June 01, 2015

Brazil seeks new routes for railway concession model

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With Brazil's ambitious programme of railway construction plans stalling, the government is revising its concession model for new projects to rely more on private investment while easing pressure on public debt. Kevin Smith looks at the intricacies of this new policy and how the market might receive it.  

AMENDMENTS to Brazil's new railway infrastructure investment and concession model, which the government was due to announce at the beginning of this month, are set to slash the number of projects included in its Investment Programme in Logistics (Pil). 

The programme, which was launched in 2012, envisaged construction of 11,000km of new 1600mm-gauge railway up to 2025. Yet this has now been scaled back to 5000km with Brazilian president Ms Dilma Rouseff expected to reveal revisions to the railway policy during a wider announcement of new infrastructure concessions.

Brazil JunAmong the expected changes, the government will inject less money into federal agency Valec, a key player in the Pil concession model. Under Pil, Valec is responsible for purchasing capacity from the private concessionaires responsible for constructing the new lines and redistributing these paths to private railfreight operators, with a single operator able to purchase up to 30% of capacity.

The government can subsequently provide up to Reais 15bn ($US 4.99bn) in guarantees to concessionaires through Valec in case of a lack of demand from open-access operators in what is known as the "Valec-guarantee."

However, this structure is unpopular, and with concerns that Valec could default on these guarantees as well as the unpredictable nature of this system, take-up has been slow.

As a result alternative financing arrangements are set to be introduced on a case-by-case basis, including a return to Brazil's traditional railway concession model.

In an apparent U-turn on efforts in the Pil policy to break up railway monopolies, railfreight operators are expected to be invited to bid for a 30-year concession to operate the new 1560km North-South line section from Porto Nacional to Estrela d'Oeste. The government held a meeting with MRS Logistics, Cosan, and Vale subsidiary VLI on May 7 to discuss the proposal, and the concession would also include a commitment to finish the 669km Ouro Verde de Goiás - Estrela d'Oeste section, which is currently 85% complete. This would require an investment of Reais 700m with the projected estimated to have already cost Reais 4.5bn. The concessionaire would be obliged to deliver the project by July 2016.

For other projects, the government is considering public-private partnership (PPP) models in which it would offer to fund part of the infrastructure investment. Under another option, the Inter-American Development Bank (IDB) could provide funds, with the government already encouraging the bank's private financing arm, Newco, to fund infrastructure developments. This could potentially provide guarantees for PPP projects, taking the responsibility away from the treasury.

Indeed minister for planning Mr Nelson Barbosa said that the large fiscal burden on the government of retaining Valec in its current role is forcing the rethink. He says the Lucas do Rio Verde - Campinorte section of the 990km Sinop - Miritituba Pil project is another scheme that is currently under evaluation for the revised concessioning programme.

Public debt

Another major objective of the reforms is to reduce the level of financing for new projects from Brazil's National Bank for Economic and Social Development (BNDES), as the government looks to ease the reliance on state-subsidised loans amidst rising concerns over public debt levels.

In the original Pil, up to 70% of the Reais 99.6bn of funding for the 11,000km of new railway would come from BNDES. However, with rating agencies indicating that current debt levels could result in a sovereign downgrade, the role of BNDES, which has been virtually Brazil's only source of long-term corporate credit since it was founded in 1952, is under review.

BNDES' role increased substantially during Rouseff's first term between 2011 and 2014 in an effort to spur investment and economic growth, with the Pil programme a key policy. Yet on April 8 Mr Nelson Siffert, the bank's head of infrastructure, said that loan disbursements will fall to Reais 170bn in 2015 from Reais 187.8bn last year.

BNDES' reduced role in infrastructure lending is driven by declining federal subsidies - the treasury will not provide additional loans in 2015 as part of the government's fiscal tightening efforts - and an increase in interest rates on existing loans, which are indexed to TJLP, a rate set by the National Monetary Council.

