Ecuador - Second Technical Assistance Project

Document of FILE copy The World Bank FILE COpy FOR OFFICIAL USE ONLY Report No. P-2125-EC L N ) REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF ECUADOR FOR A SECOND TECHNICAL ASSISTANCE PROJECT July 20, 1977 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  .CURRENCY EQUIVALENTS Currency Unit = Sucre (SI.) US$1 = S/. 25 S/.1 =.US$0.04 S/.1,000 = US$40.0 S/.l,000,000 = US$40,000.00 Fiscal Year: January 1 to December 31  FOR OFFICIAL USE ONLY Page 1 of 2 ECUADOR: SECOND TECHNICAL ASSISTANCE PROJECT LOAN AND PROJECT SUMMARY Borrower: The Republic of Ecuador Beneficiary: National Preinvestment Fund (FONAPRE) Amount: US$11.0 million Terms: Repayable over 10 years, including a 3-1/2 year period of grace, with interest at 8.0 percent. I Re-lending Terms: The loan proceeds would be made available to FONAPRE as a grant. FONAPRE would on-lend the funds to Govern- ment agencies for 5-10 years, including 1-3 years of grace, at 4-6 percent per annum. Project Description: The project's main objective is to improve the effi- ciency of the Government's investment machinery while expanding the pipeline of projects for Ecuador's investment program. It provides for preinvestment studies of agro-industrial, other industrial, power, agricultural, urban development, water supply and other investment possibilities. The project also includes technical assistance for advising and training FONAPRE's staff and that of other public agencies in project preparation and management; and assisting local consulting firms. There are no special risks involved in the project whose principal difficulty will be recruiting suitable experts and obtaining effective coordination with the local staff. Estimated Cost: Costs %'000 Project Components Total Foreign Local A. Project Studies 16,100 10,280 5,820 B. Institutional Assistance 1,470 1,200 270 C. Assistance to Domestic Consultants 200 120 80 Total 17,770 .11,600 6,170 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  Page 2 of 2 Financing Plan: Costs $ Million Foreign Local Total World Bank 11.0 - 11.0 UNDP 0.6 - 0.6 Government - 6.2 6.2 Rate of Return: Not applicable. Appraisal Report: None.  INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF ECUADOR FOR A SECOND TECHNICAL ASSISTANCE PROJECT 1. I submit the following report and recommendation on a proposed technical assistance loan to the Republic of Ecuador for the equivalent of US$11.0 million to help finance pre-investment and project preparation activi- ties. The loan would have a term of 10 years, including 3.5 years of grace, with interest at 8.0% per annum. Its proceeds would be made available to the National Preinvestment Fund as a grant. The Fund would on-lend the proceeds to public sector agencies for 5-10 years, including 1-3 years of grace, at 4-6% per annum. PART I - THE ECONOMY 2. A report entitled "Current Economic Position and Prospects of Ecuador" (No. 1382 EC) was distributed to the Executive Directors on April 1, 1977, and was based on the findings of an economic mission which visited Ecuador in August/September 1976 and in March 1977. Annex I summarizes the main economic and social indicators. 3. Until the emergence of petroleum as a major source of export earnings Ecuador depended mainly on agriculture. Its major exports were bananas, coffee, cocoa and sugar. Non-traditional exports, even though they increased rapidly during the 1960s, only represented a small fraction of total export earnings. Ecuador's manufacturing sector has been dynamic, growing at an average annual rate of 8.7% during 1965-75. It consists mainly of small private firms in a great variety of industries. Petroleum exports began in 1972, and they now make up half of total exports. Nevertheless, petroleum exports only average about US$75 per person -- about one-tenth the per capita exports in Venezuela. Ecuador is the smallest exporter in OPEC. In spite of petroleum exports, Ecuador is one of the poorest countries in Latin America with one of the fast- est rates of population growth. Only Haiti, Bolivia, Honduras and El Salvador have lower GNP per capita (1976 Bank Atlas figures). Likewise, Ecuador is among the six Latin American and Caribbean countries with the lowest protein consumption per head; the same is true for its consumption of energy per head. 4. The recent petroleum boom has improved the country's balance-of- payments and fiscal situations and has enabled the Government to expand public investment substantially. The petroleum revenues have also greatly strength- ened Ecuador's longer run development prospects. The main problem of economic management in the years ahead will be to maintain a reasonable balance between the country's petroleum output and exports, on the one hand, and the absorptive capacity of the-economy (and, particularly, of the public sector), on the  - 2 - other. Until now this balance has been fairly well maintained, and the in- flationary problems of 1974 and 1975 have come under better control in 1976. The fiscal and balance-of-payments problems attending the decline in petroleum earnings of late 1974-75 due to changes in petroleum pricing and pipeline disruptions, have also largely been resolved through a combination of prudent fiscal and monetary policies and of renewed increases in petroleum exports. 5. Petroleum policies will have a decisive influence on the country's growth prospects. The main problem is that conventional crude reserves are now being extracted faster than they are being replaced, owing to the virtual absence of exploration and development activity. A resumption of such activity on a substantial scale is warranted by the size of the in situ reserves. The main responsibility for carrying out a petroleum development program is CEPE's (the State Petroleum Corporation), which recently acquired the assets of Gulf Oil and now controls 62.5% of the Texaco/CEPE Consortium which produces all of Ecuador's petroleum exports. The Government has recently decided to step up investment in petroleum exploration and development, so as to increase pro- duction. To this effect, CEPE will receive a larger share of petroleum revenues than in the recent past for investment, and private petroleum enterprises will be encouraged to invest. These policies could lead to an increase in petroleum production from about 66 million barrels/year (1973-76 average) to about 86 million barrels/year within two years. Prospects for natural gas development in the Gulf of Guayaquil may be good, and further exploration is underway. 6. Ecuador is one of the few developing countries with enough fertile land to expand agricultural and livestock output at reasonable cost. Over the years, agriculture has been the most important source of employment, and im- provements in the standard of living of the majority of lower income Ecuadorians will hinge on increased agricultural production and efforts at incorporating farmers more fully into the market economy. Prospects for industrial develop- ment are favorable and have been enhanced by better availability of medium-term credit (due partly to the introduction of more realistic interest rates in 1976) and by improvements in physical infrastructure (transport, electric power, water). Most Ecuadorian firms are small and cater to domestic needs. 7. The Government's record in the allocation of petroleum revenues is encouraging since they have been largely devoted to economic and social devel- opment projects. Out of 1976 petroleum exports of US$565 million (net of bar- ter arrangements with Venezuela), US$480 million accrued to the public sector. The National Development Fund (FONADE) created to channel petroleum revenues into social and economic development projects absorbed US$152 million, and the next largest recipients were the Central Government, the armed forces, the national power authority, and CEPE. The balance went mainly to the National Housing Bank, the Ministries of Labor, Education and Health, as well as the universities. The past allocation of petroleum revenues suggests that the Government will continue to give priority to economic and social projects. 