Colombia - Second Cali Water Supply and Sewerage Project

FILE COPY Document of The World Bank FOR OFFICIAL USE ONLY Report No. P-2169-CO REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO EMPRESAS MUNICIPALES DE CALI (EMCALI) WITH THE GUARANTEE OF THE REPUBLIC OF COLOMBIA FOR A SECOND CALI WATER SUPPLY AND SEWERAGE PROJECT February 8, 1978 This document has a restricted distribution and My be used by recipients only in the performance of their official duties. Its contents may not otherwLse be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS Average Calendar 1977 January 24, 1978 Currency Unit = Peso - Col$ Col $ US$1 = Col$36.985 38.04 Col$l = US$0.027 0.02629 The Staff Appraisal Report is based on US$1 = Col$51.4 MEASURES AND EQUIVALENTS 1 meter (m) = 3.28 feet (ft.) 1 kilometer (km) = 0.62 mile (mi.) 1 square meter (m2) - 10.8 square feet (sq. ft.) 1 cubic meter (m3) = 35.3 cubic feet (cu. ft.) 1 US gallon (gal) = 3.785 liters (1) 1 million US gallons per day (mgd) = 43.9 liters per second (1/sec) 1 milligram per liter (mg/l) = 0.058 gram per US gallon GLOSSARY OF ACRONYMS EMCALI = Empresas Municipales de Cali IDB = Inter-American Development Bank INAS = Instituto Nacional de Salud INSFOPAL = Instituto Nacional de Fomento Municipal USAID = US Agency for International Development FISCAL YEAR January 1 to December 31  FOR OFFICIAL USE ONLY Page 1 of 3 COLOMBIA SECOND CALI WATER SUPPLY AND SEWERAGE PROJECT LOAN AND PROJECT SUMMARY Borrower: Empresas Municipales de Cali (EMCALI) Guarantor: Republic of Colombia Amount: US$13.8 million equivalent Terms: Repayment in 17 years, including 4 years of grace; interest at 7.45% per annum. Proiect Description: The project would improve sanitary conditions in Cali by moving the discharge of raw sewage downstream from the city's main intake of water, and by separating domestic sewage from stormwater run-off; it would increase utiliza- tion of the installed water production capacity by supply- ing water to the adjacent Municipality of Yumbo; it would extend the water supply and sewerage networks to, and reduce flooding in, certain low-income areas; and it would increase the area available for orderly urban growth. All of Cali's and Yumbo's population would benefit from the reduction of the very hazardous level of pollution at the point of water intake from the Cauca River, and about 250,000 people, 70% of which are among Colombia's poorest 40%, would benefit directly from the other components. Although the project faces no special risks, it may not be implemented in the intended period if EMCALI fails to generate sufficient funds through timely rate increases and betterment levies. EMCALI's and the municipal authorities' commitment to strengthening the entity's finances should ensure that funds will be available when needed and that the project will be carried out as scheduled. This documeni has a rmricwed distribution and may be used by recipients only in the performance of their official dutig. Its contents may not otherwise be disclosed without World Bank authorization.  Page 2 of 3 Estimated Cost: Local Foreign Total -----US$ Million------ (a) Proposed Project: Water Supply Subproject 1.39 1.14 2.53 Yumbo Subproject 1.21 1.98 3.19 Reforestation Subproject 0.35 0.13 0.48 Cauca Interceptor Subproject 3.29 2.49 5.78 Stormwater Subproject 1.71 0.57 2.28 Sanitary Subproject 1.65 0.55 2.20 Sewage Treatment Studies 0.12 0.06 0.18 Maintenance Equipment - 0.82 0.82 Engineering and Administration 0.87 0.88 1.75 Base Cost 10.59 8.62 19.21 Physical Contingencies 1.59 1.29 2.88 Price Contingencies 2.12 1.48 3.60 Total Project Cost 14.30 11.39 25.69 Interest and Other Charges during Construction 5.61 2.38 7.99 Total Funds Required 19.91 13.77 33.68 (b) Other Investments and Working Capital: Other Investments 2.10 - 2.10 Increase in Working Capital 7.10 - 7.10 Total Funds Required for 1978-1981 Program 29.11 13.77 42.9 Financing Plan: Local Foreign Total -----US$ Million-- Net Internal Cash Generation 17.0 - 17.0 Government Loan 5.7 - 5.7 Loan from Banco Central Hipotecario 5.7 - 5.7 Proposed Bank Loan - 13.8 13.8 Other 0.7 - 0.7 Total 29.1 13.8 42.9  Page 3 of 3 Rate of Return: The aggregate internal economic rate of return for the project is estimated to be 22%. Appraisal Report: Report No. 1679c, dated February 8, 1978.   INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO EMPRESAS MUNICIPALES DE CALI (EMCALI) WITH TIE GUARANTEE OF THE REPUBLIC OF COLOMBIA FOR A SECOND CALI WATER SUPPLY AND SEWERAGE PROJECT 1. I submit the following report and recommendation on a proposed loan to Empresas Municipales de Cali (EMCALI) with the guarantee of the Republic of Colombia for the equivalent of US$13.8 million to help finance a Second Cali Water Supply and Sewerage Project. The loan would have a term of 17 years, including 4 years of grace, with interest at 7.45% per annum. PART I: THE ECONOMY 2. *The latest economic report on Colombia (1548-CO) was distributed to the Executive Directors in May 1977. It assesses current developments and provides a medium-term perspective of the Colombian economy. Country data sheets are provided in Annex 1. Background 3. During the past two decades substantial structural transformation has taken place in the Colombian economy. The country has made impressive progress in the transition from a predominantly rural and agricultural economy made up of largely self-contained regions to a more integrated urban industrial economy oriented increasingly toward international trade. This broadening of the country's productive base has been accompanied by rapid growth of nontraditional exports and development of a modern sector which relies to a considerable extent on imported inputs. From 1967 to 1974 GDP rose by an average of 6.5% per annum in real terms, well above the historical average of less than 5% (1950-67). Accelerated economic growth coupled with a decline in population growth brought about a rapid increase in per capita incomes. Increased investment and relaxation of the foreign exchange con- straint were the major factors responsible for this acceleration in growth. Merchandise exports expanded more than four-fold during this period, and, most significantly, nontraditional exports became an increasingly important source of foreign exchange earnings, in large part compensating the slow growth of receipts from coffee exports. Much of this increase in non- traditional exports was the result of both product and market diversifica- tion attributable to the Government's export promotion program. Substantial medium- and long-term capital inflows to the public and private sectors for development projects helped sustain investment levels and enabled Colombia to maintain the favorable structure of its external debt. However, despite the substantial progress made during the past two decades, Colombia still has a long way to go on the road toward modernization; it still is essentially an underdeveloped country with a limited modern sector super- imposed on a broad, traditional and poor base.  - 2 - 4. When the present Government took office in August 1974, the country was faced with a generally deteriorating economic situation--weakening balance of payments, loss of self-sufficiency in petroleum production, accelerating inflation, deterioration of the public finances, and reduced public invest- ment. GDP growth showed signs of slowing and unemployment was increasing, especially in the urban areas, reaching a peak of 13% in 1974. As a con- sequence, the new administration moved rapidly to introduce an economic stabilization program along with a set of reforms aimed at restoring the basis for long-term economic growth. In line with these goals, it initiated basic reforms of the fiscal, monetary and price systems. 