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The Globe and Mail

Brazil’s burgeoning appetite for construction

A March 6, 2012 file photo shows the new soccer stadium under construction in Sao Paulo, Brazil. The stadium, expected to seat as many as 65,000, will host the opening match of the World Cup in 2014.

Andre Penner/AP

The instruction from Altair Guimaraes is cryptic. Meet him at Gate 10 of the Autodromo, Rio de Janeiro's old Formula One track that will be transformed into an Olympic park when the city hosts the games in 2016.

The gate marks the entrance to the Favela Vila Autodromo, of which Mr. Guimaraes is the community leader. A billboard says in Portuguese, English and Spanish: "A peaceful and orderly community since 1967."

Having been subjected to two forced relocations, including one to the City of God neighbourhood made famous by the film of the same name, Mr. Guimaraes is mounting an international campaign to save his slum of 3,000 people from being bulldozed for the Olympics project.

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"Governments here have an old habit of social cleansing," he says in the office of the community association, wearing a T-shirt in the green and gold colours of Brazil. "I told [Rio] mayor [Eduardo Paes] not to do what other countries have done and uproot people living close to games or mega events, like in China, where they put people in steel containers."

For Mr. Paes, who accepted the Olympic flag from London this month, and President Dilma Rousseff, the conflict at Vila Autodromo captures in microcosm the challenges Brazil faces not only in its plans to host the Olympics and the 2014 football World Cup but in its efforts to break the choke hold on its economy posed by chronic infrastructure bottlenecks. Together, the events represent a once-in-a-generation opportunity for Latin America's biggest economy to show it can execute large projects, as the government seeks to roll out an ambitious plan to invest $460-billion in new roads, ports, airports and power plants, with the participation of foreign investors.

The stakes are high. Ms. Rousseff, an economist by training, must steer the economy from a model too reliant on consumption toward one involving greater infrastructure investment – or risk losing Brazil's place as a new engine of global economic growth.

"At least the discussion is now on the right issues," says Alberto Ramos of Goldman Sachs. "This is not a strategy that is going to give you spectacular growth in the short term. But for sure it is a strategy that can elevate the potential growth."

Brazil's recent economic success has been driven by high commodity prices and the emergence of a middle class of consumers with easier access to credit. Gradually, though, demand for new cars and fridges and other products has overwhelmed the capacity of highways, logistics parks, ports and warehouses to supply the goods, creating inflation. Meanwhile, rising exports of commodities such as iron ore and soybeans are creating congestion on highways thousands of kilometres from the coast.

The effect is to choke off economic growth, expected to fall from an annual rate of 7.5 per cent in 2010 to below 2 per cent in 2012. "Every time we talk with an investor in Brazil, the biggest and the single most important problem they talk about is infrastructure," says David Beker of Bank of America Merrill Lynch.

Important steps have been made in increasing infrastructure investment. According to the Institute for Applied Economic Research, a government think-tank, annual state investment in toll roads and railways nearly tripled between 2002 and 2010 to a total of just under $10-billion.

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But while Brazil's road network is more extensive in terms of kilometres per 1,000 workers than Russia's or China's, only 6 per cent of it is paved, compared with 54 per cent in China and 80 per cent in Russia, according to Goldman Sachs research.

In a World Economic Forum survey of infrastructure quality, Brazil scored 3.6 out of 7, compared with China's 5.5. Mexico and Chile also beat Brazil on almost all measures, from roads, railways and ports to air transport, with the exception of electricity supply. The number of passengers using Brazilian airports rose 75 per cent between 2007 and 2011, leaving many of them running at overcapacity.

"Brazil's infrastructure bottlenecks lead to inefficiencies that end up taking logistics costs to 12-15 per cent of GDP while in the U.S., Germany and other countries they are on average at 5 per cent," says Bruno Savaris of Credit Suisse.

Until the early 1980s Brazil and other nations in the region invested heavily in infrastructure. But after a series of financial crises, spending halved to as little as 2 per cent, as governments reined in debt levels. "Total infrastructure investment collapsed in the second half of the 1980s, and the fall has not been reversed in the ensuing two decades," said a 2010 World Bank report.

Economists at Goldman Sachs estimate that if Latin America, led by Brazil, doubled its infrastructure investment to 4-6 per cent a year in 20 years, capacity would catch up with South Korea, an emerging-market success story. This would boost potential GDP growth from below 4 per cent to about 5.5 per cent. "This would reduce income inequality by 10-20 per cent," they said in a report this year.

