Mexico - Railway Sector Project

Document of The World Bank FOR OFFICIAL USE ONLY ,7 /(- ->b2~- Report No. 5464b-ME STAFF APPRAI SAL REPORT MEXICO RAILWAY SECTOR PROJECT May 14, 1985 Projects Department Latin America and tne Caribbean Regional Office This document has 2 restricted distribution and may be used by recipients only in the performance of their official duties. lts contents may not otherwise be disclosed without World Bank authorization-  Currency Equivalents Currency Unit = Peso (Mex$) US$ = Mex$ 25 in December 1981 = Mex$ 55 in February 1982 = Mex$ 70 in August 1982 = MexS 120 in June 1983 = Mex$ 150 in December 1983 = Mex$ 190 in December 1984 = Mex$ 208.79 (controlled market rate); = Mex$ 226.85 (free market exchange rate) on March 31, 1985 Fiscal Year January 1 - December 31 Weights and Measures Metric: British/US Equivalent I meter (m) = 3.28 feet (ft) 1 kilometer (km) = 0.62 mile (mi) 1 kilogram (kg) = 2.20 pounds (lb) I metric ton (m tort) = 2,205 pounds 1 liter = 0.26 gallon (gal) Abbreviations BAhNOBRAS National Bank for Public Works and Services CIF Cost, Insuirance, Freight CN Constructora Nacional CONASUPO National Marketing Organization for Basic Foods CTC Centralized Traffic Control DGP Directorate General for Planning DGT Directorate General for Tariffs DGVF Directorate General for Rail Infrastructure ERR Economic RaLe of Return FUS Ferrocarriles Unidos del Sureste ICB International Competitive Bidding IVA Value Added Taxes LTVC Long-Term Variable Costs N de M Ferrocarriles Nacionales de Mexico, National Railways of Mexico NAFINSA National Financiera, S.A. OCS Operational Control System PEMEX Mexican Petroleum Monopoly SCT Secretariat of Commumnications and Transport SHCP Secretariat of Finance and Public Credit SPP Secretariat of Programing and Budgeting STVC Short-Term Variable Costs  FOR OFFICIAL USE ONLY STAFF APPRAISAL REPORT MEXICO RAILWAY SECTOR PROJECT TABLE OF CONTENTS Page No. I. PROJECT SUMMARY ............................................... 1 II. THE TRANSPORT SECTOR . ............................................ 4 A. Transport Development and the Economy .... 4 B. Institutional Framework and Planning ...... .................. 5 C. Major Sector Issues ...................................6 D. Past Bank Participation and Experience .................... 7 E. Bank Lending Strategy ................................... 8 III. THE RAILWAY SUBSECTOR.. 8 A. Organization of the Railways ... 8 B. Management, Staffing and Training . . . 9 C. Achievements in the Railway Subsector . . .10 D. Areas of Concern in the Subsector . . . 11 IV. THE RAILWAY ACTION PLAN AND THE PROJECT ....... .................. 16 A. The Project Concept and Objectives .......................... 16 B. Investment Program 1985-1988 ................................ 17 C. Bank Participation and the Financing Plan ........ ........... 19 D. Plan of Action ............................................... 21 E. Financial Forecasts ......................................... 24 F. Economic Evaluation ......................................... 25 G. Procurement, Disbursements and Auditing ... . 26 H. Assessment of Risk .......................................... 28 V. AGREEMENTS REACHED AND RECOMNENDATION ..................... ....... 28 This report is based on the findings of an appraisal mission which visited Mexico in October 1984 and a post-appraisal mission in February 1985. The appraisal mission comprised Messrs. J. Gutman (economist), M. Lal (railway engineer), Z. Raanan (financial analyst), F. Chapman (consultant financial analyst), J. Kesson (consultant engineer) and (Ms.) M. Pokorny (consultant economist). The report has been edited by Miss V. Foster. | This document has a restricted distribution and may be used by recipients only in the performance Of 1 their official duties. Its contents may not otherwise be discosed without World Bank authorization.  TABLES 2.1 Transport Investment ............................................ 31 2.2 Bank Lending to the Transport Sector ............................ 32 3.1 Manpower Requi-rements ........................................ 33 3.2 N de M Operating Statistics ...................................... 34 3.3 N de M Freight Traffic 1970-1984 ..................... .......... 36 3.4 Railway Tariff and.Price Indices 1980-1984 ...... ................ 37 3.5 N de M Freight Traffic Forecast .................................. 38 3.6 Major Freight Commodities - Comparison Revenues/ Variable Cost 1984 ......................................... 39 3.7 N de M Current Motive Power and Rolling Stock Data ..... ......... 