Infra’s own sovereign debt crisis

Summer – and especially August in Europe – is famously known as the silly season. It means you can look forward to a solid month of light news to keep you company in the sand and sun as you take a well deserved break from the hectic madness of the rest of the year.
 
This August, however, the only silly thing about the season has been the almost absurdly  prolific amount of bad news competing for space in the world’s newspapers. A small sample: London burning as rioters run amok; Standard & Poor’s stripping the US’ AAA rating for the first time in the nation’s history; and the Eurozone’s (and some say the European Union’s) daily struggle to avoid cardiac arrest.
 
In keeping with the doom and gloom of the times, we decided to spring a little (unappetising) food for thought on our readers. The idea came from a conversation with Henk Huizing, head of infrastructure at Dutch pension asset manager PGGM, on the risks of investing in southern Europe (you can read the complete interview in the upcoming September 2011 issue of Infrastructure Investor magazine).
 
Reiterating that PGGM has no intention of withdrawing from these countries, Huizing went on to say that the pension provider will nonetheless look at projects carefully. 
 
“If it’s a PPP [public-private partnership] in Spain, we have to see who will be paying the bill. We know that some PPPs in Spain are paid by the regions and that these regions have very high debt positions. For instance, we would usually prefer a PPP toll road to a real toll road. But in the case of Spain, we can say that we already know what the impact of the crisis is on real toll roads […] (a decrease in traffic of roughly 15 percent). But while we know [this] impact, we can’t predict what will happen if one of these regions gets into trouble.”
 
Huizing’s caution is not unwarranted. In a recent article by the Associated Press, the news agency outlines how Spain’s “8,115 municipalities are being hit by a crushing revenue hangover from a nearly two-decade building boom that went bust in 2008”. 
 
Examples include delayed salaries, police told to refrain from using their patrol cars unless there is a crime in progress, and pharmacies striking because they are owed millions of euros in back payments from the regional authorities. The required medicine “is an unprecedented programme of drastically reducing services while boosting local taxes and fees in an austerity drive that could last eight years”. Ouch.
 
But what that might mean for you, infrastructure investor, is that one day, like these pharmacies, you might find that your contractually agreed revenue stream from the government is not coming in on time and, actually, might not be coming in at all, or may have to be drastically reduced.
 
It might seem far-fetched, but that outcome will really depend on how much infrastructure correlates with trends in the wider economy. After all, the private sector credit bubble that burst spectacularly in late 2008 has been swiftly followed by a terrifying sovereign debt crisis in Western developed countries that is again threatening the stability of the global financial system.
 
Is infrastructure immune to this cycle? That depends on your point of view. One could argue that infrastructure has already had its credit bubble in the mid-2000s, when you could lock-down 30-year financing paying sub-100 basis points margins.
 
You might disagree and point out that, barring a few casualties, the much dreaded “refinancing wall” – the gazillions of infrastructure-related debt that needs refinancing over the coming years at much higher prices – has so far failed to materialise. Or that privately procured infrastructure only accounts for a tiny portion of countries’ infrastructure investments.
 
But if you bear in mind that all those loans were provided to support projects in many of those “secure” Western countries that are now buried in debt, then suddenly your “guaranteed” government revenue stream – which is nothing more than off-balance sheet public debt – might not look that safe anymore.
 
Still think this whole idea is being blown out of proportion? Then rejoice and welcome to the silly season!