Speech to the AFR National Infrastructure Summit
I am very pleased to have the chance to speak at the AFR National Infrastructure Summit – an important event on the calendar for the infrastructure sector.
Today I want to speak about the Commonwealth’s approach to infrastructure investment.
The recent budget has provoked a fair bit of discussion about this topic.
My argument today is that it is not just how much the Commonwealth invests that matters – how we invest is also vitally important.
I want to start by describing the shift which is occurring, as a greater proportion of Commonwealth infrastructure investment occurs through providing debt and equity investment into projects.
Next, I want to respond to some misconceived criticisms of this approach.
Finally, I want to lay out some key reasons for this change in emphasis.
Change in the Way the Commonwealth Invests
Let me turn firstly then to describe the shift which is occurring.
The 2017 budget saw the Turnbull Government commit to a $5.3 billion equity investment in Western Sydney Airport, and an $8.4 billion equity investment to fund the Inland Rail project.
This forms part of a broader trend.
Between 2007-08 and 2012-13, 6.5 per cent of the Commonwealth’s total investment in transport infrastructure was provided through financial assets.
Since 2013-14, this has risen to almost 10 per cent of our total investment, even as our total grant funding for transport infrastructure continued to increase.[1]
Over the next ten years, some $16.5 billion of our over $75 billion transport infrastructure investment is projected to be delivered through financial assets.
Let me take a moment to explain that there are three ways in which the Commonwealth can make infrastructure investments.
As Budget Statement Number 4 of Budget Paper Number 1 sets out in some detail, the first of these is to spend directly to acquire physical assets. This happens if the Commonwealth buys a piece of land for example.
The second is when the Commonwealth provides a grant to a state government, which it then uses to acquire a capital asset.
The third is when the Commonwealth acquires a financial asset.
Now these three different approaches have very different consequences for the financial position of the Commonwealth and in turn Commonwealth taxpayers. Under the first and third approaches, the Commonwealth pays out cash – and acquires an asset in exchange.
Assuming the Commonwealth borrows to get the cash, the end result of the transaction on the Commonwealth’s balance sheet is that liabilities increase by a certain amount and assets increase by the same amount.
Under the second approach, the Commonwealth pays an amount of cash to a state government. This is treated as an operating expense of the Commonwealth and included in the underlying cash balance for the year in which the payment is made.
But the Commonwealth gets no rights over the asset that the state government buys or builds with the cash it receives. The state government gets an asset on its balance sheet; the Commonwealth gets nothing.
Let me give two examples.
The Northern Connector, in Adelaide, is a 15.5 kilometre motorway being built for a cost of $885 million. The Commonwealth is paying eighty per cent of this, or $708 million.
The Commonwealth is also funding eighty per cent of the Toowoomba Second Range Crossing, a 41 kilometre long bypass, at a cost of $1.137 billion.
Despite the Commonwealth paying eighty per cent of the cost of these two projects, they will be entirely owned by the respective state governments.
If the state government chooses to charge tolls to the road users – as will happen for trucks using the Toowoomba road – the toll revenues are entirely received by the state government.
Let me now give a couple of contrasting examples – infrastructure projects where the Commonwealth acquires a financial asset.
We are supporting the construction of WestConnex in Sydney through providing a $2 billion concessional loan to Sydney Motorway Corporation (SMC), the NSW government owned company established to build and operate this massive toll road project.
This loan appears in the SMC’s balance sheet as a liability and in the Commonwealth’s balance sheet as an asset.
To deliver Western Sydney Airport, as I mentioned, the Commonwealth will spend $5.3 billion and in return acquire shares in WSA Co, the company which will build and own the airport.
As this budget shows we are giving more careful thought to the legal and economic form of the Commonwealth’s investment in large infrastructure projects.
Of course, there continues to be very large grant expenditure on infrastructure – in 2017-18 payments to support state infrastructure services will reach a record level of $7.96 billion.
There will always be a place for capital grants to the states, particularly for infrastructure with more limited revenue-raising capacity. For example, one of the measures announced in the Budget is that we intend to spend $10 billion over 10 years on the National Rail Program. That will be grant funding – designed to provide grants which will form the core of a funding and financing structure for major rail projects.
So grant funding will continue to have a role – but it is clear that the proportion of infrastructure spending in other forms, particularly through acquiring financial assets such as loans and equity, is increasing.
Some Misconceived Criticisms
It is hardly surprising that this change in approach has been criticised by some.
If you are a Labor state Premier, you regard it as a splendid idea that you get free money from Canberra, with virtually no strings attached, for infrastructure projects that you can claim the credit for.
