Honduras - Eighth Highway Project

Document of The World Bank FILE COpy FOR OFFICIAL USE ONLY a Repirt No. P-2868-HO 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 HONDURAS FOR AN EIGHTH HIGHWAY PROJECT August 7, 1980 This document has a restricted distribution and may be used by recipients only in the performace of their official duties. Its centents may not otherwise be disclosed without World Bfk l:uthoratlom.  - HONDURAS EIGHTH HIGHWAY PROJECT CURRENCY EQUIVALENTS Currency Unit Lempira (L) US$1.00 = L 2.00 L 1 - US$0.50 L 1,000,000 - US$500,000 UNITS AND MEASURES 1 meter (m) 3.28 feet 1 kilometer (km) 2 0.62 mile 1 square kilometer (km 3 = 0.386 square mile ABBREVIATIONS CABEI - Central American Bank for Economic Integration COHDEFOR - Corporacion Hondurena de Desarrollo Forestal (Honduran Forestry Development Corporation) CONADI - Corporacion Nacional de Inversiones (National Investment Corporation) CONSUPLANE - Consejo Superior de Planificacion Economica (Economic Planning Council) DGH - Directorate General for Highways DGM - Directorate General for Maintenance of Highways and Airports DGT - Directorate General for Transport ENP - Empresa Nacional Portuaria (National Port Authority) FNH - Ferrocarril Nacional de Honduras (National Railroad of Honduras) IDB - Inter-American Development Bank IHCAFE - Instituto Hondureno del Cafe (Honduran Coffee Institute) MTPU - Mechanical Training Production Unit OECD - Organization for Economic Cooperation and Development RTPU - Road Training Production Unit SECOPT - Secretaria de Comunicaciones, Obras Publicas y Transporte (Secretariat of Communications, Public Works and Transport) USAID - US Agency for International Development FISCAL YEAR January 1 - December 31  FOR OFFICIAL USE ONLY HONDURAS EIGHTH HIGHWAY PROJECT LOAN AND PROJECT SUNMARY Borrower: Republic of Honduras Amount: US$28.0 million equivalent Terms: Twenty years, including five years of grace, at 9.25 percent interest per annum. Project Description: The project is designed to assist the Government's efforts to facilitate access to and from rural areas, to protect past investments in the highway network and to continue institutional improvements in highway administration. The project comprises (i) construction of about 350 km of feeder roads in selected agricultural valleys; (ii) improvement of about 115 km of secondary roads which serve rural areas; (iii) purchase of maintenance and workshop equipment, including spare parts; and (iv) technical assistance for maintenance management and training. The construction of feeder roads involves a cer- tain amount of risk because it is part of a larger program, also being financed by IDB and USAID, which could strain the capacity of the Directorate General of Highways (DGH) to carry out this type of work; this risk has been minimized by carefully coordinating the efforts of the three financing agencies, by assuring additional staffing for DGH, and by providing for annual reviews of DGH's entire feeder roads program. This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  - ii - Estimated Cost: US$ Millions Equivalent Local Foreign Total Construction of feeder roads 3.5 3.5 7.0 Improvement of secondary roads 3.6 5.5 9.1 Supervision of construction 0.8 0.9 1.7 Maintenance and workshop equipment and spare parts 1.1 9.9 11.0 Technical assistance and training 0.4 1.6 2.0 Baseline total 9.4 21.4 30.8 Physical contingencies 0.8 1.0 1.8 Price contingencies 2.6 5.6 8.2 Total Project Cost 12.8 28.0 40.8 1/ Financing Plan: US$ Millions Equivalent Local Foreign Total Government 12.8 - 12.8 Bank - 28.0 28.0 Total 12.8 28.0 40.8 Estimated Disbursements: US$ Millions Bank FY 1981 1982 1983 1984 1985 Annual 2.0 12.9 7.7- 3.4 2.0 Cumulative 2.0 14.9 22.6 26.0 28.0 Rate of Return: Feeder roads - For each road will at least equal 11 percent; of those roads already selected, rates of return typically exceed 20 percent; Secondary roads and Maintenance and Training Program - 47 percent. Staff Appraisal Report: Report No. 2971b-HO, dated July 18, 1980. 1/ The project is tax exempt.  INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF HONDURAS FOR AN EIGHTH HIGHWAY PROJECT 1. I submit the following Report and Recommendation on a proposed loan to the Government of Honduras for the equivalent of US$28.0 million for an Eighth Highway Project. The loan would have a term of 20 years, includ- ing 5 years of grace, with interest at 9.25 percent per annum. PART I - THE ECONOMY 1/ 2. A report entitled "Memorandum on Recent Economic Development and Prospects of Honduras" (1856-HO) was distributed to the Executive Directors on January 24, 1978. Bank missions visited Honduras during January and November 1979 to review recent economic performance. The main findings of these missions are summarized below. Country data sheets are attached as Annex I. Long-term Development Trends 3. The long-term growth rate of the Honduran economy has been exceed- ingly low. Partly because of rapid population growth, real per capita GNP grew by only one percent a year during 1950-75. While the population of Honduras was only 3.4 million in 1979 and its density is low (30 per square kilometer), it is growing at 3.3 percent a year. Both birth and death rates have begun to decline; but mortality rates have declined more rapidly and thus population growth remains high. The Government is demonstrating a growing awareness of this problem; family planning services are now available through public and private health facilities. The Ministry of Health's family planning program provided visits in 1979 to the equivalent of about 9 percent of the fertile- age women. The private Honduran Family Planning Association, an affiliate of the International Planned Parenthood Association, supports two clinics in San Pedro Sula and Tegucigalpa, with a coverage of another 3 percent of the fertile female population. External assistance to these and other smaller programs comes from the United Nations, private organizations and USAID. The Government effort, however, is still limited because of some domestic opposi- tion and a weak health infrastructure. 