Mexico - Mining Sector Restructuring Project

Docunent of The World Bank FOR OFFCIAL USE ONLY Repot No. P-5512-ME NEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN IN AN AMOUNT EQUIVALENT TO US$200 MILLION TO NACIONAL FINANCIERA, S.N.C. WITH THF. GUARANTEE OF THE UNITED MEXICAN STATES FOR A MINING SECTOR RESTRUCTURING PROJECT MAY 30, 1991 This document as a resfticktd distributon and may be used by redpietas only in the performance of thetr officW dues Its cotents may vo oterwise be dicloed wtho4o Wodd Bank authorition.  CURRENCY UNIT PESO (MEXS) On May 20, 1991, the exchange rate in the controlled market was US$ Mex$2980.40; and in the free market US$1 = Mex$3002.00. The controlled exchange rate is currently being devalued by Mex$0.40 a day. FISCAL YEAR January 1 - December 31 WEIGHTS AND MEASURES Metric System PRINCIPAL ABBREVIATIONS AND ACRONYMS USED CETES Certificados de Tesoreria (Treasury Bills) CFM Comisi6n de Fomento Minero (Mining Development Commission) CRM Consejo de Recursos Minerales (Mineral Resources Council) DGM Direcci6n General de Minas (General Directorate of Mines) FFM Fideicomiso de Fomento Minero (Trust Fund for Mining Development) FRR Financial Rate of Return GDP Gross Domestic Product LIBOR London Interbank Offered Rate NAFIN Nacional Financiera, S.N.C. PFI Participating Financial Intermediary SMM Small and Medium Scale Mining Enterprise  FOR OMCIL USE ONLY MEXICO MINING SECTOR RESTRUCTURING PROJECT Loan and Proiect Summary BorroweI: Nacional Financiera, S.J.C. (NAFIN) G-.rsntor: United Mexican States Ixecutina Comisifn de Fomento Minero (CFM), Fideicomiso de Pomento A&Mcles:, Minero (FPM), Consejo de Recursos Minerales (CRM) and Direcci6n General de Kinas (DGM) &ggunts US$200 million equivalent. Term:s 17 years, including 5 years of grace, at the standard variable interest rate. Onlending NAPIN would relend the proceeds of the loan to the Guarantor Terms: and CRM. The Guarantor would further onlend to FPM the amount (US$191.5 million) to be relent through the commercial banking system to small and medium scale mining enterprises (SMMs). Subloans would be denominated in Mexican pesos or U.S. dollars at the option of the subborrower. The cost to FPM of peso funds would be the CETES (Treasury Bills) rate and the cost of dollar denominated funds would be the six month LIBOR (London Interbank Offered Rate) rate plus 0.5Z. The cost to participating financial intermediaries (PFF1) in pesos and dollars would be the respective rates plus an FFM fee, adequate to cover financial intermediation costs. For both peso and dollar denominated subloans PPIs would be free to set the lending rate to final borrowers. The Government of Mexico would assume the foreign exchange and cross-currency risks on peso subloans and the cross-currency risk on dollar denominated subloans. Financing World Bank US$200.0 million Plant Government US$ 66.3 million Beneficiaries US$148.9 million PFIs USS 21.3 million Total Cost US$436.5 million Rate of Eligible subprojects should have financial rates of return Return: (FRR) of at least 122, reflecting the cost of capital in the Mexican market. Staff Aperaisal Renort: Report No. 9428-ME MAD: IBRD 22988 This document has a restricted distribution and may be used by recipients only in the pvrformaw%e of their official duties. Its contents may not otherwise be disclosed without World Bank Xr-'. Ation.  MEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO NACIONAL FINANCIERA, S.N.C. WITH THE GUARANTEE OF THE UNITED MEXICAN STATES FOR A MINING SECTOR RESTRUCTURING PROJECT 1. The following memorandum and recommendation on a proposed loan to Nacional Financiera, S.N.C. (NAFIN) for the equivalent of US$200 million is submitted for approval. The proposed loan, which would be guaranteed by the United Mexican States, would have a term of 17 years, including five years of grace, with interest at the standard variable rate. The loan would help finance a mining sector restructuring project. 2. Background. Mexico is a country with vast mining potential. Its comparative advantage as a mineral producer includess a) polymetallic ores of high quality and high precious metal content, b) a wide range of exportable non-metallic minerals, c) a low wage structure, d) a broad base of experienced mine workers and professionals, and e) a strategic location next to its most important market, the United States, plus access to both oceans. This comparative advantage is so significant, that although exploration efforts to date have been relatively modest, Mexico is a major mineral producer and exporter. 