Argentina - Fourth Highway Project

Document of The World Bank IFOM OIFFIICIAL USE ONLY EPQ'ORTrS D K| aepoNo. P-2003-AR E WEE REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE ARGENTINE REPUBLIC FOR A FOURTH HIGHWAY PROJECT March 3, 1977 This ioemmeun hS rio es sirae ezdb anrnau mny be used by rec0p'ents onriy An the peroromce of thelar offcal dudes. t$s courimens mDy uoq ofbeutase be discoeld wiDthout Wortd Ienk t'da@bogdiizon.  CURRENCY EQUIVALENTS (as of February 14, 1977) Currency Unit = Argentine Peso ($a) US$1 = $a304 $al,000 = US$3.29 $al,000,000 US$3,289.47 ABBREVIATIONS AND ACRONYMS AGP Administraci6n General de Puertos DNPIU = Direcci6n Nacional de Puertos e Intereses de Ultramar FA = Ferrocarriles Argentinos FHA = United States Federal Highway Administration GDP = Gross Domestic Product LRTP Long Range Transportation Plan NDSP National Directorate of Sectoral Planning NTP National Transport Plan SEGBA Servicios Electricos del Gran Buenos Aires S.A. TANS Tippetts Abbett McCarthy Stratton (US) - Consultants UNISF United Nations Special Fund  FOR OFFICIAL USE ONLY INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE ARGENTINE REPUBLIC FOR A FOURTH HIGHWAY PROJECT 1. I submit the following report and recommendation on a proposed loan to the Argentine Republic for the equivalent of US$105.0 million to help finance a Fourth Highway Project. The loan would have a term of 15 years, including three years of grace, with interest at 8.5% per annum. PART I - THE ECONOMY Introduction 2. A report entitled "Economic Memorandum on Argentina" (No. 1282-AR) was distributed to the Executive Directors on September 8, 1976. It was de- signed to assess current developments and provide a medium-term prospective of the Argentine economy. Country data sheets are attached as Annex I. Background 3. Argentina is endowed with a favorable human and natural resource base and enjoys a relatively high GDP per capita, which reached almost US$1,600 in 1975. However, the country's income level masks deep-seated structural im- balances in the economy, manifested in its inability to attain stable growth. In recent years there has been a severe deterioration of key institutions, of productive capacity and of infrastructure. High levels of protection and domestic market limitations have contributed to a generally high cost indus- trial structure which does not reflect relative costs and factor scarcities within the domestic economy. During much of the postwar period, industrial growth has been stimulated in order to maintain high levels of income and consumption in the urban sector. This has been done in part by price, income and subsidy policies which, in effect, transferred income from the agricul- tural to the urban sector. Lacking adequate incentives, the agricultural sector has produced and exported below its potential. Social and economic tensions, rooted in a clash between urban and rural interests, have made it difficult to pursue rational economic policies for any considerable period of time. The result has been a stop-go pattern of growth which, in turn, has led to frustrated expectations, rising social tensions and periodic political unrest. 4. The pace of economic growth in Argentina has been uneven, marked by persistent inflation and interrupted periodically by balance of payments crises. The economic and financial chaos inherited by the military govern- ment when it came to power in March 1976 was, however, virtually without 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.  precedent in the country's history. The annual rate of inflation, which reached 355% in 1975, accelerated to an annual rate of about 1,000% during the first quarter of 1976. The last few months of the previous administra- tion saw a total breakdown of economic management which propelled the nation toward hyperinflation and created a serious danger of default on its ex- ternal obligations. Upon taking office, the most urgent tasks before the authorities were to break inflationary expectations and to shore up the country's precarious external financial position. Since inflationary expecta- tions manifested themselves in a flight from the peso, and the consequent weak- ening of the free market exchange rate, the authorities moved to strengthen the peso. To contain the growth of the money supply and reduce the velocity of circulation, the authorities raised interest rates and introduced indexed government bonds to mop up excess liquidity. With a view to further streng- thening the peso, an increased proportion of export transactions was shifted to the free foreign exchange market rate and a US$300 million short-term credit from U.S. and European banks was arranged. In addition, the author- ities successfully rolled over about US$350 million of payments due on public sector obligations from the second to the last quarter of 1976. These measures resulted in a sharp drop in the free exchange rate from 380 pesos per dollar to 240 pesos within one month, indicating initial success in lowering infla- tionary expectations and halting capital flight. Performance in 1976 5. During the second half of 1976, the new Government in Argentina made considerable progress in stabilizing the economy. Through a strong in- comes policy, which sharply reduced real wages while permitting maintenance of the previous high level of employment, and through improved fiscal and monetary management, the Government reduced the rate of inflation from 38% per month in March to an average of 7.6% per month from June to the end of the year. Ratio- nalization of exchange rate and trade policies resulted in a sharp improvement in the balance of payments and both the resource and current account balances registered a US$1.9 billion improvement over the 1975 level. Factor payments were not as high as had been expected earlier in the year. Improved confidence in the peso and the increase in real rates of interest produced an inflow of capital estimated at between US$150 million and US$200 million. The Government has succeeded in improving the foreign debt structure by repaying the short- term loans due in the last quarter of 1976 and by contracting new loans with more favorable maturities. Despite reduction in the level of "swaps" and substantial repayments of commercial bank loans, gross international reserves increased by about US$1.0 billion in 1976. As of December 31, 1976, they amounted to US$1.6 billion, or the equivalent of six months of imports. 