August 01, 1997
by Teresa Acklin
Private sector, governments and lenders use old and new vehicles to attract investment in outmoded transportation, energy and communication systems.
Every year during the soybean harvest season from March to June, the Brazilian ports of Santos and Paranagua are clogged. Drivers line up for days to unload, their trucks snaking back for miles, while ships often wait more than three weeks to dock.
These inefficient state-run ports are more than an inconvenience. Transporting soybeans out of Brazil is estimated to add as much as 30% to exporters' costs. These costs, extended across the economy, are damaging to Brazilian competitiveness and inhibit growth.
Brazil is now bringing private capital into its ports both along the coast and in the interior (see May 1997 World Grain, page 40), following a trend that is further advanced in other parts of Latin America. Governments have turned to the private sector to improve efficiency, but more often because they themselves do not have the resources to develop infrastructure badly run down during the recessionary 1980s.
Latin America needs at least U.S.$1 billion dollars a week to maintain and expand modestly its electricity, water and sewerage systems, telephones, ports, airports, railways and roads, according to estimates from the World Bank and Inter-American Development Bank. Some U.S.$24 billion a year will be needed for power projects, U.S.$14 billion for transport, U.S.$10 billion for telecommunications and U.S.$19 billion for water and sewerage systems.
These sums, large as they are, will not be enough to bring the region's infrastructure in line with that in industrialized countries. In the U.S., for example, infrastructure stock per person is about eight times higher than in Latin America.
Already, the private sector is playing a sharply expanded role. Privatization, which in some countries such as Chile and Argentina has been radical, has seen to that. That role seems set to expand further as privatization gathers momentum in Brazil and is extended in Mexico.
Private money is also mobilizing for infrastructure finance to an extent not seen for 15 years. International commercial banks and to a lesser degree the capital markets are showing a growing appetite for debt generated by infrastructure projects, which has survived the setback dealt by Mexico's financial crisis of 1994-95. Economists at the I.A.D.B. estimate that a quarter of the region's infrastructure financing needs up to U.S.$12.5 billion a year could be generated by the private sector.
So far, however, private finance has significantly fallen short of that figure. A shortage of debt rather than equity seems to be the main constraint. Equity has been relatively plentiful, in part, says Rauf Diwan, divisional manager for the power group of the International Finance Corporation, the World Bank's private sector arm, because of high returns. Yields have been as high as 20% to 25% a year, but are now coming down, compared with a few percentage points above money market rates for debt.
And, says Craig Reynolds, senior vice-president of GE Capital's project and structured finance group, despite the recent growth and innovations, the markets for debt are not fully developed. This is especially true of Latin America's domestic capital markets. Only in Chile is true long-term financing available for the local currency portion of projects.
For some time to come, pure private sector financing without recourse to government will probably be the exception rather than the rule. Norman Anderson, whose Washington-based consulting company CGLA Infrastructure, has compiled a Latin America project finance database, says, “Not nearly as many infrastructure finance deals are going on as people say.”
According to Antonio Vives, infrastructure division chief at the I.A.D.B., writing in The Financier, a U.S. review, “A combination of difficulties the structuring of financing for deals, the complexity of negotiating for all contingencies and the inevitable political considerations make private financing of infrastructure difficult, time-consuming and expensive. As a result, it is apparent that no single party the public sector, private sector, or multilateral or bilateral creditors can overcome these obstacles alone.”
Export credit agencies, particularly the U.S. Export-Import Bank, have responded by increasing the available amounts for projects financed by the private sector. The I.A.D.B. has opened a private sector window, a pilot project that allows it to direct 5% of its loans to private sector borrowers, unguaranteed by governments. Insurance mechanisms are also being developed to cover both political and project risks.
Further development of private finance for infrastructure depends on two factors, says Mr. Reynolds. First, a stable political and policy environment is necessary because capital has to be invested over a long period of time. Second, a “strong clear regulatory environment is critical.”Risks and Reward
Latin American governments have in general shown more policy consistency through the 1990s than in the preceding two decades, although in most, a weak tradition of judicial independence calls into question the sanctity of contracts and the freedom of regulatory regimes from political meddling.
Chile is the one country that appears to satisfy most investors on both scores, helped by its investment grade status, which only it and Colombia have attained in the region. However, even in potentially less attractive countries, private capital sometimes is available.
In contrast with Asia, most private investment in infrastructure in Latin America has come through privatization of existing assets. Asian countries have generally preferred, like Mexico, to use private finance for new capacity but left existing capacity in the hands of the state. The greater private ownership of assets has helped Latin America in some areas to surpass Asia as the most dynamic and innovative area for private infrastructure finance, says Mr. Diwan of the I.F.C.
