Mexico - Second Railway Project

R ESTRI CTED CIRCULATING COPY Report No. P-1067 TO BE RETURNED TO REPORTS DESK FILE COPY This report is for official use only by the Bank Group and specifically authorized organizations or persons. It may not be published, quoted or cited without Bank Group authorization. The Bank Group does not accept rcsponsibility for the accuracy or completeness of the report. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO FERROCARRILES NACIONALES DE MEXICO AND NACIONAL FINANCIERA S.A. WITH THE GUARANTEE OF THE UNITED MEXICAN STATES FOR A RAILWAY PROJECT May 10, 1972  INTEIR\TATIONAL BANK -FOR RECO=TSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO ETERROCARRILES NACIONALES DE MEXICO AND MACIONJAL FINANCIERA S.A. WITH THE GUARANTEE OF THE UNTITED MEXICAN STATES FOR A RAILWAY PROJECT 1. I submit the following report and recommendation on a proposed loan to Ferrocarriles 'Tacionales de Mexico (Nacionales) and Nacional Financiera, S.A., with the guarantee of the United Mexican States for the equivalent of $75 million, to help finance a project for modernizing and renewing Nacionales' railway equipment and improving its operations. The loan would have a term of 25 years, including five years of grace, with interest at 7-1/4 percent per annum. PART I - BATK LENDING TO MEXICO 2. My report and recommendation (P-1036) dated April 19, 1972, which was distributed in connection with a proposed 3Bnt loan for a pbrts project, gave recent information on the Mexican economr and its prospects, and summarized the Bank's past and planned activities in Mexico (for the relevant sections of that report, see Annex IV attached). As indicated in that report, the port loan and other loans to Mexico planned for pre- sentation during the next few months total over $250 million. After taking into account scheduled repayments during the disbursement period of the new loans, Mexico's total outstanding debt to the Bank would increase by about $143 million (from the present total of about $839 to $982 million at the end of FX1975). If the Bank made no further loans to Mexico and Mexico did not increase further her outstanding external debt during this period the Bank's share in the total would increase from about 20 to 23 percent. However, Mexico will undoubtedly be borrowing extensively during the coming years to meet the growing ex- ternal financing requirements of the economy and is looking increasingly to the Bank and the Inter-American Development Bank in order to help meet these needs and improve the maturity pattern of her external debt. 3. In addition to the loans I expect to present for your considera- tion during the next few months, there is a substantial number of projects which are at an earlier stage of preparation or review including projects for rural development and education. Future lending will, of course,. depend on progress made in preparing suitable projects, as well as on Mexico's economic performance, particularly in fiscal matters, the balance of payments and investment planning. If the level of Bank lending were to average $200 million per year during the next five years, the Bank's share in Mexico's external debt would increase from about 20 per- cent at present to 25 to 30 percent by 1980.  -2- Mexico faces difficult long-term structural problems arising from a rapidly growing population, the need to improve conditions within rural areas and to start to reduce income disparities. At the same time development requires substantial capital which has to come from additional public savings if excessive reliance on foreign borrowing is to be avoided. Given sound fiscal policies the near term prospects of the econony appear favorable. Manufactured exports are expected to continue to expand rapidly. External reserves are equivalent to about 5 months imports. Service of the external debt absorbs about 20 percent of exports and non-factor services and is not projected to increase above that level over the next 10 to 15 years. In the light of past performance and present prospects I believe Mexico is creditworthy for the foreign borrowing presently contemplated. At Annex I is a summary statement of Bank loans and IFC investments in Mexico. Country data are at Annex TT. PART II - THE PROJECT The Transportation Sector 4. Over the past three decades Mexico has added an extensive net- work of high quality Federal highways, satisfactory secondary road network and an air