Mexico - Second Railway Project

RETURN TO jEJjU COPY RESTRICTED REPORTS DESK Report No. PTR-107a WITHIN ONE WEEK This report is for offichl 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 It may not be published, quoted or cited without Bank Group authorization.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 responsibility for the accuracy or completeness of the report. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT INTERNATIONAL DEVELOPMENT ASSOCIATION APPRAISAL OF A SECOND RAILWAY PROJECT MEXICO May lo, 1972 Transportation Projects Department  * iY 70 HCRTS DESK ROOIM A-124 BY:, Currency Equivalents - Currency Unit 0 Mexican peso (Ps) = US$0.08 US$1 = Ps 12.50 Ps 1,OOO,OOO = US$80,000 US$1,000,000 = Ps 12,500,000 Fiscal Year January 1 - December 31 weights and Measures Metric: British/US Equivalent 1 meter (m) = 3.28 feet (ft) 1 kilometer (km) = 0.62 mile (mi) 1 kilogram (kg) = 2.2 pounds (lb) 1 metric ton (m ton) 2,205 pounds Abbreviations and Acronyms AAR - American Association of Railroads ALALC - Latin America Free Trade Association CN - Constructora Nacional N de Y, - Ferrccarriles Nacionales de Mexico PENEX - Petroleos Mexicanos SCT - Secretaria de Comunicaciones y Transportes SOP - Secretaria de Cbras Publicas  MEXICO APPRAISAL OF A SECOND RAILWAY PROJECT TABLE OF CONTENTS Page No. SUMMARY AND CONCLUSIONS ...... ............... i 1. INTRODUCTION ........................................ 1 2. THE TRANSPORT SECTOR ........................ 2 A. Operations in the Transport Sector ..... 2 B. Role of the Railways .....* ............ 3 C. Transport Coordination .............. 4 3. THE RAILWAY SYSTEM .............................. 5 A. Introduction ....... .................... 5 B. Ferrocarriles Nacionales de Mexico ..... 6 4. THE PROJECT ..... ..................... 9 A. The Investment and Action Plans of the Mexican Railways. 9 B. The Project . ..... o ................. 10 C. The Proposed Loan ..o.. . 0. .......... 00. 14 D. Execution, Procurement and Disbursement. 15 E. Financing Plan ... ........... ........ o. 16 5. ECONOMIC EVALUATION .......... o............. 17 A. General ..o ...... ....-.......... 17 B. The 1972-1973 Project of N de M ....... . 17 C. Conclusion ........... o ................. 18 6. FINANCIAL EVALUATION . o ...... . .o. ... .o... o.. 19 A. Costs, Rates and Fares . ................. 19 B. Past and Future Earnings ......... .. o.... 20 C. Government Support .. ................. 22 D. Balance Sheets .........o ........... o.... 23 7. AGREEMENTS REACHED AND RECOMMENDATION ..o ..... 24 This Appraisal Report has been prepared by Messrs. R.A.D. Loven (railway engineer-consultant), L. Marco (economist) and F. Sander (financial analyst).   ANNEXES 1. Outline of Transport Policy and Recommended Plan of Action 2. Statement of Railway Policy 3. Analysis of Railway Role through 1976 4. Terms of Reference for Consulting Services in N de M 5. Motive Power and Rolling Stock 6. Operating Statistics 7. N de M's Plan of Action 1972-1976 8. N de M's Branch Lines of Low Traffic Density 9. Freight Traffic Forecast 10. Traffic Costs 11. 1972-1973 Investment Plans for all the Railways 12. 1972-1973 Investment Plan of N de M 13. Freight Car Requirements, End of 1973 14. Locomotive Requirements, End of 1973 15. Items to be Financed by Proposed Loan 16. Estimated Schedule of Disbursements 17. Cost Effectiveness Analysis 18. Income Account 19. Cash Flow 20. Summary Balance Sheets MAP Mexican Railways - IBRD 3655 (R)   - ii - It is proposed to finance the ex-factory cost of cars for which CN is the suc- cessful bidder. This means that up to about US$21 million of the loan could finance local currency expenditures, depending upon the outcome of the com- petltive bidding. v. Procurement of another 1,400 freight cars is proposed to be reserved to CN in line with minimum utilization of its existing capacity. It was agreed during negotiations that the price for the reserved procurement of freight cars would be (a) for cars to be delivered in 1973, equal to CN 1972 prices plus inflationary cost increases not higher than 5% and (b) for cars to be delivered in 1974, not higher than 125% of the average of the 1973 prices as in (a) above, and the lowest qualified bid under international competitive bidding. vi. The economic rate of return on the project is at least 17%. The main economic benefits will be derived from the decrease of railway operating costs and the avoidance of costly diversion to road of freight traffic. The financial benefits from the project will also be substantial, reducing a pres- ent operating deficit of over US$108 million a year to about US$3 million in 1976. The financial projections assume substantial rate increases in 1974 and 1976 to compensate for rising labor and social security costs and pro- gressive elimination of the deficit on passenger train operation. Freight rate increases amounting to some Ps 250 million a year are now needed to conform to the principle, agreed by Government and N de M, that all rates should cover long-run variable cost and make some contribution to fixed cost. Because of a slowdown of economic growth, however, Government is unwilling to increase rates prior to 1974 but will pay to the railway, in the form of identifiable user subsidies, the difference between existing and proposed rates. During negotiations, Government and N de M agreed to raise rates in 1974 and 1976 and, in the course of this and the next four years, to progressively eliminate the passenger deficit. vii. In addition to the operating losses of the railways, the Government must also meet the cost of debt service on railway borrowings and that pro- portion of railway investment which is not financed by further borrowing. To- tal Government support of all its railways has increased by more than 14% an- nually since 1964 and reached about US$200 million in 1971. By implementing the Plan of Action, the trend should be reversed. Government support of N de M is forecast at US$45 million in 1976 and total support of all railways should be less than US$65 million. An important contribution to this improvement is expected to result from borrowings for investment on repayment terms more close- ly related to the economic life of the investment than the short- and medium-term loans and suppliers' credits that have hitherto been traditional. viii. Although the upper level of N de M is capable, implementation of the project will require assistance from consultants. N de M has concluded a satis- factory two-year contract with consultants TOPS of Southern Pacific Railway (USA). The Secretaria de Comunicaciones y Transportes (SCT) will also retain consultants satisfactory to the Bank for strengthening transport sector plan- ning procedures and carrying out a study on road user charges. ix. The project is submitted as being suitable for a Bank loan of US$75 million equivalent for a term of 25 years, including a grace period of five years.  