Docnment of The World Bank FOR OFFICIAL USE ONLY Repoit No. P-5254-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 USt380 MILLION TO BANCO NACIONAL DE OBRAS Y SERVICIOS PUBLICOS, S.N.C. (BANOBRAS) WITH THE GUARANTEE OF THE UNITED MEXICAN STATES FOR A ROAD TRANSPORT AND TELECOMMUNICATIONS SECTOR ADJUSTMENT PROJECT MAY 3, 1990 This document has a restricted distribution and may be used by recipients only In the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. CURRENCY EQUIVALENTS Currency unit - Mexican peso (tMex$) On March 30, 1990 the exchanige rates stood at: tlS$1 - MEX$ 2,719 (Controlled market) US$1 = MEX$ 2,759 (Free market) The controlled exchange rate' is currently being devalued by one peso a day. FISC4L YEAR January 1 - December 31 WEIGH3TS AND MEASURES 1 kilometer (km) = 0.62 miles (mi) 1 ton (t) = 1.000 kilograms (kg) = 2.205 pounds (lb) 1 liter (1) = 0.26 gallons (gal) PRINCIPAL ABBREVIATIONS AND ACRONYMS USED BANOBRAS = Banco Nacional de Obras y Servicios Publicos (Governmenit owned development bank) DFI = Direct Foreign Investment FHN Federal Highway Network GATT = General Agreement on Tariffs and Trade 1CB = International Competitive Bidding IDB 5 Inter-American Development Bank MULTIMODAL A semi public company for transportation of containers NDP National Development Program, 1989 - 1994 PACTO Evonomic Solidarity Pact PECE = Pact for Stabilization and Growth PEMEX PetrOleos Mexicanos (Government-owned National Oil Company) SCT = Secretaria de Comunicaciones y fransporte (Secretariat of Communications and Transport) SEDUE = Secretaria de Desarrolle Urbano y Ecologia (Secretariat of Urban Development and Ecology) SHCP = Secretaria de Hacienda y Credito Publico (Secretariat of Finance) SPP Secretaria de Programacion y Presupuesto (Secretariat of Planning and Budgeting) TELMEX = Tel4fonos de Mexico S.A. de C.V. (Mexico's telephone company, 512 publicly owned) TELECOMM = Telecomunicaciones de MOxico (A decentralized state entity responsible for the basic transmissiotn network and telex and telegraph services) FOR OMCL41 USE ONL'k MEXICO TABLE OF CONTENTS Page LOAN AND PROGRAM SUMMARY . . . . . . . . . . . . . . . . . . . . . i -ii INTRODUCTION . ................. .. ....... 1 PART I -THE ECONOMY .... . . . . . . . . . . . . . ... 3 A. Background . . . . . . . . . . . . . . . . . . . . . 3 B. Macroeconemic Stabilization . . . . . . . . . . . . 3 C. Rationalized Private Sector Incentives . . . . . . . 5 D. Reorientation of Public Spending . . . . . . . . . . 6 E. External Debt Reduction Agreement . . . . . . . . . 7 F. Macroeconomic Projection 8 PART II - SECTORAL CONTEXT .... . . . . . . . . . . . . . 10 A. Introduction .... . . . . . . . . . . . . . . . 10 B. Road Transport . . . . . . . . . . . . . . . . . . . 11 Trucking Entry Restrictions . . . . . . . . . . . . 12 The Government Program to Eliminate Trucking Entry Restrictions . . . . . . . . . . . . . . . . . 14 Official Trucking Tariffs . . . . . . . . . . . . . 16 Automotive Industry . . . . . . . . . . . . . . . . 16 Highway Safety and Environment . . . . . . . . . . 17 Pricing, Cost Recovery and: Taxation . . . . . . . . 19 Road Maintenance and Efficiency . . . . . . . . . . 20 Re organization of SCT . . . . . . . . . . . . . . . 20 C. The Telecomunications Sector . . . . . . . . . . . . 21 The Mexican Telecommunications Sector . . . . . . . 21 Sector Issues .... . . . . . . . . . . . . . . . 22 The Goverunment's Telecommunications Program . . . 26 PART III - BANK STRATEGY .... . . . . . . . . . . . . . . 27 A. Government Strategy .... . . . . . . . . . . . . 27 B. Country Assistance Strategy . . . . . . . . . . . . 28 C. Bank Rationale for the Proposed Loan . . . . . . . . 29 D. Transportation .... . . . . . . . . . . . . . . . 30 E. Telecommunications ................ . 32 PART IV - THE PROPOSED LOAN . . . . . . . . . . . . . . . . . 34 A. Background . . . . . . . . . . . . . . . . . . . . . 34 B. Loan Objectives, Benefits and Risk3 . . . . . 34 C. The Borrower, the Guarantor and Project Implementation .... . . . . . . . . . 36 D. Disbursements, Procurement, Administration and Auditing .... . . . . . . . . . . . . . . . 36 E. Loan Effectiveness and Conditions of Tranche Release 37 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. PART V - BANK GROUP OPERATIONS . . . . . . . . . . . . . . . 38 A. Sectoral Composition of Bank Lending . . . . . . . . 38 Agriculture . . . . . . . . . . . . . . . . . . . . 38 Trade . . . . . . . . . . . . . . . . . . . . . . . 39 Industry and Finance . . . . . . . . . . . . . . . 39 Infrastructure and Energy . . . . . . . . . . . . . 39 Housing and Others . . . . . . . . . . . . . . . . 40 Social Sectors and Environment . . . . . . . . . . 40 B. IFC Operations . . . . . . . . . . . . . . . . . . . 41 PART VI - COLLABORATION WITH THE IMF . . . . . . . . . . . . 41 PART VII - RECOMMENDATION . . . . . . . . . . . . . . . . . . . 42 ANNEXES I. Mexico - Policy Matrix . . . . . . . . . . . . . . . . . . . 43 II. Mexico - Status of Bank and IFC Operations . . . . . . . . . 47 III. Mexico - Supplementary Loan Data Sheet . . . . . . . . . . . . 49 IV. Letter of Develnvpment Policy . . . . . . . . . . . . . . . . . 51 V. Economic Indicators . . . . . . . . . . . . . . . . . . . . . 54 MAP2 IBRD 22252 MEXICO ROAD TRANSPORT AND TELECOMMUNICATIONS SECTOR ADJUSTMENT LOAN LOAN AND PROGRAM SUMMARY Borrower: Banco Nacional de Obras y Servicios P(blicos, S.N.C. (BANOBRAS). Guarantor: United Mexican States. Beneficiary: United Mexican States. Amount: US$380 million equivalent. Terms: Repayable in 17 years, including 5 years of grace, at the standard variable interest rate. Obiective: The proposed loan is part of a program of Bank support to the Mexican Government's plans tco promote structural reforms so as to resume sustainable economic growth. The loan supports a comprehensive structural reform program in the road transport and telecommtuications sectors which will improve their efficiency benefitting all users and, in particular, firms which conduct trade related business, for which commtuication services are an important input. Description: The proposed loan supports a program of deregulation in the trucking sector, and a program of privatization and regulatory reform that will promote competition in the telecommunications ector. Pricing and taxation distortions in the two sectors are being eliminated, and the public sector institutions responsible for the oversight of the sectors are being restructured. The loan also includes measures to improve highway safety, and to monitor compliance by trucks with air pollution standards. Under a parallel loan, technical assistance would be provided to strengthen the public sector agency responsible for the formulation of telecommunications policy and for sector regulation. Benefits and Risks: By providing an appropriate institutional and regulatory framework, the proiect is expected to spur private investment and competition, thus serving to increase the efficiency of communications services and--in the case of telecommunications--to greatly expand its coverage. Resource allocation would be improved through greater reliance on market forces for pricing and by a realignment of the fiscal treatment of the sectors. A project-related - ii - risk relates to the Government's ability to fend off any internal political opposition to the terms or management of the deal for the privatization of the telephone company, TELMEX. Another risk is the lack of staff with experience in regulation and the chance of mistakes as a new regulatory framework for telecommunications is developed and put in place. On the macroeconomic front there is also a risk that the growth program may be put in jeopardy by declining oil prices, rising interest rates or protectionist trends in the trade policies of Mexico's major trading partners. Project related risks seem manageable, particularly since the significant upfront actions taken by the Government reflect a strong commitment to the reform process. The likelihood of derailment of the economic program is also felt to be small, given the success already achieved in economic stabilization, debt reduction and resumption of growth. In any case, the substantial conditionality of the Bank's adjustment loan portfolio provides for early warning signals on a worsening trend in domestic policy or in the country's external environment, and would thus enable the Bank to consider timely measures to protect its portfolio and longer term interests in Mexico. Disbursements: The proposed loan would be disbursed against eligible general imports in two tranches of US$190 million each. The first tranche of the loan would be available upon loan effectiveness. The second tranche would be released after November 15, 1990 upon fulfillment of specific conditions in all key areas supported under the loan and verification of the consistency of the macroeconomic policy framework. Disbursement of the loan is expected to be completed by June 30, 1991. Retroactive US$76 million would be made available for Financing: retroactive financing of eligible expenditures incurred from February 1, 1990. Rate of Return: Not applicable. Appraisal Report: This is a combined President's and Staff Appraisal Report. Schedule of Disbursements: US$ Million FY90 FY91 Annual Amount 190.0 190.0 Cumulative Amount 190.0 380.0 INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT RPJPoRT AnD RCIonation OF Tax FRSsIDzxT TO Th= =uETI DIRECTORS ON A PROPOSED ROAD TRANSPORT AND TELECOMMUNICATIONS SECTOR ADJUSTMENT LOAN TO BANCO RACIONAL DE OBRAS Y SERVICIOS PUBLICOS, S.N.C. INTRODUCTION 1. I submit the following report and recommendation on a proposed loan to Banco Nacional de Obras y Servicios Pdblicos, S.N.C. (BANOBRAS), for the equivalent of US$380 million in support of a progra. for road transport deregulation and of privatization and regulatory reform in telecommunications. The loan would have a term of 17 years, including five years of grace, at the standard variable interest rate. 2. In the latter years of the de La Madrid administration (1983- 1988) the roles assigned by Mexico to the public and private sectors underwent a significant change, which is being deepened further by the Salinas administration (1988-1993). The stratv-y of the seventies that relied on protectionism and public sector led L.owth has now been abandoned, and the Government has emba!ked on a wide ranging program of reforms that promotes competition and reduces public sector involvement in business activities. It has also divested itself of a large nuw:ber of public enterprises, while implementing policies to increase the efficiency of those still under public o-wnership, and has moved very far in the deregulation of trade, foreign it,vestment, the financial sector and industry, and on the elimination of subsidies. These reforms dd up to one of the most substantive and compiehensive programs of reorientation of economic policy towards zeliance on market fore that has been carried out in developing countries in recent years. 3. The Bank has supported these changes and has maintained a very close policy dialogue with the Government on these matters. In i-te 1989 three adjustment loans, for a total amount of $1.5 billion, were approved by the Board to support the Government's programs in the financial sector, public enterprise reform and industrial sector. The proposed operation is part of a follow-up stage of adjustment which focuses on sectors of strategic importance because of their linkages to most areas of economic activity. In addition to this project, the lending program also comprises operations to support deepening of reforms in trade, public sector enterprises, agriculture and, possibly, the financial sector. 4. The proposed project would seek to extend the process of adjustment to the transportation and telecommunications sectors by supporting policies that would improve their efficiency, benefitting all users and in particular firms which conduct trade related business, for which communication services are an important input through: - 2 - (a) changes to the regulatory framework: (i) by eliminating barriers to competition In road transportation, as there is evidence that such barriers have imposed heavy costs to the economy and have failed to achieve the objectives for which they had been designed, (ii) by defining the ruies for private sector participation in the telecommunications sector, promoting competition and safeguarding the interest of constumers in those areas where a private monopoly operation is warranted; (b) improving the allocation of investments by eliminating pricing distortions: (i) in road transportation, by allowing prices to be determined in the market and adjusting the price of competing modes to marginal costs, (ii) in telecommunications, by significantly reducing cross subsidies and introducing changes to the fiscal regime to align the tax treatment of the sector with the treatment now afforded to other economic activities; (c) sasisting the Government of Mexico to develop programs to attract private investment to the telecommunications sector, so as to achieve ambitious targets of sector growth and modernization; and (d) promoting complementary policy measures that would, in general, enhance the efficiency of road transportation and telecommunications services. In addition, through a parallel Technical Assistance Loan, the Bank would support the institutional development of the agency responsible for the regulation of telecommunications, so as to improve its capability to discharge its functions (which would be reformulated). 5. The measures outlined above fit well witb the development strategy of the Government of Mexico. As the success of Mexico's stabilization program progressively consolidates and the debt issue is being resolved, the priority of economic policy has shifted towards the attainment of sustainable growth. This objective, in the context of an economy that has been opened to external competition, will be assisted by the removal of barriers to efficiency in sectors, such as transportation and telecommunications, that play a vital supporting role to almost all business activities, particularly trade. Improved transportation and telecommunications should facilitate factor mobility, enhance competition and assist the development of new export activities. In addition, increased investment in these sectors, spurred by a framework more favorable to the private sector, will also contribute to economic growth. PART I - THE ECONOMY A. Background 6. Between 1950 and 1974, Itexico enjoyed a remarkable period of high gr&wth, low inflation and moderate external debt accumulation. Real growth averaged 6.4%, and inflation was in single digits throughout the period. This era of fiscal conservatism came to an abrupt end in the early seventies. Rapidly expanding government involvement in the economy pushed up the rate of economic growth. However, increasing government expenditure was not matched by rising public sector revenues. As a result. the inflation tax and external debt became increasingly important sources of finance. At the same time. a decline in private savings incentives (real interest rates turned sharply downward) prevented a matching increase in private savings, external debt thus increased, the increased oil revenues notwithstanding. The period of single digit inflation ended in 1973, the real exchange rate-' started to appreciate and the accumulation of external debt accelerated above the GNP growth rate. A serious, but comparatively brief, financial and economic crisis in 1976 termindted following major oil discoveries in 1977. The ensuing prosperity lasted until 1982, when soaring domestic inflation, falling international oil prices, rising world interest rates, and massive capital flight led to a refusal by external creditors to roll over Mexico's short-term debt and forced a subsequent suspension of payments of interest on the external debt. 7. Over the 1982-88 period, economic growth ground to a virtual halt, accompanied by sharply falling living standaris, deterioration of infrastructure, high inflation, and loss of investor confiden.ce. To reverse Mexico's declining fortunes the most important changes needed weres (a) macroeconomic stability, (b) a rationalized set of incentives for private sector investment, (c) a reallocation of public spending, both to shore up a crumbling infrastructure in support of private sector-led growth and to alleviate the impact of adjustment on the poor, and (d) a medium-term financing plan capable of removing the specter of an unsustainable overhang of debt. In each of these areas, the Mexican Government has achieved notable progress. B. Macroeconomic Stabilization 8. The onset of the financial and economic crisis of 1982 brought in its wake explosive inflationary and balance of payments difficulties whose effects had been largely repressed during the years leading up to the crisis. Initial strong fiscal and monetary adjustment efforts were alternately not sustained for a sufficiently long period (1983-85) or undermined by external shocks such as the collapse in international oil prices (1986). Inflation, rather than slowing down, accelerated, 1/ The raal exchange rate is defined as the price of foreign goods relative to domestic goods. Appreciation means a decline in this relative price. - 4 - partially in response to the sharp real devaluation of the exchange rate necessitated by the 1986 downturn in the terms of trade. The subsequent de facto targeting of the real exchange rate, together with an increase in the frequency of wage and cost adjustments, introduced an element of inherent instability into the system, culminating in a run on the peso in the last quarter of 1987 and triple-digit inflation. 