Mexico - Second Technical Training (Second CONALEP) Project

Document of The World Bank FOR OFMFCIAL USE ONLY -. Report No. P-4058-ME REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN IN AN AMOUNT EQUIVALENT TO US$81 MILLION TO NACIONAL FINANCIERA, S.A. WITH THE GUARANTEEE OF UNITED MEXICAN STATES FOR A SECOND TECHNICAL TRAINING PROJECT Ia - May 1, 1985 This document has a restricted distribution and -y be used by recipients ondy in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorizationm  Currency Unit - Peso (MexS) On March 31, 1985, the exchange rate in the controlled market was US$1 = Mex$208.79; the freemarket exchange rate stood at US$1 = Mex$226.85. Both exchange rates are currently sliding at a rate of Mex$0.21 per day against the US dollar. Fiscal Year January 1 - December 31 ABBREVIATIONS CAPFCE - Administrative Committee of Federal Programs for School Const:ruction CETs - Centers for Technological Studies CONALEP - National Agency for Professional Technical Education NAFINSA - Nacional Financiera, S.A. NDP - National Development Plan SEP - Ministry of Education SHCP - Ministry of Finance and Public Credit SPP - Ministry of Programming and Budgeting S  FoR OFFICIAL USE ONLY -i - MEXICO SECOND TECHNICAL TRAINING PROJECT LOAN AND PROJECT SUMMARY Borrower: Nacional Financiera, S.A. Guarantor: United Mexican States Beneficiary: National Agency for Professional Technical Education (CONALEP) Amount: US$81.0 million equivalent. Terms: 15 years, including 3 years of grace, at the standard variable rate. Project The project would support CONALEP in implementing the second Description: phase (1985-88) of its technical training program for skilled workers and technicians. Objectives: The project's objectives are (a) to improve CONALEP's operational efficiency and effectiveness; (b) to increase the supply of skilled workers and technicians; (c) to improve the quality of training, instructor training, and materials cost-recovery efforts; (d) to develop advanced maintenance systems for buildings and equipment; and (e) to provide flexible support for the program as a whole. Components: The project would provide technical assistance to achieve the above objectives, support the creation of 24 cost-recovery, pilot production units and assist in the development of about 97 technical training centers, with an additional enrollment capacity of 90,000 students in training and up-grading programs. Benefits: The project would greatly strengthen technical training at the middle level by further contributing to the institutional development of CONALEP and by enhancing the quality of training. The project would increase CONALEP's annual output v by 21,580 skilled workers and middle-level technicians and 1,500 technical teachers. It would also increase capacity to upgrade specialized skills for about 16,180 employed workers and technicians. 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.  Risks: The major risks are difficulties in recruiting part-time instructors during peak production hours and retention of students. The ability of CONAIEP to pay competitive salaries should diminish the problem of teacher recruitment. A favorable student-teacher ratio and well equipped facilities to aid in practical application of course-work should improve student retention. The risk of expected benefits of the production units not materializing is more than offset by f CONALEP's proven capacity for implementing innovations. Further, the project would provide for the financing of feasibility studies prior to establishing the production units. Overall, considering CONALEP's capacity for monitoring and implementing the program, the risks are acceptable. Estimated Costs: 1/ Local Foreign Total Category (US$ million)- - Construction 48.0 12.0 60.0 Furniture 3.9 0.9 4.8 Equipment 12.6 59.3 71.9 Production Supplies 0.3 0.3 0.6 Technical Assistance 0.4 0.4 0.8 Project Base Cost 65.2 72.9 138.1 Physical Contingencies 2.9 3.5 6.4 Price Contingencies 11.3 6.4 17.7 TOTAL PROJECT COST 79.4 82.8 162.2 Financing Plan: Local Foreign Total - = (US$ million) - Government 79.4 1.8 81.2 Bank - 81.0 81.0 TOTAL 79.4 82.8 162.2 1/ Figures do not add due to rounding. Costs exclude in-kind contributions and identifiable taxes and duties, but include about US$9.3 million in sunk costs.  - iii - Estimated Disbursements: - --(US$ million)- - Bank FY 86 87 88 89 90 Annual 14.0 22.5 24.5 18.0 2.0 Cumulative 14.0 36.5 61.0 79.0 81.0 Rate of Return: Not quantifiable Staff Appraisal Report: Report No. 5499-ME, dated April 29, 1985.  INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO NACIONAL FINANCIERA, S.A. WITH THE GUARANTEE OF UNITED MEXICAN STATES FOR A SECOND TECHNICAL TRAINING PROJECT 1/ 1. I submit the following report and recommendation on a proposed loan to Nacional Financiera, S.A., (NAFINSA) with the Guarantee of United Mexican States for the equivalent of US$81 million to help finance a Second Technical Training Project to be carried out by the National Agency for Professional Technical Education (CONALEP). The loan would be repaid over 15 years, including 3 years grace, at the standard variable interest rate. PART I - THE ECONOMY 2. An economic report on Mexico (Mexico: Recent Economic Developments and Prospects, No. 4996-ME) was distributed to the Executive Directors on May 14, 1984. The report's main conclusions and recent economic developments are summarized below. 3. Following an import-substitution growth strategy, Mexico experienced some two decades of high and stable growth after the early 1950s. By the late 1960s, however, Mexico had largely exhausted the easyf and efficient possibil- ities for import substitution, and faced a choice between outward-oriented growth or continued inward-directed growth led by expansion of public sector expenditures and rising subsidies and protection of inefficient domestic production. By 1972 the choice was made to pursue the latter course. Public sector expenditures as a percent of CDP more than doubled between 1970 and 1982, from 18.8% to 42.5% (Report No. 4996-ME, p. 114). By 1976 Mexico experienced a serious financial and economic crisis, followed by an even more serious one six years later. The discovery of large oil reserves in the *id-1970s led Mexico to a quick economic recovery, but it also removed the urgency of policy reforms. Primary among these was the need to reduce protec- tion and the anti-export bias of the trade regime to thereby move over time toward greater efficiency and international competitiveness. Oil revenues also temporarily helped finance the public sector deficit and reduced the need for greater fiscal restraint. Developments during 1977-1982 4. The stabilization measures initiated in 1977 and the discovery and exploitation of large oil resources in the mid-1970s allowed the Lopez Portillo 1/ Parts I and II are substantially unchanged from the President's Report for the Chiapas Agricultural Development Project (Report No. P-4023-ME of March 29, 1985).  - 2 - Administration (Jan. 1977 - Dec. 1982) to overcome the serious financial crisis of 1976 and to start working on structural, social and economic problems, including poverty, income and wealth inequality, unemployment, regional imbalances and relatively slow agricultural growth. In the early years of that Administration (1978-80) GDP growth was high (8.5% a year), 2.5 million jobs were created, domestic consumption recovered, and the share of investment and savings in GDP surpassed historical levels, but the economy became increasingly overheated. 5. Rapidly rising public expenditures unmatched by revenues led to increasing public deficits. While inflation rose, no significant pressure was felt to adjust the exchange rate, thanks to the oil earnings and the relative ease of obtaining foreign finance. By mid-1981, the economic situation began to mirror the scene prevailing before the 1976 financial crisis. The current account deficit of the balance of payments reached 5.2% of GDP, while the deteriorating international oil market conditions caused large revenue shortfalls with respect to budget expectations. The public sector deficit rose to just under 15% of GDP. Non-oil exports dropped, and the trade deficit reached record levels. External borrowing was used to finance part of the domestic fiscal deficit and to defend the exchange rate. Mexico's foreign debt increased rapidly, at a time of high and rising international interest rates. A stabilization program initiated by the Government in mid-1981 was not sufficient to redress the growing fiscal imbalance, the high cost of foreign loans and the increasing private capital flight fueled by the public's anxiety over Mexico's financial troubles. 