I do want to take a minute to respond to some of the misconceived criticisms.
The first is the claim by the Opposition that the 2017 Budget sees a reduction in infrastructure spending.
In fact, it is a once-in-a-generation, $75 billion infrastructure budget that sets a long-term vision for our future and commits to game-changing infrastructure projects across the nation.
2017-18 will be the single largest Commonwealth infrastructure spend in our nation’s history, followed by 2016-17 and 2018-19
If you total up all transport infrastructure investments - including payments to states, financial assistance grants, financing and equity - under the Rudd-Gillard-Rudd Government, the average annual spend on infrastructure was just over $6 billion.
By contrast, the average under the Coalition Government from 2013-14 to 2020-21 is over $8.1 billion per year.
The Shadow Minister likes to focus, misleadingly, on just one component of the infrastructure spend, Payments to Support State Infrastructure Services. This is part of, but not the same thing as total infrastructure spending.
Our shift in the funding mix sees an overall increase for infrastructure spending – and also sees the share of that spending represented by equity and loan funding increasing.
For some commentators, who may be in the habit of using grants payments to the states in the Budget papers as a proxy for federal infrastructure spending, it is important to note that—as we change the mix—to get the true picture they will need to look at some other pages in the Budget papers as well.
The second objection raised by some since the Budget is that using equity investment to fund major infrastructure projects is a form of “off balance sheet” financing.
On the contrary, as I have explained, the balance sheet consequences of such an approach are very clear. Assuming the investment is funded by debt, you have an increase of the amount of the investment on the liabilities side of the balance sheet – and an increase of the same amount on the asset side of the balance sheet. It would be much more accurately described as “on balance sheet”.
Consider by contrast the outcome when the Commonwealth pays a grant to a state government, again funded by debt. You again have an increase of the amount of the grant on the liabilities side of the balance sheet. But there is no increase on the asset side. The Commonwealth – and the Commonwealth taxpayer – is simply worse off.
Now it is true that the infrastructure asset acquired with this funding – be it a road, a railway or another asset – will have general economic benefits, as I discuss further below. But my point is that to regard grant funding as in some way economically pure, and equity funding as in some way an attempt to disguise spending, is quite misconceived.
It is also true that over time, as the money invested in WSA Co is expended on construction and operation of the airport, it needs to be spent wisely to ensure that the asset which is obtained has the highest possible value. The aim is for the value of the airport to considerably exceed the amount of cash spent by the Commonwealth to acquire the equity.
But again I make the point – when the Commonwealth makes a grant to a state government, the money is gone immediately. For every dollar the Commonwealth “invests”, it gets back zero. With an equity investment, if it is done well, the Commonwealth will get back more than a dollar for each dollar it invests. Even if it is done badly, and the Commonwealth gets back say seventy cents in the dollar, that is still a marked improvement on the outcome from having made a grant.
This is not an argument to be cavalier with taxpayers’ money invested in the form of equity; we must treat that money very carefully. But when you think about the Commonwealth’s incentives, there is a stronger institutional incentive to be careful with taxpayers’ money when making an investment than when making a grant, because with a grant there is no expectation of getting any of the money back.
A third criticism which some have made is that Commonwealth equity investment in infrastructure projects simply crowds out private sector investment. It is true that there is plenty of private sector capital available for existing, operational infrastructure assets with proven cashflows. But for greenfields projects, facing regulatory risks, such as Western Sydney Airport or WestConnex, government is often better placed to invest than the private sector.
Governments have a longer investment time frame, which is particularly important when it comes to infrastructure projects that involve large capital outlays upfront and take several years before they generate a positive cash flow. Governments also typically have a lower cost of capital than most private companies.
They also may be better placed to handle the regulatory and other risks that affect the economic prospects of new infrastructure projects. This is particularly important in the early years of a project before it starts to earn revenues and the risks are highest.
Of course, government owning an infrastructure asset in its early years is one thing; down the track it will very often make good sense to sell it to the private sector, thus withdrawing taxpayers’ capital which can then be reallocated to other pressing uses.
Fourthly, some argue that the Commonwealth has less operational expertise than state governments. In some areas this is clearly true. But it is not a compelling argument against the Commonwealth making a financial investment in preference to handing over a grant.
Operational expertise can be acquired contractually – and certainly when it comes to Western Sydney Airport the Commonwealth will be taking care to obtain private sector operational expertise, through our choice of board and management personnel, and through the companies we contract through the procurement process to design and build the airport.