6. Currency issue continued to increase rapidly in 1976, but private sector claims rose at a rapid pace reflecting a return of confidence in the financial system and the substantial increase in real interest rates institu- ted by the new Government shortly after taking office. Thus, while money supply expanded rapidly, there was a sharp increase in liquidity preference and commercial banks accumulated large deposits with the Central Bank. Limits on bank credit were established for credit to the Treasury, the major public  - 3 - enterprises, and the private sector. A number of financial assets were in- dexed and interest rates on.other instruments were freed and are now positive in real terms. The system of "swaps," whereby the Central Bank permitted repayment of short-term foreign loans at a subsidized forward exchange rate, was a major factor in monetary expansion during 1975 and early 1976. The new Government, however, has substantially reduced the level of foreign borrowings under this system by making them a prohibitively expensive source of credit. The outstanding balance of such borrowings fell from US$1,305 million in March to US$550 million by the end of the year. 7. During the two years prior to the change of Government in March 1976, public finances in Argentina deteriorated to an alarming extent and became a major factor contributing to the hyperinflation of early 1976. Declining tax collections in real terms, sharply increased expenditures due to massive wage settlements and expanded public sector employment, resulted in a doubling of the Treasury deficit as a share of GDP. Adjustments in tariffs of public enterprises lagged behind inflation and there was serious deterioration in the financial position of a number of important enterprises, which had to be covered by Central Government transfers. Upon taking office, the new Government intro- duced a number of special emergency taxes and drastically cut current expendi- tures by allowing real wages of public sector employees to decline. On the expenditure side, the results were dramatic and the Treasury deficit declined from almost 12% in 1975 to an estimated 8% of GDP in 1976. About 70% of this improvement in the Treasury deficit was attributable to the decline in expendi- tures. A major effort was made by the authorities to finance the deficit by mobilizing private domestic savings and this was achieved through the sale of high yielding Treasury bills offering investors positive real rates of interest, and through the sale of indexed government bonds. Central Bank financing of the deficit declined sharply in real terms and fell as a share of total financing requirements from 70% in 1975 to 45% in 1976. 8. In order to stem financial d[eterioration of the state enterprises, the Government implemented a program of periodic rate adjustments which, since the middle of the year, have resulted in a substantial real tariff increase for SEGBA, Agua y Energia, and Gas del Estado. Further progress in reduction of Central Government transfers to public enterprises is assumed in the 1977 Budget and the authorities plan to continue periodic tariff adjustments this year. 9. During 1975 and early 1976, there was a steady and increasingly sharp contraction in the level of economic activity. As the economic situation became more and more chaotic, private investment declined precipi- tously throughout the economy. The sharpest decline in investment was registered in the first quarter of 1976 as inflation accelerated and default on the country's external debt appeared imminent. The momentum of the reces- sion continued into the second quarter of 1976 as measures required to slow inflation further reduced growth. Stocks of industrial products, which had been accumulated for speculative reasons during 1975 and early 1976, were brought to market as the private sector shifted out of real goods into finan- cial assets, reflecting a return of confidence in economic management and a response to the sharp increase in real interest rates. This drawdown of stocks temporarily deepened the decline in industrial production. The automobile industry and other producers of capital and consumers' durables were espe- cially hard-hit.  10. During the second semester of 1976, the situation improved signifi- cantly due to a turnaround in private investment, increased output in the mining sector (coal, natural gas and crude petroleum production) and recovery in growth of agriculture to an estimated 4% for the year as a whole. While investment demand for manufactured goods, in large part from the agricultural sector, accelerated, decline in real wages produced a drop in consumer spend- ing. Despite declining economic activity, unemployment has not shown any substantial increase. Unemployment is currently estimated at 4.2% in Greater Buenos Aires and 4.5% for the entire country. Private firms have generally complied with Government efforts to prevent large-scale layoffs and many have shortened working hours instead of reducing their work force. Declining real wages have made it possible for enterprises to maintain staff at pre- recession levels despite falling production. Development Strategy and Prospects 11. Having achieved the objectives of the first phase of its reconstruc- tion program -- sharp reduction of inflation and shoring up of the country's precarious external position -- the Government initiated the process of intro- ducing basic reforms of the economic system necessary to lay the foundation for strong self-sustained economic growth. In contrast to the highly protectionist import substituting industrial development growth strategy, which has prevailed during most of the postwar period in Argentina, the present authorities are pursuing an export-oriented growth strategy with primary emphasis on accele- rated agricultural development. To achieve this, the Government has carried out a tariff reform of major proportions which sharply cuts import duties on industrial products and has thereby reduced the bias against agricultural goods. High export duties on a number of important agricultural products have been eliminated and, since May of last year, there has been an improvement in the internal terms of trade for agriculture. To restore efficiency and return to a more market-oriented economy, the Government has done away with the previous system of centrally administered price controls and has simplified the trade and exchange system by liberalizing non-tariff import restrictions, eliminating the multiple exchange rate system, and reducing the wide effective exchange rate differentials for exports. Work in other key areas -- fiscal reform aimed at removing the chronic structural deficiencies in the country's public finances, increased mobilization of domestic savings, expansion of private investment, liberalization of the foreign investment code, and freeing up of the financial system -- is moving ahead at a pace which indicates that most of the important reforms on which the development strategy rests will be introduced this year. 12. The major factor determining continued success of the stabilization program in 1977 is the fiscal situation. This in turn is closely linked to incomes policy since excessive wage adjustments have in the past and especially during 1975 and early 1976 not only fueled inflationary expectations, but aggravated the fiscal problem since wage and salary payments constitute about 60% of current expenditures of the Central Government. Despite the adverse impact on the Budget, the Government is anxious to permit some recuperation of real wages in 1977, not only for social reasons but also because this will foster economic recovery. Consumer spending continued to decline in the second  half of 1976 and the recovery of investment which has taken place in recent months cannot be expected to continue in the face of a prolonged depression of consumer demand. While export demand should continue to be strong, the Govern- ment is concerned that current employment levels cannot be maintained throughout 1977 at present rates of growth of the domestic economy and it is targeting an increase in real GDP of 4% this year. To achieve this, the Government plans to stimulate consumer spending by permitting an increase in real wages in 1977 proportional to the increase in productivity. The Government's objective is to reduce the Treasury deficit from 8% of GDP in 1976 to between 3% and 4% in 1977, a level which, in combination with the monetary and incomes policy measures under consideration by the Government, is estimated to be consistent with a reduction of the rate of inflation to a level considerably below the one experienced during the second half of 1976. To achieve this target, the Government plans to introduce new taxes and improve tax administration. 