INFRASTRUCTURE: On your marks… Brazil gets set for challenges ahead

SwimmersThe country’s overall infrastructure investment rate is below that of its peers. Andrew Short explores the case ahead of the World Cup in 2014 and the Olympic Games in 2016. As Boris Johnson, London’s mayor, pressed the Olympic flag into the hand of Eduardo Paes, his Rio de Janeiro counterpart, he must have felt relieved. London 2012 is considered to have been a success – stadiums were built on time (but massively over budget), there were minor problems with transport and Britain saw a haul of medals. Paes will probably be hoping for much of the same. However, Brazil faces other challenges. It needs not only to build infrastructure ahead of the World Cup in 2014 and the Olympic Games in 2016, but also boost the economy in the short-term while creating long-term stability. Brazil’s rail network, for instance, appears to be lagging behind and, if productivity is to be increased, it will need to invest heavily in this area. In the US there are 240,000 kilometres of railroad, according to the North Carolina-based Railinc Corporation. This compares with 28,530 kilometres in Brazil. Within its Bric peers, Brazil is behind Russia, which has 87,157 kilometres of track; China has 86,000 kilometres, and India, 63,940 kilometres. The lack of substantial railroad in Brazil becomes detrimental when paired with the condition of its roads. According to a 2008 report published by Goldman Sachs, entitled Building the World: Mapping Infrastructure Demand, only 6% of the country’s roads are paved. These are, however, more extensive in terms of kilometre per 1,000 workers than Russia’s or China’s roads. Such deficiencies inhibit the movement of goods through Brazil and stifle economic expansion. Brazil’s overall infrastructure investment rate is also below that of its economic peers. China has spent more than 10% of its GDP on infrastructure since the 1990s, according to the World Bank. India invested 4.5% between 2004 and 2005, 5% between 2006 and 2007, and 6% in 2008, according to the Indian government. In contrast, Brazil spent only 2.3% of its GDP on infrastructure from 2001 to 2008. Politicians have earmarked roughly 27.7 billion Brazilian reales for the World Cup and 23 billion reales for the Olympics, which are part of a wider growth acceleration programme – Programa de Aceleração do Crescimento (PAC), a project that focuses on improving basic infrastructure in Brazil. In an attempt to boost its slowing economy, the president, Dilma Rousseff, recently announced a 134 billion Brazilian reales investment programme to tackle some of the country’s most basic problems. Roberto Paolino, head of the financial institutions and public sector at Citibank Brazil, says the investment ininfrastructure will have benefits that may not be seen readily. “This level of investment may not have an impact on Brazilian GDP immediately, but the projects will help remove bottlenecks and raise Brazil’s growth rate over the medium term,” he says.
subsidisation Unlike Europe, where there is a healthy amount of infrastructure debt funds with the ability to raise long-term financing, Brazil’s base interest rate continues to be one of the highest in the world. This is a hindrance for those who want to issue longer debt profiles, which fund managers would like to add to their portfolios for inflation linked, long-term returns. The Brazilian National Development Bank (BNDES) has backed most of the infrastructure projects at subsidised rates. This crowds out private capital because it can lend cheaply for
long periods. There are, however, concerns that BNDES does not have the resources to continue providing funding for all the infrastructure projects slated for the country. The local debt markets will become an important part of complementary funding. However, this is provided Brazil keeps its interest rates low and can create a secondary market for selling these bonds. To try to stimulate its longer-term debt market, the federal government has enacted a law to allow companies to issue infrastructure debentures with a number of favourable tax incentives. In order to attract local and foreign funds, the infrastructure debentures have a reduced tax structure and investors do not have to pay the upfront Imposto Sobre Operações de Crédito tax if they are from outside Brazil. However, after the failure of the first issuance of infrastructure debentures by the Concessionária Rodovias do Tietê – a toll road concessionaire in São Paulo – to obtain the required amount of capital of 650 million Brazilian reales, questions have been raised about the attractiveness of these instruments. Paolino says issuers have been slow to use infrastructure debentures because of problems with the wording of the legislation that created them. “No projects went through because of the way the legislation was written,” he says. “It did not account for liabilities an investor could have on tax benefits if the company did not meet pledges given on the tendering process.” Paolino adds that the government is aware of the issue and will be revamping the legislation in the hope it may stimulate latent demand in the market. BlackRock’s co-head of the São Paulo office, Karina Saade, says there have been two main impediments to international investors entering the domestic market currently. “The first is tax, which this new product addresses. The second is liquidity, because there is no secondary trading of domestic credit in Brazil,” says Saade. Paolino shares this line, adding that demand would increase if there were a secondary market. “Investors could go in and hold until maturity but for whatever reasons they can sell because there is liquidity. Recent debate in Brazil has been if BNDES could foster the development of such a secondary market,” he says. With limited opportunities to pick up long-term inflation-linked debt, local funds are finding other ways to profit from the infrastructure expansion in Brazil. Gilberto Nagai, head of private equity at Itaú Asset Management, says giving equity to companies that build toll roads is a means to gain the upside from recent stimulus packages while also capitalising on the increase in other infrastructure investments. “These companies collect the fees for the cars and trucks that pass the tolls,” he says. “Toll roads are closely linked to GDP and fees rise with inflation but are also linked to other investment. This is because you need trucks to go back and forth to bring materials to build projects.” Companies that invest in toll roads and other projects typically bid at an auction. “The main concern is costs overrun and of course you do your calculations on how much return you are going to get, and try to be competitive,” says Nagai. “You will not get the same return you budgeted for if these projects overrun.” Infrastructure investments in Brazil should be a driving force for economic growth in the longer term. With improved roads and railways the country can increase its efficiency, making it potentially more attractive to do business and incrementally increase GDP. Although both sporting events in Brazil may overrun their budgets, if they are a success it will further bolster Brazil’s image in the international markets. ©2012 funds global

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