3. Notwithstanding the above, mining is today a relatively small and declining see,-.r within the Mexican economy. Over the past 50 years mining output has decreased from 4.02 to 1.52 of GDP. Stringent policy barriers to entry to domestic and foreign investors, as well as a complex and discretionary regulatory framework, have impeded the realization of the sector's full potential by restricting private participation (e.g. 502 of the 12 million hectares of discovered mineral land are currently reserved for the State). This regulatory framework also resulted in a very bureaucratic and inefficient administrative structure in the public agencies that deal with the sector. 4. The Bank shares thr view of the Government that Mexico's mining sector has significant growth pi-.ential. Total annual exploration investment in the recent past is estimated at US$40 million; however, based on statistics from other countries, exploration investment could reach 8 to 102 of output value or about US$200 million a year, i.e. five times the current level. A comprehensive 1989 Bank study entitled Republic of Mexico-Hinins Sector Review (Report No.7379-ME), identified an inadequate regulatory and institutional f-amework as the major constraint to increased private investment and further growth. More specifically, the report states that increased access to land and mineral rights, reduced foreign ownership limitations, a revision of mining tax legislation, a restructuring of the existing institutional set up, and stabilization of the macroeconomic environment are the basic requirements to enable Mexico to more fully exploit its comparative advantage in the mining sector. The Government agreed with tne report's findings, began to implement key recommendations and requested Bank support in achieving a full transformation of the mining sector. 5. Rationale for Bank Involvement. In the more developed countries venture capital plays a major role in financing mining exploration and thereby sector  - 2 - growth. In Mexico no such market exists for small and medium scale mining enterprises (SMMs). The Bank has partially filled this gap through two operations, the First Small and Medium Scale Mining Project (Loan 1820-ME) for US$40 million in 1980 and the Second Small and Medium Scale Mining Project (Loan 2546-ME) for US$105 million in 1985. These projects made available almost US$145 million in term credit facilities to the sector, which provided SdMs with access to otherwise unavailable long term investment financing. 6. Mexico's financial sector is undergoing a major reform. It has become essentially market oriented, with the Government phasing out subsidized interest rates and first-tier lending by development banks and trust funds. Moreover, initial actions to privatize the commercial banks have been taken, a process that is expected to be completed in about two years. During that period and for sometime afterwards the newly privatized commercial banks are likely to be reluctant to engage in lending to sectors with a limited track record to assess risks, in particular to a sector like mining, which is itself undergoing major policy reforms. This situation justifies the proposed Bank loan, that would provide credit to the mining sector during the transitional period until commercial banks become actively engaged in funding mining operations. In line with present Bank policy on directed credit, this loan is expected to be the last line of credit operation for mining to Mexico. 7. Project Obiectives. The proposed project would help transform mining Into a modern and dynamic sector of the Mexican economy. The main objectives of the proposed project are to: a) support the Government's program to deregulate the mining sector and stimulate private domestic and foreign investment, through the establishment of an appropriate policy and institutional framework; b) build broader financial market support to the mining industry; and c) help finance the surge in demand for investment funding that is expected to result from the improved policy and institutional setting for mining operations. 8. Prolect Descrigtion. To accomplish its objectives the proposed project, in addition to providing financing for SMVs, would support the following policy changes and institutional reforms in the mining sector: (i) liberalizing private sector access to land with mineral potential and releasing state-held mining reserves; (ii) reducing barriers to foreign investment in mining enterprises; (iii) implementing a mineral rights policy that is conducive to an improved allocation of resources; (iv) reforming the system of mining concessions; (v) phasing out state ownership of enterprises in the sector; (vi) modernizing the government agencies providing support to small and medium scale mining enterprises; (vii) establishing environmental standards for the mining sector; and (viii) phasing out direct Government financing of mining activities. 