Why is the Commonwealth Using Financial Investments More Extensively?
In this final section of my remarks, I want to speak about why you are seeing this change of emphasis from the Turnbull Government.
Grant funding will always remain an important part of the infrastructure funding approach used by the Commonwealth Government. But for several reasons, an increased weighting towards the use of financial investments makes sense.
The first is that when the Commonwealth makes a financial investment to support the creation of an infrastructure asset, such as a loan or an equity investment, it has clearer and stronger rights in relation to the asset. That is true if the Commonwealth holds one hundred per cent of the asset, as will be the case with WSA Co. But it is also true if the Commonwealth is one of many investors, as is the case with our loan to SMC for WestConnex.
Such financial investments are properly legally documented in accordance with normal commercial principles, and the Commonwealth’s rights are clear. Under grant funding arrangements, the Commonwealth has limited and unclear rights once the money has been handed over.
Secondly, this becomes particularly important if a project is not travelling well. When the Coalition came to government, we inherited a hopeless mess with NBN Co. Labor had spent $6 billion, yet only around 51,000 fixed and wireless services were operational and the company was struggling, not least because its board had little serious telecommunications experience.
As the shareholder, the Commonwealth Government had clear rights which then Communications Minister Malcolm Turnbull used to great effect, replacing most of the board and the Chief Executive.
Ziggy Switkowski – a former CEO of Telstra and Optus – came in as Chairman. Bill Morrow – a very experienced executive in a number of Vodafone businesses around the world – took up the role of Chief Executive. These were people with the skills and experience to design and execute a strategy to roll out the network quickly and reliably.
The result has been a very impressive turnaround. Today, less than four years later, there are some 5.4 million premises around Australia able to connect.
A third reason why the greater use of financial investments makes sense is so the Commonwealth can give greater effect to our policy objectives. For example, the Turnbull Government has a clear focus on cities policy – and the construction of major transport infrastructure is one of the most important ways to influence the shape and operation of our cities. If we seek to use the Commonwealth’s transport infrastructure spend to support broader policy objectives, then being an investor may well be more effective than being a grant funder.
A fourth reason: providing a financial investment rather than a grant is an important way to protect the interests of Commonwealth taxpayers. Let me give an example. In early 2016 the Victorian Labor Government pressed the Turnbull Government for a substantial grant towards what was then called the Western Distributor, now known as the West Gate Tunnel.
We were sceptical that this was a good use of Commonwealth taxpayers’ money – and in the result our scepticism proved to be justified. The Victorian Government secured a deal with Transurban to build this new project, funded through tolling revenues.
The Commonwealth’s response at the time was to offer a loan, as we had with WestConnex in New South Wales – an offer which was rejected. Had we offered a grant, that money would have been taken – and would not be available to fund all of the other pressing nationwide demands on the federal Government.
The fifth reason to look for debt and equity investment opportunities, of course, is because in many circumstances it will be a more prudent use of taxpayers’ money. As I pointed out earlier, when the Commonwealth makes a grant, one hundred cents in the dollar is gone immediately. When the Commonwealth makes a debt or equity investment, the expectation is that in due course the Commonwealth will collect its capital – and be able to reinvest it in other worthwhile projects.
Good projects, regardless of how they are funded, deliver economic benefits through improved productivity and efficiency. But if a proposed project which can generate an income stream is on the table then, as prudent stewards of public funds, we need to give consideration to the form in which the Commonwealth invests in the project. If we can use our investment to generate a stream of returns for taxpayers, that is something we will seek to do.
Many people argue that with interest rates at very low levels by historical standards, this is a good time for governments to be borrowing to fund the construction of long term infrastructure assets.
Of course the Government has been borrowing for long-term infrastructure since 2013 and are continuing to do so - at a rate that is sustainable for the Australian Government, and ultimately taxpayers, to service. As the budget papers point out:
…from the Global Financial Crisis up to 2018-19, grants for capital purposes to the states have been funded by Commonwealth Government debt – effectively generating a liability on the Commonwealth Government’s balance sheet and assets on State governments’ balance sheets.[2]
Of course, the budget papers also demonstrate that by 2018-19 we will be in a position where the Commonwealth will not need to borrow for recurrent spending. Put another way, from that point the focus of new borrowing will be on capital purposes.
The broad idea of borrowing for long-term infrastructure is one that is not particularly contentious or revolutionary, and in practical terms it’s what we’ve been doing and continue to do. But none of it changes the fact that ultimately you need to repay what is borrowed.
