Document of The World Bank FOR OMCIAL USE ONLY Report No. P-4023-ME REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN IN AN AMOUNT EQUIVALENT TO US$ 90.0 MILLION TO NACIONAL FINANCIERA, S.A. WITH THE GUARANTEE OF UNITED MEXICAN STATES FOR A CHIAPAS AGRICnLTURAL DEVELOPMENT PROJECT March 29, 1985 This document bas a restricted distribution and -y be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed witbout World Bank muthorization. Currency Unit - Peso (Mex $) On March 31, 1985, the exchange rate in the controlled market was US$1 = Mex$208.79; the freemarket exchange rate stood at USS1 = MexS226.85. Both exchange rates are currently sliding at a rate of Mex$0.21 per day against the US dollar. Fiscal Year January 1 to December 31 WEIGHTS AND MEASURES I hectare (ha) = 10,000 m2 = 2.47 acres 1 kilometer (km) = 0.62 miles I square kilometer (km2) = 0.39 sq.miles = 100 ha 1 kilogram (kg) = 2.2 pounds I liter (1) = 0.26 gallons 1,000 kg = 1 metric ton (t) = 0.98 long ton ABBREVIATIONS ACF - Average Cost of Funds BANRUR4dL - National Rural Credit Bank CECADE - Economic Development Training Center (SPP) CONAFRUT - National Fruit Commission CONASUPO - National Marketing Organization for Basic Foods CUD - Federal/State Coordinating Agreements COPLADE - State Planning and Development Committee EFF - Extended Fund Facility FIRA - Agricultura! Trust Fund FICART - Trust Fund for Credit in Rainfed Districts FIDEC - Agricultural Marketing Fund [CB - International Competitive Bidding IVA - Value Added Tax IFAD - International Fund for Agricultural Development LCB - Local Competitive Bidding LIBOR - London Inter-Bank Offer Rate NAFINSA - Nacional Financiera, S.A. NDP - National Development Plan O&M - Operation and Maintenance PDR - Regional Development Program PIDER - Integrated Rural Development Program PLANAT - Rainfed Agriculture Development Program PRODERITH - Program for Development of the Humid Tropics SAM - Mexican Food Program SAP - Special Action Program SPA - Secretariat of Agrarian Reform SARH - Secretariat of Agriculture and Water Resources SCT - Secretariat of Communication and Transport SEDUE - Secretariat of Urban Development and Ecology SHCP - Secretariat of Finance and Public Credit SPP - Secretariat of Programming and Budgeting FOR OMCIAL USE ONLY MEXICO CHIAPAS AGRICULTURAL DEVELOPMENT PROJECT Loan and Project Summary Borrower: Nacional Financiera, S.A. (NAFINSA) Guarantor: United Mexican States Beneficiary: Secretariat of Agriculture and Water Resources (SARH) Amount: US$90 million equivalent. Terms: Fifteen years, including three years grace, at the standard variable interest rate. Project Objectives and Description: The proposed loan is one of two being presented simulta- neously (agriculture and rural roads development) as part of the Bank's participation in an integrated development program for the State of Chiapas, in the Southeast of Mexico. The Chiapas Development Plan is designed to address the main constraints to the development of the State - namely, a depressed social environment, under- utilized agricultural resources and lack of adequate communications - through an integrated approach placed in the context of a wider development scheme for the south- eastern region of Mexico. At the core of this program are the investments required to achieve a more balanced socio- economic development in the areas of influence of the proposed parallel agriculture and rural roads projects. The proposed project would support the initial phase of this program through execution of an agricultural develop- ment program in coordination with other social and economic development efforts. It aims at bringing new land into rainfed crop production and intensifying crop and livestock production on existing land, increasing agricultural production and productivity, and generating rural employ- ment and income. The project would cover an area of about 317,500 ha. To achieve these objectives the project would provide for: (a) construction of flood control and road works; (b) strengthening of administration; (c) carrying out on-farm development works; (d) provision of soil conservation structures; (e) strengthening of production support services; and (f) preparation of studies. This document has a rstrited distribution and may be used by recipients only in the performance of their ofTicial dutics Its contents may not otherwise be disclosed without World Bank authoration. - ii - Beneficiaries: The project would largely focus on "ejidos" and smallhold- ers, directly benefit ing about 32,000 rural families and providing full-time employment for about 15,000 people. In addition, it would benefit most of the urban families in the area of influence of the flood control and service road works. Project Risks: The project faces three possible risks. The first flows from the fact that the institutional framework for coordination of Federal and State level planning and implementation activities is new and largely untested in practice. This institutional risk may also have implica- tions for the provi3ion of adequate and timely counterpart funding. To address this problem, the Government is taking steps to improve the institutional and budgetary capabili- ties of the executing agencies involved. The second and third risks could be the beneficiaries' failure to adopt high-yield technologies and to switch to intensified crop production. Both would be minimized by strengthening the extension, research and promotion services, and providing drainage and river control infrastructure improvements. The project's major target group--small farmers-are expected to respond positively to incentives under the prcject. Therefore, adequate safeguards are provided against the three major risks of the proposed project. Estimated Costs: Local Foreign Total ----(USS millions)-- I. Investment Program Civil Works Construction 35.5 21.8 57.3 On-Farm Development 8.8 5.4 14.2 Machinery, Vehicles, Equipment 2.1 5.3 7.4 Technical Services 11.8 2.2 14.0 Supporting Services 32.5 5.8 38.3 II. Project Base Cost 90.7 40.5 131.2 III. Physical Contingencies 7.7 5.0 12.7 IV. Price Contingencies 26.3 11.4 37.7 Total Project Cost 1/ 124.7 56.9 181.6 1/ Net of taxes. - iii - Financing Plan: Local Foreign Total ----(US$ millions)----- Government: 89.8 - 89.8 Bank 33.1 56.9 90.0 Beneficiaries 1.8 - 1.8 Total 124.7 56.9 181.6 Estimated Bank FY Disbursements: 1986 1987 1988 1989 1990 191 1992 1993 - ~ - - - US$ millions ---- - Annual 7.5 10.5 14.0 14.0 15.0 16.0 8.5 4.5 Cumulative 7.5 18.0 32.0 46.0 61.0 77.0 85.5 90.0 Economic Rate of Return: 19% Staff Appraisal Report: Report No. 5167b-ME, dated March 25, 1985. