News that the Federal government of Brazil is about to sign off on its first Public Private Partnership (PPP) project was greeted with a mixture of relief that at last something was getting done and the suspicion that wrangling between different ministries and departments means progress will continue to be hobbled. Meanwhile, São Paulo and Minas Gerais, the states with the country's largest and third largest economies, are rapidly pushing ahead with PPP programmes that are winning plaudits.

The first Federal PPP, to improve and widen two Federal highways, was set to be approved as Project Finance went to press. The project needs an approval from the National Land Transport Agency (ANTT) and Management Committee of Federal PPPs (CGP) before a tender can be opened for bids. The project, which has been through a long and gruelling process, covers roads in Bahia that require R$1.4 billion ($690 million) of investment.

Many of the ingredients are now in place for wider development. On the demand side, investor interest has already been piqued, and the likelihood of Brazil reaching investment grade in the next two years will stimulate that further, says Miguel Noronha, project manager at Booz Allen Hamilton in São Paulo.

The development of domestic infrastructure funds has also been pronounced. ABN Amro and the Inter-American Development Bank have established a R$1 billion fund, known as InfraBrasil, to invest in project debt and equity, while Grupo Andrade Gutierrez and Angra Partners manage a fund with investments from Brazilian pension funds and CVC Citigroup focused on telecoms and infrastructure.

Moreover, the state owned development bank, Banco Nacional de Desenvolvimento Econômico e Social, or BNDES, has cemented its grip on the financing of PPP projects. The country's finance minister, Guido Mantega, was previously president of BNDES, and BNDES is consulted on the structuring of most federal and state PPPs. BNDES' role in financing PPP assets is likely to be as pronounced as its role in power and renewables deals has been.

According to Mauricio Endo, a director at the São Paulo office of KPMG, BNDES is likely to supply between 60% and 70% of the cost of any given PPP project as debt, with equity accounting for 20%, and debt or equity from an infrastructure fund or multilateral the remainder.

On the supply side, the centrepiece of President Luiz Inácio Lula da Silva's second mandate is the Growth Acceleration Programme (PAC), which lays a heavy emphasis on spending on infrastructure to inject some life into Brazil's anaemic economy.

Will politics help or hinder?

But just how much progress can be made will depend on whether the government can orchestrate a more coordinated approach and resolve the philosophical differences over what role the private sector should have, if any, in funding infrastructure.

The appointment of Lula's chief of staff Dilma Rousseff to oversee the PAC should help provide momentum, as she has that most valuable resource in Brasilia: clout. She will be likely to introduce a more organised procedure and "has a reputation for being a strong manager, very detail-oriented and speedy," says KPMG's Endo. "She has a very senior role in the Federal government and will likely help put together a plan to deal with PPPs and how to manage projects," agrees Noronha. She has already viewed and approved the BR-116.

That said, Rousseff is viewed as coming from the left wing of the ruling Workers' Party (PT). Earlier this year, she created a stir by saying that the terms of the early Federal road concessions should be looked at afresh as they were too generous to private investors, an argument that echoes the rumbling going on between the Federal Accounts Court (TCU) and the ANTT on the volume of investment to be given to the private sector and rate of return, an issue that has bedevilled PPP projects from the start.

"She's not necessarily against these projects but is receiving a lot of conflicting advice, which runs the gamut from a complete review of all projects to a hawkish camp that wants to push ahead," according to one market watcher. She has reacted by going back to analyse models and returns. "Initially, they were working on returns of some 12% but wanted to reduce that to 10% or even 8% in some cases. That wouldn't be an attractive level for the private sector and would incur a significant risk of not attracting bidders," says a consultant, adding "it would have been more desirable [than Rousseff] to find someone closer to the private sector." Mauricio Portugal, director of the federal programme for PPPs at the Ministry of Planning in Brasilia, believes that renegotiating contracts can be "very damaging for investor confidence and the government doesn't get good results. The contractor has a stronger hand than the government."

Even if a compromise between the public and private sector can be reached, the second problem is the PPP process, which needs to be simplified, the consultants say. "It requires an enormous amount of licensing and allows many ministers to opine and block progress, but doesn't empower anyone to say yes", says one consultant. And there are only the first signs of progress on simplifying the process for hugely time-consuming environmental licensing, while tax incentives for infrastructure remain timid, adds another.

Future projects

If the speed of the process remains unclear, the good news is that the PAC includes a number of projects that were earlier designated as suitable for PPPs and which are likely to be fast-tracked, reasons KPMG's Endo. The PPP-viable projects listed in PAC are a ring-road around Rio de Janeiro; two railway projects and three irrigation projects, totalling R$2.8 billion, he says. Still, he cautions, it is possible the government may end up rejecting a PPP approach and funding some of these projects itself. And as Endo notes, that it has already modified key PPP projects, including the North-South railway, which will now be awarded as a straight concession.

Portugal believes that "the practical situation in Brazil will push us to private sector involvement. We know that investments are urgent." That said, the Arco Rodoviário do Rio de Janeiro road project, which links the port of Sepetiba west of the city to major roads around the city has already run into a spat. "The state and federal governments have not yet agreed on who should take responsibility for the project," says Portugal, and it is unclear if it will be built as a PPP, he admits.

The first of the two railway projects, the Anel Ferroviário de São Paulo (Ferroanel), a tranche of a larger railway project, also faces some questions. The problem is that private company MRS won a government concession in 1996 to operate rail tracks in the city and will need to be accommodated in the project, says Portugal. "We have hired BNDES to study the viability of the Ferroanel project, but it will require us to talk with MRS. We might include the project in a renegotiated contract with them," Portugal says. The second deal, a 110km rail link between the cities of Guarapuava and Ipiranga in the southern state of Paraná, requires investment of some R$200 million.