MEXICO APPRAISAL OF A SECOND RAILWAY PROJECT SUMMARY AND CONCLUSIONS i. This report appraises a project to modernize and renew the plant and equipment of the Ferrocarriles Nacionales de Mexico (N de M), to improve oper- ations and to reduce the financial deficits of the railway. N de M is state- owned and is by far the largest railway in Mexico, operating 70% of the route- km and carrying 80% of the total railway traffic of the country. ii. The proposed loan of US$75 million would be the second loan to Mexico for railway purposes and the eighth in the transport sector. Loan 103-ME in 1954 (US$61 million) was for rehabilitation and modernization of the Ferro- carril del Pacifico; six highway loans totalling US$176.8 million were for construction of highways, toll roads and bridges. Execution of all projects has been generally satisfactory. In the case of the railway loan, however, agreed financial targets were not achieved, mainly because of increasing la- bor costs, not matched by tariff adjustments. iii. The N de M, which plays an important role in the movement of freight traffic in Mexico, operates largely with new equipment and good track but suf- fers an acute financial problem which poses a heavy and increasing burden on tile Government budget. The losses are mainly the result of the railways per- forming social and economic functions through the provision of unremunerative passenger services and the carrying of minerals and agricultural products at rates below long-run marginal cost. There is also waste of capital resources due to rigid labor rules imposed by a strong labor union. The project is in- tended to start a drive toward improved performance and financial viability after the Government, accepting recommendations regarding the transport sector made by the Bank, declared it national policy that the railways should be run on a commercial basis. Implementation of the varicus measures ultimately to achieve financial viability is not going to be an easy task. Increases in rates and fares, pruning of passenger services and uneconomic lines, and changes of work rules are likely to encounter strong resistance from the groups to be affected. However, the Government and the management of the N de M are determined to initiate action. iv. The project combines the Plan of Action, based on the Bank's rec- ommendations on rail transport, with N de M's 1972-1973 Investment Plan. In- vestment will mainly be for locomotives and rolling stock, components for lo- cal construction of freight cars, track renewals, bridge strengthening, ter- minal improvements, modernization of telecommunications and consulting serv- ices for modernizing the railways and strengthening transport planning. The total estimated cost of the project, including contingencies, is US$203 million equivalent, with a foreign exchange component of US$113 million. The proposed loan of US$75 million will finance about two-thirds of the foreign exchange cost. Included in the foreign exchange component of the project and in the loan will be about 1,400 freight cars which will be offered to international competitive bidding with the Mexican state-owned firm Constructora Nacional (CN) participating in the biddings with the normal preference to local manufacturers.  MEXICO APPRAISAL OF A SECOND RAILWAY PROJECT 1. INTRODUCTION 1.01 The Government of Mexico and the Ferrocarriles Nacionales de Mexico (N de M) have asked the Bank for assistance in financing N de M's investments during 1972 and 1973, estimated at Ps 2,536 million (US$202.8 million equiva- lent). 1.02 This will be the second railway loan to Mexico. The first loan (103-ME) of US$61 million for the rehabilitation and modernization of the Ferro- carril del Pacifico was made in 1954 and the works were completed success- fully in the late fifties. Between 1960 and 1970, six Bank loans totalling US$176.8 million were made for construction of highways, toll roads and bridges; physical execution of all projects has been generally satisfactory. In the case of the railway loan, however, agreed financial targets were not achieved, mainly because labor costs increased faster than revenues. The fi- nancial situation of all the Mexican railways deteriorated in the sixties de- spite a continuous increase in traffic and large investments made for the re- habilitation and modernization of the system. This was mainly the result of Government policy of giving priority to social objectives and using railway tariffs to subsidize passengers in general as well as important freight hauls. The Bank made an in-depth review of the railways in 1964, updated in 1966 and 1969. The deficits of the railways were increasing but public policy remained unchanged throughout the period. 1.03 Early in 1970, the Government of Mexico concluded that major efforts must be made to effect improvements in the transport sector and that the advice and assistance of the Bank should be sought. A mission of transport special- ists from the Bank visited Mexico in April 1970 and, after extended discussions with the Mexican Government, completed its report in May 1971 (hereinafter called the 1971 Report). 1/ Its recommendations, encompassing all modes of transport, were well received by the Government and are reproduced as Annex 1. In April 1971, the Board of N de M, chaired by the President of Mexico, formally adopted a statement of railway policy, along the lines suggested by the Bank. According to this document, reproduced as Annex 2, the Mexican railways are to be operated on business principles, and action has already been initiated, aim- ing primarily at achieving financial stability. At the same time, a National Ports Coordinating Commission has been established, responsible for policy for- mulation, overall planning and coordination of public and private interests re- lated to ports. 1.U4 During 1970 and 1971, consultants from Canadian National Railways, with Mexican counterparts, studied the problems of N de M. The implementation of the consultants' recommendations has already produced satisfactory results and has prepared the way for detailed action plans, described in this report. 1/ IBRD, "The Transport Sector of Mexico," May 1971, PTR-88.  -2- 1.05 The Mexican railway system comprises five Government-owned railway companies, of which N de M, with some 70% of the total route network, is by far the most important. Coordinated investment plans through 1973 and action plans through 1976 have been prepared for the five railways in consultatlon with thie Bank and are briefly reviewed in this report. The detailed techni- cal, economic and financial analysis of this report concentrates, however, on N de M's Plan of Action for its operational and financial rehabilitation and on its 1972-1973 Investment Plan, which forms the basis of the proposed proj- ect. The Plan involves expenditure of about Ps 2,536 million (US$203 million equivalent), toward which the proposed Bank loan would contribute US$75 mil- lion. 1.06 This report is based on (a) N de M's 1972-1973 Investment Plan; (b) the Report on the Transport Sector of Mexico; and (c) findings of the ap- praisal mission of September 1971, consisting of Messrs. R. Loven (railway engineer-consultant), L. Marco (economist) and F. Sander (financial analyst). 2. THE TRANSPORT SECTOR A. Operations in the Transport Sector 2.01 The Mexican transport sector in its inception was designed primarily to link by road and rail the major ports with the industrial and urban centers of the interior; secondly, an intricate network of roads and railways was con- structed within the central plateau to link Mexico City with the main surround- ing centers; and, finally, road and rail connections were provided for foreign trade with the USA through a dozen border points along the frontier. Most ma- jor towns and cities also have commercial airports. As a result, Mexico has a comprehensive and strongly competitive land transport infrastructure, with port and airport facilities to complement the other modes (see Map). The efficient operation and coordination of the transport sector, which will receive about one-fifth of total public investments in the seventies, is important for a curtailment of public deficits and for the achievement of the long-term econ- omic goals. A detailed analysis of recent economic developments and prospects is given in the 1971 Economic Report on Mexico. 1/ 2.02 The road transport industry is very active. In 1970, there were more than half a million heavy trucks operating over 40,000 km of paved roads, with a road carrying capacity estimated at about 100 billion ton-km/year. Trucks have been providing efficient service and competing effectively for new traffic. Statistics concerning the intermodal split of land freight traffic are lacking but indications are that foreign trade tonnage is almost evenly shared by road and rail and will continue to be so through 1976. Railway freight traffic dou- bled over the last 15 years; the growth is expected to continue, but at a slower rate than in the past. Keener competition is expected in the future as more and bigger vehicles enter the road industry. 1/ IBRD, "Current Economic Position and Prospects of Mexico," 1971, CA-14.  2.03 Legally, although not always effectively, public roa.d transport iin Mexico is regulated by a system of concessions, permits and officially pre- scribed maximum trucking rates. The system, however, does not apply to cer- * tain trucks operating under constitutional injunctions against the Secreta- ria de Comunicaciones y Transportes (SCT) granted by the Courts in suspension of SCT's refusal to issue permits to the owners. These trucks stimulate keen price competition as they are not regulated in any way. Government is already taking steps toward an abolition of the present regulations. 2.04 A comprehensive reorganization of the ports is under way. The Gov- ernment has established a Ports Coordinating Commission to improve port man- agement and organization and, with the help of consultants, to prepare traf- fic forecasts and develop a long range port development program. A first port loan was approved by the Bank's Executive Directors on May 2, 1972. B. Role of the Railways 2.05 In the face of strong competition from the roads, the railways have substantially contributed to economic growth by carrying an increasing volume of goods at low, and in real terms, steadily decreasing cost. Railways have a clear cost advantage over road transport for the carriage in bulk of the products of the mining, agricultural, and heavy engineering industries and for most other goods over medium and long distances. (Details are shown in Annex 3.) However, unsound pricing policies, fully discussed in Chapter 6, have caused some distortion of freight traffic and created an artificial demand for passenger services. 2.06 Main traffic flows follow the historical pattern mentioned in para- graph 2.01. Grain imports arrive at the Pacific ports of Guaymas and Man- zanillo to feed the Central Plateau urban centers; raw materials move from all over the country to the industrial centers, Monterrey, San Luis Potosi, Guada- lajara and Mexico City, where finished industrial products originate in turn and are destined for export to USA through Mexicali, Ciudad Juarez, Piedras Negras, Nuevo Laredo and Matamoros. Exports are also shipped from Sonora area in the northwest through Guaymas (cotton), from Veracruz in the southeast (man- ufacturing), and from Tampico in the east (petroleum). Due to the uneven qual- ity of railway services and to the greater efficiency and flexibility of road transport, the trend of inland transport of refined oil products has been away from the railways to the roads. The railways and PEMEX, 1/ in compliance with the transport policy of Government, are jointly exploring ways to improve railway service and make better use of existing railway facilities. 2.07 The most important task in the seventies will be the strengthening of the railways' competitive position through equipment modernization, oper- ating improvements and increased emphasis on marketing. The most dynamic sources of foreign trade and railway traffic will continue to be exports of fruits and vegetables, fluorite and other minerals and manufactured goods, and imports of machinery and parts for road vehicles. In the decades ahead, Mexico will have to rely on efficient railways to export, mainly to USA, bulky agricultural products from northwestern areas and the central plateau - and 1/ Petroleos Mexicanos.  