Masters in International Development / PSIA The Future of PPPs

Name : Edwin Johan Santana Gaarder Student number : 100047222

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Public-Private Partnerships in Emerging Economies / Individual Assignment

The infrastructure needs of the world, and of emerging economies in particular, demands the involvement of the private sector

In a report on infrastructure, the McKinsey Global Institute (2013) highlights the urgency of the world’s infrastructure investment needs, claiming that “$57 trillion in infrastructure investment will be required between now and 2030—simply to keep up ! with projected global GDP growth […] nearly 60 percent more than the $36 trillion spent globally on infrastructure over the past 18 years [and] more than the estimated value of today’s worldwide infrastructure.” However, “this amount would not be sufficient to address major backlogs and deficiencies in infrastructure maintenance and renewal or meet the broader development goals of emerging economies”. The accompanying diagrams demonstrate how emerging countries already lag behind developed economies in the provision of road, rail and airport capacity and how their investment and maintenance needs are correspondingly greater (McKinsey, 2013; WEF, 2012). Governments in emerging economies simply do not have the capacity

(in terms of financial resources and technical know-how) to keep up with increased infrastructure demand in addition to closing the gap on advanced economies, meaning that the challenge can only be met with the involvement of the private sector. The concept of public-private partnership is a flexible one which can provide a range of models for private-sector involvement. Available evidence, moreover, suggests that “PPPs can contribute to the mitigation of some negative characteristics associated with public sector construction works and service provision, like delays, cost overruns, premature deterioration, excessive size, underutilization, inadequate maintenance, high operational costs, lack of operational flexibility, absence of incentive-structures, low quality and service discontinuity” (Grilo and Alves, 2011).

Brazil is a typical example of an emerging economy that has recently experienced strong growth and yet still faces overwhelming challenges in infrastructure provision

Brazil ranks 114th out of 148 countries for the overall quality of its infrastructure, according to the WEF Global Competitiveness Report (2013-2014). An infamous Special Report on Brazil by The Economist (2013) sets the scene: “Just 1.5% of Brazil’s GDP goes on infrastructure investment from all sources, both public and private. The long-run global average is 3.8%. The McKinsey Global Institute estimates the total value of Brazil’s infrastructure at 16% of GDP. Other big economies average 71%.” In reaction to these circumstances, President Dilma Rousseff promised to invest $69bn by the end of 2014 to improve Brazil’s transportation systems, attempting to take advantage of the opportunities presented by the World Cup in 2014 and the Olympics in 2016. Brazil, however, has consistently been hobbled by the inefficiency of its public sector. “Between 2007 and 2010”, for example, the state-owned company that runs Brazilian airports (Infraero), “managed to spend just 800m of the 3 billion reais it was supposed to invest” (The Economist, 2013). Other examples of infrastructure projects that are hugely behind schedule include the Transnordestina railway and the new underground urban transport systems envisioned for the cities of Fortaleza and Salvador.

Masters in International Development / PSIA The Future of PPPs

Name : Edwin Johan Santana Gaarder Student number : 100047222

!

Page 2 of 5

The seriousness of Brazilian infrastructure deficiencies, moreover, became apparent during the 2013 Confederations Cup, when massive protests were sparked by a rise of R$0.20 in bus-fares in São Paulo. The diagram to the right is emblematic of the issues at stake, where the R$0.20 rise in bus fares is presented as the tip of an iceberg that includes taxation, low-quality health and education services and poor transport infrastructure. The link between taxation and the other issues is precisely the perception that the government delivers poor value-for-money (in the words of The Economist, Brazil taxes like a rich country but spends like a poor one). One of the central arguments in favour of PPPs is that they can improve value-for-money in public service delivery. The next section will evaluate this claim in light of the Brazilian PPP experience to date.

The involvement of private companies in infrastructure investment through concessions and other PPP structures has proven to be a possible solution

AIRPORTS – The tendering processes for the concession of Brazil’s busiest airports in preparation for the World Cup was a success, securing investments of almost R$25 billion and R$20 billion in February 2012 and November 2013 respectively. The premiums committed by private investors amounted to between 2½ and 5 times the value of the minimum bids stipulated by government.

