Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 103

Implications of low rates for infrastructure

Infrastructure is often seen as an alternative to low risk defensive assets like cash and government fixed income in investors’ portfolios. In discussions with infrastructure investors over the past few months, one recurring discussion topic has been the extremely low level of base or risk free interest rates.

Why does it matter?

Part of the attraction of infrastructure at the moment and the record high prices of recent Australian core infrastructure transactions (and the gnashing of teeth amongst infrastructure investors at the cancellation of the former Newman Government asset sales programme) is that returns to traditional low risk sources of yield are so low.

The chart below shows the long term history of Australian 10 year government bond rates. Current yields of 2.5% are the lowest in the history I have been able to access (since 1969). This implies a zero real return (assuming inflation keeps within the 2-3% target band set by the RBA) before tax and fees. Post tax returns for superannuation investors will be negative, an unappetising prospect.

But will such low real base rates persist or go even lower, and how should portfolios be managed in light of low interest rates?

A long term outlook for interest rates

I am not going to make any short term forecast on bond rates. Current forward interest rate markets are probably as good a guess as anyone’s on what might happen in the short term. And in any case, most infrastructure investors are considering investments that last decades and so decisions don’t turn on the short term path for rates.

The more interesting question is the longer term – what do we think interest rates will do over the next 10 or 20 years? Are the rates a structural shift (and the high real rates enjoyed by investors over the past 20-30 years are actually unusual) or should we expect, once the short term impact of recovering from the GFC and QE work their way out of the system, that markets will return to ‘normal’?

Economic theory suggests that in the long term, growth in the economy should match nominal bond rates. The charts below illustrate these relationships for both Australia and the United States (note the different time scales).

Australian 10 Year Bond Rates versus Nominal GDP Growth

United States 10 Year Bond Rates versus Nominal GDP Growth

These charts show the relationship works pretty well – albeit recently both countries have had significantly lower bond rates than nominal GDP growth. In Australia, nominal GDP growth has been running at over 6% for the past decade, which is basically a mining boom/terms of trade story.

If you accept this relationship, future real GDP growth in Australia is likely to be significantly lower than over the past couple of decades. Australia won’t benefit from another mining boom. Population growth will be slower. There won’t be the same benefit from increased female participation in the workforce. The following chart, extracted from a speech by Martin Parkinson last year, gives an interesting decomposition of these effects.

My view is that real GDP growth will be weaker, in the 2%-3% range, rather than the 3%-4% which has been ‘normal’ for Australia over the past few decades. A key risk to this is productivity growth which could easily disappoint.

Adding to this is inflation, which will probably track at 2-3% with a continued reversal of the mining boom terms of trade effect. This suggests a 4%-5% nominal GDP growth rate and by implication bond rate. This would be a real bond rate in the 2%-3% range, significantly higher than rates today.

In the US both growth (probably 1.5%-2.5% real) and inflation (1-2%) will be lower suggesting a lower US 10 year bond rate in the 2%-3% range. And this isn’t that controversial – US bond markets currently have a forward interest rate of around 2.5% from about 2020 onwards. It just takes a while to get there from current zero rates!

It is in Australia where the gap between market views (which has cash rates getting back up to 3% in 2021 and basically tracking in the low 3% range from there) and the outlook for nominal GDP is most stark. To reconcile the two would require either much weaker expectations of economic growth or inflation.

The one factor, which is important, but doesn’t figure in a nominal GDP growth based analysis is the high level of debt across the world at present. Debt, except when invested in productive capacity, is future consumption brought forward. The current debt overhang will be a drag on growth for a substantial period ahead. This, directly or indirectly, will be a cap on sharp rises in interest rates as many parts of the world cannot afford higher interest rates. All this suggests to me that the path for rates might be somewhat lower than a raw analysis of nominal GDP growth would suggest.

What does that mean for infrastructure investors?

Infrastructure is a long duration asset. A material share of the strong performance of infrastructure over the last decade is attributable to declining bond rates. If rates rise over the medium term, then necessarily this will be a drag on the future performance of infrastructure assets from today’s valuations. An exception to this is floating rate infrastructure debt.

