US embassy cable - 04BRASILIA644

UNCLAS SECTION 01 OF 04 BRASILIA 000644 
 
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 
 
SENSITIVE 
 
E.O. 12958: N/A 
TAGS: EIND, EFIN, PGOV, ECON, EINV, BR, Economic Policy & General Analysis 
SUBJECT: BRAZIL'S ONGOING DEBATE ON PUBLIC-PRIVATE PARTNERSHIPS 
 
Ref: 2003 Brasilia 3956 
 
Sensitive but unclassified; please protect accordingly. 
 
1. (U)  Summary:  The American Chamber of Commerce and "Valor 
Economico" newspaper sponsored a seminar in Brasilia March 10 
to stimulate the national debate on Public-Private Partnerships 
(PPPs), the method by which the GoB seeks private sector 
investment to help fund essential public services and 
infrastructure needs.  The seminar highlighted significant 
differences between government and private-sector expectations 
but also demonstrated a willingness on both sides to find the 
correct PPP recipe for Brazil.  It will clearly not be easy for 
the GoB to provide the kinds of assurances the private sector 
seeks, especially amid concerns about political risk and 
regulatory uncertainty.  The draft bill (PL 2546/2003) remains 
under debate in Congress, but the GoB has designated its 
passage a prime legislative priority.  The bill's sponsor, 
Deputy Paulo Bernardo (PT/PR), expects passage by the end of 
April, despite several controversial points still unresolved. 
The seminar participants included Joaquim Levy, the Secretary 
for the National Treasury at the Ministry of Finance, 
representatives from Sao Paulo and Minas Gerais State 
Secretariats, representatives of civil construction, 
 
SIPDIS 
sanitation, and highway construction firms, international 
consultants, banks and the IADB.  End Summary. 
 
The Legislation 
--------------- 
 
2.  (U)  Federal Deputy Paulo Bernardo started the seminar with 
an update on the status of the PPP bill (PL 2546/2003), 
originally fast-tracked to be approved during Congress's 
extraordinary session from mid-January to mid-February. 
Although a relatively short piece of legislation and not 
opposed by any political party, Bernardo noted the inherent 
complexity of the PPP bill due to its direct links and 
subordination to current laws like the Law of Fiscal 
Responsibility not sure this is accurate characterization - 
dispensable anyway, I think as well as those governing 
concessions and public procurements.  The issue of the 
guarantees to be offered remains among the most controversial. 
 
3. (U)  Bernardo said that questions over the constitutionality 
of the article stipulating PPP contracts' precedence over the 
State's other contractual obligations forced the removal of 
that article.  However, he assured participants the necessary 
financial guarantees will be present in the final legislation 
through the fiduciary fund (the fund of state-owned assets 
meant to cover shortfalls in the government's PPP obligations) 
and the nature of PPP contracts themselves, even without 
establishment of the explicit precedence of PPP contracts in 
government obligations.  The Ministry of Planning is preparing 
new text to address the issue of precedence that may be voted 
on as an amendment.  The question of defining government PPP 
expenditures as recurring costs or debt is also under 
discussion.  The GoB seeks to have complementary state and 
federal PPP legislation, but already-passed Minas Gerais state 
legislation considers the state's PPP costs as recurring costs 
while Sao Paulo State Secretary for Planning, Andrea Calabi, 
told participants that state spending on PPPs would be 
considered debt and that, therefore, PPP projects would involve 
very little state money.  Many urged flexibility in the law so 
that government could evaluate each project individually. 
 
A New Concept 
------------- 
 
4. (U)  Bernardo spoke of the GoB's intention to change the way 
the government is viewed by the private sector, to put an end 
to the history of defaults, late payment, contract breaking, 
and changing of rules after the contract signing.  The MG and 
SP state secretaries also portrayed the PPP as a tool to change 
the culture of suspicion to a culture of trust, characterizing 
the partnerships as a new concept for Brazil, not yet fully 
formed, but an opportunity for the government to gain new 
respect as a reliable partner.  But how to make this admirable 
political will a reality?  Government representatives cited 
their challenges such as providing clear information and 
defined priorities, creating a can-do management style that 
values flexibility and tailors guarantees to the needs of 
specific projects.  Several underscored the point that project 
finance and traditional concessions still merit consideration, 
as PPPs will not fit every situation. 
 
5. (U)  Joaquim Levy, Treasury Secretary at the Ministry of 
Finance, said PPPs are useful tools for projects with greater 
social/economic gains than financial gains.  The benefits of 
long-term, high-quality service for the government/consumer 
balanced with guaranteed payment and reduced cost of investment 
for the private sector must be achieved while avoiding 
"skeletons" or concealed/unacknowledged liabilities.  Citing 
articles of the bill, he attempted to show that this outcome is 
entirely possible.  He described in general terms the 
regulations to govern the creation of the fiduciary funds (to 
be created by public financial institutions and to contain 
budgeted funds, stocks of state-owned companies, real estate 
and capital goods), noting that the fund will be separate from 
the Treasury and will not conflict with the government's 
primary surplus target.  He also explained that the PPP 
management agency, made up of representatives from the 
Ministries of Planning and Finance and from the Civil 
Household, will devise PPP contract procedures and determine 
priority projects, as well as authorize and evaluate bids for 
PPP contracts. 
 