8. Public investment has increased from 5-6% of GDP in the early 19708 to 9% in 1976, while GDP was growing at a rapid rate. If petroleum production rises from its 1976 level of 65.9 million barrels a year to about 90 million  - 3 - barrels by the early 1980s, a further increase in public investment should present no serious financial problems. The growth of public investment, particularly in petroleum, electric energy, agriculture and rural development, transport, industry, health and education, should encourage the further development of the economy, particularly manufacturing, agriculture and construction. As Ecuador's progress to date has alleviated only some of its development problems, the Government is now preparing a public investment program reflecting the above priorities. Domestic resources should be suffi- cient to finance a substantial part of this program, but its full realization will require continuing support from external financing agencies. Such support should include an appropriate blend of financial assistance from international institutions and of borrowing at commercial terms from other external sources required to finance its investment program while limiting the increase in the country's debt service ratio from its 1976 level of near 7% to about 12% by the early 1980s. 9. The prudent fiscal and monetary policies pursued during 1975 and 1976 have been reflected in a significant reduction in inflation and in a substantial increase in foreign reserves (during 1976 these increased by US$189 million to US$515 million, equivalent to nearly five months' imports). The 1977 budget confirms that the Government intends to continue to pursue prudent fiscal and monetary policies, thus reinforcing Ecuador's creditworthi- ness for further lending on Bank terms. PART II - BANK GROUP OPERATIONS IN ECUADOR 10. Starting with the first loan in 1954, the Bank and IDA have made twenty loans and six credits to Ecuador totalling (excluding those agreements not yet signed) US$230.8 million, net of cancellations. At May 31,1977, the Bank and IDA held about US$184.3 million including about US$115.7 million not yet disbursed. IFC has made six loans and investment commitments in Ecuador, two in a large textile company, three in a development finance company, and one in a sugar mill, amounting to US$9.4 million of which, as of May 31, 1977, US$3.1 million has been repaid, sold, terminated or cancelled. IFC is currently examining other investment prospects. Execution of Bank Group financed projects has, on the whole, been satisfactory, even though it has not been free of difficulties often caused by the insufficiency of the country's managerial and technical resources--a constraint that still is a major obstacle for Ecuador's economic and social development. Annex II contains a summary statement of Bank loans, IDA credits and IFC investments as of May 31, 1977 and notes on the execution of ongoing projects. 11. Bank and IDA lending were originally concentrated in transportation and power, where there were--and still are--substantial deficiencies to be overcome. At the end of FY76, these two sectors accounted, respectively, for about 42% and 7.3% of total past lending. Most of the lending for transporta- tion was to improve the road network of the country, although two loans were made to help finance port facilities in Guayaquil. Lending for power has been concentrated in improving generation and distribution facilities in Quito.  - 4 - The first livestock development loan (FY67) marked the beginning of a diversi- fication of lending; since then, the Bank and IDA have made eight more loans and credits for agriculture and fisheries, three loans to support industrial develoment through development finance companies, one loan and one credit for education, one loan for water supply, one loan for improved seeds production and one loan to assist Ecuador in the preparation of rural development proj- ects. Bank/IDA assistance for the directly productive and social sectors has grown to about 50.6% of total lending. 12. External development financing has also been provided by IDB and AID and, to a lesser extent, by other bilateral sources. External Financing by Sector and by Source through December 31, 1976 Other Bilateral IBRD IDA IDB US /1 Sources /1 Lending 1954-64 54.0 8.0 35.3 62.7 0.2 /2 Lending 1965-76 140.5 28.9 349.8 73.0 96.5 /3 Transport 44.0 - 65.1 - 0.8 Power - 6.8 92.7 6.2 67.2 Education 4.0 5.1 4.1 5.3 - Health and Sanitation 23.2 - 49.3 9.5 4.8 Agriculture and Fisheries 15.3 17.0 64.6 29.1 - Industry 54.0 - 53.8 7.8 8.7 Urban Development - - 14.8 - - Other - - 5.8 15.1 15.0 194.5 36.9 385.1 135.7 96.7 /1 Includes official export credits. /2 Statistics on lending during this period are probably incomplete. /3 Through December 31, 1975 only. IDB is the largest single lender, having extended most of its loans to Ecuador from the Fund for Special Operations, which has normally carried a 2% interest rate, a ten-year grace period, and repayment terms of up to 40 years. It is likely that IDB will remain the major development lender in the immediate future, although its terms have become less concessionary than in the past. Meanwhile, no new AID commitments have been made since FY73. There were in calendar year 1975 over US$205 million of new commitments of external finance, including those from international institutions, suppliers, commercial banks  and some bilateral sources. Education, health and other socially oriented activities, as well as agricultural development, have been receiving increasing attention from external lending agencies in recent years. IDB, AID and .he Bank Group have coordinated their efforts in these fields to assure the most effective use of all available resources. 13. Bank lending is aimed at supporting the Government priorities out- lined in Part I above. This objective will be met by emphasizing projects that will help strengthen the institutional framework for development policy-- including project planning, preparation and implementation--in agriculture and rural development, transportation and other high priority activities. A major institution-building effort in these fields should yield tangible benefits for Ecuador. This was.a major objective of the FY76 loan for rural development planning (EC-1230). It is the basis for the proposed project as well. In addition, considering the extreme poverty in which most of the Ecuadorian population still live, the current Bank program includes substan- tial support for integrated rural development projects and assistance for the development of the country's agricultural potential. All projects pro- grammed for this sector include sizable technical assistance components, as a major part of the overall institution--building effort referred to above. PART III - PUBLIC INVESTMENT AND PROJECT PREPARATION ACTIVITIES 14. Ecuador's first attempt at investment planning was made in 1963 as part of the preparation of the 1964-73 National Development Plan. The Plan's investment objectives were not achieved owing to the rather limited capabil- ities of most of the Government's executing agencies. In 1970, a new program for the period 1970-73 was formulated but the insufficiency of public savings made its execution impossible. In 1972, the National Planning and Economic Coordination Board (JUNAPLA) adopted the technique of preparing 5-year devel- opment plans which would be implemented through biannual public sector program budgets. Within this approach, JUNAPLA prepared that year the 1973-77 Plan Integral de Transformacion y Desarrollo which defined the basic economic pro- gram of the Government. The Plan called for annual increases of 8.6% in total investment over the 5-year period, reaching a level equivalent to 23% of GDP in 1977. Public investment would provide an increasing share of total capital formation. 