Colombia - Rural Roads Project

Document of FILE Copy The World Bank FOR OFFICIAL USE ONLY Report No. P-2992-Co 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 COLOMBIA FOR THE RURAL ROADS PROJECT March 12, 1981 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 authoriztIon.  CURRENCY EQUIVALENTS Average Calendar 1979 Average Calendar 1980 (Estimated) Currency Unit - Peso - Col$ US$1 - Col$47.274 US$1 Col$42.587 Col$1 - US$0.02115 WEIGHTS AND MEASURES 1 meter (m) 2 ' 3.281 feet (ft) 2 1 square kilomet r (km ) 0.386 square mile (mi ) 1 cubic meter (m ) = 35.315 cubic feet (ft ) 1 cubic meter - 264.2 gallons (gal) 1 kilogram (kg) - 2.206 pounds (lb) 1 ton (t;metric;l,OOO kg) - 1.000 tons (sh. tons) GLOSSARY OF ABBREVIATIONS CIDA Canadian International Development Agency CNR Colombian National Railways COLPUERTOS Colombian Port Authority CONPES Social and Economic Policy Council DAAC Administrative Department of Civil Aeronautics DNP Department of National Planning DRI Integrated Rural Development FAN National Aeronautics Fund FEDECAFE National Coffee Federation FNCV National Rural Roads Fund FONADE National Projects Fund INCORA Colombian Institute for Agrarian Reform IDB Inter-American Development Bank IDEMA Government Agricultural Marketing Institution MOPT Ministry of Public Works and Transportation PIN National Integration Plan UNDP United Nations Development Programme FISCAL YEAR January 1 to December 31  FOR OFFICIAL USE ONLY COLOMBIA RURAL ROADS PROJECT LOAN AND PROJECT SUMMARY Guarantor: Republic of Colombia. Borrower: National Feeder Roads Fund (FNCV). Amount US$33 million equivalent. Terms: Repayment in seventeen years, including four years of grace at 9.6% interest per annum. Project Description: The project would assist the Government in its efforts to foster agricultural development by facilitating farmers' access to markets and by lowering transport costs through the construction and rehabilitation of rural roads. It would also strengthen rural road maintenance and FNCV's overall administration. The project consists of: (a) construction of about 710 km of rural roads; (b) rehabilitation of about 710 km; (c) engineering for about 710 km; (d) purchase of hand tools for labor-intensive maintenance; (e) procurement of maintenance equipment and related spare parts; and (f) technical assistance to improve FNCV's management information system. The project faces no unusual risks. The works included under the project are considered to be well within the capability of FNCV. The Working Capital Fund to be set up under the project should ensure the timely availability of financial resources and thus provide for speedy project execution. This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  Estimated Cost Local Foreign Total (US$ million equivalent) I. Construction and Rehabilitation Program Engineering .47 .38 .85 Construction 15.27 12.49 27.76 Rehabilitation 7.63 6.25 13.88 Supervision 2.34 1.91 4.25 Sub Total 25.71 21.03 46.74 II. Maintenance Program Road Maintenance Equipment 1.14 7.60 8.74 Hand tools .11 .09 .20 Sub Total 1.25 7.69 8.94 III. Technical Assistance .02 .09 .11 Base Cost I-III 26.98 28.81 55.79 IV. Price Contingencies 3.02 4.19 7.21 V. Total Project Cost III-IV 1/ 30.00 33.00 63.00 Financing Plan: Proposed IBRD Loan - 33.00 33.00 FNCV Highway Fund 30.00 - 30.00 Total Funds 30.00 33.00 63.00 Estimated Disbursements: FY82 FY83 FY84 FY85 TUiS$ million equivalent) Annual Gross disbursement 7.90 10.30 9.15 5.65 Cumulative 7.90 18.20 27.35 33.00 Rate of Return: At least 11%. Appraisal Report: Report No. 3226b-CO, dated March 9, 1981. 1/ No physical contingency has been included as the actual roads to be constructed will be selected once all the preparatory work has been completed. For the first year of the project, twenty-three roads have already been selected by FNCV and approved by the Bank.  INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF COLOMBIA FOR THE RURAL ROADS PROJECT 1. I submit the following report and recommendation on a proposed loan to the Republic of Colombia, for the equivalent of US$33 million to help finance the Rural Roads Project. The loan would have a term of 17 years, including four years of grace, with interest at 9.6% per annum. PART I - THE ECONOMY 1/ 2. An Economic Report on Colombia (2535-CO) was distributed to the Executive Directors in June 1979. An updating report is being prepared and will be distributed soon. This section on the economy reflects the major findings of the forthcoming report. Country data sheets are presented in Annex I. Background 3. The Colombian economy made considerable progress over the past quarter century. From a largely rural and agricultural base in the 1950s, it evolved to a more integrated urban-industrial and services orientation. The productive structure of the economy was broadened appreciably and output in both the agricultural and industrial sectors became more diversified. Public sector investment and output came to play a greater