9. The Government responded with the "Economic Solidarity Pact" (Pacto), an agreement between business, labor, and government which called for accelerated structural reform, further tightening of fiscal and monetary policy, a freeze of minimum wages and of the prices of basic public and private sector prices and, the cornerstone of the "Pacto", a freeze of the nominal exchange rate against the U.S. dollar. This partial freeze was extended at three-month intervals through the end of 1988, and renewed, with some modifications, by the new Mexican Administration under the name of 'PECE" (Pact for Stabilization and Growth) through March 1990. The main adjustments brought about under PECE were catch-up increases in selected public sector tariffs and in prices of key inputs, a two-stage 152 cumulative adjustment in the minimum wage, and a daily adjustment of the exchange rate of about one peso against the U.S. dollar. On December 1, 1989 fuel prices and some utility rates were increased, minimum (but not contractual) wages were raised by 102, and the 'PECE" was further extended to the end of June 1990. However, some further adjustment of public sector prices, including a major restructuring of the rates for telephone services (para. 63), took place during January 1990. 10. Performance under the "Pacto" and 'PECE" has been highly satisfactory. Mlxico has fully observed all of the adjusted performance criteria specified in its Extended Arrangement vjith the IMF for 1989 (excepting for fourth quarter targets on net domestic assets and net international reserves, for which waivers were granted) and obtained Fund approval for its 1990 macroeconomic program (para. 108). In trade, the Government had originally committed to a three-year program of reforms supported by the Bank. These reforms were designed inter alia to lower the maximum import tariff to 302 ad valorem by the end of 1988. ' In fact, during the first month of the Pacto, December 1987, the tariff was lowered to a 202 maximum, i.e., 10 percentage points lower than originally agreed and one year ahead of schedule. Such efforts were all the more noteworthy, given the negative budgetary impact of further declines in international oil prices and increasingly high real interest rates on foreign debt throughout much of 1988-89. The shift in exchange rate policy at the beginning of 1989 was instrumental in bringing about a small real depreciation of the peso during the first six months of the year, reversing a trend toward appreciation throughout much of 1988. 11. The fiscal measures, backed by the temporary exchange rate freeze and an array of formal and informal wage and price controls, have had a dramatic success in reducing the rate of inflation from 1592 in 1987 to about 202 in 1989. At the same time, the economy has shown encouraging signs of economic recovery, led by a strong resurgence of private investment, which increased by around 102 in real terms. In 1989, GDP is estimated to have grown by 2.92 in real terms, as manufacturing production rose substantially, while mining and agricultural output declined. During the fi-sc quarter of 1990 inflation rose beyond what had been planned. The s3sective liberalization of price controls on some intermediate and farm products, together with adjustments in public tariffs for gasoline, power, and water toward the end of 1989. led to this temporary resurgence of inflation. After rising to 3.8? in December and 4.8? in January, the rate of consumer price inflation receded to 1.8? in March and 0.8? during the first half of April. Thus, on the basis of current trends, inflation could return to a base level averaging around one percent monthly during the remainder of 1990. For the year, it is expected that inflation would range somewhere between 20? and 25Z. Financial investors have already responded positively, bidding down the rates on Treasury bills from 47? annually in January (up from 35? in mid-1989) to around 43? currently. There is also evidence that the merchandise trade deficit has been declining as import growth during the first quarter slowed to a ten percent annual rate (from nearly 18 percent in 1989), while exports growth improved. The Government also recently announced that the extension of the PECE program would be negotiated with the private sector and implemented somewhat earlier than originally expected, perhaps by the end of June 1990. C. Rationalized Private Sector Incentives 12. Mexico has transformed itself into one of the most open economies in the world through a trade reform supported by four Bank policy-based loans. Trade liberalization has lowered the percentage of dmestic tradeable production covered by import quotas from 100? ln 1984 to around 18? at present, and maximum import tariffs from 1002 to 20Z. Non-oil merchandise exports, which represented less than one -third of total exports in 1984. have doubled their share since then. 13. This "core" reform has been complemented by many others. Recognizing that the era of public sector-led growth had passed, the Government took a number of measures to stimulate greater private investment. In May 1989, foreign investment regulations were considerably relaxed and made more transparent. A long-standing prohibition against majority foreign ownership was removed, the fishing, petrochemical, and mining sectors were opened to foreign investors for the first time, the licensing of proposed investments under US$100 million was made automatic (so long as they satisfy newly-published criteria), and approval of larger investments became automatic following a 45-day waiting period, unless the Government interposed formal objection. In addition, since 1986 the tax system has undergone a series of reforms tending to reduce the previous biases against equity finance, adjusting assets and liabilities for the effects of inflation, bringing marginal tax rates more in line with levels in major industrial countries, encouraging the repatriation of flight capital, and increasing t1he sanctions for tax evasion. 14. To encourage improved mobilization of domestic savings, the Government initiated a process of liberalization of the financial markets, supported by a F;nancial Sector Adjustment Loan from the Bank. Interest rate ceilings and credit allocation formulae were removed on commercial bank lending and credit subsidies through official development banks were reduced significantly. At present, the principal development and agricultural banks in the public sector are in the midst of significant managerial and financial restructurings, designed to consolidate these institutions, clean up their balance sheets, and reform their lending practices. 15. To reduce the role of the public sector, over 750 state-owned enterprises have been sold, transferred, or liquidated from 1983 to the present and 42 more are expected to be sold or closed during 1990. In March 1990, the Governiment announced the privatization of two large steel companies. The country's largest airline has been privatized and the Government has also placed in receivership, for eventual sale or liquidation, the country's largest mine. Under the Industrial Sector Policy Loan the Government has already moved far ahead in the deregulation of various sectors, such as petrochemicals, pharmaceuticals, microcomputers and automotives. Attention is now centering on liberalizing the transport and telecommunications sectors since their services are a vital input to all economic activity, particularly industrial production and exports. Liberalization will be useful not only in its own right, but also as a means of increasing the efficiency gains from industry and trade reforms. D. Reorientation of Public Spending 16. Since 1982, a retrenchment of public expenditure has occurred, of a dimension unprecedented in Mexican terms, if not for most developing countries. Non-interest spendlng declined by 36% in real terms. However. the composition of the cutbacks was not ideal from the standpoint of growth. Investment expenditures were cut more deeply than current expenditures, posing the risk, nc-r that growth seems to be underway once again, that infrastructure oottlenecks in areas such as roads, cotmunications, and urban services, and lack of skilled manpower availability could impose severe constraints on potential growth. 17. Also, some of the gains in reducing illiteracy, infant mortality, and nutrition during the seventies are threatened by the sharp cutbacks in public expenditures for social programs. The social sector's budgetary share declined from 20! or more in the years preceding 1982 to around 132 currently. This trend seems unsustainab,le, given the already sharp reduction in real wages, widespread unemployment, and worsening inter-personal and inter-regional income disparities, arnd for the first time in many years the 1990 budget provides for a significant increase in the social sector's share. 18. In recent years, two successive administrations have sought to soften the blow of reductions in social expenditures. Global consumer subsidies for basic food items have been replaced by less expensive, but more targeted, subsidies to the poor. In 1989 a new "National Solidarity Program, has set aside US$400 million to coordinate the activities of existing agencies and to provide limited additional budgetary support for agriculture, infrastructure and social programs in Mexico's ten poorest states. 19. As for the environment, it is widely recognized that the cumulative effects of past growth, combined with generations of public indifference about ecological issues, have resulted in severe degradation of Mexico's air, soil, water, and forestry resources. Mexico City is now one of the world's most seriously polluted cities, but many other Mexican medium-sized cities suffer from significant problems too. The Salinas Administration is the first to recognize the urgency of broad-based efforts to clean up the environment and, following up on the reformulation of an urban transport project (Loan 2824-ME) to start addressinp the pollution caused by vehicle circulation, the Bank is currently involved in the preparation of a free-standing project to address the air pollution problem in Mexico City. 20. Given the severe fiscal constraints, the task of rebuilding roads, bridges and other infrastructure is being met in limited ways. The greatest room for improvement lies in shifting resources at the margin away from support of activities, such as telecommunications, which could be better carried out by the private sector. This will permit increased financing of activities, such as transport infrastructure, where the state's role traditionally has been predominant, even though this is an area where private investment is also being sought. The restoration of sustainable growth will require a gradual increase in public investment over the next few years (para. 25), particularly for agriculture infrastructure, the environment, transportation, energy, and the social sectots. E. External Debt R-Auction Agreement 21. On September 13, 1989, the Government of Mexico and the Bank Advisory Committee representing the commercial bank creditors reached agreement on a finaticing package covering the period 1989-92, restructuring approximately US$48.4 billion of Mexico's external debt. The agreement consists of a menu of financing options which includes two debt and debt service reduction facilities and four new money facilities. The debt relief package was signed at the end of March 1990. It is estimated to reduce Mexico's annual net transfers abroad by almost US$4 billion per year over the 1989-94 period. This reduction will have a direct beneficial impact on Mexico's fiscal situation and on output growth. At least as important will be the indirect effects through renewed confidence. Lower net external transfers mean reduced pressure on the exchange rate; this should reduce the risks associated with peso-denominated public sector debt, thus taking pressure off - 8 - domestic interest rates. Indeed, %ithin days of the announcement of the terms of the agreement in July 1989, nominal interest rates fell from 56 percent to 36 percent on an uncompounded basis. At the same time, the maturity structure of foreign public debt widened considerably and repatriation of over US$2 billion in private foreign capital rebuilt the Government's foreign reserves, which are further indications of a recovery in private confidetnce. 22. Nominal interest rates have rebounded since September to around 45 percent currently, a reflection of uncertainties about what form the extension of the PECE program (para. 9) will take beyond its June 1990 horizon, as well as uncertainties stemming from the sizeable growth in the current account deficit (US$5.6 billion in 1989, compared with US$3 billion in 1988). The change in the size of the current account deficit was largely due to the increased imports drawn in by accelerating private sector investment, fast growing consumer imports (though starting from a relatively low base), and a drought-induced decline in net agricultural exports. Manufactured export growth during 1989 also slowed substantially to around 8.5 percent. However, with signs of a slowdown in the growth of private investment and a strong recovery of agricultural net exports and output already underway, the current account deficit is expected to fall substantially in 1990, even before taking into account the favorable impact of the debt agreement. This agreement is expected to reduce the current account deficit by US$2 billion in 1990, and by US$1.3 billion annually in subsequent years. Thus, external developments look set to improve in the near future. F. Macroeconomic Projections2/ 2?. The substantial improvements in macroeconomic performance and in structural adjustment are expected to lead to greatly improved prospects for sustained growth and improving standards of living. The base case starts from an assumption that the 1989 current account deficit, equivalent to nearly 3 percent of GDP, will taper to deficits of around 1.4 percent of GDP over the next five years (see Annex V). These moderate deficits should be easily financeable, and are consistent with a projected decline in the foreign debt-GDP ratio from 49 percent in 1989 to 34 percent in 1994. 24. It is also assumed that the fiscal stance will continue to be consistent with inflation targets, which means that the non-interest fiscal surplus would by assumption remain at around 6-6.5 percent of GDP. This assumed fiscal outcome would be in line with the FY90 budget, but significantly below the 8.4 percent of GDP primary surplus actually achieved in FY89. From the standpoint of consistency with macroeconomic growth and inflation targets, this level of fiscal effort would fall somewhat short of what is needed in 1990-91, when domestic real interest rates are likely to remain high, but exceed wlhat is necessary in 1992- 2/ Macroeconomic tables are attached as Annex V. 94, when real rates, are assumed to drop to a more reasonable risk premium over foreign real rates. 