Costa Rica - Power and Telecommunications Projects

RESTRICTED FILE COPY Report No. P-729 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 The report may not be published nor may it be quoted as representing their views.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 TWO PROPOSED LOANS TO THE INSTITUTO COSTARRICENSE DE ELECTRICIDAD FOR THE THIRD POWER PROJECT AND THIE SECOND TELECOMMUNICATIONS PROJECT WITH THE GUARANTEE OF THE REPUBLIC OF COSTA RICA June 25, 1969  INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVEIDPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON T'WO PROPOSED IOANS TO THE INSTITUTO COSTARRICENSE DE ELECTRICIDAD IN THE REPUBLIC OF COSTA RICA 1. I submit the following report and recommendation on two pro- posed loans in the amounts in various currencies equivalent to US$12.0 million for a power project and US$6.5 million for a telecommunications project, both to Instituto Costarricense de Electricidad (ICE). PART I - HISTORICAL 2. The proposed projects are the third power project and the second telecommunications project to be financed by the Bank Group. The first power loan, made in 1961, helped finance a 30NW hydroelectric plant on the Rio Macho and the 9 MW Colima diesel facility. Two years later, a second loan helped finance the 56 MW Cachi hydroelectric plant and associated transmission facilities, as well as the automatic exchange equipment for 26,000 telephone lines and related equipment for interurban connections. Both loans were made to ICE, an autonomous government corporation respon- sible for the promotion of electric power development and for providing telecommunications services in Costa Rica. 3. The proposed power project was submitted to the Bank in October 1967 and the telecommunications project in October 1968. Both projects were appraised in November 1968. Negotiations took place in Washington on May 26 through June 2, 1969. The Government was represented by H.E. Luis Demetrio Tinoco, Ambassador of Costa Rica in Washington, and Alfonso Guardia, Economic Director at the Costa Rican Embassy in Washington; and the Borrower by Ing. Alex Murray, Vice President, Ing. Eddy Bravo, M4ember of the Board of Directors, Ing. Rodrigo Suarez, General Manager, Ing. - Antonio Caftas, Assistant Manager and Lic. Alfonso Herrera, Legal Counsel. The regulating authority, Servicio Nacional de Electricidad, was repre- sented by Ing. Fernando Rojas. 4. The proposed loans, the ninth and tenth to Costa Rica, would increase the Bank's total lending from $50.7 to $69.2 million. The fol- lowing is a summary statement of Bank loans and IDA credits to Costa Rica as of lMay 31, 1969.  -2- loan or Amoun U milion) Credit Number Year Bank IDA Undisbursed 7 loans 1956-1963 47.7 Nil 10 1961 Government Roads 4.5 Nil 538 1968 Banco Central Agriculture 3.0 3.0 Total (less cancellations) 50.7 4.5 of which has been repaid to the Bank and others 13.7 Total now outstanding 37.0 4.5 Amount sold 3.5 of which has been repaid 3.2 .3 Total now held by Bank and IDA 36.7 h.5 Total undisbursed 3.0 3.0 5. IFC has an active investment in Costa Rica of $235,542 (out- standing loan and equity) in a company manufacturing concrete products-- Productos de Concreto, S. A. 6. Bank lending to Costa Rica in recent years has been held back by the countryts difficulties in mobilizing the public savings needed to support the expansion of investment in infrastructure. The two loans now being presented do not call for any budgetary contribution to meet local costs, but such a contribution would be required for the Siquirres- Limon Highway Project, which was appraised towards the end of last year, and this project iwill not be presented to the Executive Directors until the fiscal situation has further improved. Meamahile, a number of other projects are being prepared for consideration by the Bank, including projects in agriculture, ports and highways; of these, only the port project might be ready for presentation to the Executive Directors dur- ing the next eighteen months, and this again nould depend on a satis- factory resolution of the budgetary problem. PART II - THE EC0NOMY 7. The main conclusion of the last economic report (WH-185a, dis- tributed to the Executive Directors on November 29, 1968) was that Costa  Rica had the potential for continued substantial growth over the next few years. The key to tile realization of these favorable growtlh prospects, requiring a substantial increase in infrastructure investment, was con- sidered to be the improvement in the fiscal performance of the Government. The deterioration of the Government's finances over the last few years, a major cause of the difficult balance of payments situation in 1966 and 1967, would have to be corrected if domestic financing were to be adequate for the stepped-up investment program planned. 8. Nore recent developments are su*nmarized in the attached updat- ing memorandum. The growth performance and outlook of the Costa Rican economy continue to be good. Due to buoyant exports and substantial private capital inflows, real GDP rose last year by about 7.5 percent, the balance of payments situation has substantially improved and is likely to improve further, and the fiscal outlook for 1969 is somewhat better than was expected earlier thanks tD a marked increase in public savings. Nevertheless, there still remains a fiscal gap for 1969, and if public investment increases as planned, there will be a larger gap in the following years unless new measures are taken to raise public revenues. Service payments on external public debt will absorb around 18 percent of export earnings in 1969, but with recent improvements in the debt structure service on existing and planned new debt should decline sharply in 1970 and subsequent years. 