggregator model:
They aggregate the finance and then they run multiple
projects in multiple districts. But the interesting thing about it, which makes
it very similar to the inverted bid model, is that the government first secures
the finance—they first find the financial and investment partners—and once the
money is in place, then they tender for the construction and operation of the
schools. There is another similar model that does something similar in Scotland
called, I think, the SPD. The inverted bid model would be very suitable to
bundling a large number of projects that have similar characteristics.[35]
6.37
Dr Martinus indicated that to make the investment instrument attractive,
the competitive advantage of a region could be emphasised.[36]
Dr Martinus spoke about the ways in which this could occur:
...a discount or zero-coupon bond, mum and pop investors could
look at it as part of their superannuation or WA Super could look at. There
would be great opportunity. The cocktail component derisks a lot of the
elements for any one player and provides something at LIBOR plus three or
whatever it is. Even I as a private investor am interested in the future of
this state and, obviously, Australia. The competitiveness for me and my
children—being selfish—is my wanting to see them finish their further studies
and work and live in reasonable proximity of where they recreate and do things
with their families.[37]
6.38
However, Mr Anthony Schinck, Chief Executive Officer, City of Ballarat,
cautioned that local councils may find this impractical as local councils have
difficulty in packaging small parcels of debt together.[38]
6.39
The PC report noted the potential benefits of aggregating or bundling of
smaller projects that have a higher benefit-cost ratio:
The preference for iconic projects can also come at the
expense of smaller-scale projects that address particular bottlenecks or lead
to more efficient use of existing infrastructure.[39]
6.40
Further the PC report noted that smaller projects tend to have a higher
benefit-cost ratios:
...The Office of the Infrastructure Coordinator...indicated that
this trend reflects that smaller projects are more likely to be targeted at
addressing problems that are preventing better use of the wider network.[40]
Municipal bonds
6.41
The committee also heard from several witnesses that municipal bonds
could be an option to finance local government infrastructure. Citi in its
submission articulated that developing a municipal bond market is 'a natural
extension of the infrastructure debate at the local government level'.[41]
6.42
Citi outlined the many ancillary benefits for issuers and investors:
Firstly, it allows the cost to be spread to future
generations who will also benefit of the assets. Secondly, it prevents the need
to divert funds from internally generated renewal and maintenance budgets to
capital expenditure. Thirdly, debt finance promotes rules-based and
market-based discipline for municipals as the ability to borrow responsibly and
to meet future debt servicing obligation is normally dependent on rigorous and
robust financial governance politics and long-term planning. Fourthly, it can
facilitate institutional investment as local governments enjoy steady and
secure income streams like rates which can be used to meet debt servicing
obligations and secure debt facilities.[42]
6.43
Dr Joseph Drew, Research Fellow, Centre for Local Government, University
of New England, discussed encouraging local or municipal bond markets with a
municipal bank:
[with a] protected monopoly position, and the idea is that
they use municipal funds from councils who do have the funds to spare and bank,
and then lend out to councils who need funds to achieve something...They can also
put small parcels of debt together, and if they were to be backed by the
federal government or the state government then they would have a high bond
rating and they could secure funds at a sensible interest rate.[43]
6.44
However, Dr Drew conceded that an Australian municipal bond market may
not be sufficiently large to address infrastructure needs, even if it was
backed by governments. He believed that there was significant capacity for
private sector involvement:
The problem there is that the estimates of the infrastructure
backlog would suggest that we actually need private funds to come in, that
municipal funds in themselves are not going to be enough to do the job.[44]
6.45
Ernst and Young recommended that the Commonwealth investigate
establishing a 'national financing authority for local government' to encourage
private investment in local government infrastructure programs.[45]
It suggested that this authority could:
...bundle approved council borrowings into a limited number of
bond issues, which could by underwritten by the Australian Government.[46]
6.46
Ernst and Young argued that low-risk and competitive municipal bonds
would be an attractive investment for many private investors, including
Australian superannuation companies.[47]
6.47
Mr Sean Cameron, Manager for Economic Development, City of Ballarat,
emphasised that when packaging projects a central organisation is needed help
pull the project together. Mr Cameron suggested a revamped IA for the role:
That may be some form of Infrastructure Australia that can
actually look at that and start delivering the expertise to identify back to
the regions. We have done a lot of work in that space to understand what
productivity improvements we can get across the city in certain projects and
different economic infrastructure projects that we have a pipeline to. A lot of
other cities do not have work or do not have the expertise in local government
to actually identify those. It is not a case of just being asked to go to the
other cities and say, 'This is what we think. Let's pool.' We also need someone
to actually help work with the cities to identify those so that it does not
become a wish list which says, 'We have got this road or we have this piece of
infrastructure.'[48]
6.48
Mr Schinck added that the assistance would be with 'packaging up the
asset classes in a way that is going to be attractive to a commercial market'.[49]
He suggested that this might not necessarily be based on geography but it might
be based on types of asset classes:
It might be that it is more synergetic for large-scale
regional cities to bundle together. However, I would be really interesting in
looking at models that blend those larger regional councils with smaller rurals
that have less capacity...