role in the economy, primarily as a result of increased activity on the part of decentralized agencies and public enterprises. Also, greater reliance on foreign trade allowed the external sector of the economy to grow, with non-coffee exports, particularly exports of manufactured goods, expanding rapidly and the range of products sold abroad widening considerably. The growing urban-industrial coloration of economic activity and a rapid expansion of surplus labor in rural areas gave rise to rapid rural-urban migration as rural labor sought to take advantage of higher productivity and better paying jobs in the major metropolitan areas. Financial and capital markets evolved pari-passu with the growing financial needs of the industrial and services sectors of the economy, and Colombia has become an active participant in international capital markets. The economy has grown more resilient to external shocks as a result of the structural changes that have occurred. 4. Real GDP per capita rose by 2.4% p.a. on average during the 1950-79 period, with each succeeding decade registering greater gains in per capita income. This was the result of lower population growth, combined with more rapid GDP growth. Population growth, which had remained in the 3.0% to 3.5% range during the 1950s and early 1960s, declined dramatically after 1965 as a consequence of a sharp fall in the fertility rate. Gretater economic 1/ Substantially unchanged from report for the Playas Power Project (No. P-2953-CO, February 10, 1981).  and educational opportunities for women, rapid rural/urban migration, rising per capita income and increased effectiveness of family planning programs contributed to the decline in fertility. Colombia's population is currently growing at an annual rate of 2.1%. As a result of the high proportion of women now entering childbearing years, this rate of population growth is expected to continue until the early 1990s. 5. The combination of rising per capita income and expanded public services over the past quarter century brought about a substantial improvement in the welfare of the poorest income groups in Colombia. As a result of improved diets and better health care, the crude death rate fell by about 50% and life expectancy rose from 50 years to 62 years. The child mortality rate declined from 17 per thousand in the early 1960s to 9 per thousand in the mid 1970s. Infant mortality, one of the best indicators of welfare, fell to 98 per thousand in the mid-1970s, from about 124 per thousand in the early 1950s. School enrollment ratios have increased substantially at all grade levels since 1960, and by the late 1970s, 91% of urban children aged 7 to 14 were enrolled in school. The poorest income groups, including those in rural areas, have experienced the greatest increases in electricity and water services in recent years and have benefited more than the average of the population from services of the national health system. In spite of this progress, Colombia remains largely underdeveloped, with a relatively small modern sector superimposed on a broad, traditional and economically poor base. Development has been concentrated in relatively few areas of the country, public services are not available to a large proportion of the rural and urban populations, unemployment and underemployment are relatively high, and income and wealth distributions are skewed. The coverage of health care is still deficient and adequate housing is not available to a substantial proportion of the population. Papid migration to the three major metropolitan areas has created urban development problems, with attendant social difficulties. 6. In large part, the achievements of the past twenty five years were the result of Government efforts to stimulate the productive sectors, provide the required economic and social infrastructure and establish an effective institutional base in the economy. In the 1950s and early 1960s development policy favored import substitution supported by high tariff protection and the provision of economic infrastructure by the public sector. It was during this period that the country's major communication and trans- portation networks were completed and the transformation to semi-industrial economic structure began in earnest. By the mid-1960s the prospects for further import substitution were substantially diminished and the country was in the midst of a period of great economic uncertainty, with economic activity and the balance of payments heavily influenced by developments in the world coffee market. In 1967 the authorities adopted an outward- looking development strategy. Fxport promotion policies, including periodic exchange rate devaluations and export tax rebates, were introduced and the  authorities began lowering tariffs and freeing capital markets from controls as means of raising efficiency and increasing the competitiveness of Colombian goods in external markets. These measures were highly successful in relieving the foreign