6. The crisis came to a head in 19B2. In February, as capital flight intensified, the Bank of Mexico had to stop supporting the peso, which then experienced a 40% devaluation in dollar terms. A large wage adjustment granted in March 1982, which tended to undo the effects of the devaluation, and continuing slack in the oil market kept the balance of payments under strain. Under the circumstances, the international banking community became reluctant to commit new funds to Mexico, in the amounts required. These factors led to a second devaluation of 35% in August 1982, while the acute shortage of foretgn exchange forced the Government to suspend the amortization payments of most of Mexico's external public debt pending a broader agreement on its refinancing. Capital flight continued as private sector confidence was shaken by the nationalization of the banks in September 1982, and the mandatory conversion of US dollar deposits into pesos. Also put into effect were a generalized system of exchange controls and quantitative trade restrictions covering an unprecedented 100% of imports. Recent Developments 7. The Administration of President de la Madrid, that began its term in December 1982, lost no time in taking steps to recover domestic and external confidence, and stabilize the public sector and external finances. The Government's stabilization program supported by an EFF agreement, approved by the IMF in December 1982, laid the basis for restoring economic stability and for the re-negotiation of that part of Mexico's public external debt on which amortization payments had been discontinued in August 1982. Commercial banks agreed to restructure some US$19 billion of public sector debt and provide US$5  -3- billion in net new loans for 1983. All obligations falling due between August 23, 1982 and December 31, 1984 were restructured over an eight year period, starting from January 1983, with a grace period of four years and at an interest rate of 1-7/8 percentage points over LIBOR (or 1-3/4 over the New York prime rate). The US$5 billion syndication had a 6-year maturity, with a 3-year grace period, at a spread of 2-1/4 over LIBOR (2-1/8 over prime). The restructuring exercise included an understanding that the international banks would maintain their exposure to the Mexican banks that had been nationalized. At the same time, it provided a mechanism that would eliminate 1982 private sector interest arrears and facilitate payment of the rescheduled principal on such debt. 8. A new two-tier exchange rate system was introduced, with a controlled market for imports, most proceeds from merchandise exports (except those of in-bond industries) and debt related transactions, and a free market for all other transactions including those relating to tourism. The controlled rate was originally set at Mex$95 = US$1, a depreciation of some 35% in relation to the previously prevailing ordinary rate of Mex$70 per US dollar. The free market rate had remained at about Mex$150 per dollar until September 1983, when the authorities decided to let it slide as much as the controlled rate. The differential between the two rates, which in December 1982 stood close to 60%, is now down to less than 10%. Over the past two years, the peso has gradually appreciated in real terms as inflation in Mexico remained high. The Government increased the rate of slide of the peso from 13 centavos a day to 17 centavos in December 1984 and to 21 centavos early March 1985, in order to bring it closer to the expected inflation differential between Mexico and its trading partners. Domestic deposit interest rates were also raised in early March 1985 from an average of about 45% to nearly 50%. 9. Under the IMF Agreement, the Administration committed itself to a drastic reduction of the public sector deficit, from 18.0Z of GDP in 1982 to 8.5% in 1983, 5.5% in 1984 and 3.5% in 1985. Substantial progress has been made during the past two years in meeting the program objectives although the targets for 1984 were not fully met. The public finances were strengthened considerably and the public sector deficit was reduced to 8.7% of GDP in 1983 and an estimated 7.4% in 1984. The main reason for the higher budget deficit than the 1984 target was the much higher than expected interest payments on the domestic debt. Curbs on expenditures were wide ranging. However, recent estimates suggest that real public investment -- encompassing states and local governments -- may have been well in excess of the targets for 1984. The authorities have given priority to completing projects that were already far advanced and to those that were important for employment, equity, or foreign exchange earnings. Nonetheless, public investment expenditures are estimated to have declined to about 7% of GDP in 1983-84, well below the 1982 level of 11.7%. The fiscal performance was also aided by significant price increases for nearly all public goods and services, including petroleum nroducts, electricity rates, food, etc. The Government has committed itself to a stibstantial reduction and eventual elimination of most subsidies, including Lhose provided in the form of low incerest rates. 10. The balance of payments experienced a major turnaround in 1983 with the current account moving from a deficit of almost US$5 billion in 1982 to a surplus of US$5.5 billion. The strength of the current account and the  - 4 - availability of external finance permitted Mexico to replenish its international reserves while paying a large part of the arrears that had accumulated in 1982. The net use of foreign financing by the public sector was US$4.2 billion for the year-below the ceiling of US$5 billion under the stabilization program. The errors and omissions account of the balance of payments dropped from US$8 billion in 1982 to an estimated US$1.4 billion in 1983, largely reflecting the decline in unrecorded capital outflows. The swing in the current account was mainly the result of a very sharp contraction of merchandise imports, to US$7.7 billion representing a decline of about US$7 billion from their 1982 level. The recession, the large devaluation of the peso and the quantitative restrictions all contributed to this. The balance of payments remained strong in 1984, with a current account surplus of US$3.7 billion, and a further US$2.5 billion were added to the nation's foreign exchange reserves, which at the year's end are estimated at about 71 months of imports. Although imports recovered considerably, a rapid rise in non-oil exports, particularly in the first quarter of 1984, ensured that the trade surplus remained at the same level as in 1983, i.e., about US$13 billion. Growth in tourism and in-bond industry was also strong, and helped in alleviating unemployment. These favorable external trends during late 1983 and early 1984 weakened in mid-1984, owing to an appreciating real exchange rate. 1I. Fighting inflation remains the pivot of the Government's stabilization program. Although the Government's own inflationary targets have been missed by wide margins, the rate of inflation continued to decline through mid-1984. It declined from a rate of about 100% in 1982 to 80% and 59% in 1983 and 1984. The main factors in this were restrained fiscal and monetary policies and moderate wage adjustments. The flow of savings into the banking system continued to rise, reflecting the beneficial influence of the exchange rate and interest rate policies. The impact of the severe and sudden cuts in public expenditure and imports on economic growth in 1983 was serious when GDP declined by over 5%. However, the economic recovery in 1984 was stronger than the Government's expectations: GDP is estimated to have risen by about 3.5% compared to the earlier estimate of only 1%. Since the latter half of 1984, fiscal, monetary, and external trends have signaled a possible resurgence of inflationary pressures. 12. The Government also took steps to regain the confidence of both domestic and foreign private investors. These included efforts to deal with the problems of private external debt, procedures to compensate owners of nationalized banks, and a more flexible application of the foreign investment law. Negotiations with commercial banks and other private creditors have been completed for the refinancing of nearly half of the total of US$11.6 billion of private sector obligations at stretched out maturities varying between 6 and 12 years, with 3- to 4-year grace periods. Moreover, the Government undertook the restructuring of Mexican private sector obligations guaranteed by official credit agencies abroad. The Government has also transferred back to private ownership most of the 400 private firms that were controlled by the commercial banks prior to their nationalization. These measures and announcements have been beneficial, but more remains to be done to restore confidence of Mexican entrepreneurs and foreign investors. The Government realizes that this is an issue of the greatest importance as economic recovery beyond the current stabilization period will depend critically on the resumption of vigorous private investment.  - 5 - 13. The general improvement in the Mexican economy has been widely noted, particularly by the international banking community. Mainly for this reason, the Government's 1984 borrowing of US$3.8 billion from commercial banks carrled much more favorable terms than the borrowing in 1983 (10 year maturity, 5-3/4 year grace period, and a spread of 1lt over LIBOR or 1-1/8% over prime). The negotiations between the Government and foreign commercial bankF on the rescheduling of foreign debt have been virtually completed. The draft agreement, covering close to US$50 billion, has been submitted by the Banks' Advisory Group (consisting of the 13 largest lenders) to some 500 smaller, regional banks for their acceptance. Under the proposed terms, the previously not-rescheduled debt (amounting to about $20 billion), which is due for repayment in 1985-90, will have its maturities stretched over fourteen years. The maturities of the previously rescheduled debt coming due in 1987-90 will be stretched over eleven years. The 1983 syndicate loan of $5 billion will be restructured, after prepayment of $1 billion, to carry terms identical to the 1984 syndicate loan. In summary, the pending rescheduling agreement will stretch maturities of US$50 billion public debt in such 3 way that the debt service remains virtually constant between 1985-1998, in contrast to the present situation where 75% of the debt service is due in 1986-89. The banks will have the choice of LIBOR, a domestic reference rate, or a fixed rate. These terms nre based on the understanding that the Government will continue to adhere to prudent economic policies. The rescheduling agreement covering US$29 billion of Government debt was signed on March 29, 1985. Another US$19 billion in loans to Mexican Government agencies will be refinanced between now and June. This followed the approval on March 25 by the IMF of a third-year Extended Fund Facility. Medium-term Prospects 14. The Government's strategy, as outlined in the National Development Plan (NDP) for 1983-88, combines special efforts to recover from the present crisis with a longer-term perspective on regaining balanced and stable growth to overcome structural problems. The main problems facing Mexico in the years ahead include the still very high rate of population growth (2.6% estimated for 1983) together with an even higher rate of labor force growth (a little under 4%), slow growth in agriculture, poverty, a highly skewed interpers.2aal and interregional income distribution, and an overly oil-dependent economy with a strong anti-export bias. 15. The medium-term strategy presented in the NDP focuses on the need for structural changes in the economy including a greater export orientation through revision of external trade policies, poverty alleviation through _dsic needs policies and improvement in labor absorption, and decentralization of economic activity. The basic elements of policies to address structural problems are mentioned in the ND? and further details on specific programs and schedules for policy adjustments are provided in the sectoral plans which were prepared subsequently. 16. Mexico's medium-term prospects for recovery and stable economic growth are reasonably good, provided economic management continues to be prudent, private sector confidence is restored, and the international environment remains favorable. Adequate domestic policies include inter alia continued  - 6 - efforts to reduce the fiscal deficit, liberalize trade and minimize price distortions. Restoration of private sector confidence is crucial since only a strong and dynamic private sector will be able to raise investment from the present depressed levels and to supply the increasing non-oil export surplus required for the resumption of growth. As regards the external environment, the commercial banks are expected to maintain their exposure in Mexico in real terms, and foreign markets to be open to Mexico's non-oil exports. Mexico will benefit directly from a continuing fall in interest rates in the world financial markets (a one percentage point drop means a savings of about US$800 million in overall interest payments which compares to a loss of $550 million in gross export revenues that would result from a one dollar drop in the export price of oil). 17. Under reasonably favorable external and domestic conditions, Mexico's economic growth could reach a sustainable 6% a year--the post-War average for Mexico --towards the late 1980s. This growth would materialize through a sustained redirection of the economy toward a more outward-oriented growth pattern. Fiscal discipline, in t.ie absence of improved domestic efficiency and export development, is likely to entail a prolonged period of slow growth, characterized by insufficient labo- absorption in internationally competitive activities, by domestic price distortions, and by continued need for subsidies. External Debt and Creditworthiness 18. Mexico's external public debt increased by about US$4 billion during 1983 and by about a similar amount in 1984. With an expected net new borrowing of some US$3 to US$4 billion a year, the ratio of external debt to GDP would decline steadily from 41% in 1984 to 33% by 1990. The debt service ratio, after the proposed rescheduling, is projected to peak at 47Z in 1988, thereafter it gradually declines to about 25% in 1995. 19. At the end of 1983, the last year for which a comprehensive external debt report is available at this time, the Bank's share in Mexico's debt was 4.3% (excluding undisbursed). The Bank share in Mexico's total public external debt service payments during that year was 4%. In view of the good medium and long term potential of its economy and the prospect of continued pursuit of sound economic policies by the present Administration, Mexico is considered creditworthy for IBRD borrowing. PART II - BANK GROUP OPERATIONS IN MEXICO Bank Operations 20. As of March 31, 1985, Mexico had received 85 loans from the Bank amounting to US$6,831.3 million, net of cancellations and terminations; of these, 58 loans totalling US$3,495.2 million were fully disbursed. The Bank held US$5,465.6 million, of which US$1,948.9 million had not yet been disbursed. Some 42% of Bank lending has been for agriculture and rural development, 23% for industry, 11% for power, and 13% for transportation; the remaining 11% has been for water supply, tourism, urban development, vocational training and pollution control projects. Annex II contains a summary statement of Bank loans as of March 31, 1985.  21. Of the US$6.83 billion total lending, about US$3.5 billion was for establishing or strengthening institutions for channelling credit to areas where credit supply was deficient or non-existent, and setting up in the com- mercial banking system the ability to carry out project-related appraisal of investments in agriculture, industry and tourism. These credit programs have facilitated lending to low-income farmers and small- and medium-scale industrial and tourism enterprises based on productive investment plans, rather than credit granted on the basis of collateral. 22. The Government arranged adequate budget financing in the years 1978 to 1981, which significantly improved project implementation. Government and Bank officials met periodically to review project implementation, and greater attention was focused in Mexico on project monitoring. As a result of these measures, most of the Bank-assisted projects were being implemented satisfactorily until mid-1982 and disbursements rose from US$91 million in FY78 to US$448 million in FY82. However, the present financial crisis is again causing delays in the provision of counterpart funds, consequently, disburse- ments in FY83 declined to US$389 million. A Special Action Program (SAP) was established in early 1983 to help the Government by alleviating the counterpart funding constraints on development projects, and 18 Bank financed projects are receiving support under the Program. Partly as a result of the SAP, disburse- ments during 1984 improved significantly at US$528.87 million or 35% over disbursements in 1983. IFC Operations 23. As of March 31, 1985, IFC had made investment commitments in 27 companies in Mexico, for a total of US$753.9 million, of which US$562.5 million had been sold, repaid or cancelled. A summary statement of lFC investments is presented in Annex II. IFC has been working together with the Bank in preparing proposals to establish a facility for provision of foreign exchange financing to private sector companies for the importation of machinery, equipment and spare parts required for production of exportable products, for efficient import substitution and for improvements in the utilization of their existing productive capacity. IFC approved a US$100 million facility (including funds mobilized from foreign commercial banks) in 1983, which is providing finance for fixed investments of a larger size than those assisted under the Bank loan for an Export Development Project. Bank Strategy 24. The main objectives of Bank lending in Mexico in the past eight years have been to: (a) suDport policies and programs leading to a wider distribu- tion of the benefits of economic growth; (b) help finance projects that, di- rectly or indirectly, contribute significantly to output and employment; (c) help reduce Mexico's urban-regional imbalances; and (d) help free bottlenecks which prevent rapid growth. More recently, however, in response to Mexico's requirements following the 1982 economic crisis, the Bank, in close cooperation with the IMF, also supported the Government's stabilization program through as- sistance for export promotion and intensified and broadened economic and sector work. As for medium term prospects, the volume and composition of Bank lending to Mexico would be rel;ted to progress in the implementation of policy reforms  needed for structural economic adjustments, through broad policy conditionality affecting the entire lending program ox important parts of it. Specific policy reforms that are being pursued through a dialogue with the Government, conducted in parallel with the processing of lending operations, cover priority macro-economic and cross-sectoral issues, such as interest rate policy, energy pricing, subsidy reduction and export development. 