14hile,therefore,Costa Rica is creditworthy for some increase in external bo-rrowing, its credit- worthiness continues to be lmited by inadequate fiscal performance, and further progress in mobilizing complamentary intarnal resources will be necessary to justify the greatly iiicreaseo external borrowing program now under consideration. P.A2T III - DESCPIPTION OF TIHE PROPOSED LOANS 9. Borrowzer: Instituto Costarricense de Electri- cidad (ICE). Guarantor: Republic of Costa Rica. Amounts: (a) US$12.0 million; and (b) US$6.5 million. Purposes: (a) To assist in financing expansion of power facilities, and (b) To assist in financing expansion of telephone and telex facilities. Amortization: (a) Pcwer project - 25 years, includ- ing a 4-1/2 year period of grace; through semi-annual installments begin- ing Novem-iber 1, 1973 and ending Hay 1, 195'4; and  4h - (b) Telecommunications project - 20 years, including a 4-1/2 year period of grace, through semi-annual install- ments beginning November 1, 1973 and ending May 1, 1989. Interest Rate: 6-1/2 percent per annum. Commitment Charge: 3/4 of 1 percent per annum. Economic Rate of Return: (a) Power project - 15 percent. (b) Telecommunications project - 17 percent. PART IV - THE PROJECTS 10. An Appraisal Report entitled "Ccosta Rica - Instituto Costarri- cense de Electricidad - Appraisal of Power and Telecommunications Expan- sion Projects" is attached. 11. The total generating capacity for Costa Rica is about 216 Ng of which ICE's share is 157 MW and its subsidtiary CNFLIs share, 38 MW. About 94 percent of the power generated is; used by the Interconnected System centered around San Jose, the capital city. In the five years end- ing in 1967, the total electric power capaLcity for Costa Rica increased by 50 percent. The major part of internal telecommunications services in Costa Rica is also provided by ICE. By December 31, 1968, there were 37,50o telephone stations, including 29,0C'0 main automatic subscriber stations. A modern long-distance system allowing for subscriber direct dialing interconnects the main cities, Regional interconnection with neighboring countries of the Central American Common Market is also being gradually made by ICE. Other international telecommunications are operated principally by Radiografica Costarricense, S. A., a conces- sionary company owned jointly by ICE (50 percent) and private share- holders. 12. ICE was established in 1949 as an autonomous agency of the Government, to plan and carry out a coordinated program of electrifica- tion of the country. In 1958 it was given, in addition, the responsi- bility of providing telecommunications services in Costa Rica, but it did not enter into this field until 1962. In 1968, ICE acquired 92 per- cent of the shares of Compafnia Nacional de Fuerza y Luz (CNFL), a private company which operated the principal power distribution system in the country. ICE is governed by a seven-member Board of Directors all ap- pointed by the President of the Republic for 8-year staggered terms. Three are engineers, one is a lawyer and one is an economist. The remain- ing two have experience in finance, industry or agriculture. The Board has conducted ICE's affairs on a businesslike basis, substantially free from political interferences. The general manager appointed by the Board is responsible for all managerial and administrative functions.  - 5 - The general organization of ICE is satisfactory and its management and staff are capable of carrying out the power and telecommunications projects. 13. The proposed power project consists of (a) the construction of a 14.5 Km. tunnel and the addition of 60 MW at the Rio Macho hydro- electric plant which would also be extended to accommodate additional units; (b) installation of spillway gates at the Cachi hydroelectric plant; and (c) construction of associated transmission facilities. 14. The telecommunications project is part of ICE's second stage telecommunications program (1967-1973). It consists of new automatic exchange equipment for 22,500 telephone lines, cable and line networks, telex network and expansion of long-distance facilities to be completed over the four-year period from 1969 through 1973. 15. The total estimated cost, including interest during construc- tion, of the proposed power project is $25.7 million equivalent and of the telecommunications project $9.5 million equivalent. The two projects form a part of the power and telecommunications development program of ICE covering the period 1968-73. A financing plan, satisfactory to the Bank, has been prepared by ICE for the period 1969-75, and its total financial requirements for that period will be covered, in addition to the proposed loans of $12.0 million and $6.5 million, by ICE's internal cash generation (41 percent), borrowings from other sources (32 percent), and connection fees, consumer deposits, etc. (5 percent). Until 1967, ICE received central government subsidies to finance its investment programs, but its financial position has now strengthened to a point where this is no longer necessary. 