Mexico - Seventh Highway Project

CIRCULATING COPY, TO BE RETURNED TO RERTDc DOCUMENT OF INTERNATIONAL BANK FOR RVCOTNsTRUCTION AND DEVELOPMENT Not For Public Use Report No. P-1338a-ME REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO NACIONAL FINANCIERA, S.A. WITH THE GUARANTEE OF UNITED MEXICAN STATES FOR THE SEVENTH HIGHWAY PROJECT January 31, 1974 Latin America and the Caribbean Regional Office 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 It may not be published, quoted or cited without Bank Group authorization.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 Currency Unit Peso (Mex$) US$1.00 - Mex$12.5o Mex$1 .00 us$o.08 Mex$1 million -US$80,000  INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO NACIONAL FINANCIERA, S.A0 WITH THE GUARANTEE OF THE UNITED MEXICAN STATES FOR THE SEVENTH HIGHWAY PROJECT 1. I submit the following report and recommendation on a proposed loan to Nacional Financiera, S.A., with the guarantee of the United Mexican States for the equivalent of US$90.0 million to help finance a project for highways. The loan would have a term of 25 years, including 5 years of grace, with interest at 7-1/4 percent per annum. PART I - THE ECONOMY 2. "The Economy of Mexico: A Basic Report" (192-ME) was dis- tributed to the Executive Directors on June 26, 1973. It was designed to provide a long term perspective and a framework for the assessment of short run trends in the Mexican economy. An updating report will be prepared this spring and is scheduled to be distributed to the Exec- utive Directors in mid-1974. Country Data sheets are provided in Annex I. 3. For the three most recent of the six decades since the Revolution of 1910, the success of the Mexican system, measured in terms of GDP growth, has been outstanding. Since 1940, the annual average growth rate has exceeded 6 percent. And from the mid-1950's to 1972 Mexico was among the few countries in the developing world to combine a sustained high rate of growth with monetary and balance of payments stability. The average annual rate of inflation was less than 5 percent and the dollar value of the peso was maintained at the level fixed in 1954. 4. Rapid and sustained growth was the product of successful policies affecting the mobilization and use of both private and public sector re- sources. The role of goverrment in promoting economic growth was concerned on one hand with the development of strategic infrastructure and major utility industries and on the other with development policies which featured, in the agricultural sector, the development of price support, import control and agrarian reform measures, and in the industrial sector external pro- tection and the provision of fiscal incentives. 5. The sectoral allocation of public and private investment was reflected in a changing structure of output and employment. This featured the growth of manufacturing industry and the relative decline of agri- culture, although agriculture remained the chief source of employment, accounting in 1970 for 39 percent of the economically active population.  - 2 - 6. Rapid economic growth has not generated sufficient opportun- ities to create employment for the labor force which has recently been growing at about 3.5 percent per year. In 1970 it was estimated that 40 percent of the labor force was either engaged in marginal occupations - relatively unproductive and hence poorly paid - or totally unemployed. Partly as a consequence of rapid population growth, but also as a result of the distribution of incomes and assets in the Mexican economy, the strategy which succeeded in promoting rapid growth was not comparably suc- cessful in spreading its benefits. The incidence of poverty had by 1970 been much reduced from the level of 1940. But the differentials between rich and poor, both between people and between places, had probably increased. 7. There was, until recently, little evidence (apart from the con- tinuation of the land reform program begun in earnest during the Cardenas regime in the 1930's) that Government policies were much concerned with these problems. By 1970, however, it was apparent that a revised economic strategy - one which would focus on the improvement of the living conditions of the poor - was required. It seemed to be understood that this goal should not be pursued at the expense of rapid growth or of the monetary and balance of payments stability which appeared to be a sine qua non of sustained economic expansion. The events and trends of the last three years have demonstrated the Government's determination to develop such a strategy. They have also revealed some of the constraints to doing so. 8. There are several types of distributive measures which do not depend heavily on the growth of budgetary expenditures. Among those introduced since 1970 are a new Agrarian Reform Law (1971), a new Water Law (1971) and a revision of instructions concerning the allocation of bank credit (designed to increase the flow of resources to low income farmers and ejidatarios). 