Mexico - Mexico City Water Supply Project

or + -/a/ 'che5 .k G//tL/Q:3 DOCUMENT OF INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT Not For Public Use FILE'L'm C'lu"h PY Report No. P-1207a-ME REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO NACIONAL FINANCIERA, S.A. WITH THE GUARANTEE OF THE UNITED MEXICAN STATES FOR THE MEXICO CITY WATER SUPPLY PROJECT May 30, 1973 This report was prepared for official use only by the Bank Group. It may not be published, quoted or cited without Bank Group authorization. The Bank Group does not accept responsibility for the accuracy or completeness of the report. I  CURRENCY EQUIVALENTS Currency Unit = Peso (Mex$) US$1.00 = Mex$12.50 Mex$1.00 = US$0.08 Mex$1 million = US$80,000 GLOSSARY OF ABBREVIATIONS NAFIN = Nacional Financiera, S.A. Comision = Comision de Aguas del Valle de Mexico  INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO NACIONAL FINANCIERA, S.A. WITH THE GUARANTEE OF THE UNITED MEXICAN STATES FOR THE MEXICO CITY WATER SUPPLY PROJECT 1. I submit the following report and recommendation on a proposed loan in various currencies equivalent to US$90 million to Nacional Financiera, S.A. (NAFIN) to assist in financing a four-year program of investment by Comision de Aguas del Valle de Mexico (Comision) in the Mexico City Water Supply Project. The loan would be guaranteed by the United Mexican States and would have a term of 24 years including four years of grace, with interest at 7-1/4 percent per annum. PART I - THE ECONOMY 2. The most recent economic report entitled "Current Economic Position and Prospects of Mexico" (CA-14a) dated November 15, 1971, was distributed to the Executive Directors on November 26, 1971. A basic economic report is now in preparation. Basic Data on the economy are in Annex I. 3. During 1960-70 Mexican GNP in real terms grew, on average, at 7.1 per- cent per annum, and in 1972 reached a level of about US$750 per capita. During the decade of the 1960's the share of manufacturing in total output rose from 23 to 34 percent while the share of agriculture declined from 16 to 12 percent. Agriculture continues to be the main source of employment although its share in the labor force, which was 58 percent in 1960, had fallen to 39 percent by 1970. Labor employed in manufacturing, during the same period, rose from 16 to 23 per- cent of the labor force. Income disparities between social groups in Mexico historically have been great, and continue to be so, notwithstanding that Mexico is one of the few countries in which a major land reform - a result of the Revolution of 1910 - has taken place, and in which about one-half of all crop land is exploited on a communal (ejido) basis. 4. The high rate of population growth (3.4 percent) and the relative scarcity of arable land have contributed to the very rapid growth of the urban population. Since 1960 it has risen by some 5 percent annually, and in 1970 accounted for about 60 percent of the total population, the metropolitan regions of the three largest cities, Mexico City, Monterrey and Guadalajara grew even faster than the overall urban population. 5. Unemployment was recorded at around 9 percent in 1970 while an additional 30 percent of the economically active population were employed in activities of such low productivity as to be considered underemployed. Moreover, because of the increase in population and its present age structure, the labor force will continue to grow very rapidly.  6. President Echeverria, who has held office since the end of 1970, has stated that his Government is strongly committed to a policy of economic growth with income redistribution, and has expressed particular concern for the problem of rural poverty. In the past two years the Government has initiated several measures designed to improve the earning and living conditions of the rural poor. These include the enactment of a new Agrarian Reform Law (1971), a new Water Law (1971), instructions to the banking system to channel part of its resources to small farmers and ejidatarios, and the appropriation of funds in the national budget for an integrated rural development and works program. The new Agrarian Reform Law is directed to strengthening the legal bases of the ejido, to accel- erating the awards of final land titles and to granting individual small holders similar rights to those of ejidatarios. The new Water Law restricts individual land holdings in new irrigation districts to 20 ha.; the excess land is to be distributed to small farmers and landless families. The small farmers' credit program seeks to improve credit institutions and increase amounts to ejidatarios and small farmers. The rural development program, for which the Government has appropriated Mex$2.5 billion (US$200 million) in the fiscal 1973 budget, with the intention of spending about Mex$15 billion in 1973-76, is in the process of being defined and is meant to help the landless and seasonally unemployed poor as well as to improve the productive base of small holders and ejidatarios. It is too early to evaluate the impact of these policies, but they undoubtedly respond to some of Mexico's most serious development problems. 