Mexico - Second Power Sector Project

RESTRICTED fiLE CR Y Report No. P610 This report was prepared for use within the Bank and its affiliated organizations. They do not accept responsibility for its accuracy or completeness. The report may not be published nor may it be quoted as representing their views. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO COMISION FEDERAL DE ELECTRICIDAD (COMISION) AND NACIONAL FINANCIERA, S.A. (NAFIN) FOR THE SECOND POWER SECTOR PROGRAM June 12, 1968  INTERNATIONAL BA4K FOR RECONSTRUCTION AND DEVELOPIPNT REPORT AiD RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO COIISION FEDERAL DE ELECTRICIDAD (COlMISION) AND NACIONAL FINANCIERA, S.A. (INAFIN) FOR THE SECOND POW-ER SECTOR PROGRAM 1. I submit the following report and recommendation on a proposed Loan in an amount in various currencies equivalent to US$90 million to Comision Federal de Electricidad (Comision) and Nacional Financiera, S.A. (Nafin). PART I - HISTORICAL 2. The Bank has now made a total of eight loans for power expansion in Mexico totaling about $365 million, net of cancellations. Six of the eight power loans have been made to the Comision. The most recent power loan for $110 million, was made in 1965 to the Comision to help finance the 1965-66 expansion program of the entire Mexican power sector. The project was subsequently expanded to permit the use of the loan to help finance works started in 1967. Disbursements under the loan were completed in April 1968. 3. Initial discussions with the Bank regarding a further power loan to Mexico, to help meet the large and continuing needs of the power sector's expansion program, took place in the fall of 1967. An appraisal mission visited Mexico in March 1968. Negotiations were held during May 27-29. Negotiators from Nafin were headed by Dr. Alfredo Navarrete, Director, and from the Comision by Lic. Guillermo Martinez Dominguez, its Director General. 4. The proposed loan would increase the Banic's lending to YMexico to $768 million (net of cancellations). Mexico has received no IDA credits. The following is a summary of Bank loans to Mexico (as of May 31, 1968):  -2- Loan Year Borrower Purpose Amount (US$ Million) Bank Undisbursed 1949-1965 Loans fully disbursed 496.6 nil (less cancellations) 336-ME 1963 Nacional Financiera, S.A. Irrigation 12.5 5.1 354-MiE 1963 Nacional Financiera, S.A. Roads 39.3 2.8 401-HE 1965 Caminos y Puentes Federales de Ingresos and Nacional Financiera, S.A. Toll Transport 32.0 14.1 Facilities 430-kIE 1965 Nacional Financiera, S.A. Agricultural 25.0 7.3 Credit 450-ME 1966 Nacional Financiera, S.A. Irrigation 19.0 16.7 527-ME 1968 Nacional Financiera, S.A. Irrigation 25.0 1/ 25.0 528-ME 1968 Nacional Financiera, S.A. Roads 27.5 27.5 Total (less cancellations) 676.9 0O which has been repaid to Bank and Others 130.5 Total now outstanding 546.4 Amount sold 46.6 Of which has been repaid 33.4 8.2 Total now held by Bank 538.2 Total undisbursed 99.0 1/ lNot yet effective.  - 3 - 5. Construction and procurement financed under outstanding lonns have generally been proceeding satisfactorily. A part of the construction in one district financed under the 1963 irrigation loan (336-NE) has been postponed pending completion of studies to improve drainage and cropping patterns. Construction under the 1963 highway loan (354-ME) is now expected to be completed in mid--1969, two years behind schedule, mainly because of delays caused by unusually heavy rains, limited budgetary allocations and larger volumes of work than had been originally estimated on the basis of preliminary engineering. Construction of one road under the 1965 toll transport facilities loan (01-M'E) has been delayed pending further studies and an extension of the closing date is likely to be necessary. 6. A project for the continuation of the Agricultural Credit Program is likely to be ready for appraisal later this year. 7. IFC's total commitment to Mexico amounted to $29.0 million as of May 31, 1968, comprising $6.5 million of operational investments and $22.5 million standby and underwriting commitments. From this total commitment the Corporation held $4.6 million made up of $1.4 million in loans and $3.2 million in equity. PART II - DESCRIPTION OF THE PROPOSED LOAN 8. The main characteristics of the proposed loan would be as follows: Borrowers: Comision Federal de Electricidad, a public agency charged with the develop- ment of electric power in Mexico; and Nacional Financiera, S.A., a financial agency of the Mexican Government which, under the existing Mexican legislation, has to be the borrower or co-borrower of Bank loans. Guarantor: The United Mexican States Amount: The equivalent in various currencies of $90 million. Purpose: To help finance the continuing expansion program of the power sector. Amortization: 20 years: with no repayments during the first h years; semi-annual installments beginning June 1, 1972, to retire the loan June 1, 1988. Interest Rate: 6-1/h% per annurn. Commitment Charge: 3/4 of 1%.  - 4 - PART III - THE PROJECT 9. An appraisal report entitled "Appraisal of the Investment Program of the Electric Power Sector"' (TO-661) is attached. 