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Low return rates undermine infrastructure efforts, experts say
By Flavia Lima | São Paulo
Unattractive project return rates, business plans poorly evaluated and little predictability in rules comprise the scenario which, in the opinion of experts who spoke to Valor, have the power to undermine the government’s effort to make infrastructure investments rise above the current 2% of GDP. The general perception is that the outlined concession model induces to what they call “adverse selection”: Seeking the lowest possible tariffs — fueled by the lowest imaginable return rates — the government ends up attracting not very committed investors, who accept unrealistic rates to, further ahead, try and renegotiate contracts in better terms.
Claudio Frischtak, of Inter B
In general, doubts are not uniform and vary a lot depending on the sector. Among changes being claimed, the internal rate of return (IRR) of projects is the aspect of biggest dissatisfaction — and highest expectation regarding changes. Based on estimates of future revenues and costs, the internal rate of return set by the government in the projects for which it has already distributed viability studies, such as those for railways and roads, of 5.5% a year, is considered unattractive.
“It is necessary to erase the notion that the government improved the projects’ return rate when, actually, it improved the return rate of shareholders, by offering more favorable financing conditions for these projects,” says Raul Velloso, a consultant and former secretary of Economic Affairs of the Ministry of Planning. Indeed, the government itself clarified differences between the rates in a roadshow for infrastructure that it carried out for foreign investors in New York, on February 26th. At the meeting, it announced that it would no longer release the IRR of projects, only the leveraged return rate, which reflects prospects of remuneration on equity.
Thus, taking into account better terms for financing from the Brazilian Development Bank (BNDES), including longer timeframes for amortization and grace periods, in addition to cuts in fees and demands to approve the credit, the leveraged rate of most concessions rose from 10% a year, discounting inflation, to up to 15% for roads and up to 16% for railways.
“The fact is that if the project is bad, with low internal rate of return, there’s no BNDES financing that helps,” Mr. Velloso says. He considers that a reasonable average return rate for infrastructure projects today would be around 10% a year, depending on the risk of each project. In the same line, Paulo Godoy, president of the Brazilian Association of Base Industry and Infrastructure (ABDIB), says the risk is an important component to form the project’s return rate and the fact that it is different from project to project, from region to region, means this rate can’t be a uniform one. But Mr. Godoy also says the government is proving to be receptive to the issue.
This receptiveness may well be explained by the amount of infrastructure investments needed in the next few years. The government itself calculates the prospects of investment in Brazil in several sectors at R$1 trillion from 2011 to 2015. Only projects of handing over ports, airports, roads and railways to the private sector, added to the Growth Acceleration Program (PAC), are expected to reach R$370 billion in the next few years.
Though infrastructure investments are seen as crucial both to boost economic growth and productivity and to answer population demands as income rises, the last few years have been somewhat disheartening. A study by Inter B Consultoria Internacional de Negócios shows that the minimum needed investment in infrastructure to compensate the fixed-asset depreciation is about 3% of GDP.
Between 2001 and 2011, though, the average volume of investments in infrastructure was at 2.2% of GDP, concentrated on the power, telecommunications and road-transport industries. In 2012, Inter B estimates that this investment fell to 1.96% of GDP, the lowest percentage in the PAC era. “The issue is to know if we bottomed out in 2012 or not,” says Claudio Frischtak, president of Inter B.
The consultant says that infrastructure investments are likely to reach something around 2.5%, 2.7% of GDP only in 2014, reaching 3% for the first time in 2015. “And with that we don’t get even close to our competitors, which invest between 5% and 6% of GDP,” he says.
The consensus is that the government took a big step by acknowledging that it can’t do all by itself — either for lack of budget or for difficulty in executing the investments. The evaluation, though, is that it’s trying to attract investors without predictability in rules, which generates insecurity. “The government has to commit to be the least discretionary as possible, but the signs it’s been giving lately go in the opposite direction,” say Mauricio Canêdo, researcher at the Brazilian Institute of Economics (Ibre) of Fundação Getulio Vargas.
Monica de Bolle, managing director of Galanto Consultoria, sees distrust in both sides: From the government, which believes that without its supervision the private sector will charge very high prices; and from investors, who are always wondering if the government will not change some contract term. “And this impasse prevents investors from putting real money in these infrastructure projects,” she says.
Facing such criticism, the government has decided to act, broadening financing sources, altering timeframes for concession, or, in the case of railways, ensuring the purchase from future concessionaires of their entire transport capacity, to eliminate the demand risk and thus guarantee the business viability. “Without facing the fact that, to get investments, the return has to be minimally adequate, there’s no point in offering sweeteners to attract businesses,” Mr. Velloso says.
For Mr. Velloso, another component to keep businesses away is what he calls “inversion of phases” — the effort of putting concession auctions ahead of the pre-qualification stage and of the analysis of the business in order to accelerate the process and avoid postponements motivated by investor issues. “This is being done since the 2007 round of concessions, with unsatisfying results,” Mr. Velloso says. He adds that it’s more than obvious that detailed studies need to be conducted, since these are complex projects, with long maturation times.
In general, the fear is that a hurry to fit auctions in an electoral calendar (presidential elections are next year) and the imposition of out-of-tune return rates may end up attracting not-well-prepared competitors. “The numbers don’t add up even with cheap money from BNDES [the national development bank] and worse, it induces adverse selection. Only bad businesses show up at auctions, those that plan not to invest properly and that, when things come to a head, renegotiate from a position of strength,” says Marcio Garcia, visiting researcher at the Sloan School of Management of the Massachusetts Institute of Technology, and licensed professor from the Department of Economics of the Pontifical Catholic University of Rio de Janeiro.
But there are dissenting views. Bruno Pereira, lawyer and coordinator of the Observatory of Public-Private Partnerships, says there’s a lack of technical acuity in criticisms to the projects’ IRR. “Within its business model, the government defined a rate. But if demand booms during the 30 years of concession, the effective return rate of this project can be much bigger than that of the business model.”
Mr. Frischtak, the consultant, says that if financing conditions are more favorable, the return on equity becomes more attractive, and the best proof of this is the success of some auctions already held, such as those of the airports in Brasília, auctioned at a premium of more than 670%; Guarulhos, with a 373.5% premium; and Viracopos, with a premium of nearly 200%, according to Inter B data. The three concessions had estimated rate of return of 6.46%.
Mr. Frishtak says that more important than altering the projects’ return rate would be to look into the quality of regulating agencies and ministries important to infrastructure. “The president signals she would like to have agencies dominated by technical factors, but the issue is whether she will spend part of her political capital to defend the agencies,” he says. “Without volatility in the economic policy and with a reasonable, credible and transparent regulatory regime, investments will come.”