15. The participation of the Government in the economy has during the last three years exceeded even the increased levels planned in 1972, owing to the expanded petroleum revenues which emerged from the opening of oil production in the Oriente Province in 1972 and the subsequent worldwide oil price increases. This produced a substantial change in the economic situation and prospects of Ecuador. As noted in para. 8 above, public investment increased in 1976 to 9% of a rapidly rising GDP. The Government was thus enabled to inititate substantial new programs in highways, energy, agricul- ture, water and sewerage, and irrigation in order to reduce the many defi- ciencies prevailing in these sectors.  - 6 - 16. In the process, the Government's development program has been rela- tively free of the insufficiency of public savings which had been a character- istic weakness of the Ecuadorian scene and which had deterred Ecuador's economic growth in the past. The Government now has a far greater capability to allocate the amounts needed to finance its share of development require- ments, as well as to service an increasing public debt while maintaining favor- able overall long-term balance of payments prospects. However, the improved financial resource situation has not eliminated the other principal constraint on Ecuador's public investment process: the lack of adequate public adminis- tration capacity. 17. Ecuador's past economic growth came, to a large extent, from the private sector and, historically, Ecuador's public sector has been quite weak. This weakness reduced the efficiency of development planning in general, and particularly deterred project identification and preparation, thus causing a shortage of adequately prepared projects, and, until recently, a low level of public capital formation. This vicious circle has limited the capability of Ecuador to cope with its deep-seated development problems. 18. This experience, when rising petroleum revenues made it possible to think of an expanded level of public expenditure, alerted the Government to the need for increased capacity for preparing and executing priority invest- ment projects. Substantial improvements have been made in this regard. At the end of 1973, the Government established the National Development Fund (ref. para. 7) to finance public investment with the emerging petroleum revenues. In line with this action, the Government also addressed itself to strengthening its planning machinery, and to widening the range of investment alternatives. Both efforts have focused on increasing the quantity and improving the quality of prefeasibility and feasibility studies of potential projects. The Government strengthened JUNAPLA's authority for the formulation and execution of development policies. It organized, under JUNAPLA's direction, a "national projects system" to promote and accelerate pre-invest- ment study activities; and to strengthen budgetary and other procedures for the execution of investment programs. It also began to enlist the technical assistance needed for these areas. Sectoral planning units were improved and other organizational measures were taken in strengthening executing agencies, both at the national and the regional levels. Among these measures, perhaps the most important was the establishment in December 1973 of the National Preinvestment Fund (FONAPRE) which finances project preparation work carried out by Ministries and other Government agencies. FONAPRE's functions are described in paras. 23-27 below. Moreover, the Government also strengthened its capability to manage public finances effectively by consolidating under the National Budget many accounts which had been administered in an autonomous, almost anarchic, manner. The Government has also decided to establish a new development bank ("Banco del Estado") for which it will earmark a substantial proportion of the country's oil revenues for financing high-priority invest- ment projects.  19. The gradually improving public administration produced by these measures has enabled the Government to make considerable progress in turmu- lating and executing economic development policy during the past few years. Mainly as a result of a generally effective use of its oil revenues, Ecuador has strengthened its level of economic growth while overcoming severe infla- tionary pressures. The country's infrastructure is being substantially improved. Since 1973, there has been a reversal of the previous slump in agricultural production, in the wake of increased producer support prices, and of the tripling of agricultural credit. Present national policy is to expand on these accomplishments in the future so that Ecuador can diversify its economy. And the public investment program includes a substantial number of projects designed to help raising the living standards of the poorer segments of its population. In order to achieve these objectives, the Govern- ment intends to step up public investment further in the years ahead, and has requested the help of the Bank to set up a consultative group to assist in this regard. The Bank is now exploring this possibility. After the last economic mission's review of the investment projects being prepared by Govern- ment agencies, the Government has defined a public investment program with a commitment level of US$3.8 billion over the 1977-81 period, excluding financial investments. That level would imply a real annual increase of 12% in public investment outlays during those years over the amount reached in 1976 (about US$460 million), which was already substantially higher than that prevailing until 1975. 20. If the Government is to carry out such an ambitious program, it will have to extend its recent gains in managerial and physical capacity even further. At the end of 1974, the Government contracted advisory services from a non-profit U.S. institution experienced in government administrative improvements (the Institute of Public Administration) to prepare a program organized around: (a) the development of Government-wide policies on adminis- trative reforms; (b) individual initiatives of operating agencies for such changes; and (c) improvements in the general administrative areas of planning, financial administration, personnel administration, information systems, auditing, control and procurement. The emphases of the program's first two years of operation have been on the Office of the President and the Ministry of Agriculture, and on guidance to various ministries on in-house adminis- trative improvements. The program will continue until the end of 1977. However, in spite of these improvements, and of those others referred in para. 18 above, there remain substantial deficiencies in public administration policies and practices which hamper Government decision-making, especially in project identification, preparation and execution. These deficiencies are partly related to outmoded and cumbersome bureaucratic procedures which unduly lengthen the decision-making process concerning pre-investment activities. They also are caused partly by the scarcity of adequately trained personnel throughout the public sector. 21. These difficulties have contributed to the relatively slow execution of the Bank's FY76 loan for financing a technical assistance project for the preparation of rural development projects (Loan 1230-EC). This loan was approved on March 30, 1976, and became effective last October. It was agreed  - 8 - then that it would be channeled through FONAPRE, but no assistance was then planned to strengthen FONAPRE's technical structure and to solve the remaining institutional problems connected with project preparation activities. When this loan was approved, it was expected that disbursements would start soon afterwards for strengthening the planned central rural development unit within JUJNAPLA and, subsequently, for the preparation of rural development projects. It soon became clear however that the problems associated with the establish- ment of this unit and with JUNAPLA's coordination of the activities of multiple Government agencies were more serious, and more time-consuming than originally envisaged. These problems have by now been largely solved--through the staffing of the central unit and by JUNAPLA's working arrangements with the Ministry of Agriculture and other agencies. Nevertheless, other bureaucratic and legal difficulties continued to delay the beginning of the planned pre- investment studies until June 1977. 