later from southern regions - and to channel machinery imports into industrial regions in Monterrey, Guadalajara, San Luis Potosi and the Mexico City area. Many railway interconnections around Mexico City will have to be removed and the unified railway network will have to concentrate on long hauls. C. Transport Coordination 2.08 Following the comprehensive survey undertaken by the transport mis- sion and the subsequent recommendations of the 1971 Report, important steps have been taken by the Mexican Government. A national transport policy is being progressively implemented in railways and ports, aiming at achieving the least economic cost for the country while obtaining financial viability for the operating agencies. 2.09 Past experience brings out clearly that authority for transport in- vestment and operations should be vested in the same agency, and the recommend- ations of the 1971 Report on transport policy aim at merging the Secretariat of Public Works (SOP) into SCT in the future. SOP still has authority to pro- pose new investments to the Secretariat of the Presidency; these transport in- vestments are not always supported by adequate economic justifications or al- ways sufficiently coordinated with alternative modes. The objective of merging SOP into SCT involves considerable administrative and political difficulties and its achievement is not feasible during the project period. As a first step in this direction, the Government has agreed in principle to strengthen the sectoral Planning Directorate in SCT (a) to formulate and coordinate long- range policy and (b) to introduce project evaluation procedures. The Planning Directorate will appraise all investment proposals in the transport sector and will channel them to the Secretariat of the Presidency with its recommendations. Agreement was reached during negotiations (a) to employ consultants, accept- able to the Bank, to help SCT to strengthen the sectoral Planning Directorate and (b) to carry out a training program for staff of the sectoral Planning Directorate. Both items will be financed out of the proceeds of the loan. 2.10 A comprehensive study of passenger traffic has been undertaken by SCT to determine a coordinated and efficient long-term passenger transport strategy; this study, to be completed before mid-1972, is expected to be the first source of interagency coordination. During negotiations, agreement was reached with the Government to submit the draft study to the Bank for review and comment by June 1972 and to consult with the Bank on the implementation of the study. 2.11 The 1971 Report recommended a thorough examination of the present road user charges by a joint Government committee. The Government agreed during negotiations (a) to undertake a study on this subject, to be completed no later than 1973, under terms of reference, and assisted by consultants, acceptable to the Bank; and (b) to consult with the Bank on the implementation of the conclu- sions of the study. Consultants for this study will be financed out of the proceeds of the loan. 2.12 The Government's long-term objective is to have one single, autonomous, Government-owned railway system in order to achieve the benefits of (a) unified and standard train operations, (b) a common tariff and service approach, (c) sim- plified and standardized maintenance of railway facilities, and (d) economies  - 5 - of scale in management, administration and procurement. SCT has already pre- pared a plan, whose objectives were agreed upon during negotiations, for unified operation of, among other things, yards and standard trains, and specialization of maintenance shops. The study of a common tariff is also under way; it was agreed upon with the Government during negotiations that the comnon railway tariff would be introduced by 1975. 3. THE RAILWAY SYSTEM A. Introduction 3.01 The eleven separate railways existing until 1964 were consolidated in the late sixties to five Government railways, offering public service over almost 20,000 km route-km as detailed below: Route-km Standard Gauge Narrow Gauge Total _ (1.435 m) (0.914 m) Autonomous Operation Nacionales de MIexico 13,492 587 14,079 71.1 del Pacifico 2,284 - 2,284 11.6 SCT Lines Chihuaiiua al Pacifico 1,515 1,515 7.7 Sonora-Baja California 539 - 539 2.7 Unidos del Sureste 950 420 1,370 6.9 Total 18,780 1,007 19,787 100.0 Although SCT lines are part of the formal trunk system they are, to a large extent, long branch lines to the main Nacionales and Pacifico systems (see Map). Rolling stock and motive power are interchanged through five main junctions. 3.02 Substantial developments took place on the Mexican railway system during the 1960's. Wlile the length of the system increased only marginally to 19,300 route-km, freight traffic increased at an average rate of 5% p.a. to over 48 million tons in 1970. Passenger traffic increased more slowly at 1.4% p.a. Total revenues rose only about 6% in real terms over the decade and reached about Ps 2.8 billion in 1970. Steam locomotives have been phased out completely in favor of diesel operations. Rail has been renewed or up- graded - over half the network now has heavy rail (100 lbs or more per yard). Telecommunication systems have been improved, as have freight yards and major stations. The total number of freight cars has increased only 11%, with most of the increase being in specialized equipment (e.g. hopper cars, gondolas,  -6- refrigerator cars, etc.). Finally, there was only a small increase in the labor force from 70,000 to 72,800. To bring about these developments, large investments were made; for example, in the second half of the period (1965- 1969), investments attributable to the railways themselves averaged Ps 760 mil- lion (US$60 million) p.a. and those by the SOP on line extensions and major re- alignments of existing main lines averaged Ps 177 million (US$14 million) p.a. 3.03 N de M and del Pacifico are autonomous Government agencies. In thie conduct of operations they are managed by the same General Manager, appointed by the President of the Republic, with Boards of Directors representing var- ious Secretariats, the Chamber of Commerce and the Syndicate of Railway Workers. The other public railways are operated as a Directorate of SCT and are run by General Managers, appointed by the Secretary of Communications and Transport, who serves as Chairman of the Board of all Government railways. Through the SCT, the Government controls safety and engineering standards and the tariffs of all railways. Railway operating and capital investment budgets have to be approved by the Secretariat of the Presidency. Although the pro- grams of the N de M and Pacifico are made known to the SCT, they are, in effect, direct submissions to the Secretariat of the Presidency whereas those for the other railways have to go through a screening process by