Infrastructure, Regulation and Development: Evidence from Brazil

Infrastructure, Regulation and Development: Evidence from Brazil

Dr Edmund Amann,

University of Manchester & SAIS, Johns Hopkins University

Background:

Despite its recent slowdown Brazil remains a remarkable success story in many ways:

•The World’s 6th largest economy•A track record of comparatively decent, pro-poor growth•A strong anti-inflationary record•A strong record of attracting inward FDI, especially in the public utilities sectors

Colour values:

RIBA yellow tint (background): Red=2248, Green=244, Blue=219 (#f8f4db)

IRIBA orange: R=204, Green=106, Blue=45 (#cc6a2d)

IRIBA yellow: Red=211, Green=189, Blue=42 (#d3bd2a)

IRIBA grey: Red=88, Green=89, Blue=91 (#58595b)

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RIBA yellow tint (background): Red=2248, Green=244, Blue=219 (#f8f4db)

IRIBA orange: R=204, Green=106, Blue=45 (#cc6a2d)

IRIBA yellow: Red=211, Green=189, Blue=42 (#d3bd2a)

IRIBA grey: Red=88, Green=89, Blue=91 (#58595b)

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RIBA yellow tint (background): Red=2248, Green=244, Blue=219 (#f8f4db)

• Growth performance (av. 2-3% p.a.) easily outstripped by EMEs in E and SE Asia•Capacity constraints give rise to higher than global average inflation – need for high base rates•Overreliance on primary product exports and exposure to commodity cycle•Sense that consumption led growth model on point of exhaustion and scope for further poverty reductions limited

But challenges remain

•Brazil has a legacy of under-investment in infrastructure and that creates real capacity constraints•Poor and expensive to access infrastructure a source of social unrest (disturbances in mid 2013 and early 2014)•Poor infrastructure a real barrier to competitive export sector and export diversification•Issue in spotlight – FIFA 2014 World Cup and Rio 2016 Olympics

Infrastructure: at the heart of the problem (and solution)

Infrastructure spending: a long term decline

Source: Morgan Stanley 2010

Econometric evidence suggests strong links. Ferreira (2007) suggests that for Brazil:•A 10% increase in public infrastructure stock leads to a long term 3.3% rise in output per worker•The correlation between GDP, GDP per capita and infrastructure stocks close to 1•The biggest GDP impacts come from increased investment in power generation, then fixed and mobile phone lines then paved roads, according to the study•We are performing our own econometric analysis and will employ satellite luminosity data as one of our infrastructure stock indices – watch this space!

Infrastructure and growth

Infrastructure and social unrest

CC. Ben Tavener / Flickr

In Brazil, infrastructure is not an abstract economic or technocratic issue; it has real political resonance on the street•Protests over high public transport fares and their associated regulatory structures•Protests in favour of ramping up investment in “social infrastructure” rather than Olympics/World Cup

Infrastructure, regulation and social unrest

Brazil’s infrastructural issues are epitomised by delays around the FIFA 2014 and Rio 2016 projects

CC. Jeff Belmonte / Flickr

•Brazil has the world’s 4th largest road network •Of 1.75 million kilometers of highways, only 18% are paved •60% of Brazil’s freight moves by road. •In the budget for 2011-14 less than 1% of GDP per annum has been set aside for highway maintenance. According to the World Bank, 6% of GDP would be necessary to catch up with advanced industrial countries. •The South and South East are comparatively well served with divided multilane paved highways, •The same is not true in some of the less developed regions of the country, notably the North, the North East and the Centre West. •Transportation costs are notoriously high in Brazil: spending on logistics represents 15.4% of Brazil’s GDP. In advanced countries this is typically closer to 8-10%

A snapshot of the issues: highways

•The railway network is substantially smaller than that for paved roads in Brazil (five times smaller in fact). •Unlike in China and India for example – rail transportation is almost exclusively the preserve of freight, the latter being heavily dominated by iron ore (which accounts for no less than 79% of total rail cargo). •Brazil possesses just 3.4 km of rail per 1000 square km compared with 14.7km in the United States. •The Brazilian rail network possesses significant narrow gauge as well as standard gauge element. Such a feature poses a major challenge to network inter-operability. •Unlike in Europe, or even the USA, no meaningful steps were taken to provide a publically subsidized long distance service. •Partly as a result, today’s highway and airport infrastructure has come under acute pressure, especially in the heavily trafficked corridors between Curitiba, São Paulo, Rio de Janeiro and Belo Horizonte.

