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### Viewing cable 04BRASILIA1087, SLOW PROGRESS ON BRAZIL'S PUBLIC-PRIVATE PARTNERSHIPS

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Reference ID | Created | Released | Classification | Origin
--- | --- | --- | --- | ---
04BRASILIA1087 | 2004-05-06 12:58 | 2011-07-11 00:00 | UNCLASSIFIED//FOR OFFICIAL USE ONLY | Embassy Brasilia

`

    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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