Peru's Corruption Battle is Great for Honest Infrastructure Investors

Peru has done many things right in recent years. The economy has boomed, poverty has fallen and gradual improvements are even showing in education. However, one area that has stubbornly refused to improve is infrastructure. “When I was a student in the 1980s”, remembers Humberto Nadal del Carpio, CEO of Peru-based, NYSE-listed cement maker Cementos Pacasmayo, “we learned about the country’s terrible infrastructure deficit. Thirty years later, nothing has changed. We have failed miserably as a country to fix it.”

“We have 2,300 kilometres of coast but just one major port”, notes Nadal. “We are the land of the Incas but we have just one global airport. We have a completely flat coast but no train. We don’t even have a highway that can take us from Tumbes in the north to Tacna in the south. This has been the case for many years so we have to recognise that we have failed.”

That frank assessment is shared by Paulo Pantigoso, Managing Director of EY Peru. “Peru is ranked 89th in the IMF infrastructure ranking, which is clearly not good enough. Under previous governments we didn’t see enough infrastructure progress and that’s why our infrastructure deficit is at 80% of GDP, which is the highest in Latin America.”

It’s a refrain that will sound all too familiar to investors. In the past many have been excited by announcements of ambitious infrastructure plans only to see them founder on Peru’s traditional challenges of institutional inertia, incompetence, corruption and conflicting vested interests.  But now it seems that the mood is changing. A new government has pledged to improve the country’s infrastructure and the private sector is feeling optimistic.

This time it’s different

‘This time is different’ is probably the most dangerous phrase in investing but the early signs from the government of Pedro Pablo Kuczynski seem positive. The administration has made infrastructure a priority and despite the fact that it only commands 17 seats in the 130-seat Congress, it managed to obtain extraordinary power to legislate for 90 days in October 2016. That gave it a window to pass key changes to some of the structural challenges that normally complicate infrastructure projects in Peru. As Minister of Economy and Finance, Alfredo Thorne, told LatAm INVESTOR, these decrees have simplified the regulatory framework for public investment projects, streamlined the process for public private partnerships and restructured the infrastructure investment body, ProInversión.

"Another positive is the firm stance that Peru has taken against the corruption scandal that has engulfed several of the country’s main infrastructure projects…"

Broadly speaking there are three types of infrastructure projects in Peru: those that are completely public sector, those that are wholly private sector and those that are formed through a public private partnership PPP. The first two types of project have an important role to play but the key to reducing the infrastructure deficit are the PPPs, which are handled by ProInversión.

The most obvious change in ProInversión, is at the top where Álvaro Quijandría, formerly at the World Bank, has been installed as the new Executive Director. “The government has made it clear that it wants us to become the best public private partnership (PPP) agency in Latin America”, explains Quijandría. This will be aided by the creation of a new National Public Investment System (SNIP by its Spanish acronym), which will streamline the approval process within the public sector.

Another positive is the firm stance that Peru has taken against the corruption scandal that has engulfed several of the country’s main infrastructure projects. Key mega works that were linked to Odebrecht, the Brazilian constructor currently engaged in a continent-wide corruption probe, have been postponed or cancelled as Peru’s government roots out corrupt local parties. Yet while this will cause short-term delays it will create a transparent and fairer playing field for new entrants.

Political pressures

Of course the danger is that over the medium term the government gets derailed by political opposition. After all, with a minority in Congress and its special legislative window now coming to an end, the new government will rely on the support of other parties to pass legislation.

But Nadal feels that the political climate is supportive. “I think this government has no other choices. We can not control gold, fishmeal or copper prices. The amount of asparagus that Europe buys from us is out of our hands. But we can control what we are able to build. We have pension funds sitting on huge amounts of money that are ready and willing to invest. Our president is newly in office and it is the first time that I have seen concrete specific laws that are directly targeting the key changes that need to be made so that infrastructure investing is more accessible to local and foreign capital.”

Nadal is also dismissive of the idea that other political parties will hijack the infrastructure push. “It’s like when you get on a plane and you are offered a choice of chicken or pasta. Except this time there is no chicken, just pasta. The government has no choice in the same way that no other credible politician has a choice. All three of the candidates in the election wanted to focus on infrastructure. The funds are there, the companies are there and the appetite is there. In life there are no guarantees but I am definitely feeling optimistic.”

The perception of a political consensus on infrastructure is shared by Quijandría. “The need to develop these projects is overwhelming. Clearly the key factor is that we do it transparently without delays, corruption or problems that could attract justified political opposition.”

Private push

Of course you can have the most efficient promotion agency and licensing system in the world but to really attract investors you need attractive returns. And Peru can definitely offer them. The economy doubled in size in the decade from 2002.  This has been accompanied by a demographic boom. Over the last 50 years Peru’s population has tripled, from 10 million in 1960 to more than 30 million today. This surge of wealth, economic activity and population has redrawn the map of Peru and created a necessity for improved infrastructure.

Mining firms can also play a big role in cutting the infrastructure deficit, says Carlos Galvez, CFO, of Buenaventura, an NYSE-listed, Peru-focused, metals miner. “Mining has been a driving force of infrastructure development in the Andean highlands. Traditionally the state presence there has been weak and the infrastructure poor. But as we have developed mines we have brought roads, power lines and basic amenities to the population. Then, as the mine grows, you have a multiplier effect, of jobs, clinics and communication.” This trend of private-sector pushed infrastructure development will likely be aided by the government’s decision to improve the existing obras por impuestos (works for taxes) scheme that encourages firms to deliver infrastructure projects in lieu of taxes.

"you can have the most efficient promotion agency and licensing system in the world but to really attract investors you need attractive returns…"

Indeed, while media attention tends to focus on the mega projects, such as the 2nd line of the Lima Metro, there are also a wide range of smaller opportunities for investors. Rafael Carranza, who heads an infrastructure debt fund for boutique asset manager and consultancy, MacroConsult, believes there is a lot of value to be added with the smaller projects. “A fund like ours works to compliment the investments in infrastructure. The AFPs (local pension funds) will invest directly in mega projects, when they issue bonds, but they also want exposure to the other types of projects. The AFPs are not going to spend time analysing each one for themselves so they are happy to outsource to a fund like ours.  We are looking at the second tier of opportunities, many of which are in the provinces. So for example, a typical project may be a stake in a privately-owned transmission line to a mine, or a small renewable power project.”

Regional complications

One thing that has been painfully clear in Peru is that any project, large or small, can be subject to intense protests. Perhaps the most well-known to LatAm INVESTOR readers are the protests in the mining sector, where billions of dollars of new mining development have been postponed or cancelled because of vitriolic protests from environmental groups and local communities.

Sometimes these protests are the cause of genuine environmental or community concerns but often they are exacerbated by economic and political interests. Peru’s geography, with isolated areas, its history, with conflictive relations between social groups, and its decentralised political system, which gives a significant amount of power to local governors, makes it a hard country to govern from Lima. As a result investors in new projects in remote areas need to understand the local actors if they want to avoid problems.

It would be naïve to deny that infrastructure development in Peru has powerful structural challenges. Corruption, political pressures, weak institutions and powerful competing interests have all played their part in waylaying Peru’s infrastructure ambitions. None of these problems will disappear but there is a genuine feeling that this government is making serious headways with most of these issues. For brave investors the early signs suggest that this time it really is different.