exchange constraint and stimulating growth. However, by the mid-1970s the economy was once again experiencing difficulties caused primarily by the world recession and by excessive Central Bank financing of domestic budget deficits. Recent Economic Developments 7. In late 1974, the Government introduced a wide range of fiscal and monetary policies designed to correct the structural and policy weaknesses pre- vailing in the economy at that time. Before these reforms were fully effective, the economy was subjected to strong inflationary pressures arising from a sharp increase in world coffee prices. The increased receipts from cofifee exports, together with some official surrender of foreign exchange from il:Legal exports, caused a turnabout in the balance of payments. Incomes rose rapidly and stimu- lated aggregated demand; inflation accelerated. Economic growth also accele- rated and unemployment fell substantially, both in rural and urbani areas. Largely as a consequence of increased coffee tax revenues, the public finances generated surpluses averaging about 5.8% of GDP during the 1976-79 period, and by the end of 1979, net official international reserves had risen to about US$4.1 billion, equivalent to nearly 12 months imports of goods and non-factor services. 8. While beneficial in many respects, the foreign exchange boom has had a somewhat negative impact on the evolution of the Colombian economy, largely as a consequence of the need for measures to stabilize the economy. Public investment was curbed, thereby delaying some badly needed additions to economic and social infrastructure. The rate of currency devaluation was lowered and the conversion of export receipts into pesos was delayed to moderate the growth of domestic demand, with some adverse effects on export expansion and diversification. Also, the Government was compelled to maintain high reserve requirements and expand controls over credit (including interest rate ceilings, directed credit, portfolio requirements, etc.), thereby reducing the financing available to the private sector via the official capital market. These controls encouraged the development of a flourishing extrabank market in which credit was available albeit at high interest rates and for short maturities. 9. Although the stabilization measures were kept virtually unchanged from early 1977, they were moderately successful in restraining aggregate demand growth; however, relatively high inflation persisted. In 1979, consumer prices rose by nearly 30%. Nevertheless, real GDP growth remained strong, rising by about 5% for the year, led by a good performance in services, manu- facturing and agriculture. However, construction and mining activities declined. In response to the increasing stabilizing effects on aLggregate demand and the troublesome financial market distortions caused by inflation and the extended period of monetary restraint, the authorities began in late 1979 to adjust the stabilization program. The rate of peso devaluation was advanced to increase export incentives and reduce borrowing abroaLd, and in early 1980, credit restraints were relaxed by lowering reserve requirements.  At the same time, interest rates on time deposits captured by commercial banks and development finance companies - and on the lending therefrom - were freed from controls. To offset the inflationary effects of these measures the authorities further liberalized import payments and adopted the policy, supported by a new issue of short-term certificates, of not expanding the subsidized selective credit operations of the Central Bank in excess of the resources captured from private savings for their financing. The authorities also increased the surveillance and control of the illegal export trade. 10. The effects of the above measures were not immediately noticeable. Industrial sector growth slowed during the first half of 1980 and construction activity, which had fallen sharply in 1979, continued to slacken. Agricul- tural output was affected by drought, high incidence of disease and rising fertilizer costs. Consequently, real GDP growth is likely to decline to 3-4% in 1980. With world coffee prices at relatively high levels for most of the year, Colombia's balance of payments in 1980 is estimated to have regis- tered an over-all surplus in the US$700 million range. This would maintain net official reserves at about 11 months imports of goods and non-factor services. Colombia's consolidated public finances are estimated to have recorded a large surplus in 1980 for the fourth consecutive year, again mainly because of increased earnings on foreign exchange holdings and large receipts from the coffee tax. Inflation continued to be a problem in 1980 however, despite the slow down in economic activity, with consumer prices increasing by about 26% for the year. The major challenge facing the Colombian authorities over the next few years will be to bring about a reduction in the inflation rate, while at the same time raising investment to the level required for private sector expansion. Development Strategy 11. Achievement in this decade of the Government's objectives of increased productivity and maximum economic growth, improved distribution of income and greater welfare for all Colombians will require a major effort to remove from the economy the constraints of inadequate economic and social infrastructure and insufficient demand. Infrastructure needs are most pressing in the energy and transportation sectors. 