Colombia - Second (Cartagena) Urban Development Project

Document of f ir fD The World Bank FOR OFFICIAL USE ONLY Report No. P-2472a-CO REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF COLOMBIA FOR THE SECOND (CARTAGENA) URBAN DEVELOPMENT PROJECT April 18, 1979 This doc_mmt bos a restrieted distribelon and may be used by recipients only in the performance of their offical duties. Ib cent_s my not otherwise be disclosed witbout Worid Bank authorization.  CURRENCY EQUIVALENTS Average Calendar 1978 (estimate) Mid-1979 estimate Currency Unit = Peso - Col$ Col$ US$1 = Col$39.32 42.40 Col$ = US$0.0254 0.0236 WEIGHTS AND MEASURES Metric System GLOSSARY OF ABBREVIATIONS BCH - Banco Central Hipotecario BP - Banco Popular CAIP - Integrated Pre-School Care Center CDV - Centro de Desarrollo Vecinal (Neighborhood Development Center) CORELCA - Corporacion Electrica de la Costa Atlantica DNP - National Planning Department DRI - Integrated Rural Development Program ELECTRIBOL - Electrificadora de Bolivar EPMC - Empresas Publicas Municipales de Cartagena EPZ _ (Cartagena) Export Processing Zone ICBF - Institute of Family Welfare ICCE - Institute of School Construction ICT - Instituto de Credito Territorial (National Urban Housing Authority) IDB - Inter-American Development Bank IGAC - Instituto Geografico "Agustin Codazzi" (National Geographic Institute) INSFOPAL - Instituto Nacional de Fomento Municipal IPC - Program of Integration of Services and Community Participation MAC - Basic Module of Health Care PAN - National Food and Nutrition Program PHIZSU - Plan for Integrated Servicing of Substandard Urban Areas SENA - Servicio Nacional de Aprendizaje (National Training Service) SIP - Secretaria de Integracion Popular UPAC - Unit of Constant Purchasing Pov(er UNDP - United Nations Development Programme UPE - Employment and Productivity Unit ZFIC - Zone Franca Industrial y Commercial de Cartegena FISCAL YEAR January 1 to December 31  FOR OFFICIAL USE ONLY COLOMBIA SECOND (CARTAGENA) URBAN DEVELOPMENT PROJECT LOAN AND PROJECT SUMMARY Borrower: Republic of Colombia Amount: US$13.5 million equivalent Terms: Pepayment in 17 years, including four years of grace; interest at 7.9% per annum. Relending Terms: The Colombian peso equivalent of the loan proceeds would be made available to the Instituto de Credito Territorial (ICT) and other implementing agencies, pursuant to several agreements on terms and conditions satisfactory to the Bank. Project Description: The project includes essential components entrusted to executing agencies and optional components to be carried out by individual households or community groups with technical and financial assistance from ICT. It would consist of physical upgrading of, provision of water supply, sewerage and electricity services in, and support during 1979-1983 of social programs in, the Southeast Zone of the City of Cartagena and the nearby village of Pasacaballos, with an aggregate population of over 95,000, whose average income ranks in the 10th lowest percentile of Colombia's urban income distribution. Special arrangements would be made to provide for (a) coordination of project execution, including activities and services to be delivered after facilities' completion; (b) channelling of funds and (c) recovery of investments. This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  - ii - Estimated Costs: US$ million equivalent Local Foreign Total A. Land Filling 1.2 1.2 2.4 B. Street Drainage 1.3 0.7 2.0 C. External Drainage 2.4 1.3 3.7 D. Utility Infrastructure Off-site Water Trunk Mains 0.4 0.2 0.6 Primary Water Mains 0.4 0.2 0.6 Primary Sewerage 0.2 0.2 0.4 Electricity Networks 0.5 0.4 0.9 Subtotal D 1.5 1.0 2.5 E. ICT Loans Regularization of Land Tenure 0.2 - 0.2 Public Services and Neighborhood Improvements 2.8 0.3 3.1 Housing Improvements 0.7 0.1 0.8 Sites and Relocation 1.3 0.1 1.4 Subtotal E 5.0 0.5 5.5 F. Community Facilities Land 0.4 - 0.4 Construction 0.9 0.5 1.4 Equipment 0.3 0.2 0.5 Training 0.2 0.1 0.3 Subtotal F 1.8 0.8 2.6 G. Project Management 0.5 0.1 0.6 H. Technical Assistance 0.3 0.1 0.4 I. Design and Supervision 1.1 0.2 1.3 Base Costs (Subtotal A-I) 15.1 5.9 21.0 Physical Contingencies 2.7 1.1 3.8 Price Contingencies 7.6 2.9 10.5 TOTAL PROJECT COST 25.4 9.9 35.3  - iii - Financing Plan: US$ million equivalent Local Foreign Total A. Internal Sources _ 1. National Budget 29 10.3 - 10.3 2. ICT 23 8.1 - 8.1 3. ELECTRIBOL 2 0.7 - 0.7 4. EPMC 1 0.2 - 0.2 5. Local Government 2 0.5 - 0.5 Subtotal 57 19.8 - 19.8 B. External Sources 1. IBRD Loan 38 3.6 9.9 13.5 2. IDB Grant 5 2.0 - 2.0 Subtotal 43 5.6 9.9 15.5 TOTAL 100 25.4 9.9 35.3 Estimated Disbursements: US$ million equivalent FY80 FY81 FY82 FY83 FY84 Annual 3.0 3.5 3.1 2.4 1.5 Cumulative 3.0 6.5 9.6 12.0 13.5 Rate of Return: 16% on quantifiable project benefits, accounting for 60% of project costs. Appraisal Report: Report No. 2255b-CO, dated April 18, 1979.   INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF COLOMBIA FOR THE SECOND (CARTAGENA) URBAN DEVELOPMENT PROJECT 1. I submit the following report and recommendation on a proposed loan to the Republic of Colombia, for the equivalent of US$13.5 million to help finance the Second (Cartagena) Urban Development Project. The loan would have a term of 17 years, including four years of grace, with interest at 7.9% per annum. The Colombian peso equivalent of the loat proceeds would be made available to Instituto de Credito Territorial (ICT) and other executing agen- cies, to help finance the project components for which each of the agencies would be responsible, pursuant to several agreements on terms and conditions satisfactory to the Bank. Recovery arrangements are described in paragraph 64 below. PART I: THE ECONOMY 2. An economic report on Colombia (2235-CO) was distributed to the Executive Directors in January 1979. An updating mission visited Colombia during February 1979 and is preparing its report. Its findings are sum- marized below. Country data sheets are provided in Annex I. Background 3. During the past two decades, Colombia has made substantial 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. The productive base of the economy has been widened appreciably, and there has been substantial diversification of production in both the agricultural and industrial sectors. These improvements have been accompanied by rapid growth of non-traditional exports and by the development of a modern sector relying to a considerable extent on imported inputs. As a result, the country has become less dependent on coffee as a source of foreign exchange earnings, and fluctuations in domestic economic conditions resulting from unpredictable shifts in world coffee prices, while still considerable, have become more manageable. Although substantial progress has been made during the past two decades, Colombia is still only partially developed with a limited modern sector superimposed on a large, traditional and economically poor base. Per capita income is low by developed world standards, the maintenance of high employment is a persistent problem, and in 1975 an estimated 55.0% of the rural and 24.0% of the urban population had incomes under the relative poverty level as defined by the Bank. 4. Colombia's population growth rate declined sharply in the past two decades; from well over 3% in the 1950s, to about 2.8% in the early 1970s  - 2 - and to an estimated 2.1% at present. 1/ This was in large part the result of a rapid decline in the crude birth rate; one of the most pronounced declines ever recorded in a Latin American country. Rising per capita income, rapid rural/urban migration, expanded economic opportunities for women and increased effectiveness of family planning programs are included among the factors responsible for the lower birth rate. Although rural/urban migration slowed from the early 1960s on as progress was made in eliminating the widespread violence in the countryside, approximately 64% of the current population lives in urban centers and there are now 16 cities with populations exceeding 100,000 persons. Colombia's population is not considered excessive relative to the country's resource base. Economic growth will have to average around 7%, however, especially in the directly productive and service sectors, in order to increase employment at a pace sufficient to keep up with growth of the labor force. 5. Available information--while scanty--suggests that some improvement has occurred in income distribution and welfare of the lowest income groups in Colombia since the 1950s. These gains were probably the consequence of several factors, including migration of surplus labor from rural to urban areas, rapid growth of employment in high productivity jobs in industry and the services and reduced population growth. Policy efforts, particularly since 1967, have been directed increasingly toward improving the welfare of the poorest 50% of the population. These efforts have emphasized both employment generation and greater public investment in health, education, nutrition and urban development. The Bank has strongly supported these efforts. Continued emphasis on growth of the productive sectors of the economy, on industrial decentralization and on programs to encourage small- scale industry and agriculture should provide increased employment oppor- tunities and higher real wages for unskilled and semi-skilled labor in both rural and urban areas. Further improvement in the public services provided to the poor should reinforce these trends and raise the level of welfare of this segment of the population. 6. The Colombian authorities introduced a dramatic change in develop- ment strategy in 1967, shifting emphasis from the then existing protectionist policy of import substitution to measures designed to expand and diversify exports. These policies were highly successful in expanding exports, thereby alleviating the foreign exchange constraint and making possible a substantially higher level of investment. As a consequence, real GDP rose by an average 6.5% annually between 1967-1969 and 1974, well above the historical average. Merchandise exports in current prices expanded nearly threefold during this period, and most significantly, non-traditional exports became an increasingly important source of foreign exchange earnings, in part compensating for slow growth of receipts from coffee exports. By 1974, non-coffee exports comprised 56% of total merchandise exports, up from about 30% in 1967. 