25. Because of the difficult structural problems of agriculture and the sector's crucial importance for the one-third of the nation's population living in the rural areas, the Bank has made agriculture the leading sector for its lending. The Bank's agricultural lending program in Mexico has four goals: first, to help increase productivity of presently cultivated lands in general; second, to give emphasis to improving the productivity of small farmers; third, to complement infrastructure investments with support services, such as extension, marketing programs and credit; and fourth, to promote employment- generating investments in rural areas. The Bank has made 14 loans in FYs78-83 totalling US$1,829.4 million for irrigation, rural development and agricul- tural, agro-industrial and livestock credit programs. A US$175 million loan for a rural development project and a US$180 million loan for an irrigation rehabilitation project were approved by the Executive Directors in FY82, and a US$138.4 million loan for San Fernando rainfed agricultural development was approved in early FY83. A US$115 million loan for marketing perishables was approved by the Executive Directors in April 1983 and a $300 million Eighth Agricultural Credit Project in June 1984. A US$90 million loan for a Chiapas Agricultural Development Project together with a Chiapas Rural Rcads Project was approved by the Executive Directors on April 30, 1985. Projects for tropical agriculture, irrigation rehabilitation, extension and research, seed multiplication and agricultural credit are in various stages of preparation. 26. Bank lending for industry has aimed at: (a) reduction of the balance of payments deficit; (b) decentralizing industrial activities away from the major, increasingly congested, urban areas; and (c) promoting greater employ- ment. A steel project which the Bank helped structure and finance is now operating in a previously underdeveloped area on the west coast of Mexico, and the city in which it is located, Lazaro Cardenas, is developing into a new growth pole. Four loans for industrial projects to promote the development of small- and medium-scale industrial enterprises, to finance expansion of small- and medium-scale mining, and to support an industrial equipment fund (FONEI) were approved by the Executive Directors in FYs78-80. A US$90.0 million loan for a vocational training project, which is assisting a program to increase the supply of skilled workers and technicians, a US$152.3 million loan for the development of a capital goods industries project and a US$60 million loan for pollution control were approved by the Executive Directors in FY82. A modification in the capital goods project was approved by the Executive Directors in early 1983 to set up a pilot export development fund to help satisfy the foreign exchange needs of Mexican exporters. A US$350 million loan for an Export Development Project and a US$175 million loan for a Third Small- and Medium-Scale Industry Development Project were approved by the Executive Directors in FY83. A follow-up project to support expansion of small and medium scale mining enterprises is expected to be presented to the Board in late May 1985.  -9- 27. Bank lending for physical infrastructure has been focused on regional development and strengthening of institutions and sector policies. Two high- way sector projects (FY79 and FY84), the fourth railway project (FY81) and an industrial ports project (FY84) support these goals. The first and second medium-size cities water supply and sewerage projects (FY76 and 81) reinforce the planning, management and finance of specialized water supnly and sewerage institutions at the federal and municipal levels, and contribute to the establishment of tariffs more closely related to costs; a third project was approved by the Executive Directors on May 17, 1983. A fifth railway project is expected to be presented to the Board this fiscal year. 28. The Government has adopted a National Urban Development Plan that spells out its regional development priorities in operational terms. A project to assist in the development of the Lazaro Cardenas urban area was approved by the Executive Directors in FY78, and a second urban project for oil-producing southeastern Mexico was approved by the Executive Directors in FY81. A loan for the preparation of a deconcentration program for the Mexico City Region was approved by the Executive Directors in August 1982. 29. The Economic Development Institute (EDI) is assisting CECADE (Centro de Capacitacion de Desarrollo Economico under the Secretariat of Programming and Budgeting) in training Government staff in project preparation, monitoring and evaluation. EDI assistance is directed at courses on urban and regional development, agriculture, rural development and agro-industries. The Bank has also assisted the Mexican authorities in training personnel for managing water supply and industrial credit projects. 30. The Inter-American Development Bank (IDB) is the second largest source of multilateral aid to Mexico. The IDB has made loans to Mexico totalling US$3.4 billion as of March 31, 1985. Over 50% of the total has gone to agricultural and rural development projects, and the balance to transportation, industry, water supply and sewerage, tourism infrastructure, education, municipal development, and pre-investment. The IDB and the Bank have coordinated their sssistance on several projects. Each has made loans for the national integrated rural development program (PIDER), agricultural and livestock credtt, small- and medium-scale industries development, and hotel development projects. The International Fund for Agricultural Development (IFAD) has approved a loan of US$22 million for a rural development project in the state of Oaxaca which was appraised by the Bank's staff and for which the Bank is acting as cooperating institution for administering the loan. 31. Bank-supported power, steel, fertilizer and tourism projects in Mexico have been co-financed by several bilateral export credit agencies and commercial banks. In January 1982, Mexico borrowed US$500 million from commercial banks to provide complementary financing for Bank-assisted projects where project specific co-financing would have been difficult.  - 10 - PART III - THE TECHNICAL TRAINING SECTOR 32. Although unemployment has been officially estimated at about 14Z for 1984, the high unemployment rate coexists with manpower shortages of skilled workers and technicians (para. 39). 33. The implementation of policies to address structural problems identified in the NDP (paras. 14 and 15) would create an accelerated demand for skilled workers and technicians that far exceeds current outputs from the training system. The magnitude and momentum of this demand far exceeds overall employment target rates because of shifting sectoral labor require- ments and the great differences in the proportions of skilled workers and technicians required by each sector. The Education and Training System 34. The general education and training system in Mexico is well developed. It consists of primary, middle and higher levels, and has good coverage, fairly good efficiency and generally achieves its goals. At the primary level (grades 1-6), the net enrollment rate was 97% in 1980 and reached about 100% in 1984. Total enrollment was 15.4 million students in 1984. Internal efficiency, the ratio of current output to maximum possible output, has improved from less than 60% in 1971 to almost 81% in 1984. A free textbook program is well developed. About 83.4 million textbooks and 844,000 guides for teachers were distributed during 1983. Virtually all teachers are properly trained. Middle level education comprises a lower- and an upper-middle level. At the lower-middle level (grades 7-9), first year entrants in 1984 constituted 87.8% of all graduates from the primary level in 19B3. Enrollments at this level were 4.1 million in 1984, an increase of about 2.5 million students since 1974. Internal efficiency has remained high, reaching 95% in 1984. The upper-middle level (grades 10-12) provides the link between lower-middle and higher education, as well as between lower-middle and the labor force; as such it is responsible for supplying the training necessary to produce future qualified workers and middle level technicians. This latter function has traditionally been difficult to achieve, despite several attempts at reform during the past 20 years. Higher education (grades 13-17) received more than 308,000 first year students in 1984, or 91% of those who completed non-technical upper secondary education the previous term. Higher education includes several public and private universities of high quality. Enrollment in science and technological subjects accounts for 62% of all students at this level, including those enrolled in medical sciences. This proportion represents a reasonable balance. 