40 3.8 Accident Data Summ.ary 1980-1983 .................................. 41 3.9 N de M Passenger Traffic 1970-1988 ........... ................... 42 4.1 Railway Investment . ........................................ 43 4.2 Rail Investment Program 1985-1988 ............ ................... 44 4.3 Detailed N de M Investment Program 1985-1988 ...... .............. 45 4.4 N de M Track Rehabilitation Program 1985 ....... ................. 46 4.5 N de M Track Machinery Proposals 1985 ........ ................... 47 4.6 N de M Locomotive Reiuirements 1985-1988 ....... ................. 48 4.7 N de M Freight Car Requirements 1985 ......... ................... 49 4.8 N de M Freight Car Sumary Requirements 1985-1988 ..... .......... 50 4.9 SCT Detailed Rail Investment Program ......... ................... 51 4.10 SCT Program for Track Machinery ................................ 53 4.11 Summary of I2chnical Assistance and Training Requirements ....... 54 4.12 Summary of the Economic Evaluation of 1985 Commitments .55 4.13 Estimated Schedule of Disbursements .56 ATNEXES 1. Major Sectoral Issues ........................................... 57 2. N de M Financial Status and Forecast Details .................... 62 3. Basis of Freight Traffic Forecasts .............................. 76 4. N de M Investment Program 1985-1988 ............................. 81 5. SCT Investment Program 1985-1988 ................................ 89 6. Passenger Service Strategy ...................................... 96 7. Economic Evaluation Guidelines for the N de M Investment Program and Results of 1985 Evaluation . 100 8. Economic Evaluation Guidelines for the SCT Investment Program and Results of 1985 Evauluation ................. 109 9. Project Implementation .......................................... 115 10. Selected Documents and Data Available in the Project File ....... 118 CHARTS Chart 1 - Organization of SCT . 120 Chart 2 - Organization of N de M . 121 MAPS IBRD 11844R1 - National Railroads - Rail Traffic Flow 1983 IBRD 18768 - N de M Track Works 1985 IBRD 18767 - SCT Infrastructure Works  MEXICO RAILWAY SECTOR PROJECT I. PROJECT SUMMARY Borrower: Banco Nacional de Obras y Servicios Publicos, S.A. (BANOBRAS) Guarantor: United Mexican States Project Executing Agency: Secretaria de Comunicaciones y Transportes (SCT) Ferrocarriles Nacionales de Mexico (N de M) Amount: US$300 million Terms: Repayment in 15 years, including three years of grace, at the standard variable interest rate. Relending Terms: BANOBRAS would relend the proceeds of the loan to N de M and the Government (in the case of SCT) in US dollars oTI the same terms and conditions as the Bank loan. N de M and the Government would assume the foreign exchange risk for their respective shares of the proposed loan. Project Description: The proposed project provides for investment and operational and financial improvements to the Mexican railway system during the period 1985-1988. Investment items supported by the loan cover both the SCT and N de M investment programs for the period and include (i) acquisition of rails, track machinery, workshop equipment, locomotive spare parts and freight wagon and passenger coach components; (ii) major construction and realignment of rail lines; (iii) consultant services; and (iv) training equipment and scholarships. The project will help to accomplish the following objectives: (i) improve railway capacity; (ii) continue improvements in railway operating efficiency; (iii) promote financial self-sufficiency; (iv) strengthen commercial practices; and (v) upgrade rail infrastructure planning methods. Beneficiaries: The railways are the principal transport mode for the movement of important bulk items which are crucial to the Mexican economy, such as grain, fertilizer, coal, iron ore and cement. The incidence of transport costs in the final costs of these products is significant, and, thus, an efficient rail operation should benefit the economy as a whole and help to support the economic recovery. Last, the economy as a whole sho.ld nenefit from the reduced railway burden on the public sector deficit if operational and financial targets are met.  