Mindful of the potential gains, Ms. Rousseff has begun pushing through the sale of infrastructure concessions to public-private consortiums. In February the government auctioned concessions for major airports in Sao Paulo, the country's industrial and financial centre; the nearby satellite city of Campinas; and Brasilia. In mid-August it announced the sale of $64-billion of concessions for 10,000 kilometres of railways and 7,500 kilometres of toll roads. "It is really a positive thing for the country," says Mr. Beker. "The risk is execution."

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Some of these projects are not new. The Growth Acceleration Programme (PAC), now in its second phase, envisaged at least two of the highways back in 2008. The government regularly boasts of the program's achievements, recently saying that in 2011, the first year of PAC2, it completed 628 kilometres of road work, 11 airports, eight port ventures, nearly 3,000 megawatts of new power generation capacity and nearly 250,000 new power connections. But while the scheme is welcomed by investors, there is skepticism over its effectiveness – during the first phase, only slightly more than half of the envisaged investment for logistics and utilities was concluded. Red tape, problems with structuring projects and government inertia contributed to the delays.

Still, Ms. Rousseff's an­nouncement this month on roads and railways was taken as a positive sign that the government is moving from stimulating consumption to encouraging investment, which in Brazil is seen as too low at 19 per cent of GDP versus the estimated requirement of 22 per cent. Ms. Rousseff is expected to announce soon further sales of concessions for ports and airports in Rio, Belo Horizonte in the interior and in the booming northeast.

Foreign investors are on the alert. "We will follow very carefully everything the government is going to do in airports and ports," says Patrice Etlin of private equity firm Advent in Brazil. "There is a lot of interest among many financial investors around those assets."

To overcome reliance on Brazil's development bank, practically the sole long-term financier in the country, the government has announced income tax breaks for the private sector and foreign investors on bonds for infrastructure projects. With European and U.S. banks less inclined to lend, governments in the region are having to become more innovative in the way they attract investors.

"The more diverse you can make the sources of capital, the more you can get done," says Cherian George of Fitch Ratings in New York.

It remains too early to tell whether foreigners will be willing to take the long-term risk of investing in local-currency infrastructure bonds. But other changes in the economy could prove supportive. The central bank is expected this week to cut the benchmark interest rate to a low of 7.5 per cent in a move to revive the sluggish economy. If it can sustain lower rates, investors will begin looking at longer-term investments in search of higher returns.

"We had a country that was addicted to very high interest rates – suddenly that doesn't exist any more," says Marcelo Kayath of Credit Suisse.

But anyone hoping for quick fixes will be disappointed. Analysts say fine-tuning of concessions is needed to ensure returns are attractive for the private sector. Mr. Savaris of Credit Suisse says real returns on airport concessions announced in February amounted to 2-3 per cent for some investors. The government is reportedly seeking to lower real returns on new highway concessions to about 6 per cent but investors want a minimum of 10 per cent.

There are concerns about the structure of the railway deals, which gives state-owned network operator Valec the right to purchase all the track capacity in the new concessions. "The private sector wasn't happy – usually one company is responsible for both construction and operation," says Mr. Savaris.

Brazil must also be wary of focusing on form over substance. The government is persisting with plans for a bullet train between Sao Paulo and Rio with a reported price tag of $29-billion and echoes of Chinese-style largesse. Brazil has had white elephants before. Some projects related to Rio's 2007 Pan American Games came in at 10 times initial cost estimates, and play at a baseball stadium was suspended because of shoddy construction, says Larry Rohter, author of Brazil on the Rise. Building capacity is already strained, with a shortage of skilled labour, engineers, architects and equipment driving up prices.

Other hurdles are less tangible. They include ideological resistance to privatization from the ruling coalition, which is led by Ms. Rousseff's centre-left Workers' party; and opposition from those living in the way of infrastructure projects, such as Mr. Guimaraes in Rio. Activists say thousands of residents are being moved to make way for projects related to the World Cup and the Olympics.

Mr. Guimaraes sums up how little trust some have in the system. He says he does not believe government claims that it wants his land for public projects, pointing instead to condominiums he expects to be built in the Autodromo after the Olympics. His favela has a waterfront view potentially worth millions of dollars.

"Even if the government offers 500-square-metre apartments in another place, I still don't want it. I want to live here in my community," he says.

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