WHARTON UNIVERSITY Brazilian infrastructure: an end to the logjam?

Brazil is rolling out yet another ambitious infrastructure program. Roads, rail and ports and airports are all within its remit. A new twist is an emphasis on private sector financing and openness to foreign investment. Could projects really take off this time round?

On December 16, a smiling Dilma Rousseff, president of Brazil, visited the site of the first of 12 stadia to be completed for the 2014 World Cup, the Castelão arena in Fortaleza. She had reason to be proud: the stadium was completed four months ahead of time, on budget (at R$518m or $250m) and was the fruit of an innovative public private partnership (PPP). She loftily dismissed the cynics who had doubted her country: “Many said that we were not capable of building and delivering Castelão to international standards. Well, today, we are starting to show that we are capable and the arena is here,” she said.

Rousseff promised to go to the openings of all the stadia. Future inauguration speeches may lack such bravado, though.

A number of stadia are behind schedule. Works on the Duna stadium in Natal, the furthest behind, have been mired in labor disputes, for example. Workers laid down tools in November to demand 25% pay increases, higher daily allowances for meal vouchers and a health plan. The stadium is just one third complete. Other stadia, such as Itaquerão in São Paulo, which is supposed to host the inauguration match, have seen budgets skyrocket as construction companies work around the clock to meet tight deadlines.

Aldo Rebelo, the Minister of Sports, is confident of success and dismissive of what he sees as minor timing over-runs. But one senior financier has the impression Brazil has squandered an opportunity to innovate and to bring in more private sector participation. Moreover, he remains worried by the country’s progress in preparing for the Cup. He has visited key infrastructure projects related to big games all over the world and says both the volume of works in Brazil and the readiness look to be falling well short of international standards.

Reasons to be cheerful

The difficulties encountered in getting ready for the two sporting events may carry useful lessons for the series of vast infrastructure projects (see box) the government has announced to improve logistics.

That Brazil needs a quantum shift in infrastructure is not in doubt. The Global Competitiveness Index published by the World Economic Forum paints a grim picture. Take the transport sector. Out of 144 countries, Brazil is ranked 135th in port facilities, 134th in the quality of its airports, and 123rd in roads. Investments in all transportation modes combined do not exceed 1.2% of GDP, while in other countries the average is 2.5%.

The issue is attracting attention at least. Recent years have seen the government focus on outlining projects in greater detail and planning timeframes, says Luiz Felipe Monteiro, assistant professor of strategy at INSEAD. “There is now a clear sense of priorities and some timescale on these projects. The Cup and Games have seen projects expedited and, with written obligations to international bodies to complete works, the government has found the will to move,” he adds.

Moreover, the new government under Dilma Rousseff is more technically able than its predecessor and more pragmatic, says Monteiro. Rousseff really recognizes that Brazil needs private investment and foreign money to progress her agenda, he says.

There is also a greater sense of urgency as slow economic growth bites. Rousseff faces a much tougher economic environment globally and at home. Emerging economies have slowed and Brazil is the slowest of all the BRICs, points out Professor Mauro Guillén of the Joseph H. Lauder Institute of Management & International Studies at Wharton. Growth forecasts for Brazil have been steadily top sliced. By mid-December, the Central Bank poll of leading economists pointed to growth of just 1%, down from expected growth of 2-3% earlier in the year.

That slower growth may focus minds on the infrastructure program, says Guillén. Brazil has been running a current account deficit for the last several years, even before commodity prices started to fall, he says. The country needs to attract in foreign capital to cover that deficit, he says. So far Brazil has been able to attract in more capital than it needs thanks to attractive interest rates. But with low growth and interest rates coming down to stimulate the economy, there are questions marks over whether the flux of foreign monies will continue, he points out. “Brazil is not in a critical position but it is at a delicate moment. It will find itself in trouble if it is not able to maintain foreign investment,” he notes.

The government is keen for the contribution infrastructure would make to growth. With estimated levels of GDP growth just a smidgeon over 1% this year, any additional growth is vital, says Guillén. Moreover, the improved logistics would provide the impetus for other parts of the economy and signal to consumers that things are on the mend, he adds.