Really, the technical advice that we require is the
opportunity, I think, to look more broadly and nationally at how we would most
effectively bundle those infrastructure investment opportunities that are going
to be attracted to the commercial centre.[50]
6.49
Mr Schinck informed the committee that the Municipal Association of
Victoria (MAV) has commenced issuing municipal bonds which is a cooperation
between MAV and a large commercial bank:
I think the first or inaugural issue was for about $200-plus
million worth of bonds that was then accessible to the participating councils
in a fixed rate, interest-only loan as an alternative way of financing
particularly the money that is required to keep pace with the capital growth of
those cities. So if I look at the cities that have accessed that, I would see
the cities that are not getting a good deal out of banks or the cities that are
dealing with very acute, high-growth pressures and that have an enormous civil
infrastructure program that needs to be funded and funded in a way that is
cost-effective for that council.[51]
6.50
Citi Research outlined that the strong financial position of municipal
bonds could result in a new industry whereby bonds could eventually have a high
credit rating in their own right.[52]
Legislative issues
6.51
The Western Australian Local Government Association (WALGA) raised
legislative restrictions as an additional constraint:
...Councils in WA are often constrained by restrictive
legislation that limits their ability to more efficiently invest in the
required infrastructure.[53]
6.52
Mr Raymond Tame, Chief Executive Officer, City of Armadale, outlined
that current legislation limits access to finance:
We have a little thing called the Local Government Act, here,
which severely limits our capacity to get into private partnerships. We have to
get some relaxation of that, based on aversion to risks going to historical
features of state government 25 years ago.[54]
6.53
Mr Schinck explained that there needs to be a greater exploration of
funding that does not require grants from a higher government tier.[55]
Mr Schinck indicated that the current funding model is anchored on population
and financial availability. The opportunity to factor in the potential for
growth is not taken into consideration:
If we were to try and fund a project now, it would really
depend upon our existing book of commitments, our current financial situation
and, quite honestly, what our rate revenue looks like for the next couple of
years. What we are trying to get to here is a position where in fact there is a
suite of financing opportunities that are available to local government in
order to catalyze those projects that are going to have a long-term impact on
advancing growth...[56]
6.54
Mr Michael Foley, Chief Executive Officer, City of Swan, reported that
the situation is compounded because borrowing from state government is still
the cheapest and most reliable option:
I think the current rate is 3.09 per cent for 10 years, which
is still quite cheap compared with what it was years ago. We can still do that
at the moment and go and borrow too much money.[57]
6.55
Dr Martinus indicated that the current approaches to funding
infrastructure at the local government level are limited:
When trying to fund infrastructure...if local government, with
a decent balance sheet, and knowing it can project itself for 20 or 30 years of
rates, does not look at other opportunities for debt mechanisms or putting
something to the market in a package, it will be limited. As was mentioned
earlier, we wait on applications for federal funding or we go to the states and
we beg, but we rarely look at our balance sheets or a public-private mechanism.[58]
Private sector investment
6.56
The PC report provides data on the scale of private sector investment in
public infrastructure:
...the ABS National Accounts data indicates that the value of
Australia's capital stock of public infrastructure was approximately $991 in
2013 (at current prices, comprised of general government ($432 billion),
non-financial corporations ($520 billion) and financial corporations,
households and not-for-profits ($39 billion) (ABS 2013b). The non-financial
corporations category includes both private and public corporations. While no
accurate data are available, an indicative estimate is that public
non-financial corporations owned about half the infrastructure in these
selected industries, and private non-financial corporations owned the other
half (or about $260 billion).[59]
6.57
The PC considered that privately issued bond finance 'can play a role in
infrastructure investment, the availability of this type of finance can be a
source of competitive pressure on other types of finance'.[60]
6.58
A number of witnesses recognised the option of private sector investment
and ownership of public infrastructure. Mr Eslake, expressed the view that
there is:
...a role for private finance in infrastructure spending and
not all infrastructure spending needs to be financed by government debt. Not
all infrastructure assets need to be owned and managed by governments.[61]
6.59
Dr McLeod noted that the appropriateness of private sector investment is
related to the source of funding.
