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AmericasDecember 15 2011

No quick fix to Brazil's huge infrastructure needs

Brazilian infrastructure is in desperate need of investment if it is to support the country's growing economy. But with restrictions on foreign investment, limited public and domestic funding and opposition to further development from environmentalists, taking advantage of the plethora of opportunities in this sector is not straightforward.
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No quick fix to Brazil's huge infrastructure needs

Carlos Biedermann lives in the southern Brazilian city of Porto Alegre, where he heads the capital projects and investments division of consultancy firm PricewaterhouseCoopers (PwC). His newly created team advises states and the federal government on the development of transport, logistics and energy networks in the country, and was set up in response to the growing number of business opportunities generated by Brazil’s urgent need for infrastructure.

“Brazil is living in a unique moment,” says Mr Biedermann. “I am 58 years old and I have never in my whole life seen a moment like this.” The country has been growing at such a speed that Brazil’s existing infrastructure struggles to support it.

Mr Biedermann relays a telling anecdote about the airport in Porto Alegre – a city of about 1.5 million people – which is only 10 years old but it has already reached capacity. This has forced the authorities to re-open the old one. Air traffic in Brazil has more than doubled over the past decade, growing by a record 18% in 2011.

Rising demand

Brazilian infrastructure is feeling the strain of the country's accelerating economy, which reached a peak in 2010 when it recorded a 7.5% growth in its gross domestic product (GDP) – the highest growth rate since the mid-1980s. GDP is expected to grow, despite the severe global economic downturn, by 3% in 2011.

On top of this, the country must get ready for two international sports events: football's 2014 FIFA World Cup and the 2016 Olympic Games. Not much time is left before these events and there have been some fears expressed that a number of the cities selected to host them will have to be excluded due to their poor infrastructure. It is estimated that works related to the two sporting events are running an average of one year behind schedule.

One of the driving forces for PPPs is that they attract private investment, so you do not need public borrowing... But it should not be done how it has been done in Europe, to go around fiscal constraints

David Bloomgarden

“Not all infrastructure projects will be ready by [2014],” says Giancarlo Gerli, director of planning of the Brazilian Association of Infrastructure and Basic Industries (ABDIB). “But the need for infrastructure remains, even after the [Olympic] Games.”

The association reports that an average of $110bn per year will be needed over the next five years to develop the country’s transport and energy networks; and it predicts that a minimum 1% of GDP will be spent annually on transportation projects until 2023. The sports events alone require a total investment of $36.3bn, 68% of which has been covered by Brazil’s public sector.

Partnerships with the private sector are, therefore, high on Brazil’s agenda. Shifting funding and risk onto the private sector – which is increasingly attracted by good returns and growing business opportunities – is highly desirable. Some of the sports stadia and related projects have been pubic-private partnerships (PPP), such as those in Fortaleza, Salvador, Belo Horizonte, Natal and Recife. “That is what we try to do because [PPPs] are more affordable,” says Mr Gerli.

Borrowed blueprint

The framework for Brazil’s PPP programme is based on the UK’s, which recently came under fire when it was applied to social infrastructure, but which still maintains support when applied to traditional transportation projects.

The Inter-American Development Bank’s David Bloomgarden, senior project specialist at the bank’s Multilateral Investment Fund, believes that traditional infrastructure projects will be a growth area in Latin America. “One of the driving forces for PPPs is that they attract private investment, so you do not need public borrowing,” he says. “But it should not be done how it has been done in Europe, to go around fiscal constraints. That is a bad reason to do PPPs because ultimately you pay for it, one way or another – there is no free lunch.”

Mr Bloomgarden says that PPPs should be used when this solution is more efficient and effective than a traditional publicly funded project because the process used is conducive to a better selection of projects. In Brazil, Mr Biedermann’s view is different.

“Most of the investments [in infrastructure] are made by the government and this is an area that we, at PwC, are starting to learn how to deal with; there are particularities and peculiarities [of working with the government] that we are not so used to. The way the government hires consultants, through the public tender process [for example] is very well regulated but the best contestant does not necessarily win; it is more related to price [than quality of service.]”

Taking off

The same approach, many fear, is applied to PPP bids. Partnerships with the private sector are, of course, not the only option available to the government. A few crucial developments will be outright privatisations, such as the privatisation of three major airports, including São Paulo's Guarulhos International Airport.

The inadequacies of Guarulhos, the international airport serving Brazil’s booming financial centre, has become something of a joke among Brazilians: “Have you ever travelled through Guarulhos?” they ask foreigners. “Yes? Then you know.”

The other airports that are being privatised are the Viracopos-Campinas Airport, which deals mostly with cargo and is 100 kilometres from São Paulo, and the Presidente Juscelino Kubitschek International Airport in the country's capital, Brasilia. The estimated total cost of the modernisation is 20bn reais ($10.7bn). The government plans to invest 7.33bn reais in its airport development programme, which will include 16 airports.