5. To help strengthen the public finances, the new Government undertook a comprehensive tax reform designed to achieve a substantial improvement in the progressivity and elasticity of the tax system. Steps were also taken to correct major distortions which existed in the price system. Price controls on a number of important agricultural products were removed, thereby providing greater stimulus for increasing farm production. Far-reaching modifications in petroleum pricing policy aimed at regaining self-sufficiency in production of crude petroleum by improving incentives for exploration and exploitation were introduced. Concurrently, measures were taken to reduce the subsidy on local consumption of petroleum products, with the dollar equivalent price of gasoline being raised in successive steps by 150% between August 1975 to January 1977. 6. Economic growth slowed in 1975 and 1976, with real GDP increasing by less than 5% in both years. This was the result of the stablilization measures adopted at the end of 1974, the effects of the world recession, reduced private investment, and, in 1976, a poor harvest stemming from adverse weather conditions. The stabilization program succeeded in reducing inflation from 27% in 1974 to 18% in 1975, but the expansionary impact of rising inter- national reserves caused by higher coffee prices and shortages of basic food items produced an acceleration of inflation to 26% in 1976. Private invest- ment declined in real terms during this period as a consequence of growing investor concern over the deteriorating economic situation and tightening of credit. Public sector revenues and savings were strengthened as a result of the tax reform and of increased revenue from coffee export taxes. The balance of payments improved substantially in 1976, mainly as a result of an increasing trade surplus caused by higher world coffee prices. Consequently Colombia's net international reserves rose by nearly threefold, from US$437 million in 1974 to US$1,166 million in 1976. Recent Economic Performance 7. Growth and employment picked up significantly in 1977, largely as a result of increased internal demand generated by the income effects of exceptionally high export receipts from coffee. Preliminary information indicates an increase in GDP of 5.4%, spread over all sectors of the economy except non-coffee agriculture which was affected by the continuation of the severe drought which began in the second half of 1976. High world coffee prices during 1977 produced a record trade surplus and the balance of payments registered an overall surplus for the year of US$686 million. By year end, Colombia's net international reserves stood at US$1,852 million, equivalent to  7 months' imports, the highest level in the country's history. Increased export receipts from coffee contributed to a further strengthening of public finances over that which had occurred in 1975-76. Increased receipts from taxes on coffee exports caused a substantial increase in the current surplus of the Central Government, more than offsetting unexpected slower growth in some of the country's other major taxes. 8. Expansion of coffee earnings combined with the shortages of basic food items led to an unprecedented acceleration of inflation during the first half of 1977. For the twelve month period ending in June 1977 infla- tion reached 45%. In an attempt to reduce inflationary pressure the Govern- ment introduced a number of fiscal and monetary measures aimed at curbing growth of coffee producers disposable income, at further strengthening public finances and at slowing the growth of the monetary aggregates. Legal reserve requirements were increased, limits were placed on external borrowing, and Central Bank rediscounts were reduced. The coffee retention tax rate was doubled from 23% to 46%, and the system of delayed payments to coffee pro- ducers was used to further limit growth of coffee producers' disposable in- come. In order to increase aggregate supply and stem the rapid accumulation of foreign exchange reserves, import duties were reduced and the import licensing system was liberalized. In an effort to curb upward pressure on prices, the authorities temporarily discontinued their policy of periodic adjustments in the foreign exchange rate and in prices of petroleum products. The last two measures were of course only a temporary expedient to break the inflationary spiral. From July 1977, the Government has resumed periodic exchange rate adjustments and in January 1978 increased the price of gasoline by 20%. The Government intends to continue to pursue policies that maintain Colombia's international competitiveness and that help regain petroleum self-sufficiency. 9. Another conflict between short term and long term objectives exists in the Government's interest rate policies. To avoid cost push effects, nominal interest rates were frozen during the period of accelerating inflation and real interest rates declined rapidly and became sharply negative. As a consequence there was a growing unwillingness on the part of the public to hold medium- and long-term financial assets, and investment funds had to be increasingly allocated by cumbersome administrative controls. The problem has become less serious as inflation has abated, but will require further attention by the Government. 10. The stabilization measures taken earlier in the year, the gradual decline of world coffee prices from June 1977 on, and the availability of more ample agricultural supplies on the domestic market resulting from both im- proved weather and increased imports, produced a dramatic slowdown in infla- tion in the second half of 1977. For the full year 1977, inflation was re- duced to 29%. Further declines in the rate of inflation are expected this year as the Government maintains tight fiscal and monetary policies. Additionally, declines in international coffee prices and rapid increases  - 4 - in imports are expected to further reduce inflationary pressures from the ex- ternal sector. Prospects for this year's agricultural output appear good, and the Government is prepared to increase food imports substantially if needed. Development Strategy and Prospects 11. The Government's development strategy, embodied in the 1975-78 development plan, aims at creating the conditions necessary for substantially increasing employment opportunities, particularly for the poorest segments of the population. It provides incentives for private sector investment in the least developed areas of the country and for the use of more labor intensive production techniques. Public sector investment specified in the Plan concen- trates on expanding and improving infrastructure and on socially oriented projects designed to alleviate rural and urban poverty. This includes compre- hensive integrated rural development and nutrition programs which directly benefit the lowest income groups of the population. Because of the importance of commercial agriculture in generating employment and expanding exports, Colombia's development plan assigns a high priority to providing farmers with credit and technical services required to increase output. In order to alleviate urban poverty, the Plan places