There are projects where I think a proponent could say, 'This
ought to be justifiably done with government money,' and there are others where
you could justifiably say, 'This is almost a purely private work. User charges
would essentially fund it and that is how we intend to do it.'[62]
6.60
Similarly, Professor O'Neill made the point that:
The thing that drives the delivery and operation of
infrastructure is the source of funding. So it is not, 'What is the capacity of
governments to borrow?' It is, 'What is the capacity of governments to actually
provide either a taxation stream to fund that finance, or to generate the
conditions for user pays in order for other ways to be put in place for that
finance to be funded?'[63]
6.61
However, Professor O'Neill also noted the cost of private sector
financing:
Certainly, if you issued government bonds there would be a
slightly lower cost of capital than if the private sector raised the same
amount of money. The issue is how you pay for the cost of capital.[64]
6.62
Professor O'Neill also pointed out that where the private sector does
own public infrastructure that it is important for the government to regulate
the market to deliver public benefit:
The role of governments is to create the conditions for
market competition. Only governments can regulate the way that the market
operates. Only governments can legitimise the securing of profit and its
subsequent ownership as private wealth. The private sector would love to do it
in a much more streamlined process where they do not have to compete for it,
but we know that the benefits of private enterprise are at their greatest when
private enterprise is subject to competition. That is the role of government in
the infrastructure sector: to make sure that there are no easily gotten gains
and that, once the private sector secures ownership and operation of the asset,
there are dynamic efficiencies that are brought to bear through the regulatory
structures in order to make sure that the public benefit is maximised.[65]
Public-private partnerships
6.63
Public-private partnerships (PPPs) are a mechanism for facilitating
private sector investment in infrastructure projects. A PPP is a long term
contract:
...between the public and private sectors where government pays
the private sector to deliver infrastructure and related services on behalf, or
in support, of government's broader service responsibilities. PPPs typically
make the private sector parties who build infrastructure responsible for its
condition and performance on a whole-of-life basis.[66]
6.64
The committee heard from Standard and Poor's Ratings Services that, PPPs
could have substantial benefits for government:
As well as potentially freeing up funds that can be allocated
in other areas, cost overruns are typically lower in privately-financed
projects, and risk is also transferred, with the private party bearing the
overrun cost. It is often the case that good infrastructure benefits the whole
economy. Typically privately-backed projects are more innovative and efficient
on several measures, including energy consumption, with benefits flowing
through to other areas of the economy.[67]
6.65
Mr Jack Gilding,
Executive Officer, Tasmanian Renewable Energy Alliance Inc, supported the use
of PPPs and provided
an example where it has been successfully used to produce renewable energy
infrastructure:
... the ACT
government put out to tender for what they called a reverse auction. They said,
'Who will bid the lowest price to give us renewable energy for the next 20
years?' The price that the ACT government got was 8c a kilowatt hour, which is
certainly a little bit higher than the current wholesale price, but it is a
fixed price for 20 years. So when you do the net present value of that, it is
actually a very affordable source of electricity. That is the way of the energy
consumer seeing that they got the best possible value—by getting private
developers to compete against each other and coming up with the cheapest price
for a new renewable capacity.[68]
6.66
Mr Martin Locke, appearing in a private capacity, suggested that there
are a number of risk management factors that should inform whether projects are
undertaken as a PPP:
...you actually have to have an equation where you can say the
benefits from cost efficiency or risk transfer more than outweigh the higher
costs of raising private financing, as compared to public financing...When I look
at this concept of risk transfer, what it is really saying is that the private
sector is putting its hand up and saying, 'We are in a better position to
actually manage those risks and give you, the public sector, a better outcome'.