1/ Estimated 1978 growth rate. This rate differs from that given as the most recent estimate in the Social Indicators Data Sheet (Annex I) which is an average for early 1970s.  - 3 - 7. Despite the growth of output and the diversification of exports, the country faced some potentially serious problems at the time the new administration took office in 1974. Weakening balance of payments in part related to the slowdown of growth in the industrial countries, loss of self-sufficiency in petroleum production, deterioration of the public finances, accelerating inflation, and declining investment threatened to reduce growth of output and employment. As a consequence of these develop- ments, the Government introduced an economic stabilization program which combined basic reforms of the fiscal, monetary, and trade systems with measures aimed at accelerating long-term economic growth. 8. In an effort to strengthen the public finances, the Government undertook a comprehensive tax reform designed to improve the progressivity and elasticity of the tax system. Some of the distortions which had deve- loped in the financial system caused by forced investment requirements placed on financial institutions and by differential tax treatment of financial instruments were eliminated. Interest rates were raised in an effort to increase private savings and improve resource allocation. In order to increase the efficiency of the economy through greater reliance on market forces, price controls on a number of industrial and agricultural products were removed, thereby providing greater stimulus for increasing production. Modifications in petroleum pricing policy aimed at regaining self-sufficiency in the production of crude petroleum by improving incen- tives for exploration and exploitation were introduced. Concurrently, the Government initiated policies designed to reduce the subsidy on local consumption of petroleum products, which eventually led to a 220% increase in gasoline prices by 1978. Tariff levels and non-tariff barriers to trade were reduced significantly in order to increase competition and the effi- ciency of domestic firms. While these reforms were successful in improving the public finances and reducing inflation in 1975, they also served to reduce economic growth and the slowdown of domestic economic activity which began in 1974 continued through most of 1975. Recent Economic Developments 9. During the past three years, the Colombian economy has been dominated by developments in the external sector. As the result of a serious frost in late 1975 affecting Brazil's major coffee producing area, coffee exports from that country declined sharply triggering a fourfold increase in the world price of coffee by mid-1977. This caused Colombia's export earnings from coffee to increase to nearly US$1.8 billion in 1977 from US$764 million in 1975, and produced an unprecedented rise in incomes and demand in the country's rural areas. Lagging supply of consumer goods, particularly basic foodstuffs--the production of which was adversely affected by drought conditions in most of the country's interior--failed to keep pace with rising demand and inflation accelerated from 24% in 1975 to 44% in the twelve months ending June 1977. Inflation in Colombia has been moderate relative to that experienced by other countries in the region, seldom exceeding an annual rate of 20%. The acceleration of inflation which took place during the period, therefore, was unprecedented in recent history, and efforts to lower the rate of inflation have dictated economic policy since that time.  - 4 - 10. The authorities responded rapidly by introducing a broad range of fiscal, monetary and trade policies designed to gain control over the explosive increase in prices. Beginning in late 1976 reserve requirements were raised and rediscounting and public sector borrowing from the Central Bank were discouraged. The authorities temporarily suspended their policy of periodically adjusting the exchange rate and prices of petroleum products. In January 1977, a 100% marginal reserve requirement was placed on increases in commercial bank deposits exceeding the December 31, 1976 level. To delay the impact of rising foreign exchange receipts on the monetary base, exporters were required to accept 90-day US dollar denominated certificates of exchange in lieu of cash payment for their exports. In order to sterilize a portion of the increase in foreign exchange earnings from coffee exports, the Coffee Federation agreed to invest a large portion of its receipts in Central Bank bonds, the proceeds of which were frozen in a special account. To increase supplies in the domestic market, a number of measures were taken to liberalize imports. Food imports by the state marketing agency, IDEMA, were increased sharply. In addition, restrictive fiscal measures were introduced to curb growth of aggregate demand and in 1977 the Treasury registered an overall budgetary surplus for the first time in recent years. 11. As a consequence of these measures and a favorable second semester harvest, inflation declined sharply beginning in July 1977. By the end of the year, the annual rate of inflation had fallen to 29%. With inflation subsiding, periodic exchange rate adjustments and gasoline price increases were reintroduced. With few other exceptions, however, the stabilization policies were continued in effect throughout 1978 and by year end inflation had subsided to an annual rate of 17.8%. 12. Because of the lack of dynamism in world markets, slow growth in agricultural production, capacity constraints in the industrial sector and a decline in real investment, the Colombian economy expanded only moderately in 1976 and 1977. Growth of real GDP increased from 3.8% in 1975, to 4.6% and 4.8% respectively in the subsequent two years. The higher growth was a direct result of the expansion of domestic demand brought about by the rise in incomes of coffee producers. Output in the trade and personal services sectors of the economy (including transport and communications) responded strongly to the rising demand, while agricultural output, because of the drought, rose by only 2.2% p.a. on average for the 1976-77 period. Industrial sector output rose by only 5.4% p.a. during this period, despite the strong growth in domestic demand. Because growth occurred in the rela- tively labor intensive sectors of the economy -- personal services, trade, transport and communications and manufacturing -- the urban unemployment rate had declined to an estimated 8% by the end of 1977, from an average 12% during the early 1970s. In addition, there is evidence of labor shortages and rising real wage rates in rural areas during this period, and it is believed that rural unemployment also declined. 13. Preliminary estimates for 1978 show a strong increase in real GDP resulting primarily from continued stimulus to aggregate demand from high coffee receipts and from an expansion of investment. In addition, favorable weather conditions permitted a sharp recovery in agricultural  output. Real GDP growth is estimated at 8% for the year, with agricultural production estimated to have grown by as much as 9% over the low level of 1977. While coffee prices fell considerably in 1978 from their 1977 levels, this decline was more than offset by expanding export volume as Colombia undertook a more aggressive coffee export policy. Consequently, receipts from coffee exports rose to nearly US$2.1 billion for the year. The accompanying rise in domestic demand and a modest recovery in export markets caused manu- facturing and transport and communications to grow by 8.5% each and trade (including commerce) by 9.0%. Construction activity, which had continued at a low level during the past several years, recovered strongly in 1978, partially as a result of an increase in speculative demand arising from an inflow of funds from contraband activities. Only the mining sector, in which output fell by 2.3% as a result of declining oil production, failed to show signifi- cant growth in 1978. Open unemployment in urban areas is estimated to have fallen to 7.6% by June 1978. 14. Colombia's balance of payments was also highly favorable in 1978, continuing the trend of the previous three years. Largely as a result of the increase in coffee exports, although non-coffee exports rose modestly (7.0%) in real terms also, Colombia's net official international reserves rose by US$664 million, reaching US$2,493 million by the end of the year, equivalent to about nine months imports of goods and non-factor services. This increase in reserves occurred despite a nominal 25% increase in import payments, reflecting the rise in domestic demand, continued overvaluation of the exchange rate and liberal import policies. There were few significant modifications in trade and exchange rate policies in 1978. The slow rate of peso devaluation was continued during the first three quarters of the year, but accelerated in the fourth quarter when the pace of reserve accumu- lation began to slow. In general, trade and exchange rate policies were directed towards reducing the impact on the monetary base of reserve accumula- tion by delaying the monetization of export receipts and advancing import payments. These measures complemented monetary policies which were aimed at restraining growth of the money supply. 15. Colombia's public finances generated a large surplus in 1978 thereby permitting the Government to relax somewhat the policy of fiscal restraint which formed part of its anti-inflationary program during the previous two years. Current savings of the public sector rose to an estimated 6.0% of GDP, compared with 5.5% of GDP in 1977, and covered about 90% of public sector investment. Both the Central Government 1/ and the consolidated decentralized agencies increased their savings in 1978, the former by 29% and the latter by 153%. The strong increase in savings of the decentralized agencies, which rose to 1.4% of GDP from 0.7% in 1977, was the result of increased charges for the services they provide and of restraint on current expenditures. Large increases in customs duties and in sales taxes brought about by the growth in domestic demand were the main factors responsible for the increase in savings of the Central Government. As a consequence of this improved financial situation, public sector fixed 1/ Comprised of the National Government, the National Highway Fund and the Social Security Agencies.  -6- investment rose during the year, reaching 6.9% of GDP compared with 6.3% of GDP on average for the 1975-77 period. Some of the heaviest investment took place in the development of hydropower and in the petroleum sector, for both explora- tion and development. 16. Despite continuation of the stabilization programs largely unchanged from last year, the rate of inflation accelerated sharply in January 1979, followed by a more moderate increase in February. On an annual basis, infla- tion had reached 21.2% by the end of the latter month. At the same time, the international price of coffee fell sharply, prompting the Government to take measures to avoid a large financial deficit for the Coffee Federation. In the past, such deficits were financed in part through recourse to the Central Bank. The Federation, an autonomous entity which manages the domestic and external marketing of Colombia's coffee, purchases coffee from producers at a fixed price in pesos and then sells it on the world market. Since the Federation stands ready to purchase all coffee offered at the fixed price, it also bears the financial burden of stock accumulation in periods of declining world prices. After paying taxes and marketing costs equivalent to nearly 25% of the inter- national price, the Federation could not sustain the high domestic purchase price given the lower world coffee price without incurring huge losses. To avoid this, the domestic purchase price of coffee was lowered by 12% and the exchange certificate system was abolished for coffee exports. This latter measure will result in the conversion to cash over the next several months of around Col$10 billion in outstanding exchange certificates. To offset the monetary impact of this measure, reserve requirements on term deposits of commercial banks and financial corporations are to be increased gradually over the next few months, to 25% from 20% at present, and prior import deposit requirements have been raised substantially, to 95% from 40% and 60% previously. In addition, the interest rate on dollar denominated certificates issued by the Central Bank was raised to 14% from 7% in an attempt to absorb some of the funds flowing from the exchange certificates. In a separate measure, retail gasoline prices were increased in mid-March and Sunday sales of gasoline were outlawed. Gasoline prices have been raised by 67% since September 1978. Development Strategy and Prospects 17. The development strategy embodied in the 1975-78 Development Plan aimed at accelerating the rate of growth of GDP and at distributing the benefits of such growth more equitably. This was to be achieved by increasing the allocative efficiency of the economy through greater reliance on market forces, by providing incentives for increasing private sector investment, by expanding economic and social infrastructure, and by improving public services provided to the poorest half of the population. Substantial progress has been made in carrying out this strategy during the past four years. Public sector investments have focused increasingly on projects designed to alleviate rural and urban poverty and on expanding and improving infrastructure. Compre- hensive integrated rural development and nutrition projects aimed at increasing incomes and welfare of the lowest income groups have been introduced. Urban development projects designed to provide improved services and employment opportunities to residents of slum areas in Colombia's major cities have been initiated. These programs have been complemented by policies to encourage the development of small- and medium-scale enterprises and to decentralize industry away from the three largest cities. This latter policy, together with credit programs aimed at increasing output and employment in agriculture, have been designed to alleviate rural poverty and reduce rural/urban migration. Public  -7- sector infrastructure investments have been concentrated on improvement and extension of highway and communications systems. Special priority has been given to the development of domestic energy sources to reduce the country's growing dependence on imported oil. 18. Increased emphasis on provision of improved social services is re- flected in the increased proportion of total National Government expenditure on education, health, and water and sewerage systems, which rose from 33% in 1974 to 38% in 1977. The economic dislocations caused by the coffee boom and the need to concentrate economic policy on short-term management problems have limited expansion of public and private investment and required temporary suspension of some of the measures designed to free the price system and stimulate growth of non-traditional exports. 19. The Government, which took office in August 1978, intends to continue with essentially the same development strategy as the previous administration. Under this strategy, economic growth is to be promoted through expansion of non-coffee exports and through measures to stimulate investment and increase the efficiency of resource allocation. This Government proposes to give greater emphasis to expansion of economic and social infrastructure, however, with particular stress on improving transport and communications networks. Improvement in transport and communications infrastructure is expected to encourage increased inter-regional trade which, together with alleviation of the foreign exchange constraint, should further stimulate investment and economic growth. Measures to encourage industrial decentralization have been introduced to complement the actions taken to unify regional markets. 20. Rapid expansion of domestic energy resources is to be given high priority with the view to regaining self-sufficiency in energy as early as possible. Even under the most optimistic assumptions regarding development of such resources, however, Colombia will continue to rely heavily on energy imports until the mid-1980s when exports of coal and natural gas are expected to reduce the country's net energy deficit. Small scale agriculture and industry will continue to receive strong support through credit, and low income rural areas are to be helped through rural electrification, health and education programs and through expansion of feeder road projects. Innovative programs such as the integrated rural development (DRI) and nutrition projects financed by the Bank are expected to receive continued high priority. Public investment programs in education, health, water and sewerage and urban development (especially those directed at alleviating urban poverty) are to be continued as well. 21. Given the country's strong resource base and its high level of international reserves, Colombia should be able to achieve annual real GDP growth averaging about 7% during the 1979-83 period. Maintenance of this level of growth will require rapid expansion of non-coffee exports and high savings and investment rates. Public sector investment is expected to expand faster than GDP during this period because of the large proposed programs for infrastructure, social services and energy development. Financial require- ments for this higher level of investment will be substantial and public sector savings will have to be sustained at the current high levels. Given the expected decline in coffee revenue, improvements will be required in the administration and collection of non-coffee taxes, and additional tax measures  - 8 - may be required. Of equal importance is the continued upward adjustment in prices charged for the goods and services provided by the public decentralized agencies. Growth of non-coffee exports, especially of manufactured goods, will no doubt be strongly influenced by the rates of economic growth of Colombia's major trading partners, but appropriate domestic incentives will also play an important role. In this regard, it is expected that Colombia will follow an exchange rate policy designed to maintain the competitiveness of Colombian exports and that additional export promotion measures will be adopted to encourage both product and market diversification. 22. Greater efforts to increase efficiency and production in the agricul- tural and industrial sectors will also be needed to complement incentives given to non-traditional exports. Programs to meet these needs in the agricultural sector, including integrated rural development, expansion of farm credit, im- proved research and extension services, and upgraded marketing facilities, are already in place and will need to be strengthened. Further development of the country's capital markets is expected to increase private savings and im- prove the allocation of financial resources, thereby providing the basis for more rapid growth of industry. Ongoing and future infrastructure investments by the public sector should facilitate improvements in economic efficiency and lead to more rapid growth of output and employment in both industry and agriculture. 23. Projections of Colombia's energy balance indicate a rapidly growing deficit that is expected to reach significant proportions in the early 1980s in the absence of an aggressive energy development program. To avoid the con- straint on growth that large scale shortages of energy would entail, high priority is being given to the development of additional energy sources. The strategy which is being pursued is to reduce the nation's dependence on petro- leum as an energy source by developing substitutes such as hydropower, coal and natural gas. Major projects are being executed and others prepared to expand hydroelectric power generation and incentives are being given to pri- vate foreign companies for accelerated exploration and development of the country's petroleum, coal and natural gas potential. Exports of coal and natural gas are expected to offset a large portion of the petroleum imports projected for the mid to late 1980s. Conservation of existing resources resulting from higher energy prices is expected to slow the growth in energy demand. While the total investment cost of future energy development is still being determined, preliminary estimates indicate that the required investment could run as high as US$8.0 billion in current prices over the next decade. Even under the most optimistic assumption regarding foreign private investment, suppliers' credits and domestic resource mobilization, external long-term financing of about US$4.0 billion would be required in this sector alone during this period. Any significant delay in implementing the country's energy development program would most likely have serious adverse repercus- sions on future economic growth. 