22. These difficulties were mainly related to: (a) the lack in most Government executing agencies of technical personnel with adequate experience in project preparation; (b) the insufficient number of qualified FONAPRE staff members to substitute for the required expertise elsewhere in the Government; and (c) the cumbersome procedures for approving FONAPRE's loans to executing agencies and for hiring foreign consultants to be financed by those loans. The procedural problems emerged mainly from the need to obtain repeated and multiple authorizations from various Government agencies (e.g., the Finance Ministry, the Monetary Board, the Attorney General's Office, and the Comptroller's Office) for each FONAPRE loan agreement and for each foreign consultant's contract. The Government has realized the serious effects of these problems, and has already taken steps toward their solution. FONAPRE 23. FONAPRE is the Government's principal agency for preinvestment activities. FONAPRE is now legally autonomous and possesses independent capital. It works quite closely with JUNAPLA whose President heads FONAPRE's board of directors. Its function is to promote, identify, select, finance and evaluate studies to enable Ecuador to implement public investment projects. It receives and analyzes proposals for financing a wide range of preinvestment studies (sectoral, sub-sectoral, pre-feasibility, feasibility, engineering, design, etc.) from Government ministries, development financial institutions-- both public and private--and regional and other decentralized development agencies. As a "bank", FONAPRE's principal responsibility is to assure that Government funds are being committed to well-prepared, high priority and properly costed preinvestment studies. In its initial operating stage, FONAPRE has concentrated on encouraging a steady and increasing flow of proj- ects in order to overcome the past paucity of development opportunities. For this reason, and because of the still prevailing weaknesses in the planning units of the Ministries and other organizations, FONAPRE's staff has had to extend itself beyond the limits of its prescribed functions. That small staff has thus had to participate in the full range of project preparation activities, i.e., in defining the purpose and scope of studies, in identifying and evaluating a range of possible consultants for conducting the studies,  - 9 - in contracting arrangements and in supervision work. In addition, since it was established, FONAPRE has conducted, with IDB assistance, a comprehensive training program on project preparation techniques, for its own personnel and for the planning staffs of other government agencies. Attachment I contains a mcrce detailed description of FONAPRE. 24. Organization and Administration. FONAPRE functions under the direc- tion of its Board of Directors, which has three permanent members: the President of JUNAPLA (who serves as the president of the Board), the Minister of Finance and the General Secretary of the National Security Council. Other Government cabinet members may temporarily act as members of the Board whenever a study in their particular field of activity is being considered. The Executive and Technical Managers of FONAPRE are Board members with voice, but no vote. The Board's principal functions are to: (a) establish the general policies and financial conditions for FONAPRE's lending activities; (b) approve organizational changes, by-laws, operating regulations, national and international agreements, and lines of credit to intermediary agents; (c) review and approve budgets, financial statements, and other reports pre- sented by the Executive Manager; and (d) authorize loans to executing agencies, and other expenditures above certain limits. The chief executive officer of FONAPRE is its Executive Manager, nominated by the President of JUNAPLA and appointed by the President of the Republic. He is assisted by a technical manager, who is responsible for coordination between JUNAPLA and FONAPRE; an operations manager, who is responsible for the execution of FONAPRE's lending program, including the supervision of the work of loan officers and project committees, and for maintaining contact with all FONAPRE borrowers; and a financial-administrative assistant manager. 25. FONAPRE currently has a total staff 1/ of 25, of which 18 are pro- fessionals. These include economists, engineers and a complement of adminis- trative staff. The professional staff is relatively small since it is sup- plemented by the sectoral units of JUNAPLA which serve, to some extent, as the technical arm of FONAPRE, carrying out analyses of some technical aspects and reviewing the socio-economic priority of each study proposal. FONAPRE's senior personnel are qualified, and the entity is well organized and managed. Some of its professionals have considerable potential but they lack sufficient experience in project preparation techniques. Moreover, because of relatively low salary scales in the public sector, FONAPRE has lost some promising young staff members to better positions in the private sector. In spite of these constraints, FONAPRE has been developing some technical competence but still lacks expertise in major areas, notably in agriculture, infrastructure and industry. FONAPRE's management has been active in trying to expand the organization's capabilities by employing consultants, by training programs, and by drawing on the experience of other preinvestment funds in Latin America. At the same time, FONAPRE itself has been designated as the regional Latin American center for the interchange of information and experience among the preinvestment funds operating in that region. 1/ See Organization Chart, Attachment II.  - 10 - 26. Operations. FONAPRE's policies and regulations are consistent with Bank policy. Within the limited period of its operations, FONAPRE has complied with those regulations in the approval of studies and the selection of consul- tants, and appears to be functioning satisfactorily. However, as indicated in paragraph 22 above, the general legal framework within which the preinvestment systems has functioned cannot be considered satisfactory. It has hindered the effective functioning of the organization and does not serve overall public investment objectives. As a result of these deficiencies, project preparation and execution have often run well behind schedule; cost overruns have been frequent; and the ability of the country to obtain development finance and use it efficiently has been unduly reduced. The Government has taken during the last two months some important decisions in this respect, which constitute a satisfactory solution to the most pressing institutional problems. The main aspects of these measures are as follows: (a) FONAPRE's loans to executing agencies, and the contracts with foreign consultants and consulting firms financed by those loans, will be exempt from the specific approvals required up to now from the Attorney General, the Government's Comptroller, the Finance Minister and the Monetary Board, provided that these loans are wholly or partly financed by international financial institutions. Those authorizations constituted the major cause of the substantial delays (about three months in each case owing to those factors) prevailing up to now in the execution of pre-investment