7. Between 1960 and 1971 the share of investment in GDP rose from about 17 to almost 20 percent. By 1971 some 88 percent of gross domestic investments - 16.4 percent of GDP - we-e being financed by internal savings. While total savings are thus quite high, public sector savings need to be increased: public investments amount to less than one-third of total investment, but public savings make up only about one-fourth of total savings. It is the unusually great willing- ness of the private sector to save that has permitted the Government to maintain taxes at the low level of 9 percent of GDP, but a greater public savings effort will be needed in the future, as the new regional development schemes and rural investment programs will require substantial additional resources. There is no question about the economy's capacity to generate additional revenues in the public sector, not only through taxes but also in the public enterprises, in several of which the prices of services sold have failed to keep up with produc- tion and distribution costs. The scope for adjustment is illustrated by the recent decision to restructure water prices in the Federal District in such a way as to almost double revenues (see para. 24). 8. It is normal, in Mexico, that private investment attitudes are very cautious during the first year of a new Administration, and 1971 was no exception. Sluggish private investment, combined with a contraction of public investments and with the recession in the United States, slowed the GDP growth rate to a mere 3.7 percent. However, growth resumed in 1972 to 6 - 7 percent, while price increases - which had caused concern in 1971 - slowed to around 3 percent, i.e. below those of Mexico's principal trading partners. 9. Between 1960 and 19,0 exports of goods and services rose by an average of 9 percent per annum; merchandise exports grew at a 6.3 percent per annum rate and tourist earnings at 15 percent per annum. Export growth slowed appreciably  -3- in 1971, because of the U.S. recession and because of uncertainties in the inter- national monetary situation. In 1972, however, expansion resumed; in the first nine months exports of manufactures rose by about 30 percent and total merchandise exports by about 25 percent. 10. A recent Bank mission that evaluated Mexico's policies for promoting manufactured exports has found them generally effective. Recent moves extending the scope of tax refunds for exporters and the legislation on border industries seem especially promising. The foreseeable rate of growth of manufactured exports over the next few years is of the order of 18 percent per annum. 11. While public external borrowing increased again during 1972 with stepped-up public investment, the Government's sound debt management policies combined with substantial lending by the World Bank and the IDB have kept the maturity and terms structure of such borrowings within reasonable limits. Private capital inflows have continued at a high level. Overall, Mexico's net international reserves increased by $190 million during 1972 to $1,200 million. The ratio of payments for debt service to receipts from exports of goods and services, which in 1972 was an estimated 20 percent, is expected to peak in the late 'seventies at near 25 percent and should decline thereafter. During the next few years, Mexico's annual gross external borrowing requirements are estimated at about US$1,400 million, of which, as in the past, about 75 percent is likely to be raised from private sources. The IBRD's share in total annual debt service obligations is expected to remain near 10 percent. 12. Mexico has demonstrated over a considerable time that it can absorb, and utilize effectively, appreciable amounts of external capital. At the same time the external finances have generally been handled in a prudent manner, while domestic policies have generated private sector confidence both in the currency and in the economy. Indications are that these policies will continue as the public sector initiates a more ambitious expenditure policy in order to address Mexico's more intractable development problems, especially those of the rural poor. If such policies are supported by corresponding action to channel more resources to the public sector, Mexico will remain creditworthy for substantial external borrowing on conventional terms. 