emphasis on reducing migration to the citLes by increasing employment in agriculture and through provision of improved services in slums of Colombia's major cities. These efforts are being complemented by policies and programs to encourage the development of small- and medium-scale enterprises and to decentralize industry away from the three largest cities. Special priority is given to the development of domestic energy sources to reduce the country's growing dependence on imported oil. 12. In the past three years substantial progress has been made in carrying out this strategy despite the economic dislocations occasioned by the world recession and the need to concentrate on short-term economic management. Most of the Government's development efforts during this period have focussed on improving the standard of living of the poorest 50% of the population, with a substantial share of the benefits of public sector expenditures accruing to this segment of the population. Provision of improved social services has been a major objective of the current administration. This is reflected in the increase in expenditures on education, health, water and sewerage, which rose from 33% of total expenditures in 1974 to 37% in 1976. Preliminary estimates show an even higher share spent on such programs in 1977. 13. Projections of Colombia's energy balance indicate an expanding deficit which could reach significant proportions by the early 1980s. To avoid the constraint on growth that shortages of energy would entail, the Government is giving high priority to the development of alternative energy sources. Major projects are being developed to expand hydroelectric power generation and incentives are being provided private companies for accele- rated exploration and exploitation of the country's hydrocarbon potential. Coal and natural gas are expected to provide an increasing contribution to the country's energy needs in the future. An energy development program, which would nearly triple power generation by 1986, has been drawn up by  - 5 - the Government, with estimated investment requirements of between US$6.0 and US$8.0 billion in constant 1976 prices. Given the long gestation periods of power projects, their execution must be initiated without delay if energy constraints on future growth are to be avoided. 14. The Government is making a major effort to accelerate growth of the agricultural and industrial sectors. In the past, Colombia has been largely self-sufficient in basic foodstuffs. However, an increasing food deficit is projected for the years ahead in the absence of major advances in food pro- duction. The Government is attempting to meet these needs through integrated rural development programs directed towards small farmers, through expanded farm credit, research, extension and marketing facilities and through improved farm management practices, including farm investment planning. Industry has been singled out as the leading growth sector for the future and the Government has adopted exchange rate, fiscal incentive, credit allocation, and locational policies intended to assure that the sector fulfills its role as a major con- tributor to employment growth. 15. Based on its strong resource base and its high level of international reserves, Colombia should be able to sustain annual real growth of no less than 6% over the period 1978-82. Private sector investment is expected to recover as inflation subsides and fiscal and monetary policies are eased. Public sector investment is expected to increase as restraints on such spending are lifted and major energy projects enter the execution stage. Non-inflationary increases in public sector investment spending depends to a large degree on continuing government efforts to maintain high levels of public sector savings. In this regard, timely and adequate adjustments of tariffs on public services is especially important, and the Government has already gone a long way in the adoption of such policies. 16. Less buoyant terms of trade as world coffee prices decline from the high 1977 level and rapidly increasing imports to meet the requirements of expanding investment are expected to lead to a renewed widening of the resource balance beginning in 1978. Assuming that economic growth accele- rates in the industrialized countries and that appropriate incentives-- particularly continuation of periodic exchange rate adjustments--are provided, nonttaditional exports should resume the high rate of growth achieved in the early 1970s. Colombia is projected to require gross capital inflows of about US$3.7 billion during the five year period 1978-82, of which US$340 million should be disbursed from commitments made through the end of 1976. This inflow would enable Colombia to maintain an adequate level of foreign ex- change reserves during the period. A significant increase in capital require- ments is expected in the early 1980s when major additional projects in the energy sector will have to be initiated in order to avoid serious future constraint on economic growth. To achieve these targets, annual gross capital inflow will have to increase from US$425 million in 1976 to over US$1.0 billion in 1982. While about half of this inflow is expected to be provided by official multilateral and bilateral sources, financing from commercial sources is expected to become increasingly important during the period as Colombia gains greater access to international capital markets.  - 6 - 17. Colombia's public external debt repayable in foreign currency amounted to US$3.3 billion at the end of 1976, or about US$2.4 billion excluding undisbursed commitments. The Bank/IDA share of this external debt (disbursed only) was 28.5% and is expected to decline to about 25% by 1982. Although the public debt service ratio fell during the past two years as export growth accelerated, this ratio is projected to increase from 9.5% in 1976 to about 11% by 1982. Balance of payments prospects beyond 1980 will depend among other factors on the timely development of domestic energy sources and on progress made in executing several natural resource-based export oriented projects currently under preparation. As a developing country, it is normal to expect Colombia to be a net capital importer, i.e. to have a deficit in its balance of payments on current account. However, to avoid an excessive growth in this deficit over the next few years, careful management of internal demand will be required. Given such management, it should be possible to prevent the external sector from again becoming a constraint on economic growth, and to maintain Colombia's present creditworthiness for external borrowing of substantial amounts on conventional terms. PART II: WORLD BANK OPERATIONS IN COLOMBIA 18. The proposed loan, the 70th to be made to Colombia, would bring the total amount of Bank loans to Colombia to US$1,562.4 million (net of cancella- tions). Of this amount, US$1,179.1 million is now held by the Bank; IDA made one credit of US$19.5 million for highways in Colombia in 1961. Disbursements have been completed on 45 loans and the IDA credit. IFC has made effective investments and underwriting commitments of US$53.7 million in 24 enterprises and now holds US$28.1 million. Annex II contains a summary statement of Bank loans and the IDA credit as of November 30, 1977, and IFC investments as of December 31, 1977, and notes on the execution of the 24 on-going projects. 