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO NACIONAL FINANCIERA, S.A. WITH THE GUARANTEE OF UNITED MEXICAN STATES FOR A CHIAPAS AGRICULTURAL DEVELOPMENT PROJECTI/ 1. I submit the following report and recommendation on a proposed loan to Nacional Financiera, S.A., (NAFINSA) with the Guarantee of United Mexican States for the equivalent of US$90 million to help finance a Chiapas Agricultural Development Project to be carried out by the Secretariat of Agriculture and Hydraulic Resouces (SARH). This project is associated with a Chiapas Rural Roads Project and together they form the Bank's support for the initial phase of the Chiapas Development Plan. The proposed loan would be repaid over 15 years, including 3 years of grace, at the standard variable interest rate. PART I - THE ECONOMY 2. An economic report on Mexico (Mexico: Recent Economic Developments and Prospects, No. 4996-ME) was distributed to the Executive Directors on May 14, 1984. The report's main conclusions and recent economic developments are summarized below. 3. Following an import-substitution growth strategy, Mexico experienced some two decades of high and stable growth after the early 1950s. By the late 1960s, however, Mexico had largely exhausted the -easy" and efficient possibil- ities for import substitution, and faced a choice between outward-oriented growth or continued inward-directed growth led by expansion of public sector expenditures and rising subsidies and protection of inefficient domestic production. By 1972 the choice was made to pursue the latter course. Public sector expenditures as a percent of GDP more than doubled between 1970 and 1982, from 18.8% to 42.5% (Report No. 4996-ME, p. 114). By 1976 Mexico experienced a serious financial and economic crisis, followed by an even more serious one six years later. The discovery of large oil reserves in the mid-1970s led Mexico to a quick economic recovery, but it also removed the urgency of policy reforms. Primary among these was the need to reduce protection and the anti-export bias of the trade regime to thereby move over time toward greater efficiency and international competitiveness. Oil revenues also temporarily helped finance the public sector deficit and reduced the need for greater fiscal restraint. 1/ Parts I, II and III of this Report are identical to the corresponding sections of the President's Report for the Chiapas Rural Roads Project (Report No. P-4022-ME) being distributed at the same time as this report. -2- Developments during 1977-1982 4. The stabilization measures initiated in 1977 and the discovery and exploitation of large oil resources in the mid-1970s allowed the Lopez Portillo Administration (Jan. 1977 - Dec. 1982) to overcome the serious financial crisis of 1976 and to start working on structural, social and economic problems, including poverty, income and wealth inequality, unemployment, regional imbalances and relatively slow agricultural growth. In the early years of that Administration (1978-80) GDP growth was high (8.5% a year), 2.5 million jobs were created, domestic consumption recovered, and the share of investment and savings in GDP surpassed historical levels, but the economy became increasingly overheated. 5. Rapidly rising public expenditures unmatched by revenues led to increasing public deficits. While inflation rose, no significant pressure was felt to adjust the exchange rate, thanks to the oil earnings and the relative ease of obtaining foreign finance. By mid-1981, the economic situation began to mirror the scene prevailing before the 1976 financial crisis. The current account deficit of the balance of payments reached 5.2% of GDP, while the deteriorating international oil market conditions caused large revenue shortfalls with respect to budget expectations. The public sector deficit rose to just under 15% of GDP. Non-oil exports dropped, and the trade deficit reached record levels. External borrowing was used to finance part of the domestic fiscal deficit and to defend the exchange rate. Mexico's foreign debt increased rapidly, at a time of high and rising international interest rates. A stabilization program initiated by the Government in mid-1981 was not Sufficient to redress the growing fiscal imbalance, the high cost of foreign loans and the increasing private capital flight fueled by the public's anxiety over Mexico's financial troubles. 6. The crisis came to a head in 1982. In February, as capital flight intensified, the Bank of Mexico had to stop supporting the peso, which then experienced a 40% devaluation in dollar terms. A large wage adjustment granted in March 1982, which tended to undo the effects of the devaluation, and continuing slack in the oil market kept the balance of payments under strain. Under the circumstances, the international banking community became reluctant to commit new funds to Mexico, in the amounts required. These factors led to a second devaluation of 35% in August 1982, while the acute shortage of foreign exchange forced the Government to suspend the amortization payments of most of Mexico's external public debt pending a broader agreement on its refinancing. Capital flight continued as private sector confidence was shaken by the nationalization of the banks in September 1982, and the mandatory conversion of US dollar deposits into pesos. Also put into effect were a generalized system of exchange controls and quantitative