13. In addressing some of the socio-economic problems referred to above, public investments will have to grow in sectors in which the import component of investment is small. Moreover, Mexico has a highly developed industrial sector and increasingly Mexican products are competing successfully under international competitive bidding. External lenders, if they are to make a suitable contribution to Mexico's development, and one that is consistent with overall balance of payments requirements, will have to cover part of the local expenditures of the projects to which they attach their financing.  - 4 - PART II - BANK GROUP OPERATIONS IN MEXICO 14. The Bank has made 30 loans, for a total of US$1,329 million net of cancellations, of which at the end of April 1973 the Bank held US$1,051 million including US$343 million not yet disbursed. Most of these loans have been made for power, roads and agriculture. Execution of Bank-financed projects has, on the whole, been satisfactory. As I have explained to the Executive Directors (R73-23 of February 1, 1973) the Government has not found it possible to effect tne needed power tariff increase and only $35 million of the $125 million loan (834-ME) would be drawable unless the CFE, on or before July 31, 1973, adopts adequate measures to present an acceptable program for financing its investment needs. 15. IFC has made ten investment commitments in Mexico amounting to US$53.1 million, of which as of April 30, 1973, US$30.8 million had been sold, terminated or cancelled. The US$11.8 million held by the Corporation consists of US$10 mil- lion in loans and US$1.8 million in equity. Annex II contains a summary of Bank loans and IFC investments as of April 30, 1973, and notes on the execution of ongoing projects. 16. Bank lending to Mexico was very active in FY72, and five loans totaling US$277 million were approved. The FY73 lending program consists of the present Project and the Livestock 2nd Agriculture Development Project, also presently before you. In the next six months or so I hope to present to the Executive Directors four projects that are in an advanced stage of preparation. Now in the process of appraisal are: the publicly owned Las Truchas steel plant; two irrigation projects - on the Sinaloa and Panuco Rivers; and a highways project. In addition, we are holding discussions with the Mexicans on several transport, forestry and rural development projects, some of which are expected to be ready for your consideration later in FY74. 17. In lending to Mexico, the Bank tries to assist the Government in achiev- ing four major objectives. These objectives are interdependent and complementary; hence it is not possible to rank them in order of priority or intrinsic importance. One objective is to spread the benefits of growth more widely than before and, more particularly, to begin to address the problem of rural poverty. A second objective is to help Mexico continue to achieve the remarkable growth of output of the past two decades, both by investing in projects that directly or indirectly make large contributions to production and employment, and by supporting changes that will make existing institutions function more effectively or by creating new ones that will perform presently neglected functions. A third objective is to transfer sufficient external resources to complement Mexico's quite appreciable domestic savings and provide the necessary funds for sufficient economic and social investments in a framework of sound domestic finances and a viable balance of payments. A fourth objective is to contribute with funds and expertise to the solution of critical adjustment problems that are themselves a result of Mexico's continued growth; noteworthy among these are the problems attendant on a rapid urban expansion, and the emerging need to exploit scarce water resources more efficiently.  - 5 - 18. While the third objective primarily influences the magnitude of the Bank's program in Mexico, the others jointly determine its structure. Naturally, many operations serve more than one of the ends listed and may, moreover, support more specific government objectives. Thus the Las Truchas steel plant is expected not only to further Mexico's industrial growth in an efficient manner, but also to support the Government's program of regional industrial decentralization. The irrigation projects are designed not only to help provide a rapidly growing popula- tion with its food, fiber, and foreign exchange requirements, but also to support the Government's policies on income redistribution as expressed in the Land Reform and Water Laws, both of 1971. Concern with the vital issue of better water manage- ment also induced the Government, the Bank and UNDP to organize, jointly, a national water study; the Bank serves as Executing Agency for the UNDP. Loans in the trans- port and power sectors are designed explicitly to help improve institutional struc- tures and policies in sectors that play a vital role in industrial and agricultural production and in the generation and utilization of public sector resources. The proposed Bank-assisted