Peru - Sixth Road Project

' L E- .C.8 G' ,.iG RETLIURNED T0 RLOiFSDS DOCUMENT OF INTERNATIONAL BANK FOR RECONSTRU TION AND DEVELOPMENT Not For Public Use Report No. P-1360a-PE REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF PERU FOR A SIXTH ROAD PROJECT April 10, 1974 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 It may not be published, quoted or cited without Bank Group authorization.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.  RATE OF EXCHANGE Currency Unit Sol (S/.) US $1 S/. 38.70 s/ .1 = u$0o.0258 s/.1,ooo U$25-.80 S/.1 ,000,000 U $25,800 Peru Fiscal Period - January 1 to December 31 of the following year  INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF PERU FOR A SIXTH ROAD PROJECT 1. I submit the following report and recommendation on a proposed loan to the Republic of Peru for the equivalent of US$26.0 million to help finance a road project. The loan would have a term of 25 years, including 5 years of grace, with interest at 7-1/4 percent per annum. PART I - THE ECONOMY 2. A report entitled "Current Economic Position and Prospects of Peru" (No. 136-PE) was distributed to the Executive Directors on May 25, 1973 (R73-115). An updating economic mission is scheduled for April, 1974, and its report is expected to be ready for distribution by the end of September. Annex I summarizes the main economic and social indicators. 3. Peru has achieved a respectable rate of economic growth: excluding one year at the height of an economic crisis (1968), GNP growth in real terms has averaged over 6 percent per annum since 1960. With per capita GNP about $500 in 1972, Peru is also well removed from the group of poorest countries. The pattern of development that has brought this about, however, has been one of very unequal distribution of the fruits of growth. The modern sec- tors, where incomes are high and rising, comprise little more than one- fifth of the labor force, with a heavy concentration in the Coast, and in the Lima area. Twice as many are engaged in an agriculture of very low productivity where incomes rise slowly if at all and where large groups of Indian descent until now have hardly been touched by modern development 1/. The rest - somewhat over one-third of the total - are accounted for in handi- craft production and various service activities outside the modern commercial establishment. Their incomes also grow at rates well below those in the modern sector. The challenge that has been facing the country is to break this pattern without sacrificing further growth. 4. Upon its takeover in 1968, the military Government began to pursue structural reforms. Agrarian reform has been broadened and speeded up. By the end of 1973 about 5.7 million hectares of farmland had been expropriated, nearly half the area initially estimated to be subject to expropriation 1/ Those working in the larger export oriented farms, and particularly the members of the coastal sugar cooperatives must be counted in the modern sector.  - 2 - (which in turn is about half the total farm area in the country). Special emphasis is given to the promotion of cooperatives and other forms of col- lective management traditional among the Indian population. While still controversial, the labor communities introduced in the industrial, rrining, and fisheries sectors to bring about workers' participation in profits and ownership are now a fact in Peruvian economic life. Marketing of the im- portant export products is now Government controlled, and the state takeover of the basic industries - iron and steel, metal refining, cement, paper, petrochemicals and fertilizers - is virtually complete. The power and telecommunications sectors have been reorganized to become totally state managed. Publicly-owned banks have become more active. In parallel, the Government is carrying out comprehensive reforms of the public administra- tion, which include reorganization of many ministries, strengthening their planning offices, and setting up of a series of new state enterprises to implement the new policies. 5. The 1971-75 development plan projected extremely ambitious figures for public investment; in fact, they were challenges for the executing agencies rather than realistic targets. The agencies' performance in the first year, 1971, was rather disappointing, but 1972 was muchi better, with an increase in investment outlays of over 15 percent in real terms. Indica- tions are that the 1973 expansion will be similar. 6. A new medium-term development plan for the 1975-78 period is being prepared, built around the same objectives: achievement and consolidation of the structural reforms, and a further reduction of unemployment and underemployment. Increased importance is likely to be given to the produc- tion performance of agriculture, where public support has been relatively lacking in recent years as attention has been concentrated on the redistrib- utive aspec:t of agrarian reform. Industry and mining are likely to retain their investment priorities, with petroleum development a probable new im- portant field (see paragraph 11). The Government meanwhile is taking steps to strengthen project preparation and to set up an improved monitoring system for execution. 