transport system to a large network of railways and ports, resulting in a fairly well advanced transport system. Govern- ment emphasis is now shifting more to the development of tertiary, feeder and access roads to permit the integration into the modern eco- nomy of some 20 million people who live in isolated villages and farms. The Mexican transport sector has grown rapidly but a lack of coordination has resulted in some misallocation of resources and ad-hoc subsidies have prevented the optimal division of traffic among various transport modes. Each system was developed without adequate consideration of the other modes because the responsibility for operating and maintaining existing and designing new transport facilities had been dispersed among numerous government departments and agencies. 5. The Government of President Echeverria, which took office in December 1970, has recognized the need to attack the basic problems of transport and accepted most of the major recommendations of the report of the Bank's transport sector mission (PTR-88 dated May 13, 1971) which was distributed to the Executive Directors on June 7, 1971. The Echeverria Administration quickly initiated a series of actions to strengthen transport planning and operations. The measures which have been taken to improve port operations were summarized in my recent report and recommendation for a port loan. The Government also has been developing measures to strengthen the institutional framework of the sector and to help to improve the division of traffic among the various modes. A sector planning office has been set up within the Secretaria de Comunicaciones y Transportes (SCT) to develop and coordinate long range transport policies and investment priorities, and make a comprehensive study of the present road user charge system to determine to what extent road user charges may be distorting competition, particularly between rail and roads.  -3- 6. Mexico has five railways, all government owned, with a total route mileage of nearly 20,000 kms. Nacionales is by far-the largest railway enterprise with 14,000 route km; the second largest is Ferrocarril del Pacifico with 2,300 route km. Both are autonomous agencies with a common management. The remaining five are directly under the SOT. Nacionales operates with generally good equipment and track, but utilization of motive power and rolling stock is poor. Its main problem is a large operating deficit, that results from the fact that tariffs were not in- creased for a decade to compensate for increasing costs. Most of the deficit is caused by extensive passenger services provided at very low rates. The Government has strengthened the top management of the rail- roads and has been giving particular' attention to tackling the heavy burden on the Federal budget resulting from the large and growing operating railway deficit. The Project 7. The proposed railway project forms part of the Mexican Govern- ment's effort to improve the efficiency of and reduce subsidies to the transport sector, particularly by helping to modernize the equipment of Nacionales, improve the utilization of its manpower and rolling stock and reduce its financial deficit. The project combines Nacionales 1972-73 Investment Plan and its 1972-76 Plan of Action for improving its operations and financial situation. Both the Investment Plan and the Plan of Action take into account the recommendations of the Bank transport sector mission and a team of consultants from Canadian National Railways who worked in M4exico in 1970 and 1971. The main features of the project and the proposed loan are summarized in Annex III. 8. The total cost of the 1972-73 Investment Plan of Nacionales is estimated at $203 million with a foreign exchange cost of $113 million. Of the total expenditure, some 26 percent is for freight cars, 16 percent for locomotives, 26 percent for renewal and maintenance of track and bridges, 8 percent for terminal and maintenance shops, 8 percent for tele- communications and 16 percent for other purposes. Rirther details are sho,vn in Annex III. 9. The proposed Bank loan would cover the following items: $ millions 1,400 new freight cars 25.0 Imported components for freight cars reserved for local procurement 4.4 1,000 roller bearings and axles to rehabilitate old freight cars 1.7 Workshop equipment 2.5 690 Km of rails and fastenings 15.7 2 million hardwood timber sleepers 8.5 Way maintenance machinery and