agricultural credit project has a component earmarked for low-income farmers and peasants; if this operation is successful it should lay the foundation for a wider attack on rural poverty in the future. At the same time, the Government, together with the Bank, is attempting to prepare integrated rural investment projects in regions in which income levels are low but where some pro- ductive potential can be identified. The Project before you is a good illustration of the complementarity of the various objectives listed: it responds to the need for expanding urban infrastructure and to manage one of Mexico's truly scarce resources - water - more economically; it helps create a specialized institution for this purpose whose scope will cut across existing, functional and administrative boundaries, and it supports a government policy of relating water charges broadly to the consumers' ability to pay while at the same time recovering, in the aggregate, the full cost of the investment together with a suitable contribution to future expansion needs. PART III - THE WATER SUPPLY SECTOR IN MEXICO 19. Mexico is one of the world's most water scarce countries where long- term economic growth would be affected more by the water constraint than by the lack of any other natural resource. The problem is compounded by geographic maldistribution of water resources along with dramatic population expansion in the water-scarce central highlands. Five of the major rivers, accounting for over half of the total river flow, have a drainage area comprising only 10 percent of the land area in the sparsely populated southeast tropical part of the country. Conversely 70 percent of the population and 80 percent of industry are located in areas above 1,500 feet of elevation commanding only 15 percent of the water resources. As the population and industrial activity around Mexico City expand, water will have to be brought in from remote sources of supply, creating additional costs for the economy. Since the entire plateau is short of water, displacement of industries from Mexico City to other locations on the central plateau will not help in the long run, unless the presently irrigated area in this region is reduced  - 6 - to accommodate the water requirements of the industrial sector. As conflicts over the use of scarce water resources become serious, a more effective and further-reaching decentralization policy, and considerable investments in water supply, are called for. As a first step the Mexican Government has started a national water resources survey with the help of UNDP and the Bank; the study, started in September 1972, should be completed in 1975 and has two principal objectives: (a) the formulation of alternative water development programs for the short, medium and long term; and (b) the adoption of key policy decisions c-ncerning water development and management. 20. Mexico has made substantial progress in providing piped water to its people, increasing the percentage of population served from 13 to 60 percent between 1950 and 1970. Outside a small water supply component in the Zihuatanejo Tourism project, the proposed Project would be the first Bank-assisted potable water project in Mexico and would meet the requirements of Mexico City metropolitan area through 1977. A much larger investment program (approximately US$500 million) for meeting the growing needs of the metropolis in the years 1977-81 is under study. The Inter-American Development Bank has made four loans totaling US$32 million for water and sewerage projects serving the cities of Merida-Yucatan (US$9.2 million in 1962); Limon-Tabasco (US$4.9 million in 1963); Queretaro and Durango (US$4.6 mil- lion in 1965) and Monterrey (US$12.9 million in 1969). The UNICEF nas assisted a rural health service program including drinking water supply to selected villages with grants of US$2 million, but only 23 percent of the rural population has access to piped water and oxtension of these facilities as a part of an integrated rural development program is currently under consideration of the Government. Water for the Federal District 21. The Mexico City metropolitan area dominates the economic, political and cultural life of the nation: it accounts for close to 20 percent of the national population, 40 percent of the nation's employment, 44 percent of its invested capital, 47 percent of its production and 58 percent of its salaries and wages. The metropolitan area's population is growing by almost 6 percent per annum and at this rate would reach 15 million by 1980, from the present 9 million. 22. The topographical situation of the valley in which Mexico City is located - a closed 10,000 square kilometer basin of volcanic origin located about 2,200 meters above sea level - limits the available water and complicates access to neighboring water resources. While some waters on the distant sides of the mountains have been tapped and tunneled, about 70 percent of the valley's present water supplies originate from rains falling directly upon it, and are exploited as sub-surface water through pumped wells. 