12. The Government's strategy for accomplishing its development objec- tives are set forth in the recently promulgated Plan de Integracion Nacional (PIN). This strategy continues the previous emphasis on export promotion as a means of supplementing domestic demand and assuring balance of payments stability, and on policy measures, including further import liberalization, designed to increase economic efficiency and raise institutional capacity. It proposes a large increase in public investment, giving high priority to energy projects and to the provision of transport infrastructure. Economic decentralization, regional automomy and the uniting of regional growth centers through improved transport, communication and financial links are directed towards creating an integrated national market, a strategic goal of the PIN. The Plan also places emphasis on the promotion of both small scale and commercial agriculture as a means of diversifying and increasing exports, assuring adequate domestic food supplies, holding down inflation and contribut- ing to the Government's nutrition and welfare goals. Industrial policy  - 5 - objectives are to provide an environment of certainty, along with adequate credit and infrastructure, so that entrepreneurs are encouraged to invest and expand output. Because of its benefits in opening foreign markets, creating employment and bringing in new technology, priv.te foreign investment is to be encouraged. The Government's approach to helpirng the poor takes on a new orientation in the PIN. Programs in the health and education sectors are to be better focussed and integrate? and selected low income and economically disadvantaged groups, such as workers in the informal sector, children and unemployed youth, are singled out for special attention. Combined with extensions of the Integrated Rural Development (DRI) and Nationatl Nutrition (PAN) projects, the new directions given to social programs are expected to raise significantly the welfare cf low income groups in Colombia!. 13. While the PIN provides a good analysis of the development issues facing the country and sets forth the general guidelines for policies and programs to resolve these issues, there are two important aspects of bringing off the development strategy that are expected to receive increasing attention from the authorities' in coming months. The first involves a required deepening of the sector analyses in order to improve coordination in planning and executing sector strategies, and the second has to do with matters related to financing the PIN. Given the large investment required to carry out the PIN strategy, inadequate planning and coordination among sectors or insufficient domestic resource mobilization would be likely to result in substantial resource mis- allocation and delay execution of the strategy. It is essentiaL that this be avoided. The two most important sectors where additional work Ls urgently required are energy and transportation. 14. Colombia became a net oil importer in 1976 and by 198.5 petroleum imports are expected to absorb nearly 25% of total export proce,eds. In the absence of rapid energy development, energy shortages will become a major constraint on Colombia's growth later in this decade. Resolution of the energy problem depends on the country's success in developing its abundant domestic energy resources. The strategy for doing this will require energy pricing policies that rationalize consumption with energy resource avail- abilities, a least cost program of investments in energy and policy measures to assure the program's rapid execution. Although planning and policymaking have improved substantially in many energy sector institutions in recent years, overall planning and coordination in the sector are still weak. A study initiated in 1980 by the National Planning Department is expected to provide the basis for improvements in sector-wide planning and policy-making, and recent pricing decisions have gone a considerable way towards providing the correct signals for regulating consumption and encouraging production. The prices paid to producers (primarily foreign companies) for "incremental" and "new" crude have been raised to levels which should provide adequate production incentives, and the retail prices of petroleum products, while still below international levels, have been increased substantially in excess of world oil price rises (paragraph 33). The Government has committed itself to raise energy prices to equivalent international levels as rapidly as politically and economically possible, and a least cost energy investment program is being prepared.  