Argentina - Second Buenos Aires Power Project

RESTRICTED FILE COP Report No. P-579 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 The report may not be published nor may it be quoted as representing their views.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 SERVICIOS ELECTRICOS DEL GRAN BUENOS AIRES, S. A. IN THE ARGENTINE REPUBLIC January 8, 1968  REPORT AND RECOlvMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRiECTORS ON A PROPOSED LOAN TO SERVICIOS ELECTRICOS DEL GRAN BUENOS AIRES, S.A. IN THE ARGENTINE REPUBLIC 1. I submit the following report and recommendation on a proposed loan in an amount in various currencies equivalent to US$55 million to Servicios Electricos del Gran Buenos Aires, S.A. (SEGBA) for the second Buenos Aires power project. PART I - HISTORICAL 2. Last July 18, the Executive Directors approved a loan of $15.3 million to the Argentine Republic for a livestock project, thus marking the resumption of Bank lending to Argentina after more than five years. In recommending that loan, I considered that the economic program insti- tuted by the Government in March 1967 provided a suitable climate for Bank operations in Argentina. Developments in the last few months indicate that the implementation of the program is yielding positive results. The Bank has only one other project at an advanced stage of consideration in Argentina, namely a project for the construction of basic steel facilities by a private company, Acindar, S.A. The Government has also been keeping the Bank informed about progress in preparing the proposed El Chocon - Cerros Colorados hydroelectric project, one of the major alternative sources of power for Buenos Aires once the present round of thermal expansion is completed, with a view to possible Bank assistance. 3. In January 1962, the Bank made its first loan of $95 million to SEGBA to enable it to complete a 600 10W thermal plant and expand its trans- mission and distribution system. The project was carried out diligently and its completion put an end to severe power shortages in Buenos Aires. The loan account was closed on June 30, 1965 and a small balance cancelled. To date, about $7 million of the loan has been repaid; the final maturity date is September 1, 1986. 4. Discussions on a second power loan started before the first loan had been fully disbursed, but the Bank delayed the appraisal of the project pending improvement in the management and finances of SEGBA, which had deteriorated in 1964. After the field appraisal in April/May 1966, repre- sentatives of SEGaA and the Government discussed with the Bank in June 1966 mneasures to restore the financial position of the Company and the efficiency of its operations. However, before anything could be done, the Government changed and there was further delay.  5. Following discussions on economic policy with the new Government, and the appointment of new management of SEGBA, another appraisal mission visited Buenos Aires in April/May 1967 and found that SEGBA's position had improved substantially. Negotiations took place in Washington in October 1967 with Ing. Gabriel A. Meoli, Executive Vice-President, representing SEGBA and Dr. Angel R. Caram, Financial Counsellor at the Argentine Embassy, representing the Government. The question of powTer rates to be set for 1968 was subsequently discussed with Dr. Carlos 4loyano Llerena, a special representative of the Argentine Minister of Economy, in December 1967. 6. The following is a summary statement of the previous Bank loans to Argentina as of NTovember 30, 1967: NTo. Year Borrower Purnose Amount Undisbursed - -U.S3. $ =nillionT. 288 1961 The Argentine Republic Roads 32.0 8.0 308 1962 Servicios Electricos del Gran Buenos Aires, S.A. Power 93.3 - 505 1967 The Argentine Republic Livestock 15.3 15.3 Total (less cancellations) 140.6 of which has been repaid to Bank and others 12.1 Total now outstanding 128.5 Amount sold 2.6 of which has been repaid .9 1.7 Total now held by Bank 126.8 Total undisbursed 23.3 No IDA credits have been made to Argentina. IFC presently holds about $5.3 million of loans to three Argentine industrial companies. 7. Execution of the road project has been slow. In July 1965, 4;16.5 million of the original loan amount of $48.5 million was cancelled. At the same time, steps were taken to improve the administration of the project. Since then, performance by the National Highway Authority has been better and work has progressed satisfactorily. A proposal to post- pone the closing date from December 15, 1967 to June 30, 1968 was dis- tributed to the Executive Directors on December 29, 1967 (R67-186).  - 3 - PART II - DESCRIPTION CF THE PROPOSED LOAN 8. Borrower: Servicios Electricos del Gran Buenos Aires, S.A. (SEGBA) Guarantor: The Argentine Republic Amount: in various currencies equivalent to US$55 million. Purpose: To help finance expansion of SEGEA's facilities. Terms and Amortization: 20 years, with principal repayment beginning April 1, 1971 and ending April 1, 1988. Interest Rate: 6' % per annum. Commitment Charge: 3/4 of 1% per annum. PART III - THE PROJECT 9. A report entitled "Appraisal of the 1967-1970 Expansion Program, Servicios Electricos del Gran Buenos Aires, S.A." (TO-606a) is attached. 10. About 60% of total public supply of electricity in Argentina is generated and distributed in Greater Buenos Aires, which includes the Federal Capital and 31 municipal districts stretching to the south-cast and the north-west along the River Plate. Industry, comnerce, transport, and Government departments and agencies, are all concentrated in and around Buenos Aires and seven to eight million people, one third of the nation, live in the area. SEGBA provides most of the power requirements. The other supplier is the Swiss-controlled Compania Italo Argentina de Electricidad (CIAE). 