The Brazilian private sector seems to get it. “We need $300bn per year to sustain 5% annual growth and we are competing for this money with the other Bric countries,” says Paulo Oliveira, CEO at Brazil Investments & Business. This money cannot come from government, he believes, but will require the development of deep capital markets and the participation of foreign capital.

The message has percolated through to the all-important BNDES, which has long dominated Brazil’s infrastructure scene, says Guillén. He points out that with a balance sheet larger than that of the World Bank, the role of the BNDES is absolutely key in Brazil. The ability to lend at subsidized rates make it the first port of call for financing, he notes.

BNDES officials are making all the right sounds. Otávio Lobão Viana, head of the bank’s capital markets department, has strongly signalled to the public at a number of recent fora that the BNDES managers understand the needs to change and for the bank to act as a catalyst for private investment. The bank is abandoning old shibboleths that have prevented it from working more closely with the private sector, he says. Viana is talking about sharing guarantees with the private sector and accepting cross-default clauses. Guarantees are a stumbling block as banks are reluctant to take on all the construction and demand risk while cross-default clauses would align the bank’s interest with that of other debt holders.

One senior banker says that the BNDES has indicated that it expects at least one third of the money for infrastructure to come from the private sector. That would mark a sea change.

Guillén cautions that the government may find investors a tougher sell. The general anxiety surrounding the global economy is urging caution. Investors are also worried over the direction of the Brazilian economy and whether the real is still overvalued, despite its slide against the US dollar.

Looking back with trepidation

The country may have an enviable track record in ambitions, but it has a lousy one in actually getting projects done. So will government fiat and a greater sense of energy be enough to overcome inertia and address the practical issues that tend to dog Brazilian infrastructure programs?

There is a sense of impatience and déjà vu. “Is there anything really new to talk about? We’ve been repeating the same story again and again. It’s well known what has to be done,” says Monteiro. In the last couple of decades, very little has been done in Brazil in infrastructure, adds Guillén. “Every couple of years Lula [former president Luiz Inácio Lula da Silva] would launch a new plan or tweak an existing plan to make it bigger but a small percentage of the projects have been completed,” he says.

Indeed, under Lula, the country announced two very hefty Growth Acceleration Programs (known by their Portuguese acronym, PAC) covering principally transport, energy and housing. The first PAC launched in 2007, went through 2010 with plans to invest R$657 billion, and the second, launched in 2010, added new proejcts to bring that figure up to R$955 billion.

The PACs, however, have been a disappointment in terms of deliverables. “Even the most optimistic would acknowledge that we are far from what was expected,” says Monteiro.  Local magazine "Exame" showed that of 135 PAC projects that it studied, the average was four years late and only 7% had been concluded.

Moreover, corruption has been rife. The financial watchdog of the Federal republic, the Tribunal de Contas da União (TCU), has repeatedly called for major works to be halted. It is currently suggesting 22 projects be suspended to investigate irregularities. The TCU estimates that it has saved R$2.5bn in the programs thanks to its decisions to look at contracts.

Brazil also has to overcome its protectionist instincts if it is to bring in foreign investments on an equal footing, says Guillén. The country continues to emphasize domestic companies in a number of key areas, he says. He points to the development of Brazil’s pre-salt, deep-water oil reserves where state-owned Petrobras and its local suppliers have been awarded a near-monopoly. “That sends a message that there will be privileges for insiders,” he says.

Overall, Brazil continues to be inward looking but today needs more foreign money to develop solutions to problems that it did not have just a few years ago. “There are so many bottlenecks, from logistic weaknesses to bureaucratic approval, a shortage of talent and too few visas for well-qualified foreigners. This is what is restraining growth,” Guillén says.

There’s a final twist as well for foreign investors. In the last couple of years, the Ministry of Finance has imposed taxes on foreign investors investing in government bonds to curb the high level of the real only to relax the measures when the currency weakens, says Alexander Gorra, senior strategist and head of the international platform at BNY Mellon ARX in Rio de Janeiro. That has made foreign investors reticent, he thinks.

Summary

Brazil needs to prove that it can recoup some of its lost momentum on infrastructure. It does so at a delicate moment in the global economy and a worrisome one in its own growth trajectory. If the country continues to emphasize opportunities for domestic companies and banks and maintains the BNDES at the heart of the process, foreign investors are likely to look to more welcoming shores. They will not have to stray far: Latin America has been starved of investments and just over Brazil’s border Colombia, to name but one, is launching a $25bn road program, which is being designed with the foreign investor in mind. Peru, Chile and Mexico will all enjoy far faster GDP growth this year than Brazil so the latter will need to work harder to get investors to prick up their ears.