1/ These measures are all responsive to the needs of the rural sector and demonstrate the Government's concern to confront them. Another recent initiative is the introduction (1972) of a 5 percent payroll tax 2/ to finance a new housing program for workers in the lower-middle income groups. It is clear, however, in the light of the experience of the last three years, that neither the needs of the poor nor those of the public sector industries (on which the growth of the economy as a whole partly depends) can be met unless the Government takes new measures to mobilize additional public sector resources. 9. In 1971 the Government acted to restrain the growth of the economy in order to preserve stability and, partly as a result, the growth rate fell from the 1960 - 1970 decade average of 7.1 percent to only 3.7 percent, while prices increased by 4.8 percent. In 1972 renewed expansion was stimulated by public sector expenditures and the GDP growth rate rose to 7.5 percent, while prices increased (in terms of the GDP deflator) by slightly more than 5 percent. In 1973 there was a further substantial 1/ The ejido is a form of collective land tenure based on usufruct rather than ownership. 2/ This tax is not considered to be part of public sector resources for purposes of public finance analysis.  - 3 - increase in public expenditures which was largely financed by recourse to increased internal and external borrowing. This expansion coincided with and was partially responsible for an acceleration in the rate of domestic price increases. These increases are also, however, a con- sequence of imported inflation (the impact of which was especially serious because of the poor harvest in 1972 and the resulting need to import basic foodstuffs in a year of high commodity prices). Prices increased by roughly 20 percent during 1973 - somewhat more in the case of wholesale prices and somewhat less in the case of consumer prices. 10. In the light of these trends, the Government is introducing substantial new resource mobilization measures to generate the funds required to support the growth of public expenditures. Following some changes in the tax structure in 1972 and 1973, it is understood that there will be a more substantial increase in taxation in 1974. The action which was taken in October 1973 to adjust electricity rates (by an average of almost 30 percent) was followed by substantial increases in hydrocarbons prices in December 1973. The total of the revenue measures which have been taken or are under consideration is expected to yield the equivalent of approximately 2 percent of 1974 GDP. 11. These measures to increase public sector revenues are clearly needed and they will permit a reduction in the public sector deficit as well as a moderate increase in expenditure in 1974. The rate of increase in the latter, however, is likely to be slower than in 1973. There should be some deceleration in the rate of inflation in 1974 compared to 1973, but the rate will still be higher than in other recent years, both because of further expected increases in international prices and because the inflationary trends of 1973 have resulted in substantial wage adjust- ments which are likely to be reflected in higher costs and prices. 12. It is unlikely that the rate of economic growth in 1974 will be as high as the level of between 7 and 8 percent which is estimated for 1973. Growth will almost certainly be restrained by the capacity limit- ations derived from the low level of private investment in the last three years and because the Government recognizes the need to limit imports in order to contain the balance of payments deficit to an acceptable level. It is quite probable, therefore, that 1974 will be a year of fiscal and financial retrenchment and of moderate growth. 13. The events of recent months have illustrated the dangers inherent in large scale deficit financing, but also the willingness of the Government to take the kinds of corrective action which become necessary. The record of the Mexican authorities in economic management over the past two decades is such that there is reason to give credence to the Government's assurances that it will act to restore the relative price and balance of payments stability which, in terms of the recent experience of the Mexican economy, appear to be necessary conditions of sustained growth. The Bank, as well as the Fund, is in a continuing dialogue with the Government regarding these issues.i  - 4 - 114. As of December 31, 1972, Mexico's outstanding disbursed external public debt was US$4.0 billion as compared with a total of US$3.5 billion a year earlier. The IBRD share in the former total was US$723 million as compared with a level of US$659 million a year be- fore. For 1973, net public medium and long-term external borrowing is estimated at about US$1,300 million. This represents a sharp increase over the 1972 level ($451 million), and reflects the larger public sector deficit in 1973, a greater reliance upon external rather than domestic borrowing to finance the deficit and some borrowing undertaken to offset short-term capital movements. The substantial revenue meas- ures recently taken will reduce the public sector's needs to borrow in 1974. 