19. Since FY68, Bank lending in Colombia has become more diversified and has been concentrated on production-oriented programs and activities which carried social as well as economic benefits. Eight of the eleven agricultural loans have been made since then, seven of the ten loans for industry, all three loans in the education sector and all six loans for water supply and sewerage. This compares with only seven loans since FY68 in the power and transport sectors. 20. Bank lending to Colombia in FY77 consisted of loans for rural devel- opment, agricultural credit, telecommunications, highways and small-scale industry, totalling US$281 million equivalent. In addition to the proposed project, the FY78 program includes the recently approved loan for nutrition improvement, and proposed loans for urban development and power. Work is also under way in development finance companies, further urban development, urban sanitation and slum improvement, transportation, mining, power, and small farm development for possible consideration by the Executive Directors during the next two years.  21. The proposed Bank lending conforms closely with the Government's development strategy. To help Colombia develop domestic sources of energy, a substantial part of the proposed lending would be for hydro-power. The Bank would also assist the development of coal mines, which hold potential in helping Colombia meet part of its energy requirements. Bank involvement in the energy sector would help mobilize additional external financing as some of the projects would require co-financing. Other future loans would finance agriculture and industry to assist the Government in its efforts to raise overall productivity, income and employment and to strengthen and diversify exports. Closely related to these objectives would be the proposed Bank lending for transport infrastructure in more backward areas of the country to integrate them into the modern economy. In this context, we are proceeding with a project to improve domestic airports. Finally, we are preparing a relatively large number of loans in support of the Government's efforts to help the lowest 50% of the Colombian population. The nutrition project, the proposed urban sanitation and slum improvement project, and the proposed water supply and sewerage projects are principally designed to improve the poor's standard of living. 22. The operations of external lenders in Colombia are shown in Annex I. While IBRD, IDB, and AID provided about 75% of total external financing to Colombia in the 1961-72 period, their share has decreased since then to approximately 40%. Like the Bank, IDB and AID have given increased emphasis to social projects. For instance, the IDB has assisted projects in low cost housing, urban and rural development, agrarian reform, university education, water supply, and land erosion control; in the future IDB proposes to assist Colombia in its plans to develop sources of domestic energy and to expand the activity of the productive sectors to help generate increased employment. AID has supported programs in education, urban development and small farm develop- ment. More recently, it has moved to small project loans aimed chiefly at improving the distribution of income. It is expected to phase out its aid program in Colombia in 1979 with the commitment of a US$6 million nutrition loan. PART III: THE WATER SUPPLY AND SEWERAGE SECTOR IN COLOMBIA AND THE CITY OF CALI Urban Growth 23. During the past several decades Colombia experienced one of the highest rates of urban growth in Latin America. Its urban population is esti- mated to have reached about 70% of the total; this is more than double that of 1938. Urban population grew at an average annual rate of 5.5% during the 1951-64 period or one-and-one-half times faster than the growth of total population. Growth of the urban population has since decreased to an annual average rate of 4.6%.  - 8 - 24. Unlike other countries of comparable size and development, Colombia has several fairly large urban centers. Sixteen cities have more than 100,000 inhabitants. Bogota has about three-and-a-half million, Medellin 1.5 million, Cali over one million, Barranquilla over 700,000 and Cartagena, Bucaramanga, Manizales and Pereira each have about 300,000. Water Supply and Sewerage Facilities, Past Investments, and Financing 25. Although Colombia compares favorably with many other Latin American countries as regards water supply and sewerage facilities, one-fourth of its urban population does not have direct access to public water supply, and about 60% lack sewerage facilities. The level of service of the rural popu- lation is much lower: in 1974, 88% of the households with piped water and 96% of those sewerage connections were in urban areas; in the rural areas, only 33% of the population had access to piped water and only 13% had access to public sewerage services. 26. Water supply and sewerage services are provided by the following institutions: (a) Municipal Enterprises. Twenty-one of the cities with more than 25,000 inhabitants (accounting for one-third of Colombia's popula- tion) have their own municipal utilities to provide water supply and sewerage services. From 70 to 96% of this population receives water supply services and about 50 to 80% is connected to the sewerage system. (b) Instituto Nacional de Fomento Municipal (INSFOPAL). Smaller cities with more than 2,500 inhabitants (which account for one-fourth of Colombia's population) have their water supply and sewerage systems coordinated by INSFOPAL. About 70% of this population has direct access to piped water, while 50% is connected to sewerage systems. INSFOPAL is undergoing a reorganization, with the assis- tance of the Bank under a prior project, to enhance its central planning and financing role in the water supply and sewerage sector. (c) Instituto Nacional de Salud (INAS). Communities of less than 2,500 inhabitants have systems constructed and operated by the INAS. About 33% of this population has water supply services while 13% has access to sewerage facilities. 27. Investment outlays for water supply and sewerage have risen consider- ably, increasing from US$21.6 million equivalent in 1965 to US$55.8 million equivalent in 1975. In the 1965-75 period total investments amounted to US$392 million equivalent, of which 72% was expended by the municipal enter- prises, 20% by INSFOPAL, and 8% by INAS. About 35% of the total investment was financed from the national budget, 20% from external sources, and the remaining 45% from internally generated funds and domestic credits. Six Bank loans supported the improvement of water supply and sewerage systems in Bogota, Cali, Palmira and, through INSFOPAL, in 15 medium-size cities and 30 urban communities. Additionally, two recently approved loans for integrated rural development and nutrition improvement have water and sewerage components.  -9- Government Objectives 28. One of the Government's objectives is to improve living conditions in the urban sector. A major component of this objective is to provide water and sewerage facilities to about 80% of the urban population by 1980. With the support of external sources of finance, the Government has been financing several water and sewerage programs throughout the country. In some cases, however, progress is being slowed down by the inability of the enterprises to generate sufficient financial resources. Rate increases to compensate for raising costs have lagged and the increases now required are such that they have to be implemented gradually. Nevertheless, the Government is determined to strengthen the finances of the water and sewerage sector and it has began to condition assistance from the National Treasury to the enterprises adopting adequate rate increases. The City of Cali 29. Cali, Colombia's third largest city (para. 24), is the capital of the Departamento del Valle del Cauca, the economy of which is based on a highly mechanized agricultural sector (mainly sugarcane) and manufacturing industry (chemicals, food processing, paper, textiles, clothing, printing and electrical products). Cali is linked by railroad and highway with major cities to the Northeast and with the Pacific port of Buenaventura. Cali has also a major international airport. 30. In the 1950's, Cali mushroomed to become an important center of economic activity. This encouraged large rural migration. During the period 1951-64 Cali's population grew at an annual rate of 7.2%, i.e., two-and-one- half times faster than the growth of total population. Growth of Cali's population has since decreased to an annual average rate of 4%. 31. Of Cali's total population, 96% is serviced with water and 80% has shelter with sewerage connections. Only 18% of the area of Cali, however, has separate sewerage, while the remaining has combined sanitary sewerage and stormwater drainage which is considered a health hazard (see para. 41 below). Cali's low-income neighborhoods are located predominantly in the flood lands of the Cauca River. During the rainy season, extensive flooding makes it difficult, and sometimes impossible, to provide these neighborhoods with services such as garbage disposal, street cleaning, police and fire protec- tion, public transportation, and maintenance of the water supply, sewerage, telephone and electricity distribution systems. 32. The role of the local public agencies is very important in Cali, albeit substantially dependent on Central Government financial support. Of total public expenditures in Cali, local agencies contributed 49% (compared to 16% for all Colombia), while the National Government contributed 45% (20% directly and 25% through its decentralized agencies) in 1975. The remainder was contributed by the Departmental Government. Of the 49% contributed by local agencies, Empresas Municipales de Cali (EMCALI), the proposed borrower, contributed 60%. A Mlunicipal Planning Board, established in early 1975, provides policy guidance to the Municipal Planning Office which, in turn, is responsible for preparing the city's four-year plans and for supervising the municipal agencies.  - 10 - The First Project 33. In 1970 the Bank made a loan of US$18.5 million equivalent (Loan 682-CO) to EMCALI to finance half of the costs of the investment program in water supply, sewerage and drainage which the company proposed for the period 1970-73. The largest component of the project was the Puerto Mallarino Water Treatment Plant (about 58% of total project costs), which was to take care of maximum daily water demand from 1973 onwards. 34. Project implementation was slow; the project was completed four years behind schedule, in 1977. Institutional problems, derived in large measure from the unique political situation that prevailed in Colombia in 1970Q and operating deficits adversely affected project implementation. An increased politization of the Board, a high turnover of general managers and inaction to raise rates to compensate for rapidly increasing costs caused EMCALI's finances to deteriorate. 35. EMCALI's financial situation was affected by two other factors. In the first place, project costs (excluding the two components mentioned in para. 36 below) rose from the original estimate of US$29.8 million to US$49 million equivalent. Higher domestic and international prices accounted for most of the increase. EMCALI had to resort to medium-term borrowing at high interest rates to finance the overrun. Secondly, water demand fell short of projections. Foreign and local consultants, retained by EMCALI to prepare the 1970-73 investment program, had projected that daily per capita water consumption would rise from 230 liters in 1969 to 300 liters in 1976. Water consumption, however, was only 224 liters per day in J976. Total water sales were estimated to increase from 76 to 135 million m /year bstween 1971 and 1976, but actual sales in 1976 amounted only to 82.1 million m /year. The shortfall is due both to the slower rate of population growth (Cali s population had been expected to reach 1.3 million in 1975 but reached slightly less than 1 million) and to increased connections to low income recipients, who normally have lower water consumption. The rate of return of EMCALI's Water and Sewerage Division deteriorated sharply and became 0.1% negative in 1974. As a result of substantial increases in rates, in 1976 the rate of return has improved but is still below the level agreed upon in the loan agreement (2.9% against 6% required for 1976). It does not appear reasonable, in the light of the lower volume of water sales under forecast, to expect EMCALI to comply with the current agreement. Therefore, new and more realistic financial targets have been established in connection with the proposed loan (para. 55). 36. In view of the foregoing, the Bank agreed in 1974 that the Bank loan proceeds not be used for two components of the project, the Aguablanca sanitary interceptor (total cost US$2 million equivalent) and the Napoles stormwater drainage canal (total cost US$1 million equivalent). As a con- dition, EMCALI agreed to start construction of the two components of 1976, with its own resources, but the tight financial situation precluded it from  - 11 - doing so. In many ways this can be considered fortunate. Changes in urbani- zation patterns and sharply increased sewerage wastes now make the Aguablanca interceptor inadequate. Likewise, if built, the Napoles canal would have put additional stress on an already congested stormwater drainage system. Under the proposed project, therefore, a larger and more efficient interceptor and a redesigned drainage canal, which are considered to be the least costly solutions, would be built. 37. Notwithstanding this, the first project was successful in many respects. First, it contributed to increase the percentage of Cali's popula- tion that is served by water (from 77% in 1970 to 96% at present). Second, it assisted in providing water supply to Cali's marginal neighborhoods. Four poor neighborhoods, in which about 32,000 low-income families are living, received water supply facilities. 1/ Third, it assisted EMCALI to strengthen its operations. EMCALI simplified its tariff structure and improved water meter repair and maintenance, record keeping, billing and collections. While EMCALI's financial performance has been poor, it has begun to improve. The increased utilization of the Puerto Mallarino treatment plant and the financ- ial measures (paras. 51, 52 and 53), which are proposed under the second project, should help strengthen EMCALI's finances. PART IV: THE PROJECT Background and Objectives 38. The project was prepared by EMCALI with the assistance of Colombian consultants. It comprises most of EMCALI's 1978-81 investment program. The project was appraised by a Bank mission which visited Cali in October 1976. Supplementary work was performed by missions which visited Cali in February, April and September of 1977. Negotiations were held in Washington, D.C. on the week of December 12, 1977, with a Colombian delegation led by Mr. Gabriel Turbay, Director of Public Credit, Ministry of Finance. 