It’s not often that infrastructure draws an emotional response from people. Sure, asset class professionals might experience a range of emotions when bidding for deals – anything from elation, if you’re the lucky winner, to bitterness or disappointment, if you’re on the losing side. But to see millions of people emotionally engage with the asset class? Rare indeed.
That’s precisely what happened in Brazil, though, when a relatively localised protest over bus fare increases mushroomed into nationwide opposition to the cost of hosting the 2014 World Cup and the 2016 Olympics, bringing millions of Brazilians onto the streets, before finally transcending infrastructure and focusing on everything from corruption to the cost of the Pope’s recent visit.
No doubt it was a bitter development for President Dilma Roussef, whose government late last year “made it crystal clear that [it] sees infrastructure development as the surest way of lifting millions out of poverty and re-energising economic growth,” as Mauricio Endo, a partner with KPMG Brazil, wrote in the aftermath of the government’s announced infrastructure push.
Many Brazilians appear to disagree with at least some of that infrastructure spending. But moving beyond the country’s sporting events, there’s no arguing that Brazil is desperately in need of revamping its logistics network.
As it stands, Brazil has a widely acknowledged 30-year logistics deficit, which, according to some estimates, costs the country up to 15 percent of annual gross domestic product (GDP), versus some 5 percent for most other countries. “Soy beans, for example, now cost more to ship than to produce,” Endo pointed out in his note.
It was to counter this decisively that the government announced late last year a $121 billion logistics programme, leaving no stone unturned in its quest to modernise the country’s roads, rail, ports and airports.
The so-called ‘Programme for Investments in Logistics’ is set to span 30 years, but a significant chunk of the required investment is to be deployed over the first five years. For example, more than half of the government’s announced $21 billion roads programme is to be done in that time period, with $28 billion of the $46 billion railways programme envisaged to be completed during the same time.
Rio de Janeiro’s Galeao and Minas Gerais’ Confins airports, expected to net the government more than $4 billion, will have been awarded to the private sector by then, with the ports sector also in line for a significant amount of investment.
As well as putting all of these projects ‘out there’, the government is also “building a supportive environment”, to use Endo’s words. “To encourage foreign investment into the sector, for example, the government created targeted tax breaks on infrastructure bonds for both domestic and foreign investors,” Endo wrote.
In a bid to further woo foreign pensions, Bernardo Figueiredo, the man tasked with implementing the logistics programme, said earlier this year that the government is considering creating a new investment vehicle to facilitate foreign pension investments into Brazilian infrastructure.
Still, and in spite of the bounty of opportunity, the picture is not uniformly rosy.
For starters, allowed rates of return for Brazilian infrastructure projects are not exactly high – even, arguably, after a recent increase.
“I’d say the challenge for new investments in Brazil at the moment is that the government in its privatisation efforts – which have been underway for the last six months or so – has been trying to push the envelope down on allowed rates of return, and so they’ve had a few false starts in the privatisation process,” Sam Pollock, chief executive of Brookfield Infrastructure Partners, said at the fund’s recent Q2 earnings call.
The government, having realised this, began to make amends earlier this year, sweetening allowed rates of return for highway concessions from 5.5 percent to 7.2 percent, with returns in the rail sector upped to between 7 percent and 7.5 percent from a previous 6.3 percent.
“We’ve been encouraged with the direction that they’re heading in as far as providing an opportunity to earn a better rate of return [but] we’ll still have to wait and see how that all works out,” Pollock stated.
On top of those concerns, another red flag for investors is Brazil’s patchy procurement history, which often leads to delays and cost overruns.
For a recent high-profile example, look no further than the projected 420-kilometre high-speed rail line linking Rio de Janeiro and Sao Paulo, which, just prior to press time, was yet again pushed back by at least a year.
Brazil’s Transport Minister, Cesar Borges, said the government was delaying the project in order to get more bidders to participate. Prior to the postponement, only a French-led consortium had proclaimed itself able to meet the late August auction date.
However, this is not the first time the multi-billion dollar project has been pushed back – in fact, it’s the third, with a previous tender in 2011 cancelled due to an absence of bids, forcing the government to restructure the project so it would be more palatable to investors.
And then, of course, there are more immediate concerns, related to official reactions to the recent wave of protests. In late June, the Sao Paulo government told toll road concessionaires it was freezing tolls for a year, until summer 2014, a decision that will affect some 19 road concessions throughout the state.
Geraldo Alckmin, Sao Paulo’s Governor, did his best to disconnect the freeze from the protests which started at the heart of his state, explaining the decision “is not a populist measure […] we have been working on this problem for the past two years” and pointing out that it was partly a “penalty” to be paid by concessionaires as a response to execution delays.
So far, investors have put on a brave face in the midst of all the recent turmoil. Mark Ramsey, head of Latin American advisory and a senior managing director for Macquarie Capital, put the protests in a long-term context at a recent event on Latin America:
“Political movements in the lens of ‘five minutes’ could be viewed as troublesome, but in the long-term we don’t think they are. You have to put it into perspective. Infrastructure is rarely affected by these kinds of events.”
Pollock, whose firm teamed up with Abertis last year to acquire thousands of kilometres of roads across Brazil, including in Sao Paulo, was equally upbeat:
“With respect to some of the announcements in Sao Paulo, regarding putting a cap or a short-term freeze on some of the inflationary increases to the tariffs, there still hasn’t been any formal announcement of what the regulator intends. However, the regulator has indicated that all the concessionaires will be kept whole.”
“This is something that they’re really doing for their own population, in response to some of the tensions going on in the country, but as far as performance of roads and the concessionary framework, everything is as expected. Brazil has a long history of compensating concession holders when they make changes to the tolling regime,” he concluded.
But there’s another thing Brazil has a long history of among investors: for one reason or another, Brazil has always held more promise than it has delivered on. As the old saying goes – “Brazil is the country of the future – and always will be”.
It would be a shame if, with all it has going for it, Brazil won’t finally manage to become attractive to investors in the here and now.