Building confidence: Major infrastructure deficits drive sector growth

If physical structures reflect the process of building a strong economy, then Peru has engaged in related programmes with a passion that should continue for many years to come. According to the National Statistical Institute (Instituto Nacional de Estadística e Informá tica, INEI) the sector grew by 15.17% in 2012, far more than the 3.43% recorded in 2011. The sector continued to grow at a rate of 15.64% as of the first half of 2013. Investor confidence and trust has returned after the initial uncertainty over President Ollanta Humala’s attitude towards the business community following his victory in the 2011 elections. President Humala has repeatedly expressed his support for investors and has displayed a similar commitment during the first part of his term in office, with a positive impact on the real estate market. Investment for current projects rose by 5.79%, notably in areas where large deficits have persisted, such as housing and infrastructure.

Infrastructure

Significant economic growth as well as increased participation in global markets have prompted Peru to improve its infrastructure, which has generally lagged behind development.

In 2012 the Association for the Promotion of National Infrastructure (Asociación para el Fomento de l Infraestructura Nacional, AFIN), along with the Universidad del Pacífico and the Universidad ESAN, published a 500-page study which noted that investments estimated at $88bn would be required to close infrastructure gaps. Transportation, energy, water management, telecommunications, health and education are the main sectors targeted for improvements to place the country on a competitive level with regional neighbours and fully integrate the population into the development process. According to the World Economic Forum’s (WEF) “2013-14 Global Competitiveness Report”, Peru was ranked 91 out of 148 nations in the category of infrastructure, behind neighbouring Chile (46), Brazil (71) and Ecuador (79), but ahead of Bolivia (111). For Ernesto Tejeda, president of local construction firm Obras de Ingeniería (Obrainsa), the needs are urgent and require improved collaboration. Indeed, public-private partnerships (PPPs) have proven a successful model that the country will continue to apply when addressing such shortfalls. With a number of concession projects in the pipeline, developers and authorities are making preparations to avoid large bottlenecks. The Ministry of Transportation and Communication (Ministerio de Transportación y Comunicación, MTC) has forecast investments of some $11bn in transportation infrastructure projects until 2016.

Transportation

Of the total infrastructure investment needed for these projects, nearly $21bn is attributed to transportation, including highways, railways, airports and ports. Relieving the traffic congestion in Lima alone is a particularly expensive and challenging task. One major effort to get the capital on the move is the metro system’s Line 1 extension, which will run from the Rímac River towards San Juan de Lurigancho in the north, the capital’s most populous district with around 1m inhabitants. The extension is set to be completed in early 2014 and operational by April.

Line 2 of the metro system, planned to cover 35 km and 13 districts, will be put out to tender through the national investment promotion agency, ProInversión, in the first quarter of 2014, with estimated investments amounting to $6.5bn. As of August 2013, 35 companies had already acquired rights to participate in the bid. Concessions of the remaining three lines should follow shortly and, as with many large projects, are all being promoted under a co-financing model.

Outside Lima, the country’s mountainous terrain and abundant jungles present significant natural challenges for those wishing to travel by land, which only a decade ago had not formed a central part of development plans. Several highway networks connecting ports with internal production areas and neighbouring countries have already been constructed thanks primarily to the Initiative for the Integration of the Regional Infrastructure of South America (IIRSA), launched in 2000 (see analysis). However, priorities extend to the improvement of other major highways and roads in order to boost connectivity between provincial cities, as urban growth is expanding potential trade routes.

While most materials for highway construction are locally sourced, Peru’s complicated topography can present special conditions for which certain parts and materials must be imported. Brazilian developer Odebrecht learned this in the field when constructing the IIRSA Norte highway in northern Peru, which traverses mountains within the Andes, Amazon and Escalera.

Ronny Loor, director of investment for Odebrecht’s IIRSA projects, told OBG that the adverse weather required for certain chemicals to be imported in order to strengthen pavement and prefabricated sections of highway that were used on unstable slopes.

Another remarkable engineering feat is the Billinghurst suspension bridge, located in Madre de Dios, for which all the parts had been prefabricated abroad, shipped in and assembled on site.

