What the UK budget could do for infrastructure

Alistair Darling will unveil the UK budget for 2010 tomorrow, with infrastructure expected to play an important role in stimulating the economy. The latest news indicates that a £2bn green infrastructure fund is on the cards. InfrastructureInvestor.com assesses pre-budget expectations.

When UK Chancellor Alistair Darling reveals his budget for 2010 tomorrow at 12.30pm GMT it doesn’t take a betting man to know that the odds are in favour of infrastructure being an important part of the government’s plan to stimulate economic growth.

Alistair Darling

What is less clear, however, is what measures the government will take to increase private sector participation in funding the £434 billion (€497 billion; $700 billion) in upgrades the UK is said to need over the next decade.

The pre-budget noise certainly came thick and fast, with senior government figures like trade and investment minister Mervyn Davies and business secretary Peter Mandelson weighing in on how the government can attract more investments from the private sector.

“A little bit of government help can unlock a lot of private sector investment, and that is going to be the focus this week,” Darling said in a recent BBC interview. Assuming the budget lives up to this billing, here is a speculative list of what might be included.

A £2 billion green energy investment fund
Treasury sources have been leaking to the media that Darling will include a £2 billion green energy investment fund in tomorrow’s budget.

This fund would be financed with government asset sales – such as the High Speed 1 rail link – to the tune of £1 billion with the private sector matching this seed amount with another £1 billion. The fund would then target green energy projects such as wind farms or solar plants alongside other areas such as high-speed rail.

But there are problems. First, raising that state-backed £1 billion is expected to take some time, as the UK progresses on the £3 billion of asset sales it has earmarked to raise cash. Government insiders told the Financial Times today that the first cash for the fund is likely to come from the sale of the Channel Tunnel rail link, also known as High Speed 1, to be completed next April. Those same insiders also indicated proceeds from the asset sales would be channelled to the green fund over the next five years.

The second main problem, which you might have already guessed if you did the maths, is that £2 billion is not a lot of money considering that, just for energy, the UK is said to need some £264 billion. This prompted Nick Chism, KPMG’s global head of infrastructure, to comment to the FT that such a fund would only be “a small part” of the answer.

An infrastructure bank
Business secretary Peter Mandelson is said to be the biggest proponement of creating a UK infrastructure bank.

Peter Mandelson

In a recent speech at the University of Manchester, Mandelson said the government had to examine “the case for public sector-backed financial institutions […] to mobilise private investments on a totally new scale”. Mandelson said these public institutions could help mitigate “the initial risks and uncertainty” of infrastructure projects in a bid to attract pensions funds, “a huge pool of capital well suited to these kinds of long term investments”.

Tim Breedon, head of Legal & General, the UK’s largest pension fund manager, explained in an earlier interview with the FT that a UK infrastructure bank could help projects get started. This bank would then siphon-off debt to insurers and pension funds at credit ratings they would find attractive.

At his most ambitious, Mandelson was said to be mulling an investment bank modelled on Germany’s KfW bank, the Telegraph newspaper reported.

The KfW group was founded in the aftermath of the Second World War to help reconstruct Germany. Initially, it used funds from the Marshall Plan to help fund projects but its federal guarantee allowed it to borrow at very low costs and, in turn, provide competitive loans. It is now Germany’s sixth-largest bank with close to €400 billion of assets at the end of 2008.

But the FT poured cold water on plans for an infrastructure bank, citing government insiders who say the Treasury has become sceptical of a broader infrastructure bank. The sources indicated that to fund non-renewable sources of power, the Treasury is now favouring tweaking existing regulations to encourage more investment.

A new capital market for infrastructure
Trade and investment minister Mervyn Davies first touted the possibility of the government intervening to help kick-start a UK capital market for infrastructure.

“The big prize would be to set aside part of the long-term pension industry and get them to invest” in infrastructure, Davies told the FT in January at the sidelines of an infrastructure conference. To make sure pensions would come on board massively, he suggest the government could “take some of the building risk before converting it [infrastructure investments] into long-term loans”.

Mervyn Davies

If this mechanism were to figure in tomorrow’s budget, it could presumably see the government set aside a chunk of money to guarantee the construction period for certain infrastructure projects, similar to the €10 billion the French government set aside last year to guarantee up to 80 percent of a project’s senior debt.

The idea would be for such a guarantee to elevate most infrastructure projects to investment grade and, presumably, allow pensions to fund them from the very beginning, stepping in for cash-strapped banks as major infrastructure funders.

However, there is a distinct possibility that these mechanisms will not figure in the budget itself, but rather as part of an annexed proposal (see below).

A list of priority infrastructure projects
Perhaps the most secure bet is that, appended to tomorrow’s budget, there will be a list of the key infrastructure projects that should be prioritised in the UK over the next five to 50 years. This list is being put together by Infrastructure UK, the government’s new infrastructure body chaired by former Rio Tinto head Paul Skinner.

The FT writes today that this report is also likely to include a list of proposals on what the government can do to encourage private sector financing for infrastructure.