February 2012 November 2013 Airport City Bid Premium* Airport City Bid Premium* Guarulhos São Paulo R$16.2bn ~500% Galeão Rio de Janeiro R$19.018bn ~400% Viracopos Campinas R$3.8bn - Confins Belo Horizonte R$1.82bn 160% Brasília Brasília R$4.5bn - *premium is the % of the minimum bid represented by the winning bid

(Reuters, 2013; Financial Times, 2012)

HOSPITALS – The infrastructure gap afflicting the Brazilian healthcare sector can be demonstrated by one simple statistic : whereas 25% of the population contributes R$95bn to the private healthcare system, which attends 48 million people, the universal healthcare system receives R$138bn (+31%) from the State to attend to 150 million people (+200%) (Oliveira, 2013). In other words, the willingness-to-pay for quality healthcare services exists, as does the private-sector capacity to supply such services, but there is no middle ground between (a) fully-subsidized but under-funded and low-quality public healthcare services and (b) expensive, non-subsidized but high-quality private healthcare services. Hybrid (user-fee/availability-based) PPPs could create this middle ground.

The Hospital do Subúrbio in Salvador, Bahia, is a public-private partnership formed in 2010. In three years :

- it has become the only hospital in the underdeveloped northeastern region of Brazil to obtain Acreditação Hospitalar (official accreditation);

- it has achieved performance indicators that are much higher than hospitals run by the State; - its output and financial figures have been presented transparently made available to the public.

The hospital has a customer satisfaction rate of 97,1% and has been recognized by the World Bank. (Oliveira, 2013)

PRISONS – The dire state of the Brazilian penitentiary system has been explored in an article by The Economist (2014) entitled ‘Welcome to the Middle Ages’, where it is claimed that “Brazilian penitentaries have room for around 300.000 people” compared to a prison population of “550,000—the fourth-highest in the world, behind the United States, China and Russia”. Public-private partnerships in the penitentiary system began in earnest at the turn of the century, when several states began to implement joint management systems (co-gestão). This was amplified in 2006 when the state of Minas Gerais became a pioneer in the commission of a prison complex with a capacity of 3.000

Masters in International Development / PSIA The Future of PPPs

Name : Edwin Johan Santana Gaarder Student number : 100047222

!

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inmates, on the basis of a DBO contract. The private partner was responsible for the design and construction of the complex, as well as administrative services (cooking, clothing, cleaning, staffing, and general adminstration) during the operational phase.

Evidence suggests that Brazilian experiments with private involvement in the penitentiary system have yielded good results, including:

- lower construction and operational costs, - better security (fewer fugitives, less collective disorder, lower rates of murder and violence) - better services for inmates (medical and dental services, legal advice, food and hygiene quality

control, social reinsertion and educational programmes, professional training). (Grilo and Alves, 2011)

FOOTBALL STADIA – The preparation for the Fifa World Cup 2014 of the football stadium known as Castelão in Fortaleza, Ceará, was completed on the 15th of December 2012. The Castelão was the first stadium to be completed, attracting total investments of R$518,6m by the consortium Arena Castelão, a SPV formed by local private-sector construction firms Galvão Engenharia and Andrade Mendonça, who hold an eight-year contract to renovate, amplify, operate and maintain the stadium. Of the total budget, R$351,5m was financed by BNDES, the Brazilian development bank (Conlicitação, 2012).