25. Per capita consumption is expected to decline slightly in real terms through 1992, before experiencing a sharp recovery in 1993 -94.3/ As for public investmeiat, it is assumed to recover gradually from 4.2 percent of GDP in 1989 to around 6 percent of GDP in 1994, enabling the Government to address the accumulated bottlenecks in the economy's physical and social infrastructure which might otherwise constrain growth. Private investment, which rose from a low of 11.6 percent of GDP in 1986 to 15.8 percent in 1989 would continue to grow over the next several years, attracted by the newly-enhanced investment climate and, later in the sexenio, by the steady decline in real interest rates. By 1994, it is projected to reach around 18 percent of GDP. 26. As a consequence of the rise in total investment from 18.5 percent of GDP in 1986 to nearly 24 percent projected in 1994, real growth would accelerate to a projected 5 percent by 1994. Stronger investment growth under a smaller current account deficit target requires, of course, higher private and/or public sector savings. Private consumption is likely to grow faster than GDP over the sexenio. As a consequence, virtually all of the growth in investment would have to be financed out of increased public sector saving (defined as public investment less the operational fiscal deficit), which would rise sharply from 2.1 percent of GDP in 1989 to a projected 9.1 percent in 1994. The already completed reforms in tax administration and in the structure of personal income and property taxation, combined with continued assumed improvements in public sector pricing, offer solid underpinning for the projection of strong growth in public sector revenues. Substitution of public investment for public consumption and the drop in domestic real interest rates (projected to lower the domestic public debt service 4.4 percentage points of GDP between 1989 and 1994) will also contribute to higher public savings. 27. In conclusion, with foreign financing now in place, the program of internal reform well-advanced, and the economy in a moderate growth mode for the past year, a cautiously optimistic prognosis for Mexico's recovery in growth seems justified. Moreover, Mexico's debt indicators are projected to decline substantially. With a continuation of the Government's reform program, investing in Mexico would offer prospects of a high pay-off. Under the proposed project we would intend to closely monitor the evolution of economic events and to carry out an assessment of the medium term macroeconomic framework prior to second tranche release. 3I The projections discussed in this chapter have been generated with the help of an econometric model d-scribed in Growth, External Debt, and the Real Exchange Rate in Mexico, S. van Wijnbergen, Working Papers, August 1989. - 10 - PART II - SECTORAL CONTEXT A. Introduction 28. In the past two decades there has been a growing awareness all over the world of the negative effects of excessive regulation on private investment, productivity and growth. The original rationale for regulation had stemmed from the concern that economies of scale led to natural monopolies and that such monopolies would result in an inefficient allocation of resources. In addition, it was feared that unregulated competition could negatively affect quality and reliability (or safety) of service. However, by the seventies greater concern was being expressed that regulation limited innovation, sheltered inefficiency and led to resource misallocation. In addition, questions on the appropviate role of the state were brought up, in many cases prompted by generalized concerns about the financing of public sector budget deficits. This has been reflected in a move towards the liberalization of markets previously not open to competition, and in enhanced private sector participation in activities that had before been reserved to the public sector. 29. Mexico has been taking important steps to spur privatization and to adjust the regulatory framework in line with the considerations outlined above. Most important has been the liberalization of trade, reflected in a significant elimination of quantitative restrictions and reduction in the level and coverage of tariffs (para. 12). The Bank has supported this process through several loans and progress has exceeded the targets agreed therein, as well as commitments under GATT, which Mexico joined in 1986. Another important area of policy reform has been direct foreign investment (DFI). The rules governing DFI were liberalized in May 1989, opening new areas for DPI, allowing majority foreign ownership and simplifying the procedures for licensing (para. 13). A third area of policy reform has been the banking system, which had been subject to quantitative credit controls that now have been lifted (para. 14). Finally, reforms in the industrial sector in general (such as reduction of domestic content requirements and investment incentives) and in some subsectors in particular (i.e.: petrochemicals) also deserve to be highlighted, as they underscore the coherence and sense of direction of the overall program. 30. Within the above general policy framework, the Government has embarked on a program to expand the role of the private sector to areas previously reserved to the public sector. The de la Madrid and Salinas' administrations have made substantial progress in the divestiture of public enterprises (para. 15), and a program to continue the disengagement process has been agreed with the Bank under the Public Enterprise Reform Loan (Loan 3086-ME). In a number of sectors hitherto reserved exclusively to government ownership, new initiatives are being undertaken to attract private sector participation and investment. For example, the Government is considering cogeneration alternatives which would attract private capital to the power sector. In water supply, private provision of water services is being tried on a pilot basis in - 11 - Aguas Calientes. In urban transportation, the public bus lines serving Mexico city may be turned into cooperative enterprises. In highway construction, concessions are being given for the construction and operation of privately financed toll roads. 31. The two sectors on which the proposed project focuses (road freight transportation and telecommunications) would also be the subject of major policy changes in line with, and supportive of, the broad reform processes discussed above. Transportation and telecommunications are services on which all business activities rely, and their timely availability, quality and cost have important effects on a wide range of products and services and play an important role in facilitating trade. The proposed loan would support the Government's programs in these two sectors and would promote institutional changes to ensure the success of the program. In addition, through a parallel loan, the Bank would provide technical assistance to the telecommunications sector regulatory body. B. Road Transport 32. The regulation of road freight transportation is a common practice. It is normally justified on grounds of safety, reliability of service and stability of rates. Competition in the sector is feared to be ultimately destructive of the ability of the industry to offer good service. However, there are many countries where the industry is free from most Government regulation and operates in an efficient manner. The costs of trucking regulation arise from inefficient provision of services, shifting of traffic to less economical modes, higher costs of transportation and reduction in total transportation volumes. A study conducted in the USA in 1975, before deregulation, had estimated that these costs could amount to as much as one third of the income generated in road transportation.4/ As we discuss below, the Mexican regulatory framework involved an even higher degree of interference with market forces than in the US, so that its cost could well be in such range.5/ 33. Besides freight transportation (trucking), which--together with telecommunications--is the focus of the proposed project, road transport also includes bus passenger and tourism services. Currently, buses are given permission to operate only on specific routes, and entry to the market is highly restricted. In order to provide a permit for a service, SCT consults existing providers, which has led to a very concentrated market structure. The Goverment now intends to deregulate 41 T. Gale Moore "Deregulpting Surface Freight Transportation" in A. Phillips (ed), Promoting Competition in Regulated Markets, The Brookings Institution, Washington, D.C. 1975. 5/ The Mexican Government conducted a preliminary study on the welfare cost of regulation in trucking, which estimates that it amounted to 1122 of GNP. - 12 - entry, requiring minimal formalities to change routes. Transport services for tourism were deregulated in March 1990. Before then, these services were provided through a Government monopoly and the level of service was generally considered to be very poor. SCT has now eliminated this monopoly and will issue permits to all interested operators. Route and tariff restrictions have been eliminated and tour operators are free to contract transport services. Foreign vehicles bringing in tourists from abroad are now allowed into Mexico, which could be an important measure to promote tourism and improve the balance of payments. While outside the scope of this proposed project, the policy measures outlined above highlight the breadth and coherence of the Government's reform program. 34. While in the past regulation may have helped the development of the road freight transport industry, the Government has now reached the conclusion that the regulatory framework has been defeating the purpose for which it had been conceived. The Bank's sector dialogue with Mexico during the last two or three years has been increasingly focused on this issue, developing awareness of the problems and promoting discussion on alternative ways to address them. In mid-1988 the findings of a study conducted by the Bank among industrial users, showed generalized concern with the poor quality of trucking servicer. The main issues to be addressed in the trucking industry and the Government's policies and actions are outlined below. Trucking Entry Restrictions 35. In the past many restrictions to entry into the trucking industry have limited competition and reduced efficiency: (a) Federal trucking concessions. In order to provide public trucking services, trucking firms were required to obtain a concession to operate from the Ministry of Communications and Transport (SCT). The concessions, by law, were given primarily to existing concession holders and the administrative procedures for determining the need for additional service depended on the opinion of existing service providers. These procedures strengthened the position of existing firms and led to the formation of cartels. (b) Corridor Assignments. The country was divided into eleven corridors and each trucker needed a permit to operate within a specific corridor. As a result, both truckers and shippers experienced increased costs. For the truckers, down time increased and load factors reduced as the restrictions constrained their options for backhauling and made it more difficult to match their supply with available demand. For the shippers who wanted to send cargo across corridors, indirect routing was necessary or special arrangements with higher tariffs had to be made. Furthermore, the corridor system tended to favor existing - 13 - spatial concentration, since the corridors tended to radiate from Mexico City. (c) Freight centers: Truckers, especially small operators, were originally encouraged to form freight centers sz that they could take advantage of economies of scale for common services (such as the provision of spare parts, insurance and paperwork), and facilitate cargo movements. While these services are supportive of the industry, the freight centers, partly as a result of their market knowledge, in recent years limited entry and tended to form cartels in the assignment of cargo. Some freight centers adopted a roll call, first-come first-serve queuing system for truckers to be given access to cargo. As a result, shippers had little say in the selection of the trucker and the benefits of either competition or a close working relationship were foregone. Moreover, the centers were increasingly reluctant to allow return load facilities to other centers even on the same route, and opposed allowing vehicles from other routes to operate witl:in their service area, even when transport was in short supply. (d) Container Movements? Regulations also inhibited the efficient circulation of containers. To optimize the handling of international container movements, Multimodal, a semipublic company, was created by SCT in 1981. The company was expected to perform the role of a national freight forwarder, undertaking a host of complex services, ranging from packaging to arranging insurance and delivery. However, in practice, as a result of Multimodal's monopoly status and partly because of its lack of expertise, which requires a detailed knowledge of shipping markets and costs, international container shipments were not handled in an efficient manner. Instead, collusion between Multimodal and the freight centers led to a system of surcharges and unofficial payments which often far exceeded the stated tariffs. More important than the shipping costs, service standards were low and deliveries often delayed. As a result, there has been a strong tendency for container traffic to be confined to the port area, thus foregoing the large potential benefits of door-to-door delivery, which is the main advantage of the intermodal technology. In addition, customs regulations did not permit containers that were temporarily brought into the country boxing imlports to be used to transport domestic cargoes, which resulted in empty movements of containers and in an uneconomic utilization of their transportation capacity. (e) Cargo Handling Conce'sions. SCT granted concessions for handling cargo movements at the railroad stations and border customs facilities, as well as for the drayage services to cross the border. In most cases goods could not be removed - 14 - without the services of the concessionaire. Ag with the federal trucking concessions, entry was limited and cartels were formed, which tend to increase costs and reduce service quality. (f) International trucking. While cargo trailers are allowed to cross the international borders and proceed to their final destination with unloading and loading, the tractors (power units) are not permitted (neither by Mexico nor by the U.S.) to cross. To undertake the exchange of trailers at the border, drayage services have developed. The regulations for these services vary depending on the cities and states involved on both sides. In most cases the Mexican drayage firms (which often operated as cartels) are allowed to bring and take trailers across the US border within a commercial zone which is usually limited to the urban area at the border. The US drayage operations, on the other hand, are generally more restricted; sometimes they are not allowed to cross the border areas or to pickup return loads. Besides the increased costs of exchanging power units and drayage services, customs delays in the clearance of goods are often experienced on both sides. An additional difficulty has been that the high-growth 'maquiladora" (in-bond assembly) industries have not been permitted to transport their own products in their own private fleet, which led to inefficiency and higher costs. (g) State Restrictions. Besides the Federal regulations, some states have restrictions which affect intrastate movements of cargo. In some cases, concessions are required for specific cargo and/or route movements on state highways. A review of state regulations in Chihuahua, Jalisco, Puebla, Veracruz and the state of Mexico generally indicates that state regulations do not, in general, pose major issues as intrastate traffic is not very significant in comparison to interstate transport. However, state regulations do affect the movement of some agriculture, forestry and construction industry products. The Government Program to Eliminate Trucking Entry Restrictions 36. The recently issued National Development Program (NDP) for 1989- 1994 outlines the general policy framework under which the Government expects to achieve its objective of modernization in the road transport industry, so that the quality of services may be improved and costs reduced. The basis of the program is that private investments and competition would be encouraged and the development of multimodal transportation would be pursued. In accordance with the NDP, on July 6, 1989, the Government signed an agreement with the private sector which spelled out sector objectives and mutual commitments to modernize the road transport industry. Subsequently, on July 7, 1989 new regulations governing trucking and inter-modal transport were approved by decree. - 15 - 37. The main points