Inflation, rising rates major hurdles for IIJA progress

Inflation, rising interest rates and increasing construction costs are weighing on the implementation of the Infrastructure Investment and Jobs Act.

Some projects that were budgeted and started at the beginning of the inflation spiral are now in jeopardy. While the IIJA provides billions of grant dollars, municipal experts say hurdles remain for state and local governments to access them while navigating Federal Reserve fiscal tightening and the market volatility it is causing.

The sentiments came from a discussion at The Bond Buyer’s inaugural Infrastructure Conference held in Washington, D.C., and stemmed from the key findings of a newBond Buyer report on infrastructure spending and planning expectations, sponsored by Assured Guaranty.

The findings were culled from a survey of 152 muni marketplace stakeholders conducted from August to September 2022. The impact of a potential recession, higher interest rates and inflationary pressures on the cost of funding infrastructure in the U.S., as well as the viability and effective execution of the new law itself were the top concerns.

According to the report, “Costs for highly rated state and local governments to borrow in the municipal market have risen more than 2.5% to 3% in 2022. Municipal bond issuance volume has fallen more than 20% year-over-year as investors have pulled more than $111 billion out of municipal bond mutual funds.”  

“Inflation is number one and probably understated in some respects,” said Ben Watkins, director of the Florida Division of Bond Finance.

“What the Fed did with federal monetary policy combined with fiscal policy was like pouring gas on a fire that was already raging out of control. The way we’re having to pay for that is inflation. We have projects coming in 20%-40% above estimates and that’s significant.” 

The IIJA is poised to pump $1.2 trillion into infrastructure improvements via hundreds of new discretionary programs on top of traditional formula funding, including $550 billion of new spending over five years. In addition to concerns about the timing of the funding influx, some believe the number is already too small. 

“IIJA is a start, it’s a move in the right direction, but I think it’s a small amount for a massive problem,” said Chris Jumper, director Assured Guaranty. “I think more needs to be done, and it’s going to come down to a lot of municipal financing and privatizations.” 

Doubts about the legislation’s effectiveness also emerge in the report’s findings with only three-in-10 of the stakeholders surveyed expressing confidence that the act will meet the infrastructure investment needed. 

The report indicates that 64% of respondents are not applying for the grant funds with Watkins believing that over-complexity is the major challenge.

“There’s so much baggage on it, so many conditions. A lot of that funding is for things that I can’t even pronounce. People aren’t going to sign up for it,” he said. “We’re doing zero new projects; all we’re doing is paying for the inflation on the projects that were originally planned on our five-year capital plan. The muni finance issuers are a risk-adverse bunch. We want clear rules to follow to know that we’re not sailing over the edge.”  

Bright spots in the report include three-in-four of the respondents believe “the IIJA has positively altered the landscape in public finance for the next one-to-five years, with 14% reporting the expectation for a significant positive impact, 63% for a limited positive impact.”  

Six-in-ten of the respondents feel hopeful about the growth of public-private partnerships in public finance in the near term. One of the provisions of the legislation raises the volume cap on private activity bonds — a key component of P3, from $15 billion to $30 billion, the largest-ever increase.

Eight-in-10 respondents are expecting the IIJA to positively impact the growth of broadband over the same period. 

The report explores political divides along with the hot-button issue of environmental, social and governance. Four-in-10 respondents believe the growing focus on ESG will accelerate public finance industry growth in the next two to five years, but Democrats are more likely to be optimistic about growth, with 46% seeing accelerated growth, while Republicans see a 44% reduction in growth.

“The muni business historically has been politically agnostic,” Watkins said. “The ESG advocates have now injected a political element into the discussion that’s not constructive. It’s degenerated into a political statement with an ideological bent. I’m not into labels or verifiers because there is no value. From a risk-reward standpoint, it’s not even close. The risk far outweighs the rewards.” 

Hints of cautious optimism can also be found in report’s findings as three-in-four respondents feel the IIJA has positively altered the landscape in public finance for the next one-to-five years.

“We’ve seen issuers come thorough the Great Recession in 2008 and the pandemic,” Jumper said. “Higher interest rates make projects more expensive along with inflation, higher labor costs, and material costs. It’s definitely going to impact projects in the future. A lot of these are very long-term projects.”