So, in terms of management of construction risks or maintenance risks, the
private sector, in some cases, has certainly been
seen to demonstrate that it can generate value over and above public
sector delivery.[69]
6.67
However, Ms McGill challenged the notion that risk could be transferred
to the private sector:
This issue of de-risking is a really interesting one, because
we had a lot of projects that failed based on overly optimistic forecasts
around demand and people became more and more reluctant to take on that risk,
and the supply of capital around tollway projects pretty much dried up. Someone
then came up with this notion that they will de-risk projects so that the
government would hold on to that patronage risk or that demand risk and then
the project could be financed. We take a different view. The use of
availability payments, like they did on the Peninsula Link, does work in
certain circumstances, but why would governments engage with the private sector
in this sort of PPP arrangement if they are not transferring risk to the
private sector to be managed?[70]
6.68
Dr McLeod commented that, then:
...there is the question of whether we have the right financial
instruments to feed into the processes. Many PPPs, as I pointed out in that
research paper, end up being very, very complex structures with very, very many
participants, which makes the process of risk management even harder over time,
because the consortium members have different expectations.[71]
6.69
While Professor O'Neill agreed that private sector involvement in
infrastructure had its place, he suggested that governments need to take a new
approach to PPPs. Professor O'Neill called for closer regulatory requirements
to ensure transparency and effective assessments of when private investment is
most appropriate:
...We really need to know under which circumstances and under
what sorts of regulations private infrastructure provisions thrive, and in
which regulatory circumstances private infrastructure does not thrive. When
does the public get most benefit?...Whether you are an advocate of public
sector efficiency or of the benefits of the market, what we do know is that
efficient knowledge and learning from the past in order to improve to the
future is at the core of economic progress. And here we have in the
infrastructure sector -probably the newest emerging private economic sector in
the world -governments intervening in ways that inhibit learning, because we do
not know the conditions under which privatisations take place, so we cannot
say: 'That is good. That is not working. This is working. Let's move the
regulatory regime in that particular direction.'[72]
6.70
The committee heard that while the use of PPPs has been increasingly
popular over recent years there have been 'mixed results'.[73]
Ms Terrill informed the committee that:
Recent large infrastructure projects in Australia have
typically suffered from cost overruns of about 15 per cent, while patronage has
been 15 per cent lower than projected.[74]
6.71
While the PC noted several successful PPPs they also highlighted
examples of PPP infrastructure projects that had incurred financial losses. For
example, the Latrobe Regional Hospital in Victoria suffered operational losses
incurred from a low initial bid price and because of the 'inability of the private
sector consortium to make the efficiency gains originally assumed.' The New
South Wales Government incurred losses from the Sydney Airport Rail Link after
the PPP partner failed to meet scheduled payments to creditors.[75]
6.72
Mr Locke was also concerned that currently the flow of investment into
Australia was pushing the rate of returns too low for many investors to find
PPPs attractive:
...the pressure of the flow of money internationally and from
the domestic superannuation fund is actually putting real downward pressure on
the yields available in infrastructure, and certainly some commentators would
say that we are at a point where, almost, the returns are being pushed too low.
If you are looking at it from the perspective of a superannuation fund, given
the significant reduction in yields available in the bond market, it becomes
quite difficult to see how you can easily get longer term yielding assets to
provide the rate of return that superannuants are looking for.[76]
Local government
6.73
The committee heard that for investors, local government projects were
often insufficient in size and had limited return on investment. As a result
obtaining infrastructure finance is difficult. Mr Brenton West, Chief Executive
Officer, Southern Tasmanian Councils Authority considered that:
The scale of the state is sometimes prohibitive without
government incentive to make it occur. There are a number of brownfield and
greenfield sites throughout the region that could be infilled, but it is
getting the right investment conditions and the right incentives to make it
occur.[77]
6.74
Mr West re-iterated that user pays
funding[78]
such as tolls and taxes may not work for local governments:
With the small size of southern Tasmania, with a diverse and
spread-out population, it is difficult to see that we have the scale of
Melbourne or Sydney or a culture of toll roads.[79]
6.75
Mr Schinck explained that in regional Australia it is difficult to