24. Because of the expected continued decline in world coffee prices, accelerating oil imports and the high import content of future investment projects, the current account of the balance of payments is expected to be in deficit throughout the early to mid-1980s. Increased mineral exports including coal, natural gas, and nickel, and completion of the large invest- ments in energy development are expected to relieve the pressure on the  - 9 - balance of payments by the late 1980s. Colombia is expected, therefore, to continue to be a large net importer of capital for some time to come. Its future external resource requirements reflect the need to supplement domestic savings in order to carry out the public sector investment program and to provide increasing amounts of foreign exchange to finance required imports of capital and intermediate goods. Assuming that the Colombian authorities permit a drawdown of international reserves to the equivalent of three months' imports in the years immediately ahead, gross external capital requirements are projected at US$6.3 billion between 1979 and 1983, or an annual average of about US$1,260 million. About half of Colombia's capital inflow during this period is expected to be provided by official multilateral and bilateral sources, with commercial financial credits becoming increasingly important. 25. Colombia's public external debt repayable in foreign currency amounted to US$4.2 billion at the end of 1978, of which US$2.7 billion was disbursed and outstanding. The Bank/IDA share of this external debt was 29% and is expected to rise to 31% by 1983, before declining to 29% again by 1985. Although the public debt service ratio fell during the past two years as export growth accelerated, this ratio is expected to increase from 10.3% in 1978 to about 14.7% in 1983. Balance of payments prospects beyond 1980 will depend heavily on the timely development of domestic energy sources and on progress made in executing several natural resource- based export oriented projects currently under preparation. Given the expected continuation of sound economic and financial management and timely execution of the country's energy program, it should be possible to prevent the external sector from again becoming a constraint on economic growth and to maintain Colombia's creditworthiness for the required external borrowing. PART II: BANK GROUP OPERATIONS IN COLOMBIA 26. The proposed loan, the 78th to be made to Colombia, would bring the total amount of Bank loans to Colombia to US$2,036.7 million (net of cancella- tions). Of this amount, US$1,602.6 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 46 loans and the IDA credit. IFC has made investments and underwriting commitments of US$53.66 million in 24 enterprises and now holds US$18.14 million. Annex II contains a summary statement of Bank loans and the IDA credit as of January 31, 1979, and IFC investments as of February 28, 1979. The Annex also contains summaries on the execution of the 31 on-going projects. 27. Since FY68, Bank lending in Colombia has become more diversified and has been concentrated on production-oriented programs and activities which emphasized social as well as economic benefits. Eight of the eleven agricul- tural loans have been made since then, nine of the twelve loans for industry, all three loans in the education sector, all seven loans for water supply and sewerage, one loan for a nutrition project and one loan for an urban development project. This compares with only ten loans since FY68 in the power and transport sectors.  - 10 - 28. Bank lending to Colombia in FY78 consisted of loans for nutrition improvement, water and sewerage, urban development, power generation and interconnection, development finance companies and development of an export processing zone, totalling US$354.6 million equivalent. In addition to the proposed project, the FY79 program includes the recently approved aviation development and Mesitas hydroelectric projects and proposed loans for water and sewerage, nickel mining and processing, and agricultural credit for land reform beneficiaries. Work is also under way in medium-city water supply systems, slum improvement, transportation, further mining development, power, including rural electrification, oil exploration, industry, including small scale enterprises, and small farm development for possible consideration by the Executive Directors during the next two years. 29. 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 hydropower. The Bank intends to assist the development of coal mines and petroleum, which hold potential in helping Colombia meet part of its energy requirements and in diversifying exports. 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, incomes and employment, and to strengthen and diversify exports. Closely related to these objectives would be the proposed Bank lending for transport infrastruc- ture. In this context, we are assisting the Government in preparing a rural and feeder roads project to. integrate the more backward areas of the country into the modern economy. Other loans under preparation for highways, ports and railroads are aimed at helping Colombia handle larger volumes of non- traditional exports and the imported inputs on which the modern sector of its economy relies for expansion. Finally, a relatively large number of loans are being prepared in support of the Government's efforts to help the lowest 50% of the Colombian population. The proposed projects for urban development and slum improvement, rural electrification, small farm development, credit for land reform beneficiaries and water supply and sewerage are principally designed to improve the standard of living of the poor. 30. 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 approxi- mately 50% for the 1975-77 period. 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 develop- ment and small farm development. More recently, it has moved to small project loans aimed chiefly at improving the distribution of income. AID is now phasing out its aid program in Colombia.  - 11 - PART III - THE LOW-INCOME URBAN SECTOR IN COLOMBIA Background 31. Urbanization trends in Colombia have been marked by rapid growth and by dispersal of population among an unusually large number of urban centers. About 64% of the population now lives in cities, defined as communities of at least 2,500 inhabitants. If present trends continue, this proportion could reach 86% by 1990. Moreover, only 33.5% of residents of cities with 10,000 or more people live in Bogota, a much lower figure than for the capital cities of Venezuela (56.1%), Argentina (63.7%), and Peru (84.2%). 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 3 million, Medellin 1.5 million, Cali over 1 million, Barranquilla over 700,000, Cartagena about 400,000 and Bucaramanga, Manizales and Pereira each have about 300,000. Industrial development has concentrated around the four largest cities which, together, account for over 80% of the industrial employment and output of the country. Service Levels, Income, Unemployment and Housing 32. Average living conditions in the urban centers are better than in the rural areas, largely as a result of the Government's program to expand and improve basic public services. In 1974, for example, 90% of all households with electricity were in the urban areas, as were 88% of those with piped water and 96% of those with sewerage connections. Nevertheless, one-fourth of the urban population still does not have direct access to water and two- thirds lack sewage disposal facilities. However, in the four largest cities, the situation with respect to basic services is, on average, more favorable at all income levels. 33. Unemployment and under-employment continue to be serious problems in the urban sector, although the situation has improved recently. The highest unemployment rate is among people under 25 years of age (60% of the urban unemployed in 1973) and among females. About 40% of the urban unemployed are heads of households. Unemployment is higher among those having primary education or less (23% unemployed) than for those with secondary and higher education (11% unemployed). 34. One of the disturbing aspects of urban growth in Colombia has been the significant housing deficit. A recent survey by one of Colombia's major public agencies, Instituto de Credito Territorial (ICT), found that in 69 cities surveyed, 41% or 4.5 million of the population lived in substandard housing conditions, while 13% or 1.4 million lacked title to the land. The urban poor obtain land either by takeover or fraudulent land sales ("pirate subdivisions"). Land takeover is promptly followed by community organization so as to effectively articulate demands on municipal governments. If settlers are not allowed to stay, arrangements for resettlement are often made. "Pirate subsidivisions" are those started by promoters who purchase plots and subdivide them without municipal consent because the plots lack basic  - 12 - services. The promoters disappear as soon as the land is sold. It has been estimated that more than one-half of the 1972 population of Bogota lived in "pirate subsidivisions". Since the houses are built on land to which the occupants receive no legal title, because the final deeds are not executed or cannot be registered, the improvement of the property, which often is quite valuable and represents an impressive savings effort, cannot be used as collateral to obtain credit. Causes of Urban Poverty 35. Successive governments in Colombia have concentrated their develop- ment efforts on two interrelated goals: (a) achieving self-sustaining economic growth; and (b) expanding employment opportunities. Over the last two decades considerable progress has been achieved. Between 1960 and 1976 the GNP per capita in current dollars rose from US$210 to US$640, while employment in- creased by nearly one-half in the same period. Significant advances were also made in a variety of social services, including the expansion and con- solidation of the education sector and the spread of potable water supply and health services. The decline in population growth has also contributed to an improvement in the standard of living of a large number of Colombians (see paragraphs 3-4 above). 