El Salvador - Second Education Project

FILE COPY CIRCULATNG COPY T0 BE RETURNED TO REPORTS DESK DOCUMENT OF INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT Not For Public Use Report No. P-140 7a-ES REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF EL SALVADOR FOR A SECOND EDUCATION PROJECT May 23, 1974 This report was prepared for official use only by the Bank Group. It may not be published, quoted or cited without Bank Group authorization.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.  CURRENCY EQUIVALENTS US$1.00 = 2.50 Colones (0) 01 = uS$o.1,o 01,ooo = $4o0.oo 01,000,000 = $hoo,ooo FISCAL YEAR January 1 - December 31  INTERNATIONAL BANK FOR RECCNSTRUCTION AND DEVELOPMIENT REPORT AND RECOI;ENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF EL SALVADOR FOR A SECOND EDUCATION PROJECT 1. I submit the following report and recommendation on a proposed loan for the equivalent of US$17.0 million to the Republic of El Salvador to help finance a second education project. The loan would have a tenn of 3u years, including lCU years of grace, with interest at 7 1/4 percent per annum. PART I - THE ECONOMY 2. A memorandum entitled "Recent Economic Development and Prospects of El Salvador" is being distributed to the Executive Directors concurrently with this report. A country data sheet is attached as Annex I. 3. As discussed in the economic memorandum, the economy expanded rapidly in the 196&-67 period but slowed considerably during 1967-72. The country's principal asset, a group of dynamic entrepreneurs and a labor force with a demonstrated ability to acquire ski"lls rapidly, enabled Jhe economy to expand its production of manufactures for the Central American Common Miarket (CACM) and of cotton exports. GDP grew by about 6.5 percent annu- ally in real terms between 1960 and 1967. Its human resources along wLth a satisfactory transport network and electric power grid gave El Salvador's industry a head start within the CACM. The contribution of manufacturing to the gross domestic product increased from 1lh percent to almost l per:cent during the sixties. Nevertheless, the economy continued to depend heavily on coffee and cotton as the m?jor sources of domestic production and export earnings. In 1967-69, Ps cotton prices fell and volume was reduced to half its I1I965 peak level (because of disease and abandonment of marginal landF), growth of export earnings fell to only 1-2 percent annually. The ccnflict wi.th Honduras in 1,69 represented another setback for the economy. Exports to the Common Market declined as the border with Honduras was shut off, and expensive a1ternative arrangements had to be undertaken for shipments to Nicaragua and Costa Rica. Continued low export growth and the CAGM problems led to sharp declines in domestic saving and private investment, and real GDP growth averaged only about 4.l percent annually during 1967-1972, which is only slightly higher than the annual population growth rate of 3.5 percent. 4. El Salvador already has one of the highest population densit:ies in tEe world, and rapid population growth is a basic obstacle to a more satisfactory rate and pattern of development. The 1974 population of 3.8 million is expected to  double by 1990 unless the present growth rate can be lowered. Even aasuming a continued large migration to urban centers, the per capita availability of cultivable land for the rural population would fall further from the pres- ent 0.3 hectare. Moreover, the resource endowment is meager; known mineral resources are scant and fiahing in the Pacific is limited to the narrow con- tinental slielf. 5. L.t the same time the benefits of economic growth have remained un- evenly distributed. Eatimates for 1965-67 indicate that the top 10 percent of income recipienta received 42 percent of total income; 2 percent of land- owners hold almost two-thirds of agricultural land; and, at the other end of the scale, about 90 percent of farms are smaller than 2 hectares. Over half of the labor potential in the peasant sector (which accounts for 60 percent of the working-age population) remains unemployed for a large part of the year, while the a,bundant labor supply has kept agricultural wages at a subsistence level over a long period. Most rural incomes are below $50 per capita per annum compared with the national average of $320. Poor education, health, nutrition and housing conditions further accentuate the difficult situation in the peasant sector and have stimulated migration to urban centers where living conditions are marginally better. According to FAO, the average per capita calorie and protein intake is among the lowest in Latin America. The literacy rate of the adult population is almost 80 percent in the cities but only 40 percent in the rural areas0 It is clear that the long-term viabil- ity of the economy will depend on well-designed population policies, a more equitable distribution of the benefits of economic growth, and better edu- cation, health, nutritional and living standards for most of the population. 6. The outlook for progress in tackling the country's main social and economic problems has improved during the last three years. The Govern- ment's policies through the sixties were geared almost exclusively to main- taining price and balance-of-payments stability. The financial stability, of course, permitted the private sector to take advantage of the opportuni- ties offered by the creation of the Common Market and the cotton boonai. But a low level of tax effort (about 10 percent of GDP) and weak project pre- paration limited severely the use of long-term foreign financing, and public investment remained low. Supported by a large majority in Congress, the Administration which took office in July 1972 has introduced a number of reforms and started implementing the 1973-77 National Development Plan. To strengthen the institutional base necessary to implement the 1973-77 Plan, the Government in 1973: (1) created the Agricultural Development Bank (whose main functian will be to improve the availability of credit for small farmers) and a Housing Fund; (2) strengthened the Rural Colonization Institute's capacity to support the settlement of landless farmers; and (3) placed directl!y