Infrastructure plans in Colombia to increase building activity

With plans set to modernise transport networks and government-led housing programmes expanding the availability of homes, Colombia’s construction sector remains an essential part of the economy.

Although the macroeconomic environment has required the government to exercise fiscal discipline, which may cause several projects to be postponed or delayed, it is unlikely that the ambitious infrastructure plans will be fundamentally changed. This, coupled with real estate expansion taking place across many Colombian cities, is set to drive sector growth in the coming years. However, the internal and external environment has the potential to impact costs, while more limited access to financial resources could lead to caution from construction players.

Size

The sector’s pivotal role is based on its underlying economic effects. Construction has a direct impact on more than a third of Colombia’s productive segments through high demand for inputs.

The sector accounts for around 7.5% of GDP. It is divided into two large segments, infrastructure development – worth around COP55trn ($16.5bn) annually – and real estate development, which, according to the Colombian Chamber for Construction (Cámara Colombiana de la Construcción, CAMACOL), adds another COP60trn ($18bn) to the sector’s value.

Although the segments’ contribution to GDP is close to equal, it is likely that the implementation of the Fourth Generation Toll Road Programme (4G) – which is set to see the construction of 40 highway links across Colombia at a total investment of $24bn – will accentuate the weight of infrastructure development in the sector’s GDP over the coming years.

Having to adjust to the same conditions that brought instability to other sectors of the Colombian economy, the construction sector expanded by 4.1% in 2016, which is above the national GDP growth rate of 2%. The expansion of construction output was largely due to an increase in real estate building, which rose by 6%, and to a lesser extent the building of infrastructure, which expanded by 2.4%, according to local media reports. The sector is also an important provider of employment, accounting for 1.4m jobs, or 7% of the workforce, according to CAMACOL, with the building and real estate segment accounting for a larger slice of employment than infrastructure.

Housing Investment

Expansion of housing programmes has contributed considerably to the sector’s performance. In 2016, 178,300 homes were sold in the market, adding a total of 12.3m sq metres, according to CAMACOL. Around 225,000 new homes are built every year, and the expansion of intermediate cities has helped to maintain absorption levels.

Government support has been especially relevant to giving lower-income Colombians the chance to own a home. A free housing programme has already channelled COP4.4trn ($1.3bn) to build 100,000 homes for the poorest Colombians, and a further COP1.7trn ($510m) was assigned in early 2016 to build an additional 30,000 homes. Another housing scheme allocates a mixture of initial payment subsidies and interest rate subsidies to allow middle-income Colombians to be able to acquire a home (see analysis).

Infrastructure Gap

Housing development has grown in line with economic development. However, Colombia is still affected by deficiencies in infrastructure as well as high logistics costs. These weaknesses are costly for the entire economy, making business operations more expensive and negatively impacting the competitiveness of Colombian companies. Acknowledging this, successive governments have given primacy to long-term infrastructure development efforts. Ana Carolina Ramírez Pineda, director of economic affairs at the Colombian Chamber for Infrastructure (Cámara Colombiana de la Infraestructura, CCI), estimates that average annual public expenditure on infrastructure as a percentage of GDP has increased from 0.5% in 2010 to 2.5% at present.

Laying Down The Law

Spending has also become more fruitful. Although the country has more than 25 years of experience in public-private partnerships (PPPs), regulation has been improved to secure more robust protection for the state and to promote more efficient spending of public funds.

Analysis by the National Department of Planning (Departamento Nacional de Planeación, DNP) of 25 concession deals from 1993 to 2010 found there had been an average of 20.5 renegotiations, with an average added cost of $266.8m and an extension of six years of concession times, per PPP deal. This represented additional costs of $5.6bn to the state.

The passage of Law No. 1508, Colombia’s first PPP Law, in 2012 created a new regulatory framework to structure important PPPs. The law established some key principles; instead of financing pre-construction of projects, the state started to pay the private contractor only for previously determined functional sections of projects. The projects are now required to have an adequate risk and socioeconomic impact analysis, and over-budget costs have been capped at a maximum of 20% of the total cost of a project.

Changing the law has also resulted in more efficient use of capital investment in infrastructure projects. “Before, pre-construction was done with public resources via anticipated payments to contractors,” Fabio Villalba Ricaurte, director of the PPP unit at the DNP, told OBG. “Now, that doesn’t happen, and as a result things move faster. Project costs are advanced by the contractor. This means that they have to answer to the financial system, which is generally more efficient in recouping those resources than the state.”

Another notable change to regulations was the inclusion of a scheme that allows private companies to pitch PPP infrastructure development projects to the government. Most of these are self-sustainable, but the law permits state participation in some cases – capped at 30% of the total cost of general infrastructure projects and 20% for road projects.

