Peru - Fifth Power Project

FILE COPY Document of The World Bank FOR OFFICIAL USE ONLY Report No.P-1766-PE- REPORT AND RECOMMENDATION OF THE 'PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF PERU FOR A FIFTH POWER PROJECT February 18, 1976 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its comitents may not otherwise be disclosed without World Bank authorization.  RATE OF EXCHANGE Currency Unit = Sol (W/.) us $1 s/. 450. S/.1= US$0.02 S/..1,000 US$22.22 S/.l,OOO,OOO = US$22,222.22 Peru Fiscal Period - January 1 to December 31 of the following year.  INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT FOR OFFICIAL USE ONLY REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF PERU FOR A FIFTH POWER PROJECT 1. I submit the following report and recommendation on a proposed loan to the Republic of Peru, for the equivalent of US$36.0 million to help finance a fifth power project. 'rhe loan would have a term of 20 years, including 3 years of grace, with the interest at 8-1/2% per annum. US$33.9 million of the proceeds of the loan would be relent to ELectrolima on the same terms. PART I - THE ECONOMY 2. A report entitLed "Economic Position and Prospects of Peru" (No.655-PE) was distributed to the Executive Directors on March 3, 1975. Country data sheets are attached as Annex I. 3. Since 1968 the Government has followed a development strategy in which economic growth is linked to a transformation of the society to achieve broader popular participation in the country's economic, social and political life, thus addressing one of the most serious problems of Peru's economy and society --the sharp differences in wealth and opportunities between income classes and geographical regions. As was recognized by the Consultative Group for-Peru, which met in Paris in Apr.il 1975, much progress has been made during recent years in implementing this strategy. The land reform in the coastal areas is advanced and, although g:reater difficulty has been found in improving the lot of the Sierra peasants, efforts to organize production cooperatives there are being accelerated. In the fieLd of industry most enterprises have complied with the Industrial Community legislation --which provides for a gradual participation of the workers in the ownership of the enterprise-- and a new Social Property Law was approved aimed at promoting new industrial and entrepreneurial capacity within a system of self-maanagement by the employees. Some progress has also been made in strengthening the management capability of the public sector and the Government has been able to secure increasing amounts of foreign loans to finance the public investment program, although much of this inflow was on relatively hard terms. 4. Following two years of financial consolidation in 1968-69, GDP grew at an annual rate above '.5 percent during 1970-7h. Gross domestic investment rose from less than 13% to almost 17% of GDP between 1970 and 1974, largely because of the increase of public and private investment in mining and petroleum. However, as consumption a,lso grew faster than GDP and heavy losses were incurred by public enterprises marketing imported petroleum and foodstuffs, gross national savings fell from 15 to 11% of GNP between 1970 and 1974. The excessive growth of aggregate demanid combined with the sharp rise in Peru's import prices since 1973 resulted in both an acceleration of the annual rate of domestic inflation --fram an average annual rate of 7.2% during 1969-73 to over 171 in 1974-- and an increase in the deficit of the balance of payments on current account from 0.5 to 6.2% of GDP between 1972 and 1974. Net long-term capital inflows rose from $110 mLllion in 1972 to $840 million in 1974. This inflow went to both public and private sectors, including substantial credits for 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.  mineral resource development. This inflow permitted a $290 million increase in net international reserves in spite of the widened resource gap. 5. During 1975, the Government strove to reverse the deteriorating financial trends through a series of tax and price measures. In January 1975 indirect taxes were increased and subsidies on food were reduced. On June 30 a second set of measures included: (a) increases in prices of basic foodstuffs, petroleum (ranging from 25 percent for diesel fuel to 100 percent for premium gasoline), and other basic goods such as steel and cement; (b) a 40% reduction in prices of fertilizers; and (c) strict controls on salary adjustments in the public and private sectors. Subsequently, on September 26 the Sol was devalued by about 1l4. 