35. The sector is reasonably financed. In 1983, federal expenditures on education and training amounted Lo Mex$488 billion (US$4.06 billion). State governments and the private sector also spent significant amounts on education, bringing total education expenditures to about 4.2% of GDP in 1983. Although rather low compared to other middle income countries, and representing a decrease since 1979, this figure is deemed adequate consider- ing current fiscal circumstances. Funding for terminal technical training  - 11 - (para. 37) has almost doubled in real terms in four years, from about US$43 million in 1980 to about US$79.9 million in 1983, indicating the high priority assigned by the Government to this area. Upper-Middle Level Technical Training 36. Upper-middle level technical training enrolls 1.8 million students in more than 3,800 schools in the following four major categories of education or training: academic, teacher training, dual-purpose technical and terminal technical. Each category includes several types of schools. At this level, there are serious problems of training sufficient numbers of high quality skilled workers and technicians. The dual-purpose technical schools were a first attempt to train skilled workers by providing a practical outlet to the labor force. They have not, however, been effective in this respect; out of a total of 83,300 graduates from dual-purpose technical programs in 1984, only about 6,700, or 8%, entered the labor force. The Centers for Technological Studies (CETs) constituted another attempt to direct sufficient numbers of trained students into the labor force but have been similarly unsuccessful. A large majority of graduates continued their education. 37. Terminal Technical Training. The terminal technical training program of the upper-middle level consists of: the CETs; the National Agency for Professional Technical Education (CONALEP); and three other minor programs. Current enrollments in terminal training are 316,000 students. The effectiveness of these terminal technical training programs has improved substantially with the creation of the CONALEP system in 1978. However, the annual contribution of these programs to the labor force is still not as effective as it should be. Out of a total of 50,700 graduates in 1984, only 22,100, or 44%, entered the labor force. While approximately 97% of CONALEP's graduates entered the work force during this period, only about 15% of graduates from other -terminal" programs entered the labor force in 1984. Nevertheless, this represents an improvement over 1978 when only 5% of the graduates entered the labor force. Subsector Issues 38. The technical training subsector still has serious problems, including insufficient quantity of skilled workers and technicians and inadequate quality of training. 39. Insufficient Quantity of Skilled Workers and Technicians. The total need for additional skilled workers and technicians is estimated at 1,050,000 for the period 1980-90 plus replacement needs in excess of 200,000; total estimated output during the same period based on current trends is a maximum of 400,000 graduates, resulting in a shortfall of about 850,000 graduates. The major factors contributing to this shortfall are: insufficient training opportunities in general, exacerbated by serious  - 12 - regional imbalances; low efficiency and completion rates in terminal training programs (about 40% for non-CONALEP programs in 1983) due primarily to the poor quality and consequent lack of prestige of such programs; and, low proportion of graduates joining the labor force from the dual purpose technical training schools and even from most CETs and other "terminal" programs (paras. 36 and 37). 40. Inadequate Quality of Training. Technical training received in programs other than CONALEP is inadequate for both skilled workers and technicians in terms of application of practical skills to productive activi- ties. These inadequacies result from: a lack of qualified teachers with industrial experience; curricula, course content and basic instructional materials which are frequently irrelevant to the productive sectors due to lack of formal links with industry both during curricula development and periodic revision; lack of appropriate training equipment, because of financial constraints, lack of consultation with industry or academic biases of instructional staff; and scarcity of consumable supplies and audio visual materials. Subsector Achievements 41. Despite the significant deficiencies existing in upper-middle level technical training, tremendous achievements have been made during the 1980-84 period. With the creation of CONALEP, the proportion of graduates from terminal technical training programs entering the labor force increased significantly (para. 37). With Bank assistance (para. 45), the CONALEP system which had no schools in operation in 1980, now has 122 new and well-equipped schools located throughout the country, with an enrollment capacity of about 110,000 students. CONALEP has initiated close ties with industry, has sound advisory boards, and has initiated a job placement and follow-up system. The CONALEP schools are prestigious and are in strong demand because they are generally well staffed with industrially experienced instructors. Moreover, the success of the CONALEP system has had a positive effect on other technical training programs under the Ministry of Education as was intended. The Government has assigned to CONALEP the leading role in expanding and improving the sector; it is expected that at least the most recent CETs would emulate this example, whereas other programs, whtich have proven to be unresponsive, are being converted into regular academic programs. The National Agency for Professional Technical Education (CONALEP) 42. CONALEP was created in 1978 as an independent agency responsible for upper-middle level terminal technical training. Because of the difficul- ties involved in the creation of a new training system, it was conceived as a two-phase effort. The first phase of the CONALEP program (1979-84) which involved creating the program, testing its major components and initiating its development was supported by Bank Loan No. 2042-ME signed on July 31,  - 13 - 1981 (para. 45). Phase II of the CONALEP program (1985-88) consists of further increasing the capacity of the CONALEP system and making necessary adjustments in institutional, administrative and training aspects of the program. 43. CONALEP differs from other upper-middle level technioal training programs in that: (a) it is semi-autonomous, which facilitates flexibility and responsiveness to the changing needs and the participation of the produc- tive sectors; (b) its administration is decentralized, which facilitates delegation of operational decisions to local training authorities and industrial advisory boards; (c) its curriculum has a practical orientation and strong emphasis upon evaluation, 'hands-on experience, follow-up and feedback; (d) its training programs, both regular and part-time, are strictly terminal and job market oriented; (e) its unique student promotion activities enhance the program's public image and encourage active support from the productive sectors; (f) students pay a tuition proportio.al to their training costs and have a supplementary tuition loan program available; and (g) its technical instructors are from industry, they teach part-time (10-14 hours/ week generally) and cannot belong to the Teachers' Union. 44. Program Objectives. The CONALEP training program objectives are: (a) to expand the output of skilled workers and technicians by creating a large network of upper-middle level terminal training centers in close cooperation with the productive sectors and in the quantities required by the economy; (b) to improve the quali.y of training by emphasizing a practical curriculum, which maintains its relevance to changing regional and sectoral needs; Cc) to increase the efficiency of such training by enhancing its public image, achieving higher retention rates and decentralizing training opportunities; and (d) to upgrade the quality of the existing workforce, by designing special programs and using CONALEP's facilities for the training of both employed and unemployed adults. Previous Bank Experience 45. The proposed project would be the second Bank operation in the sector. The first operation, the Technical Training Project (FY82), for which Bank financing of US$90 million equivalent was provided by Bank Loan 2042-ME signed on July 31, 1981, supported the first phase of CONALEP's development program. The first phase program (1980-84) comprised: (a) constructing a central administrative and support complex to establish a firm base for the effective management of the system; (b) constructing, furnishing and equipping 122 training centers throughout the country with an enrollment capacity of 110,000 students; and (c) recruiting and training 9200 instructors. CONALEP's first phase program has been very successful and will be fully implemented by June 30, 1985. In addition, education oriented components have been included in projects in other sectors and experience has generally been favorable.  - 14 - PART IV - THE PROJECT 46. A Staff Appraisal Report (No. 5499-ME, dated April 29, 1985) is being distributed separately. The proposed project was appraised in November 1984. Annex III contains a timetable of key events in processing the project and a description of the special conditions of the proposed loan. Negotia- tions for the proposed loan took place in Washington, D.C. on April 10-25, 1985. The Mexican delegation was headed by Lic. Luis Nava of NAFINSA, and included representatives from the Ministry of Finance and Public Credit and CONALEP. Project Objectives and Description 47. The proposed project would assist CONALEP in implementing its second phase program (1985-88). The second phase program contemplates constructing, furnishing and equipping about 97 training centers with an additional enrollment capacity of 90,000 students. This would require an additional 7,500 trained instructors. The specific project objectives are to: (a) improve the operational efficiency and effectiveness of CONALEP; (b) increase the supply of skilled workers and technicians by expanding CONALEP's training capacity; (c) improve the quality of CONALEP's instruction; (d) develop an adequate maintenance system and explore other cost reduction measures; and (e) provide flexible support for the program as a whole by facilitating the development of strategic training options and institution building. 