15. Annex I, Page 4 shows that 41.3 percent of public external capital contracted in the period 1968-1972 was obtained from private banks - the largest single source and that international organizations accounted for the next :Largest share (22.2 percent). The World Bank accounted for 14.7 percent of total commitments. Annex I, Page 4 also shows the sectoral allocation of public external capital and reveals that power, transport and manufacturing were the dominant sectors. The terms of recent public external borrowing have continued to improve in the light of (a) the availability of capital in international markets and (b) Mexico's reputation as a creditworthy borrower. 16. During 1974, assuming normal private capital movements, it is expected that the level of net external borrowing by the public sector (or guaranteed by the public sector) will decline to around US$950 - US$1,000 million. Net borrowing of this magnitude is consistent with Mexico's debt service capacity. As a result, particularly of longer maturities on borrowings from financial institutions, Mexico's external public debt service ratio has declined over the last several years and was 18.2 percent in 1973. Assuming that the average terms in the future are about the same as those which have been recently obtained, the debt service ratio is expected to remain in the 18 to 20 percent range during the remainder of the 1970's. The Bank's share in public debt outstanding and disbursed is presently about 14 percent while its share in the corres- ponding debt service is about 10 percent. These ratios are not expected to change significantly during the remainder of the 1970's. 17. Mexico thus continues to be creditworthy for borrowing on conventional terms, always provided that the additional public savings measures are taken without undue delay. The rate increases recently enacted by the publicly owned electric power sector and the recent increase in the prices of the publicly owned hydrocarbons industry, suggest that the Government will continue to handle its financial affairs prudently.  PART II - BANK GROUP OPERATIONS IN MEXICO 18. The Bank has made 33 loans, for a total of US$1,599 million net of cancellations, of which at the end of December 1973 the Bank held US$ 1.3 billion, including US$ 0.5 billion not yet disbursed. Most of these loans have been made for power, roads and agriculture. Execution of Bank-financed projects has, on the whole, been satisfactory. However, disbursements on the US$125 million loan for the Fourth Power Sector Program were delayed because the Government found it impossible to effect necessary power tariff changes on schedule. The problem was resolved when tariffs were increased on October 16, 1973. 19. IFC has made eleven investment commitments in Mexico amounting to US$53.1 million, of which as of December 31, 1973, US$35.4 million had been sold, terminated or cancelled. The US$17-7 million held by the Corporation consists of US$15.9 million in loans and US$1.8 million in equity. Annex II contains a summary of Bank loans and IFC investments as of December 31, 1973, and notes on the execution of ongoing projects. 20. Bank lending to Mexico in FY73 consisted of two loans, for agriculture and water supply, totalling US$200 million. The FY74 program includes, in addition to the Las Truchas Steel Project which you approved last September and the proposed project, two irrigation projects - on the Sinaloa and Panuco Rivers. In addition, work is under way on rural develop- ment, irrigation, forest industries and transport projects for possible consideration by the Executive Directors during the next two years. 219 In lending to Mexico, the Bank tries to assist the Government in achieving four major objectives. These objectives are interdependent and complementary; hence it is not possible to rank them in order of priority or importance. One objective is to spread the benefits of growth more widely than before and, more particularly, to begin to address the problem of rural poverty. A second objective is to help Mexico continue to achieve the remarkable growth of output of the past two decades, both by investing in projects that directly or indirectly make large contributions to prod- uction and employment, and by supporting changes that will make existing institutions function more effectively or by creating new ones that will perform presently neglected functions. A third objective is to contribute with funds and expertise to the solution of critical adjustment problems that are themselves a result of Mexico's continued growth; noteworthy among these are the problems attendant on a rapid urban expansion, and the emerging need to exploit scarce water resources more efficiently. A fourth object- ive is to transfer sufficient external resources to complement Mexico's quite appreciable domestic savings and provide the necessary funds for sufficient economic and social investments in a framework of sound domestic finances and a viable balance of payments.  