Central banks continue to tighten monetary policy in the UK, Europe and the US.  As of March 2023, the Federal Reserve has increased interest rates nine times since March 2022 (Smith & Duguid, 2023). The European Central Bank also raised interest rates in March, albeit from a lower base, despite ongoing concern about financial stability in the region in the wake of previous rate hikes (ECB, 2023).

These actions will result in higher borrowing costs, as well as reduced consumer spending and business investment. This, in turn, can reduce cashflows to infrastructure firms. We remain alert to see how the economies are slowing, aware that there are lags before changes in monetary policy take effect.

Infrastructure companies generally have long-term debt, with interest-rate hedges to protect against higher rates. This helps to mitigate the credit risk associated with higher interest rates as the hedge protect against the impact of interest rate movements on the cash flows and debt service costs.

• Contracted firms (BR1) are less sensitive to increases in interest rates as they have long-term contracts in place for a number of years. For instance, power generation companies in IC10 and IC70, with existing PPA, would not be impacted rates hikes as their effect on power prices tends to be short-lived and should only impact the spot prices. However, interest rate changes can compound the impact of counterparty risk, which is a could be a concern for contracted constituents, depending on the creditworthiness of their counterparties.
• Firms with regulated revenues (BR3) should continue to grow slightly given, that they are relatively insulated from the slowing economy. As an example, in the UK, utilities (IC80) are tied to an allowable revenue that ensures adequate and reasonable returns; this regulated return is determined on real terms, incorporating the regulatory capital value and expenditures after any regular resets for the price control determination. This linkage enables the cost of capital to align with required returns and pass-through inflation directly. Given the relative inelasticity of demand for services provided by regulated utilities, any increase in prices is unlikely to see a significant drop in demand, ensuring ongoing returns for shareholders. To address the recent increase in energy costs, the UK has forecasted an increase in water tariffs by 7.5% (Mayes, 2023). Once this tariff increase is implemented, adjustments to the revenue forecasts of our utilities constituents may be necessary.
• Merchant companies (BR2), however, do not have a fixed revenue stream and are exposed to the market demand to generate revenue. In this case, higher interest rates can lead to a slowdown in economic growth, which can impact the demand for infrastructure services. If rates rise, and correspondingly economic growth slows, there could be lower demand for the services from infrastructure assets including transportation sectors (IC60), which in turn could impact the revenue of these companies. Currently, we have not observed clear signs that the economy is having a major impact on the demand for infrastructure services yet but we will continue to monitor this closely.

As stated in our prior quarterly report, we have already adjusted our revenue forecasts to incorporate rising inflation as well as other relevant factors discussed above.

Find the Q1 2023 data release in infraMetrics here.

References

• European Central Bank (ECB) (2023). Monetary policy decisions.
• Smith, C. & Duguid, K. (2023), Federal Reserve presses ahead with quarter-point rate rise despite banking turmoil. Financial Times.