Look under the hood. Interest rates have direct and indirect impacts on infrastructure valuations. Much of the focus has been on target equity returns and multiples. However, it is important to recognise that base rates have material impacts through the cash flow impact of debt costs.

While many investors talk of their ‘discipline’ in not reducing target equity returns in light of lower base rates, the reality is that their investment bankers (and managers) forecast the cost of debt service using market implied interest rates. This creates a substantial inconsistency between a static equity hurdle and equity return forecasts that include the benefit of cheap debt service costs.

Be consistent. Whatever your view on base rates is, you should be consistent in terms of forecasts for inflation and, for patronage or economic infrastructure assets, revenue projections. In a world where bond rates remain low it seems highly likely that inflation and economic growth outcomes will be much lower than history. A follow-on question for another day is whether low interest rates ‘justify’ the record earnings multiples for recent Australian core infrastructure transactions.

 

Alexander Austin is Chief Executive Officer of Infradebt, a specialist infrastructure debt fund manager. This article provides general information and does not constitute personal advice.

 

RELATED ARTICLES

Joe Hockey on the big investment influences on Australia

Inflation? Nothing (much) to see here

Australian and US house prices remain firm

banner

Most viewed in recent weeks

Raising the GST to 15%

Treasurer Jim Chalmers aims to tackle tax reform but faces challenges. Previous reviews struggled due to political sensitivities, highlighting the need for comprehensive and politically feasible change.

7 examples of how the new super tax will be calculated

You've no doubt heard about Division 296. These case studies show what people at various levels above the $3 million threshold might need to pay the ATO, with examples ranging from under $500 to more than $35,000.

The revolt against Baby Boomer wealth

The $3m super tax could be put down to the Government needing money and the wealthy being easy targets. It’s deeper than that though and this looks at the factors behind the policy and why more taxes on the wealthy are coming.

Are franking credits hurting Australia’s economy?

Business investment and per capita GDP have languished over the past decade and the Labor Government is conducting inquiries to find out why. Franking credits should be part of the debate about our stalling economy.

Here's what should replace the $3 million super tax

With Div. 296 looming, is there a smarter way to tax superannuation? This proposes a fairer, income-linked alternative that respects compounding, ensures predictability, and avoids taxing unrealised capital gains. 

The rubbery numbers behind super tax concessions

In selling the super tax, Labor has repeated Treasury claims of there being $50 billion in super tax concessions annually, mostly flowing to high-income earners. This figure is vastly overstated.

Latest Updates

Investment strategies

Trump's US dollar assault is fuelling CBA's rise

Australian-based investors have been perplexed by the steep rise in CBA's share price But it's becoming clear that US funds are buying into our largest bank as a hedge against potential QE and further falls in the US dollar.

Investment strategies

With markets near record highs, here's what you should do with your portfolio

Markets have weathered geopolitical turmoil, hitting near record highs. Investors face tough decisions on valuations, asset concentration, and strategic portfolio rebalancing for risk control and future returns.

Property

Soaring house prices may be locking people into marriages

Soaring house prices are deepening Australia's cost of living crisis - and possibly distorting marriage decisions. New research links unexpected price changes to whether couples separate or silently struggle together.

Investment strategies

Google is facing 'the innovator's dilemma'

Artificial intelligence is forcing Google to rethink search - and its future. As usage shifts and rivals close in, will it adapt in time, or become a cautionary tale of disrupted disruptors?

Investment strategies

Study supports what many suspected about passive investing

The surge in passive investing doesn’t just mirror the market—it shapes it, often amplifying the rise of the largest firms and creating new risks and opportunities. For investors, understanding these effects is essential.

Property

Should we dump stamp duties for land taxes?

Economists have long flagged the idea of swapping property taxes for land taxes for fairness and equity reasons. This looks at why what seems fairer may not deliver the outcomes that we expect.

Investing

Being human means being a bad investor

Many of the behaviours that have made humans such a successful species also make it difficult for us to be good, long-term investors. The key to better decision making is to understand what makes us human and adapt.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.