36. Poverty has continued and in some cases increased, despite the progress achieved. The sluggish growth of agriculture and the insufficiency of non-farm employment opportunities have prevented a large segment of the population from participating in productivity and income gains. In the urban sector, poverty has been accentuated by the continuing influx of people from the countryside who cannot find employment; they often lack education or technical skills. A study carried out by the Universidad de los Andes found that in 1973 six out of every ten urban unemployed were born outside the city surveyed. The lack of urban employment opportunities has led to a large number of under-employed, who are mostly engaged as street vendors and, at best, obtain subsistence income in the informal sector. Additionally, nutritional deprivation, poor shelter, lack of safe water and deficient sanitation often result in diseases which go untreated because of inadequate health facilities. Thus, the vicious cycle of low productivity, poverty and unemployment continues regardless of increased opportunities available. Government Policies 37. Like its predecessor, the present administration is committed to programs that assist the poor and it is allocating an important share of public funds to finance them. It is continuing all the programs started under the previous administration and proposes to implement some of its own, such as providing agrarian reform beneficiaries with sufficient technical assistance and development credit. To increase productivity and incomes in rural areas and make less compelling the urge to migrate to the cities, the Government continues to carry out the National Food and Nutrition Program (PAN) and Integrated Rural Development Program (DRI), which are assisted by two Bank loans. The DRI includes the upgrading of social services with the purpose of reducing the disparities between rural and urban amenities. This  - 13 - program is being assisted by the Canadian International Development Agency (CIDA) and the Inter-American Development Bank (IDB) in addition to the Bank. The DRI is being complemented by the National Food and Nutrition Program (PAN), which seeks to reduce malnutrition among the poorest 30% of the population. The rural two-thirds of PAN beneficiaries are generally landless and therefore benefit only indirectly from DRI. 38. In the urban sector, the Government is continuing to give priority to water supply, sewerage and public health programs. At present, water supply and sewerage programs are being carried out in 15 departmental capital cities and in 37 small towns. A National Health Plan was started in 1975 and now covers almost one-half of the urban regions of the country. The Government is also promoting integration of the more backward regions into the national economy through increased and better distributed industrial credit and through development of medium- and small-scale industry. Additionally, the Government is providing telecommunications facilities in smaller towns which lack such service and in June 1977, the Bank approved a US$60 million loan for this purpose. 39. While these programs are essential, the previous administration recognized that in the short run they were unlikely to lead to a substantial betterment of the living conditions of the urban poor. It designed, therefore, the Integrated Services and Community Participation Program (IPC) - which seeks to attack the causes as well as the symptoms of urban poverty. IPC's basic philosophy is that improvements in the standard of living of the urban poor can be sustained over time only if a reasonable increase in their incomes takes place through increases in their productivity, which in turn depends upon improved nutrition, health, education and sustained employment of the members of the same household. IPC's other basic approach is the realization that the urban poor have an impressive capability for community organization, and that only by enlisting this capability can integrated urban poverty pro- grams be successful. IPC, therefore, involves the urban poor in management and coordination of multisectoral activities which constitute the basis of the program, i.e., social services, infrastructure, communal enterprise devel- opment, and credit. The present administration is supporting IPC and it is exploring ways to accelerate it (see paragraph 42 below). 40. Besides the IPC program, special lines of credit for public utilities, home improvements, and legalization of tenure together with provision of com- munity facilities and technical assistance are administered by ICT. Established in 1939 to provide construction loans for the agricultural labor force, ICT's focus was altered in 1942 to include urban housing. By 1956 the agency was concentrating solely on urban development and moderate-income housing. Although it has more experience in conventional housing programs, ICT has attempted, especially during the past five years, to address the housing problems of low-income groups through construction of "social interest" housing. Low-cost homes are built under ICT self-help and direct construction schemes. In addition, ICT has a program to assist business enterprises with worker housing programs, and another program provides for the sharing of construction costs with a private financing agency. In addition to its central office in Bogota,  - 14 - 24 regional offices are located in departments and territories throughout Colombia. The Banco Central Hipotecario (BCH), a Government mortgage bank, serves customers in the urban middle- and upper-income brackets and, like ICT, also participates in direct construction. Bank Involvement with the Urban Poor 41. The Bank has financed a growing number of projects designed to (a) raise the living standards of the lowest income segments of Colombia's urban population, (b) expand employment opportunities in urban centers and (c) strengthen those institutions which appear better suited to help achieve the above objectives. Over the last decade, the Bank has made seven loans for water supply and sewerage projects in Bogota and in 17 other medium and small cities, for a total of US$254.3 million equivalent. Two of those loans were made to the National Institute for Municipal Development (INSFOPAL). Two more are currently under consideration for INSFOPAL (proposed to cover 23 cities) and for the city of Bogota. Water supply and sewerage facilities for the city of Cartagena are included in the second and proposed third loans to INSFOPAL, in addition to those included in the project proposed in this report. Two other Bank loans, aggregating US$20.5 million equivalent, were made in FY75 and FY77 to support the lending and technical assistance programs of Corporacion Financiera Popular (CFP), the major Colombian institution involved in financing small-scale industry, and a third is currently under consideration. Bank support for the development of an Export Processing Zone (EPZ) in Cartagena resulted in the approval of a US$15 million equivalent loan late in FY78. The EPZ project is expected to have a significant impact on employment generation in the Cartagena metropolitan area and will directly and indirectly benefit the target population of the proposed project. Bank assistance for power (21 loans totalling US$610 million equivalent) and industrial development (10 loans to development finance companies totalling US$383 million equivalent) have also contributed to improve public services and increased employment among the urban poor. 42. In addition, the Bank is supporting the aforementioned IPC program (see paragraph 39 above) with a US$24.8 million equivalent loan approved in FY78. This project, designed to reach about 550,000 urban poor in 23 cities, includes the construction of community centers to improve the delivery of educational, health, child and family welfare services with increased community participation; promotion and organization of, and technical assistance and credit for, small enterprises; extension of water supply services; a credit program for home construction and improvement; and a program of land tenure regularization. The loan became effective only recently and both the complexity of the project and the wide geographical area it covers have made for a slow start. Monitoring and evaluation systems, though, are being set up to enable the Secretaria de Integracion Popular (SIP) and the Bank to follow the project's progress, evaluate its impact on intended beneficiaries and redesign this and future projects in light of the lessons learned.  - 15 - PART IV: THE PROJECT Project Background 43. The proposed project had originally been included as a component of the Bank's first urban development project (see paragraph 39 above). Because of its unique physical environment, the Cartagena component required more technical studies and, eventually, it was decided to turn it into a separate project although closely following the approach used in the first one. The project was appraised in April 1978. However, the Bank and ICT agreed subsequently upon a modified approach, (described in paragraph 48 below), which resulted in reduced investment costs and enhanced prospects of replicability. Negotiations were held in Washington during March 1979 with a Colombian delegation headed by Mr. Alfredo Solarte of the National Planning Department, which also included representatives of the Ministry of Finance and of ICT. The Staff Appraisal Report (No. 2255b-CO) of April 18, 1979, is being distributed separately to the Executive Directors. 