9. The proposed project has a significant technical assistance component that would help improve the capabilities of DGM, CFM and CRM to perform their new roles more effectively. Activities to be carried out under this component include: a) the, modernization of DGM's system of mining administration and control; b) two studies, one to evaluate the results from the recently introduced changes to mining regulations and the other to explore the possibility for further policy adjustments; c) the establishment of industry- specific environmental standards for mining; d) the training of CFM personnel to improve their project evaluation and supervision skills, and to increase  their environmental knowledge and expertise; and e) the upgrading of CRM'8 capability to generate, process and divulge geological information. 10. Proiect Cost. Financinx and Implementation. The proceeds from the Bank loan would help SMMs finance investments in metallic and non-metallic mining subprojects f'or an estimated total amount of US$436.5 million equivalent, including project related technical assistance in the amount of US$11 million. The proposed Bank loan would finance 462 of total project costs, the remainder would be covered by the beneficiaries (34%), CF4 (15%) and the PFIs (5%). The proposed project would provide financing for: (i) a credit component of US$191.5 million, to help fund subloans to SMMs for the acquisition of fixed assets (including pollution control equipment), permanent working capital and the development of existing mineral reserves; and (ii) technical assistance of US$8.5 million, mainly to help fund institutional strengthening programs for DGM and CRM. 11. NAFIN (the Borrower) would relend the proceeds of the loan to the Guarantor and CRM. The Guarantor would further unlend to FFM the amount allocated to the credit component, which would be relent through the PFe1 to SMMs. CFM would act as project coordinator and would therefore be the main interlocutor with the Bank on project implementation. Retroactive financing of eligible expenditures incurred since September 10, 1990 (the date of project appraisal), up to a maximum amount of US$20 million is recommended. The detailed cost estimates and financing plan are shown in Schedule A. Procurement of goods and works, as well as the engagement of consultants would follow Bank guidelines. The procurement method and disbursements are shown in Schedule B. A timetable of key project processing events and the status of Bank and IFC operations in Mexico are given in Schedules C and D, respectively. 12. Main Actions Taken and Aareed Upon. The Government has issued a new "Reglamento" (implementing regulations) to the Mining Law which, inter alia, liberalizes private sector access to land and provides for the release of state-held mining reserves, permits majority foreign investment in mining enterprises and establishes a modern mineral rights policy. Any material change to the "Reglamento" that could adversely affect achievement of the project's objectives or any occurrence that would prevent its implementation would be an event of default. 13. Agreement was reached during loan negotiations with the Government, NAFIN, CFM and CRM1, inter alia, on: (i) undertaking two studies to evaluate the effectiveness of the new regulatory framework and to provide the analytical basis for any further policy adjustments in the future; (ii) implementing a comprehensive five-year business plan for CFM, that includes a policy statement, a five-year financial plan, a business plan for its beneficiation plants, a program to deal with its problem portfolio and a commitment to progressively reduce the scope of CFMEs first-tier lending; (iii) implementing a suitable five-year business plan for CRM, that includes a policy statement, and programs for aerial reconnaissance, the modernization of laboratory services and for the establishment of a computerized information network; (iv) undertaking a program to attract commercial banks to financing mining projects, particularly in the metallic subsector, and requiring commercial banks to contribute an increasing share of their own resources to finance eligible subprojects: rising to at least 202 by