trade restrictions covering an unprecedented 100% of imports. Recent Developments 7. The Administration of President de la Madrid, that began its term in December 1982, lost no time in taking steps to recover domestic and external - 3 - confidence, and stabilize the public sector and external finances. The Government's stabilization program supported by an EFF agreement, approved by the IMF in December 1982, laid the basis for restoring economic stability and for the re-negotiation of that part of Mexico's public external debt on which amortization payments had been discontinued in August 1982. Commercial banks agreed to restructure some US$19 billion of public sector debt and provide US$5 billion in net new loans for 1983. All obligations falling due between August 23, 1982 and December 31, 1984 were restructured over an eight year period, starting from January 1983, with a grace period of four years and at an interest rate of 1-7/8 percentage points over LIBOR (or 1-3/4 over the New York prime rate). The US$5 billion syndication had a 6-year maturity, with a 3-year grace period, at a spread of 2-1/4 over LIBOR (2-1/8 over prime). The restructuring exercise included an understanding that the international banks would maintain their exposure to the Mexican banks that had been nationalized. At the same time, it provided a mechanism that would eliminate 1982 private sector interest arrears and facilitate payment of the rescheduled principal on such debt. 8. A new two-tier exchange rate system was introduced, with a controlled market for imports, most proceeds from merchandise exports (except those of in-bond industries) and debt related transactions, and a free market for all other transactions including those relating to tourism. The controlled rate was originally set at MexS95 = US$1, a depreciation of some 35% in relation to the previously prevailing ordinary rate of Mex$70 per US dollar. It depreciated at a rate of 13 centavos a day until December 1984, when the daily slide was raised to 17 centavos. The free market rate had remained at about Mex$150 per dollar until September 1983, when the authorities decided to let it slide as much as the controlled rate. The differential between the two rates, which in December 1982 stood close to 60%, is now down to less than 10%. Over the past two years, the peso has gradually appreciated in real terms as inflation in Mexico remained high. The Government increased the rate of slide of the peso from 13 centavos a day to 17 centavos in December 1984 and to 21 centavos early March 1985, in order to bring it closer to the expected inflation differential between Mexico and its trading partners. Domestic deposit interest rates were also raised in early March 1985 from an average of about 45% to nearly 50%. 9. Under the IMF Agreement, the Administration committed itself to a drastic reduction of the public sector deficit, from 18.0% of GDP in 1982 to 8.5% in 1933, 5.5% in 1984 and 3.5% in 1985. Substantial progress has been made during the past two years in meeting the program objectives although the targets for 1984 were not fully met. The public finances were strengthened considerably and the public sector deficit was reduced to 8.7% of GDP in 1983 and an estimated 7.4% in 1984. The main reason for the higher budget deficit than the 1984 target was the much higher than expected interest payments on the domestic debt. Curbs on expenditures were wide ranging. However, recent estimates suggest that real public investment -- encompassing states and local governments -- may have been well in excess of the targets fcr 1984. The authorities have given priority to completing projects that were already far advanced and to those that were important for employment, equity, or foreign -4- exchange earnings. Nonetheless, public investment expenditures are estimated to have declined to about 7% of GDP in 1983-84, well below the 1982 level of 11.7%. The fiscal performance was also aided by significant price increases for nearly all public goods and services, including petroleum products, electricity rates, food, etc. The Government has committed itself to a substantial reduction and eventual elimination of most subsidies, including those provided in the form of low interest rates. 10. The balance of payments experienced a major turnaround in 1983 with the current account moving from a deficit of almost US$5 billion in 1982 to a surplus of US$5.5 billion. The strength of the current account and the availability of external finance permitted Mexico to replenish its international reserves while paying a large part of the arrears that had accumulated in 1982. The net use of foreign financing by the public sector was US$4.2 billion for the year--below the ceiling of US$5 billion under the stabilization program. The errors and omissions account of the balance of payments dropped from US$8 billion in 1982 to an estimated US$1.4 billion in 1983, largely reflecting the decline in unrecorded capital outflows. The swing in the current account was mainly the result of a very sharp contraction of merchandise imports, to US$7.7 billion representing a decline of about US$7 billion from their 1982 level. The recession, the large devaluation of the peso and the quantitative restrictions all contributed to this. The balance of payments remained strong in 1984, with a current account surplus of US$3.7 billion, and a further US$2.5 billion were added to the nation's foreign exchange reserves, which at the year's end are estimated at about 7f months of imports. Although imports recovered considerably, a rapid rise in non-oil exports, particularly in the first quarter of 1984, ensured that the trade surplus remained at the same level as in 1983, i.e., about US$13 billion. Growth in tourism and in-bond industry was also strong, and helped in alleviating unemployment. These favorable external trends during late 1983 and early 1984 weakened in mid-1984, owing to an appreciating real exchange rate. 11. Fighting inflation remains the pivot of