44. The Department of Bolivar, whose largest city, capital and port is Cartagena, has experienced an acceleration in growth in recent years. However, concentrated as it is in capital-intensive manufacturing and other activities which, except for tourism, use relatively little labor, this growth has not resulted in enough jobs to absorb all the new entrants into the departmental labor force. To establish a strategy for controlling migration into Cartagena and orient the development of the Cartagena region, the Department created the North Bolivar Regional Planning and Development Council in August 1977. Assisted by UNDP, the Regional Council has begun preparation of a comprehen- sive development plan for the North Bolivar region. Although still in the formative stages, the plan is expected to include development strategies for 14 smaller towns surrounding Cartagena, so that they may become viable recep- tion centers for migrants. One such town is Pasacaballos, located next to the area where the EPZ project is being implemented (see paragraph 41 above). Consequently, improvements for Pasacaballos were drawn up in advance of specific proposals for the 13 other towns, and are included in the proposed Bank project. 45. A high-productivity, capital-intensive refining and manufacturing sector, combined with expansion of facilities to accommodate tourism, have been the main sources of Cartagena's recent growth. The current population of about 400,000 is expected to increase to about 650,000 by 1990. The labor force in manufacturing grew at about 6% a year during the 1970s and now accounts for about 35% of the employed population. However, many jobs have gone to workers from other major cities, recruited for their greater skills and experience, rather than to Cartagena residents who often end up in low- paying jobs in the informal sector or among the unemployed. This situation should improve somewhat as training and work force upgrading programs are carried out within the EPZ project and in the proposed project. For the present, however, Cartagena has taken on even more the appearance of a "city of low-income settlements." The qualitative housing deficit (i.e., the number of substandard dwelling units) has probably increased from an estimated 11,900 units in 1964 to 13,500 today. About three quarters of these units are in  - 16 - the South-East Zone of the city, where the project would be located. Although expanding relatively rapidly in recent years, the construction sector in Cartagena has concentrated primarily on luxury apartments and hotels to accommodate tourism. Accordingly, neither middle-income nor low-income housing needs have been met over the past two decades. Efforts of the Cartagena branch of ICT to serve these income ranges, however, have been gradually increasing. Over the past two years ICT/ Cartagena has completed or begun construction of about 4,000 units, including 1,350 finished houses in the US$2,500 to US$4,000 range, in locations throughout the city. A major middle-class housing and upgraded commercial center is being built in the Chambacu urban renewal area near downtown. At a site south of the city, ICT plans to build an additional 5,000 single family and multifamily units, many of which will likely be acquired by higher-level workers at the EPZ. ICT/Cartagena has also given increased attention to low-income housing and integrated community development and productivity in closer cooperation with training and social service agencies (see paragraph 40 above). Housing Conditions in the S.E. Zone and Pasacaballos 46. Over several decades about 355 ha of mud flats along the shore of the Tesca lagoon in southeastern Cartagena (see map IBRD 13509R) have been settled by squatters. Today, this area's population numbers approximately 80,000 persons, of whom, only 25% currently have access to piped water and less than 10% to sewerage. Although in money terms S.E. Zone families live quite cheaply, they nonetheless pay a high price in terms of repercussions from the unhealthy and precarious living conditions they must face. Dwellings are subject to tidal incursions and lie in the path of storm water runoff from hills immediately behind the area. Even during the dry season, domestic effluents crisscross the area and often form large pools of stagnant water. Since the average depth of the swampy area adjacent to the lagoon is no more than 20-40 cm, settlers have gradually filled lots through their own labor. Timber shacks have been erected on the small islands of fill thus formed. However, the level of the areas so consolidated remains too low for efficient runoff of surface water or for installation of utilities. This situation is aggravated by several outfalls which discharge sewage from residential districts at the edge of the lagoon, causing pollution of the flood waters. Except for a recently completed community service center in the western-most sector, existing educational, health and institutional facilities are insufficient. Compounding these difficulties is the lack of secure land title. Most residents possess, at most, a certificate of occu- pancy, with the largest group having no written evidence of tenure whatever. Conditions in Pasacaballos (see map IBRD 13509R) are not significantly better. With the imminent development of the EPZ located about half a kilometer from Pasacaballos, the need to plan for the orderly expansion of the community has become more acute. Project Concept and Objectives 47. A number of studies and proposals to overcome the problems created by illegal settlement of the S.E. Zone have been produced since then, one of which--an updated master plan for Cartagena in 1974--recommended eradication  - 17 - of the slum dwellings and relocation of residents. In 1975 it was agreed that a policy of minimal eradication would be pursued, subject to technical studies to establish the feasibility of on-site upgrading. 48. During project preparation it was agreed that some components, par- ticularly those providing levels of service beyond a basic threshold, should be designed as options to the beneficiaries. The components of the overall improvement program were consequently defined as either essential, to be carried out by an executing agency, or optional, to be done by the communities or individual households on a "contract-in" basis. In addition to land fill- ing, essential works include physical environmental improvements such as external drainage canals and utility infrastructure, which are the minimum needed to bring physical environmental conditions of the project areas up to the level which the majority of the city's neighborhoods presently enjoy. Optional features include secondary utility networks, individual connections, and loans for housing construction and improvement, which residents would be able to contract for as their finances permit, incurring charges within their means. This project design places a greater degree of responsibility upon the residents for the overall improvement levels in their neighborhoods. If perceived mostly as a result of the residents' own decisions, it is expected that the implementation of the upgrading works as well as of the subsequent social programs would stand a better chance of securing the enthusiastic community support which is viewed more and more as critical to the success of any program aimed at low-income groups. It is also believed that the residents' propensity to invest their limited savings would be enhanced if the choices are theirs. As a by-product, the smaller demands this approach imposes on limited official resources would permit a larger degree of replic- ability. 49. In Pasacaballos, on-site rehabilitation would be supplemented by integrated programs of training, technical assistance and job placement. hlow- ever, unlike the S.E. Zone where the population has been relatively stable, that of Pasacaballos is on the verge of a major increase as the EPZ begins operations. Thus, besides installation and renovation of services in cur- rently built-up sections of the community, the emphasis is on extension of services to areas of new settlement. Project Description 50. The project would consist of physical upgrading and provision of services and would support social programs to be carried out during 1978-1983 in the S.E. Zone of Cartagena and in Pasacaballos. It would consist of: (a) land filling in the S.E. Zone project area to raise the level of streets and house lots; (b) canalization of main drains to coivey external storm water from the hinterland, through the S.E. Zone project area, to the lagoon and construction of street drainage works in the S.E. Zone;  - 18 - (c) road improvements and minor drainage works in Pasacaballos; (d) installation of utility infrastructure including primary water and electricity networks in the S.E. Zone and in Pasacaballos and primary sewerage networks in the most consolidated areas of the S.E. Zone; (e) loans and technical advice from ICT/Cartagena for (i) regularization of land tenure; (ii) construction of secondary water distribution networks, water and elec- tricity connections, and neighborhood improvements; (iii) housing improvements; (iv) purchase of serviced and unserviced sites; and (v) house construction thereon; (f) cn struction of Community Development Centers (CDVs); equipping of existing and new facilities; and a training program for staff to be involved in the provision of educational, health, and family and child welfare services. Promotion and technical advice would be provided to private and cooperative small enterprises, to assist them in gain- ing access to the formal loan market through appropriate financial intermediaries; (g) project management to strengthen participating agencies; and (.1 a program of cadastral improvements, a study of municipal fiscal planning and engineering studies of water supply, flood control and sanitation in the project area and environs. 