attract private equity, capital or investment regardless of the improvements it
will generate:
...simply because the returns on investment are not always
there or not always comparable to capital cities, to airports, to other forms
of infrastructure. We find it very difficult to be able to package up blended
investment into projects. As I said, it quite often relies on the
council...having to fund projects to a large extent or having to leverage off
both state and federal opportunities for funding...[80]
Superannuation funds
6.76
Standard & Poor's Ratings Services highlighted that Australia's
expanding superannuation industry provides an opportunity to fund
infrastructure investment that will in turn drive stronger economic growth:
...the pool of superannuation funds could be used to help fund
infrastructure, given the budget constraints faced by Australian governments.[81]
6.77
Standard & Poor's noted that Canadian pension funds are some of the
largest investors in Australian infrastructure. They highlighted to the
committee a number of barriers preventing greater investment from the
superannuation industry in local infrastructure, namely:
...the mismatch between superannuation funds' liquidity needs
and the illiquid nature of infrastructure as an investment class. Canadian
pension funds, for example, don't face the same requirements and therefore can
invest much more heavily in infrastructure. As defined benefit schemes (as
opposed to defined contribution schemes, as in Australia), Canadian funds can
focus more strongly on maximising long-term returns and less on investing in
liquid asset classes. In particular, Australian super funds need to maintain
liquidity because consumers can switch between super funds at will to seek
higher returns; in Canada, defined benefit schemes mean consumers have little
reason to switch between pension funds.[82]
6.78
The PC also mentioned the difference between Canadian and Australian
funds and noted that:
...the majority of superannuation funds in Canada are larger
defined benefit funds, whereas Australia's are predominantly smaller defined
contribution funds, which might allow Canadian funds to accept more liquidity
risk.[83]
6.79
Standard & Poor's expressed the view that the participation of
Australian superannuation funds should be encouraged as they 'may provide a
more stable source of funding'[84]
and suggested that to address the issue of liquidity other models should be
considered:
If growth is a key policy objective, and illiquidity is
determined to be a key inhibitor to accessing private sector funds to fund
viable infrastructure projects, then supporting the development of liquid,
tradable claims on infrastructure projects through private sector innovation or
co-investment models with the government would appear to be worthy in our view
of further consideration.[85]
6.80
Mr John Lawrence,
appearing in a private capacity, commented that 'infrastructure spending will grow the national
pie.'[86]
Mr Lawrence advocated for a mandated purchase of government bonds by
superannuation funds to finance infrastructure investment:
For me,
the rationale to borrow for infrastructure does not rely on the fact that
government borrowings are low compared to other countries or that interest
rates are at record lows. The reason it is a good idea is that payment of
interest does not consume resources or reduce GDP; it is simply a split up of
the enlarged pie. For every dollar of government borrowings someone holds a
financial asset. It can easily be mandated that super funds, for instance,
especially those in the pension stage that are paying nil tax and wishing to
hang onto their tax concessions—which look like they may be revised—use a small
fraction of their two trillion in assets to buy government bonds....
...Payment
of interest, the splitting up of the GDP pie, then becomes part of retirement
income policy.[87]
6.81
Mr Fitzgerald, cautioned against using Australian superannuation as a
funding source for infrastructure without value capture:
The problem there—and perhaps I should have qualified it—is
that superannuation could be a funding source, but only if there is a value
capture mechanism supporting the user charges and possible federal grants. If
it was part of the funding mix, that would be okay, but I am just horrified by
the thought of workers' hard-earned savings being thrown to the wolves because
of these extravagant infrastructure costs, extravagant traffic flow funding
models, and then a poor financing mechanism using $14 or $15 tolls for people
to get to work each day. It is just not going to work.[88]
Industry super funds
6.82
Ms McGill informed the committee the superannuation system currently had
assets exceeding $2 trillion. This is set to increase to $6 trillion by the
mid-2030s 'when we would rival the banking system in total assets'.[89]
6.83
Ms McGill confirmed that investment in infrastructure is already
occurring and they 'have assets around the world'.[90]
Ms McGill explained investing in infrastructure is an attractive option
for industry superannuation funds:
As you would be aware, the funds have very long investment
time horizons, which make it possible for them to invest in such illiquid assets.