activities financed by the Bank and other international institutions. (b) The Ministries and other executing agencies will not have to obtain--as was the case up to last month--individual presiden- tial decrees authorizing them to sign their loan agreements with FONAPRE, when those loans are wholly or partially financed by international institutions. This should eliminate delays of about one month in the execution of pre-investment activities financed through FONAPRE. (c) The process of pre-qualifying, hiring and selecting foreign consultants and consultant firms would be carried out following procedures agreed upon in each case by FONAPRE and inter- national financial institutions. (d) The ceilings established by law for the remuneration of Government employees and consultants will not be applied to individual consultants whose contracts are wholly or partly financed by international institutions. The proposed loan is intended to complement these measures by: (a) further strengthening FONAPRE's capabilities through the financing of a group of high-level internationally recruited consultants; (b) helping to identify additional ways to simplify existing Government procedures affecting pre- investment activities; and (c) financing the preparation of high-priority  - 11 - projects--in addition to those in the rural development field financed through the Bank FY76 loan--to be carried out by the Government's executing agencies under FONAPRE's supervision. 27. So far, FONAPRE has financed studies in several sectors with partic- ular emphasis on infrastructure (e.g. power, railways and roads), petroleum, forestry, and sugar production. 1/ Although still a young organization, having begun operations effectively in mid-1974, FONAPRE expects to be able shortly to increase its volume of activity. FONAPRE's expansion will have to be rapid and substantial if it is to meet the volume of requests from numerous Ecuadorian agencies. In the immediate future, the current status of FONAPRE's operations indicates a total of 50 additional studies that are expected to be underway in the period 1977-79. This list of studies 2/ covers a broad range of development activities and would contribute significantly to the Govern- ment's inventory of promising investment projects. Of the 50 studies, as of March 1977, six had already begun; contracts had been signed for eight others; FONAPRE's directors had approved 28 more for contract negotiations; and the remaining eight were being processed. Moreover, FONAPRE had received and was beginning to review last March an additional 39 requests. 28. Financial Situation and Prospects. FONAPRE finances project prepar- ation activities mainly through loans to other Government agencies. These have to be repaid in 5-10 years, and are granted at 6% interest for projects in the economic sectors, and at 4% for those directly related to social objectives. Additionally, FONAPRE also collects an annual 1% on outstanding balances as a commission for technical services rendered to its borrowers, and a 1% annual commitment charge on undisbursed balances. FONAPRE's operating income is intended to cover all its administration expenditures in the near future (by late 1977), when the disbursed loan balances are expected to reach the level required for that purpose. In its initial years, FONAPRE has not had to face any liquidity problems owing to the relatively large amounts allocated to it in the Government budgets--a fact which reflects the high priority attached to pre-investment activities within the country's develop- ment efforts. The Government contributions have reached an annual level of US$4.62 million, which is expected to be maintained at least until 1979. They constitute up to now the main source of funds to finance FONAPRE's lending program. In addition the Government has contracted two foreign loans, for US$4 million each--one from the Interamerican Development Bank (IDB) and the other the Technical Assistance loan approved by the Bank in late FY76--and has agreed to allocate their proceeds to FONAPRE on a grant basis, thus further contributing to FONAPRE's capitalization.. While very little has been disbursed from these two loans up to now, owing mainly to the institutional problems referred to in paragraph 22 above, the decisions adopted recently by the Government (see paragraph 26) should now enable FONAPRE to channel these 1/ See Attachment III. 2/ See Attachment IV.  - 12 - resources at a much faster pace. Those resources, together with the increased income that should accrue to FONAPRE from its larger operation volume and with the proceeds of the proposed Bank loan, should be sufficient to fully finance FONAPRE's lending program, and its operating expenses, in 1977-78. In 1979, these resourc.s would have to be complemented by about US$3.2 million in additional Government contributions, or by additional borrowings. To manage this increased level of operations.. FONAPRE's capable but relatively small staff (its total annual cost has not exceeded US$400,000 up to now) will have to be strengthened by hiring additional Ecuadorian and foreign high level professionals (see paragraph 33). PART IV - THE PROJECT 29. The project is based on a Government request in September 1976 for Bank assistance in its public investment efforts and on the findings of Bank appraisal missions in November 1976 and February 1977. Negotiations were held from June 13 to 23, 1977. The Ecuadorian delegation was led by Mr. J. Reyna, Subsecretary of Finance and included also Mr. M. Calisto, Executive Manager of FONAPRE and other representatives of that institution. General Description 30. The proposed project would support a three-and-a-half-year program of assistance in preinvestment activities. The main objective of the project is to improve the efficiency of the Government's investment machinery while expanding the supply of opportunities for the sustained growth of Ecuador's investment program. The proposed project principally provides for selected preinvestment studies under Bank supervision. The project would aim also at enhancing FONAPRE's ability to plan and manage the preparation of preinvestment studies. In a coordinated approach, the project would help the Government streamline its decision-making processes in this field. Another component of the project would be technical assistance to improve the capacity of local consulting firms to participate in preinvestment studies. Project Studies 31. The list of project studies was prepared from FONAPRE's 1977-79 program on the basis of the recent economic mission's findings. Nine studies were selected which relate to the important objectives of modernizing the economy, developing Ecuador's natural resources, and creating employment opportunities. The largest single study would bring improved sector planning to bear on the Government's estimated US$1.2 billion program to meet the continuing over 13% annual increase in power demand. It would include hydro- electric studies; an evaluation of geothermal resources; a feasibility study of a major hydroelectric project; and the preparation of an electrification master plan. These would assist the Government in defining an energy policy. Ecuador's steadily growing industrial sector (8.7% per annum from 1965 to 1975) is the focus of another major part of the project. Studies included in  - 13 - this group are designed for the possible establishment of new plants partic- ularly in agro-industry (forest industry and soybean production), construction materials and petrochemicals. These are important not only because of their impact on the balance of payments but also because of their capacity to absorb Ecuador's rapidly growing labor supply. The remaining studies concern the rehabilitation of the ailing cocoa industry, the improvement of living condi- tions in the poorest parts of Ecuador's largest city and the expansion of safe water supplies for small communities. As such, several of the studies concern projects that are expected to be considered by the Bank for financing and most appear suitable for submission to external financing agencies. Some may qualify for cofinancing by export credit agencies or private banks. The proposed project studies are defined in Attachment V. Institutional Assistance 32. Ecuador has increased substantially its absorptive capacity in recent years, owing to some institutional improvements, of which the creation of FONAPRE figures as particularly important. However, this capacity is still constrained by many deficiencies in the country's public administration, which hamper the Government decision-making process, especially in project identifi- cation, preparation and execution. 