“Colombia’s Infrastructure Challenges” by

Santiago Montenegro President Asofondos; Former Visiting Fellow Center for Hemispheric Policy University of Miami April 23, 2013

Introduction The Colombian society and economy have experienced a dramatic transformation during the last decade. At the turn of this century, Colombia was included on the Council on Foreign Relations list of failed states. Today, Colombia exhibits measurable progress on a number of important indicators. There has been the largest inflow of foreign direct investment in history, GDP growth has recently been one of Latin America’s highest, employment has expanded by more than two million since the beginning of the administration of President Juan Manuel Santos in August 2010, Colombian multinationals are investing throughout South and Central America, and poverty is falling. Even the stubborn and extremely high Gini coefficient, which measures income inequality, has been tending to fall over the last several years. Seen from a broader perspective, these trends indicate that after several years marked by extreme levels of violence,

economic stagnation and political polarization, Colombia has reignited its longer-term twentieth century historical development pattern that brought higher standards of living, macroeconomic stability and a polity characterized by civilian governments, limited use of power and one of the longest electoral traditions in the world. Colombia’s twentieth century pre-conflict development trajectory was unique for a continent that was closed to the world, where only minorities enjoyed modern standards of living and where autocrats, dictators and caudillos were the norm rather than the exception. However, because the world and the continent have radically changed and moved forward, Colombia’s twentieth century trends will not do in the twenty-first century. To generate higher and sustained income, to distribute that income more evenly among the population, to create good formal jobs, to improve dramatically the standards of living and to solidify its political and state institutions, Colombia has to embark on a profound path of policy reforms. It must improve the quality of all levels of education; it has to reduce its appalling levels of labor-market informality and unemployment; it has to make its public institutions more transparent in order to reduce corruption; it still has to reduce violence in general and the homicide rate, which remains at high levels, in particular. And to fully join the world economy and to make its productive capacity competitive, Colombia has to improve dramatically its physical infrastructure. Colombia’s infrastructure today is very sub-standard. This situation is quite paradoxical. On the one hand, Colombia’s demand for better roads, railroads, ports, airports and logistic hubs is immense, based on infrastructure quantity and quality indices of the World Bank and the World Economic Forum. By the same token, this backward situation is not for lack of resources, as the supply of both domestic and foreign funds has exploded during the last decade. Institutional investors, such as pension funds, fiduciary institutions or insurance companies, have been willing to finance long-term investments such as road concessions, as they have done in other countries such as Chile. Colombia’s regulatory framework for institutional investors has not been an impediment for such type of investments either. In fact, the critical bottleneck has been the lack of well-structured projects and the weaknesses of the Ministry of Transport and its related entities. The good news is that the administration of President Juan Manuel Santos has embarked on a dramatic shakeup of this ministry and has introduced a new approach to attract the resources of institutional investors within the context of a public-private partnership law recently approved by Congress (Law 1508 of 2012). The new approach to reforms is expected to finally close the infrastructure gap between Colombia and major trading economies in a globalized world. This paper is divided into five parts. Part one presents some indicators showing Colombia’s lagging infrastructure. Part two explains the dramatic increase in domestic savings, as well as in foreign direct investment coming into the country. Part three indicates that the regulatory framework concerning institutional investors has not been a bottleneck for the financing of infrastructure projects and points to the lack of well-structured projects and the weaknesses of the Ministry of Transport and it associated institutions. Part four highlights the new approach introduced by the administration of President Santos and stresses the reasons that it is attractive for institutional investors. Finally, part five concludes.

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Colombia’s Demand for Infrastructure Projects Colombia’s need for modern infrastructure projects is critical because the country has to connect its different regions with each other. It urgently needs to integrate into a world economy that is becoming globalized at an exponential rate. However, what has been a relatively easy historical task for other economies is a major challenge for a country that has one of the most rugged terrains on the planet and has its largest cities located very far from the oceans. Whereas Argentina has more than 1600 kilometers of paved roads per million people, Colombia has little more than 300. Indeed, Colombia even runs behind Ecuador and Bolivia according to this indicator (see Graph 1). Graph 1

As shown by the World Economic Forum, Colombia occupies 10th place in the infrastructure quality-gap index among the largest 12 Latin American economies (see Table 1). Together with Peru and Bolivia, Colombia is the country with the largest infrastructure needs in the continent.

