Poor roads, lack of transport routes in challenging landscapes and woefully underdeveloped infrastructure in the region has for decades been a major hurdle for developing Latin American economies, particularly in the Andean region.
Now a number of major government programmes in Colombia, Peru, Chile, Mexico and other states in the region aim to close that gap by attracting private investment in conjunction with capital injections from the public sector.
The scope and ambition of these programmes is unprecedented. The Peruvian and Colombia initiatives, in their widest interpretation, could require up to US$70bn of investment over the coming decade.
Both Colombia’s 4G road infrastructure programme, introduced back in 2010 and launched in 2015, and Peru’s more recent PPP-funded programme launched by Peruvian President Pedro Pablo Kuczynski, have already highlighted some of the challenges associated with such projects in the region. Equally, they have shown that setting the bar high helps to achieve results.
These programmes have had their fair share of challenges – some logistical, others regulatory and financial.
The biggest is planning and executing large projects in scarcely populated mountainous areas with limited access to moving water, a challenge inherent to the geography of the regions where these projects are needed. One way this has been addressed is through diversifying the transport networks that are being upgraded to include airports, seaports and railways.
A Closer Look at 4G
According to Luis Fernando Andrade Moreno, the ANI president, Colombia already has 87 port concessions, with an investment in the sector of some US$1bn annually. Passenger air travel in Colombia has increased by 10.2% over the last year (34.1 million passengers annually) and is ranked ahead of countries such as Argentina and Chile. Cargo transport grew 3.5% when compared to 2014, moving 770,000 tons of cargo. About 31 airport expansions and port developments are included in the country’s infrastructure pipeline.
The Colombian President Juan Manuel Santos’s focus on road building lays the crucial groundwork for the rest of the programme. Up to US$25bn of the 10-year infrastructure plan will go towards doubling the length of Colombia’s four-lane highway network.
The plan is expected to deliver 5,892km of roads in three waves via public-private partnerships over the next 8 years. This US$16bn program involves concessions of over 40 highways and roads, with the first two waves of projects having adjudicated 19 of the 40 concessions.
Risk sharing is also a crucial theme on these projects, and directly linked to the private sector’s willingness to foot the bill. Colombia's PPPs have risk-sharing elements like cost overrun sharing, and availability and traffic compensation payments that reduce the concessionaires' construction, operating and demand risks, explained Moody’s analysts is a recent report.
In order to tackle some of the financing challenges, the government has set up the National Infrastructure Agency, which was able to streamline the complex bidding process for these projects and has been successfully awarding concessions. A unifying infrastructure development programme that includes standardised contracts and an integrated bidding processes is essential to attracting investors, particularly from abroad.
“This has been one of the great revolutions inside the infrastructure sector, not only in the way the projects are planned, but also in how they are being licensed and carried out. It started as a change in regulations, in which two important legal frameworks were issued, the Infrastructure Law and the Public-Private Partnerships Law. These two laws changed the way in which projects are contracted, licensed, and carried out,” Colombia’s Minister of Transport Abello Vives told the press.
According to Pablo Muñoz Toro, Director of Infrastructure in Bancolombia’s Investment Banking Division, while the plan is hugely ambitious and could be undermined by changes in the FX rates, it is also achievable.
“It offers an opportunity for Colombia to catch up on infrastructure, particularly transport infrastructure, where the lag has grown in recent years.”
Attracting sufficient levels of private investment has certainly caused the most frustration among stakeholders, particularly over the past two years as the economy suffered from low commodities prices.
“There is a considerable housing shortage in Colombia. Also, the Government is aware of the need to update the road infrastructure to make the Country more competitive. Therefore, the 4G initiative is certainly timely and necessary,” said Jack Deino of Blackrock. “But the main challenge is the funding. However, the Country is supporting the effort from a fiscal perspective while maintaining the guidelines under its Fiscal Rule, and also, promoting private investment to achieve the funding require to successfully carry out the initiative.”
The trader noted that the Santos administration has been very pro-active in achieving a historic peace agreement with the FARC, and also pursuing a structural tax reform. These are two very challenging initiatives and reflects the efforts of the Colombian Government to be pragmatic, while the country’s fiscal situation is challenging due to the decline in oil prices.
“Foreign investors also recognize how pragmatic Colombian public officials generally are. Despite these efforts, foreign investors remain cautious on Colombia waiting for more economic data to trickle out during the next few months,” he added.
New Structures and More Balance
The financing plan for the 4G programme is comprised of a quarter international financing and three quarters domestic financing, with an additional US$5bn expected to come from the local capital markets, private debt offerings, or domestic bank lending.
“We have seen some increase in private sector participation over the past couple of years. It is partly a product of continued social and economic stability in these two countries, some of the fastest growing economies in the region having achieved investment grade a while ago,” pointed out a banker from Japanese lender SMBC.
This has led to a number of interesting deals and innovative financing instruments in the fixed-income market. The Pacifico 3 road concession, for instance, was notable for its innovative use of a project bond, and could pave the way for a range of similar deals. Another innovation was borne of financing projects like Pacifico 2, where a liquidity line was used to maximise the debt capacity of the project – an increasingly popular feature on forthcoming 4G deals.
The recent economic slowdown exposed the threats still hanging over many of these projects. While the majority of the first and second wave projects have been completed successfully, the third and fourth waves have increasingly hit a funding wall – examples include the “Tunel de la Linea,” the third sector of Ruta Del Sol, as well as some of the road projects that either stalled or were scrapped altogether.
“The issue is the depth of the local markets and liquidity, because most of the projects are in local currencies. In Colombia, a lot of the first wave of the 4G projects have already closed or are in the process of closing, and local banks have been very active in those, so there are concerns about whether the local banking sector can sustain the pressure now and continue to play a significant role,” a local banker involved in the deals explained.