of the new regulations, that address the entry issues raised above, are: (a) Federal trucking Permits: The public service notion, which was behind the concept that trucking operations require a concession, has been abandoned. Entry requirements have been eliminated and clear guidelines have been provided for obtaining permits. The trucker need only to prove his identity and vehicle ownership to get a permit, which is easy to obtain. This will allow an increase in the number of truckers that may engage in public transport and allow the legalization of an estimated 20,000 truckers that were operating outside the previous system. From August through December 1989 over 8500 permits have been granted (i.e.s about three times the number issued during 1986-1988). Also, own-account operators are now allowed to transport third party cargo. (b) Route assignments. The corridor restrictions have been eliminated and trucks have been freed to transport interstate cargo throughout Mexico. Direct shipments between former corridors are permitted without additional costs and truckers are free to offer their services throughout the country. (c) Freight centers. Truckers do not have to belong to freight centers to obtain cargo and shippers are free to use the trucker of their choice. The freight centers no longer control cargo shipments and certify the shipment bill of lading. (d) Container movements. The new regulations allow containers to be transported without Multimodal's services and entry into the provision of inter-modal services (under which the transporter is fully responsible for door-to- door shipments) has been opened up. Six new firms have already obtained permits to provide these services and applications from six additional firms are currently being processed. In addition, in January 1990 restrictions on the use of international containers for the transport of domestic cargo were lifted. This is expected to increase container utilization and, hence, efficiency. (e) Cargo handling concessions. In January 1990 new regulations were issued to allow open entry to the provision of cargo handling services at railroad stations and custnme facilities. These regulations forbid giving exclusive rights for the provision of these services and provide flexibility for rate charges. Operators with federal trucking permits will automatically be allowed to provide - 16 - cargo handling services in federal areas (railroad stations, customs and border crossings). (f) International trucking. Discussions under GATT are taking place between the USA and Mexico on border trade issues and a fourth meeting was held in January 1990. The new regulations issued in January 1990 allow open entry for the provision of drayage services (which also includes border crossings) so that the present cartels are being broken. In addition, the "maquiladoras" are now allowed to transport their own products in their ewn trucks across the border. (g) State Restrictions. SCT has developed s. plan of action to sign agreements that will cover road transport in the areas of freight, passenger and tourism with every individual state where this is warranted, in order to eliminate state transport restrictions. The Federal Government will provide state licenced carriers with permits to operate on the Federal network and, in exchange, the States will adjust their regulatory framework to the deregulated Federal one. While the states have autonomy to regulate intrastate transport, the elimination of state regulations would be in line with federal policy. All agreements are expected to be finalized by March 31, 1991. Official Trucking Tariffs 38. In the past, the official trucking tariffs were set by SCT. While formally the tariffs were not negotiable, in practice some flexibility existed, especially in the form of discounts for large powerful users and, conversely, surcharges by powerful truckers. Furthermore, the tariffs, which were classified into five rate categories and fixed on a countrywide basis, often bore little or no relationship with the costs for a specific shipment. Thus, supply tended to be more available in some areas and less in others, depending on the relationship of the tariffs to costs. 39. In July 1989 regulations were issued which allowed 'official' tariffs to be regarded as maximum rates. It then became legal to negotiate individual rates taking into account the specifics of the goods to be transported, provided they did not exceed the maximum official rate. Also a 152 surcharge on rates on imported goods was eliminated. More recently, in January 1990 the tariff ceilings were also eliminated, as well as the application rules that set values for, among other services, pick up-delivery, cargo insurance, exclusively served customers, empty back-hauls and warehouse spaces. Thus, rates may now be freely negotiated between the trucker and the customer. Automotive Industry 40. The automotive industry, consisting of auto, truck, and bus and parts producers, faces numerous regulations which greatly increase the - 17 - effective costs of vehicle purchase and maintenanc.. In line with the government's previous import substitution policies, protection in the form of high tariffs and numerous import quota restrictions exist. For automotive production, the effective protection is currently estimated at about SO?, compared with the 152 average for the manufacturing industry as a whole. In addition, all producers must comply with domestic component restrictions which vary depending upon whether production is for tbe domestic or export market. Furthermore, the number of lines and models which producers may manufacture is limited. Foreign ownership of domestic auto parts firms is also limited to 402. Only the "maquiladoras' which produce auto parts for export are exempted from the above regulations. 41. The automotive industry issue is being addressed under the Industrial Sector Policy Loan (ISPL), approved in June 1989, under which the Bank and the GOM agreed on an action plan to deregulate the automotive sector. In compliance with this commitment, on December 11, 1989 the GOM published two decrees which represent a major step forward in the liberalization of the sector and which exceed substantially the actions required under the ISPL. The regulations governing the automotive industry have been clianged to ensure that truckers will be able to purchase units of international quality at international prices and starting with model year 1991 the import of tractor trailere will be allowed (starting in 1992 also heavy trucks) if domestic prices exceed the international level. In addition, restrictive regulations on the organization of truck production, such as national integration requirements, compulsory incorporation of domestic components into vehicles and the majority national ownership requirement have been eliminated. The plan also calls fors (a) opening up the import of buses (which has already taken place), and of automobiles, light and medium trucks, beginning with the 1991 model year; and (b) gradual reduction of domestic content requirements for the vehicles listed above and for auto parts, and progressive removal of quantitative restrictions on auto nart imports. Highway Safety and Environment 42. While on economic grounds a convincing case may be made that most regulations which restrict entry and limit price competition should be eliminated, there is an economic rationale for safety, environmental and vehicle loading controls, based on the externalities that they cause. The total number of road fatalities in Mexico is estimated to be about 15,000 per year and a rough estimate made by the Bank in 1987 indicates that the proportion of the number of persons killed on Mexican highways to the number of accidents was six times higher than in Sweden. 43. SCT's road safety policy, outlined in the 1989-1994 national program for transport modernization, seeks to substantially reduce the number of traffic fatalities and injuries. However, although much good - 18 - work is being done by various agencies to improve road safety, coordination is weak and policy objectives are not clearly defined. To address this problem, the Government has strengthened the interagency group that is responsible for these areas. An expanded interagency group will bring to bear the views of all affected parties, and is perceived as the first step towards effective coordination. While an accident data collection system exists, collection, storage and analysis require improvement so that the data for the entire country is presented in a consistent way and subsequent action programs formulated. 44. At present, Mexico lacks an adequate inspection system to monitor vehicle safety. The present system allows potentially dangerous vehicles to use the public roads. and at least 71 of the accidents are due to vehicle factors, such as bad tires and brakes. However, it would be of little value to invest in expensive testing facilities and to employ a large number of inspectors if there is no confidence on the results tlhat such system would deliver. Furthermore, at a time when the size of the public sector is being reduced, the merits of such an option become questionable. Hence, an alternative which would be better suited to present circumstances would be to promote insurance against third party claims, which over time should result in better monitoring of the conditions of vehicles and of driver behavior; this is the course that the Government intends to follow. 45. A particular safety concern is the size and heavy loads of the cargo truck fleet. Overloaded axles of trucks cause severe damage to highway pavements, which increases the risk of accidents and results in shorter road life and high maintenance costs. The cost of the resultant damag-s caused to bridges and to pavements is borne by the highway authority, end the increased cost of accidents have to be met by the community. While little data is presently available, axle overloadings are suspected to be most serious on roads connecting major port areas, where cargoes are concentrated and heavy industries are located. This problem is to be addressed, in a first stage, by a study that has already been contracted which will first collect information on vehicle sizes and loadings and, in subsequent stages, analyze policy options and recommend measures to enforce vehicle size and weight regulations. 46. Another problem related to security, and which business firms report to be a major concern, is loss and damage to cargo. At present, the trucker's responsibility for cargo loss is limited to only Mex$ 800/ton (US$0.31) and provides little incentive to care for the cargo. Until January 1990, a further regulation indicated that the shipper could insure his cargo by paying the trucker a fixed rate of 3 mills per declared value. The fixed rate did not take into account the type of product shipping risks, which are independent of the cargo value. While now the rate for incremental insurance may be negotiated freely, the limit on the trucker's respons4bility has not been updated. The Government is now reviewing the limit and a decision is expected soon. 47. Regarding the environment, the key concern is with air pollution, particularly in the Mexico City metropolitan area. At present SEDUE and - 19 - SCT are drafting norms to control bus and truck noise and air pollution, requiring periodic inspections which would be conducted by private service stations. In addition, programs to improve the quality of fuels are under way. The Bank will also provide assistance to address the specific problem of Mexico city through Loan 2824-ME (which was amended in January 1990 for this purpose) as well as through a proposed free standing project which is now in an advanced stage of preparation. Pricing, Cost Recovery and Taxation 48. Sector cost recovery: If transportation is to be used in the most efficient way, users should face charges that adequately reflect the true cost of the mode chosen. In this context, a study conducted by the Bank indicates that while overall road costs are being recovered there are cross-subsidies between automobiles and trucks. By late 1989 trucks were only paying for a small fraction (about 152) of the costs which they caused to the highway network. This result was essentially due to the relatively low domestic price of diesel fuel, which in November 1989 was Mex$ 445/lt (US$O.65Igallon), above the international border price but not enough to allow adequate cost recovery. On December 1, 1989 the price of diesel was increased by 5.62 and this increased cost recovery from trucks to about 50%. Further measures would still be required to raise cost recovery to an acceptable level. These could involve some additional increase in the price of diesel and/or an increase in direct taxes or license fees paid by truckers. The Government's development policy letter confirms its commitment to the objective of full cost recovery. 49. Railroad tariffs. Also related to the issue of market pricing, is the present structure of railroad tariffs, since trucks compete with the railroads for traffic. In general, the tariffs charged by the railroads for the transportation of key commodities fall short of long run variable costs. This should be corrected to avoid a misallocation of traffic between trucks and the railroads. This issue is being addressed under the Railway Sector Loan (Loan 2575-ME) but the constraints placed by the ongoing stabilization program to public sector price adjustments have resulted in a build-up of distortions over the past two years. The Government has now decided to substantially increase FERRONALES' rates within the next few months, so as to realign them with economic costs. In addition, under the Public Enterprise Reform Loan (Loan 3086-ME) a study of railway rates has been initiated and, upon its completion in September 1990. it will provide an improved data base for relating railway rates to economic costs. Lastly, on January 26, 1990 the Government passed a decree which provides general guidelines for the operation of all public enterprises. The decree highlights the objective of fostering managerial autonomy, establishes that public sector prices should reflect opportunity costs or should be based on economic criteria, and assigns freedom to the enterprises to periodically adjust their prices based on these criteria, subject only to a five day prior notification to the Government. Thus the decree provides an excellent framework for the future. - 20 - 50. Taxation. Because of a special provision, the Mexican transport sector was exempt from income taxes as well as from value added atnd ownership taxes. Instead, since 1966 truckers were requtred to pay a direct tax which was a fixed amount per operated vehicle. The amount vaxied according to the type of vehicle and the kind of service it provided but on average was very small and, as a result, revenues obtainied from this tax were minuscule. Not only did this cause a distortion in the pricing and allocation system, it was a major loss of tax revenue since the transport sector accounts for about 72 of GDP and the Bank estimated that a large revenue potential from taxing truckers under the general income tax regime was not being tapped. The exclusion also presented an avenue for tax evasion, since a manufacturer could start a trucking operation to escape corporate income taxes. Within the 1990 budget that was approved by Congress, the exemption of the trucking industry from income taxes, value added and ownership taxes was eliminated. This action thus closes a large loophole in the tax structure. Road Maintenance and Efficiency 51. Closely related to the pricing and taxation issue is the amount of expenditures on road maintenance, since the condition of the roads directly influences costs and tariffs. About 202 of Mexico's 45,000 km long Federal Highway Network (FHN) is badly deteriorated, mostly due to inadequate maintenance over the past several years. The backlog of deferred maintenance is estimated to be over 502 of the federal highway network (i.e., about 25,000 kms). The problem is expected to increase in severity, particularly as the funds currently allocated to maintenance fall short of estimated needs. During the 1987-89 period routine maintenance was carried out only on about 20? of the FHN. Furthermore, to add to the difficulty, for budget management reasons the funds released to SCT often arrive during the second half of the calendar year while the main maintenance and construction period during the dry season occurs during the first half of the year. 52. An analysis of SCT's expenditures during the 1983-88 period indicates that only about half of their budget was spent on maintenance and rehabilitation activities. The remainder of SCT's resources was spent on new construction and on widening existing roads. While new construction and widening can provide acceptable returns, numerous studies both in Mexico and other countries have indicated that maintenance activities (preservation of the existing roads) show the highest returns and are the best use of limited resources. The Government's development policy letter underscores the priority it assigns to highway maintenance and this has been reflected in its recent decision to increase the originally proposed 1990 budget for maintenance by about 40?. Reorganization of SCT 53. As a result of the steps already taken, many of SCT's regulatory functions in the transportation sector are being eliminated or reduced, - 21 - particularly within the General Directorate of Land Transport and Tariffs. To ensure the efficient use of personnel SCT conducted an internal reorganization (including reductions in persornel, suppression of a department and reassignment of its staff, and reformulation of the functions of two other departments) to align its structure with its revised role in the sector. This reorganization is substantially implemented, and only some fine tuning is likely to be needed in the months ahead. C. The Telecommunications Sector 54. In recent years the telecommunications sector has been the focus of worldwide attention. The success of a recent Bank seminar in Asia6' testifies to the growing interest in management and restructuring options for the sector. Following the break-up of AT&T in the USA, and the move towards privatization and a more competitive environment (as well as innovative concepts in regulatory practice) in the UK and other large industrialized countries (such as Japan, France, Germany, Netherlands and Australia) there has been a widening interest in the potential of sector reforms. The underlying technological and economic forces of change are by now clearly visible in developing countries. 