22. Wnile the last objective primarily influences the magnit- ude of the Bank's program in Mexico, the other three jointly determine its structure. Naturally, many operations serve more than one of the ends listed and may, moreover, support more specific government object- ives. Thus the irrigation projects are designed not only to help provide a rapidly growing population with its food, fiber, and foreign exchange requirements, but also to support the Government's policies on income redistribution as expressed in the Land Reform and Water Laws, both of 1971. Concern with the vital issue of better water management also induced the Government, the Bank and UNDP to organize, jointly, a national water study; the Bank serves as Executing Agency for the UNDP. Loans in the transport and power sectors are designed explicitly both to transfer resources to Mexico and t;o help improve institutional structures and policies in sectors that play a vital role in industrial and agricultural production and in the generation and utilization of public sector resources. At the same time, the Government, together with the Bank, is attempting to prepare integrated rural investment projects in regions in which income levels are low but where some productive potential can be identified. The project before you is a good illustration of the complementarity of the various objectives listed: most importantly, it will serve as a means for transferring sufficient external resources to complement domestic savings and will assist in meeting the need for expanded infrastructure; in addition, by including four roads improving access to or opening up new agricultural areas, it will support the Government's rural development programs. 1/ PART III - TRANSPORT IN MEXICO 23. The rugged topography of Mexico, as well as the wide dispersion of its population, have made transportation a particularly crucial element in the development of the economy. During the period 1965-72, transport infrastructure has absorbed 23 percent of public investment expenditures,2/ and, as the location, composition and destination of commodity production shifts over time, further large investment needs in the sector will have to be met if development is to proceed smoothly. 24. Railroads were the main transportation element during Mexico's first big push toward becoming a modern economy, during the late nineteenth century. They were instrumental in making Mexico a large exporter of primary commodities and thus, indirectly, also had profound effects on agriculture and industry. Between 1880 and 1916 the network grew from 1,100 to 19,000 km, i.e., almost reached its present extension of about 25,000 km. During the decade of civil wars following the revolution of 1910, the system deteriorated badly. Much of subsequent investments was devoted merely to making up the losses of that period. 1/ For details, see "The Economy of Mexico: A Basic Report" (192-ME, June 27, 1973), Volume III. 2/ Of these, over one-half was for roads and one-quarter for railways.  - 7 - 25. The process of nationalization of the railways was completed in 1965, and by the late sixties the system, which had been composed of 11 separate companies, had been consolidated into five government railways. The most important of these, the Ferrocarriles Nacionales de Mexico (N de M), an autonomous public enterprise, is presently engaged, with the help of a Bank loan, in a long-term program of modernization and rehabilitation, with a view to reducing costs, rationalizing services and improving overall performance. 26. The major problems of the railway subsector are financial and refer primarily to the fact that tariffs have been held constant since 1958, while costs have steadily increased at a speed which has not been compensated by increasing revenues or by economies in operations. To help solve its financial problems, the railways have requested rate increases which are now under consideration by the Government. 27. The long border with the United States has meant that much of the country's foreign trade is shipped overland. Thus sea trade in recent decades has been of secondary importance for foreign commerce, but Mexico's ports do play a significant role in domestic trade, which provides for 55 percent of all port activity. Mexico has 36 deep water ports, five of which - Veracruz, Tampico, Guaymas, Mazatlan and Manzanillo - handle 80 percent of the total traffic. At present there is under way a long term program of expansion and modernization of these five ports, for which a Bank loan was obtained in 1972. 28. Air transport is one of the fastest growing modes of passenger traffic in Mexico. The two principal Mexican airlines have increased their traffic from 1.0 to 4.5 billion passengers/km between 1962 and 1972. Moreover, the country's size and difficult terrain also make air traffic advantageous for many types of rapidly expanding freight movements, and the Bank is at present considering supporting an expansion program of several regional airports. 29. In recent decades highways have become the prime transport mode. Details on the highway subsector are given in paras. 34 to 41 below. 