7. The 1973-74 budget and investment program contained a significant unfinanced gap, which would have to be closed by new revenue measure3 un- less capital expenditures fall much short of the projected levels. Devel- opments during 1973 have now made evideat the need for strong action in the near future. The increase in current expenditures over the budgeted amounts has been larger than that of revenues, leading to a further deterioration of central government savings. Revenues from income taxes have been buoyant, reflecting the high profits in the export industries but the yield from the 1972 tax measures has fallen short of expectations. Expenditures were higher than foreseen, particularly for interest and defense. 8. Adding to the fiscal pressures are the sharp increases in world prices for some imported commodities where Peruvian Governments have tradi- tionally sought to maintain low consumer prices: wheat, edible oils, and  - 3 - petroleum. The most drastic case is that of wheat, which is almost entirely imported and where the import price for 1974 is expected to be nearly three times the earlier long-term average. This means that despite a price increase to consumers of over 40 percent, which was approved in January, the cost of the subsidy may still be of the order of S/.3.0 billion this year (almost 1 percent of GDP). The decision of the Government not to let gasoline prices rise to reflect the higher cost of imported petroleum may add another SI. 2.0 billion to the subsidies and other minor items a further S/.1.0 billion. In terms of new revenues, the Government has so far only introduced a temporary export surtax, but the yield for 1974 is estimated at only about S/.l.0 bil- lion. This is clearly insufficient. 9. Heavy imports of capital goods, industrial and food products are needed. Rapid export growth is thus required to avoid balance of payments problems again becoming a constraint to growth. The Government is aware of this and is pursuing a vigorous development program in the mining sector, which is seen as the major provider of additional export earnings for the foreseeable future. Major mining projects underway are Cuajone, where the private developer (Southern Peru) had invested some $180 million by the end of 1973, and Cerro Verde, which is the first project undertaken by the state mining corporation, MINEROPERU. Together with some expansion from independ- ent medium and small mines, these projects should almost double annual cop- per output by 1976-77, increasing export receipts by over $250 million. MINEROPERU has several other large projects for which technical work has been initiated and discussions with potential foreign partners are continuing. 10. The decline in the anchovy catch which took place in 1972 continued throughout 1973. The catch was only one-fifth that of pre-crisis years. Very high fishmeal prices limited the loss of export earnings to some $100 mil- lion, however, and this was more than offset by price gains on other exports. International reserves had gone up by over $100 million by the end of November. This reflects foreign investment in mining and petroleum explora- tion, and substantial non-project borrowing by the Government (see para- graph 14). 11. Petroleum could provide significant additional exports. The pace of exploration in the Amazon basin has been stepped up, and foreign com- panies are expected to initiate drilling programs this year. Further sub- stantial exploration must be completed before petroleum prospects can be firmly assessed. However, PETROPERU has contracted for detailed engineering of a trans-Andean pipeline and signed preliminary contracts for the supply of pipe in the expectation that the positive preliminary indications will be confirmed. It should not be difficult to arrange the financing of the pipeline once sufficient reserves are proven and the Government hopes that petroleum can flow in 1976. 12. About two-thirds of 1973's petroleum needs were covered by domestic production. *The declining trend in production was reversed last year, and a further increase in production is expected this year. This would reduce im- port dependence further. The higher prices expected to prevail for Peru's  -4- major export commodities would at the same time boost export revenues far above earlier projections (contained in Annex I). Peru's balance of pay- ments situation should not deteriorate significantly through 1975 despite the higher prices for food imports, provided that there is a moderate recovery of fishmeal exports. The fishmeal prospects remain a major uncertainty in the short term. 13. Since 1967-68, Peru has been able gradually to restore the confidence of creditors and to obtain a rapidly increasing volume of new loans, total- ling over $500 million in 1973 (see Annex I, page 3). Although over half of this amount has been contracted with private financial institutions there has been some improvement in the average terms of new loans contracted in recent years, but debt service will remain high for the next few years. Taking into account also the uncertainties introduced by t:he anchovy crisis, the Govern- ment has preferred to shift part of this burden forward beyond 1976, when the new exports (minerals, petroleum) are expected to ease the pressures on the balance of payments. To this effect it has contracted in 1972 and 1973 a substantial volume of commercial bank loans for refinancing purposes, in addition to the new loans referred to above. This has helped maintain inter- national reserves, which exceeded $400 million at the end of 1973. 