BRAZIL'S ONGOING DEBATE ON PUBLIC-PRIVATE PARTNERSHIPS

UNCLAS SECTION 01 OF 04 BRASILIA 000644

SIPDIS

NSC FOR DEMPSEY
TREASURY FOR OASIA/SEGAL
PLS PASS FED BOARD OF GOVERNORS FOR WILSON, ROBATAILLE
USDOC FOR 4322/ITA/MAC/WH/OLAC/WBASTIAN/JANDERSEN/DMCDO UGALL

SENSITIVE

E.O. 12958: N/A
TAGS: EIND EFIN PGOV ECON EINV BR
SUBJECT: BRAZIL'S ONGOING DEBATE ON PUBLIC-PRIVATE PARTNERSHIPS

Ref: 2003 Brasilia 3956

Sensitive but unclassified; please protect accordingly.


1. (U) Summary: The American Chamber of Commerce and "Valor
Economico" newspaper sponsored a seminar in Brasilia March 10
to stimulate the national debate on Public-Private Partnerships
(PPPs),the method by which the GoB seeks private sector
investment to help fund essential public services and
infrastructure needs. The seminar highlighted significant
differences between government and private-sector expectations
but also demonstrated a willingness on both sides to find the
correct PPP recipe for Brazil. It will clearly not be easy for
the GoB to provide the kinds of assurances the private sector
seeks, especially amid concerns about political risk and
regulatory uncertainty. The draft bill (PL 2546/2003) remains
under debate in Congress, but the GoB has designated its
passage a prime legislative priority. The bill's sponsor,
Deputy Paulo Bernardo (PT/PR),expects passage by the end of
April, despite several controversial points still unresolved.
The seminar participants included Joaquim Levy, the Secretary
for the National Treasury at the Ministry of Finance,
representatives from Sao Paulo and Minas Gerais State
Secretariats, representatives of civil construction,

SIPDIS
sanitation, and highway construction firms, international
consultants, banks and the IADB. End Summary.

The Legislation
--------------


2. (U) Federal Deputy Paulo Bernardo started the seminar with
an update on the status of the PPP bill (PL 2546/2003),
originally fast-tracked to be approved during Congress's
extraordinary session from mid-January to mid-February.
Although a relatively short piece of legislation and not
opposed by any political party, Bernardo noted the inherent
complexity of the PPP bill due to its direct links and
subordination to current laws like the Law of Fiscal
Responsibility not sure this is accurate characterization -
dispensable anyway, I think as well as those governing
concessions and public procurements. The issue of the
guarantees to be offered remains among the most controversial.


3. (U) Bernardo said that questions over the constitutionality
of the article stipulating PPP contracts' precedence over the
State's other contractual obligations forced the removal of
that article. However, he assured participants the necessary
financial guarantees will be present in the final legislation
through the fiduciary fund (the fund of state-owned assets
meant to cover shortfalls in the government's PPP obligations)
and the nature of PPP contracts themselves, even without
establishment of the explicit precedence of PPP contracts in
government obligations. The Ministry of Planning is preparing
new text to address the issue of precedence that may be voted
on as an amendment. The question of defining government PPP
expenditures as recurring costs or debt is also under
discussion. The GoB seeks to have complementary state and
federal PPP legislation, but already-passed Minas Gerais state
legislation considers the state's PPP costs as recurring costs
while Sao Paulo State Secretary for Planning, Andrea Calabi,
told participants that state spending on PPPs would be
considered debt and that, therefore, PPP projects would involve
very little state money. Many urged flexibility in the law so
that government could evaluate each project individually.

A New Concept
--------------


4. (U) Bernardo spoke of the GoB's intention to change the way
the government is viewed by the private sector, to put an end
to the history of defaults, late payment, contract breaking,
and changing of rules after the contract signing. The MG and
SP state secretaries also portrayed the PPP as a tool to change
the culture of suspicion to a culture of trust, characterizing
the partnerships as a new concept for Brazil, not yet fully
formed, but an opportunity for the government to gain new
respect as a reliable partner. But how to make this admirable
political will a reality? Government representatives cited
their challenges such as providing clear information and
defined priorities, creating a can-do management style that
values flexibility and tailors guarantees to the needs of
specific projects. Several underscored the point that project
finance and traditional concessions still merit consideration,
as PPPs will not fit every situation.


5. (U) Joaquim Levy, Treasury Secretary at the Ministry of
Finance, said PPPs are useful tools for projects with greater
social/economic gains than financial gains. The benefits of
long-term, high-quality service for the government/consumer
balanced with guaranteed payment and reduced cost of investment
for the private sector must be achieved while avoiding
"skeletons" or concealed/unacknowledged liabilities. Citing
articles of the bill, he attempted to show that this outcome is
entirely possible. He described in general terms the
regulations to govern the creation of the fiduciary funds (to
be created by public financial institutions and to contain
budgeted funds, stocks of state-owned companies, real estate
and capital goods),noting that the fund will be separate from
the Treasury and will not conflict with the government's
primary surplus target. He also explained that the PPP
management agency, made up of representatives from the
Ministries of Planning and Finance and from the Civil
Household, will devise PPP contract procedures and determine
priority projects, as well as authorize and evaluate bids for
PPP contracts.