On average, the funds have 20 per cent of their assets in unlisted assets like
infrastructure. Our wholly owned fund manager, IFM Investors, is the largest
infrastructure investor in Australia and one of the top three infrastructure
investors globally, so we already playing with the big boys. They have
delivered fantastically for our members. Over two decades their fund has
achieved an average return of 11.5 per cent after tax and after fees, which is
a very attractive return compared with equity markets.[91]
Greenfield investment
6.84
Ms McGill indicated that most of their investments are in brownfields
assets and they almost never invest in greenfields projects.[92] The PC explained that:
Brownfields asset classes are attractive to institutional
investors, such as superannuation funds, because they provide a long-term
stable net revenue stream with low operating risks...[93]
6.85
The Industry Super Association informed the committee that changes in
Australia around the current bid model for infrastructure investments are
needed to allow the superannuation industry to realise investment in
greenfields projects. Ms McGill highlighted that the current bid process
for greenfields projects are convoluted, costly, time-consuming and uncertain.[94]
6.86
Ms McGill outlined that the superannuation funds are in a different
position to short-term investment banks. Short-term investment banks can put
capital at risk, with a view to winning one out of three or four projects. Ms
McGill commented that superannuation funds cannot use member money to loss lead
a project:
We are not in a position to say 'We are going to bid for this
project and by the way we need $10 million out of the funds in order to cover
the costs of the bid.' If the bid costs stay as high as they are now, we will
stay on the sidelines in terms of greenfield investment. We do not want that to
be the case. We want to begin to engage in the greenfield sector. It is great
diversification for us and offers high returns because there are greater levels
of risk to manage, but it really flexes our muscles in terms of our capacity to
manage assets over the long term.[95]
6.87
Ms McGill pointed to a misalignment of interests between short and long
term investors created by the current bid model. Short-term investors are
currently bidding for, and building long-term infrastructure projects, yet are
not in it for the long term:
They come in and they structure the bid, they earn in some
cases tens of millions of dollars of fees for doing that, but as soon as
financial close on that project has been achieved they are gone. That
introduces a real dilemma because if you are not going to be accountable for
your financial forecasts and the viability of the project, you are going to be
really motivated to make overly optimistic forecasts because that is how you
come out with the cheapest price and that is how you win the bid. You get your
transaction fees and you go.[96]
6.88
Dr Robert Bianchi, Associate Professor of Finance, Griffith University,
encouraged more investment in greenfield projects and proposed:
...for the Australian Commonwealth government to finance and
fund new greenfield infrastructure projects while they are in the design and
construction phases. Once the infrastructure project progresses to the
operations phase, the government can on-sell the asset to the superannuation
industry as a mature infrastructure project...[97]
6.89
Dr Bianchi also suggested changing the funding mix during the lifecycle
of infrastructure projects to encourage greater involvement from superannuation
funds: For example:
[The] superannuation industry can be encouraged to invest in
a greenfield infrastructure project based on the investors receiving government
availability payments when risk is at its highest in the design and
construction phases. When the greenfield project progresses to the operations
phase, the availability payment ceases and it is replaced by a market based
toll/fee for the use of the public infrastructure.[98]
'Inverted bid' model
6.90
Ms McGill suggested a different funding model called 'the inverted bid'
which would lower the initial cost of participation by securing the long-term
owner operator:
...it might be a Future Fund, it might be a QIC, it might be
Aussie Super, it might be an IFM Investors, it might be a consortium of them.
What is important is that they are equity investors, not debt, and that they
are in it for the long haul. That does not mean they can never sell that asset
down but they are much more likely to hold an asset like that for its life than
they are to sell it. Once the government has established that partnership with
a group of long-term equity investors, they then move onto phase 2, where they
have a bundled tender for the other project partners. The other project
partners would be your construction, your operation and maintenance and all
your legal and other advisory services. You pay a small price to get into the
game at the outset and going through what is called this equity funding
competition to see if you are the successful bidder. If you are unsuccessful
