While the Brazilian economy appears to be on the mend, infrastructure investments should decrease in 2018 for the seventh year in a row. However, conditions are being laid for a more sustained recovery in coming years, as Rodrigo Amaral reports. Market players told Inframation that improvements in Brazil’s federal auction program coupled with the redefinition of the role played by all-powerful development bank BNDES should help the sector emerge from its prolonged slump in the future. In another positive sign, investors are displaying a growing appetite for Brazil projects.
However, a lack of technical quality of projects, the crisis faced by the country’s largest infrastructure groups and currency risk could still hinder the recovery. Uncertainties created by the most unpredictable political climate since the return to democracy could also temper infrastructure enthusiasm around Brazil.
According to BNDES, infrastructure investments will amount to BRL 107.1bn (USD 32.5bn) in 2018, down from BRL 114.9bn this year. The number marks a sharp drop from 2012, when investments reached BRL 161.8bn.
When measuring infrastructure spending against GDP, the picture looks more gloomy. Rio de Janeiro-based consultancy Inver.B estimates that the ratio of infrastructure investments to GDP in 2012 was 2.21%, below the 2.3% the firm considers necessary to merely prevent further deterioration of existing assets. In 2018, the figure may drop as low as 1.43% of GDP. Although it represents a small improvement over 2017’s 1.37% ratio, Inter.B estimates that a ratio of 4.13% of GDP a year is required to modernize Brazil’s brittle infrastructure.
Edson Ogawa, the head of project finance at Banco Santander in Brazil, says 2018 may be tougher for infrastructure financing than 2017. This is due to a scarcity of government auctions, far the most important driver of the sector in the country. A handful of energy, oil and gas and airport auctions took place in the second half of 2017, but companies should only hit the financing market for those projects by 2019, Ogawa says.
Once that happens, ample funding is expected, particularly if the market is able to understand the new role that BNDES is expected to play in the infrastructure market. “Obviously, it is not possible to move from a market where BNDES provided hundreds of billions of reais a year to one where the number drops to zero,” Ogawa says. “But, as it appears that BNDES will still provide substantial funding, albeit less than in the past, it is likely that the market will be able to meet the difference.”
The direction to be taken by BNDES looms as one of big variable the future of infrastructure investments in 2018 and beyond.
During the governments of left-wing presidents Luiz Inácio Lula da Silva and Dilma Rousseff (2003-2016), the development bank in practice cornered the market by providing subsided loans that made competition all but impossible from other lenders.
Between January and September 2016, BNDES provided loans to infrastructure groups at a rate of 7.5% a year. During the same period, Selic, Brazil’s reference interest rate, stood at a whopping 14.2%. Earlier this year, however, the government has changed the way BNDES establishes rates for its loans. The gap with market rates is quickly shrinking. When Selic was last slashed by the Central Bank, in December, to 6.5% a year, BNDES’ TJLP was in fact higher at 7%.
Starting in January, a new rate, called TLP, should gradually converge towards market levels in the space of five years. This will create conditions for competition to finally return to the market. “With TJLP, it was not a matter of other sources wanting or not to get into the market,” Ogawa says. “It was plainly impossible for anyone else to compete.”
New lenders to emerge
If BNDES in fact stops crowding out other players, there are plenty of candidates to provide financing to infrastructure projects. They range from Chinese and Japanese banks increasing their presence in the country to European lenders. A number of ECAs from Europe, Asia and North America are also keen to provide alternatives to BNDES funding, according to sources. Money from multilateral organizations should also become more competitive in the country.
The government has a robust pipeline of projects under the PPI programme created by President Michel Temer to boost investments in infrastructure via public and private partnerships. More than 30 projects that are in different stages of maturation are listed in the program’s website.
“PPI has done a lot of work towards improving the conditions for concession contracts,” says Gaétan Quintard, the executive manager of Project Finance at BNP Paribas in Brazil. “It has become much easier to evaluate the projects, although their quality can vary according to the sector.”
With usual suspects such as Odebrecht, Andrade Gutierrez and Camargo Correa severely hampered by corruption investigations, the field is open, at least in theory, for foreign sponsors and their financial partners.