55. As noted in the IBRD book mentioned above, in most developing nations telecommunication services are provided by the public sector. often quality of service is poor and there is a large unmet demand. Sector investments, constrained by overall ceilings on total public sector investments, fall short of needs and charges tend to be influenced more by political factors than by financial and economic considerations. At the same time, technologies are in a process of constant change, costs are dropping and the uses of telecommunications in business are expanding. The inability of the sector to respond to demand is a major challenge faced by the developing world, and Mexico is no exception. The Mexican Telecommunications Sector 56. TELMEX has a monopoly on telephone service. Until 1972, TELMEX was controlled and managed by the private sector and still today 49? of its stock is publicly traded (both in the Mexico and it? the New York stock exchanges), while the other 51? is held by the Government. TELMEX is run as a government enterprise, and its tariffs, investment decisions, finances and management are constrained by the same factors as in other parastatal enterprises. SCT is responsible for telecommunications sector policy and regulation. The latter includes licensing of private networks, approval of customer premises equipment, and planning, administering and monitoring the use of the radio spectrum. Until late 1989, SCT also had direct operational 6/ B. Wellenius, P. Stern, T. Nulty and R. Stern (editors), Restructuring and Managing the Telecommunications Sector, The World Bank, Washington D.C., May 1989. - 22 - responsibility for the provision of some services (mainly telex, data transmission, operation of a sizable, but antiquated, microwave network, a modern but underutilized domestic satellite system, and a network of maritime coastal stations). 57. Mexico's present telecommunications system is a major constraint to economic growth, particularly industrial production and export activities. There are over 1.5 million applications for telephone service awaiting installation (and many more potential subscribers that do not bother to apply given known long delays in obtaining service)7!. Telephone service is also of poor quality, unreliable, and heavily congested (it is virtually impossible to get through during peak business hours). In the recent past, TELMEX has installed about 230,000 lines per year, which barely keeps up with the growth of demand. More advanced services (e.g., facsimile, data transmission, cellular telephony, access to time-shared data processing and data banks) are only in their infancy. Given Mexico's drive to open its economy, it is becoming increasingly important to ensure that business firms operating throughout Mexico have access to state-of-the-art telecommunications and information services, and that households gain access to markets and business activities through a more effective basic telephone infrastructure. Sector Issues 58. Senior government and TELMEX officials have given much careful thought to the four key sets of issues that need to be addressed in order to overcome the above deficiencies: (a) What role should the private sector play in telecommunications? In particular, how can the huge investments required to expand and modernize services be funded? And what functions should remain with the government? (b) To what extent, and how, should competition be developed? '. (c) What would be an appropriate regulatory framework? In particular, what should be the price and tax regime? How can the required regulatory capacity be developed? And, 7/ Mexico's 5.3 connected telephone lines per 100 inhabitants is somewhat less than the average for Latin America (about 6) and well below other newly industrialized countries (e.g., Korea 15, Singapore 30). Only 18S of Mexican households have a telephone (compared with about 401 in Spain). Furthermore, there are large imbalances among states (e.g. 11 lines per 100 inhabitants in the Federal District compared with 3 lines per hundred in the states of Mexico, Veracruz and Michoacan) and between urban and rural areas. - 23 - (d) How can the conflict of interest between the government's regulatory functions and its operating responsibilities be reduced or eliminated? These issues are linked to broader aspects of the Government strategy which, as noted earlier, seeks to spur private sector development and non-traditional exports and reduce public sector participation in business activities where the public sector does not have a comparative advantage or very clear rationale for its involvement. 59. Private Sector Role. There is now a widespread perception, which the Bank shares, that under private ownership TELMEX would face less constraints in mobilizing funds and operating as an efficient business than it does as a parastatal enterprise. In addition, in the context of appropriate sector policies it would be more responsive to changing market requirements and technological opportuntities. There is also the idea that ownership of a substantial proportion of TELMEX stock by a foreign operating company would bring in expert telecommunications management to steer TELMEX towards more efficient commercial operation. In order to prepare TELMEX for sale, in October 1989 the Secretary of Finance (who is responsible for handling the placement of TELMEX shares) was appointed as chairman of the Board and a new director general took over as chief executive. Furthermore, in January 1990 a Mexican investment bank, "Banco Internacionall, was appointed to handle the sale. 60. Competition. The Bank also shares the view that new private service providers should be allowed to enter the market under a regulatory framework which limits Government intervention as much as reasonably feasible. Such competition would help meet outstanding and new demands, particularly for advanced business services where innovation and responsiveness, rather than scale and scope, are the key determinants of performance. Competition would also press TELMEX to accelerate network growth, improve the quality of its services, and contain costs. 61. Policy decisions are required, however, on the competitive supply of services, participation of monopoly entities in the competitive segments, and relations between both. Unfettered competition would result in wasteful duplication of facilities, loss of benefits due to excessive network fragmentation, and dilution of surplus funds needed to complete the basic national telecommunications infrastructure required for economic development reasons. 62. Regulation, Pricing and Taxation. As the state moves out of the business of providing telecommunications services, it becomes necessary to revise the policy and regulatory framework and build up a public regulatory capability. First, regulatory objectives suited to a mix of private competitive and monopoly services need to be clearly established. Second, the role of pricing as a means to ensure efficient allocation of resources must be recognized and principles developed to set prices in such cases where market mechanisms may be inadequate. - 24 - Third, areas where disagreement between affected parties may arise must be identified and processes established to resolve disputes and ensure fairness in decision making. Finally, transparency and accountability must be brought into thte picture toi attract public trust and support for the proposed changes. The extent and pace at which Mexico can build up effective, trustworthy regulation will be a key factor in the success of privatization and competition. 63. A critical area for regulatory improvement is that of pricing. Until January 1990, installation charges were very high, montthly network access and local usage charges were very low, and tariffs on international calls (especially to the USA, which accounts for about 90? of the traffic) were extremely high. These price distortions induced excessive use of some facilities while penalizing others (especially burdening international business activities with prices that were significantly higher than those of Mexico's foreign competitors or partners). In January 1990 cross subsidies were significantly reduced, with some charges for domestic calls increasing as much as twelve times and rates for international calls dropping by about 352. As TELMEX is privatized, it becomes increasingly important to establish a process for the periodic adjustment of tariffs that reflects the objective of promoting efficiency. while ensuring an adequate level of profitabilit y{. Considerable progress has been made in this regard and the Government has now decided to rely on price-cap mechanisms, which is in line with the prevailing thinking in the USA, UK and other countries that have moved towards privatization. 64. Until recently, taxation was also a major issue. Telephone users had to pay a tax (inclusive of VAT) which ranged between 22? and 72? (depending on the type of service). On average, TELMEX suscribers paid more than 502 in taxes, which was the highest of a group of 76 countries studied by the Bank. Over the past several years, while the Government did provide funds for investment to TELMEX, the sector remained a net contributor of funds to the Treasury. It is estimated that in 1989 the net transfers (all taxes minus funds provided for investment) from TELMEX to the Government amounted to the equivalent of about US$640 million. It was increasingly felt, however, that as the sector was opened to competition, telephone taxes had to be reconsidered to avoid misallocation of resources. Applying VAT to telephone services is perfectly justifiable (indeed necessary to avoid distortions). So is taxing income under the same rules and applying the same rates as for other business activities. On this basis the tax regime was substantially realigned in January 1990. The new regime does provide for a tax on revenues (in additon to VAT and income taxes), but this new tax (which replaces the old tax otl telephone users) is a major 8/ Often the marginal cost of providing telecommunications services is lower than average cost (mainly due to economies of scale and technological innovation). Thus deviations from efficient prices may be required to ensure full cost recovery and generation of operating surpluses to sustain rapid expansion and modernization. - 25 - improvement. It allows for a substantial investment credit atid may be deducted from income taxes, so it may reasonably be expected that its financial impact on TELHEX will be negligible but it will, serve to reduce accounting profits, and hence avoid a large increase in employee participation in profits. The recently enacted price and tax changes, coupled to a phasing out of Government contributions to investment by the time that TELMEX is privatized, are expected to result in TELMEX payments to the Government of about US$754 million in 1990.9 In the medium term, increased private participation in the sector will result in system growth and increased fiscal revenues, so that by 1994 these would rise to about US$1,460 million. 65. There are also areas of essentially technical (as distinct from economic) regulation that need attention. Management of the radio spectrum, a scarce natural resource, is already antiquated and ineffective; with the advent of more private networks and service providers, this may prove an intractable bottleneck unless extensively modernized. Under a proposed Technical Assistance Loan that is being processed in parallel to this operation, the Bank would assist TELHEX in this field. Also, maintenance of national fundamental technical plans (for signalling, ntmbering, etc, required to facilitate interconnectivity among national network segments and with international standards) is currently the responsibility of TELMEX; as TELMEX is privatized, and competition develops, responsibility for this function must be taken over by an entity that is independent of the operator. 66. Lastly, there is the need to concentrate in a single agency a number of regulatory functions now dispersed between several. In particular it would be advisable to consolidate the tariff oversight function, in which SCT, SHCP and, in some way SPP, are now presently involved. This would automatically take place once TELMEX becomes private, as the role currently played by SHCP and SPP, arises from the "public' nature that TELMEX now has. The need to strengthen SCT's 91 The windfall effect on Government finances of the sale of its shareholdings in TELMEX should also be taken into account. TELMEX's net book value is about US$3.3 billion. Based on the current market price of TELMEX shares in the Mexican stock exchange, the Government's holdings in the company would be worth over US$2 billion, but now that tariffs have been substantially aligned with economic costs it is expected that such value will rise. In this context the pace of divestiture is likely to have significant financial implications. One of the key objectives of the strategy that the Government, with the assistance of investment bankers, is now developing is to obtain the best possible deal, while meeting the other objectives of the divestiture process. To achieve this, the Government will initially sell about 202 of the shares (i.e.: less than 40Z of the Government's holdings) which will provide the purchaser with a controlling interest (because of the higher voting rights that will be attached to these shares). - 26 - telecommunications regulatory capability is based on TELMEX' significant monopoly power, and is addressed by the Technical Assistance project being proposed in parallel with this operation. 