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Cablegate: Slow Progress On Brazil's Public-Private Partnerships

This record is a partial extract of the original cable. The full text of the original cable is not available.

UNCLAS SECTION 01 OF 03 BRASILIA 001087

SIPDIS

NSC FOR DEMPSEY
TREASURY FOR OASIA/SEGAL
PLS PASS FED BOARD OF GOVERNORS FOR WILSON, ROBATAILLE
USDOC FOR 4322/ITA/MAC/WH/OLAC/WBASTIAN/JANDERSEN/DMCDO UGALL
PLS PASS TO EXIM FOR A FOLEY

SENSITIVE

E.O. 12958: N/A
TAGS: EIND EFIN PGOV ECON EINV BR
SUBJECT: SLOW PROGRESS ON BRAZIL'S PUBLIC-PRIVATE PARTNERSHIPS

Refs: Brasilia 644

Sensitive but unclassified; please protect accordingly.

1. (U) Summary: In recent meetings with emboffs and Treasury
desk officer, GoB officials expressed cautious optimism on the
progress of legislation governing public-private partnerships
(PPPs) and its initial application to infrastructure
bottlenecks that threaten Brazilian exports and GDP growth.
Private consultants and World Bank representatives provided
somewhat less confident assessments of the federal-level PPP
experiment, predicting further delays in passage of the
legislation and voicing concerns on the tendering process and
financing possibilities. Minas Gerais state's PPP program
compares favorably with the shaky start of the federal PPP
effort, according to one consultant. Even if and when the
legislation passes, many details will remain to be worked out
with the first PPP bids and contracts - perhaps too much
uncertainty for most of the private sector to bear. End
Summary.

PPP Bill Working Through the Senate . . .
-----------------------------------------

2. (U) The PPP bill (PL 2546/2003) passed the Chamber of
Deputies in March and is now under review by several Senate
committees. Ministry of Planning officials, while emphasizing
that the PPP bill enjoys broad, non-partisan support,
highlighted two areas of concern in Congress and the GoB's
plans for resolving them. The precedence or seniority of PPP
contracts in the order of government payment obligations, just
after debt and salaries, posed a constitutionality issue for
some, forcing the removal of the offending article in the
Chamber of Deputies. Demian Fiocca, economic advisor to the
Minister of Planning, explained that the GoB still considers
precedence a necessary complement to the guarantee fund to
attract PPP investors. The GoB will not fight to reinstate the
article in the PPP bill, but plans to include the PPP
precedence language in the annual law that enables budget
expenditure, reasoning that Congress will not object to a
measure that requires their approval every year.

3. (U) Fiocca further maintains that the guarantee fund, made
up of real estate, blue chip stocks and other liquid assets to
include budgeted funds, provides the added security investors
require to invest in Brazilian PPPs. He noted that the
specifics of the fund's content and management would not be
decided upon until after the passage of the primary PPP
legislation, thus requiring an appendix to the law. Fiocca
asserted that discussions with interested parties in the
private sector indicate satisfaction with the general outline
of the guarantees provided for in the legislation, with the
caveat that the specifics in the appendix be "well drafted."
Dealing with exchange-rate fluctuations posed by external
financing is another concern of potential local investors,
Fiocca said. He admitted that providing a hedge would be too
costly, but talked of the possibility of setting interest-rate
limits and having lenders assume timing risks, effectively
decelerating repayments in devaluation years and accelerating
in years of currency appreciation.

4. (U) The classification of GoB and state PPP expenditures as
either debt or recurring costs for accounting purposes is the
second Congressional sticking point. The original bill
specifically empowered the Federal Finance Ministry to assess
each PPP contract to make this determination based on the
relative level of private risk involved - little or no private
risk would warrant a debt classification while substantial
private risk, where supplemented with public payments, would
render a recurring-expenditure classification. According to
Fiocca, congressional representatives of states that desired
greater accounting flexibility in the classification of their
PPPs forced the removal of this provision from the bill.
5. (U) This has sparked some IMF concern that PPPs could create
unacknowledged liabilities in public accounts. Fiocca argued
that this fear was overblown, despite the deletion of the
clause, since under the terms of Brazil's Fiscal Responsibility
Law (LRF) the Federal Finance Ministry will continue to
determine how to treat state-level obligations. By allowing
the federal government to set repayment terms on the state debt
to the federal government and limiting the contracting of new
debt, the LRF effectively requires the states and
municipalities to produce primary surpluses to be able to
service their debt. Fiocca explained that the deleted article
was redundant and thus unnecessary, as the Federal Treasury
would always retain the ability to account for PPP expenditures
by virtue of the precedence of the Fiscal Responsibility Law
(complementary law, inferior only to the constitution) over the
PPP law (ordinary law.)