Ports

Meanwhile, the WEF’s “2012-13 Global Competitiveness Report” scored Peru 3.7 out of 7 in port infrastructure quality, placing the country fifth in South America and at 93rd internationally.

Peruvian seaports are currently undergoing major remodelling as a means to boost access to foreign markets, especially those in Asia-Pacific. The largest and busiest port, at Callao, contains five docks, two of which are currently operated through concessions to major international firms Dubai Ports World (DPW) and APM Terminals. In March 2013 the northern dock, tendered to APM in 2011, began construction on a major modernisation project that includes total investment of $730m. Spanish-Peruvian developer FCC-JJC has been hired to carry out the first two stages of construction, which amount to $307m and are expected to be finished by January 2015. APM expects to generate approximately 500 new jobs during the construction phase (see Transport chapter). DPW’s southern dock is also being expanded. This dock is the port’s largest and handles roughly 70% of containerised cargo. DPW invested $600m to enlarge the dock in 2010 and planned to invest upwards of an additional $100m in 2013 to add access roads and dredge the harbour. In July 2013 the group added three gantry cranes valued at $6m, boosting cargo handling capacity by 75%.

Of the remaining 133 port installations in Peru, several are up for concession through ProInversión. For example, this is the case with the southern seaport of General San Martín, which is currently administered by the National Port Authority (Autoridad Portuaria Nacional, APN). The port is carrying out repairs after a 2007 earthquake damaged installations.

Concessions

Located in the district of Pisco, the port provides an alternative to Callao and is being pushed as a complement to work in progress at the nearby airport. The accessibility of the Panamericana highway also increases expansion potential, according to ProInversión, which estimates total investment of $101m increased for the port. Similar projects are in the planning process for ports in southern San Juan de Marcona and northern Salaverry, both of which will soon be tendered by ProInversión. In general, improvements to seaport infrastructure tend to be directly linked to recent highway construction and restoration carried out by the IIRSA projects. These provide new channels for the transportation of products both within the country and to regional neighbours.

The other major port concession in ProInversión’s portfolio is slated for the northern region of Loreto, encompassing river dredging and the construction of a network to ensure more efficient navigation along the Amazon, Marañón and Ucayali rivers. This project will complement sustainable development projects in the Peruvian Amazon, in doing so assisting both the industrial and tourism sectors (see Tourism chapter). Investments are estimated to total $74.2m and a bidder will be chosen by the first quarter of 2014. A new river port for the city of Pucallpa, located in the Ucayali region, is also undergoing technical analyses, which will be followed by a likely concession.

Air

Several projects to expand Peru’s airports are also under way. Possibly the most significant is the expansion of Lima’s Jorge Chávez International Airport. The airport is run by Lima Airport Partners, which itself is 70.01% controlled by the German transportation company Fraport. The enlarged facility will raise annual passenger capacity to around 30m – the airport han dled 13m people in 2012 – by adding almost 7m sq metres of land for a new runway, second terminal, control towers, hangars, maintenance areas and offices.

With investment that could reach as high as $850m, work was on the verge of commencing at the time of publication and should be complete by 2016.

Another major airport development includes the greenfield construction of the Chinchero-Cusco International Airport, currently up for concession through ProInversión. The project requires an investment of around $659m and will be awarded by February 2014, with operation and maintenance lasting for 40 years. The purpose of the new airport is primarily aimed at further enhancing the potential for tourism to Cusco and Machu Picchu (see Tourism chapter).

In southern Peru, renovation of Pisco’s airport began in September 2012 and is widely expected to be completed by 2015. As a former military airport, much of the necessary infrastructure is already in place, reducing both the amount of work and investment, which amounts to approximately PEN153m ($57.62m).

The company in charge of the concession, Aeropuertos del Perú, formed a corporate alliance with the MTC in 2006 to operate, maintain and develop a series of provincial airports in the country, initially involving nine locations and later extended by three more. These works cover the cities of Anta, Trujillo, Chiclayo, Piura, Talara, Tumbes, Cajamarca, Chachapoyas, Tarapoto, Pisco, Iquitos and Pucallpa. Although they may be minor in comparison to developments in Lima and Cusco, these projects are crucial for national integration and cater to both commercial and cargo flights.