Others have been bearish on potential influx of foreign capital, however appealing it would be.
“From my perspective, it would be really positive to draw-in foreign investors – one of the major obstacles to that would be the lack of a liquid long term instrument to hedge long term currency risk. The main source of funding, therefore, would be domestic, especially if you are depending on, firstly, pension funds and two, government spending, which, with weak fiscal revenues and strict limits on expenditures, could take some time,” said the investor.
Muñoz, meanwhile, listed a number of stumbling blocks in the financing of these projects, including, the execution and fulfilment of conditions for the first imbursement, as well as the red tape around land acquisitions and securing the environmental permits. But two challenges have been most prominent.
“The first concerns financial closing: this plan set up a new standard on how such projects are financed here in Colombia. It is different to what sponsors involved in these industries were used to. The second challenge is that many of these sponsors are local concession and construction companies, most of whom have strong balance sheets, but often find it difficult to juggle financing a range of projects simultaneously. Financing layers of credit and mitigating risks has been challenging,” he explained.
Peru Leads on Structure
Peru has been a shining star of the region for a number of years, and many of the legislative frameworks for its infrastructure programme have been set in place in its 1993 constitution, which is geared towards attracting private capital as part of its broader development agenda.
Currently, Peru spends 5% of GDP on infrastructure, well above the regional average of 3.5%, but many of the US$20bn worth of PPP concessions awarded from 2011 to 2016 by the previous administration have been delayed by red tape and permitting issues.
One of the key pillars of Kuczynski’s election platform was to overhaul rules and regulations governing infrastructure development and fast-track between 15 and 20 projects worth around US$18bn. He also vowed to decentralise ProInversión, the country’s investment promotion agency tasked with managing PPPs, allowing each region to have its own investment plan to encourage more participation from local investors and promote transparency.
The president hopes to reduce the US$70bn infrastructure gap over the next five years by attracting foreign capital and luring big players like BlackRock, which is rumoured to be getting ready to launch a private equity infrastructure fund in Latin America as soon as this year. That infrastructure revenues in the country are to a great extent dollarized appeals greatly to foreign investors.
There is already a revival underway for Peru’s Costa Sierra road programme, a plan to connect some 27 roads in the Costa Sierra region to production centres in the valley. Sierra Azul is another important programme that will focus on the upper parts of the watershed in the Andean mountains to improve hydrological regulation, rebuild canal systems, build dams, reservoirs and filtration trenches.
To finance many of these projects, Peru is focusing on attracting private investment through PPPs, where the government is concentrating its reform efforts.
Carlos Vargas, CEO of Andino Investment Holding, an infrastructure investment fund that focuses on transportation infrastructure, hailed a series of new rules relating to infrastructure development that simplifies administration and paperwork, allowing them to be fast-tracked into action – like those extended to the water and sanitation sector in October last year.
But that also creates complications for the local governments in terms of committing future funding to these projects. In the past decade RPICAOs (state guarantees to concessions) allowed the government to assume some of the completion risk associated with construction projects, providing a crucial incentive to private sector investors. But, over the past two years, with growing budgetary constraints amid low commodity prices, the government was able to shift some of that risk back to the private sector.
2017: A Year of Promise?
Looking to the year ahead, both countries appear to be in strong positions to continue apace with infrastructure development, but they will need to navigate a number of challenges, present and emerging.
Muñoz identified two major roadblocks that have already caused delays in the 4G programme. The first – fulfilment of all the conditions of the first disbursement that will allow projects to begin construction – is fairly crucial and unique to each project.
The second is potentially more systemic, and linked to the Odebrecht. The unprecedented corruption scandal engulfing the Brazilian construction giant has seemingly created an unwelcome “noise” in the market,” with observers noting that the ongoing investigation led some Colombian and Peruvian projects to be paused or cancelled altogether. It has created a sense of unease and uncertainty among investors and other financial stakeholders.
“Odebrecht has a strong historical presence in these two countries, including large projects under development, so the government needs to makes sure they are still viable – whether by making sure they can still be financed, selling them to other parties or scrapping them altogether. That also affects banks, which have become much more cautious and careful because of the scandal, which means that accessing financing may become more difficult,” said the banker.
Politics also plays a crucial role here. One Andean-focused investor said one concern in Colombia is the growing partisan divide between the Santos administration and their conservative predecessors led by Álvaro Uribe, who also currently serves as leader of the opposition. According to another source, there are concerns that Uribe’s supporters among the regional authorities could undermine some of the projects.
And then there are global concerns about EM economies in the emerging era of Trump-led trade wars and isolationism. According to Deino, while the macroeconomic outlook of EM sovereign issuers remains vibrant, with these headwinds looming on the horizon, the Andean corporate sector might be best served to issue locally.
“In terms of issuances, I think on the back of 4G, Financiera de Desarrollo Naciona (FDN), the national development bank, for example, could be looking to issue to finance the infrastructure projects. But a lot of the corporates are more likely to tap the domestic markets, so we might see a few Euroclearable COP issues.”
“It’s a transition year in the global economy that will be challenging for a lot of EM corporates with refinancing needs. If possible, several of them may look towards domestic sources of funding,” Deino said. While a great many companies across emerging markets have an operational hedge, several countrIies, such as Colombia, have relatively deep and receptive local markets,” Deino said.
Nevertheless, most expect to see a widening of the region’s investor base, buoyed by the ongoing construction of roads and ports and interest from emerging players in new regions – like China.
While the long road ahead is bumpy, the economic benefits to be gained from a well-functioning system of nationwide transportation arteries, and better integration of regional hubs, outweigh the fiscal constraints these programmes are putting on the budget today.