13. Argentina's balance of payments is expected to continue to improve in 1977 making it possible for the country to resume growth. Export growth is expected to be strong despite declines in world grain prices and only modest increases in beef prices. Argentina's 1976-77 wheat crop is estimated to be the highest in history and output of other grains, oilseeds and beef are also expected to increase sharply in response to the Government's new stimulative price policy for agriculture. The Government intends to continue to main- tain positive real interest rates in 1977 so as to induce further repatriation of savings held by citizens outside the country. Despite elimination of "swaps" and resumption of large external debt service payments in late 1977, both gross and net international reserves should increase during the course of the year. 14. Over the longer term, the prospects for strong self-sustained economic growth in Argentina are favorable. During the next two to three years, growth rates are likely to increase moderately as the balance of payments continues to improve and investor confidence is reestablished. Price and trade policies aimed at opening up the economy are beginning to bring about a shift in the structure of industry and agriculture, which is needed to increase economic efficiency and stimulate growth. The levels of international trade -- which have been low for an economy of Argentina's resource endowment and economic size -- are expected to expand significantly as the economy adjusts to a new price structure and set of investment incentives. It will take a number of years and continuing large capital inflows to carry out these tasks, partly because of their inherent complexity and partly because public support needed to maintain the effort can be sustained only if social costs of the adjustment process are held within tolerable limits. The inflows of medium- and long-term capital from both private and official sources will, in addition to their support of modernization of infrastructure and productive capacity, play essential roles in this process. 15. Export prospects for the longer term are excellent and assuming continued recovery of beef exports, substantial increases in the volume of grain exports coupled with expected improvements in world grain prices, ex- port earnings should increase by an average 16% annually in current terms through 1980. Roughly two-thirds of that increase would be generated by agriculture and about one-third by the industrial sector. Maintenance of a 5%  - 6 - to 6% growth of GDP during the late 1970s and beyond will require imports to increase at a rapid pace (15% annually through 1980). This pattern of growth of imports and exports would permit the country to generate a trade surplus averaging almost US$1 billion annually between 1977 and 1980. This surplus would be adequate to cover factor services and still yield a modest current account surplus. Given Argentina's heavy debt service payments, and the need to restructure its external debt and to rebuild its international reserves, however, considerable gross inflows of medium- and long-term capital will be required, averaging US$1.3 billion annually for the next four years. The bulk of these capital requirements should be available from bilateral arrangements, suppliers' credits, world capital markets, direct private investments and foreign commercial banks. Multilateral sources, however, are expected to play an important role both by providing capital and by stimulating capital flows from other sources. Debt Service and Creditworthiness 16. At the time the new Government came to power in March 1976, Argentina's external situation was precarious. To meet the immediate problems, the authorities secured short-term support from commercial banks (paragraph 4) and obtained a Standby credit from the IMF of SDR260 million (about US$300 million). This agreement included the first credit tranche of about US$180 million to be used in 1976, and about US$120 million or two-thirds of the second credit tranche for availability in 1977. On the basis of the IMF Standby, and as part of a longer-term solution, the Government obtained loans of about US$1 billion with a four-year maturity from commercial banks in the U.S., Canada, Europe and Japan. These loans and credits, needed to make payments on previous short-term bank borrowings, represent an important first step toward improving the country's external debt structure. 17. Argentina's debt management problems result from the maturity struc- ture more than from the level of its external debt. The latter is not exces- sively high. It is estimated that public debt outstanding and disbursed was US$3.2 billion at the end of 1975. Private external debt amounted to roughly US$3.8 billion, of which "swaps" with a maturity of six months consti- tuted US$1.3 billion, and short-term import financing, also with a six-month maturity, US$1.5 billion. The latter in large measure is revolving in charac- ter and normally excluded from medium- and long-term debt figures. However, almost one-third of the outstanding public debt and almost one-half of the private debt outstanding at the end of 1975 fell due during 1976. Over 70% of the total falls due within four years. External public and total debt service ratios during the current year are estimated at 20% and 29%, respectively. Despite the large gross borrowings envisaged above and continued use of financial and suppliers' credits, these debt service ratios are expected to decline to about 15% and 23% in 1980 because of the improvement in the term structure and the expected increases in exports. Provided the authorities successfully implement their policies of reconstructing the economy and manage the external indebtedness along the above indicated lines, debt service should not prove unduly burdensome. Under the circumstances, Argentina should find it manageable to service the aforementioned external borrowing required for economic reconstruction and subsequent sustained growth.  