A snapshot of the issues: railways

CC. GOVBA/ Flickr

The Growth Acceleration Program (PAC)

•The need to ramp up infrastructure spending is acknowledged and has become a policy priority. •The resulting program is known as the PAC (Programa de Aceleração de Crescimento – Growth Acceleration Program) •The PAC has divided into two phases, •(PAC 1) running from 2007-10 and the second (PAC 2), under the administration of Dilma Rousseff, from 2010 to 2014. •They consist mainly of projects to increase infrastructure spending in critical, growth-sensitive areas

Policy response: the Growth Acceleration Programme (PAC)

The Growth Acceleration Programme (PAC): spending by sector (%)

•PAC I envisaged spending of R$ 503.9 bn over its four year period•PAC 2 proposes spending of R$ 958.9 bn over its lifespan (around 2.7% of 2010 GDP per year), with a further R$631.6bn of investments planned beyond 2014.

I Brazilian Real= 4.54 South African Rand (15.3.14)

PAC 1 and 2

•PAC 2, investments fall under six key initiatives: My House, My Life (housing), Water and Light for All (Water, Sanitation and Electricity), Bringing Citizenship to the Community (safety and social inclusion), Better Cities (urban infrastructure), Transportation (railroads, highways and airports) and Energy (renewable, oil and gas). •Whether projected post PAC 2 investments take place as scheduled (or at all) will depend on the outcome of the October 2014 presidential elections •The PAC also aims to address issues infrastructural quality and durability by increasing public resources targeted at operation and maintenance.

PAC 2: Disbursements so Far

•The state did not have the technical or managerial means to accomplish these projects by itself, lacking the financial wherewithal to see these projects through to completion. •It was thus decided to turn to two models; the Public Private Partnership (PPP) and the longer-established model of concession contracts. •In the Brazilian context these structures – or modalities of PPP – have included Build Own-Operate, Build Operate Transfer and Build Own Operate Transfer formats. •However, PPP contracts, as established under a 2004 law, always envisage an injection of public sector resources to support the private sector’s investment activity

Making the PAC work: modalities

•Concession contracts, by contrast, under the terms of the law, require no such public funding and should be able to sustain themselves by the levying of (regulated) user charges alone. •They have recently been used successfully in the airports sector •The PPP approach was pioneered in the highways sector in the 1990s and has continued to be applied in that area with 17,904 km of roads under private sector operation by late 2013, compared with 15365 km by the end of 2010 (O Globo, p.49 8.12.2013).

Making the PAC work: modalities (cont.)

•In a savings constrained economy such as Brazil, need to draw in FDI to capital intense, long term projects•Regulatory arrangements thus need to strike a difficult balance:1.To set tariffs over the long term at sufficiently high levels to draw in foreign capital and to offer adequate compensation for exchange rate risk and a uncertainties about the trajectory of long run demand2.To address the social clamour for “affordable” infrastructure (especially acute in wake of protests)3.To extend the physical reach of infrastructure into disadvantaged communities whether or not through universal service provisions4.While balancing 1 through 3, not to do so on the basis that long term maintenance and upgrading are sacrificed

Making the PAC work: regulatory issues

•The authorities have adopted a very cautious approach in running bidding competitions for PPP contracts and concessions•Presidents Lula and Rousseff, appealing to their political support base, changed the regulatory model for new highway concessions, selecting winning bidders on the basis of those able to offer the lowest tolls rather than on the basis of track record or capacity to deliver. •Correspondingly, the pace of private sector-driven upgrading of the highway network has lagged behind schedule • There are curiously high disparities in toll levels between highways governed by Cardoso-era and Lula/Rousseff era contracts.

Are regulatory issues holding back the PAC?

•As a result, tolls now vary between R$1.99 and R$18.56 per 100km (O Globo 8.12.13). •Similarly, the need to rein in tariffs underpins at least in part, the failure of much needed additional power generation and distribution capacity to be put in place in the urbanized South and South East. •Stemming from this, power outages are by no means an infrequent occurrence in these economically critical regions. •Regulatory uncertainties and a State Oil Company (Petrobras) centric model for exploiting vast new pre-salt deposits have retarded foreign investment in the hydrocarbons sector

Are regulatory issues holding back the PAC (cont.)?