51. Filling in the S.E. Zone, which is being partially financed by a US$2.0 million grant from the Inter-American Development Bank (IDB), was begun in November of 1977 and is expected to be completed by December 1979. In the part of the S.E. Zone nearest the lagoon shoreline (known as the .r;ahiIitation area), filling would be undertaken up to a level ensuring protection of streets and house lots from flooding. At the northern edge of the filled area, near the lagon shoreline, a reserve 50 m wide for an eventual road would extend the length of the project area. Resettlement F ramilies within the S.E. Zone would involve about 730 dwellings, half or:tside of the project area itself and half to make way for street and commun- facilities. Relocated families would be given a new lot and a housing loan. Affected dwellings would represent about 7% of the existing S.E. Zone housing stock. This is the minimum resettlement believed consistent with the orderly growth of the area and is in line with the range of resettlement in other Bank financed urban projects. Except for the few properties on which the area residents already have property rights, all land in the project area would be acquired by ICT through cession from the state. Existing occupancy rights would continue to be recognized, and would be supported by a certifi- cate of occupancy that can be converted to a full title subsequently. Assurances have been obtained during loan negotiations that the Government and ICT would take all necessary steps to ensure that transfers of land to residents begin not later than January 1, 1981. (Section 3.01(a) of the draft Loan Agreement and Section 2.07, draft Project Agreement).  - 19 - 52. In order to supply the S.E. Zone project area with water, it is necessary to lay a trunk main system. Two sections of the trunk main, the first extending from near the El Bosque treatment plant northward to the S.E. Zone and the second serving the eastern S.E. Zone, would be included in the present project. A third section leading westward to storage tanks beyond the project area would be financed out of the proposed third Bank loan to INSFOPAL. For Pasacaballos, a 1 km main will link the distribution network to a trunk main being extended from Cartagena to the EPZ, with Bank financing (see paragraph 41 above). Secondary water and sewerage distribu- tion networks and house connections and electricity connections would be provided through individual ICT loans organized by community effort. Con- struction of interlot drains at the back of house lots and paving of sidewalks and pedestrian streets would also be financed under this component. Other ICT loans would be made available to meet the cost of land tenure surveys and title transfer connected with regularization of tenure, as well as for housing improvements and purchase of sites for house construction. 53. Four CDVs in the S.E. Zone and one in Pasacaballos would be con- structed and equipped to provide physical facilities in an integrated complex for the delivery of education, health, vocational training, family and child welfare, and employment and productivity promotion services. Local staff to provide these services would also be trained under a national program designed in conjunction with the first Bank urban project. The CDVs would serve as the chief coordination center of the project at the local level. Where facilities already exist, their use would be maximized before new ones are constructed. Project Execution 54. Overall responsibility for project execution, coordination and evaluation would be placed on ICT's Cartagena office where a project manage- ment unit has been established and would be maintained until project com- pletion to coordinate project implementation. The unit would consist of a Project Manager, a social programs director, and a director of monitoring and evaluation all satisfactory to the Bank. It would draw upon functional divisions of ICT/Cartagena for financial, legal, loan processing and personnel services, and would have its own expertise in technical management, contract supervision, social development, and monitoring and evaluation. (Sec. 2.01(b) of the draft Project Agreement). Each CDV will be staffed by a coordinator, two social workers, an ICT loan promoter, and a small-enterprise development promoter, in addition to suitably qualified staff in the required numbers for the education, health, family and child welfare, and vocational training facilities. Public utility mains and distribution networks would be con- tracted for, and supervised by, ICT in coordination with Empresas Publicas Municipales de Cartagena (EPMC), for water supply, storm drainage and sewer- age, and with Electrificadora de Bolivar (ELECTRIBOL) for electricity, particularly with regard to technical specifications. Upon completion of these facilities, they would be turned over by ICT to EPMC and ELECTRIBOL for operation and maintenance. ICT loans would be made to individual households or to community groups in the case of public services and neighborhood improve- ments such as the secondary water distribution networks. ICT would also  - 20 - coordinate the project-related education, health, and family-welfare activi- ties of the Ministries of Education and Health, the National Training Service (SENA), the Institute of School Construction (ICCE), and the Institute of Family Welfare (ICBF), as well as the cadastral improvements program to be carried out by Instituto Geografico "Agustin Codazzi" (IGAC). These agencies have had experience with similar programs and most are involved in the first urban development project which has comparable objectives and operating procedures. ICT would enter into agreements with the various participating ministries and agencies covering the respective obligations of ICT and the agencies concerning the project execution arrangements described above. These agreements would be on terms and conditions satisfactory to the Bank and would be conditions of loan effectiveness (Sec. 2.02, draft Project Agreement and Sec. 6.01(b), draft Loan Agreement). 55. Monitoring of the housing improvement, social services, and physical environmental upgrading components of the project would be undertaken by ICT/ Cartagena. Quarterly reports would be prepared by the monitoring staff of ICT's project unit on the basis of systematically kept records of key indi- cators of progress toward project goals. The reports would also include results from a number of evaluation studies, to be carried out in agreement with the Bank, designed to find out what changes in the economic and social well-being of area residents can be ascribed to the project. (Sec. 2.06, draft Project Agreement). Cost Estimates 56. Total project costs, including physical and price contingencies, have been estimated at US$35.3 million equivalent, of which US$9.9 million equivalent, or 28%, represent the estimated foreign exchange component. Except for four external drainage canals whose costs were estimated from contractors' bids, the costs of all other engineering work were estimated on the basis of consultants' feasibility studies and preliminary designs completed during January-February 1978, which were updated by post appraisal missions (May 1978 and January 1979) and during negotiations. The estimated amount of ICT loans was based on forecasts of effective credit demand. Physical contingencies of 15% for the land filling and the off-site water trunk main components, and of 20% on all other construction items have been allowed. A total price contingency of 42% was included to cover expected price inflation on all local and foreign cost components, except land acqui- sition. 1/ Financing Plan 57. The Bank loan proposed for this project would be for US$13.5 million equivalent, repayable in 17 years, including four years of grace, at 7.9% per annum. The proposed amount, which would cover the estimated foreign ex- change cost component and about 14% of local currency expenditures, would I/ A more detailed breakdown is provided in the Loan and Project Summary at the beginning of this Report.  - 21 - represent a Bank contribution of about 38% of presently estimated total proj- ect costs. This would be in line with the Bank's contribution to the first urban development project and would constitute an adequate recognition of the extraordinary effort the Government has been making to allocate budgetary resources to social sector projects over the last three years. A grant of US$2.0 million equivalent made by the IDB for the land filling component would complete the financing from external sources. The Colombian Government and its subdivisions and agencies would contribute the remainder of the project financing equivalent to 57% of the presently estimated project cost. Assurances on the timely provision of sufficient financing have been obtained from the Borrower (Sec. 3.01(c), draft Loan Agreement) and will be received from INSFOPAL, EPMC and ELECTRIBOL pursuant to the agreements referred to in paragraph 54 above. 58. Following substantially the pattern adopted for the first urban pro- ject, the Colombian peso equivalent of the proposed Bank loan would be made available, free of charge, to ICT and INSFOPAL, together with the national budget funds, appropriated for the project. Within the utility infrastructure component, 80% of the estimated cost of the off-site water trunk mains plus 100% of the estimated cost of the primary water and sewerage networks would be made available by the Government to INSFOPAL. INSFOPAL would, in turn, make the same funds available to ICT, free of charge, as required to construct the trunk mains and water and sewerage network. The remaining 20% of the cost of the trunk mains would be made available to ICT by EPMC from its internal resources. Upon completion, the water and sewerage network would be trans- ferred by ICT, free of charge, to EPMC for operation and maintenance. In line with the procedures adopted for the first urban project, EPMC would re- cognize a debt towards INSFOPAL equivalent to 40% of the construction costs of both the trunk mains and distribution networks, repayable in Colombian pesos over 17 years including four years of grace, at 18% per annum. The remaining 40% of the trunk mains and 60% of the distribution networks would be treated by EPMC as an equity contribution from INSFOPAL. The Government would treat 60% of the cost of electricity distribution networks as an equity con- tribution to ELECTRIBOL. The remaining 40% would be financed from ELECTRIBOL's own resources. Funds made available to ICT, out of the proposed Bank loan and the budget, for