39. The objectives of the project are: (i) to increase utilization of EMCALI's installed water production capacity by extending the distribution network in Cali and supplying water to the adjacent Municipality of Yumbo; (ii) to improve sanitary conditions in Cali by moving the discharge of raw sewage downstream from the city's main intake of water, and by separating domestic sewage from stormwater run-off; (iii) to improve living standards in certain low-income areas by providing facilities to reduce flooding, and by extending water supply and sewerage networks; (iv) to increase the area available for orderly urban growth; and (v) to strengthen EMCALI's financial and management operations. 40. Given the lower water demand (para. 35), with the commissioning of the Puerto Mallarino Water Treatment Plant in early 1978, a great part of 1/ The poor neighborhoods are: El Rodeo, Union de Vivienda Popular, Siloe and Terron Colorado.  - 12 - EMCALI's installed water production capacity would remain unused through the mid-eighties. By extending the distribution network to unserviced low-income areas, and by supplying water to the adjacent Municipality of Yumbo, where most of the new industry is located, the excess capacity would be reduced. 41. Although about 93% of Cali's area and 80% of its population is connected to the sewerage system, the quality of the service is poor, and constitutes a health hazard, for several reasons. Firstly, about 75% of the city is serviced by a combined system of sanitary sewerage and stormwater drainage. Concentration of recent population growth in the southern zone, where 40% of Cali's population live, has rendered inadequate the existing system, so that often sewage backs up and out into the surface stormwater drainage canals. Secondly, about 200,000 inhabitants living in the south- eastern zone discharge sewage directly into a stormwater drainage canal which traverses a densely populated area. Thirdly, another 200,000 inhabitants living in the southern and southwestern zones discharge sewage into a storm- water drainage canal which flows into the Cauca River upstream from the intake for two water treatment plants that supply about 85% of Cali's potable water. The contamination level of the Cauca River has reached about 500 times normal health standards. The proposed Cauca Interceptor subproject, Sanitary sub- project, and Stormwater subproject will remedy these situations. The Stormwater subproject aims at stabilizing 535 hectares already urbanized, as well as 1,500 hectares that will enable orderly growth of the city. Summary Description of the Project 42. The project consists of the following: I. Water Supply Subproject (i) Construction of a pumping station and a 7,500 m3 water storage tank; and (ii) construction of distribution network in the low income neighborhoods and installation of house connections, including 20,000 water meters. II. Yumbo Subproiect (i) Construction of a 12-km water transmission pipeline to transport water from Cali to the Municipality of Yumbo, and construction of service pipes for connecting indus- trial consumers along the route; and (ii) rehabilitation of the existing water distribution system, establishment of a leak detection and repair program, pitotmetric investigations, and installation of house water meters.  - 13 - III. Reforestation Subprolect Purchase and planting of about one million trees in the Cali, Canaveralejo and Pance River basins to increase water reten- tion in the surrounding area. IV. Cauca Interceptor Subproject (i) Construction of two sewage collectors and a main sewage interceptor and a lateral collector to receive sewage and convey it by gravity into a sewage pumping station; (ii) construction of pumping facilities and a pressure line to convey sewage from the pumping station to a point 300 m downstream from the intake of two existing water treatment plants; and (iii) rehabilitation of two regulatory stormwater drainage lagoons, and construction of stormwater-sewage structures. V. Stormwater Subprolect (i) Excavation and construction of 2.5 km of concrete lined stormwater drainage canal; tii) rehabilitation of 8.0 km of stormwater drainage canal and separation of storDwater drainage between gravity discharge and pumping discharge; and (iii) construction of 22 km of stormwater drainage network in various low income neighborhoods. VI. Sanitary Sewers Subproject (i) Rehabilitation of old sewers; and (ii) construction of sewerage laterals and trunk lines in various low income neighborhoods. VII. Preparation of appropriate studies and preliminary designs for sewage treatment facilities I VIII. Purchase of equipment for maintaining the water, sewerage and stormwater drainage systems IX. Engineering services for the detailed design and construction supervision of the project  - 14 - Costs and Financing 43. The total cost of the project is estimated at US$25.7 million equivalent, of which US$11.4 million equivalent correspond to the foreign exchange component. There will also be required US$8 million equivalent for interest during construction. During the period of project execution (1978 through 1981), EMCALI plans to carry out other investments at a cost of US$2.1 million equivalent, and will require an increase in working capital of US$7.1 million equivalent. 44. The proposed loan of US$13.8 million equivalent would finance 54% of total project cost, i.e. all the foreign exchange costs of the project, and interest and other charges on the Bank loan during construction (41% of EMCALI's requirements during the period of project execution). Financing of interest during construction is justified in view of EMCALI's cash flow position. The remaining cost would be financed from ENCALI's internal cash generation (US$17 million equivalent) and from domestic credits (US$11.4 million equivalent) (see para 54). Retroactive financing of up to US$200,000 the preparation of final designs for the project (Schedule 1, para. 4(i) of draft Loan Agreement). The Borrower: EMCALI 45. EMCALI is a decentralized municipal agency in charge of construc- tion, administration and maintenance of the water supply, sewerage, power and telephone facilities in Cali. EMCALI will continue to provide power and telephone services, and has recently agreed to provide also water supply services, to the adjacent Municipality of Yumbo. Tentative plans call for EMCALI taking over the operation and maintenance of Yumbo's water system. Investments in the Yumbo Subproject (para. 42) will only be made after EMCALI and the Municipality of Yumbo reach an agreement satisfactory to the Bank on the terms and conditions of such takeover (Section 5.07(b) of draft Loan Agreement). 46. Since 1972, ENCALI is governed by a seven-member Board of Directors appointed for a two-year term by the City Council. The Mayor of Cali is the ex-officio Chairman of the Board, and is appointed by the Governor of the State of the Valle del Cauca, who is appointed by the President of Colombia. The General Manager is appointed by the Mayor subject to ratification by the Board of Directors. Although in recent years there have been frequent changes of General Manager, the next level of management has undergone little change and is competent. EMCALI is adequately staffed. At present, it has 2,506 staff members, of which 988 work in the water and sewerage division, 308 work in the energy division and 609 work in the telephone division. 