equipment 2.6 Telecommunications equipment 7.0 Consultants' services 1.2 Unallocated 6 75.0  Procurement 10. All goods to be procured under the proposed Bank loan would be subject to international competitive bidding. The main foreign exchange component of the Investment Plan which would not be covered by the proposed Bank loan consists of 90 locomotives to be procured with bilateral financing of which 40 have already been ordered. Nacionales does not wish to increase the number of makes of locomotive beyond the two it already has and since the benefits of standardization would out- weight the advantages of international competitive bidding it will divide the procurement between the two firms in question. Passenger and express cars are also expected to be financed on a bilateral basis. 11. Fifty percent of the freight cars would be acquired through international competitive bidding and would be financed from the loan; the remainder would be reserved for the domestic state-owned producer, Constructora Nacional (Constructora), which has been an efficient producer of high-quality cars. The Bank would finance only imported components used for the production of these cars. For freight cars delivered in 1973 under the reserved portion, Constructora has agreed to keep its prices at not more than 5 percent above the 1972 level; for 1974, when a new labor contract will be effective, the price ceil- ing has been fixed at 125 percent of the average of Constructorats 1973 prices and the lowest foreign bid on the freight cars to be financed under the loan through international competitive bidding. Constructora would also tender under the international bid portion and would be granted a preference of 15 percent for evaluation purposes. 12. Two million softwood sleepers would not be financed by the loan, but will be reserved for the numerous low-cost Mexican suppliers, mainly peasants, who produce them from pinewood in the northern part of the country. Two million hardwood sleepers would be procured under the loan with international competitive bidding. Although there are hardwood trees in the jungles of the southeast, they are not easily accessible and it is therefore unlikely that Mexican manufacturers will participate in the international bidding. Financial Aspects 13. The Investment Plan summarized above will help to reduce the large operating deficit of Nacionales by modernizing its equipment and improving its efficiency. A much more important contribution towards this objective will be made, however, by the Plan of Action, which Nacionales and the Government would be committed to carry out and which is designed particularly to reduce the deficit. It had been caused mainly by the fact that for a period of almost 12 years rates and fares were held constant while costs have steadily increased. Exceptionally low passenger fares and extensive passenger service account for mucb of the operating deficit. In addition Nacionales carries certain kinds of cargo, mainly minerals (iron ore), grains and livestock at rates that are below long-run variable costs.  -5- 14. The main feature of the Plan of Action is the preparation and carrying out of a corporate plan to reach a series of objectives, particularly that of holding total staff to existing levels, improving the utilization of rolling stock and motive power and thereby greatly reducing the operating deficit of the railways by 1976. The Plan of Action also includes the following steps to improve Nacionales' operations: (i) the employment of consultants to advise and direct the improvement of corporate and manpower planning, line and yard operations, locomotive and car control and mainten- ance, telecommunications, costing, accounting principles and financial forecasts and control; (ii) the establishment of a traffic costing system before the end of 1972, which would allow Nacionales to determine the avoidable cost of passenger train operation and long-run variable cost of freight transport by commodity; (iii) a study to be finished by the end of 1973 proposing measures to reduce the deficits caused by low traffic density lines; (iv) payment by the Government of the cost of carrying mail, beginning in 1972; and (v) a program to cover losses on passenger train services by 1976, either by increasing tariffs, curtailment of service or Government compensation where curtailment will not be authorized. 