PART II - BANK GROUP OPERATIONS IN ARGENTINA Bank Operations 18. Because of periodic macroeconomic difficulties and unsatisfactory sector policies, along with delays and problems in arriving at agreements on specific project conditions, past Bank lending to Argentina has been sporadic. Since 1961, Argentina has received ten loans from the Bank amounting to US$647.3 million, of which five have not been fully disbursed. After the first two loans were made in 1961/62, no loans were made until 1967. In the 1967 to 1969 period, however, five loans were made totalling US$237.3 million. Two additional Bank loans to Argentina were made in 1971. The loan to SEGBA for an electric transmission and distribution project, approved by the Executive Directors in September 1976, marked the resumption of lending to Argentina after a hiatus of over five years. In total, the Bank has made five loans for the power sector, four loans for the transportation sector and one loan for livestock development. Annex II contains a summary statement of Bank loans as of January 31, 1977, and notes on the execution of ongoing projects. 19. In its past and projected lending to Argentina, the Bank has supported, and intends to continue to support, several important interdepen- dent and complementary development objectives. The first lending objective is to contribute to the Government's efforts to diversify and increase Argentina's export capacity. Argentina's past economic policies have resulted in a low level of international trade relative to the country's economic resources and development base. While recent policy changes, such as agricultural sector pricing, will provide much of the initial stimulus to increasing exports, sustained growth will require an expansion of productive facilities and infrastructure. The proposed Fourth Highway Project is but one element in a package of prospective operations aimed at increasing the country's export capacity. We plan to submit to the Executive Directors in the near future other loans pursuing this objective. These prospective operations are a grain storage project, an agricultural credit project, an industrial credit project and, possibly, a railways/ports project. The principal aim of the proposed Fourth Highway Project is to help upgrade the highway infrastructure necessary to support the planned resumption of economic growth and the expansion of agricultural export traffic. The proposed grain storage project would help remove existing storage constraints to exports. The agricultural credit project would aim at expanding and reducing the cost of agricultural produc- tion for exports. The industrial credit project has already been appraised and would support the modernization and expansion of industry in general and export industries in particular. The ongoing livestock development project also supports the export expansion objective. The recently approved power transmission and distribution project with SEGBA will help facilitate the expansion of industrial capacity in the greater Buenos Aires area, where most of Argentina's export industries are located. 20. A second lending objective is institutional development and policy reform which will ensure that public investments are made and used efficiently. This has been the case in the highway sector where the Bank has supported  - 8 - efforts to improve the management, planning capabilities, and operation of the National Highways Authority (Direccion Nacional de Vialidad). The proposed project will assist the Goverrnment in continuing these efforts. Institution building has also been important in the power sector where the Bank has supported reforms in the tariff structure which will furnish adequate rates of return on invested capital, and where the Bank has assisted in the preparation of a long overdue national power expansion program and a national power sector organization study. In lending for livestock development, the Bank loan has served to introduce modern methods of ranch management within the framework of a supervised agricultural credit program. 21. Thirdly, Bank lending to Argentina is to help provide essential long- term external capital when it can be absorbed effectively within the framework of a sound overall financial plan and when capital requirements substantially exceed availabilities from other external sources. Public investment require- ments have grown sharply as a result of past neglect. Even with the major effort presently underway, public sector savings will fall short of require- ments, and leave a substantial gap in the Government's financial program which can only be filled by external borrowing. Private sources, however, are not yet prepared to offer Argentina financing in sufficient amount and on appro- priate terms. It will take some years of successful economic management for Argentina to regain its position as a substantial borrower of long-term capital in private markets. In the meantime, very large amounts of relatively short- term external loans and credits will have to be repaid. During this period the Bank hopes to serve as a catalyst to stimulate lending from other sources as well as to directly provide a part of the needed capital inflow. 22. Finally, the Bank is maintaining a dialogue with the Government regarding possible Bank assistance in projects that would foster physical in- tegration between Argentina and its neighboring countries, especially with the low-income countries of Bolivia and Paraguay. Such projects should serve as a major impetus to the economic growth of these two landlocked countries and enable them to raise their living standards. The Bank project for a gas pipeline between Bolivia and Argentina has been a milestone in integrating the two economies in the energy field to the benefit of both countries. The proposed Fourth Highway Project supports in part this objective of phy- sical integration since several of the road sections included in the project are important links for the regional trade between Argentina and its neighbors. We are also discussing with the Government other integration projects, espe- cially in the energy field. IFC Operations 23. As of January 31, 1977, IFC had made ten loans to borrowers in Argentina totalling US$51.3 million, and one equity investment of US$2.0 million, of which US$28.6 million has been repaid, cancelled or sold. A summary of IFC's investments up to January 31, 1977, is given in Annex II.  - 9 - PART III - THE TRANSPORT SECTOR Bank Financing in the Sector 24. Since 1961, the Bank has participated in the financing of three highway projects and one railway project in Argentina. The first highway loan, for US$48.5 million, was made in June 1961 to help finance the construction and im- provement of about 2,600 km of roads and the purchase of maintenance equipment. At the same time, the Bank was also the Executing Agency for a long-range study of transportation in Argentina, financed by the United Nations Special Fund. A number of problems developed in the course of the 1961 highway project, the most important being a shortage of local funds. The project was not completed until 1968 and not until its scope had been reduced considerably and US$17.5 million of the original loan amount had been cancelled. 