Energy

Making up 37.5% of the estimated infrastructure deficit, energy is an important element for Peru and its sustainable generation will require nearly $33bn in investment, according to estimates provided by AFIN. One of the most important goals on the current government’s agenda is to expand the domestic use of natural gas, of which the country has abundant reserves. These are largely located in the Camisea gas fields in the south-east of the country. In order to carry through with these ambitious plans, proposals to construct gas pipelines have increasingly come to the fore over the past couple of years (see Energy chapter).

For instance, in 2008 local developer Kuntur (owned by Odebrecht) was granted a concession co-financed by the state to construct the Gasoducto Andino del Sur (GAS), planned to run from Camisea to all major cities in southern Peru and along to the coast for export purposes. However, during the planning stages, initial investment estimates for the gas pipeline of $1.3bn rose to around $5.5bn, and construction delays prolonged the project for years, leading the current administration to pull out of the deal and redesign a new project, similar to that by Kuntur. In fact, the Ministry of Energy and Mining announced in late 2012 the creation of the Gasoducto Sur Peruano (GSP), which would run essentially the same route as that proposed by Kuntur.

Up for concession in February 2014 by ProInversión, with an estimated investment of $250m, this project is a key addition to the country’s energy grid, but will be costly and require precise engineering techniques given that the lines will cross both tropical lowlands and the Andes. A project of this size requires thorough environmental impact studies, which Kuntur had already drafted. It is not known if Kuntur has bid for the GSP project, the winner of which is scheduled to be announced in February 2014. Since the issue is controversial, many sector specialists are reluctant to provide specific comments on the situation, offering only the general consensus that the authorities need to insist on strict quality control for infrastructure development. Despite mishaps from both the public and private sectors regarding this initiative, natural gas does provide an abundant local source of energy for the country, and domestic transportation capacity via pipelines will need to be improved soon.

ProInversión is already promoting three other concession projects for smaller gas pipelines that should find developers by the end of 2013. Isabel Roncal, an investor services consultant at ProInversión, is optimistic. “Our disadvantage is the large infrastructure gap, but this is also an advantage for investors because we need to close that gap,” she told OBG. This sums up the general sentiment within the construction industry, which is using increasingly sophisticated technologies and turning out high-quality products, albeit at prices that are still relatively low for the region.

Materials

Prices for building materials have remained stable over the past couple of years with very few significant dips or rises. From April 2012 to March 2013, the average prices of construction materials as a group (including wood, cement, bricks, metals, glass and glues) fell by 0.89%, according to the INEI. Following exchange rate fluctuations, INEI later reported that materials prices had risen by about 2.1% in January-July 2013 and 1.01% year-on-year in July. In terms of production, however, trends have largely been on the upswing. One of the most common sector indicators is cement consumption, which has been rising solidly, and local companies are looking to consolidate national production in the near future (see analysis). As local demand continues to increase, between 97% and 98% of Peru’s national production currently ends up in the domestic market, Carlos Ugás Delgado, director-general manager of Unión Andina de Cementos (UNACEM), a leading local cement producer, told OBG. In other key areas, the production of steel bars rose by 17.8% over 2012, after showing mainly negative growth patterns the previous year. Much of this expansion is linked to the construction of infrastructure projects. However, such is the demand that the two leading companies, Aceros Arequipa and Siderperú, cannot meet it, generating imports and driving up costs. ProInversión’s Roncal told OBG that both companies are likely to expand operations, but such significant demand could also provide room for other players to enter the market. Alongside the evolution of building techniques, other cost indicators are also emerging, including for instance the growth of ceramic products. While in 2006 tiles averaged PEN17.65 ($5.25) per sq metre, by February 2013, the average price had risen to PEN21.87 ($8.24). Roncal said an important national industry is emerging for finishes, led by firms such as Cerámica San Lorenzo, which tend to cater for the high-end housing segment. According to Roncal, investments of $7.5bn have been announced by consolidated industrial firms, most of which produce for the construction sector.

