Mexico - Water Supply and Sewerage Project

Report No. 885a-ME FILE COPY Appraisal of the Medium Cities Water Supply and Sewerage Project Mexico November 26, 1975 Regional Projects Department Latin America and the Caribbean Regional Office Not for Public Use Document of the World Bank This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY AND EQUIVALENT (as of August 31,1975) Currency Unit Mexican Peso (Mex$) US$1 Mex$12.50 Mex$1 = US$0.08 Mex$i million Us$80,000 ABBREVIATIONS AND MEASURES 1 mm = millimeter o 0.04 inches 1 cm - centimeter = 0.39 inches 1 m = meter = 3.28 feet 1 km = kilometer = 0.62 miles 1 1 = liter = 0.26 US gallons 1 m3 = cubic meter = 264 US gallons 1 m3/sec = cubic meters = 31.5 million cubic meters per second per year or 22.8 million US gallons per day ABBREVIATIONS AND ACRONYMS SRH = Secretarla de Recursos Hidraulicos ENOSP Banco de Obras y Servicios P6blicos P.N.H. = Plan Nacional Hidraulico JUNTA = Water and Sewerage Administration D.C.E. Departamento Crbdito Extemo of SRH PEMEX = Petroleos Mexicanos P.A.H.O. = Pan-American Health Organization GOVERNMENT OF KEXICO Fiscal Year January 1 - December 31  MEXICO APPRAISAL OF THE MEDIUM CITIES WATER SUPPLY AND SEWERAGE PROJECT TABLE OF CONTENTS Page No. SUMMARY AND CONCLUSION ..... ................. i - ii -I. INTRODUCTION ................................ II. THE SECTOR ...... ............................ 2 Service Levels .............................. 2 Institutional Aspects ..... .................. 2 Financial and Managerial Aspects .... ........ 3 Sector Objectives to be Achieved through the Project ............................ 4 III. THE BORROWER. 4 BNOSP Organization. 4 Revolving Investment Fund. 4 Operation of the Loan. 5 Subproject Loan Agreements. 5 Obligations of the Parties. 5 Terms for Onlending. 6 IV. THE EXECUTING AGENT. 6 The Ministry of Hydraulic Resources 6 Project Unit. 7 Conclusion. 8 V. THE BENEFICIARIES. 8 Organization. 8 Local Management. 9 Tariffs 9 Administration. 9 Other Water Suppliers .10  TABLE OF CONTENTS (Cont'd) Page No. VI. THE PROJECT .................. 10 Scope of the Project .10 Project Preparation .10 Existing Facilities .10 Construction .11 Training Program .12 Cost Estimates .12 Procurement .13 Project Execution and Supervision .14 Disbursement .14 Environmental Aspects .14 Technical Studies .16 VII. PROJECT JUSTIFICATION .16 Objectives of the Project .16 Project Selection and Demand .17 Return on Investment .17 Project Risk .19 VIII. FINANCES .19 Past Finances .21 Financing Plan .21 The Investment Fund .21 The Juntas .22 Tariffs .22 Connection Charges .23 Fair Value of Fixed Assets .23 Future Finances .24 IX. AGREEMENTS REACHED AND RECOMMENDATIONS 24  MEXICO APPRAISAL OF THE MEDIUM CITIES WATER SUPPLY AND SEWERAGE PROJECT LIST OF ANNEXES ANNEX No. 1. Characteristics of Beneficiaries 2. Existing Facilities 3. Details of Project 4. Cost Estimates 5. Disbursement Schedule 6. Monitoring Indicators 7. Assumptions for Financial Projections 8. Financial Projections CHARTS 15111 Organization BNOSP 71642R Organization of SRH 15109 Organization of the Construction Sub-Secretariat SRH 15110 Organization of the Operation Sub-Secretariat SRH 15159 Implementation Schedule 15382 Organization of the Project Unit MAP Mexico - Location of Subproject Cities   MEXICO APPRAISAL OF THE MEDIUM CITIES WATER SUPPLY AND SEWERAGE PROJECT SUMMARY AND CONCLUSIONS i. This report covers the appraisal of a project which initiates a reform of sector policies in Mexico through the financing of construction for water supply and sewerage works in eight medium-size cities in Mexico and a training program with a total cost of US$100.0 million appraised by Bank staff. A Bank loan of US$40 million is proposed, covering the estimated foreign exchange cost of the Project including interest during construction. ii. There are numerous deficiencies in the sanitation systems in Mexican cities, many of which stem from the traditional sectoral financial and insti- tutional practices. The situation has been recognized by the Federal Government which has enacted a National Water Law to regulate water resources, but has been facing important problems in its implementation, and requested and cooperated with an IBRD/WHO sector mission whose draft report has recently been issued. Separately, work was concluded in July 1975 on a National Hydraulic Plan in which the Bank played a significant role. iii. The Bank objective in making this loan is to initiate some of the needed changes in sector policies while the Mexican Ministries discuss the two reports, thus helping in the implementation of the National Water Law. The principal changes will be in the areas of sector financing, where the loan provisions would substitute debt financing