25. At the request of the Argentine Government, the Bank reviewed the problems and requirements of the transportation sector in 1968. On the basis of the review and recommendations made by the Bank, the Government agreed to proceed with a program to improve transport coordination and plan- ning, financially and physically rehabilitate the national railways, and improve road administration and the planning and coordination of road invest- ments. On this basis, the Bank agreed to continue to support the development of the transportation sector, and a Second Highway Loan of US$25 million was signed in June 1969. The loan helped finance the construction and improvement of 800 km of roads, consulting services to aid highway planning and purchase of equipment. All components of the project as originally defined were completed satisfactorily by June 1973 at a cost substantially below the appraisal estimate. With the Bank's agreement, in early 1974, the unspent balance of US$5.2 million was allocated to carry out construction of two additional road sections. After some delays during 1974 and 1975, due mainly to lack of equipment, the works on these two roads are now proceeding satis- factorily and are expected to be completed by the end of 1977. 26. In May 1971, the Bank made a Third Highway Loan of US$67.5 million to help finance the improvement of 28 road sections totalling 1,128 km and various consulting services to assist, inter alia, in the preparation of a highway in- vestment program. Fifteen of the road sections totalling 556 km (53% of the total) have now been completed satisfactorily. Construction of the remaining 13 sections ran into severe problems caused by the difficult economic situation prevailing in 1975 and early 1976. Delays in payments and staggering inflation during that time had a crippling effect on the financial situation of contrac- tors. Most of them had to suspend work. The few firms which remained active were hampered by difficulties in obtaining spare parts for imported equipment. After March 1976, the Government undertook to liquidate pending payments, to amend ongoing contracts to include a satisfactory price escalation formula, and to negotiate pending claims arising from suspension of work. Work has now resumed at a normal pace on nine sections, and a new call for bids is underway for the remaining four sections. The bulk of the remaining work is expected to be carried out during 1977, with the completion of several other contracts extending into the first quarter of 1978.  - 10 - 27. In April 1971, the Bank made a loan of US$84 million to the Argentine Railways to help finance a comprehensive rehabilitation and modernization pro- gram. Despite the measures that had been taken by the Government and the Railways, the Bank determined in February 1974 that little progress had taken place in achieving economies in the use of staff, facilities and equipment; in procuring new, and rehabilitating existing rolling and motive stock; and in improving tariffs in real terms. Furthermore, the deterioration of railway services caused a decline in traffic, with the result that the performance of the Railways fell below the targets agreed upon with the Bank. Therefore, in April 1974, the Bank offered the Government and the Railways the alternatives of (a) renegotiating the loan on the basis of new targets, including methods for periodically monitoring whether such targets were being achieved and specific actions to be taken by the Government and the Railways; or (b) can- celling the balance of the loan, with disbursements being permitted only against orders placed before the original closing date of April 30, 1974. The Government and the Railways elected the latter alternative and as a result US$27.5 million of the loan was cancelled in July 1974. 28. In June 1971, the Bank made a comprehensive review of the transpor- tation sector in Argentina which focused on modes which were not covered in depth by the 1968 Bank sector mission, such as ports, water transport, civil aviation, pipelines, and a number of specific problems of the Railways. The review also served as the basis for initiating preparation of a fourth highway project, which was first appraised in early 1972. However, further proces- sing of the project was kept in abeyance, pending resolution of issues on economic and transport policies between Argentina and the Bank. A decision to continue processing of the project was made in 1974, but presentation of the project to the Executive Directors was postponed because of then exist- ing uncertainties in the outlook for the Argentine economy. The presently proposed project is a substantially modified version of the project that was first appraised in 1972. 29. As the foregoing analysis indicates, the Bank has had a long asso- ciation with the transportation sector in Argentina, both in project financing and in sector studies. Although there have been some setbacks in the develop- ment of the sector, such as the problems encountered by the Railways, there has been substantial overall progress, part of which may be attributed to Bank efforts. In particular, there has been a reorganization and administrative strengthening of the National Highways Authority; an increase in the compe- tence of local consulting firms and an effective use of them in the planning, engineering and supervision of road projects; establishment in the Secretariat of Public Works and Transport of an agency to coordinate planning for transpor- tation investments; an effective effort on part of the National Highways Authority to do multi-year planning aimed at identifying and selecting priority road investments; and an improvement in transport pricing policy.  Sector Background 30. The development of the Argentine transportation system has been influenced significantly by the heavy concentration of population and economic activity around Buenos Aires. About one-third of the country's 25 million inhabitants live in the metropolitan Buenos Aires area and about two-thirds of the population live within a 500 km radius of Buenos Aires, a region comprising only 15% of the total area of the country. Buenos Aires is the industrial, financial and commercial center of the country and the national focal point for transportation. Other factors which have determined the development of the transportation system have been the traditional concentra- tion of grain and livestock production in the Pampa and the creation, during the last two decades, of an important industrial corridor in the east, extend- ing from Cordoba through Santa Fe, Rosario, Buenos Aires, and La Plata. Con- sequently, the transportation system is characterized by a large and complex interchange of products along the industrial corridor, the flow of agricul- tural products from the producing regions to the consumption centers and ports of embarkation and by a smaller flow of manufactured goods in the opposite direction. 31. In 1974, total freight movements in Argentina amounted to about 94.5 billion ton-km. Of this, 40% was carried by road transport, 37% by coastal shipping and river transport, 11% by rail and 12% by pipeline. Inter- city passenger traffic in 1974 amounted to 59.0 billion passenger-km, of which road transport accounted for 88.8%, rail for 8.5%, and air transport for the remaining 2.7%. Road transport is dominant; coastal shipping and river transport are specialized in bulk. The relative importance of rail freight traffic has decreased continuously over the last 20 years. This shift has been caused principally by a deterioration in railway services resulting from the poor financial and physical condition of the Argentine Railways as indi- cated in paragraph 27 above. 