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Table 1

In fact, Colombia’s infrastructure problems are particularly critical and concentrated in the transport sector. Thanks to an impressive set of policies and regulations introduced in the early 1990s, Colombia managed to accomplish a remarkable expansion of its infrastructure in the generation, transport and distribution of electricity. Thanks in part to the same policies that allowed the participation of the private sector in the provision of public services and in activities that were previously permitted only to the state, Colombia also saw a dramatic expansion of the oil, gas and telecommunication sectors. The expansion of these economic activities across the country also had to overcome the difficulties associated with one of the most rugged terrains on the planet, as well as those arising from the presence of insurgent groups like the Marxist guerrillas and the paramilitary organizations that appeared in the 1980s and 1990s. In fact, the same firms that have been so successful in developing this infrastructure network in the middle of enormous difficulties have also managed to expand abroad and become authentic Colombian multinationals. To give just one example, a firm like ISA (Interconección Eléctrica, SA), a publicly-controlled firm, is quoted in the stock exchange and has the private sector as a share holder. This firm is the major transporter of electricity in Colombia, is also the main transporter of electricity in Peru and is one the main actors in Brazil. Recently, ISA won a major contract in Chile and may become, in a few years, one of the main transporters of electricity in that country. Quite remarkably, an ISA subsidiary, Intervial, is already the largest road concessionaire in Chile, a country that has the best road infrastructure in Latin America.

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The Supply of Domestic and Foreign Resources While Colombia’s demand for road infrastructure projects remains huge, it is immensely paradoxical that there has been a large and growing supply of resources potentially ready to finance such needs. Several numbers confirm this reality. While in the middle of the nineties the size of the portfolio investment of the consolidated financial sector stood at $8 billion pesos, in June 2012 this figure amounted to $376 billion pesos. This number increased from 8% to 60% of GDP during the same period (see Graph 2). Of this 60% figure, the Colombian pension funds account for 20% of GDP, while the banks, the insurance companies and the fiduciaries account for the difference. Graph 2

Consistent with the evolution of the portfolio investments of the financial sector, the macroeconomic savings rate of Colombia increased from 12% to 24% of GDP between 2002 and 2012. This savings rate allowed the financing of an investment rate that reached 26% of GDP, the highest in recent Colombian economic history and one of Latin America’s highest rates. But as the mobilization of domestic savings exploded over the past decade, so did the supply of foreign savings, as measured by foreign direct investment (FDI). It is true that this phenomenon has not been particular to Colombia, as FDI has experienced a dramatic growth in recent years throughout the world. Whereas in the 1970s FDI was almost negligible, in the 1980s it accounted for a little less than 1% of the world’s GDP and increased to 3% during the last decade. In Colombia, the corresponding number was 4% of GDP. In 2011, US$12 billion arrived in the form of FDI and in 2012 this figure may reach US$15 billion (see Graph 3).

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Graph 3

In summary, while the demands and needs for infrastructure have been immense in Colombia, it is clear that supply of available resources has not been an obstacle for the financing of much needed projects in highways, ports, airports, railroads or logistical hubs. As domestic and foreign savings increased dramatically in the last few years, these resources went to finance huge infrastructure projects in oil, gas, electricity and telecommunications.

The Lack of Well-structured Transport Projects In Colombia, it is often mentioned that a principal reason for the lack of appropriate transport infrastructure is the impossibility for institutional investors to invest in highways, ports or airport projects. The truth is that there is nothing in the regulatory framework of the institutional investors that forbids them to channel resources to these types of projects. On the contrary, the legal and normative regulations have increased the opportunities for pension funds or insurance companies to participate in these activities. For example, the so-called Financial Sector Reform, introduced in Law 385 of 2009, expanded the possibilities for pension funds to direct resources into infrastructure projects. By creating the multi-fund system and forming three portfolios instead of just one, as had been the case, the new regulation allowed an increase of up to 24% of the value of the funds to be invested in vehicles that could be directed to infrastructure projects. Given the current size of the pension funds, this means that up to US$14 billion could be invested in this sector. So far, less than US$1 billion has been invested in transport infrastructure, of which half a billion dollars has taken the form of infrastructure bonds. These sums pale in comparison to the US$9 billion that has gone to infrastructure in other sectors, such as the