15. Colombia's high transportation costs and inadequate service could become a constraint on economic growth, particularly on mining development. The State Railway is in poor condition and the road network needs rehabili- tation and upgrading (paragraphs 27, 28 and 34). The authorities have begun to take steps to improve the country's infrastructure (paragraphs 28, 30, 39 and 40) and PIN assigns an important share of future investments to the sector. There is, however, a need for more efficient planning to ensure that only least cost investments are carried out and that a sound policy framework for the sector is established to deal effectively with the problems of intermodal coordination and energy conservation. Investment and Its Financing 16. A substantial increase and redirection of public sector investment will be required in the next several years to carry out the development strategy outlined in the PIN. Over the 1980-85 period, such investment is expected to increase by about 12% p.a. in real terms. The energy, transpor- tation and industrial (including mining) sectors are expected to account for the bulk (60%) of this investment; however, sizeable real increases in invest- ment are also expected in the nutrition and health, small scale agriculture and industry, water and sewerage, and education sectors. Overall, public fixed investment is projected to average 9.2% of GDP during the 1980-85 period, and is expected to total Col$1,716 billion (US$22,260 million). Private investment will have to increase also during this period to provide the goods and services required by the expanding economy. 17. This increase in investment will demand a major resource mobilization effort on the part of Colombia's public sector. The buoyancy of the tax system (excluding coffee tax revenues and receipts from earnings on foreign exchange holdings), which has declined in recent years, will have to be increased through new taxes and better tax administration and the charges levied for public services will have to be raised substantially in real terms. Since this effort is expected to coincide with increased private sector demand for investment resources, the importance of measures to expand domestic savings cannot be over-stressed. The recent capital market liberalization should encourage savings. A significant increase in voluntary private savings is not likely, however, as long as inflation remains high. Consequently, stabilization remains a sine qua non for the country's future growth and development. Growth and Balance of Payments Prospects 18. Given the country's strong resource base and sound economic manage- ment, Colombia's growth prospects for this decade are good and significant advances in economic welfare are anticipated. The urgent need to relieve the pressure on aggregate demand arising from the recent growth of foreign exchange earnings and the necessity to increase rapidly imports to develop the country's resource potential and restore higher economic growth requires a turnaround in the balance of payments from a current account surplus of US$596 million  - 7 - (2.2% of GDP) registered in 1979 to a current account deficit projected to average US$1,150 million, over the 1980-85 period, equivalent to 2.8% of GDP. By the end of this period, net official international reserves would have fallen to a level above three months of imports of goods and services (a level which is adequate for Colombia) without prejudice to the country's credit- worthiness. This should be sufficient to support an average growth of real GDP of 5.5% during this period. Beyond 1985, the current account deficit should improve as a result of increasing export proceeds (particularly coal) and a levelling-off of imports. The current account deficit would fall to 2% of GDP in 1987 and to 1% by 1990. It is expected, therefore, that the economy will be able to achieve real GDP growth averaging about 5.5% per annum during the 1980-85 period. To reach this level of growth, gross domest:ic investment will have to expand to about 24% of GDP, up from 18% in the early 1970s and 21% in recent years, and to avoid too large an increase in foreign indebted- ness, gross national savings would need to average about 21% of GDP. This is about the same level of savings achieved in 1978-79, when the terms-of-trade gains from the coffee boom raised the savings coefficient, but above the level achieved in the early 1970s. 19. Gross external capital requirements (net of reserve drawdown) are projected to total US$10.0 billion in current prices for the 1980-85 period, for an annual average requirement of US$1,670 million. About 31% of this amount will be required annually for debt amortization and the rest to cover current account deficits. Multilateral and bilateral agencies are expected to provide 40% of these requirements, 48% is expected to