Throughout the 1980s the Brazilian government maintained a strong presence in the country’s infrastructure development. The state reduced its investment to encourage the private sector to gradually take up the financial burden, with privatisation and concession programmes in the early 90s opening up key sectors like transport, energy and telecommunications.
The success of these initiatives, however, was limited, and did not compensate for the decline in public investment. Under pressure to provide for the hosting of major sporting events, such as the 2014 World Cup and 2016 Olympics, the government renewed attempts at infrastructural development with grand state-led programmes.
These included Lula’s PAC1 (Aceleração do Crescimento) investment plan in 2007, pledging BRL504bn (US$306bn) to address many long-overdue infrastructure concerns. It was followed by PAC 2 in 2010, a continuation of the project that promised additional spending of BRL959bn (US$582bn) from 2011 to 2014. Dilma Rousseff announced a further BRL200bn (US$65bn) infrastructure package in June 2015, backed by BNDES development bank’s pledge to finance 70% of highway concessions.
The second part of the programme, carried out during the post-recession credit boom, saw total investment reach BRL183bn, split between airports (BRL35.8bn), ports (BRL$8.4bn), roads (BRL29.2bn), urban transportation (BRL6.9bn), power generation and transmission (BRL96.7bn) and telecommunications (BRL6.4bn).
Yet by 2013, infrastructure was still a drain on the country’s economy. Credit Suisse estimates that inadequate infrastructure and transport facilities cost Brazil an equivalent of 10% to 15% of its GDP. The world’s seventh largest economy ranked 120th out of 144 countries in global infrastructure quality rating, with only 15% of roads paved and only one Brazilian port listed in world’s Top-100. Worse still, it has been dropping steadily in the rating for previous five years.
As recession worsened last year, the construction industry saw a slowdown of by about 8%, and it is expected to fall by another 4% this year. Brazil’s widening infrastructure gap is currently $52bn a year and state banks are all but juiced out, while the ongoing corruption scandal keeps dragging in beneficiaries of state concessions or construction firms involved in those projects.
So, with another multibillion development programme – Rousseff’s post-impeachment legacy – hanging over Temer’s administration, what fate awaits Brazil’s crumbling roads, bridges and airports?
Observers agree that Temer seems to have taken the challenge in his stride, overhauling Rousseff’s initial PIL concessions programme and announcing the PPI (Investment Partnerships Programme), which proposes 25 projects, including four airports, three railways, two highways and two port terminal concessions. Significantly, the new leader vowed that “markets, not politics, will drive infrastructure investment”.
“Although, with his party’s recent regional election defeat in Rio-de-Janeiro, Temer is a bit of a lame duck, he’s put together the right team, headed by the rock-star (ex) central banker Henrique Meirelles, who saved the economy from collapse in 2008,” says Vernon Budinger, Chief Executive Officer and Chief Investment Officer at Latin America Structured Finance.
This sentiment is echoed by Denis de Castro, director of Asset Finance – Structured Solutions and Leasing at Societe Generale Brasil, who sees the government “doing all the right things” – namely, introducing legislation that will improve the investment climate.
“Limiting public spending will allow the state to reduce inflation and interest rates, which are currently excessively high – and a drag on the financing. So, overall there is a positive trend, but it will take one or two years to pick up investment,” the expert notes.
Even if it is approved by the Senate, the new leadership will be facing two major problems with the infrastructure projects: funding and implementation, says Capital Economics’ chief emerging markets economist Neil Shearing.
At the height of the commodities boom in 2000s and early 2010s the Brazilian government relied heavily on local and foreign banks to fund its ambitious infrastructure projects. Many of the state controlled lenders, such as BNDES and Caixa Economica Federal SA (CEF), effectively became an arm of the government’s fiscal policy and used various structured finance vehicles to provide support and funding.
Under Rousseff, state development banks were expected to play a crucial role in financing the PIL concessions programme, but the US$11bn FI-FGTS scandal, along with growing doubts about the lawfulness of such financing schemes, now mean that public banks’ participation is expected to be more reserved.
This is reaffirmed by the institutions themselves. BNDES initially promised to fund 70% of highway concessions with spreads based on the TJLP long-term investment rate, but since Dilma’s impeachment, trimmed its ambitions down to 50%, stretching over a 15-year period.
The development bank also announced that it will stop providing bridge loans on such concessions, with Moreira Franco, the former governor of Rio, stating that it is “not in the position to give what it agreed to give” earlier. And in October, BNDES confirmed that it will significantly reduce the financing of power plants using coal or oil for generating electricity, instead turning its focus to developing green energy projects.
“State development banks, whose sole purpose should be to finance infrastructure development projects such as these, instead tended to get more involved in company finance rather than in big infrastructure financing,” explains Shearing. “We are now in for a period where banks are far more cautious, focus will be on maintaining asset quality, consolidating and keeping the balance sheets strong.”
This cautiousness is driven primarily by the depleted reserves, with state and private-sector banks set to reclassify at least BRL90bn (US$28bn) in troubled corporate loans.
“The big difference between this downturn and 2008 is that back then, BNDES had a war chest and was able to carry the big industrial giants through the rough times. There is no war chest this time round, so even the big companies are suffering, like Petrobras,” Budinger points out, adding that rising debt on local and municipal level means some of the remaining federal funds are likely to go towards bailouts.
The banking sector’s woes are further aggravated by the mass exodus of large foreign banks and multinationals in the recent years. Citigroup sold its credit-card and consumer-finance unit in 2013 and Societe General SA decided to close its consumer-finance operation in February 2015. Others to have left the country include Bank of America Corp., Spain’s Banco Bilbao Vizcaya Argentaria SA, Italy’s Intesa Sanpaolo SA and France’s Credit Lyonnais SA, followed by HSBC scaling down its operations in summer 2016.