15. In the Plan of Action, net operating ratios (i.e. ratios of total operating expenses to total operating revenues, excluding any kind of Government subsidy) have been established for each of the years 1972 through 1976. They would improve from 1.66 in 1971 to 1.43 in 1972 and 1.17 in 1976. These ratios reflect the expected results of various productivity and financial measures in the plan and increases in freight tariffs of 325 million pesos in both 1974 and 1976. The Bank pressed during negotiations for an earlier increase in those tariffs which are currently below marginal costs, which would have made possible a more rapid improvement in the operating ratio. The Government accepted the principle that tariffs should be raised in line with costs, but it was not prepared to make a firm commitment to increase railway freight tariffs before 1974. It maintained that there had to be increases in prices charged by a number of public agencies and to put these all into effect over a short period would cause too many dislocations. In these circum- stances the Government considered that the increases in electric power, petroleum and water tariffs should take priority. Achievement of full financial viability, defined as the ability to cover operating expenses, service debt and provide a 40 percent contribution to investments, is envisaged to be attained by 1981.  -6- 16. The loan includes $0.5 million for consulting services to aid Nacionales in carrying out the Plan of Action, as well as $0.7 million for consultants, training programs and scholarships to aid in building a sector planning office within SCT and carrying out a comprehensive study of the present road user system. Provision has been made for the possibility of financing retroactively some consultants services. Economic Evaluation 17. The railway project is economically well justified. Nacionales carries a large share of road and rail transport, mainly bulky products. It has contributed to economic growth by carrying an increasing volume of goods at low and steadily decreasing cost in real terms. Even with increased tariffs as proposed, Nacionales can carry most goods, particularly bulky commodities, at considerably lower costs than alter- native modes over distances of 150-2000 kms. The project will improve operating efficiency and introduce a tariff system designed to attain an optimum division of traffic among competing modes of transportation. The economic rates of return, which take into consideration the reductions of railway operating costs and the savings in road operating and con- struction costs that result when lesser volume of freight traffic is diverted to roads, range from over 20 percent for telecommunications to 14 percent for ways and structures. The average rate for the four major investment items is at least 17 percent. PART III - LEGAL INSTRUMENTS AND AUTHORITY 18. The draft Loan Agreement between the Bank, Nacionales and Nacional Financiera, S.A., the draft Guarantee Agreement between the United Mexican States and the Bank, the Report of the Committee pro- vided for in Article III, Section 4(iii) of the Articles of Agreement and the text of a Resolution approving the proposed loan are being distributed to the Executive Directors separately. 19. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank. PART IV - RECOMMENDATION 20. I recommend that the Executive Directors approve the proposed loan. Robert S. McNamara Attachments President May 10, 1972  Amnex I Page 1 MEXICO: &UM2 of Bank Loas - at April 30, 1972 (US$ Milliis) Amount less Cancell a- Un- Loan Year Borrower Purpose ticns disbursed .oans fullX disbursed 759.0 - 450-ME 1966 Nacimal Financiera, S,A. Irrigatimn 19.0 1.9 527-4E 1968 Nacional Financiera, S.A. Irrigation 25.0 17.2 528-mE 1968 Nacicmal Financiera, S.A. Roads 27.5 J.9 659-ME 1970- Ccuision Federal de Electricidad and NAFIN Power 125.0 ?7.5 695-ME 1970 Naciona1 Financiera, S.A. Roads 21.6 20.9 7474IE 1971 Macimal Financiera, S.A. Agriculture 75.0 62.6 793-ME 1972 Nacional Financiera, S.A. Tourin 22.0 22.0 1 Total 1,074.3 169.3 Of which has been repaid to Bank and others 230.2 Total now outstanding 844.1 Amount sold: 50.7 Of which has been repaid: 46.o 24.7 Total now held by Bank 839.lI Total undisbursed 156.0 ]f Not yet effective.  Annex I Pago 2 MEIC~O.