6. (U) Government representatives agreed that the legislation
and operation of PPPs must offer a flexibility that does not
currently exist. The concession law prohibits the public
sector from making partial payments to private service
suppliers. The public procurement law does not allow the
private contractor to charge user fees and limits contracts to
five years. The challenge remains to provide that flexibility
within the boundaries of fiscal constraints and in an
atmosphere that the private sector perceives as rife with
risks.

Private Sector on Political Risk, Regulation
--------------


7. (SBU) The Brazilian private sector participants welcomed
the opportunity to share their experiences with government
partnerships and their expectations for PPPS. All agreed on
the urgency of restarting investment in infrastructure and
basic public services to promote economic growth and job
creation. Many praised the notions of shared risks and
responsibilities and "value for money" that the PPP concept
embodies. Benefits that the private sector brings to the
partnership include improved service, timely completion of
projects, better risk evaluation and application of new
technologies. In addition to the payment guarantees that take
into account the limitations of public debt, business reps said
that a new regulatory framework is essential for the viability
of PPPs.


8. (SBU) According to private sector participants, the
framework should include measures that ensure confidence in the
bidding process, clear project evaluation criteria and contract
performance requirements, as well as guarantees of faithful
execution of the proposals. The PPP management entity should
be charged with cutting through red tape, facilitating
environmental permits, for example, and should make regular
reports to Congress. One participant cited the recent contract-
breaking actions of the state of Parana, saying that as PPPs
will be long-term contracts (10-25 years),they must be able to
withstand the political winds of change. Several participants
emphasized the importance of wisely selecting the first PPP
projects to build faith in the initiative and attract
investors.

9. (U) Several private sector reps suggested prioritization of
projects that rely on user fees or tolls rather than government
payments. This raised the question of whether rate adjustments
would be handled differently for PPPs than for concessions.
One representative of a construction firm suggested that the
GoB investigate ways to reduce the tax burden on companies that
undertake PPPs. Questions arose regarding the selection
process for projects, if and how PPPs could alter the current
system of technical pre-qualifications in the public
procurement law, perhaps exacerbating problems with the current
law that contribute to collusion. One international consultant
suggested that the current public procurement process be
altered for PPPs to allow for efficiency gains and lower final
costs through acceptance of alternative technical proposals
before the evaluation of economic offers.


10. (U) There was also discussion of the need for separate
regulatory frameworks for individual sectors. A rep from a
major highway construction firm suggested that PPPs for
highways be complementary to Brazil's existing (and successful,
according to this source) program for highway concessions,
which already has its own laws and regulations. Some expressed
doubts that PPPs would be viable for ports and railroads as
well as for hospitals and schools. Sanitation and water-
treatment projects are prime PPP candidates, but Brazil lacks a
regulatory framework for this sector, where municipalities are
responsible for providing service. A representative from an
international firm specializing in sanitation services said
that creation of sanitation-specific regulatory bodies on the
federal, state, and municipal levels is required to guarantee
the sanctity of contracts. He described difficulties with
contested rate adjustments and suspended service, and noted
that Brazil's notoriously slow judicial process compounds the
problems businesses face when partnering with government
entities.


11. (U) Consultants with international PPP experience noted the
importance of multilateral institutions in lowering perceived
political risk as well as in providing payment guarantees.
Brazil's unique situation made it difficult to apply "lessons
learned" from other countries' experiences with PPPs, but
consultants advised that greater respect for contracts, more
emphasis on negotiation, and building trust in the judiciary
would help. One emphasized that Brazil would be competing for
investments and financing with other emerging markets and would
need to publicize the program abroad. The IADB Executive
Director for Brazil said the organization stood ready to
continue its support of infrastructure projects by offering the
Brazilian private sector direct loans and guarantees to cover
commercial and political risks involved in PPPs. The IADB
plans to extend US$ 300 million for PPPs in a line of credit
through BNDES, Brazil's Development Bank.


COMMENT
--------------


12. (SBU) The seminar covered a lot of ground and left many
wondering whether Brazil, with its history of unstable
currency, inflation, mismanaged debt and business-damaging
political shenanigans, is really ready and able to live up to
its side of the bargain in PPPs. PPPs have worked in developed
countries with low political risk and respect for the rule of
law. One consultant told us that this would have been a pipe
dream for Brazil in 1998, but conceded that with a few initial
successes the model could well find its place in the Brazilian
development model. The GoB appears unshakable in the certainty
that their legislation, said to be based on European models,
provides the best possible framework for successful PPPs in
Brazil. While the 23 federal pilot projects for PPPs were
selected late last year (highways, railways, port upgrades and
irrigation projects),the delays in approving the bill will
likely push off the initiation of any projects until early

2005.


13. (U) Attendance at the seminar, held in Brasilia, surpassed
expectations and demonstrated a desire to dig into the details
of the subject among local banks, government and various
service providers and civil construction firms. The GoB's
credibility will be on the line with the first PPP projects and
will presumably give the latter kid-glove treatment to ensure
initial success. As many said at the seminar, the real test
will come years down the road with new administrations, when
Brazil's business maturity will be fairly judged with regard to
PPPs -- praised or pilloried.
HRINAK