10. The project is the continuing expansion program of the Power Sector in Mexico, consisting of facilities under construction on April 1, 1968, or expected to be started in the following twelve months. It includes not only the program of the Comision, which has overall respon- sibility for power development in Mexico, but also that of Compania de Luz y Fuerza del Centro (Centro), which still administers the distribution system in Mexico City and its environs. The loan would be made to the Comision, with a portion to be re-lent to Centro, on the same terms as the Bank loan, for parts of the project. 11. The project consists of the installation of new generating, transmission and distribution facilities, as well as a program for rural electrification and the first stage in the conversion of the 50-cycle system in the Mexico City area, to 60-cycle frequency. It will include completion of facilities under way and commencement of new ones. It is based on tlhe long-range power sector expansion plan which is reviewed periodically by the Bank and by CFE's engineering consultants, SOFRELEC. The facilities proposed to be financed under the loan represent the best means of meeting the power requirements of each system. The list of fa- cilities eligible for financing, which would be subject to modification by agreement with the Bank, is presented in Annex 10 of the Appraisal report. A supplementary letter on the Expansion Program, which summarizes procedures for detailed planning and review of the expansion program, is being distributed separately, along with the draft Loan and Guarantee Agreements. 12. The proposed Bank loan would consist of: (a) $75 million to help to finance the foreign exchange costs of needed equipment; (b) $13 million to assist in financing the foreign exchange component of civil works; (c) $2 million for consulting fees and training expenses payable in foreign exchange. It is proposed that the Bank reimburse the borrower for eligible expenditures for the sector's continuing expansion program made prior to the approval of the loan but no earlier than April 1, 1968, when Loan 436-ME was practically completely disbursed. The amount of reimbursement is not expected to exceed $15 million. 13. A special feature is that financing of equipment would be provided jointly by the Bank and financial institutions in major equipment supplying countries under an understanding agreed upon in Paris last  October. Under this arrangement joint lenders will finance one-third of individual orders of $200,000 or more placed in the participating countries, provided that such orders total $1 million, and the Bank will finance the remaining two-thirds, as well as covering the entire cost of smaller orders. 14. The loan would be divided into two segments. The first, involving approximately $71 million equivalent (together with approxi- mately $13.3 million to be made available under joint loans) is intended to help cover payments from April 1, 1968, through March 31, 1969, for construction and consulting fees, transmission and distribution equipment, and generating equipment to be delivered within a relatively short time. This segment thus follows the pattern of Loan 436-IE which provided finance for the sector's payments during a two-year period. The other segment, involving approximately $19 million equivalent (together with approxima- tely $9.0 million equivalent to be made available under joint loans), would cover the full price of selected items of major generating equipment having a relatively long delivery time; the flow of payments by the power sector for these items is expected to continue until late 1970. The program to be financed under this loan involves significantly more generating capacity than previous years' programs, and Comision has been reluctant to place, and suppliers to accept, orders for suchi long-delivery equipment without being assured that they were fully financed. I therefore consider it appropriate that part of the loan be allocated to financing the entire cost of designated major generating equipment in combination with joint loans. 15. Equipment to be financed under the loan would be procured under international competitive bidding, both abroad and in Mexico, with a 15 percent maximum preferential margin for Mexican firms, as authorized in the case of previous power loans to Mlexico. Bank financing of equipment procured in Mexico would be limited to the foreign exchange component, estimated to be 50 percent. Civil works contracts with an estimated value greater than MIex.$20 million would, as in the case of the two previous power loans to Mexico, be awarded on the basis of international competitive bidding. 16. Performance during the period of the most recent loan has been generally satisfactory. Consolidation has progressed, with all public power supply entities in Mexico now merged into Comision except Compania de Luz y Fuerza del Centro (Centro). There has also been closer cooperation betwieen Centro and Comision on operational matters and Centro has made significant internal operational improvements. The major problem of per- formance has centered around the frequency unification, which calls for the conversion of the 50-cycle Centro system to the 60-cycle frequency of the rest of Mexico. During the negotiations agreement was reached on a schedule for completing the necessary preparatory work and proceeding wzith the first phase of conversion. 