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Cablegate: Gob Focuses On Key Projects to Help Close

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 002605

SIPDIS

SENSITIVE

NSC FOR MIKE DEMPSEY
STATE PLEASE PASS TO USTR FOR SCRONIN
DEPT OF TREASURY FOR SSEGAL
USDOC FOR 4332/ITA/MAC/WH/OLAC/SHIELDS
USDOC ALSO FOR 3134/ITA/USCS/OIO/WH/RD/CREATORE
USDA FOR FAS/ITP AND FAS/FAA/WH
STATE PASS OPIC FOR MORONESE, RIVERA, MERVENNE
STATE PASS EXIM FOR NATALIE WEISS, COCONNER
STATE PASS USTDA FOR AMCKINNEY

E.O. 12958: N/A
TAGS: EINV EWWT ETRD BR
SUBJECT: GOB Focuses on Key Projects to Help Close
Infrastructure Deficit

REF: A) Brasilia 1087, B) Rio de Janeiro 1291

1. (SBU) Summary and Introduction. With exports rapidly
increasing, Brazil's transportation infrastructure is
bursting at the seams. The country's inefficient (and
insufficient) ports, its deficient roads, and its decrepit
rail network serve as bottlenecks to the timely dispatch of
commercial cargo. Well aware that past shortfalls in
infrastructure investment are now resulting in greater
costs and lost export opportunities, the GOB is now looking
at how it can quickly expand its transport capacity. Of
the four road/port/rail projects at the top of the list,
the GOB is currently contemplating moving forward with
three of them through its planned public private
partnership (PPP) regime. Delays in the passage of the PPP
legislation through congress have meant that these three
projects could - at the earliest - only be opened for
bidding by mid-2005. The GOB also needs to decide how to
account for potential liabilities arising from public
sector PPP guarantees. Notwithstanding Planning Ministry
predictions of passage of the legislation within 30 days,
this time-line is even further lengthened if congress
continues to dawdle. The export crops most affected by
this infrastructure deficit are high-volume, low-margin
bulk grains such as soybeans - the star performers in
Brazil's current export boom. End Summary and
Introduction.

2. (U) With the Brazilian real competitively priced in the
range of 2.8 - 3.2 to one USD, this year Brazil has been
enjoying an export boom. Exports, which the Ministry of
Development, Industry, and Commerce had hoped would reach
the USD 80 billion figure this calendar year, are now on
track to reach over USD 90 billion. Exports have increased
across all categories, including primary, semi-manufactured
and manufactured goods, although basic commodities (such as
soybeans) have proven to be the star performers.
Meanwhile, earlier GOB estimates of a 2004 trade balance of
a USD 23 billion, have now been adjusted upwards to USD 32
billion.

3. (U) Inadequate investment in public infrastructure,
however, has left Brazil's transport infrastructure in a
precarious state. First, the relative lack of development
of inland waterway transport in Brazil means that most of
the country's export grains must move to port via truck,
which comes out to about 3 times the cost of barge
transport. Second, three-quarters of Brazil's paved roads
have deteriorating pavement, inadequate signs or access
roads, or are improperly graded. The country's railroads
are in a similar state of disrepair, and bottlenecks at the
country's principal maritime dispatch point - the Port of
Santos - continue unabated. Indeed, exporters of high-
value items have resorted to expensive air-freight to
transport their goods to foreign markets. GOB figures show
that in August 2004, the number of exports sent by air
increased 9.2 percent over the year before. Manufacturers
are relying upon air transport to send items such as auto
parts, cellular phone parts, and even cuts of beef.

4. (SBU) Ministry of Planning officials lament the
country's lagging commitment over the past two decades to
infrastructure investment. The challenge, according to the
Ministry's International Affairs Chief, Jose Carlos
Miranda, is to reconcile the GOB's desire to expand public
investment (to generate greater growth) with its desire to
maintain a primary fiscal surplus (to maintain the
confidence of the markets). To resolve this dilemma,
Miranda observed that the GOB has taken a pragmatic
approach: it will allocate budget monies to pressing
public sector projects, it will encourage the private
sector to move forward in cases where a project can be
undertaken on a commercial basis, and through its public-
private partnership program it will promote development of
those projects that the private sector would not undertake
without some form of public assistance.

5. (SBU) Translating theory into practice, however, has
proven difficult. Though the Railroad Revitalization Plan
launched by the GOB in 2003 has sought to prioritize rail
improvements, of the USD 20 million budgeted for this
purpose this year only $15 million has been spent - a
fraction of the amount needed to do the job. The real
engine responsible for the rail improvements the country
has made has been the private sector, specifically the
steel/mining conglomerates CVRD and CSN. According to the
leading daily "O Estado de Sao Paulo," nearly all of the
USD 360 million that was invested in rail in 2003 and the
USD 285 million spent during the first half of 2004
originated from the private sector. By improving rail
lines from their inland plants to the northern port of
Itaqui (near Sao Luis in Maranhao state), CVRD and CSN hope
to cut their transport costs significantly. CVRD also has
been responsible for the rehabilitation of the rail line
connecting the Center-West and Minas Gerais with the
burgeoning Port of Vitoria in Espirito Santo; the rail line
is considered the cheapest, most modern, and most
productive rail line and carries products such as steel,
coal, and iron ore. Meanwhile, concessions for private-
sector road construction and maintenance in Brazil have
largely been successful over the past 5 to 6 years,
bringing significant improvements in road quality to the
South and Southeast.