32. Since March 1976, the Government has taken several positive steps to reverse the negative trend in the railways. First, it has increased railway tariffs substantially with a view to making the Argentine Railways financially viable. Second, it has initiated a program to reduce the very costly inter-urban passenger service. Third, it plans as a first step to abandon some 4,000 km of uneconomic lines. And fourth, it is undertaking a major reorganization of the railways and a redefinition of the role of rail- ways in the transport sector. Transport Planning and Coordination 33. Responsibility for coordinating and planning road transport, rail- ways and civil aviation lies within the Secretariat of Transport and Public Works of the Ministry of Economy. This Secretariat comprises five Under- secretariats: Transport, Public Works, Water Resources, Environmental Plan- ning, and Policy and Coordination. The planning, construction and maintenance of the national highways network is the responsibility of the National Highways Authority which is responsible to the Undersecretary of Public Works.  - 12 - 34. From the middle of 1973 to March 1976, planning and coordination of the transport sector of Argentina deteriorated noticeably. Poor adminis- tration by the Government agencies responsible for the sector resulted in gross overstaffing, inadequate maintenance and operation of facilities, and massive subsidization of revenue-earning transport agencies. Planning in the sector was almost halted and, as agencies lacked financial resources, transport construction activities were stopped. The present Government has been primarily occupied with immediate macroeconomic problems and is still in the process of formulating comprehensive sector policies for transport. It has, however, begun to implement a number of policies which have direct implications for the transport sector; i.e. (a) restricting public investments to high priority projects; (b) restoring the financial integrity of state- owned agencies; (c) developing exports; and (d) opening up new areas for agricultural development. The proposed project supports these objectives. The Government has also reinstated competent staff at decision-making levels in the various agencies dealing with transport matters and has provided to these agencies sufficient local funds to allow them to continue their oper- ations. Although the Government is strengthening the transport planning function, the formulation of policies and investment plans for effective sector management would require a thorough review of the sector. The Govern- ment recognizes this need and the proposed project includes financing for the preparation of a National Transport Plan which will provide the basis for developing effective management and planning of the sector (paragraph 43 below and Section 3.03 and Part C of Exhibit B to Schedule 2 to the draft Loan Agreement). The Highway Subsector 35. Argentina's road system comprises a national network of approxi- mately 47,500 km (of which about half is paved) and a provincial network of about 68,000 km of primary roads (22% paved), 94,000 km of secondary roads (2% paved) and 792,500 km of tertiary or feeder roads. The coverage of the present network is generally adequate for the existing traffic and the needs of the economy, except in the far north and the extreme south, where addi- tional penetration and development roads are needed. However, expected future increases in traffic levels will require a continuing program of paving. Pri- mary access roads to larger cities also need increased capacity to accommodate present high volumes of traffic. With the assistance obtained from previous Bank loans, the highway planning system has proved effective in selecting new road investments in the national system. The planning process for development roads, however, has been inadequate and the proposed project contains financing of studies to help correct this deficiency. To further improve the planning of development roads, the Government has agreed to complete the road inventory of the provincial primary system by the end of 1978, and the inventory of the provincial secondary system by the end of 1980, both at a level of detail satisfactory to the Bank (Section 4.04 of the draft Loan Agreement). 36. Total expenditures for highway construction, maintenance and admin- istration in Argentina rose from US$132 million in 1967 to US$326 million in 1972. These expenditures declined modestly in 1973 and 1974, but declined  - 13 - substantially to US$183 million in 1975, when the Government, in view of its severe financial problems, diverted a substantial portion of intended alloca- tion for the National Highways Authority to the general budget. This situation was reversed in mid-1976 and the National Highways Authority is now receiving adequate resources for current maintenance and administration and for com- pletion of ongoing investment projects. Expenditures have been financed from earmarked tax funds and from external sources. The various taxes levied either indirectly or directly on vehicle ownership and use, make up a complex system. Road user taxes were raised in the early 1970s. The level of road user charges is considered broadly adequate, in accordance with the present Government's intention of making each mode pay for itself. To remove sub- sidies on petroleum products, gasoline prices have been increased to US$0.81 equivalent per U.S. gallon for premium and to US$0.71 equivalent per U.S. gallon for regular. The proposed National Transport Plan will provide a detailed reassessment of the present taxation of road transport. 37. The quality of highway engineering and construction in Argentina is good. In preparing projects, adequate consideration is given to minimizing investment costs by carefully selecting design standards and by applying stage construction principles in pavement designs. The local construction industry is well developed. More than 20 local firms can handle road contracts of over US$10 million a year. The quality of maintenance on the national road system is also good, with an average allocation of about US$500 per km per year. Recently, however, shortage of personnel and equipment has hampered mainte- nance work, but the Government has agreed that it will take measures to main- tain roads in the national highways system adequately (Section 4.03 of the draft Loan Agreement). Regulations governing vehicle weights and dimensions are satisfactory. A program to control vehicle weights, agreed upon with the Government, will be in full operation by June 30, 1978 (Section 4.03 of the draft Loan Agreement). Such a program aims at controlling 80% of the truck traffic on national roads. PART IV - THE PROJECT 38. A report entitled "Appraisal of a Fourth Highway Project" (No. 1405b-AR dated March 3, 1977) is being circulated separately to the Executive Directors. The main features of the proposed project and loan are summarized in Annex III. The project was first appraised by the