14. Actual commitments of project loans during 1973 of $273 million fell somewhat short of the $295 million which had been projected in the most recent economic report, wlhile total borrowing was much larger than foreseen owing to the Government's greater recourse to non-project borrowing. Gross external capital requirements by 1976 are estimated at $550 million, including $470 million of new project loan commitments. Debt service is likely to remain at about 23 percent of export earnings throughout the 1973-76 period. 15. At a meeting in June 1973 members of the Consultative Grou9 re- cognized the country's serious development ambitions, particularly com- mending the Government's effort to combine eccinomic growth with social justice, and indicated their willingness to extend financial assistance, in part on concessional terms, in support of these efforts. Under t'le Consultative Group arrangement the volume of project loans with a term of seven years or more from governments, banks and international instit!itions increased from $113 million in 1972 to $181 million in 1973, consisting of $46.7 million from governments and government agencies (Germany, Japan, the Netherlands and Canada), $18.3 million from the IDB, $49.0 million from the Bank, and $67 million from banks. Further project loans wi-_h shorter maturities were provided by suppliers ($85.9 million). Eastern European countries provided additional loans f'or $6.3 million. In addition to growing in volume, external project assistance is increasingly being concentrated on the list of projects submitted to donors through the Con- sultative Group. A further meeting of the Group is planned for later this year.  16. The Peruvian Government has shown pragmatism in its economic management and genuine concern for a more equitable distribution of the fruits of development. The project preparation and execution capacity of the various public sector agencies is improving. While debt service is going to be a burden for the country for several years to come, Peru is clearly creditworthy for substantial amounts of additional borrowing, provided the required public revenue measures are taken promptly. Ylhere is a case for extended grace periods, so as not to increase the debt ser- vice problems of the next few years. There is also need for some local currency financing, as the resource transfer required to support the devel- opment program is not likely to be fully achieved if all lending is restrict- ed to the foreign exchange component of projects suitable for external fi- nancing. PART II - BANK GROUP OPERATIONS IN PERU 17. The proposed loan would be the Bank's 27th operation in Peru. With the $24 million loan for the education project, signed on December 5, 1973, total Bank lending to Peru has reached $292.3 million net of cancellations. Of this amount, 40 percent has been for transportation (mainly highways and ports), 30 percent for agriculture, 23 percent for electric power and 8 per- cent for education. In addition, a small loan was made for industry. IFC commitments to date have been about $9 million - all in industry - of which $0.4 million is held by the Corporation. Project execution has been generally satisfactory. Annex II contains a statement of Bank loans and IFC investments as of February 28, 1974, and notes on the execution of ongoing projects. Bank loans to Peru constitute about 10 percent of total outstand- ing debt, including undisbursed, and are estimated to have absorbed 5.6 percent of the country's external debt service obligations in 1973. 18. In my report on the education project (Report No. P-1300a-PE, datecd October 30, 1973), I stated that further lending to Peru should await a re- view of progress on settlement of outstanding investment disputes. Since then, the USA and Peruvian governments have signed an agreement settling in- vestment disputes with regard to American investors, which constituted the bulk of the claims. In the case of expropriations affecting companies of other countries, mainly in the fishmeal and fishoil industry, guidelines for valuation of the properties involved have been established and the valuation process is well advanced, after initial auditing delays. In these c::rcumst^- ances I conclude that the Bank should proceed with the proposed loan 19. Besides continuing to review Peru's performance and creditx,orthiness as required for the meetings of the Consultative Group, the Bank also .Iamlls to send a mission in 1975 to prepare a basic report on the economy of Peru. This report will take a more comprehensive view of the Peruvian economy, analyzing prospects for the remainder of the decade. Towards this goal at) agricultural sector study is now being completed, and we are plannin,-; to review the other productive sectors, notably industry, mining and enemgy Ii a part of the basic report.  - 6 - 20. At present two projects are at the appraisal stage. One is a com- bination of road and river port development designed to complete the all-weather road corridor across the Andes assisted by the proposed loan and to facilitate river traffic in the Peruvian Amazon area. Ttle other is to expand the power distribution network in the rapidly growing Lima-Callao area. Follcwing up on the recent agricultural sector mission Bank staff are now assisting the government in the preparation of projects for rural development in the Sierra and irrigation rehabilitation in the coastal area to support the Government's objectives of attaining a more equitable distribution of income and increasing food production. Bank staff are also assisting in the preparation of a DFC project designed to strengthen the capacity of COFIDE, the Government-owned development bank, in financing industrial and tourism development. In addi- tion, the Bank is planning to participate in the expansion program of CENTROMIN-PERU, which took over the assets of the Cerro de Pasco operation, to expand copper production and exports. IFC is presently at an advanced stage of negotiations for a loan and equity participation in the Cuajone copper project and is actively exploring other investment possibilities in the country. PART III - TRANSPORTATION IN PERU 21. The Andes, the world's second highest mountain range, divile Peru in three markedly different physical regions: the Coast, where most of the industrial and modern agricultural development has taken place; the Andean highlands, with most of the miining activities of the country; and the sparse- ly populated but potentially rich Amazon jungle region. The economic develop- ment of the country has been influenced considerably by this geographical division, and has resulted in a concentration of most of the economir activity and wealth along the narrow coastal region, in particular the Lima-Callao metropolitan area. The absence of adequate transportation infrastructure linking the three geographic areas has largely contributed to this situation, by limiting specialization and the generation of surpluses for exchange on the basis of each region's comparative advantage. 22. Transport facilities are constrained by the difficult topography of Peru. The Panamerican Highway, running the entire length of the countrv near the coast, provides the backbone of the Peruvian network. Mlajor secondary roads and two railway lines link the most important coastal cities and the main ports with large towns and mining centers in the Andean highlands. A few roads leading into the Amazon jungle have been under construction for several years, but the topographic, geologic and climatic conditions have largely contributed to the absence of arn all-year link between the coast and the interior of the country. Aside from aviation, which provides limited transport capacity, the only semi-permarnent connection between the three regions is the Lima-Pucallpa road, which links the Lima-Callao metropolitan area in the Coast to the Amazon river, and through it to the Atlantic Ocean. However, some critical sections of this road, as described below, still  - 7 - need major investments in drainage, protective structures and other improve- ments to provide for an all-weather road and reduce the presently high maintenance and transport costs. 23. The transportation system on the whole is in a rudimentarY condi- tion, resulting in high transport costs, long travel times, and considerable damage to both vehicles and cargo. The road network comprises some 50,000 km of roads of which only 5,000 km are paved. There are 35 ports, of which 11 handle most of Peru's international trade. The railway system is limited to two separate lines, which largely specialize in ore transportation. In view of the unusually difficult topographic condition of the country, the relatively long distances involved and the still low volume of traffic between major population centers in the three regions, air transportation is playing an important role in opening up new areas -- in particular the prospective oil fields in the Amazon jungle -- linking various popuiation centers in the interior where extensive fixed transport facilities cannot be justified, and connecting major urban areas along the coast, where surface transportation involves substantial travelling time. 24. On the whole, the present transport system satisfies the minimum requirements of the coastal area, but is inadequate to the development needs of the mountainous and amazonic jungle regions. In view of the high cost of road investments in Peru, more careful screening of investment projects than in the past is required and the Government is appropriately cautious in its investment decisions for new roads. Contrary to the ambitious road develop- ment plans of the past, the Government's strategy is to give relatively low priority to new road construction in the short term, unless it is part of a broader development scheme, while emphasizing road maintenance, for which budgetary allocations have been increased considerably. As to the longer term transport requirements, there is no doubt that substantial investments in roads will be needed in the coming years. 