30. The Bank has been associated with the development of the transport sector in Mexico for the past twenty years; it has financed six highway projects totalling US$177 million; two railway projects totalling US$136 million, and one port project for US$20 million. Through its transport projects the Bank has provided the much needed financing for expanding and improving the transport system and has assisted in the planning and execution of investments in the sector. The Bank has also stimulated the introduction of a number of institutional improvements in the sector. Transport Policy and Coordination 31 The framework of sectoral policy-making is complex. It includes on the one hand three secretariats with responsibility for different aspects of policy making and, on the other, a number of public enterprises respons- ible for the operation of modal services. The Secretariat of Communications  - 8 - and Transport (SCT) is in charge of licences and tariffs; the Secre- tariat of Public Works (SOP) is responsible for road, railroad and airport construction and maintenance, and for programming of invest- ments in these subsectors; the Secretariat of the Presidency (Presi- dencia) and Navy are responsible for port development. Presidencia approves all investments in the transport sector. The most important public enterprises engaged in provision of transport facilities are the National Railways, the Airports and Auri.liary Services, and the Toll Roads and Bridges Authority. A 1970 Bank sector mission made a number of recommendations designed to improve the planning and operation of the transport sector. Many of the recommendations have been put into effect, although the mission's recommendation that all departments deal- ing with transport be merged into one Secretariat was not accepted by the Government. 32. SCT is responsible for advising on transport coordination but, in practice, the work is distributed among various secretariats. The three main secretariats dealing with the formulation of policies and in- vestment programs - SOP, SCT and Presidencia - recognize the need for improved transport coordination, and a high level inter-agency commission responsible for coordinating policies and investments in the transport sector was recently created under Presidencia. Also, the Government agreed under the loan for the Second Railway Project to strengthen the planning department of SCT so that it can assist in coordinating long-range trans- port policy as well as comment on projects in the transport sector. 33. All investments for roads, railways and airports are directly carried out by SOP, which has just updated a six-year (1971-1976) invest- ment program. The revised program for 1973-1977, totalling about US$2.9 billion, allocates 51 percent for Federal and State roads; 35 percent for feeder roads and related rural development, investments; 7 percent for railway construction, and 7 percent for airports. This allocation of investments among modes seems generally consistent with the identifiable needs of the economy. The Highway Subsector 34. The network of paved roads has risen from about 1,000 km in 1929 to over 46,0OO in 1972. More than the railroads, the highways have led to a balanced expansion of foreign and domestic trade, and to opening up previously inaccessible areas of Mexico. The principal emphasis in the last few decades has been on the completion of the primary highway network - some 15,000 km - so as to provide road connections between Mexico City, state capitals, border crossings and sea ports. The primary network is a responsibility of the Federal Government. The secondary network - which has grown from l,200 km in 19h0 to 35,000 km in 1972 - is the joint responsibility of the Federal and State Governments. The standards of construction are lower than those of the Federal roads, but are well above those of compar- able roads in many other developing countries.  - 9 - 35. The present Administration has greatly expanded the con- struction of feeder roads and has launched a program of constructing them by highly labor-intensive methods, so as to alleviate the pervasive rural underemployment. During 1973 the program - together with some other rural public works - gave employment to 250,000-300,000 people and is expected to employ 500,000 during the next few years, if fiscal resources are available. 36. In 1961-1971 there was a 10 percent per year increase in the road transport fleet. Road transport is in the hands of owner drivers and is competitive, despite government regulations (including route licencing and tariffs). Each truck requires a licence which establishes the road on which it can operate, the type of freight it can carry, the maximum weight to be transported, and the tariff to be charged. The Government has agreed on the need for a study to examine the economic consequences of the current transport regulation system. Highway Planning and Financing 37. SOP has prepared a highway investment program as part of its transport program. The program's objectives are fourfold: (1) satis- factory maintenance of existing roads; (2) construction of rural infra- structure to incorporate small villages into the economic and social life of the nation; (3) construction of a network of feeder roads to increase production and obtain better use of the main network; and (4) construction of the missing links of the main (Federal) network. The program for the 1973-1976 period, which amounts to US$2.5 billion, places heavy emphasis on the rural development and feeder road construction programs which account for about 45 percent of total highway expenditures. The bulk of the financing for the 1973-1976 highway construction program will come from domestic resources. It is expected, however, that about 45 percent of expenditures for the main (Federal) network will be financed from external sources. 