4. Honduras' per capita GNP in 1978, US$480, is one of the lowest in the Western Hemisphere. Honduras' poverty is also evident from a variety of indicators. Malnutrition is severe: about three quarters of pre-school children are believed to suffer from protein and caloric deficiencies. About 1/ This section is substantially unchanged from the section on the economy in the President's Report for the Petroleum Exploration Promotion Project (P-2743-HO) dated May 6, 1980.  - 2 - 67 and 43 percent of all Hondurans have diets somewhat deficient in calories and proteins, respectively. Infant mortality is estimated at 118 per thousand live births. Roughly 54 percent of the population has no access to safe piped water and about 76 percent is lacking any form of sanitary waste disposal. Furthermore, these are country averages which conceal substantial regional disparities as living conditions in the rural areas, which account for two thirds of the population, are much worse than in the cities. 5. A major reason for Honduras' poor growth performance during 1950-75 was the continued dependence of the economy on the production and export of a few agricultural commodities, especially bananas and coffee, whose prices depend on a fluctuating world market situation and whose output may be greatly influenced by weather conditions. The latter was dramatically illustrated when extensive destruction of the banana plantations by Hurricane Fifi in 1974 reduced the volume of bananas exported in 1975 to about one half the level of 1973 and contributed to a drop in per capita income of about 3 percent. A serious lack of basic infrastructure, uneven land distribution, and deficient credit, technical services, and development programs kept non- banana agricultural growth far below its potential. Furthermore, the country's sizeable forest resources were subject to wasteful exploitation/practices, widespread burning, and uncertain ownership. In addition, the mountainous topography of the country has made the expansion of the road network slow and costly. There has been progress, however, since 1960, including the establish- ment of a basic transportation network connecting the main population centers and a considerable expansion of electric power service. Government Development Efforts, 6. Since 1972, development efforts have accelerated; several measures have laid the basis for the country's improved longer-term economic prospects. A land reform program, begun in 1972, and strengthened and expanded through comprehensive legislation in 1975, aims at greatly improving land utilization as well as increasing the income and employment of the poorer peasants through the transfer of unutilized or poorly utilized land from large landowners to landless rural families. Another major policy development was the nationaliza- tion of timber rights in 1974. A new forestry law established guidelines for private sector forestry participation and created the state-owned Honduran Forestry Development Corporation (COHDEFOR). In the same year, the Government established the National Investment Corporation (CONADI), to promote and finance industrial projects. Furthermore, improvements in Government planning and cS :uting capacity resulted in a substantial increase in public fixed in- vestment from an average 4.9 percent of GDP in 1968-72 to 6.6 percent in 1974, and 10.1 percent in 1978. The Government has also made an effort to increase investment in the social and productive sectors and strengthen public finances through tax reforms and better tax administration. A 1975 tax reform made the tax on coffee exports ad valorem, with marginal rates ranging from 10 percent to 20 percent depending on coffee prices; substituted a 3 percent value added tax for the sales tax; and raised the tax rates on beer, cigarettes and liquor. Partly as a result, current Central Government receipts increased from 13.2 percent of GDP in 1970 to 15.3 percent in 1978.  -3- Recent Developments 7. During 1974-75, the Honduran economy was adversely affected by one of the worst hurricanes in its history, by the oil price rise of 1974, and by the OECD recession. GDP remained almost stagnant, severe balance of payments difficulties arose, and the country's savings capacity was seriously reduced. Honduras, however, recovered during 1976-78. A much higher level of public investment, the gradual recovery of banana production, an extraordinary increase of coffee prices (which doubled in 1976 and again in 1977), and dynamic private fixed investment (7.4 percent real increase yearly) were the major factors responsible. Real GDP grew at about 7.4 percent a year, or almost double the long-term growth rate recorded during 1950-75. The rate of inflation reached 6.4 percent a year, mostly fueled by imported inflation and domestic difficulties with basic grain crops. 8. Although merchandise exports grew 27 percent a year in dollar terms during 1976-78 as a result of higher coffee prices and the partial recovery of banana production, imports grew at a 20 percent rate and the balance of payments continued to show large current account deficits. Expansionary policies which led to the more rapid economic and investment growth had an immediate effect on imports into the small economy. Net foreign exchange reserves, however, increased as a result of greater disbursements of foreign loans, and by the end of 1978 were US$135 million, equivalent to about two months of imports of goods and non-factor services. 