under the Office of the President the Community Development Organization (liOCCO). The Government also approved a new forestry law which provides mechanism, to carry out reforestation and soil conservation programs on public and private lands, and is expected to approve this year an Export Development Law to promote exports of non-traditional products to countries outside the CACM. In addition, some public and private institutions have started to encourage family planning and to provide advisory services in clinics. Also during 1973, a combination of higher export prices and improved tax administration resulted in an increase in Central Government revenues by an unprecedented 23 percent, or more than twice the rate of growth of GDP. The improved revenue situation facilitated an increase in capital expenditures, which rose from 2.3 percent to 3.6 percent of GDP between 1971 and 1973; moreover, the level of capital expenditures achieved  in 1973 was in line with the investment targets of the Development Plan. 7. The medium-term outlook is for an improvement in real economic growth from a 4.1 percent annual average in 1967-72 to at least 6.5 percent in 1974-76. This gain will come mainly from the secondary effects on the economy of the expected continuation of high international prices for the traditional export crops -- coffee, cotton, sugar and meat. Expanding exports of non-traditional products to markets outside the CACM remain ocritical issue because of its dual importance for introducing a new outward-oriented industrial straAegy and as a source of new jobs to alleviate the serious unemployment problem. In the longer term, scarcity of land and absence of other natural resources may limit the growth potential, while prices for the major agricultural exports are expected to be somewhat less favorable. Nonetheless, there is scope for considerable strengthening of the economy by developing industry and non- traditional agriculture aimed at world markets. The recent rise in fuel prices is expected to raise the share of petroleum in total imports from four to seven percent in the coming years. However, as long as export prices remain high, the projected resource gap should remain within manageable limits over the next two to three years. O. To achieve the main objectives of the 1973-77 Development Plan of expanding and diversifying the economy while providing a more even distri- bution of bernefits will require a sharp increase in the level of public expen- ditures. Ceritral Government investment is expected to increase from 3 percent of GDP in 196b-72 to about 6 percent in the late seventies. Total public invesciient expenditures are projected to more than double from 1960-72 to 1973-77. Agriculture (including irrigation schemes, marketing, credit pro- grams and better extension services aimed at small and medium farmers) accounts for one-fifth of planned public investment expenditures; power, transport and telecommunicctions absorb an additional 37 percent of the total. 9. To finance such a program, Central Government current revenues would have to rise substantially from current levels. While the measures mentioned in paragraph 6 above should enable the Government to achieve program targets through 1974, additional revenue measures are expected to be necessary during the 1975-76 period. Recognizing this, the Govelnment is considering the introduction of new tax measures such as export duties on cotton and sugar, on a progressive basis to vary according to the price on the interna- tional market, a sales tax that could eventually replace the present stamp tax, and higher taxes on imported luxury goods. External financing 10. The public external debt repayable in foreign currency amounted to US$194 million at the end of 1973, or US$113 million excluding undisbursed commitments. El SalvadorsB traditionally low debt-service ratio gives the Government some margin for borrowing abroad on conventional terms. Even assum- ing that a portion of its external borrowing is obtained on such terms, the debt-service ratio would remain below three percent through 1976. In view, however, of El Salvador's poverty and low per capita GNP (US$320 in 1971), the serious imbalance between natural resources and population, and the uncertain long-term prospects of its main exports, it will be desirable for El Salvador to obtain most of the external financing required for the 1973-77 Development Plan on soft terms. For the same reasorsit will be desirable for El Salvador to obtain financing for a large share of the costs of individual projects. Local currency financing is also justified, on the grounds that El Salvador is making reasonable efforts to mobilize local resources in support of its develop- ment program but requires external assistance in excess of the foreign exchange component of development projects suitable for international financing.  11. Apart from the Bank, external financing has been principally pro- vided by USAID, the Inter-American Development Bank (IDB) and the Central American Bank for Economic Integration (CABEI). IDB and CABEI funds have carried very soft terms and contained large components repayable in local currency. The IDB has made loans for housing, water and sewerage, ports, highways, agricultural credit, industry, higher education and municipal markets. TISAID has financed health centers, basic education, housirg and industry. CABEI has financed industry and also highway and telecomrrmunica- tions projects of importance for the Central American network. The past lending of these agencies through the end of 1973 is summarized below: (In millions of US dollars) IBRD IDA AID IDB CABEI Total 94.7 13.6 56.2 10i.0 62.2 of which repayable in local currency __ __ 1.6 86.5 /n.a. Cumulative Lending 1950-65 50.2 8.0 27.1 32.5 7.9 Cumulative Lending 1966-73 44.5 5.6 29.L 71.5 54.3 Transport -- -- 12.0 23.0 Power and Telecommunications 36.8 5.6 __ 38.1 3.3 Education 4.9 -- 10.1 2.0 0.5 Health -- -- 2.7 -- -- Housing -- -- 3.0 6.3 7.7 Agriculture -- -- 6.5 11.5 1.2 Industry -- -- .8 -- 17.6 Others -- -- 2.0 1.6 1.0 Includes US$38.1 million for a power loan for which the Borrower has the option to repay in local or foreign currency. PART II - BANK GROUP OPERATIONS 12.