25. To carry out this strategy, the Government is increasingly focuss- ing on three key aspects that need to be strengthened: the transport plan- ning and coordination mechanisms, the maintanance level on existing roads and the technical know-how to build roads in the Andean terrain. As to the first aspect, improvement has been noted since 1969, when coordination and administration of the transport sector, which was carried out by various agencies, was centralized in the Ministry of Transport and Communications. In addition, to strengthen the still limiited planning capacity of the Ministry, the Bank has been entrusted as Executing Agency of a United Nations Jevelop- ment Programme-financed project to assist the Government in reviewin- the policies and practices, evaluate the systems of data collection, existing transport studies, and other related matters, in order to establish improved planning and review procedures, assist in the preparation of a five-year plan, and train the Peruvian technicians needed to set up an effective plan- ning organization. The Bank is also involved, together with the Uniced Nations Economic Commission for Latin America, in a technical assistance program, which will provide the necessary statistical information on a continuing basis for transportation planning purposes. These efforts should help the Government  - 8 - in screening larger and more complicated investment projects, which will be required to meet the longer-term transportation requirements of the country. 26. In the past the maintenance level of existing highway infrastructure has been poor and there has been serious deterioration of roads through inadequate and insufficient repair and seal coat:ing. This resulted from insufficient allocations of funds for maintenance, partly because of past fiscal stringencies. The Government hias near:Ly quadrupled the maintenance budget since 1967 but, even so, the maintenance budget is still not large enough. As the financial constraint is removed, other limitations, mainly organizational and lack of qualified staff are likely to prove to be more pressing. In order to help remove this constraint, the Bank financed under the 1970 highway reconstruction loan a study of a maintenance program and the related training requirements for such a program. 27. Finally, as to the development of technology for road con<;truction, the Andean highland configuration poses serious difficulties in road design and construction methods. The combination of unstable terrain, difficult seismic, geological and soil conditions and torrential rains cause frequent floodings and landslides with consequent damage to the roads. Although significant experience has been gained in recent construction work through the Andes, particularly in the Bank financed La Oroya-Aguaytia road, extensive geotechnic studies are being carriecd out prior to deciding specific road investments. 28. The level of road user charges in Peru is considered acceptable but the structure of such charges needs to be improved. Although there is an element of progressive taxation in the present structure by taxing more heavily gasoline in the Coast than in the Amazonic jungle, for example, it appears that charges paid by the Lima-Callao area do not cover the social costs generated by private vehicles used for urban traffic. Also, indications are that a large portion of truckers are not paying their share of road use since diesel oil is not specially taxed and these truckers are tie major contributors to rapid deterioration of the road network. At a step towards improving this situation the Government will, under the proposed project, carry out a study of the marginal costs of the various vehicles using the road network in Peru, and the conclusions of such a study will he used as <n input for revising road user charges (Section 4.05 of the Loan Agreement). PART IV - THIE l'ROJECT 29. The proposed project would be the 12th in Peru's transportation sector receiving Bank financing; it was appraised in March 1973 and, fniicw'in a change in the scope of the project, reappraised in November 1973. loan negotiations took place in Washington, D.C. on March 11-15, 1974. Tli, Peruvian delegation was led by Mir. Franklin Caceres, Executive Direclor of Public Credit of the Ministry of Finance, and included representativc; ot t.ie  - 9 - Ministry of Transport and Communications. A Loan and Project Summary is attached as Annex III. An Appraisal Report (No. 302a-PE) dated April 11, 1974, on the project is being circulated separately to the Executive Directors. 