Brazil was able to promote public-private partnerships by improving its enabling environment and tayloring it to the needs of an emerging economy

The 2004 PPP Law no. 11.079 was passed in order to widen the scope of private sector participation in public service delivery, and was thus conceived as a complement to the already well-established Concession Law. The PPP Law “permits governments to complement the income of the operator when the investment cannot be recovered through tolls/tariffs” and thus provides the scope for “projects with an adequate socioeconomic return which, in the absence of complementary shadow tariffs or subsidies, would not generate the financial return necessary to attract private investors” (Grilo and Alves, 2011, p.11). The range of PPP models available to the government was thus significantly widened, and now includes the so-called concessão patrocinada (hybrid user-fee/availability-based PPP) and the concessão administrativa (pure availability-based PPP). A number of innovations were also introduced in order to avoid the pitfalls that had afflicted PPPs internationally in the past, as follows :

THE LAW STIPULATES A MINIMUM INVESTMENT – The minimum investment required in PPP contracts in Brazil is R$20m. This floor was intended to prevent the use of the PPP legislative framework for smaller projects, where the relatively costly measures required to prepare the PPP tendering process and contractual arrangements would represent an inordinate proportion of the project’s total costs.

THERE IS A LIMIT ON THE PERCENTAGE OF GOVERNMENT INCOME SPENT ON PPP PROJECTS – The initial PPP law limited the spending of federal government entities to 1% of net current income. This ceiling has since been raised to 3%, but the principle of fiscal responsibility remains the same: PPPs cannot be employed as a means to increase public spending “off balance sheet”.

PUBLIC SECTOR LIABILITIES ARE BACKED BY THE PARTNERSHIP GUARANTEE FUND (FGP) ON A

COMPULSORY BASIS – Federal liabilities assumed by the public sector through PPP contracts are backed by the Fundo Garantidor das Parcerias (Partnership Guarantee Fund). “The fund is not the primary source of payment under PPP, but is available if the public authority does not comply with its

Masters in International Development / PSIA The Future of PPPs

Name : Edwin Johan Santana Gaarder Student number : 100047222

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payment obligations”, thus reassuring private investors that public sector liabilities will not be contingent on the periodic approval of government budgets (PPIAF, 2011, p. 65). “The long-term intention […] is that as market confidence in government develops, the need for such guarantees will diminish” (ibid). A similar fund (ABFG) has been suggested in order to replicate this principle on the state level, with limited success.

GAINS RESULTING FROM REDUCED INTEREST RATES SUBSEQUENT TO FUTURE REFINANCING ARE TO BE

SHARED WITH THE PUBLIC SECTOR – Reduced interest rates are often the result of an improved lending environment following efforts by the public sector to establish confidence in the national PPP programme as a whole. This provision “ensure[s] that any benefits that may arise from refinancing the existing debt on better terms are shared between the equity investors (who, after all, have taken substantial project risks) and the public authority (who, it would argue, has been responsible for the improved environment)” (PPIAF, 2011, p. 60).

WHEN “SHADOW TOLLS” OR GOVERNMENT SUBSIDIES EXCEED 70% OF PRIVATE SECTOR INCOME

OVER THE LIFECYCLE OF THE PROJECT, LEGISLATIVE APPROVAL IS REQUIRED – The flexible upper limit on public sector payments for availability-based PPPs are intended to uphold the principle that the private sector partner must always assume a degree of risk in the PPP project, so that incentives to cut costs and improve quality are maintained.

CREDIT CONCEDED BY PUBLIC OR SEMI-PUBLIC ENTITIES IS LIMITED TO 70% OF THE PROJECT’S TOTAL

FINANCING REQUIREMENTS – Public sector development banks like the BNDES (Banco Nacional de Desenvolvimento Social e Economico) may be “important sources of stability and market development and, as institutions in their own right, may bring as much of the lender due diligence and monitoring disciplines as private sector lenders. Indeed, given their public mission, they may also be sources of further policy support and quality control in PPPs over and above those required by commercial lenders” (PPIAF, 2011, p. 66). However, their participation must be limited in order to uphold the principle that the private sector partner must always assume a degree of risk in the PPP project, so that incentives to cut costs and improve quality are maintained.

