3.4  Inflation and the PSC

The discount rate used in the PSC should generally be nominal and before income tax. The numerator cash flows should also be expressed in nominal terms (i.e. inclusive of inflation) to match the discount rate.

Nominal rather than real costs need to be considered, as the provision of infrastructure and related ancillary services over a long contractual period is typically sensitive to the effect of inflation over time. The use of nominal values also reflects accepted practice in the Australian infrastructure market.

General inflation rates should be obtained from the projections provided in the State Budget papers. Some cash flow items in the PSC may inflate at different rates from the general inflation rate. In this case, appropriate adjustments should be made to costs that are expected to increase at a different rate to the general inflation rate. Labour is an example of a cost that may inflate at a different rate from the agreed project inflation rate.

All costs and expected revenue streams should be adjusted for inflation, except where government expects to enter into contractual arrangements that would inflate at a different rate from the general inflation rate. An example of this would be if government entered into a fixed price contract for the construction of a building. In this case, the contractor would include the inflation risk within the fixed price.

The inflation rate specified in the PSC should also be incorporated into the bids, even if the bidder is expected to take financial (inflation) risk, to ensure a fair comparison of the bids against the PSC. Note that the bidder may be taking a different view on inflation, which needs to be evaluated as part of their bid. Evaluating bids against the PSC is discussed further in Section 9.

The Discount Rate Methodology Guidance provides further details on the methodology for determining the appropriate discount rate to be used in the evaluation of the PSC and should be read in conjunction with this PSC Guidance.