17. The financial position of the power sector has been improving steadily and the rate of return on the consolidated net fixed assets was 8 percent in 1966 as required under the tariff commitments of Loan 436-ME and exceeded this requirement in 1967. In combination with rising internal cash generation, joint loans,and other external borrowing, a Bank loan of  - 6 - $90 million would be appropriate to meet the financing needs of the power sector on the basis outlined above. Under the current financing plan external fi- nancing would cover 43 percent of the financing of the construction program. As in the case of 436-ME, a term of 20 years is recommended for the Bank loan; in view of both the sectorts medium-term debt burden and the Government's total external debt service burden during the next several years, a 4-year grace period is again recommended. PART IV - LEGAL INSTRUMENTS AND AUTHORITY 18. The draft Loan and Guarantee Agreements, as well as the Report of the Committee provided for in Article III, Section V(iii) of the Articles of Agree- ment of the Bank and the supplementary letter on the Expansion Program, are being distributed to the Executive Directors separately. 19. The provisions of the Loan Agreement generally conform to the pattern of loan agreements for similar projects. Special features are: (a) The borrowers agree to make their best efforts to obtain and utilize for the project joint loans from financial institutions outside Mexico in such amounts and on such terms and conditions as shall be satisfactory to the guarantor, the Bank and the borrowers (Section 5.15). The amortization schedule of the Bank loan will be revised insofar as practicable, without extending the total term of the loan, so that payments of principal on the Bank loans plus payments of principal on other loans under the "joint financing" arrangement would equal the payments of principal which would have been ne- cessary if the full amount of this external financing had been provided by the Bank (Section 2.09); and (b) A condition of effectiveness of the Loan Agreement is the effectiveness of a subsidiary agreement between the borrowers and Centro on parts of the project which Centro is to carry out (Section 7.01). 20. The Guarantee Agreement also follows the usual pattern. Special features are: (a) The guarantor will set and maintain electricity rates at levels which will provide the power sector with an annual rate of return of not less than 8 percent (Section 3.09); and (b) The guarantor shall take all action required to insure the timely completion of the detailed planning and other pre- paratory steps necessary to begin by September 1, 1969, the conversion of the 50-cycle system of Centro to 60 cycles; the completion in the peripheral area of Mexico City by that date of a 230 kv transmission line and related substations; and the conversion to 60 cycles of at least 282 MW of connected load, not later than August 31, 1971 (Section 3.10).  PART V - THE EC1Ofl0I4Y 21. Mexico's economic performance during the past twenty years has been satisfactory and the economy is continuing to grow at a high rate. Con- tinuation of the Governmentts policies for stretching out Mexico's external public debt, limiting the volume of new external borrowing and improving its terms, and strengthening the current account of the balance of payments should progressively reduce the present debt service burden. Mexico should be considered creditworthy for further Bank lending. A Memorandum on Recent Economic Developments in Mexico (WH-183a). is being submitted to the Executive Directors separately. PART VI - COMPLIANCE WITH THE ARTICLES OF AGREEMENT 22. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank. PART VII - RECOMMENDATION 23. I recommend that the Executive Directors adopt the following resolution: RESOLUTION No. 68 Approval of Loan to Comision Federal de Electricidad and Nacional Financiera, S.A. in an amount equivalent to U.S.$90,000,000 to be guaranteed by United Mexican States. RESOLVED: THAT the Bank shall grant a loan to Comision Federal de Electrici.- dad and Nacional Financiera, S.A. to be guaranteed by United Mexican States, in an amount in various currencies equivalent to ninety million United Stateo dollars (U.S.$90,000,000), to mature on and prior to June 1, 1988, to bear interest at the rate of six and one-quarter per cent (6-1/4%) per annum, and to be upon such other terms and conditions as shall be substantially in accordance with the terms and conditions set forth in the form of Loan Agreement (Second Power Sector Program) between the Bank and Comision Federal de Electricidad and Nacional Financiera, S.A., and the form of Guarantee Agreement (Second Power Sector Program) between United Mexican States and the Bank, which have been presented to this meeting. Attachment Robert S. McNamara President by J. Burke KnaDn W1ashington, D.C. June 12, 1968