all other project components would be treated as Government contributions to ICT's equity. Assurances concerning these arrangements have been obtained from ICT (Sec. 2.02, draft Project Agreement). Procurement 59. Civil works contracts not exceeding US$750,000 equivalent would be awarded through local competitive bidding using procurement procedures accept- able to the Bank. Because of the large number of competent local contractors, most such contracts will likely be won by local bidders. Contracts for civil works estimated to cost US$750,000 equivalent or more would be awarded through international competitive bidding in accordance with Bank guidelines. In an endeavor to start work before the 1978 wet season, contracts of about US$500,000 equivalent each for the first four external drainage canals were awarded under local procedures acceptable to the Bank. Contracts for land filling awarded  - 22 - to date have gone to the lowest bidders under local procedures acceptable to the Bank. Construction of the CDVs (average cost US$500,000 equivalent) would be carried out by ICT directly or hiring and supervising small private con- tractors, as is being done in the first urban development project. Hiring would be done on the basis of local competitive bidding or local shopping in which at least three contractors are invited to bid for each contract. For the ICT loans, materials would be procured by local competitive bidding or local shopping, the ICT regional manager being authorized to award contracts directly up to a value of Col$500,000 (about US$12,500 in 1978 prices) without inviting bids. Contracts for the supply of equipment and materials estimated to cost US$150,000 equivalent or more would be awarded through international competitive bidding in accordance with Bank guidelines. Contracts under US$150,000 equivalent but not exceeding, in the aggregate, the equivalent of US$2.0 million would be awarded on the basis of local competitive bidding procedures acceptable to the Bank. For bid evaluation purposes under interna- tional competitive bidding, a margin of 15% or the value of the applicable customs duties, whichever is lower, would be allowed for materials and equip- ment manufactured in Colombia. Assurances concerning these arrangements have been obtained from ICT (Section 2.04, draft Project Agreement). Consultant services are estimated to require about 110 man-months, practically all available in Colombia, at a cost of about US$1,700 equivalent per month. Disbursements 60. The Bank would reimburse the Government 40% of expenditures incurred in land filling (net of the IDB grant referred to in paragraph 57 above), civil engineering works, public utilities, consulting services, and the first four years of project management. The Bank would also reimburse ICT 40% of the amounts disbursed by ICT under loans for regularization of land tenure, housing improvement, public services and neighborhood improvements, sites purchases and relocation; in this case, however, disbursements would be made against a certified statement of amounts lent and disbursed by ICT and the pertinent documentation would be retained by ICT for review by Bank supervision missions. The completion of land filling in each of the four sectors of the S.E. Zone would be a condition of disbursement against expendi- tures for other project works in the same sector. The Bank would finance retroactively expenditures incurred after April 22, 1978 by (i) EPMC, not in excess of US$20,000 equivalent, in the carrying out of engineering studies for the S.E. zone water trunk main; (ii) ICT, not in excess of US$60,000 equivalent, in equipping and furnishing the first CDV; and (iii) ICT, not in excess of US$1.1 million equivalent in the construction of external drainage canals (Schedule 1, paragraph 4, draft Loan Agreement). Disbursements are expected to be completed during 1984. Operations and Financial Performance of ICT 61. Between 1942 and 1969 ICT constructed 150,000 housing units. In 1971, ICT participation comprised 31.2% of the construction budget of the country, but by 1974 its relative share had declined to 10.6%. This coincided with a shifting emphasis toward lower cost housing, as well as greater partici- pation in the construction industry by commercial banks, financial institutions,  - 23 - and other private resources. As of December 31, 1977, ICT had US$360 million equivalent in total assets. Of this amount, about 29% represented paid-in capital, 57% long-term debt and 14% short-term debt. ICT has adopted an inflation indexing system which, although it has fallen short of protecting ICT's portfolio from inflationary erosion in the recent past, generates signif- icant automatic increases in annual revenues. This has been accomplished by dividing its lending system into two types of mortgage operations: (a) Variable Interest Rate Loans aimed at middle-income groups and financing housing on lots larger than 60 m . The principal of the loan is divided into two tranches: (i) the first tranche, limited to a maximum of 50% of the loan, but progressively smaller as the size of the loan increases, carries an interest rate of 7%; (ii) the second tranche carries an interest rate which increases with the rate of inflation, up to a maximum of 25%; (iii) the variable interest rate is the weighted average of the interest rates for the two tranches. (b) Fixed Interest Rate Loans, aimed at the lower income groups, carry an interest rate of 12%. These types of loans are typically used to finance land tenure, home improvements, neighborhood improvements and sites and services. An addi- tional 2% is added to cover the cost of insurance, which raises the final cost to the borrower to 14%. 1/ ICT plans to discontinue underwriting variable interest rate loans and concen- trate its activities on the lower income groups. As a means of reducing the early debt service payments on fixed interest rate loans, and to bring these loans within the means of poorer families, ICT has adopted the graduated pay- ment mortgage, wherein the amortization schedule is predicated on an annual increase of 5% per annum in the amount of the monthly payments. This results in smaller monthly payments in the earlier years and an increasing amortization in later years. Assurances have been obtained that these terms shall apply to all ICT loans to be made to the project beneficiaries (Section 2.01(c), draft Project Agreement). The initial monthly payment has been used in calculation of affordability (see paragraph 63 below), based on the premise that house- holds will be able to accommodate the annual increases as incomes and the percent of income devoted to housing rise over time. 1/ See paragraph 11 above concerning inflation trends.  - 24 - 62. ICT's operating performance has been gradually weakening over the last few years. The current ratio slipped from 1.6 in 1975 to 0.9 in 1977; a ratio of 1.2 is generally considered the minimum required for adequate short-term liquidity. ICT's decreasing profits resulted mainly from (a) high borrowing costs and decreasing spreads due to higher than anticipated local rates of inflation; and (b) the diminishing potential for interest rates cross-subsidy resulting from an increase in the proportion of fixed interest rate loans, which now account for about 50% of the total lending volume. ICT expects to incur cash operating deficits during the 1979-1982 period which would further weaken its overall financial structure and force it to depend increasingly on continuous Government grants to ensure the cash flow required to maintain its lending targets. However, ICT is considering various alter- natives to strengthen its financial position. Included in the list of possi- bilities is an increase in the funds it receives from its non-interest bearing bonds that savings banks and insurance companies are required to purchase. Assurances have been obtained that a study of the alternatives available to strengthen ICT's financial condition will be undertaken and that a program for the same purpose, which will take into account the conclusions of such study, will be prepared by January 1, 1981 (Section 4.06, draft Loan Agreement and Section 3.03, draft Project Agreement). Affordability 63. The table below demonstrates the affordability of the options offered and the income groups served. Costs are in mid-1978 prices and in- clude design, supervision and physical contingencies. Payments shown are the minimum in accordance with the graduated payment system described in paragraph 61. The sole mandatory charge--a capital development levy to cover the cost of street drainage works--of US$2.82 per month initially, is afford- able to families with incomes at the sixth percentile in the project areas. Families may then, at their option, contract for public utilities, tenure, and housing improvements in various combinations. Credits for regularization of land tenure plus interlot drains, in addition to the capital development levy, would, as one illustration, imply a monthly payment of US$4.58, afford- able at the 12th percentile. Families purchasing individual water, sewerage, and electricity connections in addition to the above items would be paying US$14.15, which is affordable to families at the 68th percentile in the project areas or at roughly the 12th percentile of the national urban income distribution. Those contributing more labor than the average of 20% assumed in calculations of capacity to pay for public services and neighborhood improvements (interlot drains, sidewalks, and secondary water and sewerage) would require smaller ICT loans and hence bear lower monthly payments.  - 25 - Cost to Households and Affordability (1978 prices) Fully Minimum Intermed Serviced Infill Plots in Plot Option Improvement./a Upgradnlb Lot /c Plot /d S&S Areas/d Services: Communal Communal Individual Communal Individual Materials Loans: No No No No No 1. Cost to purchaser (US$/ household-hh) 272 445 1,616 878 1,143 2. Total monthly payments (US$/hh) /e 2.82 4.58 14.15 9.16 11.94 3. Minimum monthly income required (US$/hh) 18.84 22.91 56.63 36.66 47.77 4. Lowest Income Percentile Reached /f 6 12 68 47 61 5. Percent of invest- ment going to poverty group 100 100 80 100 100 6. Number of house- holds expected to benefit g