Labour

Construction has attracted many manual labourers over the past several years largely due to growing salaries within the sector. While the minimum wage is currently set at PEN750 ($282.45) per month, construction workers on average make double that and skilled professionals can earn much more. The basic wage for construction workers has increased 5.9-7.2% depending on position for 2013-14.

However, Peru is short of skilled workers, a situation that has not changed for several years despite private and public initiatives to generate a more technically proficient workforce. “The boom in construction requires that permanent training take place for qualified workers to participate,” said Herles Loayza Casimiro, head of statistics at the Peruvian Chamber of Construction (Cámara Peruana de la Construcción, CAPECO). “The country specifically needs more operators of heavy machinery and specialised electricians,” he added.

Efforts to improve the situation regarding qualified labour have progressed through technical training programmes and institutes, such as the National Training Service for the Construction Industry, which covers both young students and workers already on the job. From the private sector, CAPECO runs a similar technical training college. Despite the ongoing training programmes, Tejeda is less optimistic. “The lack of qualified personnel due to the increased demand in the construction industry means that efficiency is lower and costs are higher, which is an issue already quite evident in the industry.” He told OBG that this challenge should be confronted with more aggressive state policies that support initiatives but also work closely with the private sector, which knows the terrain better. Tejeda believes union power manifests itself most within the civil construction industry, and that this is a political legacy inherited from the Revolutionary Government of the Armed Forces that controlled the country for parts of the 1960s and 1970s. “Construction is the only sector that has maintained a strong national union force, which makes its influence felt in the yearly pacts that require all companies to adhere to specific regulations, irrespective of whether the company has good relations with its workers,” he said.

Timid Incentives

While the government tends to shun subsidy policies in most sectors, its support has been shown by different methods. The primary incentive programme, Public Works for Taxes (Law No 29230), Obras por Impuestos in Spanish, eliminates taxes on companies that construct additional projects for social benefits, such as schools, parks and roads, among other public infrastructure. “This initiative brings dynamic factors to the construction sector,” Roncal told OBG. “The government benefits because it is a service to the community and companies benefit because they create a presence in the community.”

However, according to CAPECO, the procedures that are involved in implementing this programme can sometimes be more complicated than they first appear. For instance, Loayza told OBG that a number of companies have chosen not to participate because a lack of organisation surrounding the application procedures causes delays. “The time it takes for developers to go through the entire application process ends up being more of a cost than simply paying taxes,” he said. “If the construction were immediate, the initiative would probably be more popular.”

In addition, the National Public Investment System (Sistema Nacional de Inversión Pública, SNIP), through which all public infrastructure projects must be channelled, does not keep pace with the demand of work to be done in the sector, according to Loayza.

“The SNIP is a bureaucracy and does not have the dynamism or motivation required for development,” he said. Monitoring public investments is one of the tasks that SNIP should perform but the results do not reflect well on its work, he said. “In Lima and especially in the provinces, some municipalities do not invest 100% of their budget,” Loayza said, adding that in some cases only 30% of municipal budgets were spent on projects for the public benefit. The rest goes unused not because of theft or corruption but because of delays and bureaucratic inefficiencies. “It is a situation that has existed for some time and needs to be resolved if we are going to continue developing,” he said.

The status quo is expected to improve with the appointment of César Villanueva as prime minister in October 2013. Villanueva’s appointment was widely welcomed given his reputation for removing bureaucratic bottlenecks to business activity when he was president of the San Martín region.

Water

Of all the obstacles facing the sector, one of the most commonly cited is water management, an enterprise run by the state through municipal companies in the provinces and Sedapal in the Lima metropolitan area. In Lima alone, around 1m people, or 10% of the city, do not even have access to running water, according to government estimates. In addition, much of the population has service restricted to certain hours of the day. Government goals for the short term include increasing access to drinking water in urban areas from 89% to 92%, and in rural zones from 39% to 57%, by 2016. To ensure success, these achievements are estimated to require an investment of $5.2bn.