for the present practice of grant financing and in institution building by the creation of a Project Appraisal Unit. iv. The Bank loan will be channeled through a Federal Development Bank, the Banco de Obras y Servicios Publicos (BNOSP). The loan proceeds and the Federal Government counterpart will be relent to individual water undertakings through an Investment Fund which will be developed as a major lending mechanism for the sector. There will be separate subloan agreements with each beneficiary and guarantee agreements from each of the State Governments concerned. Use will be made of provisions in the subloan and guarantee agreements to improve management practices, particularly in specifying the responsibilities of each institution. v. Financial covenants will be used to provide a mechanism for substantial tariff increases with the objective of making the local administrations financially viable in the short-run and able to generate cash for future investment. This is a significant change from the present situation where revenues barely cover operating expenses.  - ii - vi. The executing agent will be the Secretaria de Recursos Hidraulicos (SRH) which has national responsibilities for urban water supply in towns with populations of 2,500 or more. SRH will design and supervise the con- struction of the projects and monitor the supervision of operations. The projects for the eight cities have been appraised by Bank staff and Bank consultants. SRH staff also participated in the appraisal and was trained by the Bank in an effort to develop its capacity to carry out most future appraisal work. vii. This will be the second Bank loan for water supply in Mexico, the first being a loan of US$90 million for the Mexico City metropolitan area--a project in which SRH is the executing agent (through its Comision de Aguas del Valle de Mexico). During the last two years, the retail price of water has been tripled as a result of Bank participation in this project and this encourages the belief that the needed price increases can be made in urban centers, so that the provision of water supply is made on a finan- cially self-sustaining basic and the water demand is limited by an apprecia- tion of the cost of supply. viii. The Federal Government of Mexico will guarantee the loan and will make funds available to the Investment Fund, the initial contribution being US$60 million equivalent as a counterpart to the Bank loan. The Mexican Government will place additional sums in the Investment Fund as sector financing plans are developed and implemented. ix. All contracts for the construction work and procurement of materials will be let in accordance with Bank procurement guidelines. Other than procurement orders for some pipes, almost all contracts are expected to be won by Mexican companies. x. Providing that the conditions set out in section 9 are met, the project is suitable for a Bank loan of US$40 million equivalent for a term of 20 years including a 4-year grace period.  MEXICO APPRAISAL OF THE MEDIUM CITIES WATER SUPPLY AND SEWERAGE PROJECT I. INTRODUCTION 1.01 The Banco Nacional de Obras y Servicios Publicos (BNOSP), a Mexican Federal Development Bank, has requested a Bank loan to help finance a US$100.0 million equivalent water supply and sewerage program in 8 medium- size cities in Mexico. This will be the second Bank loan to Mexico for water supply, the first being a loan of US$90 million made in 1973 to help finance bulk supply for the Mexico City metropolitan area which is now under construc- tion. 1.02 BNOSP will be the Borrower. Funds for the Project will be relent through an Investment Fund to the local water and sewerage administrations in the project cities with guarantees from the Federal and State Governments under terms acceptable to the Bank. 1.03 This project has evolved from discussions between the Mexican Secretaria de Recursos Hidraulicos (SRH) and Bank staff initiated during an IBRD/WHO Sector Study of February 1974 for which a draft report has recently been issued and is now being studied by various Mexican Ministries. The sector study emphasizes that urgent attention is needed to improve sector policies, practices and institutions. 