the Government's stabilization program. Although the Government's own inflationary targets have been missed by wide margins, the rate of inflation continued to decline through mid-1984. It declined from a rate of about 100% in 1982 to 80% and 59% in 1983 and 1984. The main factors in this were restrained fiscal and monetary policies and moderate wage adjustments. The flow of savings into the banking system continued to rise, reflecting the beneficial influence of the exchange rate and interest rate policies. The impact of the severe and sudden cuts in public expenditure and imports on economic growth in 1983 was serious when GDP declined by over 5%. However, the economic recovery in 1984 was stronger than the Government's expectations: GDP is estimated to have risen by about 3.5% compared to the earlier estimate of only 1%. Since the latter half of 1984, fiscal, monetary, and external trends have signaled a possible resurgence of inflationary pressures. 12. The Government also took steps to regain the confidence of both domestic and foreign private investors. These included efforts to deal with the problems of private external debt, procedures to compensate owners of nationalized banks, and a more flexible application of the foreign investment law. Negotiations with commercial banks and other private creditors have been completed for the refinancing of nearly half of the total of US$11.6 billion of private sector obligations at stretched out maturities varying between 6 and 12 years, with 3- to 4-year grace periods. Moreover, the Government undertook the restructuring of Mexican private sector obligations guaranteed by official credit agencies abroad. The Government has also transferred back to private ownership most of the 400 private firms that were controlled by the commercial banks prior to their nationalization. These measures and announcements have been beneficial, but more remains to be done to restore confidence of Mexican entrepreneurs and foreign investors. The Government realizes that this is an issue of the greatest importance as economic recovery beyond the current stabilization period will depend critically on the resumption of vigorous private investment. 13. The general improvement in the Mexican economy has been widely noted, particularly by the international banking community. Mainly for this reason, the Government's 1984 borrowing of US$3.8 billion from commercial banks carried much more favorable terms than the borrowing in 1983 (10 year maturity, 5-3/4 year grace period, and a spread of 1+% over LIBOR or 1-1/8% over prime). The negotiations between the Government and foreign commercial banks on the rescheduling of foreign debt have been virtually completed. The draft agreement, covering close to US$50 billion, has been submitted by the Banks' Advisory Group (consisting of the 13 largest lenders) to some 500 smaller, regional banks for their acceptance. Under the proposed terms, the previously not-rescheduled debt (amounting to about $20 billion), which is due for repayment in 1985-90, will have its maturities stretched over fourteen years. The maturities of the previously rescheduled debt coming due in 1987-90 will be stretched over eleven years. The 1983 syndicate loan of $5 billion will be restructured, after prepayment of $1 billion, to carry terms identical to the 1984 syndicate loan. In summary, the pending rescheduling agreement will stretch maturities of US$50 billion public debt in such a way that the debt service remains virtually constant between 1985-1998, in contrast to the present situation where 75% of the debt service is due in 1986-89. The banks will have the choice of LIBOR, a domestic reference rate, or a fixed rate. These terms are based on the understanding that the Government will continue to adhere to prudent economic policies.2/ Medium-term Prospects 14. The Government's strategy, as outlined in the National Development Plan (NDP) for 1983-88, combines special efforts to recover from the present crisis with a longer-term perspective on regaining balanced and stable growth to overcome structural problems. The main problems facing Mexico in the years ahead include the still very high rate of population growth (2.6% estimated for 1983) together with an even higher rate of labor force growth (a little under 4%), slow growth in agriculture, poverty, a highly skewed interpersonal and interregional income distribution, and an overly oil-dependent economy with a strong anti-export bias. 2/ As of this writing, the rescheduling agreement was expected to be signed by end-March, following the agreement with the IMF on the third year EFF, announced March 25, 1985. 15. The medium-term strategy presented in the NDP focuses on the need for structural changes in the economy including a greater export orientation through revision of external trade policies, poverty alleviation through basic needs policies and improvement in labor absorption, and decentralization of economic activity. The basic elements of policies to address structural problems are mentioned in the NDP and further details on specific programs and schedules for policy adjustments are provided in the sectoral plans which were prepared subsequently. 16. Mexico's medium-term prospects for recovery and stable economic growth are reasonably good, provided economic management continues to be prudent, private sector confidence is restored, and the international environment remains favorable. Adequate domestic policies include inter alia continued efforts to reduce the fiscal deficit, liberalize trade and minimize price distortions. Restoration of private sector confidence is crucial since only a strong and dynamic private sector will be able to raise investment from the present depressed levels and to supply the increasing non-oil export surplus required for the resumption of growth. As regards the external environment, the commercial banks are expected to maintain their exposure in Mexico in real terms, and foreign markets to be open to Mexico's non-oil exports. Mexico will benefit directly from a continuing fall in interest rates in the world financial markets (a one percentage point drop means a savings of about US$800 million in overall interest payments which compares to a loss of $550 million in gross export revenues that would result from a one dollar drop in the export price of oil). 