Mexico - Power Projects

WOAN NO. 59 CONIDENTIAL COPY No. 51 INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT LOAN APPLICATION NACIONAL FINANCIERA, S.A._, AND COMISIONq FEDERAL DE ELECTRICIDAD REPORT AND RECOMENDATT;IOS OF THE PRESIDENT TO THE EhEnUTIVE DIRECTORS 'Washington,. D.C. January 1.991.  ITTERNATIOITAI Y 3Ai1 FOR RECOTSTCRUCTIONT A.iD DEVELOPMENT. NACIOT:hxAL FIT'NCIERA, S.A., AND COMISION FDERAL DE &L,CMIOIDAD CONTETS REPORT AYID R ECOMMEND)ATIONS OF TEE PRIESIDMINT TO TE E2ECUTI-E DIRECTORS OF ITE B.Ai Annex A. Copy of letter to The Mexican Ligii and Power Company, ILimited Annex 3, Draft of letter to Hlacional Financiera, S,A., and Comision Federal de Electricidad Aninex C. Statutory Loan Committee Report: Long- term Loan Annex D. Statutory Woan Committee Report: Short- term Loan AP ZMI IX I Drafts of Loan and Guarantee Agreements: Long-term Tioan APPEiDDIX II Drafts of Loan anC& Guarantee Agreements and Subsidiary Loan Agreement: Short-term Loan AFPE}1.5D3X III Recent Economic Developments in Mexico APPENDIX IV Appraisal of Mexican Power Projects C'har t 1 - Map Clart 2 - Diagram Annex I - C.F.2. Balance Sheet 1946 Arnnex 2 C- O.. 3alance Sheet 1947 Annex 3 Statement by the B3arnkts Ehi.igineering Adviser  CONIDETIAL INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMET REPORT AND REC001,ENDATIONS OF T4E, PRESIDENT TO TIM EXECTUTIVE DIRECTORS CONCERNIING PROPOSED LOANS (1) TO NACIONAL FINANCIERA, SjA.., AND COMIISION FEDERAL DE EL,CTRICIDAD (cOSION PROJECT), AND (2) TO NACIONAL FINANCIERA, S.A., AND COMISION FEDERAL DE EI.-CTRICIDAD (MEXLIGHT PROJECT), BOTH LOANS TO BE GUARANTEED BY THE UISITTZD I XICAi STATES 1. I submit herewith the following report and recommendations with regard to applications from Nacional .Finanq4era, S.A., (hereinafter referred to as UFinanciera") and Comision Federal de Electricidad (here- inafter referred to as "CFE.") for a long-term loan of ;;241100,000 and a short-term loan of `1QO,000,000, both loans Do be guaaranteed by the United Mexican States. part I - _istorcMal 2. In Februar,r 12948, The Mexican Light & Powfer Cor4pany, Limited, (hereinafter referred to as 111!ex-lightt) applied to the Banlk for a long term loan of ,23,689,200 to finance new electric pQwer plants and trans- mission lines to be operated by the Company and its subsidiaries in the Mlexico City system. This application was supported by the liexican Government,, which informed the Bank of its willingness to guarantee the loans. 3. on April 19, 1940, the Bank informed hiexlight thet it could not consider its application, until the Cormipany undertook to reorganize its capital structure,  -2 )4 On April 20, 1949, Financiera applied to the BanL for a long., tem loan of "'lO9,350>000 to finance the 194.7-1952 construction program of CFE. The Iem..can Government, through Financiera., informed the Bank of its willingness to guarantee the loan. 5. As a result of subsequent negotiations, the Bank informed Finapciera on November 5, 1948, that it was prepared to enter into irraTe- diate negotiations with representatives of the Mexican Government, Financiera, and CFE regardi.ngJ.twno ' *jc-s foll,ows: (a) a long-term loan in the approximate amount of '2h,000,000 to Financiera and CFD as co,obligors, to be guaranteed by the United I.1exican States, for the purpose of financinig certain projects of . CFE for the expansion of electric po-wer facilities; and (b) a shQrt-term loan in the approxirmate amournt of tll,500,000 to Financiera and CFE as co-obligors, to be guaranteed by the United 1\exican States, for the purpose ol financing equipment and material required for the program of L'exliEght, for the expansion of electric power facilities opera-ted by it and its subsidiaries in i.exico, the proceeds of such loan to be reloaned by Financiera and CFE to liexlight and its subsidiaries,., by means of a credit of the same maturity. 6. The final and Lormal application was embodied in a letter from Financiera dated December 18, 19489 requesting a long-term loan of $24,100,000 and a short-term loan of $10,000,000 to Fiiianciera. and CFE,  7s The authorized negotiators on behalf of Financiera have been Mr. Antonio Carrillo-Flores and Er. Alfonso Cortina, and on behalf of CFE, Ilr. Alexandro Paez-Urquidi. Part II - Description of Proposed Loans Borrowers 84 The co-borrowers will be Financiera, a corporation established under the laws of the United I4exican States oni June 3Q, 1934, and CFE1 a governmental agency created by a law of August 14, 1937e Guarantor 9, The blexican Government vill guarantee fully the payment of principal, interest (including comtmission) and other charges on the loans, Legislation specifically aluthorizing tihis guarantee has been enacted by the Lexdcan Congress, apd it is expected that it will be promulgated before the signing of the Loan and Guarantee Agreements, Amaounts 10 (a) The long-term loan (hereinafte:r referred to as "Comision project loan") will amount to '24l,l00,000, (b) The short-term loan (hereinafter referred to as 1tl-ex2ight project loan") nill amounlt to 102,000,O000 Purposes 11. (a) The proceeds of the Comision project loan (except for a portion estimated not to exceed '.l.,r5U000 to be applied to tlhe cost of assembling in Yexioo certain imported