come from foreign suppliers and financial institutions and the balance should come from private foreign investment. At the end of 1979, Colombia's public and publicly guaranteed external debt disbursed and outstanding amounted to US$3.4 billion, equivalent to 12% of GDP. The Bank/IDA share of this external debt was 25%. Reflecting the recently increased lending by the Bank and the decline by bilateral sources, this share is expected to increase to about 30% in 1983, before falling to about 25% in 1987. The debt service ratio at end of 1979 was 12% and is expected to climb to 17% by 1985, peak at about 18% in the early 1990s and then decline gradually. The World Bank's share in public debt service is expected to rise to about 24% in 1985 from about 13% in 1979. With continued sound economic and financial management, Colombia is expected to maintain its creditworthiness through and beyond the 1980-1990 period. PART II: BANK GROUP OPERATIONS IN COLOMBIA 20. The proposed loan, the 90th to be made to Colombia, would bring the total amount of Bank loans to Colombia to US$2,903.8 million (net of cancella- tions). Of this amount the Bank held, as of December 31, 1980, US$2,184.4 million; IDA made one credit of US$19.5 million for highways in 1961. Dis- bursements have been completed on 54 loans and the IDA credit. During 1972-77 disbursements averaged US$86 million equivalent per year, then declined slightly to US$82 million in 1978 but increased sharply to US$138 million in 1979 and to US$215 million in 1980. The improved performance of social  - 8 - sector institutions in the execution of Bank-financed projects, the gradual containment of inflationary pressures which should allow relaxation of fiscal restraint and the recent Bank lending for infrastructure projects, all point to higher levels of disbursements in the future. IFC has made investments and underwriting commitments of US$63.2 million in 25 enterprises and, as of December 31, 1980, it held US$17.6 million. Annex II contains a summary statement of Bank loans, the IDA credit and IFC investments as of December 31, 1980. The Annex also contains summaries on the execution of the 34 ongoing projects. 21. In response to the priority objectives established by successive Governments (self-sustained economic growth, increased employment and improved income distribution), since 1966, Bank lending to Colombia has become increas- ingly diversified and has been concentrated on production-oriented programs and activities which emphasized social as well as economic benefits. All three loans for education have been made during this period, and so have twelve of the fourteen loans for industry, eleven of the thirteen agricultural loans, one loan for a nutrition project, two loans for urban development projects and all nine loans for water supply and sewerage. During the same period, seventeen loans were made in the power and transport sectors, while before 1966, twenty-two out of a total of twenty-five loans were made to these sectors. 22. Bank lending to Colombia in FY80 consisted of two loans for power generation and distribution projects, and one each for a nickel project, telecommunications, and credit to small-scale industry and to development finance companies for medium- and large-scale industry, totalling US$518.0 million equivalent. In addition to the loan proposed in this report, the FY81 program includes loans for further hydro power development, railways, village electrification, irrigation rehabilitation and erosion control, secondary oil recovery, and the already approved loan for hydropower development. Work is also under way on projects for further petroleum development and mining, land settlement, rural development, ports, highways, oil refining, electric power, agro-industries, fertilizers, water supply and sewerage, urban development and environmental improvement, for possible consideration by the Executive Directors during the next two years. 23. The proposed Bank lending conforms closely with the Government's development strategy as outlined in the PIN (paragraphs 12 through 15). To help Colombia develop domestic sources of energy, a sizeable part of the proposed lending would be for hydropower. The Bank intends to assist the development of coal mines which hold potential in helping Colombia meet part of its energy requirements and in diversifying exports. In support of the Government's objective to increase the supply and the recovery of domestic petroleum, the Bank proposes to finance further petroleum projects and, for the first time, become involved in projects which promote the efficient processing of hydrocarbons. Bank financing in the energy sector would also assist in strengthening major institutions and in mobilizing external  - 9 - finance as some of the projects would require co-financing. Other future loans would finance agriculture and industry to support the Government in its efforts to raise overall productivity, income and employment, and to increase and d