17. Under reasonably favorable external and domestic conditions, Mexico's economic growth could reach a sustainable 6% a year--the post-War average for Mexico --towards the late 1980s. This growth would materialize through a sustained redirection of the economy toward a more outward-oriented growth pattern. Fiscal discipline, in the absence of improved domestic efficiency and export development, is likely to entail a prolonged period of slow growth, characterized by insufficient labor absorption in internationally competitive activities, by domestic price distortions, and by continued need for subsidies. External Debt and Creditworthiness 18. Mexico's external public debt increased by about US$4 billion during 1983 and by about a similar amount in 1984. With an expected net new borrowing of some US$3 to US$4 billion a year, the ratio of external debt to GDP would decline steadily from 41% in 1984 to 33Z by 1990. The debt service ratio, after the proposed rescheduling, is projected to peak at 47% in 1988, thereafter it gradually declines to about 25% in 1995. 19. At the end of 1983, the last year for which a comprehensive external debt report is available at this time, the Bank's share in Mexico's debt was 4.3% (excluding undisbursed). The Bank share in Mexico's total public external debt service payments during that year was 4%. In view of the good medium and long term potential of its economy and the prospect of continued pursuit of sound economic policies by the present Administration, Mexico is considered creditworthy for IBRD borrowing. - 7 - PART II - BANK GROUP OPERATIONS IN MEXICO Bank Operations 20. As of February 28, 1985, Mexico had received 85 loans from the Bank amounting to US$6,831.3 million, net of cancellations and terminations; of these, 58 loans totalling US$3,495.2 million were fully disbursed. The Bank held US$5,488.8 million, of which US$2,031.7 million had not yet been disbursed. Some 42% of Bank lending has been for agriculture and rural development, 232 for industry, 11% for power, and 13% for transportation; the remaining 11% has been for water supply, tourism, urban development, vocational training and pollution control projects. Annex II contains a summary statement of Bank loans as of February 28, 1985. 21. Of the US$6.83 billion total lending, about US$3.5 billion was for establishing or strengthening institutions for channelling credit to areas where credit supply was deficient or non-existent, and setting up in the com- mercial banking system the ability to carry out project-related appraisal of investments in agriculture, industry and tourism. These credit programs have facilitated lending to low-income farmers and small- and mediur-scale industrial and tourism enterprises based on productive investment plans, rather than credit granted on the basis of collateral. 22. The Government arranged adequate budget financing in the years 1978 to 1981, which significantly improved project implementation. Government and Bank officials met periodically to review project implementation, and greater attention was focused in Mexico on project monitoring. As a result of these measures, most of the Bank-assisted projects were being implemented satisfactorily until mid-1982 and disbursements rose from US$91 million in FY78 to US$448 million in FY82. However, the present financial crisis is again causing delays in the provision of counterpart funds, consequently, disburse- ments in FY83 declined to US$389 million. A Special Action Program (SAP) was established in early 1983 to help the Government by alleviating the counterpart funding constraints on development projects, and 18 Bank financed projects are receiving support under the Program. Partly as a result of the SAP, disburse- ments during 1984 improved significantly at US$528.87 million or 35% over disbursements in 1983. IFC Operations 23. As of February 28, 1985, IFC had made investment commitments in 27 companies in Mexico, for a total of US$753.9 million, of which US$562.5 million had been sold, repaid or cancelled. A summary statement of IFC investments is presented in Annex II. IFC has been working together with the Bank in preparing proposals to establish a facility for provision of foreign exchange financing to private sector companies for the importation of machinery, equipment and spare parts required for production of exportable products, for efficient import substitution and for improvements in the utilization of their existing productive capacity. IFC approved a US$100 million facility (including funds mobilized from foreign commercial banks) in 1983, which is providing finance for fixed investments of a larger size than those assisted under the Bank loan for an Export Development Project. Bank Strategy 24. The main objectives of Bank lending in Mexico in the past eight years have been to: (a) support policies and programs leading to a wider distribn- tion of the benefits of economic growth; (b) help fina:.ce projects that, di- rectly or indirectly, contribute significantly to output and employment; (c) help reduce Mexico's urban-regional imbalances; and (d) help free bottlenecks which prevent rapid growth. More recently, however, in response to Mexico's requirements following the 1982 economic crisis, the Bank, in close cooperation with the IMF, also supported the Government's stabilization program through as- sistance for export promotion and intensified and broadened economic and sector work. As for medium term prospects, the volume and composition of Bank lending to Mexico would be related to progress in the implementation of policy reforms needed for structural economic adjustments, through broad policy conditionality affecting the entire lending program or important parts of it. Specific policy reforms that are being pursued through a dialogue with the Government, conducted in parallel with the processing of lending operations, cover priority macro-economic and cross-sectoral issues, such as interest rate policy, energy pricing, subsidy reduction and export development. 