6. (SBU) Much the same story is true for the urgent USD
207 million project to widen and pave BR-163, the 1,760
kilometer highway linking Cuiaba in Mato Grosso state to
the Amazon river port of Santarem. Paving the current dirt
(or when it rains, mud) sections of that highway, will
allow soybean producers to export their 15.0 million ton
crop north to the coast via the Amazon - as opposed to
south via the Sao Paulo state port of Santos or the Parana
port of Paranagua. Estimates are that this northern route
will cut USD 12 per ton in freight costs, a significant
amount for a high-volume, low margin crop like soybeans.
(By way of comparison, on average Brazil's soy farmers
spend about USD 34 a ton on freight costs from many inland
areas - about twice the amount spent by Argentine and U.S.
producers.) Miranda noted that the private sector (i.e.,
soy farmers) was the primary moving force behind
implementation of this project, partly because of the gains
they would make and partly because concerns about damaging
the Amazon environment made it an issue difficult for the
GOB to tackle. The GOB is looking at the issue of
sustainable development and its impact on the rate of
deforestation along the proposed road very closely.

7. (SBU) Miranda saw PPPs as key where the private sector
return on a project did not match the public sector
benefits, i.e. - the positive externalities for the country
as a whole were not considered. Once the Senate passed the
PPP legislation currently pending in Congress (and the
Chamber of Deputies signed on to the Senate's changes), the
PPP process would be ready to go. Three projects that the
Ministry thought would bring the most bang for the buck
were queued up for quick approval, he said: a) USD 170
million in rail/road improvements to speed entry to the
Port of Santos, b) USD 33 million in similar improvements
to the Port of Sepetieba in Rio State, and c) USD 160
million in rail construction to complement ongoing efforts
on the feeder routes into Itaqui (along with the expansion
of the Itaqui port itself, costing approximately USD 55
million). The GOB envisioned 50 to 60 percent private
sector participation in these projects, with the remainder
of the work to be done by the GOB itself. More projects
were on the drawing board, Miranda said, but these would
have to wait for a second wave.

8. (SBU) Miranda optimistically predicted that the PPP bill
would be finalized soon after the second round of the
municipal elections (October 31), and indeed Senate
hearings on the draft legislation were set to resume the
week of October 11. However, Ministry of Planning Economic
Advisor Damian Fiocca noted that given the need to issue
regulations and set up an agency to run the PPP program,
once the legislation was approved it would be six months -
at a minimum - before the first project could move forward.

9. (U) Currently, negotiations are proceeding on the bill
in the Senate, principally regarding how to account for any
payments made by the GOB to concession operators in the
out-years. This issue is key given the potential for state
guarantees to PPP projects to become large unaccounted
liabilities. According to the IMF Resident Representative
(ResRep), the Ministry of Finance is convinced that the
Fiscal Responsibility Law gives it the authority to enforce
appropriate accounting of the government's liabilities at
both the state and the federal level. Unfortunately, no
satisfactory standard to account for these PPP risks
exists. In the absence of an agreed standard, the IMF has
proposed, according to the ResRep, that the federal and
state budgets explicitly list all expected fiscal flows
related to PPPs and the expected value of guarantees given
to PPPs. This would be an interim measure until such time
as an accounting standard could be agreed to. To date,
however, Ministry of Finance has not yet ruled definitively
on the accounting issue.

10. (SBU) Ministry of Planning officials note that in the
end the bill will reflect a compromise between those in the
GOB who would prefer that the government be responsible for
investment in transportation infrastructure and those who
see the need for a large private sector role. Assuming
that the bill passes, this struggle could prove to be an
ongoing one as the two poles seek to have their point of
view reflected in the make-up of the PPP agency, the
eventual implementing regulations, and the design of the
follow-on projects.

11. (SBU) Comment. Whether the final version of the PPP
program will offer interested private sector investors
sufficient guarantees is an open question. Given
congressional opposition to providing PPP investors
precedence over existing debt obligations, the GOB may have
to resort to a guarantee fund to reassure participants that
sufficient funds will be forthcoming for out-year payments.
Some economic analysts here question whether all the
internal to and fro on this issue within the Lula
Administration and the governing coalition will prove to be
worth the effort, noting that perhaps the time and
political capital devoted to this could have been spent
more wisely encouraging investment through the existing
concession/licitation process. Greater GOB attention to
the basics - like reducing bureaucratic red tape,
increasing the reliability of the judicial system, and
better defining the regulatory rules of the road - likely
would do the most, in the least amount of time, to promote
greater investment.

Danilovich

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