30. While the ports and railway projects have been carried ou. relatively smoothly, experience with the road proiects has usually been difficult. Two of the loans, totalling $15 million, were made for road maintenance (127-PE and 300-PE) with mixed results in the first and considerable success in the second. The reconstruction project, (706-PE), geared to build up rcads in the earthquake striken area and to provide technical assistance to improve road maintenance efforts, is now proceeding satisfactorily after delays _n the engineering work. Two road improvement projects, both for the Lima--Pucallpa road, have been plagued with difficulties from the outset. The first one (271-PE), which helped finance the reconstruction and pavement of about 170 km of the Aguaytia-Pucallpa road, was only 80 percent completed when loan funds were exhausted in 1967, mainly because of the unexpectedly difficult soils and climatic conditions. At that time, because of the stringent fiscal situa- tion, the Government was unable to raise funds to continue the works. Exten- sive failures have since occurred in the work done. In May 1969, the Government appointed a Ministerial Commission to investigate the quality and condition of the works and the causes of their failure. On the strength of the Commission's report, the Government initiated legal proceedings against the consultant and contractor, claiming that the failures were due to the use of unsatisfactory materials and inadequate construction methods. Pending settlement cf the dis- pute the Government suspended major works to complete the unfinished project. With the recent out-of-court settlement of this case, the Government is now planning to undertake the necessary works to bring this road up to the standards originally envisaged. The second road improvement loan (425-PE) was made to finance 60 percent of the construction v7orks on the La Oroya-Aguaytia segment of the Lima-Pucallpa road. However, after large cost overruns, the Bank agreed in November 1969 to reduce the scope of the project, which was completed by January 1973. The remaining works to complete the La Oroya-Aguaytia segment are to be carried out in two stages, the first one -- between Huanuco and Aguaytia -- would be covered under the proposed project, as explained more fully below, and the second one - between Huanuco and La Oroya - would be covered under the next Bank transport loan for Peru. Description 31. The proposed project consists of: (a) Construction and improvement of the road from Huanuco to Aguaytia, totaling about 219 km; (b) Construction and improvemet of feeder roads, totaling about 200 km;  - 10 - (c) Resealing of a 61 km stretch of t.he road from Neshuya to Pucallpa; (d) Acquisition and utilization of maintenance equipment for the La Oroya-Pucallpa road; (e) Consulting services for: (i) Construction supervision of (a) (b) and (c); (ii) Geotechnical studies; (iii) Preinvestment studies; and (iv) Study of marginal costs of road transport. 32. The main objective of the project is to open up Peru's hinterland by significantly reducing transport costs along the road from the coast to Pucallpa (and from there by river to the Brazilian border) and by eliminating closures of this road in extreme climatic conditions. The project would not only substantially improve the link between the Coast and the Amazon jungle but also improve access to a number of other economically underdeveloped areas with rich agricultural potential, such as the fertile valley of the Huallaga River, where spontaneous settlements of peasants from the highlands have already taken place with the road developments thus far in the area and some Government assistance. Bank involvement in the project is also aimed at assuring appropriate design standard's, execution and ensuing maintenance of the road. Most highway projects involve a tradeoff between construction costs, on the one hand, and maintenance and vehicle operating costs, on the other. The minimum cost solution which has been worked out during appraisal of thie project has resulted in relatively modest engineering standards for a number of sections of the road, in the most difficult: mountainous stretches, which would call for an important maintenance effort. To meet this requirement, the acquisition and utilization of the necessary maintenance equipment for the 1luanuco-Aguaytia section and for the rest of the transport corridor up to La Oroya on the one end and to Pucallpa on the other, has been included in the project. A maintenance program based on consultant's recommendations would be undertaken to help assure a satisfactory maintenance level on the entire road (Schedule 2, Part C 1 of the Loan Agreement). 33. The project will be executed by the Ministry of Transport and Communi- cations through its Directorate General for Land Transport with the assistance of consultants, and is expected to be completed by the end of 1977. The General Directorate for Land Transport staff is of high technical quality, although short in quantity, and they are expected to carry out the project adequately, with the aid of the consultants services provided under the loan. Also, the new organizational structure, which combines highway planning, design, construction and maintenance under one Directorate of the Ministry, will help improve performance. Past failures in highway construction in Peru have been mostly due to the extremely heavy and unexpected magnitude of the difficulties encountered. It is expected, however, that the experience gained  by all the parties concerned with previous construction works across the Andes -Ministry's officials, foreign and local contractors and consultants, and the Bank-- will bear fruit for the proposed and future projects. Costs and Financing 34. The total cost of the project is