1.04 The principal objectives of the project are to help to begin reforms in sector policies while discussions are taking place on the wider institutional issues and, by so doing, to provide useful experience for future changes along the lines of the National Water Law. These changes are in themselves of greater long-range significance than the physical improvements to water supply and sewerage systems in the eight cities selected. Nevertheless, the project will improve the living conditions of about one and a quarter million people who, at present, have no water supply or sewerage services, as well as contributing to health and environmental improvement. The major sector goals to be attained are: (i) changing the present pattern of financing new works largely by grants to sound loan financing through the discipline of a development bank; (ii) changing a policy of low prices for water services to one in which tariffs will cover operating costs, debt service and generate income for future investment;  - 2 - (iii) improving the capacity of SRH to undertake project appraisal to ensure that all sanitation development schemes meet least cost concepts and make the best use of money available; and (iv) specifying the responsibilities of various institutions involved at central and local levels and so assist in the long-term reform of those whose functions overlap. 1.05 The report is based on the appraisal mission of June 1975 composed of Messrs. A. Zavala, R. Costa, C. Fernandez, E. Pogson of the Bank and G. Yepes, a consultant. II. THE SECTOR 2.01 The water supply and sewerage sector of Mexico has been studied and reported on in an IBRD/WHO sector study recently published in draft form. In many of the more populated parts of Mexico water scarcities and/or conflicts among users are reaching a degree of severity that will increasingly constrain economic and social development. The principal features of the sector are: Service Levels 2.02 Service levels compare favorably with other Latin American countries but are still less than desirable; of the total urban population of about 36 million, 70% (25 million) are served with water (house connections) and 40% (14 million) by sewerage. Of the total of about 21 million rural popu- lation, about 20% (4 million) are estimated to be served through public systems mostly in the form of standpipes. Only 3% (0.6 million) have any sewer facilities, and these are mainly latrines. The situation could deteriorate rapidly because of high population growth in Mexico (3.5% average for the country as a whole; 5 to 6Z in urban areas). Institutional Aspects 2.03 By the National Water Law (1972), the SRH is responsible for all hydraulic activities in Mexico and in particular planning, project pre- paration and construction of water supply and sewerage systems in communities having over 2,500 inhabitants. However, SRH has been facing real difficulties in the Water Law implementation. At present, SRH is only active in about 500-600 out of a total of 2,179 localities, covering only about 20% of the total urban population. Consequently, information covering the entire sector is very difficult to obtain. In a similar way, the Ministry of Health, which is responsible for rural water supply (i.e. for communities with populations below 2,500), is not covering the entire subsector. Both state government and municipal authorities control operations and make investments.  - 3 - An additional source of funds for the sector is the Banco Nacional de Obras y Servicios Publicos (BNOSP). BNOSP lends for water supply and sewerage projects, and imposes a stricter financial regime on the localities than do SRH and the Ministry of Health. 2.04 There is no overall sector policy in Mexico. A National Hydraulic Plan (PNH) has recently been completed. This UNDP financed project, for which the Bank was the executing agency, is under SRH. This study along with the IBRD Sector Study is under review by the Mexican authorities with the Bank participating in these discussions. Both reports recommend sector targets and objectives. In order to facilitate implementation of the recom- mendations contained in these studies, assurances were obtained during nego- tiations that SRH will complete an inventory of all water supply and sewerage systems in Mexico urban communities with more than 2,500 inhabitants within 3 years of loan signature. Financial and Managerial Aspects 2.05 In general, the financial and managerial aspects are unsatisfactory, with the exception of a few well managed local administrations. The fragmented structure of the institutions as well as the over-centralization of SRH in Mexico City have led to weak managements. Because of the belief that water is a social good, tariffs are increased infrequently--usually only when new capital expenditure is envisaged. Since new capital works are, in effect, grant financed, existing tariffs are far below their economic level. This is particularly critical in Mexico where mounting water shortages related to unbalanced urban and regional growth are rapidly increasing the cost of water. 