That is why it is important that appropriate financial disciplines are applied in the way that we invest those borrowed funds.
This approach to investment is consistent with the greater rigour we are seeking to bring to the Commonwealth’s investment in infrastructure.
We have established a stronger role for Infrastructure Australia in providing an independent assessment of the benefits and costs of major projects. Our policy is that there must be an assessment by Infrastructure Australia on any infrastructure project requiring a Commonwealth contribution of $100 million or more.
We are giving greater emphasis to planning on major infrastructure projects. We provided $10 million in funding to the Queensland Government to further support planning and development for the proposed Cross River Rail project.
In the Budget, we announced $30 million to develop a business case for the Melbourne Airport Rail link. We also reserved $20 million to provide up to 50 per cent of the costs of developing up to three business cases, for faster rail connections between major cities and major regional centres.
We have signalled our strong interest in the greater use of value capture as a funding source for major infrastructure projects. Last year, we released a discussion paper on the Commonwealth’s role in value capture which elicited over 60 high quality responses.
We have also announced the establishment of an Infrastructure and Project Financing Agency within the Department of the Prime Minister and Cabinet. The idea here is to have a dedicated unit that has expertise in, and is specifically focused on, the question of ‘what is the right financial structure to use?’ for particular infrastructure projects.
Now the clarity of approach from the Government stands in considerable contrast to the confusion on this issue from the Opposition.
Since the budget the Shadow Minister has repeatedly made the misleading claim that the Turnbull Government is cutting spending on infrastructure. He seems to think that the provision of debt or equity investment by government does not count towards infrastructure spending.
At the same time the Leader of the Opposition is calling for increased debt and equity investment into infrastructure. In a recent speech to CEDA he said that “we need a new approach to infrastructure, clearing the way for superannuation funds and others to invest in good projects.”
Unfortunately confused thinking on this topic is not new for the Labor Party. Before the last election Labor announced its plans for a $10 billion ‘Concrete Bank’ which would provide loans or equity investment into new projects.
Once a project is underway and financeable, Infrastructure Australia could sell its equity or debt interests to long-term investors like super funds.[3]
The big problem with this idea was that the projects Labor talked about using the Concrete Bank to finance are ones that would not have generated a financial return – so there was no way to repay the loan or pay dividends on the equity.
The projects Labor cited included heavy rail or light rail projects such as Melbourne Metro, Cross River Rail in Brisbane and the Gawler Line in Adelaide. But in Australia rail does not even cover its operating costs; it certainly does not provide a return of or return on capital.
The other projects Labor said could be funded from the Concrete Bank were road projects such as the Ipswich Motorway, Tasmania’s Midland Highway and the Pacific and Bruce Highway. Unless Bill Shorten is proposing to charge tolls on these roads, they will not generate a financial return either.
Conclusion
Let me conclude by returning to my central point: the Turnbull Government is putting a lot of focus onto the legal and financial form in which we make infrastructure investments.
Our total infrastructure spend is large and growing; we have committed to spend $75 billion on infrastructure over the next decade.
A large part of that spending is, and will continue to be, in the form of grants to state and territory governments. Indeed just yesterday we announced grants of $1.52 billion for regional rail projects in Victoria.
But we are making greater use of direct investment, in the form of equity and loans.
I have spoken today about Western Sydney Airport and ARTC where we have equity investment and our debt investment in WestConnex.
I have highlighted the fact that – despite complaints from some state governments - if you look at the total infrastructure spend it is going up.
We are investing in different ways, but the total amount of cash going out the door is increasing, and that is reflected in the volume of physical assets that will be constructed.
As we seek to execute on our national infrastructure agenda, the form in which the Commonwealth makes its investments is an important policy lever. We are using that lever, along with the others available to us, to secure the best policy outcomes and deliver the infrastructure Australia needs.
[1] Between 2007-08 and 2012-13 inclusive, the Commonwealth invested $33.59 million in grants and $2.37 million in equity (primarily through equity injections to the ARTC). Between 2013-14 and 2020-21, the Commonwealth has committed $53.83 million in grants and $5.58 million in financing (including equity and the WestConnex Loan). Between 2016-17 and 2026-27, the Government has committed $61.8 million in grants and $16.46 million in financing (including WSA). All grant allocations include FAGS (untied local road allocations), ARI and minor programs. Figures do not include allocations in the Contingency Reserve or contingent liabilities.
[2] 2017-18 Budget Paper Number 1, Budget Statement 4, p 4-11
[3] Bill Shorten, Address to the Queensland Media Club, 8 October 2015