16. The annual growth rate in total power sales in the Intercon- nected System in the past 10 years has ranged from 6.8 percent to 14 percent with an average of 9.7 percent. Future growth in sales for the Interconnected System will be met by ICE. Its power sales in the period 1969-75 are expected to grow at an average annual rate cf 9.3 percent. The power project is needed to meet this growing demand for power and is the most economic alternative means of meeting the demand. The incre- mental rate of return of the new investment would be about 15 percent. 17. The number of telephones in Costa Rica is estimated to increase at an average ainual rate of about 11 percent, resulting in an increase in telephone density from the present 2.0 to 3.1 telephones per hundred population by 1975. The proposed new long-distance system will eliminate the present congestion in traffic, which is due to traffic growth faster than expected in some parts of the network. New facilities will be provided to meet an anticipated growth in traffic of about 18 percent per year through 1974. The proposed new telex network will replace the existing private circuit systems and will also be used for public tele- graph service, thus improving its efficiency. The telecommunications project will yield an incremental rate of return of about 17 percent.  - 6 - 18. Procurement of goods and services will be on the basis of in- ternational competitive bidding, except for telecommunications equipment worth about $1 million which is required to extend existing installations financed after international competitive bidding under Bank Loan 346-CR, and which it would be more economical and efficient to purchase from the original suppliers. Steps will be taken to insure that the prices paid for such equipment are reasonable. 19. In carrying out international competitive bidding on the pres- ent projects, it is proposed to give recognition to existing arrangements in the Central American Common Market by allowing a margin of preference for bids submitted by suppliers in the Central American countries, includ- ing Costa Rica. These countries have recently entered into an Agreement on Fiscal Incentives in which they each agree to give preferential treat- ment (limited to 50 percent of existing import duties) to products of Central American origin in all public procurement, even though the procur- ing agencies (such as ICE) may be entitled to exemption from import duties. So far as the Central American countries other than Costa Rica are concerned, it seems appropriate to accept the provisions of the Agreement on Fiscal Incentives, since the Bank normally accepts preferen- tial customs duties in making bid comparisons among foreign suppliers. It further seems reasonable, so far as Costa Rican suppliers are con- cerned, to finance procurement which may fall to them with the same margin of preference, since otherwise they would be discriminated against as compared with suppliers in the other countries of the Common Market. This would not involve any departure from the Bankts normal practice of limiting preferences to local suppliers to 15 percent, since in this instance 50 percent of the existing import duties should in no case amount to more than 13 percent; in any case, provision is made in the loan Agreements that the preference shall not exceed 15 percent. It is estimated that under these exceptional arrangements procurement in the other Central American countries might amount to some $60o,ooo for tele- communications equipment, and procurement in Costa Rica to some $1.8 million for supplies for the power project. Of the latter sum, after deducting the foreign exchange component, the amount of actual local currency financing would amount to between $500,000 and a possible maximum of $1 million. 20. In the case of the power project, it has been urgently neces- sary to award major equipment contracts in order to maintain the cons- truction schedules required to meet power demand in future years and it is proposed that expenditures of up to $50o,000 made on these con- tracts prior to the date of the loan be eligible for reimbursement. 21. ICEts financial position is sound and is expected to remain so. It is estimated that, starting in 1970, the rate of return on its plant in operation for the power project will be over 9 percent, and for the telecommunications project, over 11 percent, until the end of the  construction period. The coverage by internal cash generation of total debt service requirements during this period is acceptable. PART V - LEGAL INSTRUTMENTS AND AUTBORITY 22. The draft loan Agreements between the Bank and ICE, the draft Guarantee Agreements between the Bank and the Republic of Costa Rica, the reports of the Committee provided for in Article III, Section 4 (iii) of the Articles of Agreement and the text of the Resolutions on the two proposed loans, are being distributed to the Executive Directors separately. 23. Consistent with the purpose of the negative pledge clause contained in Section 5.05 of both draft loan Agreements and given the Borrower's current practice of securing some of its borrowings with mortgages and other liens on its assets, Article VI of both draft Loan Agreements and Schedule 5 thereto provide for the creation of a mortgage and a floating chattel mortgage on certain property of the Borrower to secure the payment of the principal, in)terest and other charges on the loans and the Bonds. PART VI - COMPLIANCE WITH ARTICLES OF AGREEMENT 24. I am satisfied that the proposed loans would comply with the articles of agreement of the Bank. PART VII - RECOMMEIDATION 25. I recommend that the Executive Directors approve the proposed loans. Attachments Robert S. IHIcNamara President June 25, 1969 Washington, D. C.