23. A large quantity of water is stored by nature below ground; by drawing upon this storage water can be removed, for a limited duration, at a greater rate than it is replenished. This "mining" of water has been practiced in Mexico City's center for years, and contributes substantially to the subsidence of the earth's  - 7 - surface which, in turn, damages buildings and other structures. In areas where the probability of damage is slight, mining is a viable alternative to developing other, more distant (and hence more costly) water sources. Under the Project about 13.5 m3/sec would be mined both north and south of the city, and studies which are crucial to assuring that post-project works are economically planned (see para. 31), would establish the rate and location of future, post-project abstraction. 24. The Government faces difficult issues relating to pricing policies and allocation of water to competing sectors of the economy in the metropolitan region. Although the recent Water Law gives domestic consumers the first right to water, agriculturalists around the capital city have de facto prior rights and obtain water at prices well below cost; and in the Federal District the price to domestic and industrial consumers until recently covered only 30 to 70 percent of the cost of providing the service. In the face of a steeply rising marginal cost for water, the price mechanism could advantageously be employed to encourage economic use of water and to generate funds for subsequent water development projects. Recognizing this the Goverrnment in January 1973 revised the water charges in the Federal District, so that the average revenue per cubic meter delivered will rise from Mex$0.45 to Mex$1.00. The new tariff regime is concessional to the small consumers and will affect the larger consumers progressively. The old rate of Mex$0.30 per cubic meter for the first 50 cubic meters will be retained but the previous rate of Mex$0.70 per cubic meter in excess of 50 cubic meters has now been raised to Mex$1.50. It is hoped that the new water rates will be a disincentive for water- intensive new iiidustrial units in the metropolitan region. The Government is also elimating "free consumers" (including, inter alia, government agencies and enter- prises, schools, hospitals) and will gradually replace the present "free consumer" system with "social subsidies" paid directly by the Government in deserving cases. Improved collections will still be required and the Government has decided to undertake further studies to this end. Its immediate objective, agreed with the Bank, is to improve the "revenue effectiveness index'"A/ from the current 45 percent to 60 percent by 1976. PART IV - THE PROJECT 25. The metropolitan area of Mexico City has presently a drinking water supply of 42 m3/sec; it would need 57 m3/sec by 1977 and 65 m3/sec by 1980. The 1/ The revenue effectiveness index is defined as: Revenue Collected 4 Volume Produced and Bought from Comision Average Tariff/m3 on Metered Connections It would be equal to 100 percent if all water were sold and billed through meters and all users paid 100 percent of their bills. Thus it is affected by the degree to which meters are installed, the leakage in the system and by the payment delinquency rate of users.  - 8 - Project before you consists of five groundwater and one surface water sub-projects, and related treatmInt and transmission facilities; it will augment the current supplies by 15.5 m /sec; will meet the demand of the metropolis through 1977; and it will improve service in the crowded substandard residential zones presently dependent on public hydrants or inadequately served. One of the groundwater projects - the Texcoco - is a multipurpose land reclamation - afforestation - irrigation scheme and will improve the ecology of the area. Attached to each of these sub- projects are certain social-type public works, "obras sociales" - schools, small roads, health centers and similar facilities - which social considerations require to be undertaken as a form of water rights compensation to residents of areas from which water is to be abstracted. (Annex III contains details of the project.) Parallel to the Bank-assisted bulk water project, the Federal District and the State of Mexico will respectively invest Mex$700 million and Mex$400 million (about US$88 million in all) on related water-distribution facilities and another US$320 million on the essential drainage and sewerage works. 