In the past this arrangement resulted in favourable conditions for infrastructure borrowers, but created a high subsidy burden for the government. TJLP was recently increased to 6% from 5.5% in the first quarter of 2015 and 5% in 2014, but remains well below Brazil's benchmark interest rate, the Selic, which was increased to 12.75% in March.

Ratings agency Fitch says that further increases in TJLP are possible although these are limited because debt service is added for any rate above 6%, which could put borrowers in a difficult position. It says an alternative might be for BNDES to reduce the share of its TJLP-linked loans, but with more private sector involvement, this would result in an increase in short-term borrowing costs.

If this is the case, Fitch argues that operations must bring in more revenue, which could result in higher tariffs than initially envisaged. "This effectively transfers the project's cost to those who directly benefit from the infrastructure rather than through the general tax base," the agency says.

Brazil's finance minister Mr Joaquim Levy, who is leading the concession reforms, visited Washington in the week of April 13 to attend the spring meeting of the World Bank and International Monetary Fund (IMF), and to speak to institutional investors, including pension funds, about possible investments in Brazil. Levy was also looking to secure advice on how best to amend Brazil's financial structures to encourage investment and is similarly working with the Brazilian Association of Financial Capital Market (Anbima) to reassess this process.

Levy says the goal of the upcoming reforms is to increase the concession model's attractiveness to boost private funding thereby reducing the reliance on public funds, adding that the World Bank has indicated that it is willing to support this new initiative.

Brazilian Railway Industry Association (Abifer) president Mr Vicente Abate feels that through revising the programme, the government and industry can reach an attractive concession model which does not burden the treasury during this period of "fiscal adjustment." He adds that the reforms are positive "and not a defeat for the government," because the railway industry is more complex and needs a more flexible arrangement with the private sector than other sectors in Brazil which have experienced greater success with Pil.

Fitch says efforts to develop fixed income instruments that wean large companies off state-backed loans could provide incentives for borrowers to sell bonds in local capital markets.

However, the agency is sceptical about foreign investor interest in projects in the local currency given high hedging costs, although it does expect private sector banks to "play some role in the development of these alternatives." Indeed China's reported interest in the West East Integration Railway project (Fiol) and North-South Railway is offering some encouragement to the government.

Existing projects

Overcoming this funding conundrum is critical for the viability of Brazil's ambitious long-term railway infrastructure development agenda. However, difficulties also appear to be emerging with existing schemes.

Contractors working on Fiol, the 1022km line from Barreiras to Ilhéus, are reducing the pace of construction following late payments from Valec and a general suspicion over the cash-flow for these projects which unions accuse the government of "paying little attention to."

In April Galvão Engineering laid off 700 employees working on the 100km section between Manuel Vitorino and Aiquarara in Bahia and is now employing 148 workers compared with 1500 at the end of 2014. In addition, while not making redundancies on this project just yet, construction firm Constran is only focusing on secondary construction and maintenance activities on its section of the project which is divided into eight lots.

Valec acknowledges the problem and says that while it is in the process of settling the payments, it is waiting for the Ministry of Finance to set out its 2015 budget including its limits of expenditure and disbursement schedule.

Settling the budget may overcome these problems in the short-term, but with the inevitable delays to the projects that will follow, it does not boost confidence in the longevity of these investments.

Indeed consistent stalling of the Pil railway projects means that Brazil's ambitious railway construction plans are now at a crossroads. In 2015 the government, it seems, is attempting to get its house in order before pursuing its plans to enhance infrastructure. Levy is clearly focused on securing a sound financial footing for these schemes which do not add to the country's growing debt burden due to the understanding that any downgrade would be a real hammer blow to investor confidence in Brazil and attempts to secure private finance.

This change in focus is reflected in Levy's role. He admits that he is no longer selling Brazil's infrastructure schemes to prospective contractors and concessionaires, but aiming to secure other sources of private funding so that they may happen at all.

However, this is clearly a risk. Businesses in the country's vast hinterland and others aiming to benefit from enhanced infrastructure that will improve freight transport must hope he is able to convince prospective private investors of the desirability of backing these projects soon. If not, they will remain firmly on the drawing board.

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