Brazil Supplement: Infrastructure, Indecision Thwarts Ambition

After all the hot air about desperate need for investment, Brazil has failed to deliver on large parts of its infrastructure promise, with the notable exception of power.

The Federal government and Brazil’s most developed states are desperately aware that they need to address bottlenecks and missing links in the infrastructure matrix, particularly at a time of strong economic growth. The media are fuming over record traffic congestion, jammed ports and rotten airport infrastructure. Any politician worth his salt is campaigning on the issue. Yet, with the notable exception of power, financial commitment is lagging the sound bites.

The PAC, Brazil’s growth acceleration program, is a centerpiece of the second Lula mandate and was given total spending plans of just over 500 billion reais by 2010, mostly in infrastructure. Of the total, 275 billion reais was dedicated to power, 171 billion reais on social and urban projects and 58 billion reais on transport. The project is accelerating and has achieved some success, particularly in power. But in other areas, particularly transport, there is a disconnect and financing remains too dependent on the public sector, preventing innovation.

Brazil’s national development bank, the BNDES, is involved in funding for most of the projects, with 77 so far approved. “We are seeing faster growth than before as we work to match demand at a time of strong economic growth,” says Wagner Bittencourt, director of infrastructure at the development bank. The bank has achieved particular success in energy – both distribution and transmission – petrol, gas, and alternative energy. It is also focusing on logistics, including railways and roads. Bittencourt expects the bank’s total disbursements to increase from 65 billion reais last year to 80-83 billion reais this year.

The government notes that 88 projects have been concluded, involving spending of just over R$10 billion, and says that 87% of the 2,120 actions are progressing at “an adequate rhythm”. But spending is lagging, even it admits. Of R$14.6 billion allocated to the PAC budget in 2007, just R$3.6 billion was indeed spent, representing 24.7%. In the first five months of the year, just $2.9 billion of the R$15.8 billion in the budget has been spent, according to data from SIAFI, the government’s accounting watchdog.

The biggest problem is in the preliminary stages, as the government has neglected to carry out basic feasibility studies over the last decade, says Mauricio Endo, director at KPMG in São Paulo, which has advised the government on public private partnerships. Once these are completed, the program should accelerate.

Infrastructure development has been occurring organically in projects that were going to happen anyway, and PAC has not had a huge impact, agrees João Zani, a banker at Bradesco BBI in São Paulo. He adds that the government’s willingness to stimulate the sector and provide more confidence is helping, but tangible progress is less evident. Part of the reason is the sheer volume of projects that the BNDES is being asked to consider. There is also slow development in government policies on how best to develop sectors such as ports and airports.

Rate Crunch
Pressure on the BNDES to fund infrastructure is likely to mount with the turning of the interest rate cycle. Long-term borrowing rates, which can be 20 years, at the BNDES are stable at 6.25% while the Selic rate, mandated by the Central Bank, has been on the rise, hitting 13% in July with predictions of further hikes to come. That widens the gap between commercial bank and public sector funding.

The inevitable resulting tightening of credit is causing delays and putting pressure on existing projects. Those projects running to a deadline that risk incurring financial penalties have to secure as much funding as possible from the BNDES, according to Zani. Bids will be more conservatively calculated and sponsors that can put projects on hold most likely will do so, he adds.

National development banks remain the first port of call for debt financing, agrees Miguel Noronha, executive director, at AG Angra Investimentos, a firm established as general partner of AG Angra Infra-Estrutura Fundo de Investimento em Participações, a private equity fund. “Project sponsors try and get as much as they can out of the BNDES and the regional development banks such as the Banco do Nordeste, that have similar products,” he adds. This dependence on the BNDES for well priced long-term investments is now putting unreasonable pressure on the bank’s resources, thinks Noronha.

Co-financing Pickup
Tougher capital markets should enable multilateral development banks to become more active, believes Roberto Deutsch, executive director for infrastructure business development at giant conglomerate Camargo Corrêa, with over R$12 billion in annual gross revenues, in São Paulo. “Sponsors’ ability to raise money in capital markets and the emergence of structured finance in the last few years meant that multilaterals had lost competitiveness. They are now likely to return in force,” he says.

At the IDB, for example, rules have been altered to allow more financing of private sector projects. Bittencourt confirms that his bank and multilaterals are working closely together, having had partnerships for years in jointly financing projects.

Reliance on public sector financing is likely to slow the roll out of projects because of longer, more complex approval processes. Fortunately, the BNDES has been accelerating and it is nearly in line with that of the multilaterals, says Deutsch. Still, there is some fine-tuning to achieve synergies as the approval of guarantees is more time consuming at the BNDES than at multilaterals, while the latter spend more time on bespoke environmental impact assessments, he says.

Commercial Bank Freeze
The downturn in public equity markets and higher rates have meant that companies are paying more attention to private equity (PE) and other sources of funding, particularly for mid-sized deals, says Noronha. There has been an expansion of private equity infrastructure funds, which now number half a dozen, he notes. They include funds from ABN Amro, Darby Overseas Investments and GP Investimentos. PE is particularly important as commercial banks tend to take a back seat as suppliers of bridge loans and short-term funding, such as working capital needs, he adds.