All of Brazil's airports are currently managed by the public sector company Infraero, which may retain a minority shareholding in the new entities. To execute a privatisation scheme so close to the FIFA World Cup puts extra pressure on the government, and adds to the mounting fear that Brazil might not be fully ready to host this event. Many, however, believe that it will be a success, even if some of the infrastructure required for hosting the event will have to be temporary. 

In mid-2011, ahead of the larger privatisation schemes, São Gonçalo do Amarante, Natal’s airport in the state of Rio Grande do Norte, became the first Brazilian airport to be built and run under a concession contract by a private operator, Inframérica – a consortium that includes the Brazilian engineering firm Engevix and the Argentinian airport operator Corporación America. The private sector investment over the 25-year concession is estimated to stand at 650m reais.

Faith in the top

Eduardo Muller Borges, head of credit markets at Santander Brasil, has faith in the ability of the country’s president, Dilma Rousseff, to get things done. “[Ms Rousseff] is a strong-willed person, very determined; she knows this is a priority and she is putting a lot of pressure on accelerating the privatisation of the airports,” he says.

“Obviously, the full spectrum of investments that need to be made will not be made on time for those events. So they are probably going to do things in two stages, [including work] that is more an emergency adjustment, that needs to be made to accommodate bigger traffic [demands].”

The long-term interests of the Brazilian economy transcend any short-lived or temporary financial gains from a privatisation process

Tony Tyler

Guarulhos is the natural contender to become the main air traffic hub for Latin America, but the development of Viracopos-Campinas is even more ambitious. It involves significantly growing its levels of passenger traffic, alongside its existing cargo lines, as it is planned to be the main base for Brazilian low-cost airline Azul.

These privatisations have attracted criticisms on many fronts, including the Latin American and Caribbean Air Transport Association. At the association’s gathering of airline leaders in Rio de Janeiro in November 2011, Tony Tyler, director-general of the International Air Transport Association, said that the Brazilian government should select the best proposals, not simply the proposals that generate the highest revenues. “Our message will be that the long-term interests of the Brazilian economy transcend any short-lived or temporary financial gains from a privatisation process,” he said.

Boosting its power

Other projects include the building of hydroelectric power plans to increase the country's power supply. Brazil’s abundance of water means that hydroelectric power is a crucial energy source, supplying the country's base load demand, which is the minimum amount of electricity required to meet reasonable customer demand.

Brazil already has the most powerful hydroelectric plant in the world, the Itaipu Dam, which is on the Iguazú falls at the border with Argentina and Paraguay. The country now plans to develop other plants, including two that are currently under construction on the Madeira River, the largest tributary to the Amazon River: the Santo Antonio Dam and the Jurau Dam.

Another hydroelectric plant in Belo Monte, in the state of Pará, is set to become the second largest hydroelectric dam complex in the country and the world's third largest in terms of production capacity when it is completed. All of these projects have raised environmental concerns, however, and there have been objections from local communities, which have caused lengthy delays to their construction.

Home improvements

So far, the vast majority of infrastructure developments, across all sectors from transportation to energy, have been made possible thanks to the Brazilian Development Bank (BNDES). Between 2003 and 2010, the bank invested 265bn reais in infrastructure projects, with 77.5bn reais invested in 2010 alone, equal to 46% of BNDES’s total disbursement for the year.

Total figures for 2011 and projections for 2012 are similar, says Roberto Zurli, managing director of the bank’s infrastructure division. Between 2011 and 2014, BNDES plans to spend a total of 246.4bn reais on energy, railway, road, port and airport deals. But Brazil’s development bank has its limits, and participation from private sector lenders and investors is increasingly welcomed.

“People look at Brazil and think that there is not much project finance because there is BNDES,” says Mr Muller Borges at Santander Brasil. “There is project finance with BNDES and there is some without BNDES. But even the part with BNDES requires project finance knowledge and expertise – you need to be able to set up facilities that have tranches with or without BNDES, and guarantees that are shared with BNDES.”

The heavy involvement of Brazil’s development bank means that interest rates on project finance deals have been kept at relatively low levels. A typical road project would be given an interest rate of about 6% a year when BNDES lends directly to the project vehicle. This would go up to 9% if a private sector bank is involved – for instance when banks fund themselves through BNDES in order to lend to projects, sharing the risk and gaining an interest rate margin. It rises to 12% or more for private sector-only financings.

