Australia must re-think how it assesses future infra

But the Grattan Institute’s focus on discount rate is largely seen as missing the mark by the industry.

Australia’s method of selecting and prioritising major transportation projects is in need of “long overdue changes,” the Grattan Institute, an independent think-tank based in Melbourne, argued in its latest report.

In particular, it said that the discount rate – a mechanism used to compare costs and benefits of projects – has remained at 7 percent since at least 1989.

“Back in 1989, when the 7 percent discount rate was established in Australia, the government borrowing rate was 6.8 percent in real terms (adjusted for inflation); in 2017, it was 0.8 percent,” the Grattan Institute stated in Smart money: A better way for Australia to select big transport infrastructure projects.

“Discount rates should reflect such a dramatic change in the cost of money,” it added.

But members of the infrastructure industry are less certain that a focus on the discount rate is the decisive factor in the selection of new transportation projects.

“We’re at the end of a cycle where interest rates are beginning to turn, and it’s not the time to be assuming this perspective is the new normal,” QIC’s global head of infrastructure Ross Israel told Infrastructure Investor. “Changing [discount rates] without the context of market history could be dangerous.”

He added: “We’d say, from our experience, that there are different forces in play when deciding how infrastructure will be procured than just the pure cost of capital.

The Grattan Institute’s recommendation comes as pressure continues to mount on central banks to raise interest rates, although the Reserve Bank of Australia chose to hold rates steady at a record low of 1.5 percent on 5 March.

Garry Bowditch, executive director of the Better Infrastructure Initiative within the University of Sydney’s John Grill Centre for Project Leadership, also welcomed the report but said “in some ways [it] misses the bigger issues at play. Adding: “I believe that, even if the recommendations were adopted, it would have made zero difference to the outcome.”

Politically-motivated decision-making plays an important role, he argued: “Governments don’t just choose projects based on the cost-benefit analysis.”

Israel, though, also claimed that what customers want is changing and that upgrading existing infrastructure to take advantage of changes in technology was important.

“There will be significantly more risk in some of these projects going forward, so it’s not just a simple decision based on cost of capital,” he said.

“A better metric might be a more service-led one. Are you incentivising the right kind of investment?”

The Grattan Institute recommended that discount rates in 2018 should be lowered to around 3.5 percent for projects where systematic risk is low, such as roads and passenger rail; and around 5 percent where it is high by the standards of transport infrastructure projects, such as ferries.