2.06 Substantial progress has been made in the past to increase service levels both in urban and rural areas. However, the Santiago goals l/ appear unattainable by 1980. SRH estimates that the investment necessary solely to keep the percentage of the population served from declining would amount to over 6 billion pesos (in 1975 prices) over the 1976-1980 period (125 million dollars/year) with more than 80% being allocated to the larger cities. This is a substantial amount given the present keen competition for public funds in Mexico. In the 1971-75 period about Mexican 8.8 billion pesos (141 million dollars/year) (in current prices) were invested in the sector. The sector study estimates that more than 15 billion pesos (about 1.25 billion dollars) (in 1975 prices) would be needed in the 1976-1980 period in the urban sector to achieve the Santiago goals. Such a program is feasible only if average sector revenues are increased substantially (at least 50% in real terms) so as to be sufficient to cover operating and capital costs. 1/ The following targets were agreed upon by all Ministries of Health in Santiago in October 1971: to serve 80% of the urban population and 50% of the rural with water and 50% of the urban population and 30% of the rural population with sewerage or latrines by 1980.  - 4 - Sector Objectives to be Achieved through the Project 2.07 The proposed project will facilitate introduction of new policies into the sector along the lines of the National Water Law. These changes will include: (i) A departure from past methods of investment financing-- (effectively grant financing) by introducing loan financing supported by a policy of adequate internal cash generation; (ii) Increases in tariff levels to ensure that the revenues pay for operation and maintenance and debt service payments; (iii) Definition of responsibilities at central and local levels to facilitate major institutional reforms. III. THE BORROWER BNOSP Organization 3.01 The Borrower will be the Banco Nacional de Obras y Servicios Publicos SA of Mexico (BNOSP). BNOSP, founded in 1933, is a wholly owned Government institution with a paid up capital at December 31, 1974 of Mex$1,000 million (US$80 million). BNOSP is a development bank specializing in public and social works (sanitation, urban development, market places, housing and transportation). It provides loans to federal, state and municipal governments and agencies, and obtains its funds from the Mexican and international markets (bond issues and bank lines of credit). BNOSP is also a financial agent of the Federal Government (Ministry of Finance), and as such operates various earmarked funds. BNOSP is a well-run entity. It realized a net profit of US$11 million in 1974, i.e., a return of 4% on its total assets. It has a tight control over all its financial operations which are guaranteed by Federal or State taxes. BNOSP either evaluates and supervises the execution of projects it finances or relies on other executive agencies whenever they exist (e.g., SRH). This will be the first occasion BNOSP has acted as a Bank borrower. The Bank loan will be handled by the Economic Development Department (see organization chart - Chart 15111). BNOSP is legally empowered to act as a Bank borrower. Revolving Investment Fund 3.02 The intention of the Mexican authorities is to progressively eliminate Federal budgetary allocation for the sector. As a first and essential step towards this objective, an Investment Fund has been estab- lished. The fund has been placed, as a trust fund, under BNOSP. During negotiations the Mexican Government provided the Bank with a copy of the structure, management, scope and financing of the proposed fund. These  -5- arrangements are satisfactory. Assurances were obtained during negotiations that the accounts of the Investment Fund will be subject to an annual audit by qualified independent auditors. The fund will begin operation by lending for the sub-projects selected for the proposed loan. The fund will receive about US$100 million; US$60 million from the Federal Government on an equity basis and US$40 million from the proposed Bank loan on a reimbursement basis. The Government will bear the risk of any exchange rate variations. Operation of the Loan 3.03 BNOSP will not itself evaluate or supervise the execution of projects (which will be done by SRH). It would act with respect to this loan as a financial agent of the Federal Government and as such will present disbursement requests to the Bank and will repay debt service to the Bank. Payments to contractors and suppliers for work done, as certified by SRH, will be made by the fund which will also be responsible for the collection of timely payments of debt service from the beneficiaries. Subproject Loan Agreements 3.04 The Investment Fund will relend to the beneficiaries, who will be the local water and sewerage administrations (Juntas) in each subproject city (Chapter 5 describes the