In addition to its importance in attracting private investment into social infrastructure, the private initiative scheme has had an impact on the development of road projects. As of November 2016 the National Agency for Infrastructure had already awarded 10 private initiative projects, and was studying the feasibility of an additional nine, amounting to a value of over COP8trn ($2.4bn). Recent private initiative projects approved by the government include the Neiva-Girardot road connection awarded in September 2015 at a cost of COP2trn ($600m) and the Buga-Buenaventura link, which was awarded in May 2016 and is estimated to cost COP3trn ($900m), according to DNP figures.

Transport Upgrades

In addition to the significant investments and economic impact expected as a result of the 4G programme, a number of other major infrastructure plans are set to keep the sector working at full capacity. Chief among them is the Master Plan for Intermodal Transport, which could see as much as COP208trn ($62.4bn) flow into infrastructure between 2015 and 2035 across all modes of transport. Up to COP182trn ($54.6bn) is allocated for almost 20,000 km of roads and highways. The country’s airports, meanwhile, will receive as much as COP16trn ($4.80bn) for building and expansion work at 31 locations. Priority will also be given to river transport in order to expand passenger and cargo capacity through the Fluvial Master Plan, which is estimated to cost COP8.8trn ($2.6bn). Additionally, rail networks will receive an investment of COP$10trn ($3bn).

Although financing for the large number of projects the country is aiming to develop has not been secured as yet, setting priorities has been important in order to establish a focus on long-term development. “Having sectoral master plans ensures that critical projects are not left at the whim of any specific government,” Villalba Ricaurte told OBG.

Key transport infrastructure projects to be put out to tender in the next two years include the first line of the Bogotá Metro and the El Dorado II airport, also located in the capital. The central government has committed COP9trn ($2.7bn) to support the construction of the metro in Bogotá, with the remainder to be funded by municipal authorities.

The government has also announced that while the railway and rolling stock will be tendered as a public works project, the individual stations will likely be constructed through a series of PPP agreements.

With capacity filling up faster than expected at Bogotá’s El Dorado International Airport, initial studies have begun for the city’s second airport, El Dorado II, planned for the outskirts. Construction is expected to cost up to COP1.4trn ($420m), with the tender for the project likely to be launched in 2018.

Power & Water

Other sectors are also set to present opportunities for the construction sector over the medium term. Although electricity coverage has progressed considerably, increasing from 76.1% in 1995 to 96.7% by 2014, the government has estimated that reaching full coverage will require an additional COP4.3trn ($1.3bn) to be invested in transmission and distribution infrastructure. Water distribution will also require further investment, especially to expand access in rural areas, which currently have overall coverage of 73%, compared to 97% for urban areas. An estimated COP29.2trn ($8.8bn) will be needed up to 2030 to establish full coverage, improve treatment facilities for potable water and reduce wastage in the country’s water distribution systems. A further COP14.2trn ($4.3bn) of investment will be required for basic sanitation infrastructure.

New Mechanism

Gradual improvements in regulation have had a positive impact on construction of infrastructure and real estate. One recent addition was the Obras por Impuestos (Projects for Taxes) law announced by the government in 2016 as part of that year’s fiscal reforms. Similar to a programme implemented by the Peruvian government, the new law allows firms operating in the country to pay up to half of their corporate tax by investing in infrastructure projects. The regulation is partly designed to accelerate the development of basic and social infrastructure in some of the areas affected by the civil conflict. Projects were previously approved by the DNP and the Agency for the Renovation of Territory, and will centre on sanitation, health and the provision of electricity. Although the overarching law was approved, its specific implementation will still depend on a series of decrees to be announced in 2017.

“The law needs additional regulation so we can understand how it will work. We don’t just want it to be used as a mechanism to delay project execution or increase costs on projects,” Ramírez Pineda told OBG.

SME Support

The coming years are expected to see an acceleration of activity in the sector. However, some requirements of the large-scale infrastructure projects might put added strain on the financial health of construction firms. “It is important for companies to capitalise themselves, because after the 4G road projects a lot of them became undercapitalised,” Ramírez Pineda told OBG. “The equity demands of the programme were high, and they were necessary investments, but now the companies need to strengthen their capital position. One good way to do this might be to get international partners.”

The project pipeline will also be crucial in sustaining the sector’s small and medium-sized enterprises (SMEs), although unlike the larger firms in the market, construction SMEs are more focused on the smaller projects being implemented by regional authorities. Construction of small bridges and the modernisation of water, electricity and gas connections are a lifeline for these companies. “SMEs need to be seen by authorities from a company perspective, so that programmes for innovation as well as access to technology for the small players in the construction sector are established,” said Ramírez Pineda.

