Unlike banks, capital markets offer more flexibility and resilience to the economy.
THREE KEY POINTS:
John Norling is director, head of wealth research at Jarden.
OPINION
What do capital markets have to do with infrastructure? A lot, according to Larry Fink, the chief executive of Blackrock, the world’s largest asset manager.
In his recent letter to Blackrock investors, he argues that well-developed capital markets are essential for funding infrastructure projects.
What value do capital markets offer?
Capital markets are where investors buy and sell shares, bonds, currencies, and other financial assets.
Unlike banks, which can face liquidity problems and regulatory constraints as we have seen in the United States with the demise of Silicon Valley Bank, Silvergate Bank and Signature Bank, capital markets offer more flexibility and resilience to the economy.
This was evident in the 2008 Global Financial Crisis, when interbank lending froze, and credit to consumers and businesses dried up. The existence of well-developed deep capital markets typically provides greater flexibility than banks and offer an alternative to grow or get money.
It is estimated that in the US capital markets, as represented by equities and debt securities, provide over 70% of the financing for US non-financial corporations, the largest percentage of any country.
This helps explain the strong growth of the US economy and why financial problems are typically cauterised quickly in the US, allowing its economy to return to normality relatively quickly.
What are the infrastructure funding challenges?
Funding infrastructure construction is one of the world’s major economic challenges.
As populations grow, there is greater demand for infrastructure - roads, bridges, tunnels, railways, airports, cellphone towers, fibre networks, and energy infrastructure.
As well as building new infrastructure, many countries are facing massive issues relating to deferred maintenance and the need to replace infrastructure which has reached the end of its life.
The US faces an estimated US$2 trillion ($3.3t) of deferred infrastructure maintenance, while in New Zealand there are well known issues around roads, pipes, and infrastructure damaged by Cyclone Gabrielle.
Energy infrastructure is particularly important given the growth in data centres and artificial intelligence (AI), and the transition from fossil fuels to electricity largely generated from renewable sources – wind, solar, hydro, and geothermal.
In some countries nuclear fuelled electricity generation will play a role in the electricity transition. Many countries, including New Zealand, are legislating to drive the energy transition and decarbonisation of their economies.
The drive to decarbonise is experiencing resistance as people battle high inflation, high interest rates and increasingly, job losses.
For many, surviving the next year is a more pressing issue than the long-term issue of climate change. This highlights another important issue around decarbonisation. If people are to embrace the transition, the cost of doing so cannot be prohibitive and it shouldn’t have a material adverse impact on people’s lifestyles.
Infrastructure usually has a large upfront cost to construct but a long life. The issues around how to fund the massive amount of infrastructure required is a global issue, not just a New Zealand issue.
While local and central government has a role to play, the cost is substantial and is likely to be too large to be entirely funded by them.
This is a much more serious problem for countries with high debt levels, particularly now that interest rates have risen significantly. When interest rates are low, a high level of debt is readily affordable. However, as interest rates rise the interest cost can become a real problem, driving debt higher despite other government spending remaining in check.
How can capital markets provide a solution?
Building infrastructure in a timely manner puts an additional burden on funding capacity. Waiting decades for new infrastructure is costly.
However, new roads, bridges and tunnels can save material amounts of workers’ time spent stuck in traffic with engines running. New pipes can save millions of litres of water from being wasted.
While fibre networks can allow computers to process more information faster. All these things are a direct cost to the community, and do not consider the inconveniences created in people’s day to day lives.
In New Zealand and offshore, public-private partnerships are used to stretch government funding and accelerate infrastructure construction. It is a long-term arrangement between a government and private sector institutions.
It typically involves financing government projects and services up-front, and then drawing revenues from the government and/or users for profit over the course of the public-private partnership contract, at which time the asset typically reverts to government ownership.
Infrastructure has a long lifespan but until now we haven’t taken a strategic approach to how we plan for, develop, fund, and maintain infrastructure. New Zealand has been in ‘fix-it’ mode, rather than getting ahead of the challenges that the nation faces.
Using capital markets directly or in conjunction with public-private partnerships can fund infrastructure needed in a timely way for the benefit of citizens and businesses in New Zealand and globally.
DISCLAIMER: This research has been prepared by Jarden Wealth Limited (Jarden) which holds a licence issued by the Financial Markets Authority to provide a financial advice service. The information in this research solely relates to the companies and investment opportunities specified within. For a full publicly available disclosure statement, see https://www.jarden.co.nz/our-services/wealth-management/financial-advice-provider-disclosure-statement/.
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