Juntas). Each loan will be secured by a contractual agreement between the Investment Fund and (a) SRH; (b) the Government of the State; (c) the Junta, and in certain cases, (d) the municipal authority. The State Government will guarantee every loan for a Junta (or municipal body) in its state and will give the Investment Fund a lien on the state's share of federal taxes. Should a beneficiary fall behind with debt repayments, the National Treasury could deduct the amount overdue from its monthly distribution of Federal Taxes to that State. This method is a standard practice and is acceptable to the Bank. Obligations of the Parties 3.05 Each agreement will contain certain common conditions including conditions of effectiveness and each Junta would have to comply with specific conditions. SRH, acting through the Project Unit (see paras. 4.04 to 4.08) would be responsible for construction and procurement as well as the supervision of technical and administrative functions during and after construction. The function of SRH is described in more detail in Chapter 4. During negotiations BNOSP provided the Bank with a draft of subloan agreements. It was agreed that Bank approval of every subloan agreement will be a condition of Bank disbursement for the corresponding subproject. All subloans will be made in accordance with the policies and procedures outlined below (see paras. 5.03, 5.04, 5.05, 6.03 and 6.12). 3.06 The Junta will be the beneficiary of the subloans and will be responsible for debt service repayments and for the discharge of certain management obligations: for example, reducing amount of outstanding billings.  -6- 3.07 The Municipal Anthority will in certain cases be a signatory when the Junta has no authority for certain responsibilities such as making timely increases on charges to new customers for connections. Terms for Onlending 3.09 The Investment Fund loans to the beneficiaries are assumed to have a term of about 18 years, including a period of grace equal to the construction period of the subprojects, usually 3 to 4 years, and to carry interest rates at 9% on the total loan. Although 9% is lower than the cost of capital in Mexico, and negative at current rates of inflation, this is justified as the first and major step away from Government grant financing. Long-term objectives of the Government on this matter will be discussed with the Mexicans on the basis of the recommendations made in the sector study report (see para. 2.04). There will be a small spread between the terms of funds received by the Investment Fund and the terms at which it relends, i.e., a shorter amortization period. The shorter repayment period has been selected to more rapidly generate the funds required in the sector, and to cover the Investment Fund administrative costs. 3.10 Until now, Federal investments have been made as loans from budgetary allocations, but the Juntas have been required to repay the loan with the surplus cash, if any, remaining at the year-end after meeting operating costs. Frequently, the whole outstanding debt has been forgiven after some time. The operation of the Investment Fund will bring a financial discipline to the Juntas through the project loan agreements. The subloan mechanism discussed above offers a satisfactory arrangement. IV. THE EXECUTING AGENT The Ministry of Hydraulic Resources 4.01 The Mexican Ministry of Hydraulic Resources (SRH) will be the executing agency for the proposed loan. The Ministry has principal legal responsibility for water resources in the country (see para. 2.03), although other ministries operate in the sector. Chart 7164 (2B), showing the main structure of SRH, illustrates the division of activity into four sub-Secre- tariats, viz. (1) Planning, (2) Construction, (3) Operation, (4) Support Services. SRH has offices in the States which are controlled by the SRH State General Managers who report directly to the Secretary independently of both the operation and construction sub-Secretariats. 4.02 The strengths of SRH as an executing agency are in the separation of responsibility for water and sewerage projects from other hydraulic activities and in the competence of its engineering staff in design and construction. The weakness lies in the separation of construction and  - 7 - operation activities, the centralization of control activities of these departments in Mexico City, and the lack of training in project analysis. Chart 15109 shows the activities of the Director General of Water Supply and Sewerage, is in the Construction Subsecretariat. Chart 15110 shows the Operation Subsecretariat. For water supply and sewerage operations, the quality of supervision is good for construction work but poor for operation. The existence of a "General Manager" in the States diffuses responsibility further because of poor liaison between the departments in Mexico City and those in the State. 