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already-mentioned generation, transport and distribution of electricity, oil and gas, and telecommunications. Based on the evidence already cited, policy impediments to the expansion of the transport sector must be uncovered within the transport sector itself. On paper, the transport sector could have taken advantage of a policy and a regulatory framework that allowed the participation of the private sector in the provision of public services and the construction and operation of infrastructure projects in other sectors. Indeed, during the administration of President César Gaviria (1990-1994), at the initiative of the government, Congress approved several laws that revolutionized the economic model by, among other things, creating the first public-private partnership (PPP) policy framework. As mentioned above, this new regulatory framework was successful in sectors other than transport. Therefore, the critical question that arises is: Why, since the early nineties, did the transport sector not benefit from these new policies? Roughly speaking, there are two answers to this important question: a short answer and a long answer. The short answer is that there was no development of transport infrastructure in Colombia during the last two decades because neither the builders nor the government was interested in its rapid expansion. As most transport infrastructure projects were financed by public funds that went to a few construction firms, there was a sort of happy marriage between the politicians and a few construction companies. The politicians could fully direct and decide which projects would provide the highest political returns in the regions and a relatively small number of construction firms would make sound private returns. It was a model controlled fundamentally by domestic constructors that required no long-term financing, let alone the participation of foreign investors and constructors. As the pace of development of the network of highways was very slow, the financing could come from the government budget and from road tolls paid by the customers of the roads. Or, conversely, if the financing allowed by the government budget and the tolls was tight, given the fiscal restrictions of Colombia during this period, the expansion of the road system was also restricted. The nineties and the first years of the 21st century were also periods of high levels of insecurity, which made traveling around Colombia very difficult and risky. In part, for the same reason, this was also a period of slow economic growth, which helps explain why the general public did not strongly demand better roads and other transportation infrastructure. With the 2000s came a new perspective. Security improved dramatically during the administrations of presidents Alvaro Uribe and Juan Manuel Santos. As foreign trade agreements were signed with Canada, the United States and the European Union, and as economic growth picked up and the economy regained investment-grade status, the demand for much better transport infrastructure became almost an obsession among economic, political and academic groups in Colombia. It has become clearer by the day that political patronage and clientelism should no longer dictate the path of infrastructure expansion. And this brings us to the second and more complicated answer to the question as to why Colombia has so far been unable to have a world-class transport infrastructure. Although on paper Colombia had a PPP model for almost two decades, in practice it was an arrangement that was fundamentally dependent on, and funded by, the government. In fact, it was a model that should have allowed a massive participation of the private sector in the preparation of projects, construction, operation and maintenance of the

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transportation infrastructure. Since, in principle, both the domestic and foreign private sectors faced no financing constraints as tight as that of the government, the result should have been a significant expansion of the highway network, as well as the construction of new ports, airports and railroads. Such an outcome did not materialize for a number of reasons. First, the Ministry of Transport allowed open-bidding processes without complete technical studies estimating the costs of the projects and all associated risks. These included geological, environmental and legal risks, as well as those risks linked to the disruption of public utilities, such as sewage systems or electricity lines, during the construction process. Second, the model favored the lowest bidder and allowed, without much restriction (and with very bad excuses), the renegotiation of contracts by the winning parties. Such renegotiation often included more public resources, a reduction of the length and size of the projects and longer periods of concessions. And third, and perhaps most outrageous, the model allowed resources to be advanced to the construction companies (from the government budget or from the toll flows) even before construction on the projects had begun. In summary, the actual infrastructure model that prevailed during several years in Colombia minimized the provision of equity and leverage financing by the private builders and concessionaries; transferred all major risks to the government; slowed the pace of much-needed infrastructure and wasted scarce public resources. All of this was made possible by a very weak Ministry of Transport and its related entities, such as the Institute of Concessions, INCO (now eliminated) and INVIAS, the public works institute. These bodies were extremely inept. For example, they had no capacity to monitor properly the development of the projects, nor could they make an appraisal of the value of the toll flows. Both the ministry and the associated bodies were staffed with political appointees, sometimes recommended by the same concessionaries whom they should have supervised. As the Colombian media has consistently pointed out and denounced, these entities were routinely hit by scandals and corruption. For example, eight out of the nine directors that INCO had during the 2002-08 period ended up in jail or in court. One of the first decisions taken by the administration of President Juan Manuel Santos, as soon as he took office, was the liquidation of INCO and the creation of a new institution, ANI, the National Infrastructure Agency.

The New Policy and Regulatory Framework The administration of President Santos has decided to overhaul the transportation infrastructure framework in Colombia. It plans to invest up to US$23 billion in the next five years, which amounts to double the investment that Colombia made in infrastructure over the last two decades. The government is aware that to reach this ambitious new goal, the old ways will not do. High economic growth and an ever-increasing foreign trade sector require Colombia to close the infrastructure gap with trading partners without delay. With tight fiscal restrictions, the only way to reach this goal is with the active participation of the private sector. With this ambitious goal in mind, the government sent to Congress, and received approval of, a new Public-Private Partnership Law redefining and stimulating the participation of the private

