Brazil will need to spend about $500 billion in critical infrastructure over the next five years as it prepares to host two of the world’s major sporting events, estimates ratings agency Standard and Poor’s (S&P), in a recent report.
These critical upgrades will cover transportation, power plants, water treatment facilities, and, of course, sports venues in time for the 2014 football World Cup and the 2016 Summer Olympics.
However, talking with Arthur Simonson and Jane Eddy, two S&P managing directors responsible for US utilities and infrastructure and Latin America, respectively, one gets a different impression. Even though there is great potential for the private sector to finance Brazilian infrastructure, the federal government has yet to take decisive steps to secure its participation.
For example, Simonson argues the time is right for local pension funds to jump into funding infrastructure. “Returns on traditional government treasuries have tightened, which could lead pensions to turn to other investments, like infrastructure, to get additional yields”, he reasons.
But as compelling as this argument is, even mature infrastructure markets like the UK are struggling to find creative solutions to make pensions comfortable funding infrastructure en masse.
So what is Brazil doing to woo its deep-pocketed institutional investors? “Unfortunately, it is unclear what will encourage pensions to invest in the country's critical projects,” Simonson and Eddy say. “Brazil is now in the middle of an election year and a solid perspective on alternative methods of funding infrastructure remains unclear.”
This is somewhat worrying, considering that strong political support is usually an indispensible ingredient to securing institutional investor support. Just ask Mark Ramsey, the president of Macquarie Capital’s Mexican operations. As he recounts in the March issue of Infrastructure Investor:
“It [the support for infrastructure] was there, it was very public and it was a high priority for the government, so it attracted our attention.” Without it, Macquarie probably wouldn’t have been able to secure $266 million in commitments from seven Mexican pension funds for its peso-denominated, debut Mexican infrastructure fund.
Another result of the Mexican government’s support was the introduction of a new type of security class last year, allowing developers to list their projects on the Mexican stock exchange, thus facilitating access to institutional investors. This yielded immediate results, with Goldman Sachs Infrastructure Partners and local construction company ICA selling a 32 percent stake in the operator of FARAC I – the country’s largest toll road package – for $483 million through the issue of these securities.
Without similar measures, banks are still the likeliest source of capital to finance private sector participation in Brazil’s infrastructure. But again, Simonson and Eddy do no paint a very encouraging picture, saying that “local banks do not seem that keen on true off-balance sheet project structures.”A look at the financing arranged for most of the road concessions awarded in Brazil last year seems to confirm their point, with BNDES emerging as the biggest source of capital.
Part of the reason for this may lie in the fact that Brazil, despite its experience with tendering concessions, does not have a lot of experience with true public-private partnerships (PPPs). S&P says in its report that most Brazilian project finance deals have been structured “to rely more on corporate or sponsor support rather than on robust legal and structural separateness elements.”
In other words, future “transactions [have] to rely more on the creditworthiness of the project assets than on sponsor support”, S&P says, in order to “attract more investment in infrastructure projects on more favourable terms”.
True PPPs in Brazil have so far been championed mostly by municipalities and states, local magazine Exame wrote at the end of August 2009, with the federal government yet to sign its first PPP contract at that time. Again, this contrasts unfavourably with the efforts coming out of Mexico, where the local private sector seems to be more in sync with the central government.
At a recent conference in Madrid, organised by Mexican infrastructure bank BANOBRAS and attended by senior government officials keen to capture Spanish investment in its infrastructure programme, the president of the Mexican bank association (AMB) told investors that local commercial banks were well acquainted with the strengths of the PPP model and should have no problems funding these projects at competitive rates.
In the end, the difference between Mexico and Brazil’s infrastructure policies reflects the difference between a government that is committed to attracting private sector investment for its infrastructure needs, and a government that still seems unsure whether this is the best way to go.
Mauricio Endo, a partner at KPMG Brazil’s structured finance division, complained in Exame that “there is a lot of frustration in the market because the federal government, which had everything going for it, has yet to do PPPs. It’s as if the government is still at a learning stage,” he adds.
Considering that it was President Lula da Silva that signed the country’s PPP law in December 2004, Endo is right to complain that things have moved slowly over the last five years. According to Exame, Brazil signs two to three PPP contracts per year, compared to the 60 or 70 signed in the UK each year.
“The lack of Infrastructure could stifle growth in Brazil,” Simonson warns. Brazil’s forthcoming sporting events present the best opportunity for the government to seriously address its infrastructure gap.
Whether it will be enough to convince the government that now is the time to open the doors to private sector participation remains to be seen. But if it decides to do so, it would do well to look at Mexico’s example.