33. As noted in paragraph 26 above, the Government has recently taken some important steps toward the solution of the main institutional defi- ciencies affecting pre-investment activities. But some other important problems still remain in this respect. Therefore, it is also proposed that the following internationally recruited experts be financed under the proposed project: (a) A general advisor on institutional matters related to project preparation and execution, and to foreign financing. This expert would work with FONAPRE and other Government agencies to: (i) speed up the project preparation and execution process, by proposing additional changes required in FONAPRE's and other entities' regulations and procedures; (ii) ensure the consistency of decisions on project preparation and execution adopted by the Govern- ment and by autonomous agencies with the require- ments of external financial agencies; (iii) devise ways to obtain financing, at appropriate terms and conditions, from foreign private sources; (iv) identify projects potentially suitable for external financing;  -_ 14 - (v) coordinate Government actions related to the proposed consultative group. (b) Three internationally recruited experts in project prepa- ration including one general project economist and two project specialists, one for agriculture and the other for the economic infrastructure sectors. The three experts would would work in close relationship with FONAPRE's staff to pro- vide on-the-job training in all the operational aspects of preinvestment activities. Specifically, the experts would assist FONAPRE and the executing agencies in: (i) The identification of study proposals and in their analysis; (ii) The preparation of detailed terms of reference, costing and timing of the studies FONAPRE will finance; (iii) The supervision of studies, the assessment of study reports, and of general project preparation work. In selected instances, the experts would also partici- pate in the solution of specific technical problems of individual projects which may emerge in the preparation process. These three experts would be financed by the UNDP (ref. para. 39) which has agreed to designate the Bank as executing agency for this purpose. The project also provides for about 19 man months of services from short-term experts. These experts would assist FONAPRE and the executing agencies in (a) preparing terms of reference, cost estimates and work schedules for selected project studies in the industrial and some other sectors; and (b) solving specific management and technical problems which may emerge in connection with the preparation and execution of investment projects. (c) An internationally recruited expert, supported by short-term consultants, to help improve the project management capabi- lities of various public sector agencies. The Government has requested Bank assistance to: (a) identify the main causes of project execution problems; and (b) develop and conduct training courses for Government officials responsible for investment projects. The proposed loan would finance the expert referred to above during a two-and- a-half year period, and about thirteen man months of services from short-term consultants. They would work in close coordination with the Economic Development Institute and with other Bank staff which will assist these experts in the diagnosis stage, and in the preparation and supervision of the courses.  - 15 - 34. The five experts and the short-term consultants referred to above would be attached to FONAPRE. Their technical support, however, would not be limited to FONAPRE itself. The three project experts would work closely not only with FONAPRE staff but also with project preparation technicians of the executing agencies. One of the results of this work would be the development of case studies in project preparation, which would be used in FONAPRE's training program. The three project experts would participate personally in that program, particularly in the discussion of the case studies developed by them and, also in selected seminars on specific project preparation techniques. The contribution of the three experts to the training program would be coor- dinated by the project economist referred to in paragraph 33 above. This program, started in 1974, has been financed mainly through an IDB grant. In view of its positive results, IDB has just agreed to extend the program until 1979. The participation of the three experts to be financed by the proposed Bank loan should ensure a more direct relationship of those training activi- ties with the actual project preparation work being done in Ecuador. The training to be provided by the expert in project management would become a part of FONAPRE's overall training program, and would be closely coordinated with the project preparation activities referred to above. In the case of the general advisor, a flexible arrangement has been agreed upon to permit him to work directly, when needed, with the National Planning Board, the Finance Ministry and the executing agencies, particularly in connection with external financing matters and the solution of specific problems related to project preparation and execution. The total cost of the five experts and of the short-term consultants is estimated at US$1,470,000. Assistance to Domestic Consultants 35. The Government of Ecuador has also asked for the Bank's assistance in developing local economic and engineering consulting firms in order to enhance their competitive position in relation to foreign companies. By promoting the greater efficiency of domestic firms, the Government seeks to bring about eventual foreign exchange savings and to make fuller use of local skills. Current Government policy is to contract more significantly with local consul- tants either directly or through sub-contracts to, or joint ventures with, international firms. FONAPRE has already begun on a modest scale to try to raise the standards of local firms but much remains to be done. In order to achieve these objectives, technical assistance would be furnished under the project directed towards making the industry more efficient. Emphasis would be placed on training, analysis of existing Government procedures and insti- tutions, and appropriate research. Consultant services from international sources with professional expertise and managerial experience in this work would be employed for this purpose. They would work with a group of domestic contractors selected on the basis of criteria to be furnished by FONAPRE. The consultants would review the technical, managerial and financial capacity of the domestic industry in relation to private and public sector needs. They would evaluate also the administrative environment in which the industry operates, especially the impact of Government policies, standards and practices. The consultants would assess present bidding; contracting, cost control, financial planning and management practices of consultant firms. They would  - 16 - prepare recommendations for correction of any shortcomings in Ecuadorian laws and regulations, as well as measures to improve, as needed, contracting, payment, performance bonds and bank guarantees, and other techniques. This assistance would give special emphasis to the long-term training requirements of the local industry and to the institutional arrangements that might be required to meet them. In addition the experts financed through the proposed loan would also provide--in collaboration with FONAPRE and local consultants' associations--on-the-job training for the solution of the managerial and technical problems which are faced by the local consultant firms. These services are estimated to cost about US$200,000. Project Execution 36. FONAPRE would be responsible for the execution of the project. It would designate FONAPRE's operations manager as the project coordinator, over- seeing all the aforementioned activities. Should FONAPRE subsequently wish to change the project coordinator, the experience and qualifications of his pro- posed replacement would have to be satisfactory to the Bank (Section 2.05 of the Project Agreement). The operations manager would serve also as the counterpart to the general advisor who would head the advisory team for the institutional assistance component. 