25. Because of the difficult structural problems of agriculture and the sector's crucial importance for the one-third of the nation's population living in the rural areas, the Bank has made agriculture the leading sector for its lending. The Bank's agricultural lending program in Mexico has four goals: first, to help increase productivity of presently cultivated lands in general; second, to give emphasis to improving the productivity of small farmers; third, to complement infrastructure investments with support services, such as extension, marketing programs and credit; and fourth, to promote employment- generating investments in rural areas. The Bank has made 14 loans in FYs78-83 totalling US$1,829.4 million for irrigation, rural development and agricul- tural, agro-industrial and livestock credit programs. A US$175 million loan for a rural development project and a US$180 million loan for an irrigation rehabilitation project were approved by the Executive Directors in FY82, and a US$138.4 million loan for San Fernando rainfed agricultural development was approved in early FY83. A US$115 million loan for marketing perishables was approved by the Executive Directors in April 1983 and a $300 million Eighth Agricultural Credit Project in June 1984. Projects for irrigation rehabilitation, extension and research (seed multiplication) and agricultural credit are in various stages of preparation. - 9 - 26. Bank lending for industry has aimed at: (a) reduction of the balance of payments deficit; (b) decentralizing industrial activities away from the major, increasingly congested, urban areas; and (c) promoting greater employ- ment. A steel project which the Bank helped structure and finance is now operating in a previously underdeveloped area on the west coast of Mexico, and the city in which it is located, Lazaro Cardenas, is developing into a new growth pole. Four loans for industrial projects to promote the development of small- and medium-scale industrial enterprises, to finance expansion of small- and medium-scale mining, and to support an industrial equipment fund (FONEI) were approved by the Executive Directors in FYs78-80. A US$90.0 million loan for a vocational training project, which is assisting a program to increase the supply of skilled workers and technicians, a US$152.3 million loan for the development of a capital goods industries project and a US$60 million loan for pollution control were approved by the Executive Directors in FY82. A modification in the capital goods project was approved by the Executive Directors in early 1983 to set up a pilot export development fund to help satisfy the foreign exchange needs of Mexican exporters. A US$350 million loan for an Export Development Project and a US$175 million loan for a Third Small- and Medium-Scale Industry Development Project were approved by the Executive Directors in FY83. Follow-up projects to support expansion of small and medium scale mining enterprises and vocational training are under preparation. 27. Bank lending for physical infrastructure has been focused on regional development and strengthening of institutions and sector policies. Two high- way sector projects (FY79 and FY84), the fourth railway project (FY81) and an industrial ports project (FY84) support these goals. The first and second medium-size cities water supply and sewerage projects (FY76 and 81) reinforce the planning, management and finance of specialized water supply and sewerage institutions at the federal and municipal levels, and contribute to the establishment of tariffs more closely related to costs; a third project was approved by the Executive Directors on May 17, 1983. A fifth railway project is under preparation. 28. The Gcvernment has adopted a National Urban Developmen1t Plan that spells out its regional development priorities in operational terms. A project to assist in the development of the Lazaro Cardenas urban area was approved by the Executive Directors in FY7d, and a second urban project for oil-producing southeastern Mexico was approved by the Executive Directors in FY81. A loan for the preparation of a deconcentration program for the Mexico City Region was approved by the Executive Directors in August 1982. A 'ow income housing project is under preparation. 29. The Economic Development Institute (EDI) is assisting CECADE (Centro de Capacitacion de Desarrollo Economico under the Secretariat of Programming and Budgeting) in training Government staff in project preparation, monitoring and evaluation. EDI assistance is directed at courses on urban and regional development, agriculture, rural development and agro-industries. The Bank has also assisted the Mexican authorities in training personnel for managing water supply and industrial credit projects. - 10 - 30. The Inter-American Development Bank (IDB) is the second largest source of multilateral aid to Mexico. The IDB has made loans to Mexico totalling US$3.4 billion as of December 31, 1984. Over 50% of the total has gone to agricultural and rural development projects, and the balance to transportation, industry, water supply and sewerage, tourism infrastructure, education, municipal development, and pre-investment. The IDB and the Bank have coordinated their assistance on several projects. Each has made loans for the national integrated rural development program (PIDER), agricultural and livestock credit, small- and medium-scale industries development, and hotel development projects. The International Fund for Agricultural Development (IFAD) has approved a loan of US$22 million for a rural development project in the state of Oaxaca which was appraised by the Bank's staff and for which the