US embassy cable - 04BRASILIA2605

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, Transportation Issues 
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