9. Central Government finances during 1976-78 reflected the economic performance. Current revenues increased rapidly (21 percent yearly) but current expenditures grew almost equally fast and current savings showed only a modest improvement. As a result, the large increment in capital expendi- tures was largely financed by foreign credits. The increase in Central Government current revenues between 1975 and 1978 resulted from higher income and property tax collections; almost a tripling of export and import tax revenues (including an increase of coffee taxes from US$4 million in 1975 to US$32 million in 1978); and a rapid increase in receipts from domestic taxes. Current expenditures for wages, goods and services, and transfers showed large percentage increases. Higher wage expenditures resulted from expanded employ- ment (7 percent annually) and higher nominal wages (about 9 percent annually). The Government expanded significantly operating expenditures for education, health, and defense. About 57 percent of the new Government posts created were teaching positions. Budgeted expenditures for education increased by 81 percent from 1975 to 1978; health expenditures doubled; and defense expen- ditures increased by 80 percent. 10. In 1979, the Honduran economy continued its much improved growth performance. Real GDP growth is estimated at about 6.5 percent owing mainly to larger export volumes than in 1978 and increased public expenditures. GDY, however, increased little because the terms of trade deteriorated by about 13 percent. In spite of larger export volumes of coffee (15 percent) and bananas (26 percent), lower coffee prices slowed export earnings growth and, coupled with rapidly rising import prices, resulted in a sharp decline in the terms of trade. The annual average rate of inflation accelerated to about  4 - 8.8 percent, mostly because of inoorted inflation and higher domestic prices for housing and food products, partly related to the influx of Nicaraguan refugees. Towards the end of the year, however, inflation accelerated to an annual rate of 19 percent. The current account deficit of the balance of payments increased from US$154 million in 1978 to about US$183 million in 1979 as exports of goods grew 20 percent and imports (CIF) 18 percent, fueled by higher import prices and the expansion of economic activity. While Central Government current revenues grew rapidly, they were nevertheless outpaced by current expenditures; as a result, current savings declined from 1.1 percent of GDP in 1978 to 0.5 percent of GDP in 1979. Public fixed investment is estimated at about 9.9 percent of GDP, a slight decrease with respect to 1978. Prospects and Devel opment_ograms 11. Real GDP growth, while expected to remain well above historic levels, is likely to be less than in 1977-79, and to average about 5.6 percent a year during 1980-83. The main reason for the deceleration is the expected lower export growth. Exports (in constant prices) may increase by about 7.0 percent a year, compared to 17.2 percent in 1978-79, since banana production has already recovered significantly and coffee production completed a cyclical peak in the 1979/80 harvest. Further output expansion will be slower than in the recent past. Export growth would depend mainly on lumber exports (made possible by the expansion of sawmill capacity now underway) together with increased beef and sugar production, expansion of fruit and vegetable produc- tion for export, and promotion of tourism. The prospects for export expansion within Central America have been affected by the political unrest in the region. A slower growth of the quantum of total exports coupled with higher levels of imports, partly fueled by rising public investment, will likely result in continued moderately high deficits in the current account of the balance of payments durino 1980-83. Private investment is expected to show less dynamism, as CONADI's support for large private projects may have peaked since most of its existing projects are being completed and few significant new projects have been identified. Within certain parameters dictated by the public sector's revenue and indebtedness capability, public expenditures, both current and capital-, maY be a positive factor for GDP growth. Real current expenditures are expected to increase at rates slightly above those of GDP, although some restraint is needed to insure adequate public savings. Real public investment is expected to average about 10-11 percent of GDP during 1980-83. 12. The public investment program for 1980-83 calls for large invest- ments to alleviate the most significant bottlenecks to the country's develop- ment process and expand productive activities. The program includes investments for infrastructure, particularly for power and transport; for export diversifi- cation, mainly through forestry development; for agricultural development to advance the agrarian reform program and increase rural productivity; and for health, particularly potable water. Fixed investments will be supplemented by growing credit programs for agriculture and industry. Full implementation of this program is not likely because of limitations in administrative capacity to prepare and implement Projects, particularly in the rural and social sectors. Nevertheless, the public sector's administrative capacity to prepare  - 5 - and execute projects has shown a marked improvement in the past few years. This is reflected in the doubling of the share of public investment in GDP since the early 1970's and has made it reasonable to expect that the major components of the program, some of which have been under preparation for a number of years, will be implemented in a relatively timely manner. 