Risks: The project faces three risks: (i) rail traffic projections are subject to substantial uncertainty as experienced in railway projects all over the world. Appropriate measures calling for an annual updating of traffic forecasts and investment requirements have been incorporated, and financial projections have been based on more conservative estimates of traffic to ensure an improved financial position for N de M despite a possible traffic shortfall; (ii) Government counterpart funds may be further restricted during project implementation, but the proposed sector loan format - allowing for flexibility in investment priorities - and the agreed minimum outlays for maintenance-related activities - would minimize the impact of budget cuts; (iii) it may become difficult for the Government to continue acting on its policy of reducing subsidies and raising prices to reflect the cost of services in the face of potential political resistance. The Government, up to now, has shown a serious commitment to its stated pricing policies, particularly in the transport sector. Estimated Cost: Tne total cost of the SCT and N de M rail investment program for 1985-1988 is estimated at US$2.35 billion equivalent with a foreign exchange component of US$849 million equivalent. The Bank loan represents 13% of the total program and 35% of the foreign exchange requirements.  - 3 - Railway Investment Program 1985-1988 (US$ millions equivalent) Local Foreign Total N de M Investment Civil Works 197.1 - 197.1 Rails - 71.5 71.5 Equipment/Machinery 77.5 155.8 233.3 Locomotives/Wagons 372.9 173.2 546.1 Passenger Coaches 94.4 14.O 108.4 Administration/Technical Support 37.1 2.0 39.1 Subtotal 779.0 416.5 1,195.5 SCT Investment Civil Works 490.8 260.7 751.5 Rails - 79.9 79.9 Equipment - 9.8 9.8 Administration/Technical Support 73.8 1.4 75.2 Subtotal 564.6 351.8 916.4 Total Baseline Costs 1,343.6 768.3 2,111.9 Price Contingencies 161.6 80.9 242.5 TOTAL COSTS 1,505.2 849.2 2,354.4 Financing Sources IBRD (1929-ME) - 44.5 44.5 IBRD (Sector Project) 300.0 300.0 Supplier Credits and Commercial Banks - 273.9 273.9 Gevernment 1,505.2 230.8 1,736.0 TOTAL 1,505.2 849.2 2,354.4 Bank Fiscal Year Estimated Disbursements 1986 1987 1988 1989 1990 1991 1992 Annual . 20.0 49.0 81.0 66.0 42.0 24.0 18.0 Cunulative 20.0 69.0 150.0 216.0 258.0 282.0 300.0 Rate of Return: Items to be financed under the proposed loan should be appraised according to agreed technical and economic criteria and would have a m ,mum estimated rate of return of 12%. A detailed evalua__on of the major investment commitments in 1985 found that the SCT works have estimated rates of return ranging from 16% to 56% and the N de M works and goods have estimated rates of return of from 18% to 74%.  - 4 - II. THE TRANSPORT SECTOR A. Transport Development and the Economy i/ 2.01 Mexico has developed an extensive transport network which comprises over 200,000 km of roads (including 67,000 km of paved and over 80,000 km of rural roads, with the rest being state and local unpaved roads); about 20,000 km of railways (all except 300 km being standard gauge); some 33 ports, of which 13 serve international traffic; about 50 airports capable of handling medium or larger size aircraft; and over 20,000 km of pipelines for crude oil, refined products and gas. For the 10 years prior to 1982, traffic on the nation's roads grew by 10% annually, with road traffic representing an estimated 48% of total traffic in ton-km and over 90% in passenger-km. Railway freight traffic, representing about 14% of total ton-km, experienced a growth of 7% annually in that period. Even more significant growth rates were registered by coastal shipping and pipelines because of increased oil production, resultinz in estimated shares of 15% and 21% respectively. After only limited groiwth prior to 1977, the ports registered average annual increases of almost 17% in cargo tons handled after 1977. In passenger transport, domestic aviation traffic increased by over 17% annually, with total passenger-km generally equal to that of the railways. 2.02 During the 1960s and early 1970s, substantial amounts were invested in transport - particularly roads, railways and aviation - with the transport sector receiving about 20% of all public investment. With the trunk network generally in place, emphasis shifted to operatlonal improvements and pricing and using transport investment to foster the development of outlying areas, especially through the extensive rural roads construction program of the mid-1970s. Transport investment declined to 9% of all public investment. This investment policy, however, proved to be untenable with the surge of economic activity in the late 1970s, which was accompanied by accelerated growth in traffic in all modes. Between 1978 and 1981, serious port and rail bottlenecks emerged, clearly affecting the operation of basic industries and the conduct of international trade. Consequently, in 1977, the Government launched an important industrial ports development program and a major track improvement and modernization plan for the railways. While highways' share of transport sector investments declined from 68% in 1977 to 44% in 1984, railways' share grew from 39% to 42% (Table 2.1). Although there were instances of premature investment and some works suffered from poor programing, the overall response of the Government to the situation in those years was appropriate. 