4.03 During the last 18 months, a number of proposals for ins-titutional reform have been under discussion within SRH with the dual aims of clarifying management lines of responsibility and providing a measure of decentralized operation. These proposals include: (1) Unifying the field offices of the Construction Subsecretariat and State General Managers, and (2) Forming a Water and Sewerage entity (possibly a national Water Commission) separate from the other activities of SRH. It is not thought appropriate that the proposed loan agreement should contain requirements for sector institutional reorganization because the draft sector report has been issued so recently, and the government is in the process of reviewing possible alternative institutional arrangements. Project Unit 4.04 In August 1974, a special unit (DCE) was formed in the office of the Director General of Water Supply and Sewerage. It was intended to operate as the project unit, particularly to prepare feasibility studies for Bank review during appraisal of the project. It did not function properly because of lack of competent staff and lack of coordination of the Departments involved. Moreover, the unit was not given authority for the supervision of operational activities. 4.05 During appraisal, the Bank stressed to the Mexican authorities that the creation of an adequate Project Unit would be a condition of the loan. Since then SRH has established such a unit (Gerencia de Proyectos Especiales de Agua Potable y Alcantarillados). It reports, in an advisory capacity, directly to the Minister. The unit has the necessary authority to monitor project preparation, appraisal, design, execution and administration of sub- projects financed with the proposed Bank loan. The organization structure of the unit, which was discussed during negotiations, is satisfactory (see Chart 15382). It provides for five departments: Project Evaluation, Super- vision of Construction, Supervision of Operations, Training and Administration. A competent engineer, hitherto director of small water supply systems within SRH, has been appointed as the head of the unit and participated in the nego- tiations. Unit staffing is underway: already 13 engineers and 7 financial analysts have been recruited.  - 8 - 4.06 The unit's role is to appraise existing and further feasibility studies for subprojects prepared by other SRH departments which are being considered for Bank financing. One of its first tasks will be to draw up guidelines for the use of SRH engineers in designing subprojects. It will monitor the construction of the subprojects and will act as a training ground for SRH staff. 4.07 The unit will also monitor the subprojects' system operations. It will participate in the preparation and implementation of adequate guidelines for the operation and administration of subprojects and will monitor the financial performances of the local authorities in correlation with the Directorate of Operations, BNOSP and the Investment Fund. 4.08 In order to ensure a better efficiency of the unit, the following assurances were obtained during negotiations from the Federal Government: (1) That the unit will be maintained within SRH with its present responsibilities; (2) That, at all times, suitable qualified staff in adequate numbers will be assigned to the unit; (3) That guidelines for preparation of subproject feasibility studies and designs would be prepared by SRH within six months of loan signature and implemented within the following six months. The Bank will be afforded a reasonable opportunity to exchange views on these guidelines. 4.09 The creation of a Project Unit is recognized to be only an inter- mediary solution intended to ensure adequate management of the Project within a complex and enormous organization. This set-up should, however, be revised within the context of a possible SRH reorganization (see para. 4.03). Conclusion 4.10 SRH is competent in the engineering field but its capacity in management and project appraisal require improvement. With the understanding that the Project Unit will continue to be provided with qualified staff and sufficient authority, SRH is suitable as the Executing Agent. V. THE BENEFICIARIES Organization 5.01 The beneficiaries will be the water and sewerage 1/ administrations of the subproject cities (the Juntas). A Junta is established by a state or 1/ For detailed characteristics of Juntas see Annex 1.  - 9- municipal decree. There are several types of Juntas but these are variations of three basic types: (1) "Juntas Federales" are administered by SRH and supervised by staff in the sub-Secretariat of Operation; (2) "Juntas Estatales" are legally dependent jointly on the respective State Government and the SRH State organization (General Manager) but in practice tend to be treated as subsidiaries of the State Government; and (3) "Juntas Municipales" are dependencies of the local municipal authorities. Other than the composition of the managing body, the bylaws generally follow a standard pattern. Each of the Juntas for the project cities has legal personality and could contract for a loan with BNOSP. 1/ Local Management 5.02 The direction of a Junta is carried out by a number of representative members-five is the typical number--who are nominated by or elected from specified bodies, including representatives of SRH, the State Government, the municipal government and consumers. In general, the Juntas are not well managed, and there is a diffusion of management authority between the Juntas, SRH and the State Government. The Juntas in smaller towns frequently do not employ qualified staff; it is unusual for a Junta to have its own engineer. This is reflected in the poor standard of maintenance and particularly the excessive water losses. Tariffs 5.03 The Juntas do not possess the power to set tariffs. This right is held by the elected Congress of the state. In practice, and in the belief that water is a social good, tariffs have been increased principally, often solely, as part of an agreement under which SRH provides additional capital work. In many cities tariffs have not been raised in ten years. In order to make the Juntas financially self-supporting, the terms of the proposed loan mechanism are designed to focus attention on the need for timely tariff increases. Each subproject loan agreement will contain a guarantee by the State Government to present timely requests to the Congress for tariff increases to meet the financial covenants (see para. 8.04). Administration 5.04 The Juntas maintain cash accounting records, and, in general, have deficient billing and collecting procedures. Other weaknesses, such as poor organization, lack of qualified engineers and accountants, etc., have been identified in each individual city. The proposed training program described in para. 6.05 will be directed to improve personnel qualifications, and specific proposals for improvement of administration (including monitoring indicators) will be contained in the subproject loan agreements. 1/ For detailed characteristics of Juntas see Annex 1.  - 10 - 5.05 The accounts of all the Juntas are subject to audit by the staff of audit departments of either SRH, the State Government or the Municipal Authority. Actual practices vary, but in some Juntas audits have not been made for several years. The subproject loan agreements will require an annual audit, and where one is overdue an audit prior to disbursement of the loan. The Mexican authorities agreed during negotiations that the audits will be carried out by qualified and experienced auditors independent from the Beneficiaries appointed by SRH (with terms of reference acceptable to the Bank). Other Water Suppliers 5.06 In some cities, water is produced and distributed by other organizations--particularly the State-owned petroleum company PEMEX and the Federal Power Authority, CFE. TheIprincipal use of water is for industrial purposes, but the companies also supply water free of charge to employees who reside in company houses. While the Federal Water Law permits the SRH both to license any private use and to charge for the license, this has not been done with any consistency. SRH proposes to negotiate terms with the companies for the takeover of their systems by the Juntas. The Federal Government has agreed during negotiations to use its best efforts to reach such an arrangement. VI. THE PROJECT Scope of the Project 6.01 The project will cover eight subprojects, each designed to improve or extend water supply (and in six cases sewer systems) in eight medium-size cities in Mexico with a training program for SRH and the Beneficiaries' staff. Project Preparation 6.02 Detailed evaluation reports for the subprojects were prepared by DCE with considerable assistance from Bank staff and consultants (see para. 4.04). The location of the cities is shown on the enclosed map. Existing Facilities 6.03 Details of the existing facilities are given in Annex 2. The eight cities have a total population of 1.5 million in 1975. Service levels and incremental population served by the Project are shown in the following Table:  - 11 - TABLE 1 SERVICE LEVELS Incremental Population 1975 Served in 1982 Population % Served Water % Served Sewerage '000 City '000 1975 1982 1975 1982 Water Sewerage Ciudad Victoria 105.2 56 59 50 70 24.1 45.5 Jalapa 156.4 58 80 40 60 82.5 67.9 