- Sunmary of IFC Irzvestnmmts at April 30, 1972 Year C qmpa2arpose Loan Total ($ MiUi.ons) 1958/1959 Induztrias Perfect Circle, Indistrial 0.8 _ 0.8 S.A. * equipfnent 1958 Bristol de Mexico, S.A. * A/C Engine 0.5 -0.5 Overhaul 1961 Acero Solar, S.A. * Twist Drills 0.3 - 0.3 1962/ Sompania FundLdora fierro Steel 2.3 21.4 23.7 5/6/8 y Acero de Monters=yj S.A. 1963 Tubos de Acero de Me:ico, S.A. Seamless 0.9 0.1 1.0 steel Pipes 1963 Quimica del Rey, S.A. * Sodium 0.7 - 0.7 Sulphate 196 4966 Industria del Hierro, S.A. Const. - 2.0 2.0 Eqtj.pment 1970 Minera del Norte, S.A. Iron Ore Mining 1.5 - 1.5 1971 Celanese Mexicana, S.A. Textiles 12.0 - 12.0 Total gross commitments 19.0 23.5 42.5 Less cancellations, terminations, repayments and sales 9.0 21.7 30.7 Total commitments now held by IFC 10.0 1.8 11.8 Total undisbursed 2.9 - 2.9 * Investments which have been fully cancelled, terminated, written off, sold, redeemed or repaid are indicated with an aster.isk.  Annex II Page 1 of 4 MEXICO: COUNTRY DATA SHEET Area: 2 million square kilometers Populationt 52 million (1971) I. ECONOMIC INDICATORS Calendar Years 1960 1970 1971 n (Mex$ billion) GDP 151 423 440 Per capita (in current USv) 334 668 708 Real growth rates (percent) - 7.7 4.0 Structure of GDP (percent) Agriculture, livestock, forestry 15.9 11.4 - fisheries Mining 1.5 1.2 Industry (including petroleum and 20.4 26.0 petrochemicals) Construction 6.2 5.1 Power 1.0 1.5 - Commerce 31.1 30.3 - General services 20.5 22.0 _ Other 3.4 2.5 - Money supply (percent change) - 9.6 _ Prices (percent change) GDP deflator - 4.8 - Mexico City wholesale index - 6.0 3.7 Public finances Federal Government: current revenues 11.0 33.6 38.0 current expenditures _ 26.930.2 current surplus 3.3 6.7 7.8 Federal District (Mexico City): current surplus 0.8 2.1 2.2 Decentralized public sector agencies: current surplus 3.6 5.1 n. 8. Total public sector current surplus 7.7 13.9 n.a. a/ Preliminary  Annex II Page 2 of 4 Calendar Years 1960 1970 l97a/' (Mex$ billion) Public finances (cont.) Capital revenues - 1.0 0.9 Public investment 11.2 27.0 *.& Net domestic borrowing 1.7 8.9 n.a. Net external borrowing 1.8 3.2 - Total borrowing 3.5 12.1 n.a. Public investment financed out of non-borrowed resources (percent) 69 55 n.a. Balance of payments (US$ million) Exports of goods and non-factor 1,330 3,012 3,45 services Imports of goods and non-factor -L,481 -3,34 -3,2489 services Balance before factor income - 151 - 335 - 144 payments Factor income payments (net) - 160 - 672 - 788 Balance on current account - 311 -1,007 - 932 Private direct investment (net) - 38 352 394 Gross public sector borrowing for 317 932 930 investment b/ Amortization of public sector - 172 - 673 - 538 debts c/ Other capital flows (net), errors 204 396 500 and omissions and changes in reserves Public medium- and long-term debt Total outstanding (end of period, 842 3,764 n.a including undisbursed) a! Preliminary b/1 Public sector accounts figures c/ Public sector accounts data. Include short-term loans and loans repayable in local currency.  Annex II Page 3 of 1 Calendar Years 1960 1970 1971 (US$ million) Debt servi6e: interest h4 217 207 amortization 172 714 4h4 Total service 216 691 651 Debt service to IBRD 53.7 59,9 *as percent of total debt service 7.7 9.2 Debt service ratio (percent of exports 16.2 22.9 19.5 of goods and non-factor services) Calendar Years 1950 1960 1965 1970 III. SOCIAL AND RELATED INDICATCRS a? a. Population Birth rate (per 1,000 population) 44.7 44.6 44.3 44.5 Death rate (per 1,000 population) 15.9 11.2 9.5 9.3 Infant mortality rate (per 1,000 96.2 74.2 60.7 67.2 live births) Life expectancy (years) 48.8 - _ 61.8 Depeniency coefficient .9 1.026 - 1.081 Urban population (% of total 42.5 5o.7 - 58.5 population) b. Employment Economically active population - 11.3 - 15.9 (million) Economically active population, by sector: (% of total) Agriculture & mining - 55.0 - 48.o Manufacturing, public utilities - 18.0 - 23.0 construction Others - 27.0 - 29.0 c. Public Expenditures on Social Sectors: % of GDP at current market prices - - - 6.7 % of Public sector expenditures - - - 25.0 % of Central Government expenditures - - - 25.0 a/ Values of some indicators are estimated from statistics referring to different years than those in the table.  Annex II. Page 4 of 4 Calendar Years 1950 1960 1965 1970 d. Education Functional literacy rate 9 40.0 - - 0.0 of adult population) Primary school enrollment (% of 39.0 - - 70.0 school age population) Primary school retention ratiob/ - 15.o - 30.6 b/ Graduates over initially enrolled six years earlier.  