Brazil's construction sector, an economic dynamo in the past decade, has hit trouble. For this, blame general economic slowdown, government spending cuts, and fall-out from wide-ranging sleaze probe. But, combined with a new infrastructure programme, the sector's woes could be good news in the long run.
Brazil's builders had some rare good news last month, when the government unveiled PIL-2, the second stage of its Logistics Investment Programme. Aiming to attract BRL198.4bn in private investment by offering concessions in new road, rail, airport and port projects, PIL-2 seemed just the medicine the ailing construction sector needs.
For it had seemed, lately, that the carnival was over for Brazilian builders. They'd had a festive time in the commodity-boom years of 2009-2013, with annual sectoral growth averaging over 7%. The real estate sector surged, while governments spent heavily on fixing infrastructure and preparing Brazil for the 2014 football World Cup and the 2016 Olympics.
Then, in 2014, came sector recession, as construction output fell for the first time since 2006. Economic slowdown, stubbornly high inflation, restricted credit supply, flagging consumer and investor confidence, drastic cuts in government spending—you name it, Brazil's builders were hit by it.
Washed out
And by "Operation Car Wash". That's the probe into money laundering at state-controlled oil giant Petrobras (Petroleo Brasileiro), which expanded to cover allegations of corruption in public procurement tenders generally between 2004 and 2012. Former top executives and politicians were accused of systematically inflating procurement prices.
The scandal paralysed construction activity: 24 engineering and construction (E&C) firms allegedly involved were banned from bidding for Petrobras contracts from December 2014, losing a big chunk of their revenues. And some of the biggest builders and Petrobras suppliers faced credit-rating downgrades and a finance and liquidity squeeze. That translated into halted construction projects, job cuts, emergency asset sales and credit restructurings. Hence a wave of bankruptcy filings in the first half of 2015 by E&C firms, including Alumini Engenharia, OAS, Galvao Engenharia, Grupo Schahin and TKK Engenharia.
In May 2015 came another blow. The government cut BRL69.9bn (USD 22.9bn) from its 2015 budget, aiming to balance the books and restore markets’ confidence. Construction fared badly. The Growth Acceleration Programme ("PAC" in Portuguese), involving investments in sanitation, logistics, energy and housing, saw its budget slashed by BRL27.5bn to BRL40.5bn. And, in particular, the "My House, My Life" programme—which funds housing for low-income households, urban and rural—had its budget docked from BRL19.9bn to BRL13bn.
So nearly BRL200bn worth of investment under PIL-2 is good news. It should boost construction activity and jobs: finance minister Joaquim Levy reckons PIL-2's direct effects will increase GDP 0.25%. And it’s not only good for builders. No-one denies the crying need for better infrastructure: the World Economic Forum latest (144-country) competitiveness report ranks Brazil’s infrastructure quality a dismal 120th. And Levy thinks the programme's indirect effects will be equivalent to another 0.25% on GDP.
No magic PIL?
That's if PIL-2 works. On which, there’s some scepticism.
One criticism is that it's just too conservative. PIL-2 foresees investment of just BRL69.2bn between 2015 and 2018, with the remaining BRL129.2bn expected thereafter. But Bernardo Figueiredo, former president at the Logistics Planning Company (EPL) - effectively, the state's transport sector think-tank - reckons around BRL100bn annually is needed over the next seven years to fix Brazil's infrastructure.
But the main doubt is whether PIL-2 can attract enough private-sector interest. Its predecessor didn't: PIL-1 envisaged 200 infrastructure project concessions involving investments of BRL213bn. In fact, it attracted just 20% of that. True, all five airport concessions were snapped up, as were six out of nine road projects. But most of those airports and roads went to local firms: foreigners mostly stayed away. And not one of 13 railway and 160 port-terminal projects found a taker. That's worrying because some PIL-2 projects are just PIL-1 leftovers—mainly railways and ports—that nobody thought viable.
And the private sector really needs to be interested. Because PIL-2 involves a smaller role for state-run banks in project financing—and a bigger one for the capital market.
