Infrastructure, and the connections it enables, is critical to the functioning and success of our society, economy, and environment.
For years, Australia has had a backlog of infrastructure requirements. It’s a welcome development that many projects are now underway.
Unleashing investment from the private sector requires regulatory certainty and the ability to charge prices that produce an acceptable risk-adjusted return, as well as enablers like spectrum or land access, permits, and approvals. The key question of course is what that return needs to be.
In short, most investors seek returns from infrastructure investment that are large enough for projects to pay for themselves.
A report by the Grattan Institute suggests that lowering the “hurdle rate” applied to these projects could help to boost government investment.
The report states that “with Australian cities growing rapidly, smart investment in infrastructure is vital. Project evaluation must improve, so we build the right transport projects in the right order. Better discounting would be a big step in that direction.”
The Grattan Institute points out that interest rates have fallen dramatically since the 1980s, and suggests “it makes no sense that discount rates in Australia have been stuck since then”.
They recommend the “7 per cent standard rate” should be abandoned in favour of two lower rates: 3.5 per cent for low-risk transport projects and 5 per cent for slightly higher-risk investments.
However, the economy is running up against constraints in the ability to deliver these projects.
Commonwealth Bank’s Michael Thorpe says it is more important than ever for project execution to be spot on “in an environment of cost pressures due to a shortage of contractors and skilled workers needed to design and build projects”.
“This means rigorously testing assumptions, and ensuring the right skills mix at all stages of project development and implementation to ensure high-quality execution,” Thorpe says.
“It is vital to ensure that the outcome will be of overarching benefit to the economy.”
In the long term, lowering discount rates might make projects appear viable, but cost pressures and lower returns could easily offset this.
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