US embassy cable - 04BRASILIA1087

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, Economic Policy & General Analysis 
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