37. The preinvestment studies financed through the proposed loan would be administered through FONAPRE's normal operating procedures as amended by the recent decisions adopted by the government (ref. para. 26). During the execution of the project, the Bank would be afforded an opportunity to comment on any proposed change in FONAPRE's financing and procurement procedures (Section 2.06 of the Project Agreement). By January 1, 1978, FONAPRE would furnish the Bank a schedule for the preparation of the project studies (Section 2.08 (a) of the Project Agreement). The executing agencies would prepare the terms of reference for each study with the assistance of FONAPRE and of the experts referred to in paragraph 33 above. The ministries, regional organizations and other executing entities would prequalify consul- ting firms, select the consultants for the studies, and enter into contracts with them. For every study, FONAPRE would obtain the approval of the Bank at two stages. FONAPRE would first submit the draft terms of reference, a short list of qualified consultants and the proposed invitation for proposals (including the estimated cost) before advertising begins. Subsequently, before the final award of contracts, the Bank would be advised of the consultants selected, their proposal and the ranking of the proposals of other consultants. The Bank would approve the draft contract with the consultants selected, as well as the provisions of FONAPRE's loan agreements to the executing agencies.  38. Assurances have been obtained on the arrangements for the conduct of the project studies, as specified in para. 37 (Section 2.03(a)(ii) of the Project Agreement); and on the conditions for the designation of the project coordinator as specified in para. 36 (Section 2.05 of the Project Agreement). It was also agreed that the five individual experts to assist FONAPRE's staff, referred to in paragraph 33 above, would be employed by the Bank (Section 2.04(a) of the Project Agreement). The general advisor would be seconded from the Bank staff and the remaining four would be hired under fixed term appoint- ments. The short-term consultants and those to assist the domestic industry would be hired by FONAPRE, and their terms of reference, qualifications and terms and conditions of employment would be acceptable to the Bank. FONAPRE has agreed also to submit to the Bank during the disbursement period: (a) semi-annual progress reports; (b) an annual forecast of studies planned for each subsequent twelve-month period; (c) periodic consultants' reports on each study; and (d) the report of its auditors not later than three months after the end of each financial year. It is expected that the Bank would also receive annual reports on FONAPRE's utilization of loan recoveries and addi- tional contributions to FONAPRE. It was also agreed that the new measures simplifying FONAPRE's procedures would not be amended or suspended in such a way as to impede FONAPRE's activities under the project (Section 5.01(c) of the Loan Agreement). Cost and Financing 39. The overall cost of the project is estimated at US$17.8 million, including a foreign exchange component of US$11.6 million. Its composition is reflected in Table 1 below. The project would be financed as follows: US$6.2 million or 35% of the project cost by the Government; US$600,000 or 3% of the project cost by UNDP; and US$11.0 million or 62% of the project cost by the proposed Bank loan. Costs have been estimated at 1977 prices with price contingencies based on an estimated annual price increase of about 8% per year. The Bank's financing would meet (a) the equivalent of the estimated foreign exchange cost of the project studies--US$10.28 million--and of the assistance to domestic consultant firms--US$120,000; and (b) the cost of the general advisor, the training expert and the short-term consultants included in the institutional assistance component--US$600,000. The UNDP would finance the three project experts also included in the insti- tutional assistance component. With its participation in this project, UNDP would complement its long-standing assistance to Ecuador's pre-investment activities with a direct and important contribution to the strengthening of FONAPRE's technical structure. The Government would provide services and equipment for this project component at an estimated cost of US$270,000. The Republic of Ecuador would be the borrower and would grant the proceeds of the loan to FONAPRE. FONAPRE would on-lend the funds required for the project studies to the public agencies designated to carry them out. For this purpose, FONAPRE will use its standard lending terms. The public entities would repay their obligations to FONAPRE through automatic retention of a portion of their future budget allocations (via Central Bank transfers from the entities' accounts directly to FONAPRE). The executing agencies are required by FONAPRE to finance at least 10% of the total costs of the studies; they usually  - 18 - finance more than that, with an average participation up to now of about 20%. Amortization and interest of the proposed Bank loan would be paid by the Government without any FONAPRE contribution so that repayments from the funds on-lent by FONAPRE can accrue as a revolving fund to its own resources for future use in further lending operations. This is considered satisfactory for FONAPRE's financial circumstances. The effect of this is to provide FONAPRE with an additional capital contribution from the Government in order to help ensure adequate funds for FONAPRE's long-term financial needs. FONAPRE would open a special account for the project within its accounting system, and cause the executing agencies carrying out the project studies to do the same. Table 1: ESTIMATED COSTS ('000 $) Costs Total Foreign Local Costs A. Project Studies 16,100 10,280 5,820 Agro-Industries 1,500 900 600 Other Industries 4,000 2,400 1,600 Power Studies 5,000 3,500 1,500 Agriculture 300 180 120 Rural Water Supply 1,200 720 480 Urban Development 620 370 250 Unidentified Projects 1,130 680 450 Contingencies 2,350 1,530 820 B. Institutional Assistance 1,470 1,200 270 C. Assistance to Domestic Consultants 200 120 80 Total 17,770 11,600 _6170 Note: Services to be obtained for the project studies are for foreign and local experts. Foreign consulting services have been estimated at an average of US$47,000 per man-year for long-term consultants, and an average of US$7,800 per man-month of short-term consultants, based on recent Bank experience in comparable projects in Latin America.  - 19 - Procurement and Disbursements 40. The proposed loan would be disbursed over an estimated four-year period against appropriate documentation for (a) 60% of the cost of each study (other than the power studies); (b) 70% of the cost of preparing the power studies; (c) 100% of the cost of the general advisor, the training expert and the short-term consultants; and (d) 60% of the cost of the assist- ance to domestic consultant firms. As noted above, FONAPRE would obtain Bank approval of the content and estimated cost of each study to be taken prior to their inviting proposals, as well as subsequent contracting. In addition, the individual experts and consultants to be employed under the project would have qualifications acceptable to the Bank, as would be the procedures used in obtaining their services. It is expected that, in several of the project studies, foreign consultants will be involved with Ecuadorian firms in joint venture or sub-contractual arrangements. Retroactive financing would be provided up to US$750,000 for expenditures made after March 1, 1977 to cover initial contractual services under the project. Benefits and Risks 41. The services to be provided under the proposed project would help stengthen the capabilities of FONAPRE and other Ecuadorian agencies to carry out priority development tasks, and thus reduce the effects of the national shortage of manpower skilled in project preparation activities. FONAPRE, as the central coordinating agency for all government activities related to project preparation, already has considerable potential for achieving an adequate level of technical competence. Nevertheless, without this proposed assistance, future project preparation work in Ecuador could result in un- economic or otherwise ineffective investments, and become increasingly beset by costly delays. Further, by increasing the number of well-prepared projects, the project would encourage better resource allocation, thus contri- buting to more substantial benefits from the public investment effort. Moreover, the measures recently taken by the Government in connection with this project, to remove some of the bottlenecks in the rules and procedures governing the public investment program should help to rationalize and intro- duce greater discipline in the Government's mechanisms related to pre- investment activities. Such activities are also likely to be strengthened by the participation of the experts to be financed through the proposed loan in the training of the planning staff of Government agencies, and by the project component directed toward increasing the overall efficiency of Ecuador's -domestic consultant firms. 42. There are no special risks involved in the proposed project. The presence of the foreign experts would help strengthen FONAPRE's capability to execute the project. The main risk -- a normal one for projects of this kind -- arises, therefore, in connection with the recruitment of suitable foreign experts and ensuring their cooperation with local staff. In order to minimize this risk, the five experts would be appointed by the Bank. Their work would be complemented by the training assistance provided by IDB, with which close coordination will be maintained.  - 20 - PART V - LEGAL INSTRUMENTS AND AUTHORITY 43. The draft Loan Agreement between the Republic of Ecuador and the Bank, the draft Project Agreement between FONAPRE 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 the draft resolution approving the proposed loan, are being distributed to the Executive Directors separately. 44. Additional conditions of effectiveness are that the Operations Manager of FONAPRE has been designated as the project coordinator (see para. 36), and that the necessary arrangements have been made for the employment of the general advisor and the general project economist (Section 6.01 of the Loan Agreement). Special conditions of the loan are listed in Section III of Annex III. 45. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank. PART VI - RECOMIMENDATION 46. I recommend that the Executive Directors approve the proposed loan. Robert S. McNamara President Attachments July 20, 1977  Attachment I Page 1 of 2 FONAPRE Identity 1. The National Preinvestment Fund (FONAPRE) was created on December 14, 1973, by Government Decree No. 1385 and modified by Decree No. 27 of January 9, 1974. It is an autonomous public entity affiliated to the National Planning Board. Objectives and Principal Activities 2. The fundamental objective of FONAPRE is to identify, elaborate, accelerate and evaluate studies, including final design of projects contributing to the social and economic development of the country, especially those which, due to their magnitude and importance, would result in a sizeable investment in sectors of great priority. 3. Pursuant to its objectives, FONAPRE will finance directly or through intermediary agencies the following types of studies, in both the public and private sectors: (a) Specific Studies (i) Prefeasibility and feasibility studies leading to the execution of investment projects at a national, regional or local levels. (ii) Final engineering and design studies, including the revision of equipment specifications and bidding documents, and all phases preceding the execution of a specific investment project. (iii) Complementary studies, including all technical, financial and economic information to prove the final feasibility of a project, or the necessity of an additional study; short-term services required to solve a highly specialized problem prior to investment; or any additional preparation necessary to fulfill requisites prior to investment or to obtaining financial credits. (b) General Studies (i) Sectoral or sub-sectoral studies,' national geographical zones and river basin surveys, when these are oriented to the identification of specific projects and high priority programs, including the quantification of technical, economic and investment requisites and alternatives.  Attachment I Page 2 (ii) Air photometry and magnetometric studies. (iii) Industrial, scientific and technical investigation studies. (c) Other Studies Studies designed to improve the administrative, operational, productive or marketing capacity, or studies not specified before but which have been authorized by the National Plan- ning Board on the basis of their priority. Sources of Funds and Uses of Resources 4. FONAPRE's resources derive from: (a) ordinary and extraordinary budget contributions; (b) annual contributions from the londo Nacional de Participaciones (FONAPAR): (c) all funds from external and internal loans contracted by the National Government to finance preinvestment studies through FONAPRE; (d) recoveries of principal and interest payments on loans granted by FONAPRE; (e) other sources. 5. All resources and funds administered by FONAPRE will be deposited at the Central Bank of Ecuador. 6. FONAPRE administers three types of funds to finance preinvestment studies: (i) Special Fund. Finances preinvestment studies of a general nature, and specific studies in health, education, low-cost housing and ecology. The fund will finance studies in industry, mining, agro-industries, and agriculture for Municipalities, with the exception of Quito and Guayaquil, and studies of the private sector involving small benefi- ciaries. Financing of private sector studies involves a ceiling of one million sucres (US$400,000). (ii) Ordinary Fund. Finances preinvestment studies of specific investment projects and studies to improve the administra- tive, productive, and operating capacity of public and private enterprises. (iii) Non-Reimbursable Fund. General nature studies; sectoral and sub-sector studies; scientific, technologic and industrial research. Studies of high national priority and studies specified by the National Government or an international financial institution for which special resources have been allocated.  F O 9 A P R E B.oarI of Directors - Eecutive Manager ruiiil Technical Operations Manager Manager JtJULLPI. A _____________ ~~~~~~~~~~~~~~~~~TechnLical Deprtaent ZxtArnal~~~~~~ l 1sisa Socal e Econuc Agricultural |Engineerin | Loan a 1 Are as Areas Areas Consulting |ti Departent r Fins scial. ll Ad3inistration Datain L Statistics Processing freasury | rAccoointig | Ad