11. SEGBA is one of the largest power utilities in South America. Presently, it sells 4.5 billion kwh per annum, serves 1.9 million customers and employs 25,000 people. A stock corporation with all shares owned by the Government, SEGBA is a successor to the Belgian-owned Compania Argentina de Electricidad (CADE). Established in 1958, SEGBA was reorganized at the time of the Bank's first loan to give it the scope, financial base and degree of autonomy required for sound administration and development of power services. As an expression of the Argentine Government's policy to encourage the investment of private savings in SEGBA, its common shares were placed in escrow with the government-owned Industrial Bank of Argentina for eventual sale to private investors.  12. To achieve the most economic use of the power facilities for the benefit of Buenos Aires consumers, the Bank has long sought to bring about a coordination of the expansion and operations of SEGBA and CIAE. In December 1966, the two companies signed an agreement providing for studies of joint system development, design standardization and reapportionment of supply zones. Some progress in these matters has been made already and a central dispatch office responsible for scheduling the operations of all generating plantsof the two companies started functioning on January 1, 1968. 13. The present chief executive of SEGBA is competent and experienced. Ilanagement control of the Company's activities is being improved with the help of consultants. Significant progress has also been made in restoring the management's authority in labor matters. Nevertheless, labor problems remain the thorniest issue facing the Company. Only changes in the work rules embodied in the agreement with the labor union to permit more flexible hiring and firing practices would make it possible for SEGBA to achieve real efficiency in its operations and substantially lower costs. This is a problem which is not unique to SEGBA and which is only part of the per- vasive issue of Argentine labor relations. The Government is considering basic changes in labor agreements in the public sector as a whole and has already made a beginning in the ports and the railways. 14. SEGBA is carrying out a program for expansion of its facilities in the four years 1967-70, which aims at improving services, connecting new customers and gradually substituting public supply for self-generation by industry. The program consists of the installation of eight 15 iHii gas turbines and a 250 14W base load steam unit, the extension of the 132 kv transmission system, and the extension and strengthening of the distribution networks. The estimated cost of the program is equivalent to about $300 million. Two thirds of this would be for distribution and one sixth each for generation and transmission. SEGEA has placed orders for generation equipment on the basis of international competitive bidding and arranged for the financing of most of the cost by supplying countries. The Bank has been asked to help finance investment under SEGBA's program during the eighteen months, October 1, 1967 - M,larch 31, 1969. SEGBA estimates that expenditure on the program during this period would be about $150 million. To this amount, the Bank would contribute $55 million or 37%. 15. As most of the expenditure on generation would be financed by suppliers' credits, the Bank's loan would be used mainly for transmission and distribution equipment and materials. Most of this equipment is pro- duced in Argentina by an electrical goods industry which is partly owned and controlled by foreign companies. This industry depends on SEGBA for a large part of its sales and has been working below capacity in the past few years because of SEGBA's low capital expenditures. All transmission and distribution equipment would be purchased after international competi- tive bidding, in which Argentine suppliers would be allowed a margin of preference of 15%.  - 5 - 16. The proposed loan would finance the foreign cost component of civil works, down-payments on the imported generation equipment which is being purchased after international competitive bidding and financed mainly by suppliers' credits, and imported transmission and distribution equipment and materials. The loan will also finance the foreign currency component (estimated at 60%) of equipment manufactured in Argentina, and up to $10 million of the local currency component of domestically procured items. I consider that this amount of local expenditure financing is justified in this case by the facts cited above regarding the Argentine electrical industry, the improving fiscal performance of the Argentine Government, and the fact that the Bank loan would still cover a modest proportion (37%) of the total project costs. 17. SEGBA should have no difficulty in servicing the proposed loan. Its concession provides for a level of rates sufficient to cover operating expenses, including adequate maintenance and depreciation, and to yield a reasonable return on net assets. As shown in the appraisal report, SEGBA's capitalization is heavily weighted in favor of equity and its debt is rela- tively small. SEGBA could incur additional debt substantially larger than the proposed loan within the debt limitation covenant. PART IV - LEGAL IITTSTRIMNTS AND AUTHORITY 18. The draft Loan Agreement between the Bank and Servicios Electricos del Gran Buenos Aires, S.A., the draft Guarantee Agreement between The Argentine Republic and the Bank, and the Report of the Committee provided for in Article III, Section 4 (iii) of the Articles of Agreement are being distributed to the Executive Directors separately. 