48. The proposed project, in supporting the second phase of CONALEP's development program, would provide technical assistance to achieve the above objectives, support the creation of 24 pilot production units and assist in the development of about 97 Phase II institutions which are to be fully operational by October 1990. The Implementing Agency 49. Administration. CONALEP is administered at both central and local levels. At the central level, the Board of Governors, comprised of seven business and industrial leaders appointed by the Minister of Education to serve staggered terms, determines policy. The President appoints the Director General of CONALEP, who chairs the Board for a maximum of two four- year terms. The Director General is the chief administrative officer and is assisted by eight departmental directors in charge of planning, academic operations and teacher training, buildings and equipment, evaluation and certification, administration and finance, legal affairs, promotion and external relations, and equipment procurement. At the local level, a director, assisted by coordinators of training programs and administrative services, heads each technical training center. A committee comprised of local and regional business and industry personnel, instructors and students, advises the director on training matters. 50. The CONALEP program is publicized through an effective promotional campaign directed to business, industry, parents and potential students. The campaign emphasizes the important role of skilled workers and technicians in  - 15 - economic and social development, and describes the CONALEP training program (including details of selected courses), employment opportunities, the job placement system and enrollment procedures. The large number of students admitted to the program as a result of this campaign (estimated at 80% of students admitted), as well as the amount of assistance CONALEP receives from industry, is an indication of the campaign's success. 51. Training Programs and Enrollments. CONALEP has developed 97 regular training programs primarily for the manufacturing and service sectors. These programs, which have a duration of three years, are carried out in centers located throughout the country. The enrollment capacity, programs of study, and location of centers were determined on the basis of national, regional and local development plans and well-designed criteria. Enrollment is open to qualified students who have completed grade nine. Regular training programs operate in two daily shifts of six hours each for five days per week. In addition, an upgrading program is open to employed youths and adults who have at least six years of basic education. Current enrollment capacity for regular and upgrading programs, both day and evening shifts, totals about 110,000 students in the following broad fields: Agriculture and Food Processing, Industry and Construction, Fisheries, Services, and Health. 52. Curricula. Experienced subject matters specialists, assisted by specialists from business and industry develop all curricula and course syllabi. In addition to the training programs for regular students (para. 51) there are 82 training programs for upgrading the existing workforce. Instructors and advisory members from local industry adapt the basic course syllabi to regional requirements. CONALEP's courses of study are heavily oriented toward practical experience; on average 60% of student time is devoted to technical practice; and 20% each to technical and general theory. 53. Instructor Characteristics and Preparation. Experienced and fully qualified instructors teach all general subjects. Technicians and engineers are recruited on a part-time basis to teach technical theory and technical practice. Local industry cooperates by making industrially qualified instructors available. Preparation of these instructors is carried out by CONALEP through its own teacher training unit, comprised of qualified and experienced professional teacher trainers, assisted by qualified part-time trainers. 54. The instructor training program consists of preservice courses and ad-hoc inservice caurses, and in special instances programmed learning courses by correspondence. The preservice courses are conducted in CONALEP's central facilities, or at the regional level, in local training centers, and consist of 56 hours of pedagogical preparation, including 14 hours of practice teaching. The minimum inservice training consists of 64 hours of human relations, instructional methodology, modular curriculum preparation, and shop work organization and management. Additional inservice course work is provided for upgrading specialized technical skills. The curricula and course syllabi for instructor training courses are well developed according to modern pedagogical practice. The 122 training centers fully or partially  - 16 - operational in 1984-85 employed about 9200 instructors. About 1500 instructors will be trained for the 1985-86 school year. 55. Operational Performance Evaluation. Student and instructor evalua- tion and feedback are joint functions of the local training centers and the National Directorate of Evaluation and Certification. This directorate has a well-qualified staff consisting of 22 professionals and adequate numbers of support personnel. It has developed a series of well-designed and executed instruments for evaluating instructor and student performance. New students are regularly tested, and undergo four weeks of remedial studies, if warranted. This pre-enrollment evaluation has had a significant effect in reducing the high rate of dropouts in the early years of CONALEP. The directorate assists the local centers in the proper use and evaluation of these instruments and in the feedback of relevant information into the curricula and the teacher-learning process. This information assists the local instructors and the national level subject matter specialists to improve curricula, course syllabi and overall performance. 56. Placement and Follow-up of Graduates. Each training center, with the assistance of its local industrial advisory committee is responsible for job placement and for assessing the relevance of training as measured by job performance. The local advisory committees are expected to diligently pursue the development of a strong placement and follow-up system. The National Directorate of Evaluation and Certification provides advice and necessary instruments for the systematic evaluation of graduate placement and performance. 57. Financing. The allocation of the Federal Government to the CONALEP program during 1984 was Mex$11,000 million (US$63.6 million) or about 1.6% of the total budget of the Ministry of Education and Culture. In addition to federal funds, CONALEP is empowered to receive funds from the productive sectors. Total contributions and contracts from 1979 to 1984 have amounted to approximately Mex$655 million (US$4.8 million) at 1984 prices, and were mostly in-kind donations of land, rent-free or donated buildings and equip- ment. CONALEP's students pay tuition and may commit themselves to a deferred payment plan upon graduation and employment. Student revenues amounted to about Mex$510 million (about US$3.0 million) in 1984. The National Directorate of Financing and Administration is currently reviewing CONALEP's long-term policy regarding tuition fees. 58. Unit costs were US$876 per student in 1984, and are estimated to be US$823 per student in 1985. The recurrent unit costs for other upper-middle level technical training programs In 1983 ranged from US$650 to US$1,250 per student year. 59. The CONALEP program appropriately addresses the issues of the sub- sector, is well designed and is being rapidly implemented. Among its more important strengths are: (a) a well organized and staffed administration; (b) the practical orientation of its curriculum, which is terminal in nature; (c) the use of industrially experienced and pedagogically qualified instructors; and (d) a highly successful promotional program. However, there are some deficiencies and weaknesses which must be addressed to achieve the goals of its development. The main goal is to increase the output of skilled  - 17 - workers and technicians to levels more in line with the country's needs. In order to achieve this goal, CONALEP will have to: (a) improve student retention rates, currently 48.4X; (b) nearly double its training capacity to respond to demand for skilled workers and technicians; (c) make plans to avoid potential instructor shortages during peak production hours; (d) establish systems for maintenance and other cost-reduction alteriativeR; and (e) adequately equip all CONALEP training centers to eliminate the artificial distinction of project and -non-project centers - the latter of which are ill-equipped. Improving Operational Efficiency and Effectiveness 60. Central and Local Administration. CONALEP's central administrative system has demonstrated proficiency in project planning and implementation (para. 49). However, in view of expansion plans which would involve a near doubling of present capacity and the problems inherent in -oordinating such a large training system, the project would finance the costs of specialist assistance and short study tours for staff to observe, study and participate in administrative and industrial advisory activities applicable to the CONALEP system. The project would also finance a variety of management training activities aimed at strengthening the administrative abilities of key local administrators. 