1/ The transport sector and, in particular, the highways and ports subsectors have been treated in more detail in recent Staff Appraisal Reports for Loans 2428-ME and 2450-ME, both issued in late FY84. Thus, the discussion of the sector is presented in summary form in this report.  - 5 - 2.03 With the onset of severe budgetary restrictions from 1982 to the present, transport investment priorities have shifted again. Transport investment levels, excluding urban transport, were reduced in 1984, in real terms, to about US$1.2 billion (roughly equivalent to average 1979-1980 levels), focusing on maintenance, reconstruction of existing infrastructure, and completion of high priority ongoing works, while deFerring major new investments. Given the lull in transport demand caused by the recession, this strategy has been satisfactory for the time being. Rail traffic declined 12% in 1982; highway traffic, while increasing in 1982, dropped by 10 to 15% in 1983, and several industries, which experienced transport bottlenecks in the recent past, do not anticipate difficulties in the near future. 2.04 Projected 1985 transport investment levels stili reflect the continued restrictive economic situation of the past three years, and no substantive increases are planned for the sector. As the economy and traffic begin to recover, however, and many of the major investments initiated before 1982 approach completion, the Government is contemplating new investments in highways, railways, airports and ports to meet the expected demand. Among the investments are priority toll road widenings, new rail lines to and along the Gulf Coast, new railway yards, expanded capacitv for Mexico City airport, commercial port improvements, and the completion of the industrial port of Altamira. It remains to be seen whether the economic recovery will be sufficient and rapid enough to warrant some of these investments. The Bank sectoral lending program is designed to assist the Government in analyzing medium- and long-term investments needs through a series of projects in highways (Loan 2428-ME, FY84), ports (Loan 2450-ME, FY84) and the Railway Sector Project, the subject of this appraisal report. 2.05 The economic situation has also directed the Government's attention to pricing and taxation issues which have been of concern to the Bank under previous projects. In particular, the Government has acted to raise fuel prices toward international levels; railway tariffs lhave been increased and costs reduced in real terms, improving the railways' financial position; and road user tax:es have been increased on the toll road net-,ork. Further efforts, however, are still required (para 2.08). B. Institutional Framework and Planning 2.06 Based on the institutional reforms of the current Administration, all transport agencies are incorporated under the Secretariat for Communications and Transport (SCT) (Chart 1). A Subsecretariat For Infrastructure in SCT handles infrastructure development for almost all transport, and a Subsecretariat for Operations has responsibility for operational, regulatory and tariff matters. A Directorate General for Planning (DCP), which reports directly to the Secretary, is in charge of overall planning and budget preparation. Planning units within the various modal directorates are responsible for identifying and proposing capital investments and provide the technical details required for the analysis of such investments. DGP, in turn, has responsibility for carrying out the economic feasibility analysis and providing a multimodal consistent analytic framework for the preparation of the medium- and long-term investment programs. With the recent institutional reorganization of the sector, SCT is upgrading its planning procedures and criteria, and the Bank is providing  - 6 - assistance to this effort under various ongoing transport loans. In addition to SCT, the Secretariat for Programing and Budgeting (SPP) plays an important role in ensuring consistent modal planning. The Directorate for Public Infrastructure of SPP must approve the proposed SCT investment and operating budgets and conducts a serious review of all major investments in the sector. Although small, this unit has proven effective and capable during the first years of this Administration. 