Warning as council debt levels outstrip revenue growth
Council debt levels may be growing, but local authorities are still relatively under-leveraged compared with previous infrastructure investment cycles.
The Infrastructure Commission/Te Waihanga released new research last week reviewing local government financing tools and asking how debt constrained councils are.
As Geoff Cooper, the general manager for strategy at the commission, told attendees of a recent conference hosted by Infrastructure New Zealand: “We are seeing the amount of debt local government is taking on rising, which will be a surprise to exactly nobody in the room, particularly people from local government.”
“What we use debt for matters,” he added later.
At the end of 2022, councils and council-controlled organisations had $22.5 billion of debt, the vast majority with the Local Government Funding Agency (LGFA), set up to provide councils with efficient finance from local and international lenders. As of August 2023, LGFA had loans worth $17.2b.
Councils that borrow via the LGFA have to adhere to financial covenants, including a requirement they maintain a debt-to-revenue ratio of below 280 per cent.
While their debt levels are forecast to rise further, the debt-to-revenue ratio for local government (a key metric for lenders and credit rating agencies) is still well below that of previous investment cycles (1920-1936 and 1950-1970) when councils were building out their critical infrastructure networks.
As Cooper joked at the conference, in the early 1900s when councils were building out their cities and critical networks, they would have struggled to find projects with benefit cost ratios below one, ie investments would have spurred economic growth, enabling local authorities to take in more revenue either indirectly or via user charges.
Commission economics director Peter Nunns said councils now faced a different proposition: maintaining existing networks, including assets at the end of their useful life.
“Today, councils need to invest much more in renewing and replacing the infrastructure they’ve already got. While essential, this work doesn’t tend to generate new economic activity or new revenue for councils. Even with many councils currently raising rates, however, debt is currently rising faster than revenues. If this trend continues, councils will eventually need to cut back future infrastructure investment to service their debt.”
As the report said: “Using debt to finance renewal deficits effectively pushes the payments on future generations twice: first when we underinvested and again when we use debt to finance the deficit. “In such cases, pay-as-you-go financing or funding depreciation may be a better approach.”
Says Nunns: “If the problem was that we kicked the can down the road, the solution shouldn’t be kicking the can down the road again.”
A pay-as-you-go approach was one of three identified in the report for providing infrastructure, along with debt financing infrastructure and making payments using existing revenue streams, and debt financing infrastructure but paying for it by also growing revenue.