How to fund NZ’s infrastructure investment deficit - Kali Mercier

Kali Mercier.

Kali Mercier is the deputy director and WSP Fellow of the Helen Clark Foundation

A new report by the Helen Clark Foundation and WSP in New Zealand, Bridging the Infrastructure Gap, sets out a range of funding and financing tools Aotearoa could use to dig itself out of an investment deficit — a deficit that has been many decades in the making and is now reaching a crisis point.

As a country, we simply cannot keep kicking the issue down the road for future generations to deal with. Besides any questions of fairness, such an approach is not good economic management.

A key finding of the report was that the most efficient, straightforward and transparent way to address the bulk of Aotearoa New Zealand’s infrastructure deficit is most likely to be by means of long-term borrowing, paid back over time by appropriate taxation and/or rates.

This is not a politically popular conclusion: politicians at both central and local level chase votes by promising to keep rates, taxes, and debt as low as possible, while the media usually focus more on how much government and councils are spending than on the benefits of investing in the right projects.

However, the uncomfortable truth is becoming more difficult to ignore: infrastructure costs money. To get more of it, we need to spend more.

Investment in new infrastructure can be financed by central and local governments in two ways: by spending revenue as it becomes available (pay-as-you-go), or by borrowing. Debt-financing can help governments defray upfront investment costs and spread the cost of the project out over time. This approach allows more to be built now, and more quickly.

Financing infrastructure using debt is also generally seen as equitable. Costs are spread over the lifetime of the asset, meaning they are shared by the people who use the infrastructure throughout its lifetime.

Building revenue-generating opportunities such as user charges into new (and existing) projects gives an added benefit — it takes some pressure off debt repayments, allowing more infrastructure to be built in the future.

Total capacity for investment over five and 25 years (Infrastructure Commission, 2024, see graphic)

In this hypothetical example from the Infrastructure Commission, $100 million is spent annually on new assets, either using existing funds or by borrowing (with or without revenue attached).

Borrowing to finance infrastructure that has revenue attached allows more to be built in the short and longer term.

Our report recommends building revenue-producing opportunities into infrastructure provision where it makes sense to do so — in particular where it brings additional benefits.

Volumetric charging for water is a good example because when people pay for their water consumption they are motivated to waste less, reducing the overall demand for new infrastructure.

In Aotearoa, central government borrowing is carried out by the Treasury on behalf of the Crown by selling funding or debt instruments, known as securities (mainly bonds and bills) to a narrow range of pre-agreed lenders. This is the cheapest and most straightforward way for the Government to borrow.

There are strong arguments to suggest Aotearoa is in a good position to borrow. The country has a strong Crown balance sheet and comparatively low public debt compared with other countries in the OECD.

In a recent media interview, Anthony Walker, S&P’s global director of sovereign and public finance ratings, said the Crown’s AAA rating is solid, estimating it could borrow a further 30% of GDP ($120 billion) before risking a credit rating downgrade.

There are downsides to borrowing more money, of course. The principal and interest must be paid back, increasing pressures on the Crown’s revenue.

How much a government borrows can also affect the wider economy — by pushing up inflation, for example. So as a country we should be borrowing only for the right projects, investing sensibly, and steadily over time.

Another way for the Government to borrow is to seek private financing of specific infrastructure programmes and projects (via public-private partnership, for example).

Interest rates are higher for this form of borrowing, because the investor carries more risk than when investing in a government bond or bill. Procurement methods such as public-private partnerships can introduce additional complexity and risk because of the long-term nature of the contracts involved, so are best used in situations where they can be shown to offer better outcomes than the Government can achieve by financing the infrastructure itself via public borrowing.

Aotearoa’s infrastructure deficit is not down to the central government alone. Local authorities are behind too, and most have headroom to borrow more to bridge the gap. It’s true they have been borrowing steadily more over the past decade or so, with council debt to revenue ratios rising from around 80% in 2009 to more than 180% in 2022. Despite these increases, council debt is still significantly lower than it has been historically during periods when high investment was needed. In the 40 years prior to the World War II for example, local government sustained debt burdens that were several times greater than they are today.

Most council debt (around 90%) is financed through the Local Government Funding Agency (LGFA) — established in 2011 to deliver efficient financing for local government by pooling councils’ borrowing power. It sets a lending limit for councils, calculated in relation to their incomes, and a handful of councils have begun to approach these lending limits. This has led to worries that councils are facing borrowing constraints.

Recent Government announcements will mean councils can borrow outside existing lending limits to finance water infrastructure, which will take some pressure off the ability to borrow for some.

However, councils are not just constrained by LGFA rules — they are facing a revenue crisis, and have been for some time. Paying for debt is already a struggle for many, with repayments making up 8.8% of councils’ operating income on average.

It is becoming increasingly clear councils will need an additional stream of steady, reliable and non-contestable revenue to address the infrastructure gap.

Our report echoes recommendations made by many others over the years to develop solutions to this longstanding issue. If we do not agree a practical and sustainable way to better share central government resources with local authorities, we can expect rates to continue to rise sharply, with the burden felt most by those with the least ability to pay.

Debt-financing more infrastructure investment is only a part of the solution to the infrastructure gap.

We shouldn’t be using debt to cover routine maintenance and renewals, for example, and we need to improve planning, efficiency and decision-making processes across the board.

But we need to keep in mind that — whether or not it plays well with voters — failing to properly invest in the infrastructure needed for the country to function well will cost us more in the long term than prudent borrowing now.