2.07 To carry out the Government's comprehensive regulation of prices and operations of the sector, SCT and the Secretariat of Finance (SHCP) share responsibilities. SCT, through its Directorate General for Tariffs (DGT), makes the final decision with regard to the pricing of transport services provided by private operators such as trucking companies and private port operating firms. For the quasi-public enterprises such as the railways and public port operating entities, DGT reviews and makes recommendations to the Pricing Unit of SHCP for final decisions. Other types of regulation of transport services are carried out by various directorates in SCT under the Subsecretary of Operations. Although the Bank has expressed concern in the past over the extensive regulation of transport (including entry, capacity, route, product and tariff regulation), a recent Bank review of the road transport industry did not reveal any apparent major distortions and concluded that, in general, the industry was performing well under the existing regulatory structure. The review did find that the data base used by SCT for regulatory decisions was insufficient for the timely identification of potential transport problems which could require regulatory change. The Government is now considering the Bank's recommendations and possible technical assistance under the Second Highway Sector Project to upgrade the data base. C. Major Sector Issues 2.08 The major issues in the sector are listed below, and a more detailed discussion of the issues and the actions being taken is orovided in Annex 1: (a) Scope and timing of transport investments. While presently maintaining a holding strategy on transport investments, the Government must face major decisions concerning deferred large, new transport investments. Planning has been complicated by the uncertainty of the timing, scope and composition of the economic recovery. Bank lending has been designed to help determine long-term investment needs, e.g., analytical procedures and criteria for evaluating investments have been developed and agreed to under the Second Highway Project (Loan 2428-ME) and under the proposed Railway Sector Project; (b) Diesel prices. The Government has raised gasoline prices by 247Th, in real terms, from 1981 to 1985 and diesel prices by 367%. Diesel prices are now about 77% of international levels (Caribbean FOB price). The Government continues to move progressively toward international levels and, in January 1985, established an automatic monthly increase for diesel prices of 2.5% for the rest of the year;  (c) Road user charges for heavy vehicles. It is apparent that heavy vehicles are not paying sufficiently for the costs they impose upon the network. SCT is carrying nuIt the needed studies with financing under Loan 2428-ME, and appropriate consultation clauses on this issue have been agree-d to under that loan; (d) Railway financial situiation. The railways have made substantial progress in improving their financial situation and have complied withl financial tairgets under thie Fourth Railway Project (1929-ME); further measures, however, will be requtired to make the railway a financially viable ent-itv as proposed tinder this Sector Project (Paras 3.144-3.15); (e) IPort charsges. Present port rhlarges do not adequately relate to costs and d(i not re-rover port infrastructure Investment costs. Stud ies have heetn iLitlated withi Bank support tinder Loan 2450-ME; and (f) Rtiral roads nia-intenance. B'dgid.letarv levels for maintenance of the rural roads nitwotrk h.-vo beeni ra ised sigrit iicantly since 19892, htit are stiIlI abtiut (1'2. nI estimadLt re-pit red levels to meet periodic and ron tine i-ia in tenant c' need! ds. A timetabhle f)r budgetary Inc rea-ses was agreced tipon Villdvr the S.-c in I Highwa v S.ctor Project and thte Chi apas Rural ;Rods -Proj-r-t. 1). Past Bank Partici latinn ind Expvritynce 2.09 The Bank lias had an -xti enciv.- i;v:oilvtment inI the Mexi can transp.rt sector (TabT]e 2.2). Nine highiwi': I;nn:; haiv- be-n math', focusing cipon the trunk network, the tiir't in !'-P anA the ninth (a Second Highway Sector Projert - Loan 2428-ME) in 14H84. Th. r. i-; been ft:- ralwav loans; , w1ith the Fourth R.aiiwa v Pro.le-, l0 .1Ti H 9-Mi';) ilI V'Xerltion, In adcidition, thesre hiave been three prrt iic'an--, rl 2lii nI g pnrt pre-paratiintl 1 nan in 1481 (Loan 19164-ME) fotr tie inidi'iisf r; 1:1 p1orts pro jret and tlit. recently approved I,azaro) Cairdetnas I dltius t r i l ' 1,r. t ro, ert ( I.Cn '245(i-ME). For atir traIlisport, cin airporr loan C(I;in wit: 2<I.) W:O