Mexico - Rio Panuco Irrigation Project

'COPY DOCUMENT OF INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT INTERNATIONAL DEVELOPMENT ASSOCIATION Not For Public Use Report No. P-1354a-ME REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO NACIONAL FINANCIERA, S.A. WITH THE GUARANTEE OF UNITED MEXICAN STATES FOR PANUCO (FIRST STAGE) IRRIGATION PROJECT February 4, 1974 Latin America and the Caribbean Regional Office 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 It may not be published, quoted or cited without Bank Group authorization.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.  C-URRENCY EQUIVALENTS Currency Unit = Peso (Mex$) US$1.00 = Mex$12.50 Ix$1.00 = uS$o.o8 Me $ 1 million = US$80,000 GLOSSARY OF ABBREVIATIONS NAFIN - Nacional Financiera, S.A. SRH - SecretarIa de Recursos Hidra4licos  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 PANUCO ('IRST STAGE) IRRIGATION PROJECT 1. I submit the following report and recommendation on a proposed loan in various currencies equivalent to US$77 million to Nacional Fi- nanciera, S.A. (NAFIN) to assist in financing the Panuco (First Stage) Irrigation Project. The loan would be guaranteed by the United Mexican States and would have a term of 25 years including five years of grace, with interest at 7-1/4 percent per annum. PART I - THE ECONOMY 2. "The Economy of Mexico: A Basic Report" (192-ME) was distributed to the Executive Directors on June 26, 1973. It was designed to provide a long-term perspective and a framework for the assessment of short-run trends in the Mexican economy. An updating report will be prepared this spring and is scheduled to be distributed to the Executive Directors in mid-1974. Country Data sheets are provided in Annex I. 3. For the three most recent of the six decades since the Revolution of 1910, the success of the Mexican system, measured in terms of GDP growth, has been outstanding. Since 1940, the annual average growth rate has ex- ceeded 6 percent. And from the mid-1950's to 1972 Mexico was among the few countries in the developing world to combine a sustained high rate of growth with monetary and balance of payments stability. The average annual rate of inflation was less than 5 percent and the dollar value of the peso was maintained at the level fixed in 1954. 4. Rapid and sustained growth was the product of successful policies affecting the mobilization and use of both private and public sector re- sources. The role of Government in promoting economic growth was concerned on one hand with the development of strategic infrastructure and major uti- lity industries and on the other with development policies which featured, in the agricultural sector, the development of price support, import control and agrarian reform measures, and in the industrial sector external pro- tection and the provision of fiscal incentives. 5. The sectoral allocation of public and private investment was reflected in a changing structure of output and employment. This featured the growth of manufacturing industry and the relative decline of agri- culture, although agriculture remained the chief source of employment, ac- counting in 1970 for 39 percent of the economically active population.  6. Rapid economic growth has not generated sufficient opportun- ities to create employment for the labor force which has recently been growing at about 3.5 percent per year. In 1970 it was estimated that 40 percent of the labor force was either engaged in marginal occupations - relatively unproductive and hence poorly paid - or totally unemployed. Partly as a consequence of rapid population growth, but also as a result of the distribution of incomes and assets in the Mexican economy, the strategy which succeeded in promoting rapid growth was not comparably suc- cessful in spreading its benefits. The incidence of poverty had by 1970 been much reduced from the level of 1940. But the differentials between rich and poor, both between people and between places, had probably increased. 7. There was, until recently, little evidence (apart from the con- tinuation of the land reform program begun in earnest during the Cardenas regime in the 1930's) that Government policies were much concerned with these problems. By 1970, however, it was apparent that a revised economic strategy - one which would focus on the improvement of the living conditions of the poor - was required. It seemed to be understood that this goal should not be pursued at the expense of rapid growth or of the monetary and balance of payments stability which appeared to be a sine qua non of sustained economic expansion. The events and trends of the last three years have demonstrated the Government's determination to develop such a strategy. They have slso revealed some of the constraints to doing so. 8. There are several types of distributive measures which do not depend heavily on the growth of budgetary expenditures. Among those introduced since 1970 are a new Agrarian Reform Law (1971), a new Water Law (1971) and a revision of instructions concerning the allocation of bank credit (designed to increase the flow of resources to low income farmers and ejidatarios).l/ These measures are all responsive to the needs of the rural sector and demonstrate the Government's concern to confront them. Another recent initiative is the introduction (1972) of a 5 percent payroll tax 2/ to finance a new housing program for workers in the lower-middle income groups. It is clear, however, in the light of the experience of the last three years, that neither the needs of the poor nor those of the public sector industries (on which the growth of the economy as a whole partly depends) can be met unless the Government takes new measures to mobilize additional public sector resources. 9. In 1971 the Government acted to restrain the growth of the economy in order to preserve stability and, partly as a result, the growth rate fell from the 1960-1970 decade average of 7.1 percent to only 3.7 percent, while prices increased by 4.8 percent. In 1972 renewed expansion was stimulated by public sector expenditures and the GDP growth rate rose to 7.5 percent, while prices increased (in terms of the GDP deflator) by slightly more than 5 percent. In 1973 there was a further substantial 1/ The ejido is a form of collective land tenure based on usufruct rather than ownership. 2/ This tax is not considered to be part of public sector resources for purposes of public finance analysis.  - 3 - increase in public expenditures which was largely financed by recourse to increased internal and external borrowing. This expansion coincided with and was partially responsible for an acceleration in the rate of domestic price increases. These increases are also, however, a conse- quence of imported inflation (the impact of which was especially serious because of the poor harvest in 1972 and the resulting need to import basic foodstuffs in a year of high commodity prices). Prices increased by roughly 20 percent during 1973 - somewhat more in the case of whole- sale prices and somewhat less in the case of consumer prices. 10. In the light of these trends, the Government is introducing substantial new resource mobilization measures to generate the funds required to support the growth of public expenditures. Following some changes in the tax structure in 1972 and 1973, it is understood that there will be a more substantial increase in taxation in 1974. The action which was taken in October 1973 to adjust electricity rates (by an average of almost 30 percent) was followed by substantial increases in hydrocarbons prices in December 1973. The total of the revenue measures which have been taken or are under consideration is expected to yield the equivalent of approximately 2 percent of 197h GDP. 11. These measures to increase public sector revenues are clearly needed and they will permit a reduction in the public sector deficit as well as a moderate increase in expenditure in 197h. The rate of increase in the latter, however, is likely to be slower than in 1973. There should be some deceleration in the rate of inflation in 1974 compared to 1973, but the rate will still be higher than in other recent years, both because of further expected increases in international prices and because the inflationary trends of 1973 have resulted in substantial wage adjust- ments which are likely to be reflected in higher costs and prices. 12. It is unlikely that the rate of economic growth in 1974 will be as high as the level of between 7 and 8 percent which is estimated for 1973. Growth will almost certainly be restrained by the capacity limit- ations derived from the low level of private investment in the last three years and because the Government recognizes the need to limit imports in order to contain the balance of payments deficit to an acceptable level. It is quite probable, therefore, that 1974 will be a year of fiscal and financial retrenchment and of moderate growth. 13. The events of recent months have illustrated the dangers inherent in large scale deficit financing, but also the willingness of the Government to take the kinds of corrective action which become necessary. The record of the Mexican authorities in economic management over the past two decades is such that there is reason to give credence to the Government's assurances that it will act to restore the relative price and balance of payments sta- bility which, in terms of the recent experience of the Mexican economy, ap- pear to be necessary conditions of sustained growth. The Bank, as well as the Fund, is in a continuing dialogue with the Government regarding these issues.  - 4 - 14. As of December 31, 1972, Mexico's outstanding disbursed ex- ternal public debt was US$4.0 billion as compared with a total of US$3.5 billion a year earlier. The IBRD share in the former total was US$723 million as compared with a level of US$659 million a year before. For 1973, net public medium and long-term external borrowing is estimated at about US$1,300 million. This represents a sharp increase over the 1972 level ($h51 million), and reflects the larger public sector defi- cit in 1973, a greater reliance upon external rather than deestic bor- rowing to finance the deficit and some borrowing undertaken to offset short-term capital movements. The substantial revenue measures re- cently taken will reduce the public sector's needs to borrow in 1974. 15. Annex I, Page 4 shows that 41.3 percent of public external ca- pital contracted in the period 1968-1972 was obtained from private banks - the largest single source and that international organizations ac- counted for the next largest share (22.2 percent). The World Bank ac- counted for 14.7 percent of total commitments. Annex I, Page 4 also shows the sectorial allocation of public external capital and reveals that power, transport and manufacturing were the dominant sectors. The terms of recent public external borrowing have continued to improve in the light of (a) the availability of capital in international markets and (b) Mexico's reputation as a creditworthy borrower. 16. During 1974, assuming normal private capital movements, it is expected that the level of net external borrowing by the public sector (or guaranteed by the public sector) will decline to around US$950 - US$1,000 million. Net borrowing of this magnitude is consistent with Mexico's debt service capacity. As a result, particularly of longer maturities on borrowings from financial institutions, Mexico's external public debt service ratio has declined over the last several years and was 18.2 percent in 1973. Assuming that the average terms in the future are about the same as those which have been recently obtained, the debt service ratio is expected to remain in the 18 to 20 percent range during the remainder of the 1970's. The Bank's share in public debt outstanding and disbursed is presently about 14 percent while its share in the corres- ponding debt service is about 10 percent. These ratios are not expected to change significantly during the remainder of the 1970's. 17. Mexico thus continues to be creditworthy for borrowing on con- ventional terms, always provided that the additional public savings measures are taken without undue delay. The rate increases recently enacted by the publicly owned electric power sector and the recent in- crease in the prices of the publicly owned hydrocarbons industry, suggest that the Government will continue to handle its financing affairs prudently. PART II - BANK GROUP OPERATIONS IN MEXICO 18. The Bank has made 33 loans, for a total of US$1,599 million net of cancellations, of which at the end of December 31, 1973 the Bank held US$1.3 billion including US$0.5 billion 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. However, disburse- ments on the US$125 million loan for the Fourth Power Sector Program were  delayed because the Government found it impossible to effect necessary power tariff changes on schedule. The problen was resolved when tariffs were increased on October 16, 1