6. The measures taken in 1975 were directed at attacking some of the basic causes of Peru's financial difficulties, excessive growth of aggregate demand with resulting fall in national savings, stagnation of food output and low drnamism of export volume. However, the country's financial position remained under strong pressures as export earnings and the rate of growth of GDP fell mainly because of the contraction in world demand for Peru's exports, adverse weather conditions and labor strikes. The decline in export demand, tDgether with work stoppages, resulted in a drop in mining output. Abnormal ecological conditions limited the recovery of fishmeal output and contracted the catch of food fish. Bad weather conditions, inadequate supply and high prices of fertilizers and other production inputs, and inadequate price and marketing policies followed in previous years affected agricultural output. In addition to export related factors, other causes added to a widening of the external gap. While gross domestic investment rose to 19% of GDP, the measures taken did not suffice to stop the fall in savings and the resource gap widened to over 9% of GDP. The fall in savings was principally caused by the large losses of state enterprises marketing petroleum, foodstuffs and fertilizers. In addition, a contraction in real terms of private sector financial savings occurred mainly because of increasingly negative real interest rates and the intensification of inflationary expectations. Import demand grew rapidly not only because of the expansionary financing of public sector deficits but also because of the sharp increase in food and petroleum imports and because the increase in investment (mainly in petroleum and mining) had a high import content. Thus much of the fiscal package's impact was eroded during the second half of 1975. Net long-term capital inflows totalled an estimated $1.2 billion in 1975, but were not sufficient to finance the current account deficit and net international reserves fell from $690 million in December 1974 to around $150 million in December 1975, equ.ivalent to only about 3.5 weeks of merchandise imports. 7. In the next few years Peru's finances --external and domestic-- will be under considerable pressure. Much will depend on the speed at which the economies of the industrialized countries recover with the resulting increase in prices and values of Peru's exports, on the availability of long- term foreign capital on softer terms than in 1975 and on the Government's ability  -3 - to cash the growth of aggregate demand and increase savings. In 1976 the terms of trade are not likely to improve, while the volume of exports will not expand much because most of the large mining projects now under construction will not be completed until 1977 or later. At the same time, if international capital markets continue to be as tight as they are now Peru may have difficulty in obtaining large net additional funds from commercial sources on suitable terms. It, therefore, has been clear to the Government that most of the effort to reduce the resource gap during 1976 will have to be made internally. Accord- ingly, on January 10 the Government approved another set of more stringent austerity mneasures aimed at reducing the public sector deficit, discouraging imports and stimulating agricultural production. The measures approved include: (a) further increases in prices of petroleum products and basic foodstuffs; (b) increases in taxes on income, property and consumption abroad; (c) inclu- sion of agricultural cooperatives and public enterprises in the income tax rolls; (d) a 5% cut in central government budgeted current expenditures; and (e) licensing for all imports. These measures are expected to reduce the public sector unfinancedl gap by the equivalent of about $330 million by sub- stantially cutting the projected deficits of the public enterprises and increasing tax revenues. The Government is also studying a revision of interest rate policies and a change in incentives to industry aimed at reducing their fiscal cost. Moreover, it has stated that it is prepared to take additional measures later this yea.r should the financial position make this necessary. 8. Starting in 1977 the balance of payments situation is likely to begin to improve as the volume of mining exports will increase substantially. In addition, it is likely that Peru will virtually eliminate its dependence on imported petroleum by the end of 1977 and will thereby save some $350 million per year by 1981 (at 1975 prices). However, it is now considered unlikely that the country will become a substantial net exporter of petroleum in the foresee- able future. The Government is also making efforts to develop other lines of export, such as in manufactures and tourism. 9. In the future Peru will have to rely more on medium and long-term borrowing to finance its investment program, rather than on continuing large- scale commercial borrow5.ng. The April 1975 5ons-ultative Group reviewed the list of projects presented by the Peruvian Government and concluded that project loan commitments of the order of $950 million annually would be required during 1975-76. The Consultati've Group recommended that external financing should be provided on terms as favrorable as possible (including assistance on concessional terms) and agreed that some local cost financing was needed. To ensure that the burden of debt service does not become excessive in the late seventies and early eighties, at least one half of new loan commitments should be obtained on terms similar to those of official lending agencies. This is comparable with what was achieved during 197i-74.  - 4 - 10. While actual inflows of external loans during 1975 were similar to what was expected by the Consultative Group, the average terms were much harder. Only about one third of new commitments were obtained at terms comparable to those of official lending agencies and the average maturity of commercial loans was below five years. Together with the poorer prospects for petroleum produc- tion this makes it even more critical for Peru to obtain longer maturities in future borrowing. The public debt service ratio which was 22% in 1974 rose to an estimated 27% in 1975 reflecting mainly a sharp increase in interest pay- ments and the decline in the value of merchandise exports. Although the debt service ratio will remain high for the rest of this decade, it should decline gradually in the early 1980's if the Government is successful in increasing national savings and stimulating non-traditional exports and if more suitable lending terms are obtained in future years. 11. In sum, during recent years the Government has continued to carry out the economic and social reforms initiated in 1968 and simultaneously achieved a satisfactory rat-e of economic growth. While the Government is committed to consolidating these reforms so as to move toward a more just society, efforts are also being made to mobilize natural and financial resources to achieve and finance a satisfactory expansion of the economy and of per capita income. As has been the case in most other Latin American countries, Peru has been seriously affected by the international recession and is now experiencing considerable financial difficulties. Since early 1975 it has taken measures designed to help solve the present problems and it proposes to take further action if this should become necessary. Moreover, the Government has also shown its willingness to re-examine its industrial development policies, which is a subject of particular importance for the sound long term growth and diversification of the economy. 12. Given Peru's export prospects and the present structure of its external debt, the country will need a substantial amount of long-term financing to meet its development requirements. We expect that the efforts to restore and maintain internal and external financial stability will continue and that the policies to develop natural resources, improve human resources and increase the standards of living of the rural poor will continue to be pursued. Given such policies, Peru continues to be creditworthy for external lending on conventional terms.  - 5 - PART II - BANK GROUP OPERATIONS IN PERU 13. The proposed loan would be the Bank's 29th operation in Peru. With the $76.5 million loan for a Lima-Amazon transport corridor project approved on December 30, 1975, Bank lending to Peru has reached $394.7 million net of cancellations. Of this amount, 56 percent has been for transportation (mainly highways and ports), 21 percent for agriculture, 17 percent for electric power and about 6 percent for education. In addition, a small loan was made for industry. Bank lending to l'eru during FY68-73 was limited to a reconstruction loan made in 1970, due to a combination of factors, mainly the Bank's concern over the Peruvian fiscal situation and balance of payments prospects and the then outstanding investment dispuites. As these problems were being solved the Bank resumed lending to Peru in FY74 with three loans for a total amount of $75 mil- lion. As lending was being resumed during that period, Bank project identifica- tion and preparation activities proceeded and now Bank lending to the country is being increased. 14. On July 25, 1975, the Government nationalized the assets of the Marcona Mining Company in Peru without making provision for the payment of compensation. Subsequent negotiations between the Company and the Government did not reach a conclusion and the matter was taken up for negotiation between the United States and Peruv.ian governments. Certain interim understandings were reached, and the discussionS are continuing. In these circumstances, it has seemed to me appropriate to present this loan proposal to the Executive Directors. I intend to review progress made on this matter prior to presentation to the Board of other loans now at an advanced stage of consideration (see paragraph 20 below). 15. IFC commitments to date have been about $24.0 million ($15 million to Southern Peru Copper Corporation for the Cuajone Copper mining project and the rest all in industry) of whi.ch $15.3 million is held by the Corporation. Project execution has been generally satisfactory. Annex II contains a statement of Bank loans and IFC investments as of December 31, 1975, and notes on the execu- tion of ongoing projects. 16. The Bank plans to assist the Government in achieving its economic and social development goals by aiding in: (a) the expansion of productive capacity in crucial sectors; (b) the creation of a physical and social infrastructure capable of sustaining and fostering the positive evolution of the nation's productive capacity; and (c) the consolidation of structural and institutional reform which will help the socioeconomic transformation now underway. Also the Bank expects to continue to play a role in coordinating external assistance through the mechanism of the Consultative Group, the next meeting of which is scheduled to convene in late 1976 or early 1977, and will try to become a catalyst for new sources of funds for major investment projects.  - 6 - 17. The Bank's program in agriculture has a two-fold objective: raising the standard of living of the large rural population of the highlands and increasing food production. Following up on the agricultural sector mission which visited the country in 1974, Bank staff and the Bank/FAO Cooperative Program are assisting the Government in the preparation of projects for rural development in the Sierra and irrigation rehabilitation in the coastal area; a first irrigation rehabilitation project is being appraised by the Bank. A mining project has been appraised jointly with the IDB and negotiations for a joint financing operation are now in progress. This project of CENTROMIN-PERU, which took over the Cerro de Pasco operations, is to expand copper production and exports, to reduce the environmental effects of the mining operations, and to improve the living conditions of the miners. Also, a DFC project and a sites and services project to help alleviate poverty among the urban poor are currently being appraised. In addition, the Bank has identified other projects in the power and transport sectors. At present, Bank loans to Peru constitute about 5.8 percent of total outstanding debt, including undisbursed, and absorbed 4.8 percent of the country's external debt service obligations in 1974. No significant changes in these ratios are expected for the next five years. PART III - THE POWER SECTOR Energy Resources 18. Peru is well-endowed with energy resources. At present the main source of energy is petroleum which accounted for 77% of all commercial sources in 1972. About one third of the petroleum needs is currently imported but recent discoveries in the Amazon basin indicate that by 1977 the country may be self-sufficient. The second source of energy is hydroelectric resources which provide 72% of all electric energy generation and about 18% of all energy consumed in the country; vast hydroelectric resources are still unexploited. Coal has been a relatively minor source of energy, but recent preliminary investigations have revealed the existence of important exploitable coal deposits in the north of the country, which would also allow for development of this source of energy as a complement to the others. It is the stated policy of the Government to substitute for petroleum products in the genera- tion of electricity; under this policy, a number of hydro projects are now under consideration for early implementation. Sector Organization 19. Up to 1972, the power sector consisted of a number of private municipal and state-owned utilities, the largest of which by far was Empresas Electricas Asociadas - recently renamed Electrolima, serving several concession zones and regulated by State agencies; captive plants serving large mining and industrial installations were not interconnected with public-service systems.  - 7 - 20. The sector was reorganized by Decree Law of September 1972, known as the Basic Electricity Lavr (Ley Normativa). This law made the State the primary factor in the sector by reserving for it the responsibility for public service electricity supply, creating a central State-owned enterprise (Electroperu), providing for State participation in existing private companies and providing for interconnection of power systems. 21. Electroperu was thus created by consolidating the then State-owned utilities and it was made responsible for planning, studying, engineering, construction, construction supervision and operation for all new generating facilities larger than 10 MW and for the transmission and distribution functions of the State electric utilities. State participation in the other utilities was accomplished by means of capitalizing the public-domain assets (mainly primary and secondary distribution facilities paid for by third parties - developers or customers - and located in public streets) and declaring the State as their owner, and by providing that the State is to be the only buyer of new shares issued by utilities and all shares currently held by non-Peruvians. Intercon- nection of private utilities and captive plants with Electroperu's system is compulsory when Electroperu deems such interconnection necessary. 22. The new organization and structure of the sector, as prescribed by the Basic Electricity Law, follow rational principles and should provide a sound basis for an orderly development of the sector in line with the general develop- ment objectives of the country. In practice, however, a number of problems have come to light which may be considered transitional consequences of the profound institutional changes that are taking place, but that will have to be addressed lest they jeopardize the sound development of the sector. In the first place, despite the provisions of the Basic Electricity Law, the General Directorate for Electricity in the Ministry of Energy and Mines, has "de facto" assumed respon- sibility for sector planning and selection of future generating and transmission works, citing its own organic law as authority for doing so. This arrangement, in the absence of a properly defined coordination with the entity responsible for the execution and operation of the selected works, is unsatisfactory in that the company's direct contact with the market and knowledge of field and operating conditions, which are basic inputs for sound planning, are mostly lost; the results of this "de facto" organization have not been encouraging so