On the day after he took power in July 2001, President Alejandro Toledo of Peru authorized bidding on a feasibility study for a cherished project of his, one that had been a plank of his campaign platform: the Peruvian leg of an interoceanic highway linking that country’s Pacific ports with Brazil’s Atlantic ones and uniting Peru’s jungle interior with its coastal cities.
Toledo, though, wasn’t the only Peruvian who felt passionate about the long-standing idea of such a highway -- the Carretera Interoceánica Sur. Demonstrators in Puno, on Lake Titicaca; workers in Cuzco, gateway city to the Inca ruins at Machu Picchu; and merchants in Peru’s second-biggest city, Arequipa, all clamored for access to the highway.
The upshot is a partially completed road with more forks than a diplomatic dinner party, one designed as much by politicians as by engineers. Yet as meandering as the 1,600 miles of the Peruvian section of the two-lane Interoceánica Sur is, the highway should be a boon. For a start, Peru can more readily ship fresh vegetables and fruits to Brazil, while Brazil can more easily send soy products, beef and timber to Peru. And the roadway could, or should, be the start of much more. Peru’s prime minister, Pedro Pablo Kuczynski, a former Finance minister and Wall Street banker, tells Institutional Investor that if his country had “adequate” investment in infrastructure, it could increase GDP growth by 2 percent per year, to 7 percent.
Throughout Latin America, countries are getting around to the long-neglected task of building the infrastructure to support their economies and to tie themselves more closely to their neighbors through trade -- a necessity if they are to prosper and compete with China and India. The Interoceánica Sur is just one of 335 projects in an ambitious $38 billion-plus, 12-country infrastructure-development agenda known as the Initiative for the Integration of Regional Infrastructure in South America, or Iirsa. At the January 21 dedication of one of the roadway’s 22 bridges, Brazilian president Luiz Inácio Lula da Silva proclaimed, “We have fulfilled the promise of replacing empty speeches about integration with concrete works.”
Regional infrastructure projects could pay a political as well as an economic dividend for Brazil. Fostering better transportation and communication throughout South America should encourage the formation of a true regional trading bloc. In turn, that would permit Brasília to realize a long-held aspiration: to assume a bigger role in hemispheric and global economic affairs.
To be sure, the notion of rectifying decades of underdevelopment by hastily throwing up transportation, energy and telecommunications networks crisscrossing miles of mountains and jungles strikes some observers as far-fetched. Grandiose infrastructure schemes have foundered before because of impractical designs, political corruption and, above all, the protracted Latin American debt crisis.
Lately, however, most of the region has been thriving, and its debt load is much more manageable. What’s more, the capital to pay for a massive infrastructure upgrade has been piling up in public treasuries -- and in private kitties. Indeed, deep pools of capital -- South American pension funds could be tapped for tens of billions -- are increasingly available to underwrite projects.
So-called public-private partnerships have become a workhorse of the latest round of infrastructure financing. Some analysts suggest that the bulk of the Iirsa projects may wind up being financed with private monies -- a conspicuous departure from past infrastructure programs. Financial innovations make this even more likely. Tellingly, Mexico’s richest man, Teléfonos de México impresario Carlos Slim, sensing that Latin America is serious about fixing its infrastructure, has launched a fund dedicated to toll-road and water-treatment ventures.
Moreover, it’s hard to fault the region’s market timing. As Ricardo Amorim, head of Latin America research at WestLB in New York, explains, “Because of the lack of other high-yield alternatives, global investors are now forced to accept risks that they could afford to avoid in the past, and on top of that there are good structures available in Latin American infrastructure deals to mitigate part of the risks.”
Washington asset manager Darby Overseas Investments, which specializes in emerging markets, has channeled $160 million of its $1.2 billion portfolio into infrastructure-related investments in Latin America and is raising an additional $150 million for that purpose. Pedro Batalla, managing director of Darby Americas and supervisor of the Darby Latin American Mezzanine Fund, which has been investing in the region for 15 years, is enthusiastic about the infrastructure-spending trend but is by no means overly exuberant. “There is going to be lot of activity but spread over many years -- not a boom, but growth,” he says.
For all the current infrastructure efforts, Latin America’s needs are daunting. And urgent. That was brought home dramatically -- and embarrassingly, for Venezuela’s president, Hugo Chávez -- in January when the Viaducto highway from Caracas to the airport and on to the country’s leading commercial seaport of La Guaira had to be shut down for a minimum of five months because a major bridge was found to be on the verge of collapse. Engineers warned in 1987 that the bridge badly needed repair.
The World Bank concluded in a study last August that Latin America and the Caribbean would have to double or triple infrastructure spending “to catch up or keep up with countries that once trailed [them], such as South Korea and China.” The Bank notes that Latin American and Caribbean nations as a group devote less than 2 percent of their GDP to infrastructure but ought to spend 3 percent.