the SCT be- fore final submission. The sectoral Planning Directorate in SCT (para 2.09) will in the future coordinate all railways' investments plans. B. Ferrocarriles Nacionales de Mexico (i) Management, Organization and Staff 3.04 In October 1970, the new Mexican Government, which will remain in office until end 1976, brought a new General Manager to N de M and, at the same time, three new posts of Assistant General Manager were created: one for Operations and Engineering; one for Finance and the third for Planning. In this manner, the number of staff reporting directly to the General Manager was substantially reduced. The persons appointed to the four managerial posts, although without previous railway experience, are men of considerable indus- trial, commercial and managerial capacity. They appear to have good under- standing of the problems of the railways and the actions needed to solve them. 3.05 Organization at the operational level, subdivided into 17 divisions, needs a major overhaul. The divisions are highly departmentalized, each op- erating virtually independently. Negotiations with the labor union will be needed to change certain of the present operational practices as these are agreed in the labor contract. Consultants will be retained under the project to assist the railway - inter alia - in projecting future organization at the field level (para 4.15). 3.06 Total staff has remained practically stable since 1966 and numbers about 59,000. As a part of N de M's Plan of Action, and with the assistance of consultants (terms of reference in Annex 4), a manpower plan is to be pre- pared to show how many staff and what skills are needed in each part of the railway and to set up related training programs. This is an important and  urgent task as there is little doubt that a considerable number of men are redundant, although the productivity per man employed was 375,000 traffic units (pass-km plus net ton-km) in 1970, which is similar to that of solne European railways (Netherlands, 392,000; Switzerland, 333,000; France, 319 ,),000). The expected traffic increase will absorb much of the redundancy. The Gov- ernment has directed that the railway should not reduce staff because of the present high unemployment, but Government and N de M have agreed not to in- crease the labor force through 1976. This was confirmed during negotiations and has been incorporated in the Plan of Action (Annex 7). (ii) Railway Property 3.07 N de M operates approximately 13,900 route-km of single track rail- way. A short stretch of the standard gauge line (103 km) is electrified. Centralized traffic control has been installed over some 500 route-km of main line. Control on the remainder of the system is by train order. The tele- communication system is in process of modernization. 3.08 The motive power fleet consists of 821 diesel locomotives, 9 elec- tric locomotives and 34 diesel railcars. All steam locomotives were phased out in 1968. Of the diesel fleet, 151 locomotives are over 20 years old (Annex 5). It is expected that 187 will be retired during the next three years due to wrecks and obsolescence. Forty new locomotives have been delivered in 1971, and 90 more are contemplated in the project (para 4.08). 3.09 There are approximately 1,600 passenger cars, of which 830 are more than 30 years old and cause problems of maintenance and unsatisfactory serv- ice. The freight car fleet of 22,200 (end 1970) is relatively new. Only 6,660 cars (30%) are between 25 and 30 years old and still have 5 to 10 years of service life left. Most of the remainder are less than 15 years old (Annex 5). 3.10 In general, track and equipment are maintained satisfactorily. (iii) Operations 3.11 The most important operating statistics are presented in Annex 6. Freight train loads have increased with dieselization from 812 net tons in 1966 to 931 tons in 1970, which is satisfactory for a country like Mexico where grades are often severe and where there are many sections of light traffic. 3.12 Utilization of motive power and rolling stock is poor. Diesel loco- motives are used in train service less than 10 hours a day rather than, say, 18 hours, because diesels are being worked in the same way as the former steam locomotives. No records are kept of kilometrage of each individual locomotive which prevents doing maintenance on a kilometrage basis, as it should be done. At present, maintenance is on a time basis at low average kilometrage, result- ing in the locomotives being in shops and running sheds too often. Overload- ing of locomotives frequently leads to failures in service but the railway is  - 8 - taking steps to improve the situation. There is no central control of loco- motive and car utilization, resulting in unsatisfactory turnaround times and contributing to locomotive and car shortages and empty car runs. Consultants to be retained under the project will pay special attention, as part of the Plan of Action, to locomotive usage and availability. Physical targets in locomotive usage and availability have also been agreed upon during negotia- tions (Annex 7). 3.13 In addition to its own cars, N de M operated on its lines, in 1970, an average of about 1,400 cars of the other Mexican railways, 7,500 Mexican private owners' cars, 4,200 foreign private owners' cars, and 7,500 foreign railway cars (USA and Canada). The average number of N de Hf cars on otlher railways inside or outside the country was approximately 1,400. By improving car utilization, N de M will reduce by two-thirds its dependence on foreign cars and its resulting rental payments. (iv) Uneconomic Lines 3.14 The Plan of Action for N de M contemplates the removal, of sections which prove to be uneconomic and for which alternative modes of transport exist or could be provided more economically. The 1964 Bank Transport Sector mission estimated that there were about 2,600 km of low traffic density branclh lines for which there was doubtful economic or financial justification (Annex 8>. Potential net avoidable losses in those branch lines are estimated at about Ps 90 million p.a. (US$7.2 million equivalent), a large part stemming from passenger services. During negotiations, the Government and N de Mi agreed, as part of the Plan of Action, to make a feasibility study of low traffic lines before end 1973 and, where it is not possible to establish suchl lines on a profitable basis, to make appropriate recommendations to Government and to take action to reduce the deficit (see outline Terms of Reference for the study in Annex 8). The Government also agreed, during