19. The Loan and Guarantee Agreements contain provisions usual for this type of project. They have generally the same structure as the 1962 Agreements covering the first loan to SEGBA. 20. Significant undertakings which affect finances or management are mentioned below. The Borrower promises: (i) to refrain from any other major expansion while the project is under construction unless approved by the Bank (Section 5.10); (ii) to pursue a sound dividend policy (Section 5.12); (iii) to limit its debt (Section 5.14); (iv) not to amend its Estatutos without the consent of the Bank (Section 5.03 (c)); and (v) to appoint certain key officials only after consultation with the Bank (5.03 (e)). 21. The Guarantee Agreement contains an undertaking by the Guarantor to take action both as Guarantor and as shareholder to enable SEGBA to per- form its obligations (Section 3.06). The Government, as sole shareholder, is obliged by the Guarantee Agreement to provide any additional funds needed to complete the project (Section 2.02) and reiterates its policy of en- couraging sale of shares to private investors (Section 3.07).  - 6 - PART V - THE ECONOMY 22. The report on the "Economic Position and Prospects of Argentina" (WH-175a), distributed to the Executive Directors on November 30, 1967 concludes that the Government's economic program for 1967 is a pragmatic and well-balanced one which promises substantial progress towards internal financial stability and a major strengthening of the balance of payments, thus providing the needed basis for more rapid economic development. Good progress has been made in implementing the stabilization program in 1967; information through the end of November confirms that the Government has been successful in sharply raising tax revenues and reducing the budgetary deficit and that the expansion of central bank credit, including credit to the Treasury, is likely to be well under the ceilings agreed to with the IiiF. There will still be a large rise in prices, but this was probably unavoidable in view of the devaluation and because adverse weather in the second half of the year helped to push up food prices. GDP, which declined somewhat in 1966, was expected to rise by about 3% in 1967, mainly as a result of good grain harvests. The Government has introduced generous ta, incentives for investment and a variety of other measures intended to end the recession in industry and bring about more ranid growth in 1968. This year, the Government intends to reinforce its fiscal program by tightly limiting current expenditures and increasing revenues with the aid of new taxes. It is hoped that a olanned sharp increase in public investment can be financed in part by borrowing on the domestic capital market and through the sale of long-term Government bonds abroad. Recently, Argentina offered in Europe a 7%, 12-year bond issue at 95% in the amount of 10 million German marks (equivalent to about $25 million). 23. In the balance of payments, another current account surplus of some $250 million was expected in 1967, and prospects for continuing size- able surpluses over the next several years appear favorable owing to Argentina's strong export position. The 40% devaluation of the peso in March 1967 was followed by a massive inflow of capital from abroad and through the end of iNovember net foreign exchange reserves had risen by more than v370 million. Argentina is carrying a very heavy load of external debt contracted on unfavorable terms; service payments will absorb well over one third of current account receipts in 1967 and 1968. However, projected service on the existing debt declines sharply after 1968 and, while Argentina will have to borrow sizeable sums over the next few years, it should be possible to reduce the annual debt service burden substantially. 24. The Government has emphasized the importance it attaches to dealing with the "real" as well as the financial problems of the economy, and measures have been taken to promote the structural changes essential to more rapid and sustained growth over the longer run. In the public sector, a start has been made on the formidable task of overhauling management and rationalizing the labor force in the state enterprises. As regards the private sector, protective barriers have been lowered through broad tariff cuts and the virtual elimination of quantitative import restrictions, and the petroleum sector has been reopened to domestic and foreign private capital.  - 7 - PART VI - COMPLIANCE WITH ARTICLES OF AGREEIENT 25. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank. PART VII - RECO4MENDATIONY 26. I recommend that the Executive Directors adopt the following resolution: RESOLUTION NO. Approval of Loan to Servicios Electricos del Gran Buenos Aires, S.A., in an amount equivalent to U.S. $55,OOO,ooo to be guaran- teed by The Argentine Republic. RESOLVED: THAT the Bank shall grant a loan to Servicios Electricos del Gran Buenos Aires, S.A., to be guaranteed by The Argentine Republic, in an amout in various currencies equivalent to fifty-five million United States dollars (U.s.5,00ooo,ooo), to mature on and prior to April 1, 1988, to bear interest at the rate of six and one-quarter percent (61-1%) 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 Buenos Aires Power Project) between the Bank and Servicios Electricos del Gran Buenos Aires, S.A., and the form of Guarantee Agreement (Second Buenos Aires Power Project) between The Argentine Republic and the Bank, which have been presented to this meeting. George D. Wdoods President Attachments W4ashington, D.C. January 8, 1968