components of equipment) are to be applied to the financing of the foregn exchange cost of a program of e-.ansion, to be completed by the end of 195a, of hydro-electric and  steam power generation, transmission and distribution facilities owned and operated by CFE. Lost of the equipment and mnaterial is likely to be purchased in t'he U,S.A. (b) The proceeds of the Lexlight project loan (except for.a portion estimated not to exceed $j20Q,OOO to be applied to the cost of assembling in ,exico certain imported components of equipment) are to he applied to the financing of the foreign exchange expenditures iMn 1949 on account of equipmient and material required for the expansion program of IMiexlight and its subsidiaries operating ini M1exico, Most of the equip- ment and material is likely to be purchased in the U,S5AO Terms and Amortizat-ion Arrangements 12. (a) The amortization of the Comision project 'loan wvill be made in semi-annual payments, beginning February 1, 1953., in the amounts set out in ochedule 1 of the proposed Loan Agreemilent. These payments will retire the 'entire loan by maturity on August.l, 2973, i.e, in a period of nearly 25 years, (b) The Mvexlight project lana is repayable in full on December 31, 1b9h HoweveJr, by a letter dated December 31., 1948, of which a copy is contained in Annex t"Alt attached., the Bank has informned MeU,.ighb that it is the intention Qf the Bank to negotiate a long-term loan in the approximate amuouut of $26,OO,Q000 for the benefit of Iviexlight for the purposes of refunding the shorttermn boan and financing further foreign exchange expenditures of Mexlight in connection with its program, pro- vided that during 19049 M.Iexliaht shall effect a reorganization satisfactory to the Bank and tlhat. in the opinion of the 3ank, relevant conditions at the time w7arrant the malking of such a long,tem loan. Moreover, the Bank h..-  ploposes to wvrite a letter to Pinanciera and CFL substantially in the form of Lnnex "B "1 attached, stating,among other things,the intention of the Barik to negotiat,e an extension of the short-term loani, if for reasons relating to I;e;clight the Bank finds itself unable to malke the above-mentioned long-term loan, Interest and Commission 13. (a) The Comision project loan Will bear interest (including cor;uissior) at the rate of 4-1/2 per cent per annumt (b) The -YexliCht project loan will bear interest (including commission)at the rate of 4-1/2 per cent per annunrq (c) The commission provided for in Article IV, Section 4 (a) of the Articles of Agreement is not specified in the Loan Agreement as a separate charge as in previous loan agreements entered Into by the Bank. Instead, the rate of interest speciLied in the Loan Agreement includes commission at a rate of I per cent per anntwn, It is proposed that this comnission be established by the resolution of' the Executive Directors, and the Bankl -will accordingly set aside from interest received anad appro- priate to the Sr,ecial Re.serve an amount equal to commission at that .rate. The inclusion of the commission in the rate of linterest is desirable as a general practice; Lacilitating the resale by the Bank to private investors of bonds given by the borrowers under the Agreements ISf the bonds to be resold are issued under an indenture, the Bank will be able to attach the sanle security to the payment of cormnission as to the payment of interest and principal. This praQtice will also permit more flexibility in the sale of bonds without recourse,since the Bark will be able to qall for bonds bearing interest at a rate equal to the rate of interest on the loan includinig commission.  (d) A commitmenit charge will be provided for in accordance with the present policy of the Bank. Legal Instruments 14. (a) Appendix I contains drafts of the following legaJ instru- ments to be executed in order to give effect to the proposed Comision project loan. (i) a Loan Agreement betwveen Financiera and CFE of the one part, and the Bank of the other; (ii) a Guarantee Agreement between the United Mtexican States and the Bank. (b) Appendix II contai-ns drafts of the following legal instru- ments to be executed in order to -ive effect to the proposed 11exlight project loan: (i) a Loan Agreement between Financiera and CIE of the one part, and the Bank of the other; (ii) a Guarantee Agreement between the United MlYexican States and the Bank; and (iii) a Subsidiany Loan Agreement ;, Financiera and CFE of the one part, and I -exlight of the other,. (c) The forms of Loan Agreements and Guarantee Agreements follow in general the forms used in the Chilean Loan (Endesa Project) except for the special provisions referred to in paragraphs 13 above and 15 below and except for modifications in the Ilexlight project loan (e.g. the om4asion of any provision for amortization or for delivery of bonds) required by the fact that the loan is for one ygar only and the fact that the proceeds are to be reloaned to 11Iexlight.  