26. The Project for the proposed loan was appraised by a Bank mission in September 1972. Negotiations were held in April and May, 1973. Negotiators were Mr. Cesar Buenrostro, Executive Director of Comision; Mr. Pedro Galicia Estrada of NAFIN and Mr. Carlos Tello of the Ministry of Finance assisted by two members of the Guarantor's staff. The Comision de Aguas del Valle de Mexico 27. The Government, through a decree dated July 1972, has established an agency, within the Ministry of Hydraulic Resources (SRH), the Comision de Aguas del Valle de Mexico, as a regional bulk wal;er producer and vendor to distribution agencies in the valley. The Comision has the exclusive authority to develop all new water projects in the valley and will account for an increasing share of piped water consumed in the metropolitan region: from nil at present to 27 percent in 1977, 36 by 1981, and to an estimated 67 by 1985. The Government is conscious of the importance of building a viable and efficient institution. The Comision is to enjoy full autonomy in financial management and in fixing bulk water rates. In the initial stages the Comision will consult with the Bank on adequate staffing and consultants assistance. Appointment of a competent financial manager will be a condition of effectiveness of the loan. Costs and Financing Plan 28. The capital requirements of the Project - including capitalized interest (US$19 million) and incremental working capital (US$20 million) are US$194 million. Of this amount an estimated US$66 million would be foreign exchange costs, including US$14 million of interest during construction on the proposed loan. The Bank loan would finance the full foreign exchange costs plus about US$24 million of local costs. As noted earlier, the financing of a portion of local costs in Mexico is fully justified ona country grounds. The other sources of Project financing are indicated in the following Table which summarizes the financing plan of the Comision:  -9 - US$ million Percentage Internal cash generation 53 27.3 Less: debt service ( 4.6) Net internal cash generation 44 22.7 Loans from Mexican institutions 36 18.6 IBRD loan 90 46.3 Total borrowings 126 64.9 Government contributions 24 12.4 Total 194 100.0 29. The Comision's investments during the Project period (1973-1976) would be the beginning of an increasingly important program vital to orderly growth of the metropolis and a pure water supply to the inhabitants. The magnitude of the problem is illustrated by the following Table: 1972 1977 1981 1. Water required by Mexico City and adjoining municipalities (m3/sec) 42 57 65 2. Supply from Comision nil 15.5 24 3. (2) as percentage of (1) nil 27 36 4. Investment needs in the previous period ($ million) - 194 500 Bulk Water Rates 30. The Government has agreed that bulk water rates will be set and maintained to provide the Comision with revenues sufficient to finance about one-fourth of the investment in the Project after covering operating and maintenance costs, including depreciation, and loan service charges (for investments financed with budgetary grants the loan service charges will be imputed at normal commercial rates). A condition for effectiveness of the Bank loan will be the execution of bulk sale contracts with the Federal District and the Government of the State of Mexico in amounts which justify the carrying out of the Project.  - 10 - Studies 31. As stated earlier the Government faces complex issues relating to orderly and sustained growth of the metropolitan region within the constraint imposed by the scarcity of water. The marginal cost of water will continue to rise sharply - even in the program financed by the current project the marginal cost will increase from Mex$0.41 per cubic meter for the Pozos Sur sub-project to Mex$1.33 for Apan - and well before the limit to growth is reached in the metropolitan region the Government will be faced with sensitive decisions on land use and location of industries. The Government has therefore initiated several studies including: (i) land use in the metropolitan region; (ii) demand forecast of water; (iii) investment strategy for meeting the demand, including economics of groundwater extraction and sewerage reuse directly for industry and irrigation or indirectly for aquifer recharge; and (iv) future water pricing policy in the region. Procurement 32. Whenever feasible contracts for civil works, equipment and materials included in the Project would be grouped together to attract international competitive bidding. Bidders for civil works contracts estimated to cost the equivalent of US$1.6 million or more would be required to prequalify and such contracts as well as contracts for equipment estimated to cost the equivalent of US$80,000 or more, would be let under international competitive bidding. Contracts for civil works costing less than US$1.6 million and for equipment costing less than US$80,000, would also be open for international bidding but invitation for bids would be advertised locally. However, the social public works described in para. 