The government is also working to get three PPP irrigation projects off the ground. "It's more difficult for the Federal government because there is no previous experience of private sector involvement in the sector, unlike in road and rail projects," says Portugal, adding that even so there is considerable interest from the private sector. Codevasf, a development agency, has hired the IFC to work on the projects.

The Pontal project is the front-runner and was chosen as it is small and requires less investment, he notes. A final report is expected by the end of June with tendering in the second half of the year. There has also been progress on the Baixio de Irecê project where preliminary studies have been wrapped up and the World Bank is carrying out further studies that are now nearing completion. Portugal believes the project may be launched as early as the second half of this year. Work on the third project, Salitre, is preliminary.

In addition to the PPP programmes brought under PAC's wing, the BNDES is studying a package of seven Federal roads in the south and south-east of the country, some of which may end up as PPP projects. They include parts of BR-040 between Juiz de Fora and Rio de Janeiro, a further segment of BR-116 between Minas Gerais and Bahia and the BR-380 linking Belo Horizonte and São Paulo.

States move into the vacuum

At the state level, São Paulo and Minas Gerais, are leading the way, says Noronha. Many other states, including southerly Rio Grande do Sul and eastern Espirito Santo, have studied, but are yet to show commitment to, the idea of PPPs. And plans in Bahia, which was widely seen as the other state with advanced studies on using the PPP mechanism, have been thrown into doubt, says Endo. The political leadership of Bahia changed at the last elections when, in a surprise upset, the right-leaning Party of the Liberal Front was defeated by the left-leaning Progressive Party. The state is going to review all its plans for implementing PPPs and there may be a complete change of guard at the PPP unit. Calls to the PPP unit there were not returned.

São Paulo, however, signed its first PPP agreement last November. Tomás Bruginski de Paula, director of the Companhia Paulista de Parcerias (CPP), a unit within the state government's Ministry of Finance, explains that the state picked an attractive, well-known project first, Line 4 of the Metro, a 12.8km stretch from Luz to Vila Sônia, as a 30-year contract. Private sector investment of $340 million will be needed to buy 29 trains and related systems.

Of the total cost of over $1 billion equivalent, São Paulo state will be responsible for 70%, largely building and maintaining lines, track and tunnels. The PPP contract will include the maintenance of platforms, as well as maintaining the rolling stock that it has procured.

But the concessionaire is repaid through fare revenues, including 100% of revenues from passengers using only Line 4, and 50% of revenues from passengers using Line 4 and other lines. The state will provide compensation if passenger numbers fall below 90% of the state's forecasts, and the contract will be renegotiated if it falls below 60%. Backing the state's obligations under the contract is a pledge of the revenues of the entire Metro, as well as the suburban CPTM railway.

The state is now working on a PPP for water company Sabesp. Documents were published last year, but there was a legal challenge in the state's Accounts Court and work was suspended. "We're now revising the documents after a period of public consultation," says Bruginski. The project will increase by half the capacity of a water treatment system that's responsible for 15% of the state capital's water supply. Sabesp will award the contract for 15 years, the first two years covering the building phase. Some R$300 million is required and Bruginski expects the tender documents to be ready in June with at least another 60 days required to award a contract.

Other projects include a railway between the cities of São Paulo and Guarulhos with an optional link to the international airport. "We provide the basic guidelines but will leave it to the private sector to make suggestions on equipment, stations and service," he says. Capital investment for both links should total some $500 million and the tender could be ready in as little as six months' time.

In other cases where the state was considering a PPP, such as a rail export corridor, the project could as easily end up as a straight concession and is currently under review. The city ring-road is also likely to be a pure toll concession rather than an availability-based PPP. Details on these will become more clear when the state government reveals its multi-year plan for PPPs, which is expected imminently, Bruginski notes. He estimates there could be as many as three or four PPP projects signed over the life of this government, and notes that it is even mulling more off-beat plans, including one to use the PPP mechanism to build a plant to make medicines.

In neighbouring Minas Gerais, the first PPP project was awarded in December and covers improvements to a 372km stretch of state road MG-050. The winning contractor, Equipav, will spend R$645 million on the concession over 25 years. Five companies bid for the deal but Equipav won because it required the least government support, notes Luis Antônio Athayde, sub-secretary of international relations in the economic development department of the state government. The project is set to reach commercial close in June.

Other projects are for the expansion of the state's prisons, where studies for 3,000 additional spaces are reaching the final phase. The contract would last for 25 years, covering both the building phase and ancillary services such as medical care, education, courses, recreation, food, psychological assistance and parts of the security, according to Athayde.

Projects to develop the campus of the state university (UEMG) and basic sanitation are also underway, and, says Athayde, "we are at the initial stages of studying irrigation projects and looking at the thermic treatment of waste to energy". But even in Minas there has been some scaling down. The state government has modified its approach to building its state administrative centre. It will now build the project itself, but will bring in the private sector to provide maintenance and ancillary services, a model that has precedents, Athayde says.

Now that the Federal government and two states are launched on their respective projects, there is a little more optimism that at least some PPP projects will see the light of day. "After all, it is a major effort required to start a PPP programme anywhere in the world", says Andrew Gunther, the new country manager for Brazil at the International Finance Corporation (IFC). In many places, it has taken two to three years to get projects off the drawing board, so Brazil is not atypical. But nearly three years after passage of the law enabling PPPs, it is still very unclear just how much of the ambitious Federal infrastructure package will be met through the mechanism and on what terms.