38. Road user charges cover all the maintenance costs plus a large proportion of investment outlays. It is uncertain whether the distribution of charges amoung users is appropriate, and the Government will soon begin a study in order to determine whether distortions exist as a result of the present charge structure. Highway Engineering, Construction and Maintenance 39. Highway and bridge engineering is the responsibility of the Directorate of Federal Highways in SOP and is done efficiently using up-to-date techniques. The same Directorate is responsible for construction and supervision of construction of Federal highways. The Directorate is well staffed and organized, and carries out its functions properly.  _10 - 40. Contracts for highway construction are awarded on the basis of competitive bidding. The local construction industry is strong, well equipped and well organized. Competition among local contractors is intense, and this may have discouraged foreign firms from bidding for highway contracts in Mexico. 41. SOP, through its Directorate of General Maintenance, is responsible for maintenance of the highway system. Routine maintenance is carried out by the Government's own forces and is generally satisfactory. Only major betterment works are carried out by contract. PART IV - THE PROJECT 42. A Report entitled "Mexico - Appraisal of a Seventh Highway Project"t (No. 278a-ME) dated January 21, 1974, is being distributed separately. The main features of the loan and project are summarized in Annex III. Technical and economic studies for the proposed project were carried out by SOP. The project was appraised in the field in May/June 1973. Negotiations for the proposed loan were held in Washington in December 1973. Negotiators were Messrs. Fernando Torres and German Sandoval of Nacional Financiera; Mr. Carlos Vidali of the Secretariat of Finance; and Messrs. Juan Duran Romano and Daniel Diaz Diaz of the Secretariat of Public Works. Project Description 43. The project represents about 4o percent of SOP's Federal highway construction program for 1973-1976, and consists of the construc- tion of sixteen roads, totalling 1875 km, of three types, as follows: (a) Widening, including paving, from two to four lanes of four major highways (201 km). Length (Kmi). (1) Monterrey-Linares 101 (2) Coatzacoalcos-Minatitlan 22 (3) Mazatlan-Aeropuerto 14 (4) Los Reyes-Texcoco-Lecheria 64 (b) Construction, including paving, of eight new highways linking major cities or important industrial or agricultural areas (1035 km). (5) Tepalcatepec-Tecalitlan 96 (6) Miahuatlan-Santa Elena 111 (7) Temascaltepec-Zihuatanejo 306 (8) Huixtla-Motozintla-Comalapa 111 (9) Maravatio-Zinapecuario 42 (10) Ameca-Puerto Vallarta 180 (11) Tlapa-Huamuxtitlan-Tecomatlan 87 ( 1 2) N-aucalpan-Atlacomulco 102  - 11 - (c) Construction, including paving, of four new roads improving access to or opening up agricultural areas (639 km). Length (Km) (13) Playa Azul-Coahuayana 203 (14) Sayula-Rio Uspanapa 120 (15) Pochutla-Salina Cruz 185 (16) Guerrero-Nuevo Laredo 131 4hh. The project highways, whose location is given in the annexed map, have been selected according to their priority within the Federal highway system. Some of the highways- Nos. (1), (2), (5), (7), (9), (10), (12), (13) and(16)- are extensions of highways financed under previous Bank loans,and the others are connections between highways also financed by previous highway loans. The standards of design of each group of highways listed in para 43 above vary according to traffic, topography and weather conditions in the affected regions. Project Execution 45. Execution of project works will be the responsibility of SOP through the Directorate of Federal Highways. In addition, the Control Office under the Directorate-General for Programming, which was established in 1967 to ensure that Bank projects are carried out according to the agreed schedule, will continue its function for works under the present project. The project is expected to be carried out during 1974-1978. Cost Estimates and Financing 46. The total cost of the project is estimated at US$241.4 million, including contingency allowances; a detailed breakdown of costs is given in Annex III. The proposed loan of US$90 million equivalent would finance the estimated foreign exchange component of construction works. The bal- ance would be financed by the Government out of the budget. Procurement and Disbursement h7. Contracts for all highways will be awarded on the basis of international competitive bidding in accordance with Bank guidelines. So far, foreign participation for highway works in Mexico has been very limited and most works under Bank-financed highway projects have been carried out by local firms. Several measures were taken in previous loans to encourage foreign participation and to maximize competition, and will con- tinue under the present project. For example, (a) contracts will be awarded for complete road sections, that is, earthworks, pavement and drainage (in earlier projects, road works had been contracted "horizontally", that is, separate contracts for (i) earthworks and drainage and (ii) pave- ment); and (b) invitations to bid will be made on the basis of "packaging" of contracts, whereby contractors may bid for one or several sections of a road as a package. Contracts would be awarded to the lowest evaluated bid  - 12 - for the entire road or to the lowest evaluated combination of bids for its sections. The estimated value of the works