25 above, and the afforestation and land reclamation components of the Texcoco sub-project would not be suitable for competitive bidding and coI- tracts for these may be awarded after inviting quotations from not less than three contractors following the Government's usual procedures. Mexican suppliers of equipment and materials will be eligible for a preference up to the amount of customs duties which a non-exempt importer would have to pay, or 15 percent, whichever is lower. It is expected that the civil works contracts and most of the equipment supply contracts would be won by local firms. Disbursement 33. The Bank loan would be disbursed against 57 percent of construction and equipment contracts and to cover 100 percent of interest during construction on the loan. The loan would be disbursed in four years 1973-1976.  Ecology 34. The Project will increase water supply in the metropolitan area, especially in the peripheral low-income areas, which will permit a change from public hydrants to individual house connections thereby improving sanitation. The Texcoco multipurpose sub-project will substantially reduce Mexico City's air pollution by eliminating dust storms from the Texcoco area; irrigation and afforestation will help transform the existing desert area in this region into parks and make available land for urban and agricultural use. Economic and Financial Evaluation 35. Mexico City's immediate water requirements are clear. The cost of not satisfying these requirements is likely to be high and would fall largely upon the poorer segments of the population living in areas where shortages occur first and where distribution system extensions are made possible because of the Project. The Project is the least-cost alternative, at discount rates of up to 15 percent, for providing the metropolitan area with the projected bulk water needs through 1977. 36. The financial rate of return on the Comision's net fixed assets would be 23 percent in 1977, the year in which the Project would be completed. Bulk rates for the sale of water by the Comision will be set at levels to enable the Comision to generate sufficient cash to meet a reasonable portion of the increas- ing investment costs on bulk water projects in the coming years. The Comision's financial return would decrease to more modest levels in the 1980's as more expensive long-distance water sources are required to be exploited. The initial high rates of financial return also reflect quick utilization of the full capacity of the sub-projects and low initial operating costs of the Comision. 37. While the financial rate of return to the Comision is therefore very satisfactory, a much more detailed analysis is required to determine the internal economic rate of return on the investment in the entire water supply complex, taking into account investments in retail distribution as well as in the bulk supply. This analysis, which is presented in some detail in the Appraisal Report, encounters the problem that the retail water price in Mexico City, even after the 100 percent increase of January 1973, does not yet represent an economic pricing for water. It is at the same time very difficult to establish what is an economic price; there is little doubt that consumers could, and would, pay more for water than they are presently being charged, and that eventually they will have to do so. On the basis of existing water charges, the overall rate of return for the water complex would come to only 4 percent, but this figure would be very substantially larger if account were taken of (i) the continued serious underpricing of water in relation to the economic benefits to consumers and (ii) the unquantifiable health and ecological benefits to be derived from the Project.  - 12 - PART IV - LEGAL INSTRUMENTS AND AUTHORITY 38. The draft Loan Agreement between the Bank and Nacional Financiera, S.A., the draft Guarantee Agreement between United Mexican States and the Bank, the Report of the Committee provided for in Article III, Section 4(iii) of the Articles of Agreement and the text of a Resolution approving the proposed loan are being distributed to the Executive Directors separately. .-I). I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank. PART V - RECOMMENDATION 40. I recommend that the Executive Directors approve the proposed loan. Robert S. McNamara President Attachments May 30, 1973  J011.4iX I Page 1 COUNTRY DATA - MECICO AREA POPULATION DENSITY 514.0 million (mid-1972) 27.4 per km2 1,973,000 kin2 Rate of Growth: 3,4,, (froml960to 1972) 1843 per km2 of "arable" area POPULATION CHARACTERISTICS (1972) HEALTH (1Lq6aR Crude Birth Rate (per 1,000): 43.1 Population per physiciaJ / 1,852 (1968) Crude Death Rate (per 1,000): 3.2 Population per hospital bed 510 (1966) Infant Mortality (per 1,000 live births) 58.4 INCOME DISTRIBUTION (1969) 2/ DISTRIBUTION OF LAND OWNERSHIP (1960)-/