Trend 7: Governments look to unlock funding paradigm | KPMG | QA

Trend 7: Governments look to unlock the funding paradigm

Trend 7: Governments look to unlock funding paradigm

If the financial markets have been relatively benign then why are so many projects stuck? A big part of the answer is funding.

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With so much effort being put towards improving project development and increasing finance capacity why are so many projects stuck? In many cases, the problem has been related to funding. Simply put, infrastructure project pipelines around the world have remained blocked because governments are still struggling to decide how to pay for the assets and services that must be delivered.

Traditionally, governments at all levels have focused on two broad types of infrastructure projects. The first is the ‘taxpayer pay’ where government essentially pays for the capital and operating costs (on behalf of the consumer) out of current budgets or future taxes, commonly referred to as an ‘availability payment’ in the public-private partnership world. This is the typical approach for assets that have no obvious revenue streams (such as schools or hospitals). The second approach is through concession-type deals where private financing covers the upfront cost and then recoups a return directly from consumers (user pay).

Where governments are struggling most is with the projects that fall in the middle – roads and railways for example – where some user pay cash flow exists, but not enough to cover the cost of the entire asset across its lifecycle.

A number of issues have emerged. The first is structural and, to a certain extent, behavioral: many governments are reluctant to provide capital contributions to support projects with user pay options. This must change.

The second challenge is the shift in focus and prioritization towards cities as governments at all levels realize the value of investing into cities. But this, in turn, is creating funding questions as responsibly – and costs – are devolved (sic. handed off) to a municipal level.

Likely the biggest issue, however, is how to fill the funding gap. As we noted in last year’s Emerging Trends, governments are increasingly devising innovative alternative funding sources for these projects (although, once again, we have seen much more talk than action). Some are trying to leverage land values to fund the gap. Others are exploring the potential for creating new development taxes and business taxes.

Whatever the strategy, it is clear that the public discourse is changing: it is now publicly acceptable to engage in a discussion about who pays for infrastructure. And while these open public discussions may be cumbersome and complex, they are a very important first step to resolving this vexing issue at both the project level and at the economy level.

A more strategic solution is required and we therefore believe (and hope) that 2017 will bring renewed focus on asset ‘recycling’ (or, to give its politically incorrect term, privatization). While this is currently an unpopular policy in many markets, we believe that more pragmatism is required if new infrastructure is to be built. And, as certain state governments have demonstrated in Australia, political opposition can be overcome through the right messaging.

In many cases, governments will focus their asset recycling efforts on selling existing and profitable assets in order to help fund the development of new assets. But, increasingly, governments will find ways to use their own money to finance the initial development of infrastructure assets and then also sell down once the project is operational and ‘de-risked’.

However, to be successful with any alternative funding solution, governments will need to be clear with their populations about how the proceeds will be used. Trust in government is not currently high and success will depend on iron clad commitments to develop new infrastructure, combined with a clear regulatory approach in relation to the privatized assets. Both the consumer and the investor need protection if the use of asset recycling is to become a widespread approach.

The long view

In the mature markets, trust issues will continue to vex but – ultimately – populations will become more comfortable with the idea of asset recycling and governments will start to look deeper for less obvious, and potentially more controversial assets to monetize.

In the developing world, asset selection will be key. The absence of robust regulatory environments to protect both investors and consumers will rule some assets out and dampen appetite for secondary sales. The long-term value is there, but strong cash flows and the ability to implement will be key.

As infrastructure grows in size and crosses jurisdictional boundaries, owners will also need to contend with concerns about ‘free riders’ who live outside of a tax zone but still enjoy all of the benefits of that zone’s assets.  

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