Mexicali 323.7 93 95 54 80 93.5 155.0 Morelia 203.3 86 90 69 78 69.0 71.1 Reynosa 183.8 45 80 24 40 122.7 109.9 Salamanca 74.8 61 80 37 69 33.8 10.6 Tampico 329.0 65 80 53 70 132.5 128.7 Tuxtla-Gutierrez 85.1 71 95 24 75 24.0 53.7 1,470.6 582.1 642.4 Unaccounted-for water averages 42%, and may be higher since reliable statistics on revenue from non-metered water connections are not available. Causes include water leakage in old pipes of the distribution system, poor maintenance, damaged house connections, free water distribution to official institutions and lack of water meters. In total, about 29% of house con- nections do not have water meters. It was agreed during negotiations that annual targets showing the reduction of unaccounted-for water will be incor- porated in the subsidiary loan agreements between the Investment Fund and the local authorities. Construction 6.04 A detailed description of the proposed works in each of the eight subprojects is given in Annex 3. Features common to all projects include the extension of water service to new users, the installation of meters on unmetered sources, repair of meters and a leak detection and repair program. About 39,000 water meters will be installed during the con- struction period, and the total to be ordered is around 75,000. SRH will have the benefit of bulk purchasing. About 44,000 new sewerage discharges will be installed.  - 12 - Training Program 6.05 The training proposed, while essentially for the benefit of people associated with this project, will also be used to develop a nation- wide training plan. The proposed loan would finance 40% of the training cost, including the correlated studies. The Pan-American Health Organization (PAHO) has been assisting SRH with training and has developed a number of programs for both operational and administrative staff which will be the basis of the training for SRH and Junta staff associated with this project. As far as possible, training will be held at local or regional centers, and a good proportion of the operator training will be within the Junta. Assurances were obtained during negotiations on the terms of the SRH training program for the subproject cities. This training will help SRH to prepare, on a limited scale, a nationwide training program and to submit this for Bank approval before December 31, 1977. Cost Estimates 6.06 The total investment for the Project is estimated to be around US$90 million as shown on page 13. Interest during construction on Bank and local funds amounts to US$10 million. An analysis of the construction cost for the eight cities is given in Annex 4. The estimates are based on prices of January 1975, using the Unit Prices Catalogue-1975 prepared yearly by the Sub-Secretariat for Construction of SRH. The Bank reviewed the Catalogue and found it sound, and unit prices justified. The direct and indirect foreign exchange component would be about 26% of the construction cost if locally manufactured asbestos pipe were used exclusively. However, experience suggests that pipe will have to be imported since the local manufactures do not have capacity to meet all demands. Thus Mexico can be regarded as a net pipe importer, and on this basis the total foreign component has been estimated as 40% of project cost. Physical contingencies amount to 15% of the estimated project construction costs, reflecting potential additional costs which may arise during detailed design and construction of some of the project components. Engineering and administration costs have been estimated at 10% of the construction costs. 6.07 The exchange rate has been stable in Mexico for many years at Mex$12.50 for 1 US dollar. Increases in prices due to inflation have been calculated using the Mexican Retail Price Index for civil works, namely 17%, 15% and 12% for the years 1975, 1976 and 1977 respectively; and 10% thereafter. For imported equipment, inflation has been estimated on the basis of construc- tion cost indices for the United States. The resulting inflation rates for equipment are 14% in 1975, 12% in 1976 and 10% in 1977. It is expected that most of the imported equipment will originate from the United States.  - 13 - TABLE TWO Cost Estimates Mex$ million US$ million Local Foreign Total Local Foreign Total I. Construction Cost City Subprojects Ciudad Victoria 20.6 13.8 34.4 1.7 1.1 2.8 Jalapa 33.7 22.4 56.1 2.7 1.8 4.5 Mexicali 99.0 65.0 164.0 7.9 5.2 13.1 Morelia 31.0 21.3 52.3 2.5 1.7 4.2 Reynosa 65.2 43.7 108.9 5-2 3.5 8.7 Salamanca 17.8 12.5 30.3 1.4 1.0 2.4 Tampico-C. Madero 99.0 65.O 164.0 7.9 5.2 13.1 Tuxtla-Gutierrez 38.9 26.3 65.2 3.1 2.1 5.2 T270.0 677.2 32.47 40 II. Engineering and Admainistration (10%) 41.2 27.6 68.8 3.3 2.2 5-5 III. Training Program 3.7 2.5 6.2 0.3 0.2