Commercial banks are generally not interested in participating in infrastructure projects, agrees Endo. Still, growth in capital markets and innovations in debt and securitization markets should compensate for the limitations of the BNDES and commercial sector in the long-term, he adds, with new debt instruments, such as receivables, and more open equity markets.

But Zani believes commercial banks, like his shop, have an important role. He points to the eight mandates for project finance that Bradesco already has and notes that the bank has more than 15 more in the pipeline. The bank is concentrating on deals in electricity, hydro and gas, he says. Sponsors are also increasingly looking to leverage their equity, typically, with debt financing, bringing in further business for banks, he says.

Favoring Real Assets
Power has been the government’s number one priority, given painful memories of the blackouts in 2001 and, until recently at least, a very real fear they may recur. A very large part of the PAC is dedicated to power, energy and exploration with Petrobras accounting for some one fourth of the 500 billion reais budgeted for 2007-2010, says Noronha.

One reason to hope for success is that the government and market are used to such projects – concessions date back to the 1990s – meaning that a model exists, says Endo. Most of the attention has been on hydro-electric power, where the giant projects on the Rio Madeira are moving forward and a plethora of smaller, shorter-duration hydro projects are also underway or even complete.

Investors favor the sector in today’s risk-averse climate because of stability and predictability of the cashflow, says Zani. They do not depend on non-proven behavior, a problem that besets road concessions where guestimates for traffic levels at different price levels need to be made, he adds.

Bids for Jirau and Santo Antônio, the two massive hydro projects on the Rio Madeira, have been concluded. Last December, the consortium Madeira Energia SA (MESA), including engineering firm Odebrecht and state utility Furnas won the right to build Santo Antônio with a bid of about $50 per mega watt hour (MWh) with the expectation they would go on to win the Jirau bid.

But, in May, the Enersus consortium, led by French water and energy conglomerate Suez and Camargo Corrêa won the Jirau bid, offering to sell electricity to the grid for less than $45 per MWh. A legal attempt by MESA to overturn the decision has been rejected by Aneel.

Total investments in the two projects will include some $16 billion in debt and $4 billion in equity with negotiations between the sponsors and BNDES ongoing, notes Zani.

Brazil has done less well with alternative energies. Ironically that is in large part because it is so rich in hydro resources, which make wind, geothermal or other technologies unenticing, says Zani. The promoter of alternatives, PROINFA, has stalled and the government will need to figure out how it will price wind energy before investors show interest.

That said, there are efforts to get a new nuclear project off the ground, Angra 3, on the Rio de Janeiro coast. Other interesting possibilities are co-generation, particularly with the growth of cane farming, which produces waste that can be used as a source of power.

Transport Jam
After last year’s success in achieving low bids for a bundle of seven federal roads for concession, little progress has been made with the next wave. One of the difficulties, reckons Noronha, is that the government does not have realistic expectations for future concessions. After last year’s success in achieving low bids for a bundle of seven Federal roads for concession, some progress has been made on the next moves. One of the problems, reckons Noronha, is that flush with success, the government may have difficulties to set realistic expectations for future concessions.

It remains to be seen with the very low bids just how much maintenance the winning companies will be able to afford, says Noronha. He points out that concessions from this bundle cover some of the most important highways in the country, for example, the road corridor that connects Belo Horizonte, São Paulo and southern Brazil, leading to Argentina and Chile, linking up some 70% of South America’s economy.

The other difficulty is what to do with roads that do not have the volume of traffic necessary to make concessions attractive. These were originally destined to be public private partnerships (PPPs) but since the success of the first round of bidding, PPPs have fallen out of favor as they require government spending commitments and the successful concessions bids suggest that the government will not need to contribute. Only the MG-050 has been completed in that format.

A lack of urgency is also evident in the airport sector, where no decision has been made on what to do with public sector infrastructure firm Infraero. “The federal government has asked BNDES to analyze the sector and put forward suggestions for the future of Infraero,” says Deutsch. The report should be delivered soon, he believes. Possibilities include an IPO, privatization, or concessions of individual or bundled airports, with contracts designed to ensure there is enough money for regional airports. At least here, Brazil is planning to spend close to 4 billion reais through 2010 in preparation for the 2014 soccer World Cup.

Meanwhile, in ports, an air of indecision pervades. That hurts in a sector which is overstretched by a trade boom.

Last year, the government created a secretary of ports to speed up the process of developing new ports. But the tender processes for private concessions are hardly trouble free, as they involve land expropriation, notes Endo.

Noronha reasons that the government’s blueprint may look like that for hydro development – an overall plan of where to install facilities and then a bid process with private concessions. “This is an interesting public-private design that may generate new business opportunities. We are reaching the limit of rational development of public ports in Brazil. The bureaucracy in this sector makes change difficult and private terminals in ports get blocked up as they are contained within the public areas,” he says.

The mixed picture of infrastructure development in Brazil is punctuated by success in power, where the government has real grit and determination and where smaller scale projects – relatively easily financed by the private sector – exist. But across modes of transport, tough decisions are being delayed and Brazil’s traffic nightmares are going to get worse before they get better. Ironically, that may be the very spur needed to cause action.

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