in the packages would range from about US$1.2 million to about $7.2 million. L8. Construction of bridges over 15 meters span, traffic signals and other minor specialized works will not be included in the highway contracts since Mexico's experience is that because of the exist- ence of firms engaged exclusively in these kinds of works, major bridge construction, installation of traffic signals and other minor specialized works tend to be cheaper if bid directly rather than as part of a road contract. Hence, contracts for these works, together accounting for about 10 percent of the project cost (about US$24 million equivalent) will be bid separately from the road contracts. Because these works are unlikely to attract firms not already established in the country, the bids will be advertised locally only. This procedure would not exclude participation by foreign bidders, although it is unlikely that they would show interest. lL9. The loan would be disbursed against 40 percent of the expend- itures for civil works contracts. Annex III includes the disbursement schedule for the proposed loan. Economic Benefits 50. The economic rate of return on the project as a whole is about 20 percent if passenger time savings on the four highways to be widened are excluded. If they are included, the rate of return for the entire project increases to 23 percent. The economic rate of return on individual roads ranges from 10 percent to 41 percent. The main benefits from the four roads to be widened and eight roads linking major cities/ areas will be road user savings resulting from improved riding surfaces and shorter routes. The main benefits from construction of the agricul- tural roads will be increased agricultural production in the areas of influence. The Government has confirmed that it intends to make the investments in minor irrigation works that will be necessary after com- pletion of the roads in order to realize their full economic benefits. 51. It is possible that much of the direct benefits resulting from widening of the four major roads from two to four lanes will go to the vehicle owners, in particular to the truckers, because the present road regulation system does not provide for official tariff reductions when the quality of the road is improved. Nevertheless, since minimum tariffs are difficult to enforce, and there is competition among truckers, some of the benefits are likely in practice to be passed on to the shippers and eventually to consumers. The Government has agreed in this connection to undertake a study to determine the economic consequences of the present regulatory system. The direct benefits of the construction of the other roads will be split between the vehicle owners, the shippers and the local workers. Shippers will benefit from a reduction in tariffs for freight, as a result of considerable shortening of distances of transport. Local  - 13 - workers will benefit indirectly from increased wages since studies carried out by SOP show that in areas served by all-weather roads the minimum wage actually paid is appreciably higher than in areas not so served. The eight linking roads included in the proposed project will serve approximately 1.1 million people, of whom at least 100,000 are salaried workers. The agricultural roads will help some 10,000 to 12,000 independent farmers who own the land in the areas of influence of the roads; some 85,000 inhabitants of the area will also be benefited by the construction of the proposed roads. 52. Final cost estimates based on detailed engineering are avail- able for ten of the sixteen roads, for which $40 million has been allocated out of the loan. For the remaining six roads estimates have been based on preliminary engineering; experience in Mexico indicates that final engineering tends to confirm the preliminary figures. Nevertheless, the economic justification for these six roads where the detailed engineering has not been completed will be reviewed when cost estimates based on com- pleted detailed engineering are available. Agreement by the Bank and the Government that they are each economically justified is a condition of disbursement for these roads. If any of these roads is not economically justified, the Bank has agreed to sympathetically consider the substitution of another road or roads of equivalent cost which can be shown to be economically justified. PART V - LEGAL INSTRUMENTS AND AUTHORITY 53. The draft Loan Agreement between the Bank and Nacional Financiera, S.A., the draft Guarantee Agreement between United Mexican States and the Bank, the Report of the Committee provided 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. 54. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank. PART VI - RECOMMENDATION 55. In formulating this proposal, it has not been possible to take full account of the consequences of recent increases in petroleum prices. However, available information indicates that the proposed loan remains fully justified. 56. I recommend that the Executive Directors approve the proposed loan. Robert S. McNamara Attachnents January 31, 1974   AlQNlX I Page 1 of 4 pages 00WmRR DaT.a - MEYICo AML POPUIJATIWN BNmIr 1,973 km2 54 -dlion (mid-19'72) 27 Per imZ Par km2of arable land SOCIAL DIDiCAYR Re.z1ference Countries BrazEr Luble rugosavia~ 1960 1