The National Development Bank (BNDES) is to remain the major financing source, funding up to 70% of the investment in new roads, ports and airports and up to 90% in railways. But the subsidised Long-Term Interest Rate (TJLP) will account for just 45% of each loan (70% for rail), with the rest granted at—currently rather high—market rates, thus increasing concessionaires’ financing costs. Which, say critics, will likely mean higher toll-rates than those obtained under PIL-1 projects.
BNDES has also made provision of the maximum share of TJLP-linked funds contingent on issue of infrastructure bonds (IBs) by the private sector. Which could be a problem. The Valor Economico daily calculates the private sector would need to issue infrastructure bonds (IBs) worth BRL24bn in 2016-2018 to access that maximum share. Optimistic, maybe, since only BRL16bn was raised by IBs between their introduction in 2011 and May 2015.
Reasons to be cheerful
But maybe PIL-2 needn't be such a downer. It all depends how things are handled. Take IBs. The Brazilian Financial and Capital Markets Association (ANBIMA) has called for eased issue and sale requirements - and additional incentives for bondholders. ANBIMA might be right. And if the government is serious about PIL-2, it might take notice.
Or take tender conditions. Experts blame excessive government regulation, restrictive conditions for new concessionaires and limited return on investment for the lukewarm response to PIL-1. The government seems concerned to get it right this time. It has announced changes in the concession rules and investment requirements for the most problematic projects—notably those PIL-1 leftovers. But PIL-2 generally offers an improved regulatory framework and market-friendly conditions for new concessionaires—which could cut red tape and let new players in. The devil, of course, is in the detail: for instance, Sinduscon-SP—the Civil Construction Industry Union of the State of Sao Paulo—has criticised scant information about tender terms and guarantee requirements. The next month or two should show whether the government’s serious.
Meanwhile it's a good sign that, separately from PIL-2, the government has taken several steps to lure foreign companies into participating in infrastructure development. As part of a May 2015 cooperation deal, China has pledged USD53bn to fund infrastructure and energy projects in Brazil between 2015 and 2021. An expected new USD50-bn fund, managed by Brazil's bank Caixa Economica Federal and the Industrial and Commercial Bank of China, will invest in road, railway, port, airport, renewables and housing projects. The flagship project is construction of the 3,500-km, BRL40bn Brazilian section of the Bi-Oceanic Railway, connecting Brazil’s Atlantic coast with the Pacific ports of Peru. This would give Brazil a cheaper route to China, its main trading partner (turnover nudged USD79bn in 2014). And China Railway Engineering Group has already expressed interest in investing in one of this railway's sections.
There are also signs of growing foreign interest in the construction sector itself. In June 2015, Spanish infrastructure group Essentium entered Brazil by acquiring the assets of local E&C firm Delta Engenharia e Manutencao Industrial for an estimated BRL450mn, saying it would compete for future infrastructure concessions. Also in June, UK-based construction services group ISG consolidated its presence by acquiring 49% of Brazilian peer ACE. For now, foreigners generally remain cautious, since it’s still unclear how the Petrobras scandal and current economic and fiscal adjustments will play out.
All shook up
But, handled right, the new round of concessions—along with Operation Car Wash—should shake up the construction industry nicely. Currently the sector is heavily regulated and dominated by a few large domestic players. But with the big boys strapped for finance and under a corruption cloud, it's an opportunity for local SMEs to gain market share by completing projects at risk. And expected changes in tendering and financing conditions could be the liberalisation needed to let small locals and foreign heavyweights into public procurement tenders and infrastructure auctions.
All in all, a more competitive and sustainable construction sector should result. Brazil needs better infrastructure. And the government says it's committed to less intervention—and more market. That could mean a chance for foreign investors to enter the sector by acquiring assets at reasonable prices or partnering with small and medium-sized locals. Cooperation between international heavyweights and those local firms that aren't touched by the Petrobras scandal could well fill the gaps left by those that are.
Which, medium term, could be good for the sector as a whole. Construction companies could diversify revenues and become less dependent on government contracts. More competition would push them to adopt new technologies and better management practices. Meaning more efficiency. And bigger profits.