61. Integrated Approach. CONALEP should strengthen its incipient system of placement and follow-up for graduates by actively maintaining its contacts with local industries and employers. The project would finance specialists' assistance for the analysis of options and the marginal costs of strengthening the system of placement and follow-up for graduates (para. 56). Increasing the Output of Skilled Workers and Technicians 62. Technical Training Centers. The project, which would enable CONALEP to meet the targets set by the Government for its second phase program, includes the construction, furnishing and equipping of about 97 training centers. The training centers would be distributed among the 31 states and the Federal District. When the centers are fully operational in 1990-91, enrollment and output by major fields of study in the 97 centers would be as follows: Major Field of Study Enrollment Annual Output (Students) (graduates) Regular Upgraded Agriculture 4,950 1,180 900 Fisheries 1,080 260 200 Services 37,800 9,080 6,800 Industrial 41,940 10,060 7,520 Health 4,230 1,000 760 TOTAL 90,000 21,580 16,180  - 18 - It is expected that women will occupy about 30% of the training places. Curricula and course syllabi are complete for all new centers and would be basically the same as those used for the first phase program (para. 52). Improving the Quality of Instruction and the Instructor Training Program 63. Instructor Training Program. When fully operational in 1990-91, the new training centers would require the equivalent of an additional 7,500 full time instructors. CONALEP is continuing to expand its instructor train- ing programs, recruitment procedures and instructor services (paras. 53 and 54). The project would provide specialists' assistance for further revising instructor training materials and to upgrade recruitment procedures and instructor services. 64. Pilot Production Units. The project would provide initial financial support to create revolving funds for the initial purchase of production materials and supplies for about 24 pilot "production units" within selected training centers and programs. The funds would be allocated to programs such as meat processing, textiles, metal machining, welding, cabinet making, foundry and hot metal working and other training programs where the cost of consumable supplies is high. These production units would emphasize the production of marketable items to be sold to industry or individuals under prearranged contracts. The full costs of materials, energy and non-labor costs would therefore be recaptured to sustain the program. This "production unit" approach, which has proven successful in many training institutions, is expected to improve student motivation, enhance student retention and reduce training costs financed from the regular budget. The project would provide technical assistance to CONALEP for carrying out several feasibility studies for the selection of pilot production units (para. 66). Development of a Maintenance System and Other Efficiency Measures 65. Maintenance. The project would support the development of a build- ing and equipment maintenance system which would include: (a) a method for verifying that proper maintenance records are being kept in each training center; (b) a set of procedures to follow when equipment breaks down, includ- ing repair and temporary replacement policies; and (c) policies for spare parts inventory control. During negotiations of the proposed loan, agreement was reached that a provisional system for the maintenance of buildings and equipment would be implemented by September 30, 1985. Based on experience with the provisional system, a definitive system would be forwarded to the Bank for review by December 31, 1986 and put into effect not later than March 31, 1937 (Section 2.03 of the draft Project Agreement). 66. Efficiency Measures. The project would provide technical assis- tance for studying and/or implementing cost reduction measures such as: (a) reducing local adminiscrative costs by increasing the size of the smaller training centers, where justified by local need; (b) finding administrative means to effect cost reductions in the fixed commitments of small centers where scale cannot be increased; and (c) initiating practical production activities in selected centers and programs where sales by "production units" (para. 64) could ease the financial burden of providing consumable supplies.  - 19 - Overall Institutional Support 67. Criteria for the Creation of New Centers. With Bank assistance, CONALEP has been refining the eligibility criteria for the creation of future training institutions and has developed guidelines for the allocation of equipment funds. New centers have been selected concurrently with the development of these refinements and they would be established on the basis of economic need (economic demand and gainful employment), feasibility (social demand and geographical distribution and instructor availability) and economic efficiency (economic size, minimum class size and other efficiency alternatives). These criteria, which include certain revisions and clarifi- cations of those used in Phase I, are reasonable and acceptable to the Bank. The expansion of existing training centers and the location of new training centers financed under the project would be in accordance with the revised and agreed upon criteria (Section 2.03 of the draft Project Agreement). Furthermore, CONALEP, with specialists' assistance would develop a draft transitional program for identifying existing centers that are too small or otherwise do not meet the revised criteria and actions to be taken to correct existing deficiencies. The draft plan would be presented to the Bank for review and comment by December 31, 1985 and necessary adjustments would be implemented during the years 1986 through 1988 (Section 2.03 of the draft Project Agreement). 68. Strategic Training Options. The project would provide consultants' services for the creation of an outreach training system for the development of strategic training alternatives with sufficient flexibility to meet short- and medium-term local and regional needs, particularly those of smaller communities. Among the alternatives to be studied are: (a) 'feeder training centers" offering core first and second year curricula; (b) a system for rotation of programs and equipment from centers where they no longer match employment needs; (c) cooperative training programs with local industry in those specializations requiring excessively costly equipment and/or consumable supplies; and (d) a system for transporting students among three or four nearby municipalities to increase efficiency of facilities. Project Cost and Financing 69. Capital Costs. Total project costs are estimated to be US$162.2 million, of which US$82.8 is in foreign exchange. Project costs include about US$9.3 million of sunk costs, representing civil works prior to January 1, 1985. Project costs include physical contingencies equal to 5% of base costs on construction (after January 1, 1985), furniture, equipment, produc- tion supplies and technical assistance. Price contingencies have been estimated at 20% for construction (excluding sunk costs), 9% for equipment, 18% for furniture and 13% for technical assistance. Total contingencies are estimated at about 19% of base costs and 16% of total costs. The proposed loan of US$81.0 million would finance about 53% of project cost (excluding sunk costs), equivalent to the estimated foreign exchange cost. The Govern- ment would finance the balance of project cost. CONALEP also receives contributions from the productive sector; such contributions have not been considered in project costs because they are mostly in-kind donations such as land, rent-free buildings and second hand equipment (para. 57).  - 20 - 70. The proposed Loan would be made to Nacional Financiera, S.A. (NAFINSA), a Government agency designated to borrow from the Bank, at standard terms for Mexico. NAFINSA would, through contractual arrangements satisfactory to the Bank (condition of effectiveness), transfer loan funds to CONALEP for the carrying out of the project (Sections 3.01 and 6.01 of the draft Loan Agreement and Section 2.04 of the draft Project Agreement). NAPINSA would repay the principal amount of the Bank loan together with interest and other charges. Up to US$7.0 million ,f the Bank loan would be made available as retroactive financing for equipment and technical assis- tance expenditures after January 1, 1985. 