BOX: THE MAIN PROJECTS

In August, the government announced an initial R$133bn billion plan for roads and railways. It said it would build 10,000 kilometers of new railways and build or upgrade 7,500 kilometers of roads. The planned investments in rail, which got the lion’s share of the total at R$91bn, surprised many. Much of Brazil’s railway network has been dismantled, forcing far more traffic onto the road. With the soft and hard commodities boom, that has overloaded the road system and rail is seen as a cheaper, more environmentally-friendly solution.

For rail, state-owned Valec will oversee a program of PPPs. The new projects will be aimed at opening new areas and unblocking bottlenecks and include an extension of the North-South line, from São Paulo state to the far south of Brazil. The completion of the rail-ring for São Paulo, the Ferroanel, will help open up the port of Santos, Brazil’s largest and most important, to rail freight.

The road program will see R$42 billion in investments, with 7,500km of federal roads coming under concession. The first concessions are set to be signed in March-April of next year and 5,700km should be ready within five years of contact signing.

Three airports, including São Paulo’s Guarulhos, have already come under the hammer as concessions and more are set to follow. Galeão, the international airport for Rio de Janeiro and Confins, the main airport for Belo Horizonte, have been confirmed with others being talked about. The model of future airport privatizations is being revisited as relatively small companies won the concession for Viracopos airport, eliciting fears that they may not be able to run such a large airport.

In December, Rousseff announced some R$55bn in investments in ports over the next 17 years with 20 being affected. She is also clarifying the rules regarding privately-owned ports in Brazil, which faced onerous restrictions on multiple usage. They will now be more open to all-comers and that should drive investment in the area.

The most ambitious and controversial project is for a high-speed train between Rio de Janeiro and Campnias via São Paulo. Bids for the R$33bn Rio de Janeiro-São Paulo-Campinas bullet train have had to be redrafted several times to attract in foreign interest. The government has been forced to assume more risk on passenger numbers, cut the minimum number of trains at peak times, and take on more risk from construction cost over-runs, especially thanks to the high number of tunnels that will be required on the hilly route.

About admin

I've been researching and writing on Brazilian financial markets, industry and economy since 2006 for a wide range of specialist media, consultancies and investors. Before that I spent over 10 years in London and New York writing for and editing magazines and journals dedicated to finance, investment and economics in developing markets, mostly for the Euromoney Institutional Investor group and Thomson Financial. Areas of coverage Below are samples of areas that I cover and some of the common themes that I investigate. Capital markets BM&FBovespa markets *capital raising trends: via equities (IPOs and secondary issuance), debt and loans *the asset management industry: legislation and coverage of the key hedge, pension and investment funds * corporate governance: how the regulator is seeking to strengthen best practice and limitations * debt markets: the nascent corporate markets, attempts to boost liquidity and new insturments. * private equity market: why this market has been so successful, who’s involved. *electronic, high frequency trading and alternative trading platforms: what does the future hold? Banking *credit: the growth of consumer and business credit and competition between banks and models *Public versus private: the role and market share of public and private sector banks and the politicization of the industry * internationalization: which Brazilian banks are expanding overseas and where * investment banking: the growth of the domestic market and who’s winning which mandates *regional banks and development banks: what role they play in the industry and how they compete Mining *licensing: the complex process of obtaining environmental, water, land and operating licenses at a state and federal level. * capacity: the feasibility and sustainability of capacity increases * financing: how miners are raising finance in Brazil and abroad *competition: the interplay Vale, MMX and junior miners *logistics: rail, road and port connections Oil and gas: the fund raising issues related to the massive of pre-salt (link) Multilatinas: Who are they and how and where they are expanding Meatpacking: Are debt burdens sustainable, what are the different business models for areas such as branding and distrbution Agriculture: How are farms consolidating, what are environmental risks, how can foreign investors be involved. IT and software: Can Brazil take on India and build a viable long-term IT industry? For more information on clients and work, please see the media and consultancy sections.
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