negotiations, not to build any new railway line before the end of 1975 unless its economic and financial feasibility has been established and agreed with the Bank. (v) Accounts and Audit 3.15 The accounts of N de M are maintained and presented in a satisfac- tory manner, and are audited by a well-known firm of public accountants, Roberto Casas Alatriste. (vi) Freight Traffic 3.16 N de M's freight traffic increased from about 14.4 billion ton-km in 1965 to about 18 billion ton-km in 1970, mainly due to a substantial in- crease in traffic of petroleum, steel and building products. By securing new traffic of mineral and steel products, average hauls have also increased from 446 km in 1965 to 472 km in 1970. In conjunction with Bank staff, N de M has made detailed freight traffic forecasts through 1976 by major commodity groups (a summary is given in Annex 9). As a general principle, it has been assumed  - 9 - that tariffs for both railway and road will be proportional to their respec- tive operating costs and that the railways will secure traffic only where their operating costs and resulting tariffs for any commodity are lower than the cor- responding road operating costs and tariffs, after appropriate allowance for differences in quality of service. Annex 3 gives a detailed test of the traf- fic forecast. Substantial increases in rail traffic are expected in sugar cane, grains, fruits, fluorite, petroleum products, building materials and manufactured goods. An average annual growth of 3.3% is expected through 1976, compared with 4.1% p.a. obtained since 1965, and a traffic of 23.6 billion ton-km over an average haul of 498 km is expected by 1976. Based on consultants' re- commendations (para 1.04), N de M is developing a new commercial strategy to secure all traffic for which the railways are the lowest cost mode of transport. (vii) Passenger Traffic 3.17 Passenger traffic, which grew by less than 2% p.a. between 1950 and 1965, grew by more than 2.8% p.a. between 1965 and 1970 as a result of increased economic activity and a decrease of fares in real terms (para 6.04). In 1970, N de 14 moved more than 33 million passengers, and the total traffic was 3.4 billion pass-km, most of it second class; urban traffic is negligible. The losses of this service, calculated in Annex 10 as the difference between avoidable costs and actual revenues, are estimated at about Ps 285 million in 1971 (about US$23 million equivalent), or one-fourth of N de M's net operating deficit in the same year. Targets for elimination of passenger deficits are part of the Plan of Action (para. 4.03 and Annex 7). In accordance with this Plan, N de M has already studied 20 passenger services and submitted the re- sults to the Government; the methodology developed will apply to the whole network. No dependable forecast of passenger traffic can be made because it is not possible at this time to forecast in what measure the loss of passenger train operation will be reduced by curtailing or abandoning services, increas- ing fares and other charges, or subsidy of the users by Government. Neverthe- less, an average rate of decrease of about 5% p.a. ,can reasonably be expected through 1976. 4. THE PROJECT A. The Investment and Action Plans of the Mexican Railways 4.01 The five Mexican railways have prepared coordinated 1972-1973 In- vestment Plans wlhich have been approved by the Government and included in the Government's annual budgets. The Plans are considered acceptable and are summarized as follows:  - 10 - Chihuahua Sonora- al Baja N de M Pacifico Pacifico California Sureste Total % ----------------------- Pesos (Millions)------------------ Motive Power & Rolling Stock 1,160 259 136 50 30 1,635 47.6 Ways and Struc- tures 878 188 52 83 5 1,206 35.1 Terminals 189 21 26 2 1 239 6.9 Teleconmunications 189 5 3 2 3 202 5.9 Consulting Services 24 - - - - 24 0.7 Sub-Total 2,440 473 217 137 39 3,306 96.2 Contingencies 96 18 9 5 2 130 3.8 Grand Total 2,536 491 226 142 41 3,436 100.0 7% 73.7 14.3 6.6 4.2 1.2 100.0 Annex 11 contains a detail of the requirements, for all railways, of locomo- tives, rolling stock and workshop plants. Since all railways are interconnect- ed and rolling stock is frequently exchanged, reductions in investments by the other railways might have a negative impact on N de M's performance and carry- ing capacity. During negotiations, the Government undertook to implement the 1972-1973 Investment Plans for all the railways. 4.02 With the help of SCT and N de M, all the railways are to prepare Corporate Plans, similar to that of N de M, and coordinated investment plans through 1976. During negotiations, the preparation and introduction of Cor- porate Plans for all railways, under the coordination of SCT, no later than D)ecember 31, 1973, was agreed by the Government. B. The Project (i) The Plan of Act:Lon of N de M 4.03 As part of the project, N de M has prepared a Plan of Action for the period 1972-1976. The Plan follows the recommendations of the 1971 Report and the consultants' studies (paras. 1.03 And 1.04) and has been agreed with the Bank; its main objectives are discussed in various sections of this report and are listed in Annex 7. These are (a) to prepare before 1973 a comprehen- sive Corporate Plan designed to achieve agreed quantitative targets through 1976 aiming at improving operations and greatly reducing operating deficits by 1976; (b) to eliminate the deficit on passenger traffic by 1976; and (c) to introduce a new freight tariff system.  - 11 - (ii) The 1972-1973 Investment Plan of N de M 4.04 Based on expected traffic requirements, N de M has prepared a 1972- * 1973 Investment Plan, which will supplement and support the Plan of Action in order to continue improving N de M's operational performance and especially to initiate a concentrated effort toward financial viability. Total investment is estimated at Ps 2.5 billion (US$203 million equivalent) with a maximum for- eign exchange component of US$112.8 million (paras. 4.17 and 4.23). 4.05 Cost estimates are based on mid 1971 prices. N de M's budget is expressed in monetary instead of physical terms and price increases in local cost will be dealt with through carryovers into the 1974 budget. No price or physical contingencies have been allowed for local costs. N de M will procure most of the local materials for the project at an early stage; since local prices have remained stable in recent years, neither significant over- runs nor imbalance between local and foreign components are expected. Total price contingencies of about 9% have been added on items to be financed by the loan, and only 2% on items to be financed by bilateral lenders, the majority of which is already committed. The main items of N de M's 1972-1973 Invest- ment Plan are summarized in the table on page 12 and details are given in Annex 12. 