67. Divestiture of SCT's Operations. An essential element of sector reform must be separating operational activities under SCT from its policy and regulatory responsibilities. This would substantially reduce the risk that SCT would seek to protect its own business activities at the expense of overall sectoral development. It is also essential to give adequate assurances to private investors (particularly those expected to buy TELMEX) that state operations will not be used as a tool for arbitrary interference in the market. To achieve this, the Government has decided to reorganize SCT's operations under an autonomous state enterprise, TELECOMM, subject to the same rules and regulations as any private operating entity, and without further Government financial support. The Government's Telecommunications Program 68. The Government has decided that a major effort to step up the pace of telecommunications development is required, and has set as a goal an investment program of about US$10 billion over 6 years (1989-1994), which would allow increasing the telephone density from about 5.3 lines per 100 inhabitants (end 1988) to 8.5 (1994). The Government is willing to take action on the issues outlined above and is quite advanced in implementing a far reaching program of reforms, of which the following key aspects deserve to be highlighted: (a) Privatization: Privatization of TELMEX, announced by the President several months ago, is the center piece of the Government's telecommunications reform plan and is well underway. A satisfactory program and timetable have been furnished to the Bank: under them in early 1991 Banco Internacionalu expects to transfer administrative control of TELMEX to private owners and to initiate the sale of remaining Government-held shares in the national and international markets. To achieve this, "Banco Internacionalf has finalized an agreement with a foreign investment banker that will coordinate efforts in placing shares abroad; for which purpose other foreign investment banks are also to be engaged soon. (b) Competition: Concurrent with the sale of TELMEX shares, competition will be widely encouraged, including development of private user networks interconnected to the public network, cellular telephony (mainly for mobile service but also as an alternative to TELMEX's fixed telephone service), supply of customer premises equipment (e.g., telephones, PABXs, fax and telex machines), provision of information services, and eventually long-distance and international voice and data transmission. Franchises for cellular services in Mexico City and in eight regions covering the - 27 - rest of the country have already been awarded (with a large response from prospective suppliers, as over 100 bids had been received for the country's eight regions). (c) Regulation, Tariffs and Taxes: A new franchise contract for TELMEX has beets prepared, for discussion with TELMEX's prospective shareholders. Rules and regulations for licensing telecommunications networks and services, which would define the rules of the game to all firms interested in competing in these markets have also been drafted. TELMEX tariffs have been substantially restructured (January 1990) increasing on average by more than 702 and significantly reducing cross subsidies (para. 63) and, while there is still room for some fine tuning, the present tariff structure would allow TELMEX to internally finance about 802 of its 1990 investment plan. And; (d) Divestiture of SCT's Operations: While SCT will retain and develop its policy and regulatory responsibilities, all its telecommunications operating functions have now been transfered to a new decentralized state enterprise, TELECOMM/10, and a competent management team has been appointed to run it. 69. Finally, the collective contract with TELMEX's union was successfully renegotiated in April 1989, overcoming long standing problems that had limited management's freedom to run the company as a business. However, while in the case of road transport most of the important steps have already been taken, in the telecommunications sector some important reforms still have to be implemented. PART III - BANK STRATEGY A. Government Strategy 70. After six years of falling per capita income and a protracted stabilization and adjustment process, the Government's main objective is the restoration of sustainable economic growth. To achieve this objective, macroeconomic stability had to be consolidated and the burden of the country's external debt overhang had to be credibly reduced so as to restore investor confidence. The ongoing stabilization program has brought down inflation from an annual 159Z to about 202 in 1989. The debt rescheduling was also satisfactorily concluded in March 1990 (paras. 21-22); the debt package has been supported by the IMF and the 10, Presidential decree of November 17, 1989. Some of the services taken over by TELECOMM may be privatized, e.g. the small packet-switched network and the telex service. SCT's reservations network, also small, established in 1985 as a decentralized agency, would be privatized directly; a decree to this effect is being drafted. - 28 - Bank (an interest support loan for US$1.26 billion was approved by the Board on January 30, 1990; see report No. 5235-ME wlhich discusses in detail the debt agreement between Mexico and the commercial banks). 71. The Government has stated that growth must be private sector based, with the Government playing a supportive role by providing incentives for private sector investment and reallocating public spending to improve public infrastructure, alleviate poverty and solve long-neglected problems of the environment. To eliminate the anti- agriculture bias in the incentive and trade regime, the Government has resolved to adjust sector policies in agriculture, where reforms in the past have been lagging behind industry. To prevent inadequate service levels from becoming a bottleneck for renewed growth, infrastructure policies will assign prio.ity to the rehabilitation and maintenance of existing infrastructure (power, water, transportation, irrigation, etc.) and, where feasible, private sector investment will also be sought. The Government is also committed to equitable development and is emphasizing social sector programs, including health, nutrition, education, and rural development, and the budget for 1990 already includes a sizeable increase in the share of resources assigned to these sectors. These programs would be targeted to the truly needy, to reduce the social cost of adjustment and to address issues of structural poverty. On the environment, the Government has launched a major initiative to tackle high priority problems which have been affecting increasingly the health and living condition of the country's people and its economic growth potential. B. Country Assistance Strategy 72. Given such a comprehensive and balanced Government strategy, the Bank has a major role to play. Our assistance strategy is based on the highly successful partnership that the Bank has built up with the Government over the last few years. Through adjustment lending in support of structural reforms and increased sector investment lending, the Bank is giving a signal of confidence so that the inflow of external capital necessary for growth will be forthcoming. At the same time, adjustment lending and credit enhancement by the Bank in support of the 1990 debt package are helping relax Mexico's resource constraint that is stifling growth. thus playing a major role in helping the country break out of the macroeconomic and financial bind in which the country finds itself. That is the main rationale for sustained high levels of Bank lending with a robust conditionality. After FY91, as the conditions for growth have been restored, lending would shift away from adjustment lending to growth-oriented sector investment lending and to social and environmental projects. 73. In support of the Government's program to consolidate macro economic stability and to restore growth, the Bank's strategy would pursue the following objectives: (a) consolidation of the stabilization effort; (b) support of incentives for efficiencylprivate sector led growth, including the necessary infrastructure investments, particularly in transport, power, agriculture and urban services; (c) poverty - 29 - alleviation/improved social services; (d) environmental protection; and (e) secure continued access to external resources. 74. The above outlined assistance strategy and sectoral objectives will be implemented with the help of sustained high levels of Bank lending to Mexico over the medium term, which would be maintained at US$2 billion per year. Such high levels of new commitments would, of course, hinge on the maintenance of a consistent macroeconomic environment and on thie depth and quality of MexLco's further sttuctural reforms. As 61X of Bank lending to Mexico has been in support of adjustment and debt reduction in FYs88-90, it is the Bank's intention to cut back on quick-dinbursing adjustment operations and, in a manner consistent with the requirements of the recovery of economic growth, focus on sector investment operations which are designed to support agreed investment programs in high priority sectors. To keep resource transfers at adequate levels, the Bank and the Government are currently reviewing the requirements of time slice financing, which would be an essential feature of the sector investment operations. To help achieve the stated objectives of the Bank's country assistance strategy, the policy content of the proposed lending program would be directed at: fiscal issues, financial sector efficiency, domestic deregulation, trade and export development, subsidy control and pricing issues, improved public sector and parastatal enterprise management, decentralization and deconcentration of the public sector, social welfare and poverty programs, and envirounmental measures. As a result of recent high levels of Bank lending to Mexico, the Bank would, under the proposed US$2 billion annual lending scenario, increase its exposure by US$5.55 billion by 1994. Mexico's share in the Bank's total disbursed and outstanding loans would reach a peak of 11.82 at end-FY91 and decline slowly thereafter. C. Bank Rationale for the Proposed Loan 75. As noted in preceding paragraphs, the Government of Mexico has moved very far in the implementation of a program of adjustment designed to reduce the involvement of the public sector in activities which can be conducted more efficiently by private enterprises and to provide a liberalized legal and institutional framework which promotes private investment and competition. The reforms already implemented and supported by the Bank in the trade regime, financial sector and industry and the program of divestiture of public enterprises reflect these objectives, and the project now proposed complements and reinforces these adjustments efforts by extending them to two sectors of strategic importance: road transport and telecommunications. The e sectors provide services which are vital to business development and, particularly, to trade. As already discussed (para. 37), elimination of constraints to entry and of price controls in trucking have already taken place and deregulation of the automotive industry also is ahead of the agreed schedule (para. 41). In the case of telecommunications, the Bank played an important role in helping to shape the Government program, which goes far beyond what had been expected only one year ago. The privatization of TELMEX, one of the largest parastatals in Latin - 30 - America, and the opening up of the telecommunications market to private (including foreign) investment are unprecedented steps in Mexico. These measures, and the additional actions proposed under the project, would make transportation and telecommunications services much more efficient. They, therefore, justify the Batnk's assistance to the Government's decision to extend its adjustment efforts to transportation and telecommunications. Furthermore, the depth and comprehensiveness of the adjustment efforts that Mexico is undertaking and the need to help restore growth, still limited by a balance of payments constraint (at a time when access to external financial markets is still very constrained), justify a significant level of adjustment lending and provide the basis for having framed the proposed operation as a sector adJustment loan. D. Transportation 76. In the road transport sector, the proposed project would monitor the implementation of the deregulation measures already announced, and would promote additional measures, as outlined below: (a) Open Entry? Much progress has already been made in providing open entry into the transport industry by replacing restrictive concession requirements by a simple and open system of permit awards, eliminating corridor and freight center restrictions, opening access into cargo handling and drayage services and introducing competition in the movement of containers. Also, a plan of action has been developed under which the Government will seek agreement with every state where this is warranted to deregulate trucking within its jurisdiction. This is expected to be fully achieved by March 31, 1991. In addition, :mprovement of customs operations, which would have a high economic significance for international trade and trucking, would be sought under an Export Promotion Project which is now in an advanced stage of preparation. (b) Official Tariffs: On this important issue, all the actions that the Bank sought have been already taken, as tariffs are now freely negotiated by the truckers and their customers. (c) Highway Safety and Environment: While highway safety is an important concern in its own right, in the future attention to safety will be particularly important since the issue may be used as a justification for the reintroduction of trucking industry regulations. To improve highway safety, we have agreed with the Government on: - 31 - (1) completion of phase I of the study, which is already under way (para. 45), on vehicle sizes and loadings and initiation of phases II and III:111 and (2) the presentation of a satisfactory action plan to improve road safety, as a condition of second tranche release. To address the air pollution caused by trucks (para. 47), by second tranche release, the Government would issue satisfactory regulations requiring mandatory periodic inspection of trucks to monitor compliance with federal e ission standards. It is now expected that such inspections would be conducted through private service stations. (d) Pricing and cost recovery: (1) The analyeis of cost recovery from truckers indicates that they have not been paying for all the maintenance and improvements costs which they cause to the road network. One of the main reasons has been that the price of diesel did not include an adequate surcharge through which to recover costs. This distortion has now been partially corrected, but cost recovery is still only about 50Z and, consequently, further actions are still necessary to achieve full cost recovery (para. 48). The Government has now confirmed to the Bank its commitment to achieve full cost recovery. For second tranche release significant progress should have have been achieved through an increase of not less than 102 (in real terms) in the price of diesel fuel; and (2) To ensure that the distribution of cargo between competing modes (road and railway) is conducted on the basis of the "right' price signals (which is necessary to ensure an efficient allocation of investment resources between the modes), the Government has advised the Bank that it intends to adjust FERRONALES rates so as to align them with long run variable costs (para. 49). For second tranche release the Government should furnish to the Bank the study on railway rates initiated under the Public Enterprise Reform loan, which will provide an improved data base for rate setting. In addition, for second tranche release FERRONALES should have approved increases (to become effective not later than January 11/ Phase I refers essentially to data collection; phases II and III to the development of policy options. - 32 - 1. 1991) of not less than 252 (in real terms), or to long run variable cost levels, in the rates for the transportation of selected commodities and goods, which account for about 70? of the traffic. This increase would bring most of them to the required level, so that further real adjustment requirements would be limited to few commodities. (e) HiLhway maintenance: Since 1982 Mexico has been facing a mounting shortfall in highway maintenance, which will be reflected in increased operating costs for trucking in the coming years (paras. 