Regulatory issues: the role of environmental licensing

CC. Brent Milikan/ International Rivers / Flickr

•Perhaps the most glaring obstacle to accelerated process has centered on the delayed issue of environmental permits by IBAMA and state-level bodies. •The delays here have largely concerned the slow operation of dispute resolution procedures and the licensing mechanisms rather than the environmental regulatory provisions themselves •Brazil’s environmental licensing procedure involve a three stage process involving the issue of Preliminary, Installation and Operating licenses, each of which requires its own procedures and creates separate scope for the generation of disputes and appeals. •This stands in marked contrast to the more streamlined processes which are typically found in other emerging and developed economies. •According to a recent World Bank study, no less than 15-20% of the budgets of hydroelectric projects in Brazil are accounted for by environmental licensing costs•Easily the most celebrated case in this regard has been the Belo Monte dam project, which, in the wake of environmental disputes, has met with repeated delays and budget overruns.

Are environmental regulatory issues holding back the PAC?

•While public attention has been focused on the role of regulatory obstacles to accelerated infrastructural investment it is important to recognize the role of two other critical factors: access to long term finance and technical capacity. •Since the 1980s the capacity of both the federal and sub-national governments to expand the scope of discretionary spending in the field of capital investment has been severely restricted. •As a result, and as already made clear, the private sector has been expected to fill the breach. •However, at least as far as the domestic private sector is concerned and unlike its counterpart in high-investing, China, its ability to perform this function has been severely constrained by the comparative shallowness and illiquidity of domestic capital markets •At the same time, and, again in telling contrast to China, base real interest rates have been maintained at among the highest levels in the emerging market world as part of the authorities’ counter inflationary strategy.

Infrastructural investment and the PAC: financing issues

•Consequently, for potential domestic private sector infrastructure operators, the provision of capital has become a binding constraint• The only viable sources here are retained earnings, or, more usually, subsidized credit from official sources such as Brazil’s BNDES development bank or the International Finance Corporation. •The BNDES has played a very active role in supporting the provision of infrastructural provision through the extension of long term credit. •Still, the scale of the investment challenges involved will require additional sources of capital if growth constraints are to be alleviated. •Foreign investors have, and will continue to play an important role. However, following a burst of foreign participation in infrastructure projects following major privatizations in the 1990s (notably in the telecommunications sector), the surge of foreign infrastructural investment has slowed largely as a result of a less favorable regulatory climate.

•The role of technical capacity should not be underestimated in considering the challenges that Brazil faces in trying to ramp up spending on complex and technologically demanding infrastructure projects. •Brazil possesses world class technical expertise and home grown infrastructure project specialist multinationals such as Odebrecht and Camargo Corrêa. •However, a legacy of under-investment in human capital born of the 1980s and 1990s infrastructure squeeze, means that this expertise is now very thinly spread.•Although this technical capacity constraint is being alleviated through a renewed commitment to training and investment within the construction and other relevant sectors, there are considerable lags involved. •In the absence of increased foreign participation in Brazil’s infrastructural investment, these constraints will continue to bite in the short and medium term.

Infrastructural investment and the PAC: technical capacity

Learning from the Brazilian experience

CC. Thomas Sennett / World Bank / Flickr

•Infrastructure is vital for growth, competitiveness and trade. Under investment can severely retard progress•Increasingly in aspirational emerging market societies, access to good quality affordable infrastructural services is an issue of real political salience •Addressing a legacy of decades of under-investment is a huge challenge•The role of the foreign private sector is key given fiscal constraints and thin domestic capital markets•There will be regulatory conflicts between the need to incentivize investment and the need to address social objectives

Learning from the Brazilian experience

•Effective regulation is not just about balancing the interests of investors and consumers; it is about ensuring predictability of the de facto regulatory arrangements and rapidity in decision making•Efforts to ramp up infrastructural spending need to take account of the availability of domestic technical capacity. This can be spread very thinly once projects begin to multiply

Learning from the Brazilian experience (cont.)