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Mixed ownership model

Show me the money

Author: Paul Callow

Budget 2012Infrastructure has received some attention in most of this Government’s three previous Budgets. All the right noises have been made about creating a fiscally sound balance sheet, prioritising the areas in which the Government invests its limited capital, and analysing whether the current portfolio mix puts it to best use. This is the first time in a long while that a Government has undertaken this approach. And not only has it asked these important questions, it has now actually tried to do something with the conclusions it has reached.

So far, however, the only tangible action has been the mixed ownership model programme, in which Government has quite sensibly decided that full or significant majority ownership of electricity companies, coal mines and the national airline is not a particularly good use of taxpayers’ capital. This is not a particularly surprising outcome given that many of the other countries with which we like to compare ourselves arrived at this conclusion quite a while ago. It is, however, a sad reflection of how far behind them we have fallen that it’s taken this long. 

What is also concerning is that the Government’s explanation of why it is undertaking the mixed ownership model has been handled poorly. Is it about debt reduction? Or making money available for investing in other services or infrastructure? Or is more about improving the performance of the companies concerned? The Government’s answer seems to be “all of the above”, which is clearly quite a confusing message to try to convey to a public which thinks they are just “selling the family silver”. The proof of the pudding, however, will depend very much on what Government does with the proceeds.

The Government has announced the $5 billion to $7 billion which is expected to be raised from the various floats will be vested in the Future Investment Fund, and the funds will be allocated to specific projects which meet a yet-to-be-defined set of criteria. Budget 2012 allocated $559 million for the fund from the first floats, to be used for various investments in schools, health and tertiary education. Nearly half went towards the turnaround in KiwiRail which at least explains how Government plans to fund the commitments it has already made. Apparently this will promptly disappear in asset write downs.

At least that answers the question as to what the Government is going to do with the proceeds – plug gaps and prop things up, hardly what you would call visionary. 

Tagging the proceeds in this way doesn’t really fool anyone: money is money and the fact that the Government has just sold a stake in an SOE simply means it has more of it to spend or needs to borrow less. The important thing about the fund is the opportunity it presents to do something different and send a strong message about the Government’s economic priorities and what it plans to do to achieve them. 

During the last election the National Party announced it was setting aside $400 million for investment in irrigation schemes and planned to use cash from the Future Investment Fund to co-invest with the private sector in suitable projects. The plan is to use a similar model to that used for the ultra-fast broadband roll-out, enabling the Government to recover its investment and recycle the cash into other projects. This is an innovative approach to infrastructure projects which have a major potential economic pay-off but which would otherwise not be built.

So far so good, but what thought has gone into how to use the rest of the cash? In short, not much apparently. Other than some vague recent comments about building and modernising schools and unspecified major hospital redevelopments, the Government has been largely silent on its plans for the fund.

This is a shame as the licence to innovate which the fund can bring has the potential to transform many areas of our economic infrastructure. Social housing, for example, could benefit enormously from a government-backed lease-to-buy model for tenants who the private sector won’t fund. 

Urban transportation projects are another area where the fund could be used. They require substantial investment in the face of uncertain demand but often prove to be strong drivers of economic transformation as our major cities grow and become more congested. They can also prove to be financially sound projects in their own right in the fullness of time. 

The Government has already shown its willingness to take on exactly these sorts of long-term demand risks with its roll-out of the ultra-fast broadband network and plans for irrigation projects. Using the broadband model as an example, the Government makes the initial investment but gradually recovers its money by replacing it with private capital as demand on the network grows and provides cash flows to support commercial investment.

The fund provides the perfect vehicle to support this model. It is of a fixed size and lends itself to funding specific projects in specified sectors. The really exciting aspect of these investments is that the broadband model can be used to recycle the original cash investment over time, meaning it can go back into the fund together with any returns earned. The fund can be self-perpetuating and grow over time, eventually becoming a progressively greater source of investment for economic growth.

With a little bit of imagination between now and Budget 2013, the Government could use the initial proceeds of mixed ownership to set the scene for a whole new way of thinking about investment in economic infrastructure in New Zealand, as well as providing real clarity on why the assets were sold in the first place. Let’s hope the Government doesn’t miss the opportunity next time.

Budget 2012 Analysis

 

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