Brazil still faces considerable challenges and its PPP programme must be continuously improved and adapted to circumstances

Despite its involvement in many recent PPP projects, the current left-wing Brazilian government (Partido dos Trabalhadores) still employs hostile rhetoric when discussing private-sector involvement in public service provision. State-owned enterprises like Infraero (which is still a 49% shareholder of airports under concession) and VALEC (responsible for the planning, construction, operation and maintenance of the national railway network) continue to be protected by the administration despite evidence of maladministration. VALEC, for example, “has difficulties in complying with its budget, suffers from successive losses, [and has] inherited labour-related liabilities from the RFFSA and the liquidated GEIPOT. In addition to this, constant media coverage has questioned the administrative probity of the organisation as well as financial irregularities in its administration of public works, as identified by the TCU (Court of Accounts)” (Lohbauer, 2013). Nevertheless, under the national logistics investment plan (Plano de Investimento em Logística), the concessionaires responsible for construction and maintenance of railways are expected to transfer new railway infrastructure to VALEC in return for monthly payments (contraprestações). VALEC is thereafter responsible for “selling” the use of the infrastructure to private operators in return for a fee. This set-up was intended to shield the construction companies from demand risk, a deal-breaker for investors at the time of bidding. However, despite a R$15bn public injection of equity into the VALEC, “the private sector is now faced with another risk: the possible bankruptcy of VALEC” (Valois, 2014). The PPP structure is thus compromised by its dependence on a (possibly insolvent) “institution of public law, susceptible to influences and opportunistic acts on the part of political agents” (Ibid). In addition to a complex and punitive tax structure, a heavy bureaucratic burden, and overlapping federal/state legislations, these sorts of set ups constitute an obstacle to the further development of PPPs in Brazil.

Masters in International Development / PSIA The Future of PPPs

Name : Edwin Johan Santana Gaarder Student number : 100047222

!

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Sources

N.B.: All translations are mine.

Conlicitação, 2012, ‘Construído com uso de PPP, Castelão é primeiro estádio da Copa a ser entregue’, December 18th 2012, viewed online 20/03/2014, http://portal.conlicitacao.com.br

Financial Times, 2012, ‘Consortiums win Brazil airport deals’, February 6th 2012, viewed online 20/03/2014, www.ft.com

Grillo, Leonardo M., and Alves, Rubens T., 2011, Guia Prático de Análise do Value for Money em Projetos de PPP, São Paulo

Lohbauer, R.M., 2013, ‘O novo decreto sobre as concessões ferroviárias’, 25th October 2013, viewed online 20/03/2014, www.pppbrasil.com.br

McKinsey, 2013, Infrastructure productivity – how to save $1 trillion a year, McKinsey Global Institute, January 2013

Oliveira, J., 2013, ‘PPP na saúde - inovação para o bem do serviço público’, 6th December 2013, viewed online 20/03/2014, www.pppbrasil.com.br

PPIAF, 2011, Farquharson et al., How to Engage with the Private Sector in PPPs in Emerging Markets, Washington

Reuters, 2013, ‘Brazil's Odebrecht, CCR, foreign companies win airport concessions’, November 22nd 2013, viewed online 20/03/2014, www.reuters.com

Reuters, 2013, ‘Brazil awards $9 billion of airport deals, prepping Rio for Olympics’, November 22nd 2013, viewed online 20/03/2014, www.reuters.com

The Economist, 2013, Special Report: Brazil, ‘Infrastructure: The Road to Hell’, September 28th 2013, from the print edition, viewed online 20/03/2014, www.theeconomist.com

The Economist, 2014, ‘Prison in Brazil: Welcome to the Middle Ages’, January 18th 2014, from the print edition, viewed online 20/03/2014, www.theeconomist.com

Valois, D.J., 2014, ‘O nó górdio das concessões ferroviárias’, 30th January 2014, viewed online 20/03/2014, www.pppbrasil.com.br

WEF, 2012, Strategic Infrastructure – Steps to Prioritize and Deliver Infrastructure Effectively and Efficiently, World Economic Forum (prepared in collaboration with PwC), Cologny/Geneva 2012

WEF, 2013, Global Competitiveness Report (2013-2014), Geneva