47. Effective March 1, 1977, EMCALI's organizational structure was decen- tralized into three self-contained operating units for water and sewerage, energy, and telephones, which function independently and report directly to the General Manager. Previously, each division was responsible for physical production and distribution only.  - 15 - 48. As stated, EMCALI's management has improved considerably under the first Bank-supported project. However, further improvement is needed regarding coordination and financial planning. EMCALI has therefore agreed to prepare by June 30, 1978, a program to improve EMCALI's management information, budget- ary and internal control systems and to strengthen the coordination of its administration and operation units, and promptly thereafter to carry out such program, with the assistance of consultants to the extent that such assistance is required in the opinion of the Bank (Part C.2 of Schedule 2 and Section 3.02 of the draft Loan Agreement). 49. EMCALI has also agreed to employ engineering consultants, to the extent required in the opinion of the Bank, to prepare detailed designs for the project and to assist in the supervision of construction. The consultants will also carry out studies of future sewerage treatment requirements (Section 3.02 of draft Loan Agreement). The average man-month cost of these consultants is estimated at US$5,000 equivalent. Finances 50. As stated, EMCALI's financial performance deteriorated from 1972 through 1974. Consolidated income, which in 1973 was of Col$70 million, decreased to Col$59 million in 1974. Substantial tariff increases were ob- tained in 1975 and 1976, raising EMCALI's net income to Col$78 million and Col$92 million, respectively. Such increases were insufficient, however, for EMCALI to service its debt, finance its investments, and meet its working capital needs. EMCALI, therefore, had to resort to heavy medium-term borrowing at high rates of interest. By the end of 1976, EMCALI had accumulated US$15 million equivalent of such loans. 51. Automatic monthly increases in the water and power rates became effective on January 1, 1976. Water rates have been increased by 1.5% per month on consumption over a certain quantity. (Of total consumption within each of the 13 progressive rate categories, about 60% is subject to the excess consumption surcharge.) Power rates have been increased by 2.2% per month. Effective May 1, 1976, telephone rates for local calls were increased from Col$0.10 per impulse to Col$0.16; effective October 1, 1977, they were increased to Col$0.25 per impulse and to Col$0.30 per impulse on January 1, 1978. Assurances have been obtained that rates for water and sewerage, and power services will continue to be increased monthly, auto- matically, at current rates until December 31, 1981 for water and until June 30, 1979 for power (Sections 5.04(a) and 5.05 (a)(ii) of draft Loan Agreement, and Section 3.02 of draft Guarantee Agreement). 52. About Col$340 million (about US$6.7 million equivalent) of addi- tional revenues for water supply and sewerage operations will be obtained from a program of reassessment of property values, started in early 1977, which moves the affected properties into higher rate categories. The new assessment, for which no further decision is required, will be gradually implemented over three years. EMCALI agreed fully to implement its reassessment program by June 30, 1979 (Section 5.04(b) of draft Loan Agreement). The automatic monthly increases in water rates plus the reassessment of property values will cause average water and sewerage rates to increase by 22% in 1977, 28% in 1978, 15% in 1979, 10% in 1980 and 13% in 1981.  - 16 - 53. In Colombia, as in some other countries, certain investment costs are recovered through a betterment levy (impuesto de valorizacion) imposed on the owners of property which benefit from public infrastructure works. Such levies have been particularly successful in Colombia, especially regarding urban road and sewerage systems construction. Assurances were therefore obtained that EMCALI will charge and collect during the 1978-1984 period not less than a proportion agreed with the Bank of the cost of certain sewerage works included in the project (about US$15.5 million equivalent) (Section 5.09 of draft Loan Agreement). Disbursements of the proposed Bank loan on account of expenditures for each subproject in respect of which valorizacion must be collected, will be made only after the Bank receives satisfactory evidence that all necessary authorizations and approvals required to charge and collect valorizacion in respect of such works have been obtained (Para- graph 4 (ii) of Schedule I to draft Loan Agreement). Storm water drainage facilities and certain other works (but in the latter case only to the extent that their cost has been recovered through valorizacion) will be excluded from the base on which the rate of return is calculated. 54. EMCALI will also receive a loan of Col$300 million (US$5.7 million equivalent) from the Government, and a loan of Col$300 million to be partly financed by the mortgage bank (Banco Central Hipotecario). The proposed Bank loan will only become effective after arrangements satisfactory to the Bank are made to provide EMCALI with these loans on terms and conditions, including the schedule of disbursement, satisfactory to the Bank (Sections 3.01(b) and 8.01(a) of draft Loan Agreement and Section 2.02(i) and (ii) of draft Guarantee Agreement). 55. EMCALI would continue to obtain an acceptable rate of return for water and sewerage, though lower than agreed under Loan 682-CO. The latter provided for targets requiring tariffs higher than the marginal cost of water. In addition, assets in operation of the water and sewerage division will almost double in the near future. EMCALI therefore agreed to obtain annually, starting in 1978, operating revenues sufficient to achieve a financial rate of return of not less than 3% in the water and sewerage division, increasing to 4% in 1982, 4.5% in 1983, and 5% thereafter; 8% in the power division; and 5.5% increasing to 8% in 1979 and thereafter in the telephone division, such returns to be computed on the revalued cost less accumulated depreciation of fixed assets in service of each division (Section 5.05 of draft Loan Agree- ment). An additional condition of effectiveness will be that all decisions on rates necessary to enable EMCALI to achieve the agreed 1978 return on its telephone divisions shall have been taken (Section 8.01(b) of draft Loan Agreement.) For purposes of calculating the rate of return, fixed assets will continue to be revalued in accordance with methods satisfactory to the Bank (para. 5 of Schedule 5 to draft Loan Agreement). The proposed annual rates of return would place EMCALI in a satisfactory financial position, i.e. would generate sufficient funds to cover its debt service and its working capital requirements, and to contribute to finance its investment program. 