Marianne Fay, the World Bank’s lead economist for the region, says that Latin America could maintain existing roads and in time achieve universal electricity, water and sewage services if it spent only 1 percent of GDP on infrastructure -- less than it does now. But, she adds, if Latin American countries “want to grow a lot faster,” they need to step up spending to 3 percent. Fay estimates this would mean a gain of 1.4 to 1.8 percentage points in the region’s GDP.
Over the past 20 years, however, Latin America’s public investment in infrastructure shrank as the region’s debilitating debt crisis imposed strict fiscal discipline. The current infrastructure spending of less than 2 percent of GDP annually contrasts with the 3.7 percent-a-year outlay from 1980 to 1985. Private investment has also plunged. In a rough gauge, the World Bank found that the value of infrastructure projects in Latin America and the Caribbean in which there was at least some private participation fell from $71 billion in 1998, during a wave of privatizations of crown jewels, to $16 billion in 2003.
IIRSA IS DESIGNED TO MAKE UP IN PART FOR LATIN America’s years of underfunding infrastructure. The initiative was launched by former Brazilian president Fernando Henrique Cardoso at the first South American presidential summit in fall 2000. The heads of 12 nations, from Argentina to Guyana and from Chile to Venezuela, endorsed Cardoso’s sweeping plan to create a South American logistics platform that would help draw the region together in what some saw as a Latin European Union.
After much deliberation, representatives from the Iirsa 12 forged a consensus around developing 11 hubs. Wide bands of territory extending across South America, the hubs are to be the sites of ambitious, mainly transnational infrastructure projects, from electricity transmission grids to gas pipelines to trans-Andean tunnels. Within the hubs are corridors that link regions through highways or railroads or rivers to facilitate trade and boost economic activity in underdeveloped zones.
Initially, says Mauro Marcondes, Iirsa coordinator for the Inter-American Development Bank, more than 600 projects were put forward. That overly expansive list was culled by almost half. “But now there are projects that make sense being in the hub, and each hub has an anchor project that can influence the others positively,” Marcondes says.
Iirsa’s 20-year horizon, which started in 2000, envisions forging transportation, energy and telecom networks to stimulate intraregional trade, boost agricultural output, lower trade costs, create incentives for exporters and foster ecotourism. The theory is that by conquering South America’s daunting geography -- vast jungles, huge wetlands, wide rivers and the jagged Andes -- Iirsa can promote faster, broader growth in a market of 360 million people whose annual output exceeds $1.2 trillion.
For Iirsa’s initial phase of construction, from 2005 to 2010, roughly 40 projects costing $6 billion have been assigned priority; $3.2 billion worth have been approved or are under consideration. The projects encompass electricity transmission hookups between Venezuela and Brazil’s Amazonian state of Roraima, to assure reliable power; a north-south highway on the eastern slopes of the Andes, to link Ecuador with Colombia and Peru; and the refurbishing, upgrading and expansion of railways.
“Infrastructure is broader than engineering,” Enrique García, president of the Andean Development Corp. (Corporación Andina de Fomento, or CAF) tells II. He says the corridors are “not merely highways but rather a means of promoting sustainability, development of productive sectors, increasing exports, raising employment.”
CAF has invested $3 billion in 40 infrastructure projects over the past seven years and now dedicates 25 percent of its funding to Iirsa. And CAF is just one of the Latin American multilateral banks doling out funding and offering assistance to the infrastructure endeavor. The banks “have rediscovered the issue,” says Robert Vos, director of development policy and analysis at the United Nations Department of Economic and Social Affairs. They see it, he adds, as “an important ingredient to stimulate growth and integration in the region.”
Luis Alberto Moreno, president of the IDB, sees his institution’s role as eliminating bottlenecks and enabling complex projects that span borders or pose special environmental and social concerns. The bank has put $650 million toward Iirsa and is studying funding requests for a further $1 billion. The World Bank, having chided Latin America and the Caribbean for inadequate spending on infrastructure, has shown a new willingness to support projects. Late last year, for instance, the Bank approved a $200 million guarantee fund for Peru to help underwrite roads, ports, airports, telecom systems and gas projects. In all, multilaterals are expected to underwrite roughly half of Iirsa’s initial priority projects.
Yet what sets Iirsa apart from past Latin American development initiatives -- and helps give it credibility in the markets -- is that so much of the funding is ultimately expected to come from private sources. Indeed, the IDB’s Marcondes estimates that a majority of Iirsa projects will eventually be financed through public-private partnerships.
