Awaiting the next leg of Australia’s infrastructure journey
According to Diana Mousina, Senior Economist, the stars have been in alignment for infrastructure investment in recent years, which is likely to continue. For those invested in (or looking to invest in) infrastructure, Diana explains why this is the case, explains the infrastructure model in Australia, and expectations for what’s to come.
The stars have been in alignment for an infrastructure investment and development boom in recent years, an environment that’s likely to continue throughout this year and into 2019.
However, the next leg of Australia’s infrastructure journey, beyond the next year-and-a-half will be driven by different factors than in the past, and many of these factors are still falling into place.
The transition of funding models, for instance, will be a big theme in infrastructure, particularly from mid-2019 onwards, when public spending within state and federal government budgets are expected to taper.
New funding sources for brownfield and increasingly greenfield infrastructure development is being sought from various other sources, including from the superannuation industry as well as private investors, a topic discussed in this recent paper
by Michael Cummings, AMP Capital’s head Australia and New Zealand Infrastructure Equity Funds.
When talking about infrastructure, this refers to buildings and structures that form the systems of a society – for example transportation, water and electrical systems, hospital buildings – which are led by the government both at the federal and state level.
A series of global and domestic factors conspiring together have paved the way for an infrastructure investment and development boom.
Firstly, the limits of monetary policy have been reached after central banks cut interest rates to record lows and started quantitative easing, stimulating consumer spending and asset price growth. Meanwhile, the impact on other parts of the economy – such as investment – has been softer because monetary policy has less of a direct impact on these areas.
Secondly, growth in Gross Domestic Product in the advanced economies has been below its long-run average since the financial crisis (until recently) which has kept inflation below central bank targets. As a result, there is a need to lift growth and bring inflation back to its target rate.
Meanwhile, borrowing costs are low because interest rates have been cut substantially to stimulate growth which is supportive for potential government borrowing.
Finally, there is a need to replenish the capital stock as it ages to improve productivity growth and living standards, lift economic progress and development.
When thinking about what’s ahead for infrastructure spending and development in the future, it is helpful to understand how infrastructure is actually provided in Australia.
Infrastructure spending is mainly undertaken by the states. States obtain funding for infrastructure spending from state-based sources – largely taxation – but also rely on Commonwealth Government grants. Recently, states have also been utilising the Federal Government’s asset recycling scheme.
Asset recycling was a Federal Government program introduced in the 2014 Budget that incentivised the states and territories to privatise their assets - particularly underperforming or surplus assets – and use the proceeds to fund new infrastructure, with the Federal Government providing a financial incentive for the sale. This initiative has now finished, and New South Wales and Victoria were the two main adopters of the program.
Besides providing grants and promoting asset recycling to the states, the Federal Government can also push through infrastructure spending, through direct spending to acquire physical assets, which is generally done for defence spending. This spending adds to the budget deficit which is difficult at the moment given pressures to meet the 2021 budget surplus target.
The other way the federal government can push through infrastructure spending is via direct spending to acquire financial assets. This latter form of direct spending takes the form of loan or equity contribution to a separately established third party, which is eventually sold to the private sector. This transaction appears on the cash flow statement as an investment but doesn’t impact the underlying cash balance.
Based on state and federal budget plans for capital spending, infrastructure investment growth will remain strong over 2018, and will then taper off.
Where to next?
Federal Government grants to the states are still high, state budgets have been bolstered by payments from asset recyling initatives and states – particularly in New South Wales and Victoria – have been collecting significant stamp duty payments from a booming property market.
Since 2016, infrastructure growth has been bouncing back thanks to a lift in Federal Government spending and buoyant state budgets.
In the 2017 budget, the Federal Government also committed to spending directly through equity financing to build the Melbourne to Brisbane Inland Rail and Western Sydney Airport.
Over recent years, there has been increased talk from global policymakers and organisations – like the International Monetary Fund – about the need to lift infrastructure investment, especially across the advanced economies.
The advancements in infrastructure have come at a convenient time in Australia’s growth profile. Business investment expenditure is still low as the end of the mining downturn drags on, housing construction is slowing, and consumer spending growth remains modest.
The recent uplift in government spending has been offsetting much of the weakness across other parts of the economy. But, it won’t last forever. The questions around how much longer the strength in government spending will last and what happens as the pipeline of infrastructure projects dwindles still remain.