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sector in the construction, finance, maintenance and operation of infrastructure assets in Colombia (Law 1508 of 2012). The new model has the following characteristics: 1) Bidding processes should be opened in projects with reliable studies estimating construction costs and risk assessments. Such risk assessments include geological, environmental and legal risks, as well as those arising from land acquisitions and the intervention of public infrastructure such as sewage systems. 2) The contracts within the regulatory framework should clearly define the provision of public resources, the provision of equity and leverage by the concessionaire, the distribution of risks between the government and the concessionary, and the duration of the concession. The provision of equity should equal at least 20% of the cost of the project and all major risks are to be assumed by the concessionaire, except in the case of tunnels, where the risks will be shared between the concessionary and the government. The concessionary will be obligated to insure for construction and related risks. 3) No funds, whether in the form of toll flows or allocations from the national budget, will be paid to the concessionaire until the completion of a project’s previously-determined functional units of construction. This means that so-called advances to the concessionaires are eliminated. Likewise, additions to already-existing contracts can be no higher than 20% of the total cost of the project and will be approved under very strict conditions. Given that the government plans to invest up to US$23 billion in the next six years, equity financing amounting to US$4.6 billion will be required. Perhaps US$1 billion could be raised among Colombian investors. This means that a huge effort will need to be made to attract foreign direct investment into the transport sector. If successful, this would represent an important cultural change within a sector that has been largely dominated by Colombian construction companies and investors who had tacitly resisted the participation of foreign firms in significant numbers. Given the government’s ambitious goals and the amount of resources required to finance this effort, it is clear that the participation of foreign investors is not only necessary, but also needs to be stimulated. Colombia, therefore, has to emulate Chile, where out of the twelve largest road concessionaries, eleven are foreign firms. It should be emphasized that the most important concessionaire, in terms of the number of kilometers involved, is the Colombiancontrolled Intervial, a subsidiary of ISA, a so-called multilatina. Finally, pension funds and other institutional investors are expected to participate only in the operational phase, and not in the construction phase, of projects. As these transport projects are highly-leveraged investments, in order to encourage the participation of institutional investors, ANI is designing a new asset class (infrastructure bonds). These bonds, which will be issued as soon as component units of the projects are completed, will be issued against traffic revenues and, where needed, budgetary annuities. Since these bonds will bear some of the projects’ risks, they will not be considered part of the public debt.

Conclusions The administration of President Juan Manuel Santos has embarked on a dramatic shakeup of the ministry of transport and its related institutions and has introduced a new policy framework to attract the resources of domestic institutional investors as well as of foreign investors into the transport sector. The determination and decisiveness shown by the Santos administration is

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expected to finally start closing the infrastructure gap between Colombia and major trading economies. This is very good news because Colombia urgently requires better roads, railroads, ports, airports and logistic hubs if it wants to compete in the world economy. The gap with trading partners is immense, according to the infrastructure quantity and quality indices of major organizations such as The World Bank and the World Economic Forum. Such a backward situation is paradoxical, for it is not due to the lack of resources: the supply of both domestic and foreign funds has exploded during the last decade and institutional investors, such as the pension funds, fiduciary institutions and insurance companies have been willing to finance long-term investments in transportation infrastructure. Colombia’s regulatory framework for institutional investors has not been an impediment for such investments. The critical bottleneck has been the lack of wellstructured projects and the weaknesses of the Ministry of Transport and its adjacent entities. As the government starts correcting these shortcomings, Colombia will see in the coming years a dramatic improvement in its transport infrastructure. With better roads, ports, airports and logistics hubs, GDP and employment will grow at higher rates and the economy’s competitiveness will improve. This will help reverse the loss in competitiveness that the tradable sectors have experienced in response to the massive inflow of foreign resources due to the oil and mining booms of the last decade. The lack of adequate transport infrastructure is not the only problem Colombia has to solve, but overcoming this bottleneck would be a decisive step in positioning the country to better face other major challenges in the years to come.

Santiago Montenegro is president of the Asociación Colombiana de Administradores de Fondos de Pensiones y Cesantías (ASOFONDOS). From 2002 to 2006, he served as general director of Colombia’s National Planning Department. Previously, Dr. Montenegro was president of the Asociación Nacional de Instituciones Financieras (ANIF) and, before that, dean of the School of Economics at Universidad de Los Andes. He has also worked as an economist for the World Bank. Dr. Montenegro was a visiting fellow at the Center for Hemispheric Policy in 2008. He currently sits on several boards, writes a weekly column for El Espectador, and is the author and editor of several books, the latest ones being Crisis mundial, protección e industrialización (2007) and Sociedad abierta, geografía y desarrollo (2006). All statements of fact or expression of opinion contained in this publication are the responsibility of the authors.

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