With the burden shifting on local FIs, private sector banks are buckling. Brazil's top two private-sector banks, Itaú Unibanco Holding SA and Banco Bradesco SA, faced a flood of loan renegotiation requests in the last quarter as corporate sector liquidity plummeted.
As local and state banks retrench and infrastructure financing gap grows, the Brazilian government will be forced to seek out and attract foreign capital. There are a number of options, some of them more exotic than others – including its Latin American neighbours, Asian lenders, or global development banks, such as CAF, AAIB or NDB. China has traditionally been a big contributor, but observers are sceptical about the prospects of its involvement.
“Chinese financial institutions have been helping out the Brazilian government after investing heavily into Petrobras. They also invested heavily in the energy sector, but suffered losses with the FX risk and now they seem more cautious in taking such risk,” notes de Castro. “We do expect some pinpoint investment, as they look for fresh opportunities, but nowhere near the same level as before.”
Shearing echoes this sentiment: “This new administration is slightly less prone to domestic participation and displays more openness to foreign investors, so we can potentially see involvement of other LaTam FIs or international lenders, but there is no concrete sign of that yet.”
The key difference between current and past approaches to attracting capital – and the biggest challenge, as Shearing noted – would be the implementation of new regulations to boost investment. Terms for private investors in government tenders and the general business environment (with the corruption probe drawing to a close) have improved dramatically under Temer, the economist admits, but we are still in early days. Reducing involvement of the state and revising the role of public banks will be crucial.
“Whilst before state banks offered a heavily subsidised interest rate, with big lending to the concessions, now their role will be limited to 40-50% of the project cost, whilst 40% is expected to come from other public sector banks – such Banco do Brasil, for instance, and more likely capital markets, via Project Bonds (locally known as “Debentures de Infraestrutura”) with the remaining 20-25% from the equity holders,” proposes de Castro.
Private-public partnerships (PPPs) have been a successful tool in the past. But, if the government instead looks to the capital markets, or using structured finance and special purpose vehicles via asset backed securities, it would provide an incentive for stronger investment.
“The most likely structure for some of the road and railway projects involves selling Fundo de Investimento em Direitos Creditórios (FIDCs), whereby a percentage of the receipts from a project or a metropolitan area were pledged to the FIDC and the size of this percentage is determined by the coverage needed for the FIDC payments,” Budinger says.
Many of these FIDC funds are created with assets with debt and equity tranches, where the bank keeps the equity tranche (the first tranche to default if its finances become distressed), thus the credit rating of the FIDC is better than that of the original loan.
“A lot of green energy projects, such as hydroelectric grid entities, could utilise FIDCs to sell future receipts to a structured finance vehicle in return for upfront capital – the scheme is proven to be successful,” he adds.
Such funds can be used by local capital markets participants to hedge their positions against medium-to-long term financing in local currency. This would spread some of the risk from equity holders to other investors.
Project bonds are another option, as they are being increasingly utilised in infrastructure development projects across the emerging markets. Infrastructure debentures, which offer some tax incentives, were originally created with aim of attracting investors, but failed to provide a mechanism to raise liquidity due to tenor limitations.
“Now the authorities have sought to provide alternatives to create liquidity through incentivizing greenfield projects or expansions. If they are able to set up these mechanisms, there should be an important inflow of investment – by the attraction of new players, into this and other similar project bonds,” claims de Castro.
Others are sceptical about long-term success of project bonds, namely because of flaws in the local regulatory systems and property legislations. As Budinger points out in a recent report, there are three major areas of concern.
“The sector is over-regulated and under-enforced, with the Comissão de valores mobiliários (CVM - the equivalent of the SEC in the United States) usually being slow to react to infringements and few cases of fraud in such funds and projects leading to prosecution. Secondly, administrators and custodians do not have the necessary systems to expose fraudulent activity. Thirdly, the market is generally shrouded in secrecy, which manifests in failure to publish or the slow publication of shareholder meeting minutes on the CVM's website. This makes it difficult for the public to learn about the meetings and find the minutes."
With additional weight of red tape and a lack of transparency, the business environment in Brazil deters serious venture capitalists. The pressure to raise compliance and transparency, to a large extent, rests on the government, and Shearing defines three key areas it could improve on.
“First of all, the state has to demonstrate that there is basic political and economic stability. Also, it must confront the current image of rampant corruption, which it can do by allowing the judiciary to carry out the “carwash” and other corruption probes without interference. Finally, policymakers must offer attractive terms to foreign investors through raising macroeconomic competence, completing fiscal reforms and lowering currency risks.”
The wheels are already in motion for some of these targets. In September the government passed an IPP Law, which focuses on facilitating the early stages in the planning and development of infrastructure projects. By putting in place centralised monitoring mechanisms, the IPP Law is intended to improve coordination between the participating governmental authorities.
A looser tax policy would be another strong signal to investors. At the beginning of this decade draconian measures, such as the 6% tax on infrastructure deals, drove up the value of the real and made Brazil less competitive.
The government has to find a balance between easing the tax burden and maintaining continuity in its fiscal and monetary policies. The state must not interfere in capital markets, while its participation in the infrastructure projects should be minimal, limited to a monitoring role, Budinger says. Brazil’s private and corporate sectors also need to raise the bar and show a change in attitude. They need to reject secrecy and corrupt practices in favour of a market friendly, cooperative and transparent approach.
With ongoing corruption investigations, upcoming regional elections and urgent need to pass pension and other, often unpopular reforms, Temer and his team can be forgiven for pushing the PPI down the list of priorities. But without revitalising the country’s ailing transport systems, power stations and telecoms, they cannot kick-start economic growth. The pressure is now on the government to choose an effective development course and create the right environment for investment to thrive.
