Brazil’s economic woes weigh on PPPs

The number of projects slated for development in the country's two most active states could be halved over the next two years, Fitch says.

Public-private partnerships (PPP; P3) in Brazil's pipeline are expected to drop over the next two years on the back of a weak economy and a lack of resources to structure and monitor projects, Fitch argued in a recent note.

“We estimate that the 25 PPP projects in the two most active states (Sao Paulo and Minas Gerais) could be halved over the next two years,” the ratings agency said.

“Even though some of these projects have been approved, they have not yet been built so the state might be able to cancel them without incurring huge penalties for doing so,” Humberto Panti Garza, Fitch's head of international public finance in Latin America, elaborated during an interview with Infrastructure Investor.

Due to regional governments’ fiscal constraints, Fitch recommends that Brazilian states channel their support towards the most critical projects. To attract private investment, the agency also reckons Brazil should improve PPPs’ structural features.

“In Mexico, for example, local governments pledge local or federal tax revenues to prioritise their PPP obligation payments,” Garza commented, noting that explicit guarantees and similar mechanisms are not used in Brazil. “This would be taken into account for our ratings decision.”

Fitch rates PPP projects using the governments’ Issuer Default Rating (IDR) as a starting point. However, according to Fitch’s methodology, “a grantor’s obligation under a framework agreement is, in almost all cases, weaker than its IDR,” since a government can choose to perform on some financial obligations but default on others. For this reason, PPP obligations are rated one to three notches lower than the government’s IDR.

This methodology applies to PPPs that rely on multi-annual payments from government entities. PPPs that allow the project company to charge user fees or tariffs in return for taking demand risks associated with the project are less affected by a government entity’s revenue constraints.

“If a local or regional government fails to service a PPP-related obligation, the debt likely become a judicial ruling debt (precatorio), which adds additional costs to government balance sheets,” Fitch stated in its note.

“Precatorios are recognised obligations of states and municipalities in favor of creditors – whether individuals or companies,” Paulo Fugulin, Fitch’s Sao Paulo-based director of international public finance, explained during a phone interview. “By law, states and municipalities must allocate a percentage of their revenues to service these payments.”

However, precatorios are negotiated in the market at considerable discounts over face values. And while the rulings cannot be appealed, “the obligations are not that enforceable,” with creditors waiting 20-30 years to receive payment, according to Fugulin.

The additional costs that governments can incur in the event of a judicial debt ruling could be in the form of contractual fees and penalties. However, that depends on the contract.

“There is no standard contact that we’re aware of,” Fugulin said.