Galvanising the sector’s smaller players might require adjustments in regulation. As the state remains SMEs’ main customer, easing their way into projects will be crucial. Ramírez Pineda believes one necessary measure is to revise the selection criteria in the majority of tender processes, which is sometimes arbitrarily made to benefit specific companies. “It is very discretionary as the hiring entity has a lot of power to determine the criteria, which can put some of these companies at a disadvantage,” she said. “Many of them have stopped going after government tenders, and [are] resigned to being providers to the bigger companies.” The CCI and other market observers have been lobbying authorities for the establishment of standard bidding requirements for companies to be able to compete equally for contracts. The issue is especially constricting regarding the tendering of contracts in the regions where local authorities can set up specific conditions for the benefit of certain firms. Jorge Eduardo Rojas, the minister of transport, told local media in October 2016 that a majority of tenders are designed for specific companies, which end up being the sole competitors for a project.

Currently under discussion in the Senate is a law that would allow changing regulation regarding contracting rules for government tenders. The law includes the establishment of standardised bidding procedures and requirements to prevent local authorities from establishing bidding conditions that favour particular firms. “If this is implemented there will be less room for discretion, which will open more opportunities for companies and for competition in general,” said Ramírez Pineda. Establishing fairer and more transparent bidding rules is especially relevant in 2017, when a number of projects are set to advance, as regional authorities start implementing their budgets.

Corruption Probe

Reducing room for corruption has become a critical sector topic. The high-profile case involving Brazilian construction firm Odebrecht, which was found guilty of bribing government officials in several countries, has had an impact in Colombia. As of January 2017 the firm was reportedly attempting to settle corruption cases in 12 countries, and had already announced that it would pay $32m to the Colombian state, in addition to $8.9m to Peruvian authorities and $59m to the government of Panama.

In Colombia, the case has had major political and sectoral repercussions, leading to the arrest of former and acting Colombian government officials and businessmen. Additionally, the execution of the two infrastructure projects in which the firm was involved has been turned upside down.

After finding irregularities in the attribution of the project to build section two of the Ruta del Sol highway project, between Puerto Salgar and San Roque, won by Odebrecht in 2009, Colombian authorities announced the liquidation of the contract in February 2017. By then the project had reportedly reached the halfway stage, and a new contract for the completion of the road section will likely be launched.

Magdalena River

The COP2.5trn ($750m) project to increase the navigability of the Magdalena River has also been affected by the corruption case. The financial structuring of the project, which is 87% owned by Odebrecht, missed its deadline. As of early March 2017 authorities were considering whether to annul the contract altogether for failing to achieve financial closing, or to find an investor to take control of Odebrecht’s share in the project. Sinohydro, part of Chinese conglomerate Power China, announced in February 2017 that it was negotiating with Odebrecht over the acquisition of the Brazilian firm’s participation. Resolution of the Magdalena River conundrum might be further delayed due to the ongoing investigation by Colombian prosecutors to determine whether or not there was any wrongdoing in the initial attribution of the project to the consortium, which includes the Brazilian contractor, in 2014.

Besides the procedural issues involved with changing existing contracts and their impact on the completion of projects, it is still unclear what the long-term effect of the Odebrecht case will be on the infrastructure sector’s reputation and its ability to secure financing. “It will likely bring additional noise into the process of the projects, but I don’t think that international financing institutions will punish one country specifically, when the noise is regional,” César Augusto Peñaloza Pabón, director for infrastructure and sustainable energy at the DNP, told OBG. For Ramírez Pineda, the case will likely impact the sector’s image. “One of the risks is reputational. It took us years to get rid of this image of corrupt contractors, and this case goes against that work,” she said.

The change of government in the US may also impact Colombia, especially if the significant investments in infrastructure renovation across the US announced by President Donald Trump take place. “This [could] move the interest of firms and financing away from Latin America and back towards the US. This is an open and globalised market, and today we compete for resources with any country that invests heavily in infrastructure,” said Ramírez Pineda.

Outlook

The construction sector is poised to continue expanding and will remain an essential element of the Colombian economy. The government estimated that the construction sector will grow by 3.9% in 2017, largely driven by the execution of large-scale projects, which is set to accelerate growth of the infrastructure segment from 2.4% in 2016 to as much as 8% by 2017, as the various 4G projects take shape.

Residential, commercial and office projects as well as large-scale infrastructure development will continue to drive the sector in coming years. Opportunities are also set to emerge at regional level, with 2017 to be the year in which local authorities will begin to execute budgets. Linked to this, improving the way contracting is managed, especially at regional level, will be critical in enabling SMEs to play a larger role in the sector. Approval of the new regulation will be a crucial first step. Helping SMEs to become an increasingly important part of the market will also help spread benefits more broadly across the economy.