far. Another practical problem is that because of the fragmented origin of the sector, Electroperu's control over operations, particularly over the 250 isolated plants for which it is responsible, is limited; its participation in the managernent of other utilities is only carried out in part; and its operating results in general are poor. The sectoral technical assistance component of the project, as described below in paragraph 29, will help define and solve these problems. Regulation and Tariffs 23. Electric utilities in Peru are effectively regulated by the General Directorate for mlectricity of the Ministry of Energy and Mines following sound guidelines, which are consistent with the Basic Electricity Law and are expected to be crystallized in a general electricity law. The underlying philosophy for  - 8 - the establishment of tariffs is to provide public utilities with revenues sufficient to cover their operating expenses and financial charges and to generate a surplus which will allow the utilities to contribute significantly to the financing of their own expansion programs. Sector Development 24. Peru has planned several mining and industrial projects with large power and energy needs which will obviously create major demands on the power sector. The orderly and efficient development of the sector to meet these demands is intimately related to the sound sector planning mechanism to be established, and to which the technical assistance component of the propcsed project is directed. The master plan to be drawn on the basis of the existing identified projects will provide a program to add about 2,300 MW in the northern and central regions and about 700 MW in the rest of the country by 1984. The Bank is planning to participate in the financing of such expansion of generating capacity and concurrently to assist the sector in setting up adequate planning for future expansion. PART IV - THE PROJECT 25. The proposed project, which includes the estimated requirements for the expansion of the transmission and distribution systems of Electrolima from 1975 to 1978, would be the fifth project of the company, and the sector, receiving Bank financing. The Bank appraised a previous version of this company's expan- sion program in early 1973, but further loan processing was delayed until 1975 to allow time to solve the then outstanding financial problems of Electrolima. These included its need for higher tariffs and refinancing a large amount of short term debt. After the Government took appropriate steps to resolve these problems the proposed project was appraised in July 1975. Negotiations were held in Washington, D. C. on January 26-30, 1976; Electrolima's delegation was led by Mr. Ricardo Tirado, General Manager, and the Government was represented by Messrs. Ulises Montoya and Luis Ampuero of the Ministries of Econonm and Finance and Energy and Mines, respectively. A Loan and Project Summary is attached as Annex III. An appraisal report No. 904a-PE dated February 11, 1976, on the project is being circulated separately to the Executive Directors. Description 26. The proposed project consists of two distinct components: the 1975-78 expansion program of Electrolima's transmission and distribution systems and technical assistance to, and training for, the State entities in the power sector. The component of the project related to Electrolima wauld include transmission, subtransmission and distribution facilities, auxiliary services and consultant services and training needed to carry out the expansion program. The technical assistance component for the power sector consists of: 1) con- sulting services to assist the Government in improving coordination among its power agencies, establish a "master plan" of future generating and transmission  works and identify the training needs of sector personnel; 2) a training program for sector personnel in operation, planning and administration of' large public utilities enterprises; and 3) a tariff study. A more detailed descrip- tion of the project ccmponents may be found in Annex III. 27. Electrolima will carry out the expansion program and the Ministry of Energy and Mines will be responsible for the administration of the sectoral technical assistance component of the project, employing consultants as required under terms and conditions acceptable to the Bank; the part of the loan allocated to Electrolima's expansion program will be relent by the Republic of Peru to Electrolima on the same terms as the Bank loan to the Republic of Peru, under contractual arrangements to be approved by the Bank; Electrolima will bear the exchange risk of the part of the loan relent to it. Electrolima, with the limited technical assistance in specific areas provided for in the project, will have the administrative and technical capacity to carry out the project. The company's performance in project execution under previous loans has been satisfactory. It is now expected that the proposed project will be completed by mid-1979. Electrolima 28. Electrolima is the public-service concessionaire for the Metropolitan Lima Area. Formerly, under other names (i.e. Empresas Electricas Asociadas and Lima Light & Power) Electrolima was a privately-owned, Swiss controlled company. In 1973, the Government established control over it by assuming ownership, in the name of Electroperu, of the public domain assets managed by the company and in August 1975 it reached agreement with the foreign holders of Electrolima's shares to acquire their share capital participation; in mid-1975, a voluntary exchange of shares held by Peruvians for the company's bonds has been offered and it is expected that GDvernment ownership of the company will soon become close to 100%. 