6. (U) Approval of the text by three Senate committees would
eliminate the need for a plenary vote, but further changes in
the Senate would send the bill back to the Chamber of Deputies.
Several of our interlocutors outside the GoB predict the
measure will be returned to the Chamber and may not be finally
passed until the end of 2004. Planning Ministry officials did
not speculate on a passage date, but did predict the start of 2-
3 pilot projects by the end of the year with up to R$ 5 billion
(US$ 1.6 billion) in GoB investment. Looking to stimulate GDP
growth, Fiocca said the GoB wants to focus these first projects
on multi-modal solutions to logistical bottlenecks, aimed
primarily at agribusiness exports - ports, roads and railways.

. . . as High Risk Profile Remains
-----------------------------------

7. (U) Noting the difficulty in legislating away the political
risk of investing in Brazil, representatives from the World
Bank and PricewaterhouseCoopers (PWC) did not agree that the
guarantee fund was alone sufficient to attract investment in
PPPs. They cited a weak judicial system and the tendency to
resort to inflexible legislation and the inability of
regulatory agencies to guard against abuse and corruption as
further complications. The current uncertainty of the
regulatory regime and the ideological divide within the ruling
PT party on such key PPP sectors as water and sanitation also
do not bode well. A World Bank water specialist suggested that
the Ministry of Cities, which has jurisdiction over water and
sanitation projects and leans far to the left, would not likely
favor private-sector solutions to Brazil's water and sanitation
service woes. Conflicts between state and municipal
authorities over water rights as well as the GoB's dicey draft
regulatory legislation for the sector (allegedly prepared in
secret) would cause any investor to think twice in evaluating a

SIPDIS
Brazilian water sanitation PPP proposal.

8. (U) A PWC representative warned of pitfalls in the details
of how PPP contracts will be tendered and how arbitration would
be handled. The bill addresses some of these issues
superficially, but key determinations will likely be made only
with the first PPP contracts. PWC is working with the Ministry
of Planning and the PPP management authority (comprising the
Ministries of Planning, Finance and Civil Household), sharing
with them model PPP contracts from other countries and helping
them to set project priorities. The PWC rep told us that
Brazil is the first country with a sub-investment grade credit
rating to attempt PPPs, making the undertaking very much an
experiment, particularly given the culture of distrust between
the public and private sectors.

9. (U) Echoing concerns similar to those of World Bank
officials, the PWC rep noted the challenge of obtaining the
value for money that PPPs promise in a judicially weak system
that tends to over-legislate. Warning of the currency risks,
he wondered what institutions would finance Brazil's PPPs,
noting that BNDES would not be able to shoulder the burden, and
expressing uncertainty about IDB and World Bank readiness to
invest heavily. He characterized the GoB's announcement of its
23 desired pilot projects in December 2003 as ill-advised,
coming before legislation was in place and without carefully
planned investor proposals for each project. Some of the 23,
he said, are actually in-process concession projects that have
lapsed or failed. In his opinion, the international roadshow
that GoB officials mounted in the U.S., Europe and the Middle
East late last year did not offer potential investors a
reassuring picture of Brazil's readiness for PPPs.

Bright Spot in Minas Gerais
---------------------------

10. (U) Our PWC contact juxtaposed "misguided" federal actions
with those of Minas Gerais (MG) state, where PPP legislation
was passed and 5 pilot projects designated in 2003 without
great fanfare. MG is the only Brazilian state to pass PPP
legislation; other states such as Sao Paulo have draft bills
but are awaiting passage of the federal law before moving
ahead. The MG law does not address tendering procedures,
preserving flexibility, according to PWC. He said the state
recently held a public meeting on a PPP water project, already
providing potential investors details on project specifics.
The smaller scale of these projects, the improved financial
profile of the state, and its business-friendly administration,
may be the best available launching pad for Brazil's PPP
experiment, he argued.

COMMENT
-------

11. (SBU) The Lula administration's goal is to develop a
hybrid version of a PPP that corresponds to Brazil's needs and
circumstances. Key elements of success, such as firm high-
level political commitment, clearly exist. Guarantees that
might be judged as transferring too much risk to the public
sector in a more stable environment are essential in Brazil's
context. However, as one consultant noted, dispute resolution
procedures, availability of long-term private capital, and the
development of in-house expertise in the federal PPP management
authority remain outstanding requirements. The expectation is
that this can all be addressed as "pathfinder" projects develop
and act as the catalyst to resolve policy and legal issues not
yet imagined. Once legislation is passed, the difficult work
of the management unit will begin, as it assesses the pilot
projects and develops the first contracts. These partnerships
are long-term solutions, and Brazil's hybrid PPPs will likely
need to incubate for longer than their champions would like.

HRINAK

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