Security and Debt Limitation 15. (a) The legal instruments contain the usual negative pledge provisions.,. No security will be rece.ired by the Bank from the borrQwers- in connection with either loan, except that under the VlMexlight prQject loan the borrowers will agree to hold, as security for the loan. the notes to be delivered by MIexlight under the Subsidiary Loan Agreement, (b) In each Loan Agreement C1E will agree that, unless it has the prior written approval of the Bank, it will not increase its out- standing indebtedness if as a result the total service charges on all its indebtedness, including interest and repayment of principal, in any year would amount to more than 66-2/3 per cent of its total revenues (excluding Federal Government appropriations) during the fiscal year iummediately preceding the date on which it proposes to increase its indebtedness, . Part III - Appraisal of Proposed Loans 16. A report on the economic situation in Idexico was distributed to the Board on October 11, 19)481 Comments on recent economic develop-! ment3 in lexico are set out in a memorandum attached as Appendix IIT. 17. A !fSumnmarvy of Electric Power Projects included in the Yexican Loan Applications" was circulated to the Board with the Secretaryts hlemorandum No. 447. 18. An appraisal of the projects to be financed by the proposed loans, and a description of th.e financial condition of - CFE are set out in Appendix IV.  A, The Need for a Loan 19. During the war and in the postwxar period, financial develop- ments in 1.exico followed, in general, the same patt,ern as in other Latin American countries. EJxport surpluses led to the accumulation of foreign exchange reserves, and a consequient growth of the moiney supply. Ileasuares taken by the Government to limit credit exrpansion wvrere only partially stuccessful. After the ver the release of the pent-iip demand for imports resulted in the loss of most of the accumnulated reserves. 20. There are, however, distinctive features in, the Lexican situa- tion. llexico has advanced beyond the stage of early development. This advance has been accompanied by progress towards a more mature and stable social structure. At the same time econoiiic activity has become diver- sfied,as reflected in the declining importance of mining relative to industry, while the pattern of trade has become relatively inflexible, In the long run further economic progress must, except insofar as new oilfields are developed, come from the intensified use of existing resources, 21. IEexi.co is faced with problems arising out of the rapid growth of population4, Therefore, not only must food production continue to expand, but industrialization must proceed in order to prevcnt a decline in the standard of living. To solve :exicoTs problems a high rate of capital formation is necessary. Hiolwever, here, as in other coluntriess the growth of savings is retarded by the low level of incomes and the inadeqpacy of the capital market. M.ilexican Governments have attermpted to fil1 the gap by financing extensive agriculbural, indut.rial and public utility projects through inflationary pub'ic finance, which has been the chief ca.use of the.maladjustment of the balance of payments,  22. In order to restore financial equilibriumn without interrupting economic development, iLexico's present defi4iency of capital formation must be supplemented by foreign invest.ment0 In recent years the Government, by offering the prospect of tax exemptions and unrestricted tr.nsfer of capital and profits and by coming to terms with the holders of defaulted debt, has induced some foreign enterprises to invest capital in Miexico, This flov; of foreign capi-tal has not, howvever, reached a volume sufficient to meet more than a small fraction qf the country's needs. At the present stage, therefore, the assistance of the Bank, in order to promote the con- tinued and orderly development of iJexico's resources, and to encourage a further influx of private capital, would be fruitful and in accordance with its aims. 23, 1 should not be disposed, however) to recommnend such assistance without previously having had some assurance from the Mexican Government that it intenads to take all measures reasonably within its power to re-establish financial equilibriutim The Government, in presenting its 1949 estimates to Congress, has reaffirmed the intention it announced in Oct. 1948 of balancing the budget by means of increased taxation, the limita- tion oL its program of public wvorks and the avoidance of further expansion of the public debt. 24. The peso exchange rate has varied only fractionally since August 1948. The Government has preferred to postpone declaration of a new parity until it could clearly see how far the current market valua- tion of the peso vwas real3,stic and not due to abnorraal and temporary factors, and until foreign exchange reserves had been restored to a working level. It has given assurance, however, of its intention to fix  10 - a new parity in consultation wvith the Internatimnal l;onetary Fund at the earliest possible timeo B. Effects of the Proposed Loans on the M4exican Economy 25. Study of the MA!exican economy reveals that one of the factors essential to the further development of the country, and one vhich requires considerable foreign exchange expenditure, is the provision of electrio power. The output of power has not kept pace wgith the growvth of popula- tion and the tendency towards industrialization. In the more developed areas, particulazly around L;exico City, shortage of power has already