71. Recurrent Costs. When fully operational in 1990-91, the recurrent costs of the project are estimated in constant 1985 pesos at Mex$19,730 mil- lion (US$96.3 million). CONALEPs future operating budget represents about 1.8Z of projected federal recurrent expenditures for education and culture in 1990. CONALEP's current recurrent expenditures are 1.6Z of the federal budget for education and culture. In view of the high pr..ority given to the proposed program and the Government's strong commitment to expanding output of technical labor, it is expected that those expenditures will be met. Procurement 72. Civil works would total US$60.1 million, excluding contingencies. Works would be spread over about 97 sites in the 31 states and the Federal District. None of the individual construction contract costs would be great enough to attract foreign bidders. Therefore, construction contracts would be awarded through local competitive bidding (LCB) procedures which have been reviewed and are acceptable to the Bank. Mexico's construction industry is highly developed and capable of executing works at costs competitive with international bidders. 73. Equipment purchases under the project would total about US$71.9 million (base cost). Equipment contracts exceeding US$600,000, representing approximately 30Z of the total value of equipment procured under ICB, would be subject to the Bank's prior review. Where feasible, contracts for equip- ment would be in packages of at least US$300,000 and would be procured through international competitive bidding (ICB). However, up to US$20 mil- lion of equipment would be procured in packages of US$40,000-300,000 in accordance with LCB procedures acceptable to the Bank. Up to US$4.0 million of equipment, in packages smaller than US$40,000, would be procured through local shopping. Furniture costing about US$4.8 million (base cost) would be procured through LCB procedures which were reviewed and are acceptable to the Bank. Supplies for the production units would be mostly procured through LCB procedures acceptable to the Bank. However, small groups of items costing less than US$30,000, and not exceeding in the aggregate US$250,000 would be procured through local shopping (Schedule of the draft Project Agreement). Terms of reference for consultants' contracts exceeding US$100,000 would be submitted for the Bank's prior review and approval (Schedule I of the draft Loan Agreement). Disbursements 74. In line wi1 experience under the first project, the loan is expected to be disbursed over a four and one half year period. To facilitate  - 21 - administration, disbursements would be concentrated on a few components of the project. The Bank would disburse 100% of foreign expenditures, 100X of local expenditures (ex-factory costs) and 85% of local expenditures for off-the-shelf purchases for equipment (including installation), production materials and supplies. In addition, the Bank would disburse against 100% of expenditures for technical assistance for specialists in adm'nistration, management training, and training materials, and feasibility studies for production un'ts, cost-reduction measures and outreach programs (Schedule 1 of the draft Loan Agreement). To accelerate disbursements, NAFINSA would establish and maintain under its control a Special Account, with an initial deposit of US$8.0 million, which would be operated in accordance with terms and conditions satisfactory to the Bank (Section 2.02 and Schedule I of the draft Loan Agreement). NAFINSA would make disbursements from the Special Account against requests submitted by CONALEP to pay eligible expenditures, and would subsequently forward withdrawal applications to the Bank for replenishment of the Special Account. Project Implementation 75. Coordination, implementation, supervision and monitoring of the project would be the responsibility of the administrative directorates of CONALEP. Actual construction of training centers would be the responsibility of the Administrative Committee of Federal Programs for School Construction (CAPFCE), a semi-autonomous agency responsible for all school building construction, in coordination with CONALEP. The project is expected to be completed by June 30, 1989. The closing date would be December 31, 1989. Accounts and Auditing 76. An agreement was obtained during negotiations that CONALEP would maintain accounts to reflect the operations, resources and expenditures of the project. The independent auditors' reports of CONALEP's accounts and of the Special Account would be submitted to the Bank no later than six months after the close of each fiscal year (Section 4.01 of the draft Project Agree- ment and Section 4.01 of the draft Loan Agreement). Project Justification 77. Bank assistance to CONALEP would support Government efforts in resuming economic and social growth by expanding employment, improving the living standards of a large segment of the population, and promoting essential structural industrial reforms. The project would support a balanced regional distribution of these efforts through the expansion of technical and vocational training opportunities to less developed regions of the country. Furthermore, the proposed project would ensure Bank involvement in improving the overall management efficiency of the institution during a critical expansion phase. Finally, the proposed project would provide foreign exchange necessary for the institution to maintain a well defined and effective training policy.  - 22 - Project Benefits 78. The proposed project would greatly strengthen technical training at the middle level. The project would: (a) contribute to the further institutional development of CONALEP; (b) enhance the overall quality of training; and (c) increase the output of skilled workers and technicians. In addition, WONALEP's success would have a beneficial demonstration effect on the quality and effectiveness and, hence, eventually on the prestige of the other upper-middle level technical training programs. 79. The major quantifiable benefits of the project, when fully operational in 1990-91 would be an annual increase of about: (a) 21,580 skilled workers and technicians; (b) 1,500 technical teachers; and (c) highly specialized skills upgrading for about 16,180 employed workers and technicians. Assuming that CONALEP and other technical training programs could increase their annual output to a total of about 75,000 skilled workers and technicians by 1990, these graduates would represeit only about 8% of the new job seekers (2.6% technicians, 5.4% skilled workers). Upgrading of the labor force would still require the support of other programs. Project Risks 80. The major risks are difficulties in recruiting part-time instructors during peak production hours and retention of students. The ability of CONALEP to pay competitive salaries should diminish the problem of teacher recruitment. A favorable student-teacher ratio and well-equipped facilities which result in a practical application to course-work should diminish the risk of student retention. The risk of expected benefits of the production units not materializing is more than offset by CONALEP's proven capacity for implementing innovations. Further, the project would provide for the financing of feasibility studies prior to establishing the production units. Overall, considering CONALEP's capacity for monitoring and implementing the program, as demonstrated under the previous project (para. 45), the risks are acceptable. PART V - LEGAL IF TRUMENTS AND AUTHORITY 81. The draft Loan Agreement between the Bank and Nacional Financiera, S.A., the draft Guarantee Agreement between United Mexican States and the Bank, the draft Project Agreement between the Bank and Colegio Nacional de Educacion Profesional Tecnica and the Report of the Committee provided for in Article III, Section 4(iii) of the Articles of Agreement are being distributed to the Executive Directors separately. Special conditions of effectiveness and other covenants of the project are listed in Section III of Annex III. 82. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank.  - 23 - PART VI - RECOMHENDATION 83. I recommend that the Executive Directors approve the proposed loan. A. W. Clausen President Attachments May 1, 1985  - 24 - ANEX I T A IILS 9 3h Page 1 of 5 NERICO - SOCIAL INDCATOR8 DATA SEET ICRO RR cGROUPS (EIGHTED AVERAGE) /a MOST ( lSR30W ESTZHTI) /b RLECEST NICODL R t EDItxDLE r1CoN itiaLk l9mlO ISTTxATzIkb LAT. AMRt50 8 CA EUROPE AM (T3I0LA SQ. R) TOTAL 1972.5 1972.5 1972.5 ACRICULTURAL 953.2 976.4 979.5 GN PR CuAITA (U1f) 360.0 130.0 2270.0 I2OB.6 2345.1 sm au_sIFITON P CAPXTA (KILOGRAMS OF OIL EQUIVALENT3 539.0 773.0 1340.' 9S.5 1122.6 PnwILAUD D 9SITAlL STATISTC * POULATION.HIDYKAR (THOUSANDS) 17073.0 51176.0 73122.0 URWAN poPULATlON CZ OF TOTAL) 50.8 59.0 68.0 66.5 46.6 POPULATION PRoJECTIONS POPULATION IN YE 2000 (HILL) 109.4 STArIONARY POPULATION (HILL) 19.5 POPULATION IHENTIRE 1.9 POPULATION DENSITY PER SQ. a. 13.3 25.9 36.1 33.7 32.9 PER SQ. IQI. AII. LAND 37.7 52.4 12.8 92.4 158.9 POPULATION AGE STRUCTURE (X) 0-It. IRS 45.6 46.5 44.1 39.9 31.6 15-61 VRS 51.0 50.0 52.2 56.0 61.1 65 AND AIIOYE 3.4 3.5 3.4 4.1 7.1 POPULATION GROWTH RATE (I) TOTAL 3.0 3.2 3.0 2.4 1.6 URN ^4.a 4.7 4.2 3.6 3.7 CRUDE BIRTH RATE (PER THOUS) 45.4 43.4 33.9 31.3 23.4 CRUDE DEArH SATE IPER THOUS) 11.1 9.7 7.1 S.1 8.8 GROSS REPEOOUCTtON RATE 3.3 3.2 2.2 2.0 1.6 FAMELY PLANNING ACCEPTORS. ANNUAL (THOUS) .. 25.1 1145.0 Ic USERS (2 OF HARRIED WIEN) .. .. 39.0 7ir