Bankers also see the possibility of non-recourse project finance finally gaining a foothold. The vertical system used by Odebrecht, where the same group provided capital, built and operated a project, has fallen out of favor from both from the authorities and lenders. “From now on, we will see more construction companies doing the construction work, and other companies operating the assets,” says Eduardo Centola, a managing partner at Banco Modal. “The market will become more efficient.” One concern, however, is that new entrants and traditional players alike may struggle to meet the more stringent technical requirements demanded by private lenders, sources say.
Another funding method that presents interesting possibilities, according to BNP’s Quintard, is infrastructure debentures, which were introduced half a decade ago to attract investments from individual savers, via tax benefits to infrastructure projects. When issued by companies, debentures may amount to somewhere between 10% and 20% of the value of the projects that they are linked to. With the corporate debt market set to receive a boost from lower interest rates, they could reach significantly higher ratios, Quintard says.
But it may be necessary to improve regulations to give the bonds a proper boost. In addition to companies, projects should be able to issue infrastructure debentures, which is not the case today. Tax benefits to individuals should be reviewed, or the rates of return offered by issuers could turn out to be uninteresting for other investors who do not benefit from the tax breaks. According to the Ministry of Finance, there were 39 issuances of infrastructure debentures in the first ten months of 2017, raising BRL 7.71bn.
A lesser role by BNDES could also pave the way for Brazilian banks to become more active in the infrastructure market. Some, such as Banco do Brasil and CEF, have already announced new lines of credit for projects, although they are mostly in the government’s sphere. Market players estimate that less than half a dozen local lenders have the financial muscle to provide funding to large infrastructure projects. Therefore, international markets will have to get more involved if the government’s goal to increase the share of private money in infrastructure investments is to be achieved. And it will have to, as the government itself has little money to invest.
Investors await changes
For international players to provide more liquidity to the market, however, some issues still need to be addressed. One of the most pressing of all is currency risk, a serious concern in an economy where currency fluctuations have historically been dramatic, and revenues from infrastructure projects auctioned by the government are fully denominated in reais.
Quintard says the government is studying the creation of mechanisms in which the concession will compensate investors, if the latter has taken loans in dollars or other strong currencies, and the Brazil currency suffers significant devaluations. The idea is that compensation will work in the other way, if the Brazilian currency appreciates. But it is not clear yet whether this kind of initiative will bear fruit.
In the meantime, bankers are making use of derivatives and other market-based mechanisms to address currency risk. Santander, for instance, was able to set up a 15-year contract to hedge currency risk linked to a solar energy project sponsored by Enel and guaranteed by Sinosure, China’s export agency, with funding provided by Santanderand the Bank of China. Banco Modal, for its part, has used projections of revenues in dollar contracts from export trading companies as guarantees in the construction of a private port in the Maranhão estate. Funded by Chinese banks and built by the China Communications Construction Company, the port targets agricultural exporters, which made it possible to associate estimated revenues with USD, Centola says.
According to Ogawa, ECAs from several parts of the world are also more willing to provide funding in Brazilian currency than in previous years. But he warned that such solutions have a limit, and it is necessary to find in 2018 other alternatives for currency risk that will make investors comfortable to fund large infrastructure investments when the next big wave of projects approaches the market for financing in 2019.
In fact, if plans by the federal government become reality, the pipeline of projects should require plenty of financing opportunities. The PPI website lists 35 investment projects under development, including oil and gas auctions, logistics and electricity concessions,and the privatization of companies such as Eletrobras, the big electricity group, possibly by October.
Even though it is acknowledged in the market that the Temer government has given a new shot of efficiency into the process, delays have already taken place in the publication of tenders. For example, the Norte-Sul railway, which was at first expected for February, should take place at least three months later.
And 2018 brings extra risks associated with the election year, as Brazilians vote for president, state and local governments and a new Congress in October. In a chat with Brazilian journalists in December, BNDES President Paulo Rabello de Castro warned that the elections will hinder the progress of infrastructure investments in 2018.
One effort that could boost the confidence of investors is an overhaul of the unbalanced public pensions system, which is projected by the Ministry of Finance to consume 80% of the government’s budget by 2027. The voting of a proposal made by Temer’s economic team to Congress has been delayed several times. It is more likely now that no vote will take place before mid-February. As the election looms, politicians will be pressed to take a stand against a reform that is very unpopular with large swatches of voters.
That surely does not bode too well for investors. In a note to clients, Claudio Fritschak, the president of Inter.B, says that addressing the government’s precarious fiscal position, thus increasing macroeconomic security, is the first requisite for the resumption of sustained infrastructure investments in the country