A number of important infrastructure projects is also directed at improving regional integration. With more than one country involved, financing risks become more complicated. Some projects, such as the gas pipeline from Bolivia to Brazil, have already been opened for bidding. Others, including the road bridge from Buenos Aires, Argentina, to Colonia in Uruguay, seem much further from fruition.
But competition is growing among international banks for loans to infrastructure projects in Latin America. With margins shrinking on conventional syndicated lending business and on project deals in Europe, the U.S. and Asia, the region is becoming more attractive. Bankers are more prepared to lend to a wider range of projects and countries; the volume of loans has increased; lenders have developed new financing methods, such as raising capital from bond and equity markets; and deals are being approved for longer periods and on easier terms than they were only two years ago.
A World Bank report notes that the appearance of “three converging forces” is promoting private sector solutions for the massive infrastructure gap. Innovations in technology have made it possible for the private sector to provide services more efficiently than monopolies. The traumas of the 1980s have left Latin America's leaders more open to the idea of private industry input into traditionally public sector areas. Furthermore, the democratized governments are increasingly concerned about poverty and the environment.
However, all the excitement about private sector participation must not obscure the continued need for public sector spending.
“Let's not kid ourselves,” says Mr. Vives of the I.A.D.B. “The private sector will provide about one-fifth of the financing at best, so the public sector has to do about fourth-fifths. The multilateral development banks (such as the World Bank) will provide about 10% of that, which leaves the rest for the governments.”New Strategies
The World Bank alone expects to finance up to U.S.$3 billion annually, or 5% of the total annual needs of the region's estimated U.S.$60 billion in spending. It says it will seek maximum leverage for its funding by bringing in financing from private and public sources. Four approaches have been devised to spur infrastructure investment from other sources:
intensifying efforts to encourage co-financing of projects between the public and private sectors;
attracting lenders by using World Bank guarantees, instruments that require counter-guarantees by the governments;
creating special infrastructure funds that can “jump start” capital flows for specific projects; and
designing projects from the outset with private capital investment in mind. This is helpful for countries that cannot yet invite the private sector into projects, because the bank will act as a last-resort financier and help governments prepare projects for future privatization.
The I.A.D.B.'s strategy is to make governmental agencies more conducive to involvement from private enterprise. It says it will focus on improving the capacity of transport-related institutions and decentralizing highway administrations. Civil works activities will include maintenance to preserve existing roads and improve access to centers of economic activity.
Much has been learned from disastrous privatized road projects in Mexico, where an emphasis on short-term loan recovery forced up the toll charges, leading to dramatic declines in traffic. The banks are now pushing long-term lending for the building of toll roads.
Officials acknowledge that priva-tization is not the ultimate panacea for infrastructure problems, but argue that what is really important is a coherent package of reforms and economic management that includes the private sector. The sheer scale of Latin America's demands for power plants, roads, railways and airports and other infrastructure means that traditional sources of project finance multilateral development agencies and international commercial banks are never going to be enough.
Not surprisingly, therefore, developers and construction companies, together with their banks and advisers, have been exploring possible supplies of additional funds from the world's capital markets. And over the past two years, as the continent's creditworthiness has improved, a number of projects has successfully raised money on international markets.
Most significantly, mainstream North American investors such as mutual funds and insurance companies have successfully placed bonds on the U.S. 144a market, named after the U.S. Securities and Exchange Commission rule 144a, which restricts investments to so-called “qualified institutional investors.” More than U.S.$800 million has been raised in this way, with a further U.S.$500 million or so from the private placement market, which caters to a smaller universe of specialist investors.
William Chew, head of project finance at Standard & Poor's rating agency, says “the market is beginning to broaden. Latin American project finance is a major evolving sector of the dollar (bond) market.” Nevertheless, bankers concede that the bond markets alone are unlikely to provide finance for all the projects, particularly in those countries that are rated below investment grade by international agencies.
The use of securitization techniques to raise the credit quality of projects might help fill the gap. This will allow a wider group of investors to buy the paper than would be able to acquire conventional foreign currency bonds, which may rated sub-investment grade.
At the same time, the equity markets could also be an important source of funds. The growth of new equity funds targeting infrastructure investments, along the lines of a number of similar funds established in Asia, is one relevant development here.
Editor's note: This article is excerpted from a 1996 Financial Times “Survey on Infrastructure in Latin America,” as provided by the Brazilian Embassy in London.