4.06 A brief description of the main items of the Investment Plan follows. (a) Rolling stock and motive power 4.07 Freiglht cars. An amount of Ps 625 million (US$50.0 million) is allocated in the project for acquisition of freight cars and Ps 21 million (US$1.7 million), for roller bearings necessary for car rehabilitation, to- gether representing 26% of total investment during the project period. Annex 13 shows the calculation of freight car requirements through the end of 1973. Substantial improvements in carload and car availability are expected to cope with needs created by new traffic. Since appraisal, N de M has informed the Bank that, by implementing further operating improvements, it is believed that the number of cars to be delivered in the two years 1972-1973 can be reduced by about 10%. The project has not been altered, however, since the reduced es- timate may well be exceeded if the higher standards of utilization are not achlieved or if traffic should grow faster than estimated. 4.08 Locomotives and spare parts. During 1972-1973, N de It will purchase or commit 90 locomotives and spare parts for a total amount of Ps 420 million (US$33.6 million), representing 17% of total investment during the period. The number of 90 (40 ordered for 1972 and 50 about to be ordered for delivery end 1973) has been based on (a) the need to replace 187 old locomotives and (b) the expected traffic increase (Annex 14). Account has been taken of planned reductions in passenger services and improvement of locomotive utilization by changing existing work rules. Since N de M fears that the next renego- tiation of the labor contract - necessary to change the relevant work rules - would take a long time to conclude, N de M has agreed to review, assisted by  - 12 - The Project Proposed Loan Total Cost % of Foreign Cost Loan Items % of US$ million Project Cost US$ million US$ million Loan Rolling stock and motive power Freight cars: 1,400 to be procured under ICB 25.0 12.3 25.0 25.0 33.3 1,400 reserved for local procurement 25.0 12.3 4.4 4.4 5.9 90 locomotives and spare parts 33.6 16.6 33.6 - - 64 passenger cars and 64 express cars 3.4 1.7 3.4 - - 1,000 sets of roller bearings 1.7 0.8 1.7 1.7 2.3 Workshop equipment 4.1 2.1 2.5 2.5 3.3 Ways and Structures Rails and fastenings 18.8 9.3 15.7 15.7 21.0 Timber sleepers: Two million to be procured under ICB 8.5 4.2 8.5 8.5 11.3 Two million re- served for local procurement 9.1 4.5 - - - Maintenance equipment 3.3 1.6 2.6 2.6 3.5 Other 31.5 15.5 - - - Terminals 15.1 7.4 - - - Telecommunications 15.1 7.4 7.0 7.0 9.3 Consulting Services 1.4 0.8 1.2 1.2 1.6 Sub-Total 195.6 96.5 105.6 68.6 91.5 Price Contingencies 7.2 3.5 7.2 6.4 8.5 Total 202.8 100.0 112.8 75.0 100.0  - 13 - consultants and in consultation with the Bank, the appropriate timing for the procurement of the 50 locomotives, before placing any contract. 4.09 N de Di's locomotive fleet is composed of about equal quantities of only two makes, General Motors of USA (GM) and Alco of Canada. The locomo- tives included in the project are to be procured from these two manufacturers to maintain locomotive standardization. 4.10 Passenger cars. N de M proposes to purchase 64 second hand pas- senger cars in the USA or Canada and to rehabilitate them for service as first class coaches. In addition, 64 mail and express cars are to be acquired, also second hand. In general, investments in passenger cars would not be justified in view of financial losses now incurred by railways in passenger traffic. Nevertheless, by partially renewing the obsolete stock of first class coaches (Annex 6), and by improving the first class service, all rates can be substan- tially raised, and losses can be mitigated. 4.11 Workshop equipment. In line with the general concept of modern- izing the entire railroad, it is planned to rationalize the number of main- tenance facilities for cars and locomotives and possibly reduce their number. The shops to remain in service require upgrading to enable them to handle increasing work loads as other shops are phased out. The project contemplates tlhe acquisition of workshop machinery up to a total of Ps 72 million (US$5.8 million equivalent). (b) Ways and Structures 4.12 A total of Ps 890 million (US$71.2 million equivalent) is included, representing 34.2% of the total investment. Among the main items are: (i) 690 km of new rails, amounting to 9.3% of total project investment, to replace used rails in six high traffic density sections; ballasting of certain sections (1% of total investment) and easing of extreme gradients and curvature on the main lines (1.2% of total investment); (ii) four million timber sleepers, amounting to 8.7% of total project investment, for normal replacements and to over- take arrears in replacing sleepers in medium to low den- sity sections of the railway and particularly in dry areas of the country; (iii) bridge renewal and strengthening, amounting to 7.2% of total project investment, to cope with the heavier axle- loads demanded by the operation of heavier locomotives and cars; and (iv) way maintenance machinery, welding equipment, track work- shops, small tools and engineering equipment, amounting to 2.7% of total project investment, to be used over the whole network.  - 14 - (c) Terminals 4.13 An investment amount of Ps 189 million (US$15.1 milllon equivalent), or 7.4% of total investment, will help (a) to increase the efficiency of the remaining workshops; (b) to introduce track revisions and extensions at the terminals of Guadalajara, Monterrey, San Luis Potosi and Veracruz, whichl are presently handling the highest car volumes; and (c) to carry out minimum in- provements of freiglit sheds and stations. (d) Telecommunications 4.14 Investment under this heading will amount to Ps 189 million (US$15 million equivalent) or 7.4% of total investments. The bulk of it will be in line construction, installation of carriers, dispatch circuitry, highway cross- ing protections, and train control, resulting in improved turnaround of rolling stock and safety standards. (e) Consultants 4.15 As a part of the project, N de M will be assisted by consultants over the project period in the following fields: corporate planning, including manpower planning; line and yard operations; locomotive and car control; lo- comotive and car maintenance; telecommunications; costing, accounting prin- ciples and financial forecasts and control. N de M has concluded a satisfac- tory two-year contract, under terms of reference agreed with the Banlk (Annex 4), with consultants TOPS of Southern Pacific Railway (USA). The expected foreign exchange component of US$0.7 million has been included in the loan. 4.16 Strengthiening intermodal coordination in the Mexican transport sec- tor is one of the main objectives of the Government and the Bank. Also as part of the project, consultants satisfactory to the Bank will be appointed 1by SCT for strengthening its Sectoral Planning Directorate, introducing trans- port sector planning procedures and assisting the Govertment in carryin- out, under terms of reference acceptable to the Bank, a study on road user charges. The expected foreign exchange component of US$0.5 million is included in the loaui (paras. 