Bank is acting as cooperating institution for administerinig the loan. 31. Bank-supported power, steel, fertilizer and tourism projects in Mexico have been co-financed by several bilateral export credit agencies and commercial banks. In January 1982, Mexico borrowed US$500 million from commercial banks to provide complementary financing for Bank-assisted projects where project specific co-financing would have been difficult. PART III: THE CHIAPAS DEVELOPMENT PLAN The Setting: Chiapas and the Southeastern Region of Mexico 32. The Southeast, which includes the States of Tabasco, Veracruz, Campeche, Quintana Roo, Oaxaca and Chiapas, is the least developed region of Mexico. Until the recent discovery and production of oLl in Tabasco, Veracruz and Chiapas, this region grew at a lower rate than the rest of the country. Despite many natural resources, the Southeast suffers from socio-economic constraints which have hampered development efforts (serious infrastructure bottlenecks, shortage of skilled manpower and underdeveloped human resources). The region also has the highest concentration of indigenous population. Within the Southeast, Chiapas is perceived as a region of great economic potential, especially in agriculture, tourism and agroindustries. As a result, it has recently received priority attention from the Government. 33. Chiapas is the most rural State in Mexico with a population of 2.3 million, of which about 25% is indigenous. It is one of the poorest and least developed States in the country, with a per capita annual income of about US$350, compared with the national average of US$2,250. However, it is well endowed with natural resources which have not yet been fully exploited or explored. About one third of the population is estimated to live in urban areas which is about half the average national ratio. Agriculture represents about 36Z of the State's GNP, accounting for 80% of all employment. Services, commerce, construction and transport account for 31% of GNP and industry, mining (petroleum) and hydro-electricity for the remaining 33%. - II - 34. A poor intrastate communications system has kept factor mobility low, and thus contributed to sharp income and social disparities between the four different subregions (the Coast, the Central Depression, the Central Highlands and the Tropical Forest). There is a danger that plans for the accelerated development of Chiapas, if not properly conceived and managed, could exacerbate these disparities because the most promising investment opportunities lie in the relatively flat Coastal areas and Central Depression (irrigation and drain- age) where incomes are already higher and population densities lower than average. The least developed and relatively densely populated parts of the State are the less fertile and more fragile sloping areas in the Central High- lands (the Altos) where communications are difficult. The Government aims at pursuing a more balanced growth pattern, with priority focus on tree crops, rainfed agriculture and transport in :he Central Highlands. A major effort is being made to identify and prepare projects that will yield substantial and sustainable income increases in those areas. Its initial stages are being supported through the studies component of the proposed Chiapas Agricultural Development Project. Regional Development Strategy 35. The Government requested Bank assistance in the formulation of a strategy for the development of Chiapas in September 1980. The following year, a multisectoral Bank mission visited the State and its report contributed to the formulation of the Government's first initiative in regional development policy and the Chiapas Development Plan, launched by the President of Mexico in May 1983. In 1984, a similar plan was formulated for the neighboring State of Oaxaca. Other State development plans are under preparation. 36. The new regional orientation in Mexico's approach to development planning also required institutional changes to ensure the proper coordination of Federal and State Government activities. As of 1981, Development Planning Committees (COPLADES) were established in each State to plan, monitor and evaluate the activities of regional branches of central Federal Government, with the State Governor as chairman and the Regional Delegate of the Secretariat of Programming and Budgeting (SPP) as technical secretary. The central Government agencies are also represented on such Committees. These committees formulate and propose annually to the Federal and State Governments the investment, expenditure and financing programs for the State, and oversee the execution of regional development plans. Furthermore, to formalize the coordination of development planning and project implementation at the State level, Coordinating Agreements are entered into between the Federal Government and each State (Convenios Unicos de Desarrollo, CUDs). Such an agreement between the Federal Government and the State of Chiapas was signed in February 1984. Within this framework, specific coordinating agreements would be entered into for the implementation of the proposed parallel Agricultural and Rural Roads Projects (Section 3.02(a)(ii) of the draft Guarantee Agreement). 