56. EMCALI has also agreed: (a) not to undertake any investment not included in the financing plan on the basis of which this proposed loan is presented, through any of its divisions, without the concurrence of the Bank, until the project is completed, if the aggregate cost of all the investments  - 17 - in the same division exceed the equivalent of US$1 million in any year (Section 5.07(a) of draft Loan Agreement); (b) not to incur any long-term debt without the Bank's concurrence, unless the projected net income before interest and depreciation in respect of the division for the benefit of which the debt is to be incurred (excluding income derived from valorizacion) is at least 1.3 times its maximum debt service in respect of such division (Section 5.06 of draft Loan Agreement); and (c) to continue to have its financial statements and accounts audited by independent auditors acceptable to the Bank (Section 5.02 of draft Loan Agreement). 57. Until mid-1977, EMCALI used in an unrestricted manner funds gener- ated in one division to finance expenditures of other divisions. Transfers were made to the water and sewerage division even hampering the financial position of the power and telephone divisions. EMCALI has agreed that in the future such inter-division transfers will be made only in cases where the division originating the funds does not require them for its operations, debt service, and investments. Furthermore, after June 30, 1977, the transfers will be treated as loans from one division to the other, on commercial terms (Section 5.08 of draft Loan Agreement). Procurement and Disbursement 58. All contracts will be let under international competitive bidding in accordance with Bank guidelines, except for civil works contracts under US$300,000 equivalent, up to an aggregate of US$2 million equivalent, which will be let under local competitive bidding procedures satisfactory to the Bank. Suppliers of goods manufactured in Colombia would receive a margin of preference of 15% or the import duties, whichever is lower. 59. The loan would be disbursed over a four-year period. Disbursements would be made against (i) 100% of the foreign expenditures for imported goods; (ii) 25% of the ex-factory cost of Colombian goods which represents the esti- mated foreign exchange cost of such goods; (iii) 25% of civil works, which represents their estimated foreign exchange cost; (iv) 100% of foreign expendi- tures or 40% of total expenditures for consulting services; and (v) interest and other charges on the Bank loan during project construction. The loan is expected to be fully disbursed by June 30, 1982. Benefits and Risks 60. The proposed project aims at improving the living conditions of the residents of Cali and Yumbo. About 250,000 people would benefit directly from the project, of which 70% are among the lower forty percent of income recipients. The sewerage subprojects (Cauca Interceptor, Stormwater and Sanitary Subprojects) have benefits that can not be measured exclusively against the expected incremental operating revenues; the land affected by the subprojects would appreciate in value, and EMCALI proposes to tax part of this increase (see para. 53). For the purpose of computing the increased land values and the revenues thereon, two assumptions were made: (a) the value of land presently subject to frequent flooding would be equal to the value of nearby land free of flooding and (b) the value of unimproved land  - 18 - in the southern zone would be equal to the value of improved land in the same area, but the increase would be reflected over a 10-year period to take account of market fluctuations. On this basis, the aggregate internal rate of return for the sewerage subprojects, which account for 59% of total project cost, is estimated to be 21%. The estimated internal economic rate of return of the Water Supply Subproject, whose revenues would come directly from water sales and which accounts for 14% of total project costs, is 36%. The Yumbo Subproject, whose revenues would come from water sales and valorizacion and which accounts for 18% of total project costs, has a rate of return of 13%. The weighted average internal rate of return of these subproj- ects, which account for 91% of total project costs, is estimated to be 22%. Internal rates of return were not computed for the remaining components of the project because of the predominance of non-quantifiable factors. 61. The project is technically feasible and offers limited risk. The water supply component is based on the increased utilization of production facilities constructed under the prior project. The sanitation components do not present any major engineering difficulty, as they take into account the experience gained under the prior project. The only risk is that the project may not be implemented in the time proposed if EMCALI, because of inaction to raise rates, would be unable to mobilize the required local currency resources. Given the assurances obtained from EMCALI that rate increases and betterment levies will be implemented in a timely fashion (paras. 51 and 53), and, more importantly, the general acceptance by all political sectors of the need to strengthen EMCALI's finances, it is expected that the project will be carried out in the intended period. PART V: LEGAL INSTRUMENTS AND AUTHORITY 62. The draft Loan Agreement between the Bank and EKCALI, the draft Guarantee Agreement between the Republic of Colombia and the Bank, and the report of the Committee provided for in Article III, Section 4 (iii) of the Bank's Articles of Agreement are being distributed to the Executive Directors separately. 63. Special conditions of the loan are listed in Section III of Annex III. Additional conditions of effectiveness would be the finalization of arrangements for the Col$600 million loan to EMCALI (para. 54) and all action necessary to enable EMCALI to obtain in 1978 the agreed rate of return on its telephone division (para. 55). Disbursements for each subproject in respect of which valorizacion would be collected would be made only after all autho- rizations required to charge it have been obtained. 64. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank.  - 19 - PART VI: RECOMMENDATION 65. I recommend that the Executive Directors approve the proposed loan. Robert S. McNamara President Attachments February 8, 1978   ANNEX I TABLE 3A Page I of 4 pages COLOMBIA - SOCIAL INDICATORS DATA SHEET LANU AREA (THOU KM2) --------------- COLOMBIA REFERENCE COUNTRIES (1970) TOTAL 1138.9 MOST RECENT AGRIC. 223.9 1960 1970 ESTIMATE TURKEY BRAZIL MEXICO** GNP PER CAPITA (USS) 210.0* 350.0* 640.0*/a 500.0* 550.0* 690.0* POPULATION AND VITAL STATISTICS ____-__________________________ POPULATION (MID-YR, MILLION) 15.4 20.6 24.2/a 35.6 92.8 50.4 POPULATION DENSITY PER SQUARE KM. 14.0 18.0 21.0 46.0 11.0 26.0 PER SO. KM. AGRICULTURAL LAND 71.0 93.0 108.0/a 65.0 49.0 52.0 VITAL STATISTICS CRUDE BIRTH RATE (/THOU, AV) 46.1** 44.3** 40.6** 40.6 38.4 43.8 CRUDE DEATH RATE (/THOU.AV) 14.7 11.0 8.8 14.4 9.9 10.2 INFANT MoRTALITY RATE (/THOU) 100.0JA 70.0/a 153.60/a 110.0 68.5 LIFE EXPECTANCY AT BIRTH (YRS) 54.7 58.5 60.9 54.4 59.4 62.4 GROSS REPRODUCTION RATE 3.2 3.2 3.1 2.6/b,c 2.6 3.1 POPULiTION GROWTH RATE 3.2 2.9 2.8(X TOTAL 32 29 .82.5 2.9 3.4 OURAN 6.0/b 5.s/b 4.6 4.9/d 5.0 4.8 URBAN POPULATION (% OF TOTAL) 53.0/c 60.0 70.0 fb 38.7 56.0 58.7 AGE STRUCTURE (PERCENT) 0 TO 14 YEARS 46.6LC 46.6 44.1 41.7 42.0 46.2 15 TO 64 YEARS 50-4 C 50.4 52.7 54.0 55.0 50.1 65 YEARS AND OVER ,3.37 3.0 3.2 4.3 3.0 3.7 AGE DEPENDENCY RATIO 1.0/c 1.0 0.9 0.9 0.8 1.0 ECONOMIC DEPENDENCY RATIO 1. c 1.6/c 1.6/c 1.1/e 1.5 2.0 FAMILY PLANNING ACCEPTORS (CUMULATIVE, THOU) 0.5 306.9 955.1 *. 250.0 55.5 USERS (X OF MARRIED WOMEN) .. .. 31.0 8.2 1.6 EMPLOYMENT TOTAL LABOR FORCE (THOUSAND) 5100. c 6300.0 6B00.0 14500.0/f 29400.0 13000.0 LABOR FORCE IN AGRICULTURE (%) 47.0 - 39.0 ,, 67.0 40.4 45.0 UNEMPLOYED (% OF LABOR FORCE) 8