Bank in February 1972, reappraised in May 1975 and most recently in July 1976. Negotiations with the Government were held in Washington from February 3 to February 11, 1977. The Government was represented by a team headed by Mr. Gustavo R. Carmona, head of the National Highways Authority. Objectives of the Project 39. The principal objective of the proposed project is to assist the Government in upgrading the country's highway infrastructure necessary to faci- litate the expected expansion of agricultural export traffic. Since March 1976,  - 14 - the Government has taken appropriate measures, including agricultural pricing policies, to stimulate increases in agricultural production, and thereby in agricultural exports. Partially as a result of these policies, it is now expected that grain exports would increase at an average annual rate in excess of 5% during the next decade. The road sections included in this project are located in regions which export, and are expected to continue to export, a significant portion of their production. Such roads are presently in poor physical condition mainly because they have been supporting an average daily traffic substantially heavier than the traffic for which they were originally designed. In terms of kilometers, about 70% of such roads are earth and gravel roads. Therefore, the road improvements proposed under the project are urgently needed both to support present: levels of traffic and to ensure the evacuation of the expected increases in agricultural exports. A second objec- tive of the project is to assist the Government in the preparation of programs aimed at improving transport sector management and operations, investment planning, and intensification of agricultural land utilization. Project Description 40. The proposed project would consist of: (a) Road Betterment Program. Paving and improving of fourteen earth or gravel roads totalling about 925 km; repaving and improving of four paved roads totalling about 390 km; and upgrading of two roads to four-lane highways totalling about 36 km; (b) Regional Agricultural Development Study. Preparation of regional studies for agricultural development in Northern Argentina; (c) Preparation of a National Transport Plan; and (d) Preparation of a Pavement Overlay Study and a Traffic Safety Program. 41. The roads included in the Road Betterment Program are listed in Annex III and shown on Map IBRD 12627R. The need for improving these roads was confirmed by feasibility and detailed engineering studies carried out under the Third Highway Project (Loan 734-AR of May 1971). Such studies, including the economic evaluation of the proposed roads, were updated during the second half of 1976 by the consultants Ingeneco and Organtec (Argentina). As explained in paragraph 51 below, the proposed roads are economically jus- tified and represent the bulk of the 1977-79 Three-Year Investment Program to be undertaken by the National Highways Authority. The proposed invest- ments include the upgrading and paving of heavily trafficked earth and gravel roads, the repaving and improving of congested paved roads and the realignment of segments to higher standards, with distance savings. In addition to reducing transport costs, several of the improvements would contribute to (i) developing areas which have not yet reached their full potential for agri- cultural production; (ii) alleviating congestion on the arterial links leading to main export and provincial centers; and (iii) facilitating integration and  - 15 - trade with neighboring countries through improved road transport. Since the proposed works focus on the betterment of existing roads, no adverse effects on the environment are expected. There is little or no competition among transport modes in the zones of influence of the project roads. 42. The Regional Agricultural Development Study would assist the Govern- ment in preparing agricultural development programs in regions with develop- ment potential where land is presently underutilized and where the lack of secondary and feeder roads is a major constraint for development. Argentina is one of the few countries in the worLd that still has abundant unutilized lands available that could be brought into agricultural production if adequate road transport and complementary investments were provided. However, past policies in Argentina have provided little inducement for development of this exploitable land. The present Government's policy is to stimulate increases in agricultural production, but because of the lack of emphasis on land development in prior administrations there is little specific information regarding the exact potential of these unexploited lands. The proposed study would include identification of the most suitable area in Northern Argentina for intensified agricultural development, including the settlement of farmers to develop crop and/or livestock production; and the preparation of a feasi- bility study for an agricultural development project in the selected area. Such study would be undertaken under terms of reference and a progress schedule satisfactory to the Bank (Section 3.01(b) of the draft Loan Agreement). 43. The National Transport Plan will provide the basis for future plan- ning and coordination in the sector and will be carried out with the parti- cipation of the relevant agencies and public enterprises under terms of refer- ence and a progress schedule satisfactory to the Bank (Section 3.03 of the draft Loan Agreement). The preparation of the National Transport Plan will include: (i) a short-term program (1'78-1979) that will identify and diagnose the critical problems of the sector, propose a mechanism for coordinating management, operational and investment decisions, and provide a coordinated 1978-1979 investment plan for the sector. Such investments are expected to consist principally of improvements and rehabilitation of the most urgently needed transport facilities; and (ii) a detailed five-year action program (1980-1984), which will include (a) a proposed national strategy and set of policies for the management and development of the transport system; (b) a program of policy measures for each transport mode that would include, inter alia, required changes in transport pricing, required regulations for each subsector and required improvements in operations; (c) an institution- alized system for the future planning and coordination of transport operations and investments; (d) a determination of the future role of each transport mode on the basis of an  - 16 - analysis and forecast of future transport demand in relation to the expected development of the economy, particularly the development of a phased program for the closure of uneconomic railway lines; and (e) a five-year investment plan and an indicative ten-year investment plan, which will include new 44. The Government has agreed to furnish to the Bank by January 31, 1978, the short-term program referred to above, for an exchange of views thereon. The Government has also agreed to exchange views from time to time with the Bank on the implementation of the recommendations to be made under the National Transport Plan (Section 3.03 of the draft Loan Agreement). 