The sector specialists interviewed by OBG do acknowledge that the privatisation of water services, or at least a measure of private participation in their provision, is necessary to improve living conditions and sustain urban development. While the private sector points to sub-standard public administration, the Ministry of Housing, Construction and Sanitation (Ministerio de Vivienda, Construcción y Saneamiento, MVCS) attribute most problems to financing. This issue has significantly affected the industry since many projects are unable to proceed if no water services are available.

According to Gonzalo Sarmiento, CEO of Centenario, a local real estate developer, “The government does not do enough to expand the water network and repair deficiencies, which impedes the construction and sale of houses, offices, and land plots. Water is wholly controlled by Sedapal, the state-owned entity, which does not have sufficient funds for effective enlargement of the system. A PPP between the private sector and Sedapal could ensure that a lack of water does not continue to hamper private investment and development.” CAPECO’s Loayza believes Sedapal has proven unable of maintaining a quality of service commensurate with its responsibilities, especially for housing projects.

For example, when a house is demolished in order to construct an apartment building in its place, the existing water pipes are often insufficient for the number of apartments planned and require upgrading, a service that Sedapal is reluctant to carry out, he claimed.

“This investment should be paid for by Sedapal, but often the bureaucratic procedures are so long that companies end up covering the costs,” Loayza told OBG, attributing the underlying cause to insufficient public infrastructure financing and an inability to pinpoint short-term basic needs. “As long as the state alone is managing this service, the shortage of access to potable water and wastewater services is unlikely to improve,” he said. Responding precisely to these sorts of issues, CAPECO has for years campaigned for more private participation in water management, and these efforts may be beginning to bear fruit.

Carlos Lock, chief of housing at the MVCS, told OBG that the government is reviewing several proposals from firms to take part in a pilot project for private water management. Many details have yet to be worked out and no specific plans have been made public. PPP initiatives for water management have already been attempted under previous governments, albeit with few positive results. However, growing demand may push the Humala administration to consider private options.

Municipalities

One major issue affecting the industry involves local municipalities, which are autonomous and oversee the issuing of construction permits. According to Luis Tagle Pizarro, national director of urbanism at the MVCS, many municipal authorities do not facilitate projects since they have separate visions of development that do not extend beyond the boundaries of their own jurisdiction, thus hindering urban growth. “Lima metropolitan area has more than 40 municipal districts, translating into more than 40 independent authorities,” Tagle told OBG, adding that this is a formula for bureaucratic disorganisation and disunity. By contrast, the offices that handle building and zoning in neighbouring Chile have a standardised approach, meaning administration, procedures and costs are the same from municipality to municipality.

The independence of municipalities presents some particular challenges for the construction sector because of the use of land, which is also rapidly increasing in value. Although many municipalities have become increasingly politicised in recent years, Tagle remains confident that the central government will soon be able to make structural changes to remedy such conflicts and improve efficiency. He also defended the contribution of private investment. “Our cities have not changed because of the work of mayors or local authorities,” he told OBG. “Our cities have changed through private investment, which provides a new face for urban centres. The competition generated by this private sector activity has greatly improved the standards for construction on all levels,” he said.

Outlook

CAPECO forecasts that construction will continue its dynamic growth course for at least the next five years. The work required to close large gaps in infrastructure will provide ample activity for the sector and benefit overall economic performance as the channels for trade and production improve.

PPPs appear to be the favoured model for the development of public works, combining private expertise and financing with state assistance. However, these models may need to set their sights higher, with the aim of attracting more investors and developers to achieve the goals set by authorities. Along these lines, incentive programmes would need to be redesigned to draw the attention of developers and make an impact.

In addition to these needs, the effects of activity in the construction sector can also be seen directly in various other industries that provide materials as well as in the labour force. These factors can help to generate local support, which often has considerable influence, including the ability to sway decisions regarding controversial investment projects, especially with regards to extractive industries. Although obstacles related to water management and land remain the largest pending issues affecting projects, the sector is unlikely to slow down because of them. Overcoming these barriers will require the creation of more efficient institutions through which investments and development can fully prosper. And various indicators suggest that such benefits may not be too far around the corner.