you walk away, you have not lost a great deal of money; if you are successful,
you will incur further costs but it is in connection with a real, tangible
project.[99]
6.91
The committee heard that the inverted bid model would be suited to
larger, more complex projects because:
...[t]he inverted bid model brings a level of sophistication
and elevates the quality of the partnership with government around a project
that is more complex and hence more risky. It also gives you the scope for
government and the investment partner to actually say, 'Let's imagine down the
track that something changes, how would we manage adjusting the contract to
achieve that outcome?' That is not possible under the current model. So yes,
complex and risky projects and probably large, expensive projects.[100]
6.92
Ms McGill indicated that Industry Super Australia has participated in
the PC review and have undertaken extensive consultation in relation to the
inverted bid model. The process was favoured by construction companies as:
Construction companies hate the current bid process, because
they have to bear quite a lot of the cost in order to be involved. They see our
model as a much neater solution, because the money is already there on the
table and they just have to do what they do best and bid for the construction
of a project.[101]
6.93
The PC ultimately came up with its own 'hybrid' model 'which pursues the
same objective as the inverted bid model and adopts a number of its elements'
while overcoming 'some of the shortcomings' and 'offers a more gradual change'.[102]
Self-managed super funds
6.94
Mrs Andrea Slattery, Managing Director and CEO, Self-Managed Super Fund
(SMSF) Association, told the committee that the SMSF sector is suited to
investing in and funding infrastructure:
With $590 billion funds under management in the SMSF sector,
which is predicted to grow to $2.2 trillion by 2033 by the Deloitte Access
Economics report, with about one-third of these funds held in low-risk assets,
we believe the SMSF sector is ideally suited to infrastructure investment. This
large pool of low-risk preferred capital would be viable in a stable source of
Australian infrastructure funding in the years to come.[103]
6.95
Mrs Slattery explained that infrastructure offers an attractive
alternative investment as it has a risk-return point between cash and fixed
interest and equity investments:
Additionally, the asset's characteristics of low volatility,
stable yield and acting as an inflation hedge is attractive to SMSFs, whether
they are still saving or in the retirement phase. Such assets help SMSF
investors attain sustainable retirement income and manage longevity risks.[104]
6.96
However, the committee heard that while there is appetite for investment
in infrastructure, currently there are significant barriers to this occurring
in the areas of liquidity and high investment management fees:
Currently SMSFs are extremely limited in investing directly
in infrastructure due to the high dollar threshold for infrastructure
investment and the illiquid nature of the required investment. Also, the high
investment management fees for non-direct infrastructure investments can be a
disincentive for those cost-aware SMSF investors. We believe that addressing
these liquidity issues and removing administrative barriers will provide the
most significant challenges in allowing SMSFs to have better opportunities to
invest in infrastructure projects.[105]
6.97
Mrs Slattery suggested that overcoming the current limitations could be
achieved by unitising investment and infrastructure projects to smaller
investment units or parcels for SMSFs, in the area of $25,000 units or issuing
small scale government or other infrastructure bonds. Developing a secondary
market for these products would allow SMSFs to manage liquidity risks,
especially in retirement phase so they can realise their SMSF capital to
generate income.[106]
6.98
Mr Jordan George, Head of Policy, SMSF Association, explained that with
the length of infrastructure projects, bonds would have different values at
different times which would allow people to get in and out at different phases.[107]
Mr George stressed that people with self-managed superannuation funds need to
have assets or products that generate stable, long-term returns but with
flexibility.[108]
6.99
The PC also noted liquidity requirements which, it was argued,
constrained the ability of superannuation funds to invest in relatively
illiquid asset classes such as infrastructure. They also noted that others have
argued against such changes in order to assure stability in the superannuation
system. The PC concluded that the primary objective of superannuation funds is
to provide benefits to retiring members:
Australian superannuation funds already have relatively high
average asset allocation to unlisted infrastructure relative to other developed
country pension funds, and can invest in infrastructure assets through a range
of channels — particularly in mature brownfield assets — either directly, or
through pooled open-ended unlisted infrastructure funds and various index
funds.