Another limitation to the growth of a private market is the difficultly facing lenders trying to fund themselves in Brazilian real. The lack of a long-term swap curve between the Brazilian real and the US dollar means that project finance banks must have an adequate balance sheet in the country to have a significant presence in this market. Otherwise currency risk would push the cost of international banks’ involvement higher. Beside local banks, such as the government-owned Banco do Brasil and private sector leaders Itaú Unibanco and Bradesco, the only two banks part of international groups with substantial local balance sheets are Santander Brasil and HSBC.

Private purse

Private sector interest in infrastructure has risen recently, not just from the lending side, but also from an equity investment point of view. Although difficult to measure for lack of sufficient publicly available data, the Brazilian Venture Capital and Private Equity association's president, Sydney Chameh, believes that the business opportunities in the infrastructure sector have encouraged many local and international investment funds to look at small and medium-sized companies operating in this field.

Specific infrastructure funds have been set up by fund manager Pátria Investimentos, BTG Pactual, Banco do Brasil and Santander Brasil. The returns offered by infrastructure are lower than private equity investors would typically look for, but their low-risk nature makes them more attractive to investors such as pension funds.

The market value of infrastructure companies listed on the São Paulo stock exchange, Bovespa, are encouraging as they have been on an upward trend since October 2008.

International investors may soon have another option available to them. In 2010 and 2011, a few Brazilian issuers successfully placed project bonds with international investors. Project bonds have become increasingly popular in infrastructure and energy finance as they provide funding to a project on a non-recourse basis. Instead they rely on cash-flow projections, without engaging financiers’ balance sheets for large amounts and long tenures – something that many banks around the world, and in particular European lenders, which traditionally have been more active in project finance, are no longer able to do.

The $1.5bn project bond by oil and gas company Odebrecht’s special purpose vehicle, Odebrecht Drilling Norbe VIII and IX, was the largest in Brazil, and generated financing before the project was completed, adding an additional layer of complexity to the deal. The bonds pay 6.35% in interest and are due in 2021. The bookrunners were Deutsche Bank, Banco do Brasil, HSBC and Santander Brasil.

The local investor base is not going to be enough to absorb the local project bonds... So now we have also an [incentive] for the international investor community

Eduardo Muller Borges

Given the convulsions of international capital markets right now, it may take some time before other such large issuances are made. Appetite in the local market, however, is expected to spike. “These days, there is no room for deals like those, but the Brazilian market is growing to be more diversified,” says Sandro Kohler Marcondes, managing director at the commercial division of Banco do Brasil.

New funding routes

The government is currently discussing regulation of project bonds denominated in Brazilian real – which Brazilians refer to as debentures – so that they will eventually be traded as any other debt instruments, and have a secondary market. For oil and gas companies, receivables are typically denominated in US dollars, meaning that raising funds in that currency is a good fit, but in the transport sector issuers tend to operate in reais only.

Bankers believe that the regulation will come to life by the first half of 2012, if not earlier. “There obviously is not enough [capital on BNDES's] and private banks’ balance sheets to be able to undertake these huge [infrastructure projects],” says Mr Muller Borges.

“The combination of both [and project bonds] can be very healthy, in a sense that they will have to start with balance sheet financing especially in the construction period, and when construction is more advanced and you can have an horizon of cash-flow generation, you can go to the capital markets and issue bonds.”

Given the vast funding requirements of infrastructure projects, local demand may not be enough either. International investors have been taxed for bringing money into the country – a move that attempted to cool the overwhelming capital inflows of the past years. But to make sure that there will be enough demand for these instruments, the government has lifted this tax for foreign investors buying eligible project bonds, on top of creating other tax incentives available to all investors.

“The local investor base is not going to be enough to absorb the local project bonds,” says Mr Muller Borges. “So now we have also an [incentive] for the international investor community. We expect growth of this market in the future.”

Brazil is experiencing rapid growth, which offers unprecedented business and investment opportunities, for the country and the world. Challenges are, however, numerous too, from dealing with a public sector that has specific views on the PPP procurement process, to environmental concerns.

In Brazil, what looks on paper to be a straight road to development can turn into a complex project. PwC’s Mr Biedermann states an example: “[There is] a road in the south of the country that goes from Florianopolis, the capital of the state of Santa Caterina, to Porto Alegre. It is 500 kilometres long [and needs] to be doubled, but there are places where they have been struggling for over four, five years to [reach agreement]. Why? There is a lagoon where they have to build a new long bridge, and this lagoon has some shrimp [colonies]; environmentalists do not want the bridge.” As this shows, Brazil's size, environmental diversity and demographic complexity are both a blessing and a curse when it comes to the country's development.

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Silvia Pavoni is editor in chief of The Banker. Silvia also serves as an advisory board member for the Women of the Future Programme and for the European Risk Management Council, and is part of the London council of non-profit WILL, Women in Leadership in Latin America. In 2019, she was awarded an honorary fellowship by City University of London.
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