51-52). To help address this problem, in 1987 the Bank made a US$135 million loan to finance a Highway Maintenance Projett (Loan 2875-ME) but the achievements sO) far have been very modest. Within a framework of fiscal discipline, much more can be done to address this problem than at present. Under the proposed project, the Government furnished a general policy declaration on the priority of maintenance expenditures over new construcLion and approved an increase of Mex$ 155 billion (i.e., about 40Z) in SCT's 1990 budget for highway maintenance activities. At negotiations, it was agreed that presentation to Congress of a satisfactory budget proposal for CY91 (which should further increase by Mex$ 45 billion over the revised CY 1990 level to Hex$ 475 billion in 1990 prices, and should also provide that at least 402 of the allocation for maintenance is for routine maintenance) would be a condition of second tranche release. E. Telecommunications 77. In the case of telecommunications, the Bank has an opportunity to play a valuable role at a critical juncture, when changes of a scope that would have been impossible to expect only a year ago are now being undertaken. We have a strong base to start from. First, a good high- level dialogue on policy matters has built up from 1988, and the Government's economic team, and now also SCT, are very interested in the views of Bank staff and consultants. Second, SCT and SHCP recognize that, should the Bank endorse the package of sector reforms and implementation plans, this would add confidence to potential (especially foreign) investors interested in TELMEX. Third, and perhaps most importantly, the Government is interested that the Bank help them in the critically important initial stages of reform implementation. The latter includes developing an effective regulatory process. Lastly, loan conditionality would add a degree of stability to the package of agreed reforms and initial implementation plans. 78. The progress achieved in the past few months towards developing new policies and defining the desired structure for the sector has been excellent and the key political commitments have been made. SHOP has taken firm control of the process of selling TELMEX and has appointed the investment bank that will advise them and conduct the sale, and a - 33 - satisfactory plan and timetable have been developed for this. A new franchise agreement and regulations for competition have already been drafted. However, SCT is still short of experienced staff and resources to address the development of sector regulation at an appropriate level and pace and consequently has engaged consultants, that will be funded under the proposed Telecommunications Technical Assistance project, to assist them in this field. 79. An effective regulatory process and the necessary institutional adjustments can only be built up over tinme and as experience develops among all major players. For example, price regulation for those services that TELMEX will continue to provide on a monopoly basis is likely to require development of cost accounting by TELMEX and related guidelines by SCT. Under price cap regulation (as used in the U.K. for British Telecom and in the U.S. for AT&T) it will still be necessary to review the caps from time to time, at which time the profitability (or lack thereof) of TELMFX will need to be taken into account. Even some of the formal changes (i.e., devise of dispute resolution procedures, including controversies over access and pricing) cannot be rushed. Although the current telecommunications law gives the government enough latitude to proceed with the planned reforms, at some point it will be necessary to prepare new legislation better suited to the new policies, but this may well be several years from now. 80. At negotiations, agreemenit was reached on the following conditions for the telecommunications sector: (a) Privatization. As a condition for second tranche release, there should be satisfactory further progress in the privatization of TXLMEX (which would be monitored against the plan already furnished to the Bank, which includes a timetable for the key steps in the process), including teceipt of bids for a controlling interest in the company as well as an award decision by the Government. (b) Regulation. Prior to second tranche release, (i) consultants should be engaged, under terms of reference satisfactory to the Bank, to assist SCT to develop its regulatory capacity, (ii) the Government should enact satisfactory regulations governing the licensing of telecommunications networks and services, and (iii) a satisfactory regulatory at a plan, that takes account of the recommendations of the consultants that have been engaged to assist SCT in thiz field, should have been furnished to the Bank. (c) Divestiture of SCT's Operations. Before second tranche release, a business plan for TELECOMM, including investment and financing plans until 1994, which should be satisfactory to the Bank, should be furnished to the Bank. - 34 X PART IV - THE PROPOSED LOAN A. Background 81. The Bank has had a close involvement with Mexico's transportation sector, dating back to the first highway project, approved in 1960. In that context, concerns about the net benefits of the regulatory framework for trucking were periodically raised and were topics of discussion during the annual reviews that took place under two Highway Sector Projects (one of which is still underway) and extensive sector work was conducted ove. a period of time spanning at least 15 years. Under the Industrial Sector Policy Loan, approved in June, 1989, it was agreed that the Government would conduct a comprehensive study to identify and remove impediments to competition and efficiency in the trucking sector and before second tranche release would complete the study and agree upon a plan of action for its implementation. hlowever, this was just one of a number of Issues that the project addressed, and it was not envisaged that the actions to be taken would be as far reaching as is now beitng proposed. 82. The Bank's dialogue on telecommunications issues has not been as close, but over the years we have periodically fielded missions to keep in touch with sector developments. In a succession of short missions from mid-1988, the Bank produced an issues and options paper which opened up the discussion with senior government officials, followed by a proposed 'minimum package" of sector reforms, which was also handed to the outgoing administration. This set the framework for the current programs, which go significantly beyond what had been envisioned under the minimum package. More recently, the Bank prepared a paper on issues in the implementation of the sector reforms proposed by the Government, and has been informally reviewing and discussing sector policies, TELMEX's franchise, and the process of privatization. B. Loan Objectives, Benefits and Risks 83. The proposed loan is part of a program of Bank support to the Mexican Government's objectives of promoting private sector development and increasing the efficiency and effectiveness of public sector institutions so as to enable the resumption of economic growth. The loan supports a program of reforms in two sectors (road transport and telecommunications) which have in common that they both provide a vital service to business activities in general and to external trade in particular. By providing an appropriate institutional and regulatory framework, the project is expected to spur competition, thus serving to increase the efficiency of communications services and--in the case of teiecommunications--greatly expand its coverage. Resource allocation would be improved through greater reliance on market forces, and (in the case of monopolies) on economic criteria for pricing. 84. The project would be cofinanced by IDB, which is expected to reco'umend a loan ot $200 million to its Board. IDBs processing is expected to follow that of the Bank. IDB has already completed its - 35 - appraisal of the project and Board presentation is scheduled for June/July 1990. Coordination between the two institutions has been close. 85. Th& project would be supported by a parallel free standing technical assistance (T.A.) loan for telecommunications of US$22 million equivalent. The T.A. loan would finance consultants to prepare plans for developing SCT's telecommunications regulatory capacity, including management and monitoring of the radio spectrum, as well as long term experts, training and equipment (computer hardware and software, and radio monitoring facilities) required for the first two years' implementation of these plans. The technical assistance loan would also support TELECOMM in its start-up phase. 86. At negotiations, the Government furnished to the Bank a policy letter, which is provided in Annex IV. The agreed policy matrix is also attached (Annex I). 87. If the objectives outlined in para. 83 are achieved, the benefits accruing from the project would be significant: the quality of road transportation would improve and costs would drop, benefitting users in general and particularly those which make more intensive use of transportation, such as those engaged in foreign trade. Also, competition in various telecommunications services should result in better quality services to consumers and greater receptivity to technological change, both of which should improve the ability of Mexican firms to communicate with and compete in world markets. In addition, private ownership of TELMEX should remove present financial and other constraints to a faster pace of sector growth, rapidly expanding availability of telephone and more advanced services. Furthermore, greater reliance on market mechanisms for price setting should improve resource allocation and eliminate a source of corruption. Finally, improved regulation and enforcement of safety and environmental standards and of weight loads should bring about security and health benefits to large segments of the population. 88. There are, however, risks which also deserve to be highlighted. First, it is important to ensure that the divestiture of the Government's controlling interest in TELMEX is *well" handled, since this is the largest parastatal to be privatized in Mexico and all aspects of the operation will be particularly scrutinized by opponents to the Government's privatization policies. Errors in this respect could jeopardize subsequent privatization attempts in other sectors. Second, the (,vernment does not now have staff with adequate experience to regulate public utilities, and the regulatory framework is still in an inception stage. The Bank and the Government should resist the urge to rush into solutions that have not been adequately thought through. Third, there are practical and financial limits to the pace at which investments in telephone services may proceed, even under private ownership. The Goverrment should avoid developing undue expectations, which later may result in disappointment with the result of privatization. - 36 - 89. The risks discussed above seem manageable, and are outweighed by the benefits of the proposed course of action. Of greater significance, however, may be the risks that either for external or internal reasons Mexico may be unable to stay the course of economic reforms. But even if that were to occur, which today does not appear too likely (even though there are still many uncertainties), the policy reforms that the proposed project would support would have a good chance of staying in place and yielding substantial benefits to the economy. C. The Borrower, the Guarantor and Project Implementation. 90. The Government has designated BANOBRAS as the borrower of the proposed loan, in line with its function as Mexico's official financial agent for infrastructure sector loans. The loan would be guaranteed by the Mexican Government, and SCT would be responsible for project implementation. D. Disbursements, Procurement, Administration and Auditing 91. The loan would be released in two tranches, of US$190 million each. The first traniche would become available upon loan effectiveness, and the second tranche after November 15. 1990 and upon the fulfillment of specific conditions for tranche release. The closing date of the proposed loan would be June 30, 1991. 92. The loan proceeds up to US$380 million would be relent on terms and conditions satisfactory to the Bank, and will be used to reimburse 100? of the CIF cost of eligible general imports (on the basis of a negative list that stipulates that goods subject to QRs, goods financed from other multilateral or bilateral sources, goods intended for luxury consumption or goods imported for military or paramilitary purposes, would not be eligible for Bank financing). 93. Retroactive financing, up to US$76 million (20? of the loan), for expenditures incurred since February 1, 1990 would be available. Both private and public sector imports would be eligible for financing. Individual contracts under US$5 million equivalent each would be (i) awarded by public sector agencies on the basis of their established procurement procedures which have been found acceptaable to the Bank; and (ii) awarded by private sector importers in accordance with established commercial practice and, when they are over US$1 million, providing evaluation and comparison of price quotations obtained from eligible suppliers from at least two countries, except where direct contracting is permissible under the circumstances described in paragraph 3.5 of the - 37 - Bank's procurement guidelines.AY Individual contracts exceeding US$5 millinra equivalent in value would be awarded following simplified IOB procedures in accordatnce with Bank guidelines. 94. Except for contracts awarded through simplified ICB, disbursements would be made on the basis of statements of expenditure (SOE) from Banco de Mexico detailing individual import transactions in each relevant period, and certifying their eligibility under the loan. The minimum value for each request for disbursement would be US$20 million equivalent and the minimum value of each import transaction would not be less than USS1O,000. 95. BANOBRAS would provide to the Bank quarterly reports prepared by their auditors, under terms of reference satisfactory to the Bank, verifying that all conditions governing the elligibility of the imports that the Bank financed during the period had been met. Detailed documentation evidencing expenditures claimed under SOE would be retained by Banco de Mexico and made available to independent auditors acceptable to the Bank. Complete auditors' reports would be submitted to the Bant within six months of the end of each fiscal year. E. Loan Effectiveness and Conditions of Tranche Release 96. Loan effectiveness would be conditional upon BANOBRAS entering into contractual arrangements with the Government, which are satisfactory to the Bank, for relending the proceeds of the loan. 97. Second tranche release would be contingent upon: (a) satisfactory assessment of the medium term macroeconomic framework (para. 27); (b) actions to improve road safety (para. 76(c)): (i) completion of Phase I of the study on vehicle sizes and loadings and initiation of Phases II and III; and (ii) presentation of a satisfactory action plan to improve road safety; (c) issuance of regulations requiring periodic inspection of trucks to monitor compliance with environmental standards (para. 76(c)); 121 Under the adjustment loans that were approved by the Board on June 1989 the Bank conducted a review of public and private sector procurement practices and found them to be acceptable. Because the time elapsed since that review was short, for this operation we conducted an update based on a representative sample of firms, which verified that our prior assessment remains valid. - 38 - (d) actions to further improve transport pricing and cost recovery (para. 76(d)): (i) satisfactory compliance with commitments to significantly improve cost recovery from trucks through an increase of 10 (in real terms) in the price of diesel fuel, and (ii) furnish to the Bank the completed study on railway rates, currently under way, and increase FERRONALES rates for cargo transport for selected commodities which account for about 702 of cargo revenues by not less than 252 (in real terms), such increase to be effective not later than January 1, 1991, provided however that rates would not be increased beyond the level of long run variable costs; (e) presentation to Congress of a satisfactory budget proposal for highway maintenance for FY91 (increasing by Mex$ 45,000 million, in real terms, over the revised 1990 !evel to an amount equivalent to not less than Mex$ 475 .lion in 1990 prices) and also providing that at least 402 of the budget would be for routine maintenance (para. 76(e)); (f) satisfactory progress towards the sale of a controlling interest in TELMEX, including receipt of bids and award decision (para. 80(a)); (g) engagement of consultants, under terms of reference satisfactory to the Bank, to assist SCT to develop its regulatory capacity, enactment of satisfactory regulations governing the licensing of telecommunications networks and services, and presentation of a satisfactory action plan to strengthen SCT's regulatory capabilities in telecommunications (para. 80(b)); and (h) presentation of a satisfactory business plan (including financial and investment programs through 1994) for TELECOMM (para. 80(c)). PART V - BANK GROUP OPERATIONS A. Sectoral Composition