45. Consulting services and equipment will be provided under the project to undertake a Pavement Overlay Study, which will determine the optimal timing for the renewal and strengthening of pavements of national roads. This study is expected to help the Government in introducing new methods which will reduce significantly road maintenance and reconstruction costs. The project also includes consulting services for the preparation of a Traffic Safety Program. Such a program would include the improvement of signs, markings, and road designs; education of the public; establishment of vehicle safety stand- ards; strengthening of police enforcement and establishment of adequate vehicle accident statistics. 46. The Government has agreed to employ the consultants required under the project within six months after the signing of the proposed Loan Agreement. The qualifications, experience and terms and conditions of employment of such consultants will be satisfactory to the Bank (Section 3.02 of the draft Loan Agreement). Cost Estimates and Financing 47. The total cost of the project is estimated at US$345.1 million (in- cluding physical and price contingencies) with a foreign exchange component of US$124.0 million, or 36%. The proposed Bank loan of US$105 million would finance most of the foreign exchange cost of the project. The Government would finance all local cost as well as the foreign exchange cost not covered by the proposed Bank loan. Physical contingencies were estimated at 10% of civil works and supervision. Price contingencies were estimated at 19% of the base cost estimate on the basis of expected annual international price in- creases of 9% during 1977-79 and 8% thEreafter, which are the standard rates used by the Bank. The base cost estimetes are expressed in US dollars and at March 1977 prices. The foreign exchange cost estimate is based on the assumption that all bids for civil works contracts, after international com- petitive bidding, would be won by local firms, as was the case in the previous two Bank highway projects in Argentina. Contracts will incorporate a revised and more responsive price adjustment fcrmula for civil works, which has been agreed upon with the Government in order to avoid some of the pricing problems with contractors which developed during the execution of the Third Highway Project (para. 26). The equipment for the Pavement Overlay Study is expected to be imported. The project includes about 6,500 man-months of consulting services, as detailed in page 3 of Annex III.  - 17 - Project Execution 48. The execution of the Road Betterment Program, the Pavement Overlay Study and the Traffic Safety Program will be undertaken by the National High- ways Authority, which was the executing agency for the previous Bank highway projects. The National Directorate of Sectoral Planning under the Under- sectary of Transport within the Ministry of Economy, will be responsible for the management and coordination of studies and investigation to be carried out for the proposed National Transport Plan. The Government has developed detailed organizational arrangements to ensure participation of various agencies and public enterprises in the preparation of the National Transport Plan. The completion of satisfactory arrangements establishing such organiza- tional set-up would be a condition of disbursement for this part of the project (paragraph 4(iii) of Schedule I to the draft Loan Agreement). The Ministry of Economy will be responsible for undertaking the Regional Agri- cultural Development Study, with the Secretariat of Economic Programming and Coordination providing supervision and coordination. Procurement and Disbursements 49. Construction of road sections under the Road Betterment Program is expected to commence at the end of 1977 and all road sections are expected to be completed by the end of 1980. Construction contracts would be let on the basis of unit prices after international competitive bidding in accord- ance with the Bank's Guidelines. The estimated value of individual contracts would range from US$2.0 to US$8.0 million, so that small- and middle-size local contractors would have an opportunity to bid. However, in order to attract the larger contractors, individual contracts would be grouped, where feasible, into "packages" of two or three lots. Works in each package would be bid simultaneously and bids would be allowed for any or all lots and packages. The equipment needed for the Pavement Overlay Study (US$300,000) would be procured under negotiated contracts. The Bank would disburse at the rate of 30% for road construction works and supervision; 45% for consulting services for the National Transport Plan, the Regional Development Study, the Pavement Overlay Study and the Traffic Safety Program; and 100% for foreign expenditures for the equipment required for the Pavement Overlay Study. 50. Prequalification of local bidders on the basis of a permanent registry is an established practice in Argentina. During March 1977, the National Highway Authority intends to invite foreign firms to submit documen- tation for prequalification, in accordance with the Bank's Guidelines for Procurement. The Bank has accepted this prequalification approach under the Second and Third Highway Projects and experience with it has been satisfactory. It is proposed that such practice be continued under the proposed project. Economic Evaluation and Project Risks 51. The economic evaluation of the Road Betterment Program takes into consideration the expected economic costs of civil works and the expected benefits to be derived from savings in vehicle operating costs, savings in  - 18 - time and savings in maintenance costs. Traffic counts on the proposed roads were undertaken by the National Highways Authority during 1976. Projections of annual increases in normal traffic range from 3.5% to 9.0%, with a weighted average of 5% per year, which is in line with the Bank's projections of GDP growth. The average economic rate of return of the road betterment program is estimated at 23%, with a first year benefit of 22%. Individual road segments under this program have economic rates of return, ranging from 16% to 53%. The program is well justified. The project does not face any special risks. PART V - LEGAL INSTRUMENTS AND AUTHORITY 52. The draft Loan Agreement between the Bank and the Argentine Republic and the Report of the Committee provided for in Article II, Section 4(iii) of the Articles of Agreement and the text of a draft resolution approving the proposed loan are being distributed to the Executive Directors separately. Special conditions of the project are listed in Section III of Annex IV. Con- dition of disbursement for the National Transport Plan would be the making of satisfactory arrangements to ensure the participation of relevant Government agencies and public enterprises in the preparation of the National Transport Plan. 53. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank. PART VI - RECOMMENDATION 54. I recommend that the Executive Directors approve the proposed loan. Robert S. McNamara President Attachments March 3, 1977  APIDX I TABLE 3A Page I of 4 pago ARGETIA - SOCIAL INDICATORS DATA SHEET LAND AREA tTHOU KHZI