Richard Threlfall, Head of Infrastructure, Building and Construction, KPMG UK, comments: "This week’s announcement of UK Government guarantees for up to £40bn of infrastructure projects was a bold move, designed to revive both the construction industry and the economy generally. It marks a clear turning point where the Government’s positive rhetoric on infrastructure over the last few months has turned into action. Indeed the potential scope of the intervention goes some way beyond what the industry was expecting.
The infrastructure financing problem has been apparent for some time. According to the National Infrastructure Plan £400bn needs to be invested in the UK’s infrastructure between now and 2020 if the country wants to remain competitive in a global market. But long-term bank market finance for infrastructure has been slowly evaporating like the Cheshire Cat. Pension funds and other bond market investors are not interested in construction risk. A black hole was gradually opening up in the ability to privately finance infrastructure projects.
It was a problem the Government could not ignore any longer. With the economy remaining sluggish it had to intervene to get infrastructure projects started and the UK construction industry back to work. The sector employs around 3 million people across a huge supply chain and has a strong multiplier effect on the UK economy. Economists estimate that every £1 spent on construction generates almost £3 in economic activity. Looking more long term, the Government knows that with the fourth fastest growing population in Europe, it can’t ignore the growing demand for new and improved infrastructure any longer.
So how will the Government’s intervention help? There are two main components.
The co-lending programme provides for Government finance to be invested alongside private finance where there is insufficient commercial lending appetite. This is a re-launch of the Treasury Infrastructure Finance Unit whose brief existence prior to the last election allowed the Manchester Waste deal to be financed but was then shut down as the bank markets briefly recovered.
The guarantee scheme allows project promoters struggling to finance their projects to apply to Treasury for bespoke guarantees, in return for which (and to satisfy state aid rules) the Treasury will levy a guarantee fee. The guarantee is likely to cover specific scheme risks, such as construction risk or revenue risk, and should open the door to pension and bond market finance for infrastructure projects. It dovetails well with the promised creation of the £2bn Pension Infrastructure Platform next January, and puts the UK’s AAA rating to good use without scoring on the Government’s balance sheet.
For projects to qualify they have to fulfil five criteria, including that work can start within a year of the guarantee being agreed. This targets the Government’s support at well developed projects that are already past planning hurdles. What is unclear is how many projects are this well prepared. The risk is that projects spend too long being scrutinised before getting the support they need and that for all the fanfare today in the end very few projects actually benefit. Nonetheless it is a much needed safety net and one that should instil confidence in project sponsors to push on with projects in the knowledge that no well structured project will fail for lack of access to private finance.
How does this compare to the approach in other countries? The UK has arguably exacerbated its own problem by cutting public investment in infrastructure at the same time as private demand was so low, creating a double-whammy on the industry. UK investment in infrastructure as a percentage of GDP has lagged the OECD average for years, and, as the CBI has warned, is due to fall further by 2015. Finance has been less of a constraint also. In Canada pension funds have invested directly into infrastructure for years, reducing reliance on bank finance. In Australia the Government has shared refinancing risk on projects to allow short-term bank lending in the construction phase. Germany and Brazil, amongst others, have state-owned infrastructure banks that lend to projects.
So the Government’s new boldness is helpful. But is it enough? Cancellations and delays to projects over the last couple of years have created a sharp drop in pipeline and collapsing order books for UK construction companies. Earlier this month Markit / CIPS data revealed the biggest drop in construction output for two and half years, and well respected construction businesses such as Killby and Gayford and Doyle Group have recently gone into administration. If the Government is really going to reverse this trend, today’s announcement needs to be part of a package of wider interventions, to stimulate public and private infrastructure investment demand.
The Government should re-introduce tax relief for infrastructure investment in buildings and structures, recognising that the UK is the only country in the G20 that has no such allowance. It should provide stronger support for the housing market, which outside of the London commuter belt remains highly depressed. And it should, in the next version of the National Infrastructure Plan, provide a proper vision for the development of the country’s infrastructure networks covering energy generation and transmission, south-east runway capacity, national and international freight connectivity and high speed communication networks.
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