Annex III Page 1 LOAN AViD PROJECT SUIiiRY Borrowers: Ferrocarriles Wacionales de I-Iexico (Nacionales) and Nacional Financiera, S.A. Guarantor: United Ned.can States. Amount: q 75 million equivalent. The proposed loan would cover about ttwo-thirds of the foreign exchange cost of the project. In case Constructora lNacional (the lotal manufacturer) would be successful in lntem &tional competitive bidding for freight cars, the proposed loan would also cover most of the re- sulting local costs. Project: To modernize and renew the plant and equipment of Nacionales, to improve their operations and to re- duce their financial deficit and to improve Govern- ment's planning capability in the transport sector. Terms: Payable in 25 years, including five years of grace, at an interest of 7-1/4 percent per annum. Ah6unt - OmLllon) Cost of Project: Component Total Foreign Loan Items Rolling stock and motive power Freight cars: 1,400 to be procured under ICB 25.0 25.0 25.0 1,400 reserved for local procurement 25.0 4.4 4.4 90 locomotives and spare parts 33.6 33.6 --- 64 passenger cars and 64 express cars 3.4 3.4 --- 1,000 roller bearings 1.7 1.7 1.7 17orkshop equipment 4.1 2.5 2.5  Annex III Page 2 Amount ($million) Component Total Foreign Loan Items WJ'ays and Structures Rails and fastenings 18.8 15.7 15.7 Timber sleepers: TvJo million to be procured under ICB 8.5 8.5 8.5 Two million reserved for local procurement 9.1 --- --- M1aintenance equipment 3.3 2.6 2.6 Other 31.5 --- --- Terminals 15.1 --- --- Telecommnmications 15.1 7.0 7.0 Consulting Services 1.4 1.2 1.2 Sub-Total 195.6 105.6 68.6 Price Contingencies 7.2 7.2 6.4 Total 202.8 112.8 75.0 Financing: Source Amount (4mil1ion) Local Foreign Total IBiW Loan --- 75.0 75.0 Government 48.0 --- 48.0 Foreign suppliers --- 37.8 37.8 Local suppliers and banks 42.0 --- 42.0 90.0 112.8 202.8 Procurement: All goods financed by the loan to be procured under intermational competitive bidding. Consultants: For the railways: TOPS (Southem Pacific RaiLxays, U.S.A.) under terms of reference agreed with the Bank. For transport planning in Secretaria de Comu- nicaciones y Transportes: to be selected by the Government in agreement with the Bank.  Annex III Page 3 Estimated FY-1973 FY-1974 FY-1975 Disbursements: Rmi3lionl 32.0 30.0 13.0 Rate of Return: The internal economic return of the four major investment items, representing about 83 percent of the total project investments, is at least 17 percent. Appraisal Report No. PTR-107a- (hay 10, 1972) Report. Transportation Projects Department.  Annex IV Page 1 EXTRACT FRaH TIE PRESIDEiT'S REPORT A9D RECOIi1-DDATIOJS CU A PROPOSED IDAH TO flACIGIAL FfIXICIBRA FOR A PORITS PROJECT (P-1036 DATED APRIL 19, 1972-.) 8. lexico, with a GDP of around i35 billion a year, ranks closely behind Brazil as the Bank' s second largest borrower in terms of loans outstanding. Its economy is comparable in size to Brazil and larger than that of any other country to which the Bank Group is lending except India. llexico has been remarkably successful in sustaining a 6-7 percent annual growth rate over a period of 15 years, wTith only a moderate increase in the general price level. This achievement is attributable to a unique combination of historical and geographical factors, intelligent economic and financial policies (exhibiting a high degree of pragmatism and freedom from economic dogma) and a continuity in economic management unparalleled elsewihere in Latin America. Taxation has been kept low (around 9 percent of GDP), but private savings have been encouraged, and a considerable proportion of these savings has been channelled into the public sector tlhrough the banking system. UTational savings have been maintained at close to one-fifth of GDP. and although there has been a significant increase in the external deficit on current account since 1968, this still constitutes less than 3 percent of GDP. 9. T.here is another side of the picture to which attention has been drawn in rny previous reports on Iexico. Of all countries in the world with populations of comparable size, 1iexico has the fastest demogra- phic growth rate. While per capita: income at current prices has risen from tR200-250 a year in the middle 1950's to about .'70O a year today, the increase in income has been very unevenly distributed. While organized workers and the groning middle class have snared in the benefits of economic development and a few people have become very rich, relatively little has been done