29. Electrolima is a well organized, well managed utility with technical competence to execute the project and operate the system. The natural transi- tional problems associated with the change in ownership have not interfered significantly with managenent's administration of day-to-day operations. Most of top management positions, previously held by Europeans are now filled by Peruvians. The company's policy of promotion from within, the depth of its middle management and supervisory personnel, and its training program have served to provide sufficient management continuity. 30. Electrolima's financial performance up to 1972 was generally satisfac- tcry, but mainly because of the lack of adequate tariff increases, Electrolima's earnings declined seriously in 1972-74. In 1972, Electrolima showed profits equal to its legal dividends (8 percent and 8.5 percent on the par value of preference and ordinary shares, respectively) by reducing its depreciation provision; in 1973 its profits were only sufficient to pay legal dividends on its prefered shares and a cash dividend of 1% on its ordinary stock; in 1974, the ccmpany registered a net loss and paid no dividends. Electrolima's net  - 10 - cash generation was negative in 1972-74 and it met its financing requirements by an equity contribution from the Government in 1972 and short-term borrowing in 1973; subsequently, the refinancing of some of its short-term debt and the conversion of Government loans into equity in 1974 reduced the severity of the company's immediate cash requirements. Electrolima's financial performance in 1975 has improved significatnly by virtue of a 30% increase in its tariff levels put into effect in February 1975 and a further 6.6% increase effective July 1, which have resulted in net internal cash generation of about $6.7 million in 1975. These tariff increases are a step in the right direction, resulting in a projected surplus for 1976 which will cover 30% of the compary's capital expenditures during the year; although this coverage of capital expenditures from internal sources is somewhat lower than desirable for pawer distribution companies, further tariff adjustments so that at least 45% of capital expendi- tures be financed from internal cash generation in 1977 and thereafter, have been agreed upon (Section 4.05 of the Project Agreement). Estimated Cost and Financing 31. The total cost of the project is estimated at $137.3 million of which $135.2 million are for Electrolima's expansion program and $2.1 million for the sector technical assistance. Total foreign exchange costs are estimated at $35.3 million of which $33.4 million are for Electrolima's expansion program and $1.9 million for sectoral technical assistance. These cost estimates include allowances for increases in both quantities and prices which amount to $6.8 mil- lion and $28.1 million respectively. Price increases have been estimated at a rate of 12% per annum in 1976, 10% in 1977 and 9% in 1978 for local currency costs, and at 10% in 1976 and 8% in 1977 and 1978 for foreign costs. The rates used to calculate price contingencies for the local currency costs of the project are lower than the expected inflation rates for Peru because Electrolima has received informal quotations for most of the equipment and services to be obtained which indicate that such lower rates are appropriate. Also, relatively low physical contingencies of 5% for the transmission and subtransmission components of the project and 10% for the rest have been assumed since final designs are well advanced for most project components and no major civil works are involved in the project. 32. The proposed $36.0 million loan would finance the foreign exchange cost of the project (except for $3.0 million of urgently-needed imported equip- ment which Electrolima has contracted using procurement procedures not in accordance with the Bank guidelines) plus $3.7 million interest during construc- tion. The balance of the sector technical assistance component of the project will be financed by Government through budgetary allocations and the balance of the Electrolima expansion program plus $15.2 million of required working capital increases, will be financed by the company's own cash generation ($61.4 million), connection fees ($35.8 million), long term borrowing from the State-owned development finance company - COFIDE - ($32.2 million) and Government equity contributions ($23.6 million).  