of Bank Lending 98. As of March 31, 1990, Mexico had received 121 loans from the Bank, amounting to US$15.4 billion net of cancellations and terminations; of these, 82 loans, totalling US$7.5 billion, were fully disbursed and US$2.7 billion remained undisbursed. The Bank's exposure was US$9.1 billion on a cash basis. The sectoral composition and policy content of past lending, as well as the design of major new lending operations, are discussed below for key areas of the Mexican economy in which the Bank - 39 - has been active over the years. Additional information on the portfolio is provided in Annex II. Agriculture 99. Because of the crucial importance of agriculture for the one- third of the country's population living in rural areas, some 27Z of the Bank's past lending has supported agricultural development, and nine operations are currently under supervision. The Bank's lending program in agriculture is aimed at: (a) helping correct the incentive regime in agriculture through gradual reductions in input subsidies and export controls; (b) promoting more efficient and rational use of natural resources supported by improved technologies and services; (c) generating employment-intensive investments in rural areas and effective assistance to small farmerss and (d) creating an integral framework for sound rural development. To support these goals, the Bank made a US$300 million Agriculture Sector Loan in FY88, and has since made a loan for investment in agricultural marketing and storage facilities, and another for forestry development. Additional operations are planned to support further policy adjustment in agriculture, technology development, rehabilitation of the irrigation infrastructure, including improved cost recovery and maintenance operations, and for food security and poverty alleviation. Trade 100. About 12? of past Bank lending has been for trade, and two loans remain under supervision. Two trade policy loans of US$500 million each were made in FY87 and FY88 in support of the Government's sweeping trade reforms. These operations supported the reduction of non-tariff barriers (quotas and official reference prices) and rationalization of the tariff system (reduced levels and dispersion). The Bank supported the development of non-oil exports through two export development operations in FY83 and FY87. These loans were intended to strengthen the supply response by Mexican industry to the new trade policy signals. A US$500 million Industrial Sector Policy Loan in FY89, the second tranche of which was released in early 1990, has supported additional trade measures designed to liberalize imports and rationalize the incentive regime in key subsectors. Further trade reform measures are under consideration, which would strengthen the temporary import regime, provide further support to indirect exporters, assure automatic access to finance by exporters under the various credit programs, streamline financial and administrative procedures, and seek further reductions in export controls. Industry and Finance 101. Some 281 of the Bank's lending has supported industry, and currently eleven projects are under supervision. The Bank's lending strategy for industry, covering small-and medium-scale industry, mining, the capital goods industry, industrial restructuring and technology development, is designed to support industrial restructuring, regulatory - 40 - reform, clarification of foreign investment rules, and export promotion to assure a vigorous supply response to trade liberalization and increased international competitiveness. The FY89 US$500 million Industrial Sector Policy Loan and US$500 million Parastatal Enterprise Reform Loan have provided support for policy reform in industry, for the more efficient management and privatization of public enterprises, restructuring of the fertilizer, steel, automotive parts, textile, and flower sectors, and other key private industrial subsectors demonstrating a capacity for undertaking integrated restructuring operations. In the financial sector, the Bank's operations have supported the strengthening of competition and the restructuring of financial intermediaries. An adljustment operation in FY89, the US$500 million Financial Sector Adjustment Loan, has been providing support for the liberalization of the financial sector, elimination of forced lending to the Government at subsidized rates, increasing competition among banks and brokerage houses and improving regulations in the banking sector. The second tranche release conditions have been met under all three adjustment operations. Infrastructure and Energy 102. Lending for transportation, power and water accounts for 22Z of the Bank's total in Mexico, with fourteen projects currently under supervision. Lending for infrastructure is focussing on institutional development (including attracting private funding to the sector), decentralization, more efficient public investment allocation, and improved cost recovery. Recent Bank loans supported urban transport and the power and ports sub-sectors. In the power sector, special importance was attached to the achievement of financial self sufficiency through improved pricing policies, to least-cost expansion planning and to the consideration of environmental factors in project selection and project implementation. In transportation, emphasis was placed on obtaining more realistic user fees and deferring all but the highest- yielding investment projects so as to permit a minimum of budgetary outlays. Proposed loans would support the Government's initiatives for private sector development, decentralization, cost-based pricing, and managerial improvements. Loans are at an advanced stage of preparation for water supply and sewerage, and urban transport. Housing and Others 103. The Bank has lent some 11Z of its total for tourism, urban development, housing and vocational training. Currently three housing loans are under supervision. Government housing programs are designed to improve cost recovery. A Housing Finance loan under execution is supporting graduated loan cost recovery linked to the income of final borrowers, thus ensuring a reduced drain on the budget. Another housing project, focusing on low-income beneficiaries, has recently been approved. - 41 - Social Sectors and Environment 104. The Bank is assisting the Government in redesigning public health, education, and human resource programs to make them more cost effective and targi'ed to meet the needs of the poor. A proposed health project would support decentralization measures, finance new primary health facilities, and strengthen professioual services. Similar initiatives are being pursued in education and nutrition. A pilot project in execution is improving the well-being of women in low-income areas. It includes the provision of piped water, health and educational services training for productive activities, and credit for launching new microenterprises. These targeted operations would be followed by broader programs, once the institutional conditions and capacity for project implementation can support a larger Bank presence. 105. The Bank is also preparing an air pollution operation in the Federal District, which would tackle urban transport related causes, and has amended an ongoing loan (Loan 2824-ME) to support immediate relief measures requiring investments. With strong Government commitment, other future operations would address industry related causes of air pollution in the Federal District, technical assistance for investment evaluation and institutional strengthening in the environmental area and strengthened environmental components in investment loans. Soil erosion and water conservation programs would also be supported. As soon as the policy framework and suitable institutional arrangements are in place the Bank would consider loans for sector-wide environmental programs in support of remaining policy issues. B. IFC Operations 106. The IFC has worked with the Bank to: (i) identify private sector investment opportunities likely to thrive in the current climate of growth-oriented adjustment and greater integration with the world economy; and (ii) assist in strengthening the country's capital markets through economic sector work and venture capital operations. As of March 31, 1990, the IFC had invested US$1,129.2 million in 40 companies in Hexico, of which US$782.3 million had been sold, repaid, or cancelled. Additional information on IFC's portfolio is provided in Annex II, page 2. PART VI - COLLABORATION WITH THE IMF 107. Bank/IMF collaboration has been close over the years, especially since 1982, when the Fund supported the Government to help address the underlying causes of the economic crisis. Since that time, the Government has benefitted from an extended arrangement of SDR 3.4 billion, a special emergency drawing for SDR 291 million after the 1985 earthquake, a stand-by for SDR 1.4 billion in 1986 and, in 1989, for an SDR 2.8 billion extended arrangement through 1992 and a drawing of SDR 453 million under the compensatory financing facility. Extensive consultations have taken place between Fund and Bank staff concerning - 42 - Mexico's economic situation and prospects, covering fiscal, monetary, financial and exchange and interest rate policies. 108. Since the approval by the Fund's Board of the current extended arrangement on May 26, 1989, consultations have continued between the two institutions to monitor macroeconomic performance, adjustment measures and further structural reforms so as to meet the objectives of the Government's agreed growth oriented program. To date, the Mexican Government has purchased under the extended arrangement an amount equivalent to SDR 1.45 billion, including SDR 466.2 million in augmentation of resources, based on economic performance through the end of 1989. A recent Fund mission to Mexico reviewed recent developments and policy intentions and prospects and agreed on targets for 1990. 109. The Fund has also contributed to Mexico's debt reduction program through the SDR 2.8 billion extended arrangement in the form of set asides and through an augmentation of the arrangement in an amount of SDR 466.2 million, equivalent to 40? of Mexico's quota. Set asides under the extended arrangement and the augmentation of resources amount to a total of SDR 1.3 billion, which is roughly equivalent to US$1.7 billion. Of this total amount, some US$1.2 billion had been released by early 1990. The remaining US$443 million would oe available early in 1991 and 1992, after scheduled regular consulte ions have taken place. These funds would be used for the collateral c interest payments of exit bonds, replacing a commercial bank bridg,- loan made available in early 1990 for purposes of credit enhancement under Mexico's debt package. PART VII - RECOMMENDATION 110. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank and recommend that the Executive Directors approve the proposed loan. Barber B. Conable President Attachments May 3, 1990 Washington, D.C. ANNEX I Page 1 of 4 MEXICO UEXICO - NW1 TR1WNDT AND TELECCUMICATIWS SECTOR ADJUSIfNT PRCJECT Policy Matrix Actions to be Taken ObieCtives Actions Already Taken by Second Trnache I. SCT 1. Improve the institutional A modernization unit has been set-up to arrangemnt., organization, undertake the reorganization. staffing and training for regulatory activities within SCT. . Developed and substantially Implemented * plan to reorganize SCT's functions In the trucking sector. Consultants should be engaged to strengthen SCT s regulatory capacity in the telecom _unicat;ons sector. Satisfactory action plan to strengthen SCT's regulatory capacity In the telecoemunications sector should be furnished II. Road Transport 2. Eliminate regulatory barriers Eliminated system of concssion. to competition and efficiency. Eliminated system of route restrictions. Eliminated systom of freight centers. Eliminated Multimodal's monopoly on multi- modal transport. . Eliminated restrictions to access Into cargo handling. . Eliminated restrictions on "maquiladoraes to own and operate their own trucks. ANNEX I Page 2 of 4 Eliminoted restrictions on return load;n of international containers. . Devoloped a plan of action to enter into trucking deregulation grseoments with all states. S. Allow trucking prices to be Eliminated 15S surcharge on imported determined by market forces, and goodC eliminate distortions on cost. . Eliminated Government involvement In sotting tariffs. . Eliminated preferential tax treatomnt for truckers. . Provided commitment to schieve full Increase diesel fuel prices by 10O cost recovery from truckers and Increased (in rel term) so es to dioesl price by C.8%. significantly Improve cost recovory from truckers. 4. 4. Ensure that the price of Provided commitment to odjust Furnish to the Dank a compl-ted competing mode (railways) is baed FERROMALES rates for key commodities to study of railway rates based on on econotic criteria), long run variable cost levels and economic criteria and increaso approved a More agile system for rate FERRONALES rates for key coodities. revision. Initiated study to lmprove which account for 705 of cargo data base for tariff setting decisions, revenue, by 25 (in real terms) or to long run variable costs; such increas to becomo effective not later than January 1, 1991. S. Improve allocation of highway Provided commitmont to Increase highowy exponditures. mintenance budgets, taking Into account macroeconomic constraints. Increased SCT'* budget for mintenance Submit budgot proposal for highway expenditures In 1990 by MexS 156 billion. maintenance for 1991, further increasing It by Next 46 billion (in real terms); of the total at least 401 should be for routine maintenance. ANNEX I Page 8 of 4 6. Improve quality and enforcement Strengthened group to coordinate saiety of necessary regulations for policies. safety, weight controls and environmont. Started study on vehicle sizes and Complete first phose and initiate loadings, second and third phases (policy recoamendations) of study. Present satisfactory action plan to improve road safety. Drafted regulations requiring periodic . Issue regulations requiring inspection of trucks to monitor periodic inspection of trucks to compliance with environmental standards monitor compliance with environmental and initiated a program to Improve fuel standards. quality. III. Telecommunications UZ M. Teeomniain L 7. Promote increased private Public announcement of policy goals in sector participation and sector, including promoting competition competition In telecommunications, and privatizing TELMEX. Engagement of investment bankers to handle sale of TELMEX's shares. Engaged foreign investment banker to assist in handling sale. Prepared program and timetable for handling privatization of TELMEX. Furnished a satisfactory draft franchise. Satisfactory progress towards sale of a controlling interest in TELMEX, Including receipt of bids and award decision by Government. ANNEX I Page 4 of 4 Awarded concessions for cellular telephony In Federal District and In rest of the country. Issue regulations governing the licensing of tolocomunications networks and services. S. Iprove resource allocation in . Rates oere adjusted in January 1990, the market for tolecoemunications reducing cross subsidies end incressing servieas. average lovol by 70X . Tax trer --'qt of seetor has been rea igned. 9. Improve the efficiency of . Decree setting up TELECOMM has beon sector Institutions. issud, and SCT's operating functions havo boon transforod to TELECOW. Furnished a statement of TELECOMM Furnish satisfactory business plan 4 policy and objectives. (including investment and financing) O for TELECOMM. IV. Macroeconomic Masngoent 10. Macroeconomic consistoncy. . Satisfactory assessment of the medium tem macroeconomic frauovork. - 47 - STAIUS OF BANO GROUP OPERATIONS IN MEXICO AN= II ____-__ ------__--_--_--__ --_--_ Page 1 of 2 A. STATEMENT OF OANM LOANS (As of March 81, 190) Amount In USS millon (les cancellation) Credit/ Fiscal ----------------- Loon No. Year Borrower Purpo Bank IDA Undicbursed 82 loans fully disbursed 7,489.68 Of which SECAL., SALa, and Program Loans a) Ln. 1929-ME 1061 BANOBRAS Rail way IV 149.88 Ln. 2428-ME 1984 SANOSRAS Highway Sector II 200.90 Ln. 2882-ME 1966 BANCOMEXT Trade Plcy Ln IS 600.00 Subtotal 849.88 Ln. 1706-5-ME 1979 NAFIN Irrigation 81.80 14.28 Ln. 18S8-S-ME 1980 NAFIN Irrigatlon 64.40 12.61 Ln. 2281-ME 1988 BANOBRAS Third Water Supply 100.80 19.02
Groupe de la Banque mondiale · President's Report
Mexico - Road Transport and Telecommunications Sector Adjustment Loan
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