to alleviate rural poverty. Some 40 percent of the population still depends on agriculture for a living, but agriculture accounts for only 11 or 12 percent of the national income. Wlithin the agricultural sector itself there is a sharp contrast betwieen the prosper- ous conditions of the larger private farms, particularly in the irrigated north and along the coast of the Gulf of iLexico, and the desperate poverty of the small farmers in the central plateau and along tile central and south Pacific Coast. Rural education and health have not been given much at- tention; and away from the main roads, communications in most parts of the country are still quite primitive. 10. The Administration of President Echeverria, wihich took office at the end of 1970, has laid great stress on the need to improve the conditions of the poor and to correct inequalities in income. At the same time, how-i- ever, the Government has beenIbrced to recognize the ccnstraints imposed on the growth of the econorm by the widening gap between imports and ex- ports and the increasing extermal debt which has kept the debt service ratio above 20 percent in recent years. First priority has accordingly been given to changes in economic policy and improvements in economic managernent required to rmlaintain a satisfactory overall growth. As noted in nm last report on -iexico, a series of new tax measures was enacted in  Annex IV 'Page 2 late 1970, sugar prices were increased, and steps were taken to strengthen central control of public borrowing. At the same time, newi emphasis was given to export promotion, and a scheme wras introduced under which manu- factured exports are entitled to tax rebates up to 10 percent of export value. A second fiscal package was adopted early this year, including a new tax on income fron fixed-interest securities, an increase in mar- ginal rates of personal income tax and tax incentives for industrial in- vestment. There is also a new taxi equivalent to 5 percent of enter- prise payrolls, the proceeds of which are to be used to finance workers' housing through a 1,ational Housing Fund. The twJo tax packages together, excluding the housing tax, are expected to increase federal tax revenues by about 10 percent and should raise the ratio of taxes to GDP by approxi- mately one percentage point. 11. Public investment was deliberately held dowm in 1971 to protect the balance of payments, and this was one reason ashy the real growth of GDP slotted daon to 3 or 4 percent, producing something of a recession from which industry may now be slowly recovering. On the more positive side, there appears to have been a net reduction in medium and long-term ex- ternal public indebtedness during 1971, made possible in part by a small improvement in the current balance of payments, but more importantly by a large inflao of short-term funds. International reserves increased by 4200 million during the year and now stand at well over 41 billion. 12. Improved external debt management has been reflected in the terms on wihich the Iiexican authorities borrowed in international capital mark.ets during 1971. For example, loans with maturities of 1 - 5 years, which accounted for over 40 percent of total external public borrowing in 1970, made up only 12 percent of such borrowing during the first 9 months of last year. Two major operations concluded with consortia of foreign bankcs for a total of "p220 million carry final maturities of 8 and 10 years from signing, wxith a grace period of 4 years in each case. The public issue of D.ilO0 zaillion in Germany in I1ovember 1971 had a term of 15 years, including 5 years of grace. Another issue of 1'40 million rarketed in i!ew York, a short time ago has a term of 15 years. TZhis im- provement in the terms of borrowing from private sources till makce it easier for iexico to support a continued high rate of economic expansion without endangering its credit standing abroad. There is, however, little prospect of the country obtaining all the external capital it needs on extended terms without substantial contributions froa the 13BRD and the IDB which are the only official lending agencies in a position to offer development assistance on non-commercial terms. 