2.09 and 2.11). C. The Proposed Loan 4.17 A loan of US$75 million is proposed to finance the foreign excliange component of the project except for diesel locomotives and passenger and ex- press cars which are to be financed on a bilateral basis. Some local currency financing may be involved, depending on success of local industry in winning bids for procurement of freight cars under international competitive bidding (para 4.23). The possibility exists of a small retroactive financing of con- sultant service for N de M if a contract for the provision of such service is signed in May 1972. Loan items are described in Annex 15 and have been sum- marized in the table on page 12.  - 1 5 - D. Execution, Procurement and Disbursement 4.18 N de M, assisted by consultants, is capable of carrying out the project. All goods financed by the loan would be procured through interna- tional competitive bidding. 4.19 The Mexican Government has requested that part of the freight cars included in the project be supplied by the only domestic freight car manufac- turer, the state-owned firm Constructora Nacional (CN), which operates effi- ciently on a commercial basis, producing high-quality cars. The prices quoted by CN are competitive and have, in recent years, attracted orders from rail- ways in the USA, Panama and Colombia. N de M has already ordered about 1,000 freight cars from CN for delivery in 1972. All further tenders for freight cars to be invited prior to the end of 1973 will be called simultaneously for two groups of cars of similar types: 50% (Group A) to be acquired under international competitive bidding in which CN would participate and 50% (Group B) to be reserved for CN. The number of cars to be ordered under this arrangement, covering N de M's needs up to the end of 1974, is estimated at about 2,800. In the Group A bidding, CN should enjoy a margin of prefer- ence of 15% on CIF prices, or the prevailing custom duty, whichever is lower. 4.20 In Group B, CN will supply freight cars at an average per unit price not exceeding, in cars of comparable specifications: (a) for cars to be deliv- ered in 1973, the 1972 CN average price plus inflationary cost increases of less than 5% and (b) for cars to be delivered in 1974, 125% of the average of 1973 CN prices described in (a) and the price under the lowest qualified CIF bid of cars in Group A. This procedure ensures a double objective: it puts a ceil- ing on prices paid by N de M and it forestalls the possibility that CN could charge unduly high prices for the cars in Group B to enable it to quote unduly low prices for the cars in Group A. The number of freight cars reserved for CN, together with other cars to be supplied by CN to the other Mexican rail- ways, is sufficient to ensure minimum occupation of CN's existing capacity. 4.21 The landed cost of cars in Group A (ex-factory, if bids are won by CN), has been included in the proposed loan, and it is recommended that the Bank finance it whether the contracts are won by foreign firms or by CN. While the Bank will not finance the cars to be ordered from CN in Group B, it is pro- posed that the Bank should finance the cost of imported components for such cars. These components, comprising mainly roller bearings, steel wheels and axles and heavy underframe members, are to be procured under international bidding and on a worldwide basis, in full conformity with Bank guidelines. The sum involved, Ps 55 million (US$4.4 million) is included in the proposed loan. 4.22 There are four million timber sleepers in the project, of which two million (50%) hard wood sleepers are included in the proposed loan and will be procured through international competitive bidding. The other two million, soft wood sleepers, not proposed for Bank financing, are reserved for the large number of Mexican manufacturers whose productive capacity and competi- tion the Covernment wishes to support. 4.23 The proposed loan would involve local financing up to a maximum of US$21 million, depending on the outcome of the competitive bidding for freight cars. This is considered reasonable in view of the fact that it assures in- ternational competitive bidding for substantial items in N de M's investment program which, so far, have been procured exclusively on the local market.  - 16 - 4.24 N de M is subject to import duties. At the same time,Mexico is a member of the Latin America Free Trade Association (ALALC) and has nego- tiated preferences for the importation of lists of products originating in member countries of ALALC. As of now,this will apply only to hardwood timber sleepers and axles for freight cars. Should offers be submitted in inter- national tenders from suppliers located in ALALC countries, N de M proposes to evaluate bids on the basis of CIF landed price plus import duties. 4.25 Any savings in the loan account resulting from prices lower than estimated would be used to finance similar project items in the ongoing pro- gram subject to agreement with the Bank. Disbursements would be made on the basis of CIF costs of US$67.4 million imported goods (or ex-factory costs, excluding identifiable taxes, of locally procured goods), and of thie foreign costs of consulting services (US$1.2 million). The balance of the loan funds (US$6.4 million) is unallocated. Annex 16 shows estimated quarterly disburse- ments assuming the proposed loan becomes effective in the third quarter of 1972. E. Financing Plan 4.26 Throughout the project period, N de M will be unable to provide from earnings any finance for investment, which will consequently have to be found entirely from borrowing and from Government resources, in the following manner: Local Foreign Total %