imlposed a bralke on the expansion of both domesti,c and foreign-ovwned enter- prises, while in other areas the provisionl of reliable sources of povwer is the essential condition of the modernization of agriculture and the development of associated processing industries. In LIe4:Lco, electric powrer has always been primarily applied to productive uses; even in the MIexico City area, writh a large well-to-do residential populatioi, 56 per cent of the power generated is presently used by industry and mnining0 It is estimated that from 60 to 70 per cent of the additional power to be generated as a result of the projects now under consideration will be used by industry and agriculture. This high proportion amply illustrates the productive character of the projects, 26. The CFE project will increase the generating capacity of J14.exco by 33 per cent and, when the Iexliyht project is compleated, a further 14 per cent vill have been addedJ Although these projeots wvill have no direct effect on the foreign exchange earnings of L.eic.uoi> `.;he increased industrial and agricultural production which they will make possible will in the long run improve the balance of payments.  27, CFB has prepared a program of electric powver expansion to be carried out during the period 194h?.1952. It has been estimated that the completion of this entire program would cost about $212 million, of which 51,20 million would be in foreign exchange. Part ofa $20 m-illion loan obtained for CFiE from the Export-nmport Bank in 1l94 was. unad.to?bagTh: the prqgxrame. Originally the Bank was approached by the M1exican Government with a request to finance the balance of the foreian cost of the program. After giving careful consideration to CFE's program, the Bank concluded that some of the projects were of less immediate urgency than others, and. that both on this ground and that of the large local expenditures involved, a decision to execute the entire program should be postponed in the pre- sent financial situation of M'e:sico, As a result of discussions betwreen the Bank, CFE,and the main private power companies operating in Lexico, the program has therefore been reduced to those projects which are most urgently needed and which are complementary to the development program of the private comipanies8 In the course of their visits to M1exico to study the CFE program, members of the Bankts staff have been impressed by the high quality of CFEts management and by the technical competence with which the engineering plans have beenl drawn up. 28. Since 1902, i;exlight and its subsidiaries have been the largest single enterprise engaged in the production and distribution of electricity in elexico. UntilJ recently. Meylight produced and distributed all the electric powrer used in the imsiportant i.e4ico City area. For some years this region, with its rapidly growing population and industry, has suffered from a shortage of power. To remedy this defi:ciency, CFE began the construction of the M.iruel Alerian hyrdroelectric system, of -.hlaich the  Ixtapantongo plant is already in operation, its output being sold to Iviexlight. Liexlight has proposed a three-year program of expFrnsion of generating and distribution facilities, iich has been approved by CIFE. The execution of this program has so far been delayed by the difficulty of securing the necessary capital. The B2nk has studied the 1.e,li,ht program and is of the opinion that it is on sounid engineering lines and that, in conjunction with CFE s own program, it represents the Pninimum ex:pansion necessary to make reasonable provision for the needs of the near future. Any postponerment of the ILexlight project would make necessary a corresponding additional expansion of CFEIs capacity and would also lead to a failure of distributive capacity to keep pace with generating capacity. 29. In view of the fact that nost of the local financing will be provided by the Government, the Bank, in deciding on the scale of the program which it should finance, has borne in mind the need to keep tlle financing at a level wshich would not add to the financial problems of the Government. The annual sums required for the local financing of the selected projects will not be larger than those in 1948 eXcept for f-unids which will be required by hexlight to supplement its own current revenues. In 1949 the supplementary requirements are estimated to be not more than 10,000,000 pesos. C, The Capacity for Repayment V,'i (a) Comi-sion Federal de Electricidad 30. A detailed analysis of CF-Zts financial situation, given in Appendix IV, (paras, 7h-81), shows t'hat after the complet,ion of the Comi- sion project.,the net proceeds of the sales of power and I'eceipts from the 10 per oent ele-otricity tax and other sources of reveniue are estimated to  - 13 - be adequate to provide pesos to rneet existing debt charges and the service of the proposed long-term loan, proviided a conservative policy is followed in incurring additional obligations, and there is no further appreciable depreciation of the peso. A speci.al provision limiting future borrowings of CFE without the consent of the Bank has been included in the Loan Agreements .*. (b) Nacional Financiera, S *A, 31. Since Financiera, according to a Resolution of the L