July 1, 1994; (v)  -4 providing the Bank an environmental impact statement for every subproject before any subloan is approved, strengthening CFM's environmental capability and establishing satisfactory environmental standards for the mining industry by June 30, 1992; (vi) the technical assistance component of the project; (vii) the applicable relending term and conditions; and (viii) conducting a joint annual review with the Bank to exchange views on the progress of the project and assess the need for further measures to achieve its objectives. A condition of effectiveness would be that contractual arrangements for the transfer of loan proceeds between RAFIN, the Guarantor, PFM and CRM, which are satisfactory to the Bank, have been signed and are legally binding. 14. Benefits. The proposed project would help develop Mexico's mining sector, which is believed to have strong growth potential, in an environmentally sound manner. The recent changes in the regulatory framework providing for increased private sector access to land and mineral rights, and for the streamlining of concession procedures and majority foreign ownership of mining firms, should result in higher investment by private domestic and foreign companies. Furthermore, the reorientation of the sector's policies and public institutions in favor of activities that directly support private mining exploration and exploitation, and the increase in commercial bank lending for mining operations that would be expected to be initiated by the project, should also lead to higher investment in the sector. Increased investment would in turn result over time in higher mining output, exports and employment. Moreover, the establishment of environmental standards for the mining industry should help ensure that the sector's development is sustainable. 15. Risks. Policy reversals, which would be the main concern to private investors, seem unlikely given Mexico's impressive and sustained efforts to open up and deregulate its economy. Hence, the main project risks relate to issues that could adversely affect loan disbursements: a) continued low international metal prices; b) an overvalued exchange rate; and c) lot-or than expected commercial bank participation in lending to mining, particularly during the coming years when these bunks are to be privatized. The potential negative impact of these risks is, however, ameliorated by the fact that Mexico is a low cost mineral producer, the Government has export promotion as a key objective of its economic policy, and CFM/FPM has been succesful in the past in attracting commercial banks to finance non-metallic mining operations. Moreover, the proposed loan amount is based on a conservative demand estimate for financial resources. In this context, the risks faced by the project are considered acceptable. 16. Recommendation. I sm 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 Washington, D.C. May 30, 1991  Sghedulpe A MINING SECTOR R$STRUCTURING PROJECT ESTIMATED COSTS aND FIUNMNING PLAN Etimnated Coat,s s Local Freltn Total (Millions of U.S. Dollars) Equipment 114.0 191.5 305.5 Civil Works (Mine Dev.) 58.0 7.0 65.0 Working Capital 31.0 31.0 Exploration 21.0 3.0 24.0 Technical Assistance 2.5 8.5 11.0 TOTAL 226.5 210.0 436.5 Financins Plans (Millions of U.S. Dollars) Beneficiaries 138.9 10.0 148.9 World Bank - 200.0 200.0 Government (CPM) 66.3 - 66.3 PFI. 21.3 21.3 TOTAL 226.5 210.0 436.5  -6- Schedule B MINING SECTOR RESTRUCSURING PROJECT PROCUREMENT MIETHOD AMD DISBUR3EMENTS I Procurement og Goode and Works under the Technical Assistance CM2Nmfift. The participating institutions (CRM and DGM) would have the responsibility for ensuring the competitiveness, in price and qualitv, of the items procured and their suitability for the purpose inteaded. Consultant services financed with loan proceeds would be open to international recruitment, and corresponding Bank guidelines would be applied. Goods and works estimated to cost per contract: (i) less than US$50,000 would be procured under local shopping, provided, however, that the aggregate amount for wotk. does not exceed US$250,000, (ii) between US$50,000 and US$250,000, would be procured under local competitive bidding; and (iii) more than US$250,000, would be procured under international competitive bidding according to Bank guidelines. 