6. (U)  Government representatives agreed that the legislation 
and operation of PPPs must offer a flexibility that does not 
currently exist.  The concession law prohibits the public 
sector from making partial payments to private service 
suppliers.  The public procurement law does not allow the 
private contractor to charge user fees and limits contracts to 
five years.  The challenge remains to provide that flexibility 
within the boundaries of fiscal constraints and in an 
atmosphere that the private sector perceives as rife with 
risks. 
 
Private Sector on Political Risk, Regulation 
-------------------------------------------- 
 
7.  (SBU) The Brazilian private sector participants welcomed 
the opportunity to share their experiences with government 
partnerships and their expectations for PPPS.  All agreed on 
the urgency of restarting investment in infrastructure and 
basic public services to promote economic growth and job 
creation.  Many praised the notions of shared risks and 
responsibilities and "value for money" that the PPP concept 
embodies.  Benefits that the private sector brings to the 
partnership include improved service, timely completion of 
projects, better risk evaluation and application of new 
technologies.  In addition to the payment guarantees that take 
into account the limitations of public debt, business reps said 
that a new regulatory framework is essential for the viability 
of PPPs. 
 
8. (SBU)  According to private sector participants, the 
framework should include measures that ensure confidence in the 
bidding process, clear project evaluation criteria and contract 
performance requirements, as well as guarantees of faithful 
execution of the proposals.  The PPP management entity should 
be charged with cutting through red tape, facilitating 
environmental permits, for example, and should make regular 
reports to Congress.  One participant cited the recent contract- 
breaking actions of the state of Parana, saying that as PPPs 
will be long-term contracts (10-25 years), they must be able to 
withstand the political winds of change.  Several participants 
emphasized the importance of wisely selecting the first PPP 
projects to build faith in the initiative and attract 
investors. 
9. (U)  Several private sector reps suggested prioritization of 
projects that rely on user fees or tolls rather than government 
payments.  This raised the question of whether rate adjustments 
would be handled differently for PPPs than for concessions. 
One representative of a construction firm suggested that the 
GoB investigate ways to reduce the tax burden on companies that 
undertake PPPs.  Questions arose regarding the selection 
process for projects, if and how PPPs could alter the current 
system of technical pre-qualifications in the public 
procurement law, perhaps exacerbating problems with the current 
law that contribute to collusion.  One international consultant 
suggested that the current public procurement process be 
altered for PPPs to allow for efficiency gains and lower final 
costs through acceptance of alternative technical proposals 
before the evaluation of economic offers. 
 
10. (U) There was also discussion of the need for separate 
regulatory frameworks for individual sectors.  A rep from a 
major highway construction firm suggested that PPPs for 
highways be complementary to Brazil's existing (and successful, 
according to this source) program for highway concessions, 
which already has its own laws and regulations.  Some expressed 
doubts that PPPs would be viable for ports and railroads as 
well as for hospitals and schools.  Sanitation and water- 
treatment projects are prime PPP candidates, but Brazil lacks a 
regulatory framework for this sector, where municipalities are 
responsible for providing service.  A representative from an 
international firm specializing in sanitation services said 
that creation of sanitation-specific regulatory bodies on the 
federal, state, and municipal levels is required to guarantee 
the sanctity of contracts.  He described difficulties with 
contested rate adjustments and suspended service, and noted 
that Brazil's notoriously slow judicial process compounds the 
problems businesses face when partnering with government 
entities. 
 
11. (U) Consultants with international PPP experience noted the 
importance of multilateral institutions in lowering perceived 
political risk as well as in providing payment guarantees. 
Brazil's unique situation made it difficult to apply "lessons 
learned" from other countries' experiences with PPPs, but 
consultants advised that greater respect for contracts, more 
emphasis on negotiation, and building trust in the judiciary 
would help.  One emphasized that Brazil would be competing for 
investments and financing with other emerging markets and would 
need to publicize the program abroad.  The IADB Executive 
Director for Brazil said the organization stood ready to 
continue its support of infrastructure projects by offering the 
Brazilian private sector direct loans and guarantees to cover 
commercial and political risks involved in PPPs.  The IADB 
plans to extend US$ 300 million for PPPs in a line of credit 
through BNDES, Brazil's Development Bank. 
 
 
COMMENT 
------- 
 
12. (SBU) The seminar covered a lot of ground and left many 
wondering whether Brazil, with its history of unstable 
currency, inflation, mismanaged debt and business-damaging 
political shenanigans, is really ready and able to live up to 
its side of the bargain in PPPs.  PPPs have worked in developed 
countries with low political risk and respect for the rule of 
law.  One consultant told us that this would have been a pipe 
dream for Brazil in 1998, but conceded that with a few initial 
successes the model could well find its place in the Brazilian 
development model.  The GoB appears unshakable in the certainty 
that their legislation, said to be based on European models, 
provides the best possible framework for successful PPPs in 
Brazil.  While the 23 federal pilot projects for PPPs were 
selected late last year (highways, railways, port upgrades and 
irrigation projects), the delays in approving the bill will 
likely push off the initiation of any projects until early 
2005. 
 
13.  (U) Attendance at the seminar, held in Brasilia, surpassed 
expectations and demonstrated a desire to dig into the details 
of the subject among local banks, government and various 
service providers and civil construction firms.  The GoB's 
credibility will be on the line with the first PPP projects and 
will presumably give the latter kid-glove treatment to ensure 
initial success.  As many said at the seminar, the real test 
will come years down the road with new administrations, when 
Brazil's business maturity will be fairly judged with regard to 
PPPs -- praised or pilloried. 
HRINAK