More generally, infrastructure funds have an incentive to
optimise their portfolio between different asset classes, with liquidity being
one of the considerations. Interventions that blunt those incentives would be
sub-optimal.[109]
Accounting and management
6.100
IA state in their Infrastructure Plan that:
More effective use of public borrowing that differentiates
between 'good debt' for infrastructure investment and 'bad debt' to meet
unsustainable operating expenses.[110]
6.101
Mr Eslake strongly supported the separation of infrastructure spending
in the Commonwealth government accounting:
...state and territory governments have, in most cases, for 15
or more years presented their budgets and subsequent financial reports,
mid-year economic updates and the like in overtly accrual accounting terms so
that the measure of their fiscal prudence or otherwise is usually the net
operating balance, which is revenues minus recurrent expenses, including
interest and depreciation. Separate consideration is then given to the capital
budget, financed by the operating surplus, if there is one then government
borrowings, various leasing and other financing transactions. That would
encourage what I think is a more mature, sensible and commercial view of
infrastructure spending. And accrual accounting is, of course, the way listed
companies and private businesses manage their financial affairs and very few
businesses regard borrowing to fund long-term investment as inappropriate.[111]
Infrastructure funds
6.102
Professor Hewson, agreed with the separation of infrastructure spending
from recurrent spending, and suggested money raised from infrastructure bonds:
...go into a separate fund, separate from consolidated revenue,
that would be professionally managed and administered. It would be available
for use as equity and/or debt finance for specific projects.[112]
6.103
The PC explains:
The term 'infrastructure fund' potentially captures a variety
of models. Some involve funding dedicated to a specific-purpose fund within the
public sector. This may or may not be accompanied by new rules, criteria and
processes (including between levels of government) to determine the allocation
of funds. Other models may involve the creation of a new entity to administer
the funds and/or other forms of financial support. Such approaches are more
akin to the 'infrastructure bank' model.[113]
6.104
The PC noted the suggestion of infrastructure funds as a means to:
...address problems with the availability and certainty of
funding for infrastructure projects, and could also include governance
arrangements which provide incentives for better project selection and more
efficient delivery.[114]
6.105
During its inquiry, the PC noted that IA proposed consolidating
government funding sources into a single national fund. IA suggested that this
would:
...improve the quality, efficiency and transparency of
infrastructure spending by leading to a more robust prioritisation of projects,
and a move away from a project-by-project view of infrastructure development...[115]
6.106
In its Infrastructure Plan, IA again proposed establishing an infrastructure fund
to encourage consistent decision making and to ensure funds are directed where
they are needed most. IA's plan identified multiple Commonwealth infrastructure
funding programs with singular purposes and individual assessment frameworks.
IA identified that prioritising infrastructure projects is at times
unnecessarily disjointed:
Infrastructure spending is dispersed according to often
overlapping purposes of different funding pools. This means the outcomes of the
Australian Government's infrastructure spending can be inconsistent and poorly
directed. This situation reflects the tendency by governments to establish
single funds to solve single problems rather than taking an integrated network
approach.[116]
6.107
At the Melbourne hearing IA also spoke about this proposal:
At the moment there are lots of different separate funds.
This is largely looking at it from a federal government level. There are lots
of different federal funds. We are suggesting that, particularly within
transport, that they are brought together in one fund.[117]
6.108
Professor Hewson proposed that an infrastructure fund could co-invest
with banks and other private equity groups to develop some projects:
....every project would be structured in a projects-financed
sense—perhaps differently one to the next, there are different mixtures of debt
and equity—but that fund would be in a position to drive it. With the
government putting its imprimatur, if you like, through the fund on such
projects, I think the private sector bank and private equity sector would be
well attracted to that.[118]
Infrastructure bank
6.109
The concept of an infrastructure bank is active in Europe in the form of
the European Investment Bank[119]
and under consideration in the USA (the National Infrastructure Development
Bank).[120]
6.110
As noted earlier in this chapter, Dr Drew proposed an infrastructure
bank for municipal borrowing:
The recommendation is a municipal bond bank where you can
have the best of both worlds. They can also put small parcels of debt together,
and if they were to be backed by the federal government or the state government
then they would have a high bond rating and they could secure funds at a
sensible interest rate.[121]
6.111
The PC noted the benefits of an infrastructure bank:
-
increasing the pool of funds
available for infrastructure investment and filling the gaps in private sector
finance
-
reduced transaction costs through
improved procurement processes and the development of public sector expertise
in infrastructure financing
-
the ability to diversity and
spread specific project risks across a wide pool of infrastructure assets
through the infrastructure bonds issued by the bank.[122]
6.112
However, the PC found that the costs of establishing an Infrastructure
Bank in Australia were likely to outweigh the benefits, as outlined:
-
...the pool of funds available for
infrastructure and the extent of government involvement in funding are a
distinct issue from how those funds are administered – an infrastructure bank
is not a pre-requisite for increasing government funding...
-
...the Commission can see risks
associated with government ownership of a bank. Since the 1990s, the financial
system in Australia has largely moved away from government ownership of
financial institutions...
-
...there is a risk that the
establishment of an infrastructure bank would create pressure to fund projects
that would otherwise not pass a cost-benefit assessment, simply because there
is capital available at any given time.[123]
6.113
Ultimately the PC concluded that an infrastructure bank 'appears to
offer little benefit in addressing the identified issues in Australian
infrastructure investment'.[124]
While noting some potential benefits, the PC could not justify providing unique
specialised support for infrastructure via a dedicated funding stream.
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