The Government is in a strong position to borrow to fund an infrastructure rebuild at much lower interest rates than its maturing debt. Photo / Bloomberg
COMMENT:
Reserve Bank governor Adrian Orr has been severely criticised on numerous issues, including his call for more fiscal or government stimulus if the economy slows.
Most of his critics believe he should stick to monetary issues and shouldn't be trying to influence Government policy.
However, Orr's views are consistent with many prominent global economists, including Larry Summers, a Harvard economics professor and former US Treasury Secretary.
Summers recently wrote that monetary policy, particularly lower and lower interest rates, has become less effective in stimulating economic growth.
He wrote in his Financial Times column: "Given the risk of a catastrophic deflationary spiral, central banks are probably right to attempt to ease monetary conditions. But diminishing returns have surely set in with respect to monetary policy and there is risk of doing real damage to the health of the banks and financial intermediaries."
He continued: "Most importantly governments need to rethink fiscal policy. With real rates near zero or even negative, the cost of debt service is very low and low rates can be locked in for decades. That means that the debt levels that were prudent when rates were at 5 per cent no longer apply in today's zero interest rate world. Governments that run chronic surpluses are failing to do their part to support the global economy."
This begs the question: Why doesn't the NZ Government borrow an additional $10 billion to $20b to update the country's ageing infrastructure? This could be borrowed at extremely low interest rates and with long-term maturity profiles.
Economists are increasingly arguing that this would be a far more effective way of stimulating economic growth, compared with ever-reducing interest rates, and would have significant long-term benefits for an economy.
What are the pros and cons of a substantial increase in NZ Government borrowings, albeit at low interest rates, to rebuild the country's ailing infrastructure?
The Treasury's 2015 report "The Thirty-Year New Zealand Infrastructure Plan" noted that "Some of our biggest infrastructure networks face renewal pressure over the next 30 years, particularly in the social infrastructure, electricity distribution and three waters sectors. These renewals are simply a result of the fact that many of these assets were built or put under the ground at the same time and therefore need replacing at the same time."
The report went on to state: "Our schooling estate has an average age of 42 years and over 50 per cent of our social housing stock is over 42 years old. The estimated cost of renewing our [drinking water, waste water and storm water assets] over the next 15 years varies from $30b to $50b, in fact one of the biggest challenges facing the sector is trying to understand what the true costs are and when they will be incurred."
These latter comments don't include roads, rail, airports, seaports, telecommunications networks or electricity and gas infrastructure assets.
The list of New Zealand's infrastructure assets in 2015 included:
• 10,886km of state highways
• 83,703km of local roads
• 4000km rail corridor
• 12,000km of national transmission grid
• 42,312 GWh of electricity produced
• 2532 schools
• 38 public hospitals
• 52 municipal landfills.
The Thirty-Year vision was for New Zealand to have "a modern, integrated and efficient infrastructure system which underpins a prosperous and inclusive society [and] supports international connectedness, increased productivity, movement up the global value chain, and more exports and growth".
Underinvestment in infrastructure can cause major problems as is being demonstrated by the large-scale electricity blackouts in California at present. The root cause of these blackouts is the state's fragile and poorly maintained power lines, surrounded by untrimmed trees, that can spark major wildfires such as the one in Paradise, California, that killed 80 people in 2018.
The state's utility company, Pacific Gas & Electricity Co (PG&E), now regularly shuts down its electricity grid, particularly in dry and high wind conditions, because the company's ageing power lines are prone to instigate new wildfires.
Meanwhile, back in New Zealand a new independent infrastructure body, the New Zealand Infrastructure Commission — Te Whihanga, is being established to develop a 30-year infrastructure strategy, in conjunction with central and local government. The commission will be an autonomous Crown entity, with an independent board of between five and seven members with a range of perspectives and private sector expertise.
The Treasury believes that a fresh approach is required because "New Zealand is facing a major infrastructure deficit, which, if not addressed, will impact our economic future and our social and environmental wellbeing."
The new commission doesn't appear to have any mandate to recommend how this "major infrastructure deficit" will be financed.
As most of the major projects will be undertaken and financed by government, we need to focus our attention on the Crown's financial position (see accompanying table).
The Crown reported a surplus of $7.5b for the June year compared with a surplus of $5.5b in the year to June 2018. The huge deficits in 2011 and 2012 were mainly due to the Christchurch earthquakes.
Gross Crown debt is now $84.4b, or 28.1 per cent of GDP, which is only slightly higher than the 27.2 per cent pre-earthquake debt/GDP ratio.
NZ Government debt is extremely low, on a debt/GDP basis, compared with most other countries. It is also low compared with NZ household or individual debt, which currently stands at $225b.
Annual Crown interest costs have risen from $2.8b to $4.1b between 2010 and 2019 but as a percentage of Crown expenditure these costs have risen from 3.4 per cent in 2010 to only 3.6 per cent in the latest year.
Consequently, the NZ Government is in a strong position to borrow to fund an infrastructure rebuild at much lower interest rates than its maturing debt. For example, in 2021 the Crown has $11.3b worth of debt maturing, with a 6.0 per cent coupon rate, and in 2023 a further $9.2b matures with a 5.5 per cent coupon rate.
In the latest NZ Government bond tender, which had an April 2037 maturity date, the weighted average accepted yield was 1.61 per cent, significantly below the coupon rates of bonds that mature over the next few years.
It is quite conceivable that the Crown could borrow an additional $20b-plus but its total interest costs could fall as more expensive current borrowings are rolled over at significantly lower interest rates.
If the current Government is genuinely determined to reduce the country's infrastructure deficit, there has never been a better time to fund this through low-interest rate borrowings.
However, there is one major problem: the fragile state of the domestic construction and building sector and its ability to rebuild the country's infrastructure.
This problem was evident again this week with the SkyCity International Convention Centre fire, a disaster that surely would never have happened if we had higher quality building standard and work practices.
The construction sector isn't attracting new capital or high-quality employees because profit margins and profitability are far too low, partly because the Crown has been a tough negotiator on contract terms.
Consequently, the construction and infrastructure building sectors are unprofitable, are failing to attract new talent and have incurred substantial write-downs, losses and failures.
Finance is available for a major infrastructure rebuild and a visionary Government should take advantage of this situation. However, there will be huge problems with this rebuild unless the Crown is willing to take a softer approach to contract negotiations which would enable the construction sector to be more profitable and attract highly skilled managers, engineers, tradies and other onsite workers.
Adrian Orr is on the right track as far as fiscal stimulus is concerned but the country needs a far more profitable and robust construction sector if this strategy is to be successful.
- Brian Gaynor is a director of Milford Asset Management.
"If you’re loyal to them, they will be loyal to you."