One immense piggy bank for infrastructure monies is Latin America’s pension funds. Their assets top $18 billion in Argentina, $100 billion in Brazil, $73 billion in Chile and $10 billion in Peru, according to a recent IDB study. Brazilian funds finance Petróleo Brasileiro’s offshore oil-drilling platforms; in Chile pensions pay for toll roads; and in Peru they helped underwrite the Camisea gas pipeline (Institutional Investor, September 2004).
But as Gonzalo de las Casas, chief investment officer of Lima’s $3 billion-in-assets AFP Integra private pension fund, points out, the pension funds need credit enhancements, such as multilateral-bank guarantees, to underwrite self-financing projects. “If our conditions are met, we are interested in participating,” declares de las Casas, who has invested so far in irrigation, power transmission and gas pipelines.
The development banks are doing their utmost to accommodate infrastructure investors through not only bridge and other direct loans but also through credit enhancements and guarantees of government obligations. “Any enhancement CAF or the IDB can provide is very important,” says Darby’s Batalla.
The financial engineering for an infrastructure project can be as complex as the civil engineering, but the basic formula is straightforward. Take a typical toll road. Private sector sources -- typically, contractors and investors -- put up the construction money and get to collect tolls. Over time the government repays them the construction costs plus the financing and operating expenses, minus the toll receipts.
“The low density of infrastructure” --highways, for instance, traverse sparsely populated terrain--combined with low levels of income translate into a low capacity for establishing direct payment by users,” notes Antonio Juan Sosa, CAF’s vice president for infrastructure. To compensate, governments are pledging to pay the shortfall between toll receipts, for example, and construction and maintenance costs over the life of a project concession.
Lima has assured investors that it will cover the costs of completing highways if the tolls fall short. “There is no risk,” insists Peruvian Finance Minister Fernando Zavala. “All future commitments are accounted for in the national accounts. This type of [toll road] concession has been prioritized.”
The public-private partnership format for infrastructure financing is becoming all-pervasive. Argentina, Brazil, Chile, Colombia, Peru and Uruguay have all adopted the approach in recent years, with some notable successes. Chile’s annual investment in highways has doubled in the past four years, and Colombia has signed 150 public-private contracts worth a total $5 billion for everything from highways to health care facilities.
The partnerships vary in structure, but they are all designed to parcel out the risk among the public and the private entities. For example, in Peru’s newly begun Amazonas Norte highway project, a two-lane toll road that will go from Yurimaguas in the northwestern Amazon to the Pacific port of Paita, the construction, operating, maintenance and financing risks are to be assumed by the concessionaire, a private consortium led by big Brazilian contractor Norberto Odebrecht. The IDB will soften the financing risk by offering a partial payment guarantee.
Meanwhile, Lima absorbs the commercial risk, agreeing to pay the concessionaire the difference between the toll receipts and the highway’s maintenance costs. On the other hand, the concessionaire must contend with the environmental and social risks, and it and the government share the risk that the highway will only be partially completed.
“Using this structure is good,” says Lehman Brothers senior vice president John Welch, who analyzes sovereign strategy in emerging markets for the New York investment bank. “The only worry is if the state has to come in and bail out the private sector party doing the work.”
Latin American construction companies are a cornerstone of infrastructure financing. Brazil’s Andrade Gutierrez and Odebrecht and Peru’s J.J.C. Contratistas Generales, Ingenieros Civiles y Contratistas Generales and Corporación Graña y Montero will soon be going to the global markets to raise funds. Odebrecht estimates that it will need close to $800 million to fund work on the two highways, the Amazonas Norte and the Interoceánica Sur, on which it has been awarded concessions. (Bidding on a third road, the Amazonas Central, opens this June.) Odebrecht Peru executive director Jorge Barata says the company expects to raise $200 million in Peru and $600 million abroad. On both roads 100 percent of the initial financing is coming from the private sector.
Builders also make direct investments in projects. For instance, the Interoceánica Sur agreement requires Odebrecht and other shareholders of two 420-mile-long concessions to put up between $26 million and $75 million in equity during construction. “We are changing from a short-term contractor to an investor and concessionaire,” says Luiz Fernando Santos, director of investments in Peru for the construction firm. “That’s a sign of confidence in the country. It is an evolution.”
To expedite big projects, Lima’s private investment promotion agency, ProInversión, recently concocted a financial instrument -- the certificate of work progress, or CAO (for certificado de aceptación de obra) -- for infrastructure construction. The certificates allow up to 90 percent leveraging of project financing. Sergio Bravo, president of ProInversión’s infrastructure committee, explains that CAOs prevent “the issue of capital from limiting the participation of interested companies.”