estimated at $40.0 million equiv- alent, of which about $21.1 million are in foreign exchange. This cost estimate includes contingency allowances for both increases in quantities and price escalation which amount to $3.5 million and $6.5 million, respectively. Price increases have been estimated at rates varying between 5 percent and 10 percent per annum for the various components of the project during the three and a half year construction period; increases in quantities have been estimated at 15 percent of construction costs. The latter percentage, which is unusually high, is justified by the uncertainties involved in road construction in the Andes and past experience in earlier Bank loans for road projects ir. this area. 35. The proposed $26 million loan would finance the foreign exchange costs of the project and $4.9 million of local currency costs, in line with our assessment that the resource transfer required to support the country's development program is not likely to be achieved if lending is restricted to the foreign exchange component of projects suitable for external financing. A grace period of five years, i.e., one and a half years beyond the estimated disbursement period, is proposed for the loan, in view of the balance of pay- ments tightness which Peru is likely to experience until the mining projects now under construction, and perhaps petroleum prospecting, bear fruit. Procurement and Disbursement 36. Construction contracts will be awarded after international competitive bidding except for the construction and improvement of feeder roads, which because of their dispersed locations and small size, the Borrower would have the option to carry out by force account'under supervision of consultants (para. 2 of Schedule 4 to the Loan Agreement). Bidding procedures azceptable to the Bank for the reconstruction works on the Huanuco-Aguaytia road have been already initiated but no expenditures have been incurred in the project as yet. Procurement of equipment is to be made through international com- petitive bidding, with local suppliers to be granted a margin of preference of 15 percent or the customs duties payable by a non-exempt importer, whichever is less. At present, major maintenance equipment is not produced in Peru. 37. Disbursements will be made on the following basis: (a) 65 percent of total expenditures for civil works contracts and of total expenditures certified by consultants in the case of works carried out by force account: (b) 60 percent of total expenditures for consulting services; and (c) 100 per- cent of foreign exchange costs of road maintenance equipment. Based on the project execution schedule, the Loan will be fully disbursed by mid-1978.  - 12 - Justification 38. The project is economically justified. Taking into account only savings in presently very high maintenance costs and direct users savings in vehicle operating costs, the economic rate of resturn is estimated at 24 percent. This does not include other important benefits, such as time savings of drivers and passengers, the reduction of traffic accidents, breakage and spoilage of cargo, reduced inventory requirements for goods in transit and, more import- antly, the multiplying effects on productive activities in the areas to be opened up. As has been observed with the first phase of this project, it is likely that the proposedl project will have a development effect on the agri- culture production areas with widespread benefits to their population. The immediate effect of the proposed investment will probably be to lower prices of agricultural and forestry products from the hinterlands to consumers in the coast, and to reduce prices of industrial products from the coastal region to Andean and hinterland consumers sinc-e the Peruvian truck industry is highly competitive. PART V - LEGAL INSTRUR ENTS AND AtJTHORITY 39. The draft Loan Agreement between the Republic of Peru and the Bank, the Report of the Committee provided for in Article III, Section 4 (iii) of the Articles of the Agreement and the text of a Resolution approving the proposed loan are being distributed to the Executive Directors separately. 40. The draft Loan Agreement conforms to the normal pattern for loans for road projects. 41. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank. PART VI - RECOP4E*NDATION 42. In formulating this proposal, if has not been possible to take full account of the consequences of recent increases in petroleum prices. However, available information indicates that the proposed loan remains fully justified. 43. I recommend that the Executive Directors approve the proposed loan. Robert S. McNamara President Attachments Washington, D.C.  ANNEX 1 Iage 1 of j page COUNTRY DATA - PERU AREA POPULATION DENSITY 1,285,215 kes 14.5 millios (mid-197d) W Pe k.2of rable land SOCIAL INDICATORS Reference Countries Peru Coloabia A n n ___ 20 1970 197 0 1970 ON? PER CAPITA 83$ (ATLAS BASIS) / .. 450 340 1,260 1,020 DEMOGRPAPHIC Crudeibirth rate (per thousand) 39 /a 42 /b i 55 /e 21 20 Crude death rate (per thousand) 12 7 11t 11 8 8 Infant mortality rate (per thousand live births) 92 75 /b 70 58 28 Life expectancy at birth (years) 52 75 58 7E61 68 71 Oross reproduction rate