13. Power investments will be the largest of the proposed program, averaging about 40 percent of public fixed investment, mostly because of the large, lumpy investment required for the El Cajon hydroelectric project. This high share is justified in view of the need to provide adequate power supply to an economy expected to grow at a higher long term rate than in the past. Expenditures on imported oil and lubricants were US$113 million (13.4 percent of merchandise imports) in 1979 compared to only US$14.7 million (6.6 percent of merchandise imports) in 1970. Rising prices and the expanded domestic demand would bring about a much larger bill for imported oil in the future. Clearly Honduras has to pursue a policy to minimize the negative balance of payments impact of its dependence on foreign energy sources. The El Cajon project will contribute significantly toward this goal in the 1980's. Honduras, however, has to continue looking for other sources of energy. Through a project financed by a recently approved Bank loan (Loan 1861-HO, signed on June 23, 1980), the Government will step up efforts to promote oil exploration by private companies. The Government is also examining areas which appear to have potential for geothermal development, is studying the use of woodwaste for small steam power plants and is investigating gasohol possibilities, and, to a lesser extent, wind power and biogas prospects. 14. Forestry investments include four relatively large sawmills. Trans- port investments will also be large and include the roads for the sawmills in the Olancho region, further rural roads, the expansion of the trunk highway system and a new port for wood product exports. Agricultural investments will be focused on rural development projects for three major valleys: Aguan, Guayape and Comayagua. Health investments will be concentrated on water supply and medical facilities for Tegucigalpa, San Pedro Sula and provincial towns, as well as for expanded health services in rural areas. Special efforts are underway to train nurses and other auxiliary health personnel, which will facilitate stepped up health and family planning activities in the future. Three-fifths of educational investments are for primary schools; one-fifth is for the university; agricultural and vocational training institutions will receive 13 percent. A nutritional planning unit has been established; programs under consideration by it will provide for widened food distribution and vaccine coverage for school children and expectant mothers. 15. The Government has declared its intention to mobilize additional domestic resources needed to support prudently its ambitious development program. For this purpose, it put through a tax package which will increase revenues of the Central Government by about 1.6 percent of GDP in 1980. Other measures are expected to include a reduction of annual current expenditure growth from 22 percent in 1976-78 and 17 percent in 1979 to 14.5 percent in 1980 and the following years; higher tariffs for public enterprises, particu- larly electricity and port tariffs; and, if necessary, further reforms of the tax system. In addition, the Government has established ceilings for total  - 6 - public fixed investment (about 11 percent of GDP). To avoid excessive pressures on the balance of payments and the domestic price level, the Govern- ment is also expected to increase credit only slightly faster than nominal GDP. Interest rates have been raised to keep them in line with external market conditions and to stimulate savings deposits. Based on its development program, the Government earlier this year negotiated with the IMF a loan package totalling about US$75 million (of which US$57 million is from the Extended Fund Facility). The three-year EFF arrangement provides Fund re- sources in support of sound overall economic and financial policies during the implementation of the public investment program; the latter should strengthen substantially the balance of payments in the mid-1980s by reducing significant- ly the fuel import requirement of the economy and by generating increased ex- ports, particularly lumber and wood products. However, given the present and foreseeable poverty of the country, even with the above measures, Honduras needs external assistance in excess of the foreign exchange component of devel- opment projects suitable for international finance to enable the Government to implement its public investment program. The large size of this program, the political uncertainty now prevailing in the Central American region, and past volatility in Honduras' export receipts have led the authorities to agree with the Bank on annual reviews of the investment program and its financing pros- pects. We plan to continue monitoring closely Honduras' progress. External Financing 16. As the import needs of the economy expand, in particular the imports related to the public investment program, the current account deficit is expected to increase to about US$329 million by 1983 (about 9.7 percent of GDP) and, as a result, large capital inflows will be required. The bulk of the external financing requirements is expected to be met through public bor- rowing. Honduras will require an estimated gross capital inflow of US$1.1 billion during 1980-83, of which over US$360 million will be disbursed from commitments made through the end of 1979. 17. Honduras' public external debt repayable in foreign currency amounted to US$591.1 million at the end of 1978, US$917.9 million if undis- bursed commitments are included. In the past, Honduras has managed to keep its external debt service ratio fairly low, because foreign loans were almost all on concessionary terms. The debt service ratio at the end of 1978 was