The innovation behind CAOs is to divide each infrastructure project into “benchmarks,” or segments. For example, a highway could be broken into 100-mile stretches, divvying up the costs into manageable units. The concessionaire would put up, say, $100 million to finish the first segment, whereupon the government would issue a CAO to it vouchsafing that the work was done -- and that the concessionaire was entitled to collect tolls and eventually be reimbursed for the construction and financing, less the toll receipts. That certificate could then be translated into liquidity critical to continuing the project: “It gives the right for a financier or an investor to pay the concessionaire the nominal value of the CAO,” explains Bravo.
Once the concessionaire obtains that first CAO, it can roll over the investment time and again, segment by segment, in steamroller fashion until the whole highway is laid down. Four international banks -- ABN Amro, Citibank, Credit Suisse and Deutsche Bank -- are bidding to underwrite CAOs for the Interoceánica Sur and sell them directly to the market.
Still, project lending of any type in any place has its perils. “Infrastructure like roads and power stations are natural monopolies and involve a higher-than-average degree of political risk,” cautions George Hoguet, emerging-markets portfolio manager for Boston-based State Street Global Advisors. “It is important to have exit mechanisms.” Some analysts speculate that Latin American pension funds or even the IFC could eventually provide that escape route.
Critics of Iirsa are quick to put forward reminders of the risks. They contend that Latin America, having shortchanged its infrastructure needs for decades, is now in too big a hurry to catch up and so is not taking sufficient care with projects.
The Interoceánica Sur, they argue, was never properly reviewed under Peru’s established procedures; the Finance Ministry is supposed to examine all ventures to prevent the waste of public resources and to verify cost projections. “Since the feasibility study was very poor, it was exempted [by Congress] from the review -- this was a first,” contends Gustavo Guerra García, Peru’s former vice minister of Transportation and Communications. In 2002, Guerra left the government in one of Toledo’s cabinet shake-ups and rejoined the opposition while returning to infrastructure consulting for the IDB and other clients.
The onetime vice minister asserts that the highway’s planning documents overstate the potential economic benefits; that the road surface -- asphalt concrete -- is the most costly option; and that the ongoing expenses of the Interoceánica Sur and the Amazonas Norte plus projected costs for proposed highland-to-coast roads (with no Brazil link) exceed the government’s annual ceiling on new borrowing. “When one contract takes up half of the entire budget for highways of a ministry, it is not sustainable,” says Guerra.
Transportation Ministry officials dispute virtually every point, arguing that extensive mathematical modeling confirmed the project’s economic merits and that preliminary traffic usage surpasses the original projections. Moreover, they say, the government studied alternatives and concluded that asphalt concrete was the most efficient all-weather surface. As for the budget issue, they contend that although the Interoceánica Sur $100 million in annual expenses will consume the ministry’s spending allotment for 2005, the proportion will diminish over the next 14 years as Lima’s allocation for transportation investment grows 5 percent annually.
Although any major infrastructure project is bound to have an environmental impact, Iirsa must carry out construction in especially sensitive terrain. Eight of its priority projects are roads that pass through the Amazon forest. Environmental watchdogs question whether multilaterals can mitigate Iirsa’s impact, particularly on rain forests. “We would start by saying to the IDB and CAF that each hub should conduct strategic environmental assessments looking at cumulative impacts and alternative investments and come up with ways for the indigenous population to be protected,” says Francis Grant-Suttie, a director of the Washington-based World Wildlife Fund.
“We have not participated at all in the definition of environmental terms in [project] contracts,” complains Gabriel Quijandría, environmental adviser to the Peruvian government’s National Environmental Council. He says that Lima’s environmental impact assessments are being hurried to make a June deadline. “A highway can be an instrument for development,” adds Quijandría, “but it is not a development plan.”
CAF’s García counters the critics by noting that “environment is an integral part of the entire process, from planning through follow-up.” CAF, he notes, is providing $17 million for a study of water, tourism and population migration along the Interoceánica Sur route.
On January 19, the IDB adopted formal procedures for conducting environmental reviews, replacing a sketchy, 20-year-old ad hoc policy. Now the bank will manage project risks in partnership with its borrowing countries, obtain community support before financing large projects, measure each project’s greenhouse gases and support biodiversity by emphasizing conservation.
Still, a gathering environmental backlash has prompted changes. A Peruvian commission appointed by President Toledo designed a development plan for the area surrounding the Interoceánica Sur that is intended to forestall environmental degradation. Transportation Ministry officials also note that multilateral lenders backing the project insisted upon a strategic plan to protect the environment in the highway’s vicinity.
Progress can be messy. The infrastructure push will do some harm, but it will do more good. “There will be boondoggles and corruption,” says Michael Pettis, a hedge fund adviser who has looked into Latin American infrastructure initiatives and currently teaches international finance at Peking University. “But if the region is left with an infrastructure, then there will be benefits.” Not a ringing endorsement, perhaps, but a realistic one.