Procurement and Disbursement 33. All purchase3 by Electrolima for Bank-financed equipment would be made after international comapetitive bidding in accordance with the Bank's Guidelines for Procurement. In accordance with 'Peruvian legislation purchases of equipment and materials which are produced in Peru (representing about one third of the total expansion program) will be made domestically and will not be financed by the Bank; similar imported equipment would cost about 30% less than such non- competitive locally-manufactured equipment, so that reserve procurement of these items has the effect of increasing the project cost by about 10%. Consultant services to be used by both the Company and the sector would be employed under terms and conditions acceptable to the Bank. 34. Disbursement3 will be made on the following basis: (a) the CIF cost of imported equipment and materials; (b) the cost of consultant services and training; and (c) interest and other charges on the loan due on or before April 15, 1979. Disbui^sements would be made for expenditures incurred after July 1, 1975, for the ])urchase of equipment and materiaLs made in accordance with the Bank Guidelines for Procurement. The amount of retroactive financing involved would not exceed $1.1 million. Based on the project execution sched- ule, the proposed loan would be fully disbursed by December 1979. Justification 35. It is not possible to give a single estimate of the economic rate of return of a transmission and distribution project, because (a) the tariffs charged are a regulated price not necessarily reflecting the full value of the service to the consumer and (b) the economic cost of generating the additional power to be distributed is not known with certainty. However, taking the proposed tariff levels as the minimum value consumers put on the service, and making alternative reasonable assumptions about the marginal economic cost of generating power, the economic rate of return of the project can be estimated to be no less than 9% and under plausible assumptions, may be as high as 15.7%. This range compares favorably with the one of the probable opportunity cost of capital in Peru, particularly when the relatively low risk of the project is taken into account. By providing facilities to expand Lima's distribution system and thus meet future demand for electricity in that city, which accounts for 35% of the national market, an important constraint for future growth will be removed. Also, the project would be instrumental in making available public-service electricity to the poor settlements in the outskirts of the city of Lima (pueblos jovenes) since Electrolima would build distribution facilities in them, including the necessary substations and transmission lines; it is expected that the number of households in pueblos jovenes with public-service electricity would increase by about 300% by mid-1979, thereby contributing to alleviate the present poor living conditions of those areas of Metropolitan Lima. In addition planning and management of the power sector would be strengthened by the technical assistance component of the project through providing the Govern- ment with a master plan, aiding the Government in organizing the sector more efficiently and training of key administrative, operative and planning personnel.  - 12 - PART V - LBGAL INSTRUMENTS AND AUTHORITY 36. The draft Loan Agreement between the Republic of Peru and the Bank, the draft Project Agreement between the Bank and Electrolima, the Report of the Committee provided for in Article III, Section 4(iii) of the Articles of Agreement and the text of the draft resolution approving the proposed loan are being distributed to the Executive Directors separately. 37. The draft Loan and Project Agreements conform to the normal pattern for loans for power projects. A speoial condition to the effectiveness of the Loan is that the Borrower and Electrolima enter into contractual arrangements for relending to Electrolima of part of the proceeds of the Loan. (Section 6.01(b) of draft Loan Agreement). 38. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank. PART VI - RECOMMENDATION 39. I recommend that the Executive Directors approve the proposed loan. Robert S. McNamara President by J. Burke Knapp Attachments Washington, D. C. February 18, 1976  hpa 1 of 3 palpa OUNURTR DITA - PERU l,9,m15, kat IrV -fnson (sid-1972) t0o Per mlof arabie land SOCIAL DIDIGA?ORS Rference Countries Pero wtaic Chile' ied_n M-0 m IY7ng m (M PEE CAPITA USl (ATLAS BASIS) a I 520 La 750 Is to /a L,LeoLi DUEM.PPMC r&-rt rate (per thoausand1 I4.-5 62 Li.66 27 13 6 4 Qoads death rate (Per thousandi Wdlwbits 12-IL U 1 ! 9 2.0 6 tj Inanet eortulity rate (per ahumdlv it. 91 73 j 61 f 9 11.1Z Life espectancy at birth (yers) 60 636 63 73. Dress ~eproductia rte' 3.:g22:0 .1 ~ Pepolacion growth rate - urbanL Age structure (percent) 66/p 39 2. over 5 ~ shea5 5C5 S Aedoendency ratio T. _9 210 0.8 0.1 Ecnrcdependency A . o41619 /6i 2.01. 08 Urban population as percent of total 1.7 /i.n. 55 La& 6i. 76 la 51 /r Fatily planning, No oaf acoaptoi smalative (thoua..) . . No. of users CE of eavrned wmen) ... arsbor force (thmosands) 3,20C 6,3000 ~ 13,000 3,000 7 3,600 lea Percen'tage employed in cgrirulta a 50 15 ohb La 19 7k 7.5 7.. Pecntg iesploya 3 5 M/aj,a 1.5 2.5 S.- Dr~ D'ISTIT ILN Pcetof nMatinl inccoe received by highest 5% 5. /Y.v36,364 ~ 3 Percent of rational mnoos received by highest 20 69lv 60 Ni 6 A.LW 57A Per rent of rational inoos receive.) by lowest 20% 3 2 Ls Percent of natioala acocme received by lowest 40% '713 I1 j 13 MSTRWT0 OF LAND 0bERRSHI S we ytop 101 of owners . 93 % cited by smallest 10% of omwrs 0.1. HAT DNTRTION Foplatonpe physician 2,200 Isa 1,920 /i 1,7-mO 2,020 dk n