2 Procurement of Goods and Works under the Line of Credit Coonent. Contracts estimated to cost US$5 million or more vould be procured under ICB procedures, in accordance with Bank guidelines. Contracts estimated to cost between US$1.5 million and US$5 million equivalent, would be procured through shopping procedures acceptable to the Bank, requiring at least three responsive price quotations from eligible suppliers. For contracts costing less than US$1.5 million, procurement would be done under established commercial procurement practices acceptable to the Bank. In all cases, a preference margin of 151 or the applicable duty, whichever is lower, may be granted to local producers under ICB contracts for goods, in accordance with Bank guidelines. 3 Prior Review of Procurement Decisions. Procurement documentation for all ICB contracts for goods and works would be subject to the Bank's prior review. In addition, the procurement documentation for the first three contracts for goods and works under the line of credit component, estimated to cost US$1.5 million or more but less than US$5 million equivalent, and the first three LCB contracts under the technical assistance component, would also be subject to the Bank's prior review. 4 Disbursement. In order to facilitate project execution, a Special Account would be opened and maintained in US dollars, with an initial deposit of US$20.0 million. NAFIN, as financial agent of the Government, would manage withdrawals under the Loan, including the Special Account. Withdrawal applications would be made on the basis of statements of expenditures for contracta costing less than US$1 million. NAFIN would ensure that all supporting documentation is adequately maintained and made available for review upon the Bank's request. NAFIN would be required to submit to the Bank a monthly statement of the transactions of the Special Account, it would also be responsible for compliance with the corresponding audit requirements. Estimated Disbursements: FY92 FY93 FY94 FX95 PY96 Annual 50.0 40.0 45.0 45.0 20.0 Cumulative 50.0 90.0 135.0 180.0 200.0  -7- Schedule C EXICO MINING SECTOR RESTRUCTURING PROJECT TIMETABLE OF REY PROJECT PROCESSING EVENTS (a) Time taken to prepares 24 months (b) Prepared by: Government, Nacional Financiera, Comisifn de Fomento Minero and Consejo de Recursos Minerales (c) First Banik missiont May 24, 1989 (d) Appraisal mission departure: September 9, 1990 (e) Negotiations: May 8-16, 1991 (f) Planned date of effectiveness: July 15, 1991 (g) List of relevant PCRs and PPARss First Small and Medium Scale Mining; Development Project (Loan 1820-ME)  - 8 - STAUS T AM Of mu .0W 0 SItMS Dl 10 s8beule D .,.... ..............,... ,......................... ............. _ A. STATW or gm LOA Cv"tti fiscal.................................... (A e6 NrIbtc 31, 1991) Aont in 0$ millin (Ieee cauecll tion La" Be. Tear Borrower Purpoec ank IA Undiebureed ..... .... _ ..... . 1 ;. ; ............ ._ _.__.__............. _______.____. .. ......... . ... ..... _..._ of loen. fully diJbursed 8,384.21 Of uhthb SALc, SALe. Program Loans, end Interest Support s3 La. 1i4M 19Se aB*ROS Railway IV 140 8 Li. 268241 1968 BANUOl Trade Policy La I1 500.00 Lu. 292846 1986 RAM APric Sector Lon 300.00 Le. 313946 1990 U68CCIT tnteract Support Loam 1.260.00 Subtotal 2-- 09.- 8 Ln. 1706e341 1979 NWFIN Irrigation 81.60 6.93 Lu. 1838.5d4 198o KAFIX Irrigation 64.40 6.72 La. 34384d 1964 368345 higebayc 300.00 47.64 La. 24304m 1984 SANPES Ports 38.25 14.32 Lim. 23264d 1985 NUIN Chipasc Aric. Dev. 38.00 33.21 Lu. 2546dm 1985 NUIII Salld miming It 105.00 3.27 Lu. 23594m 1985 Wm3l Vocational Iduc 61.00 1.96 tn. 2573dm 1985 BA683S Railways V 300.00 60.08 LU. 265386 1986 S" Proderith It 88.30 66.40 Li. 2663dm 1986 BN0S* Earthquake Rehab. 600.00 0.45 Li. 2666dmR 1986 B36036S ielpal Strength. 40.00 35.49 Li. 2e694M 1986 BA0OS0 Solid Waste Pilot 35.00 16.32 * Lu. 2745dm 1987 SBOt= Trade Policy Locn I 500.00 5.59 Lu. 27464d 1987 3IUII tudtrial RFeovry 150.00 14.49 iu. 27474d 1987 m0u1 Teenology DOV 4S.00 25.75 Lu. 2777d4 1987 368C0KT Erport Dv It 2350.00 7.81 L*. 2414dm 1987 B36O36 Urban Ttranport 125.00 62.42 Lu. 28574d 1987 win Agricultural Credit 400.00 4.57 La. 2858dm 1987 DIN SSaled Industry IV 100.00 53.10 Lu. 2839dm 1987 WAul Agric Isteuion *0.00 10.90 Lu. 2875d4 1987 36S80336 Nighasy Iaint 135.00 114.93 Lu. 28764d 198 IN Nanpowent Training S0.00 34.66 lu. 29164dm 1988 NAM Steal Setr Restruct. 325.00 162.34 a la. 29194d 1968 PD1 Fartilixer Sctr Lon 265.00 98.20 La. 29461N 198S B36036 Ports Rehab 30.00 32.21 Lu. 29474m 1988 B402S Rousing Punce 300.00 28.09 La. 30474d 1989 I Industril Recttuct 250.00 163.66 Lu. 30834M 1989 NUD Bydroelactric Dev 460.00 376.81 a Lu. 306541C 1969 1ANCOT Financial Sctr Loan 487.14 2.03 * ?A. 30646m 1989 Wlli VUblic But 3e*truct 500.00 0.71