13. Public savings in l.xico must also be increased if expenditures on rural development and social services are to be raised to more adequate levels, and tbis has been a constant theme of the Bankts economic reports. As a result of the tax measures alreacdr described, there does appear to have been some increase in federal government savings during 1971, and the savings of the Federal District also improved slightly. On the other hand, there has been a decline in the total savings of the three major public enterprises (the national petroleum company, the federal power com- mission and the railroads) from iHex:;3 billion in 1970 to !,bx$2.1 billion in 1971, and this trend needs to be reversed - a matter of special concern to the Dank in view of the proposed loans for railways and power.  Annex IV Page 3 14. The primary objective of Bank lending to RLoico has always been to support the growith of the economny by providing long-term capital for projects that can both behefit from the Bankts special expertise and promise high dieeldpmental returns. At the same time, in the case of the power program and the steel project now under consideration, both of T*-ich have large import components, Bank participation helps i*lexico to orgahtize financing from other sources on the basis of broad international competitive bidding. The Bank has been associated with the pouer sector since 1949, and while the federal power commission, with the Bank' a encouragement, now looCA to export credits to meet a significant propor- tion of its extemal capital requiremaits under joint or parallel fin- ancing arrangeaents, the iiexican authorities attach great importance to a continuation of Bank lending for power, particularly for financing the foreign exchange costs of civil works and equipment for transmission and distribution. The ilexican Government has also sought the Bankl's financial and technical assistance for the development of the transport sector, initially mainly for roads, but since the 1970 sector study., for ports and railwiays as well. 15. Power and transport apart, the Bank is giving special emphasis to projects which directly help to strengthen the balance of payments, since the balance of payments is liable to be a critical constraint on economic developmient in an econonm tied to free convertibility of its currency and heavily dependent at the margin on private capital inflow. Thiis has been a;n important consideration in past lending for irrigation (cotton) and tourism and in the lending now proposed for a newi industrial fund. Additionally, nowi that it is the declared policy of the 1e,xican Government to give more attention to the quality of economic develop- ment, especially in rural areas, the Dank is interested in giving what support it can to programs for education and rural development, and a cornsiderable amount of staff time is currently being devoted to the identification of possible projects in these twio sectors. Hownever, the capital expenditures involved are likely to be quite small. Finally, in View of the great potential scarcity of water in ilexico, plans are going ahead for a national wJater study to be carried out w-ritlh the BankWs help, possibly with some financing froa the UINDP, and a project for the Supply of water to Iiexico City and adjacent urban areas is scheduled for appraisal shortly. 16. The choice of Bank projects in iexico is naturally governed to an im9portant extent by the priorities of the iiexican Government and by the availability of financing from other sources. Since in the past the Inter-American Development Bank has been able to provide soft loans for projects of a social character, and has also been more liberal in financing local costs, i exico has sought its assistance in preference to that of the I3RPD for such projects as feeder roads and minor irrigation works. The main contribution to thie extemal financing of industrial development in l exico has coma from export credit agencies and private sources. Cver the period 1966-70, the 3an1c accounted for 11 percent of the flowt of medium and long-term capital to ,.exico and the IDB for 5 per- cent. These proportions are likely to be si&mificantly higher in future  Annex IV rag-e 4 in conformity with the i*edcan Government's aim of improving its external debt structure, but the greater part of the capital wthich ;'exico requires from abroad will continue to come from private financial institutions and export credit agencies. "'  , = 7 < U. S. A. '4 t;w- ^ EN ' L C, A RAILWAYS 0 100 ADO 10 000 50 1 Cd. ~ ~ ~ GMF OF MEX/CO DU+ OT HR RALWAYL S () DEL PA501C0 ERIEp SONORA-BAJA CALICORNIA C' / vII. CHIlUAHUA AL PACFICO -. 1'-