37. Chiapas contains a number of unique ecological reserves which are important in terms of wildlife and plants, as well as for watershed management, soil conservation, water quality, fisheries and tourism potential. With Bank assistance, the Government has established an environmental review process applicable to all construction works, with the Secretariat for Urban Develop- ment and Ecology (SEDUE) acting as the responsible agency, to duly manage the - 12 - impact of the proposed investments under the Chiapas Development Plan on the delicate ecological balance and on the indigenous population in the State. Program Objectives 38. To address the current uneven pattern of the State's development, and to help integrate the economically marginal regions into the development pro- cess, the Chiapas P1.elopment Plan aims at promoting greater social and econo- mic equality between the various subregions and productivity improvement generally. These objectives would be achieved through a package of carefully balanced and integrated plans for the development of physical and social infra- structure and directly productive activities, mainly in agriculture, supported by improvements and expansion in rural communications system. The first stage of the Plan was initiated in 1983 and is expected to be implemented over the remainder of this decade. Bank participation in the financing of this first stage includes the proposed priority Agricultural and Rural Roads Projects, as well as measures to help monitor the program's impact on the natural environ- ment. The Government will finance basic infrastructure components and special assistance subprograms for the indigenous population mainly concentrated in the Altos subregion. Under the proposed Agricultural Development Project, the Bank would support this objective by helping finance soil conservation structures and related technical assistance, which are critical for the sustained develop- ment of this subregion. The second stage of the Chiapas Development Plan would focus in particular on the promotion of agroindustries, fisheries, forestry and energy development. Future Bank participation would be dependent upon the identification of suitable investment opportunities through the studies component included under the proposed project. 39. Execution of the investments supported by the Bank would be the responsibility of Federal sector agencies involved, the Secretariats of Agri- culture and Water Resources (SARH) and Communications and Transport (SCT). This would include physical planning, construction and supervision. Implemeu- tation of appropriate environmental protection measures would be the responsi- bility of the Secretariat of Urban Development and Ecology (SEDUE). At the Federal level, a special multisectoral Directing Council for implementation of the Chiapas Plan, composed of representatives of all the agencies involved, would provide overall guidance. At the State level, COPLADE would coordinate and monitor all project activities (para. 36). Counterpart funding for the proposed agricultural and rural roads projects would come from the budgets of SARH and SCT and the Regional Development Program (PDR). Agricultural credit would be financed outside the Chiapas Plan budget through existing credit programs in the State which are adequate to meet financing requirements under the Plan. Program risks 40. The Chiapas Plan is the first integrated regional development opera- tion in Mexico within a new and largely untested institutional framework. Inevitably the new institutions are of uneven quality. The Federal and local executing agencies within the CUD/COPLADE system (para. 36) would receive substantial inputs through the various projects to improve their institutional and budgetary capabilities. Despite those mitigating measures, the execution of this complex multi-sectoral program entails a certain risk. However, the risk is considered inevitable and acceptable if the Bank is to support Mexico's renewed regional development efforts in a substantive and timely manner. - 13 - PART IV - THE AGRICULTURAL SECTOR3/ Agriculture in the Economy 41. Mexico's agricultural sector contributes about 10% of the gross domestic product, employs about one-third of the country's active labor force and contributes about 6% of the country's exports. Between 1945 and 1955, agricultural production growth rates averaged about 6% annually, but declined to about 4.4% between 1955 and 1965, and to less than 3% between 1965 and 1980. During the latter period, production increases from newly irrigated land slowed down and agricultural terms of trade gradually worsened. However, agricultural production increased at an annual average rate of about 8.5% in 1981 and 1982. The increase was the combined result of favorable weather conditions, higher farm-gate prices and large input subsidies under the Government-sponsored Mexican Food Program (SAM). During most of this period, the population grew at an annual rate of about 3.3%, but growth has declined recently to about 2.6% annually. 42. The reduced agricultural production growth before 1981, coupled with increasing internal demand, resulted in increased food imports and deterioration in the agricultural trade balance. In 1979 the country experienced its first agricultural trade deficit, and in 1981 the deficit was over US$1 billion. However, since 1982 the agricultural trade deficit has begun to decrease primarily due to reduced imports influenced by substantial devaluations. Since 1970, corn, wheat, soybeans, sorghum and powdered milk have been the principal food imports, representing almost 8% of total imports in 1980. During the same period, cotton, coffee, and vegetables constituted the main exports. Production, Trends and Past Agricultural Policy 43. Mexico's basic crops, which include maize, beans, wheat, rice, sorghum, soybeans and sugarcane, are produced on about 75% of the cultivated area. Production has varied strongly from year to year with a growth trend of 1.5% to 2.5% over the 1970s, i.e., well below the population growth rate. Government intervention in the price setting and marketing of these crops gradually grew stronger over the decade. With the pressure to protect the consumer against increased food prices during a period of gradually increasing inflation, the terms of trade worsened and negative protection rates prevailed. As a result, imports of these crops increased sharply: maize imports from 736,000 tons in 1970 to 3.8 million tons in 1980, and sorghum imports from 10,900 tons in 1970 to 2.8 million tons in 1981. From 1980 to 1982, the Government attempted to reverse this trend by substantially increasing farm-gate prices and introducing a range of input subsidies in the 3/ This section is substantially unchanged from the President's Report for the Eighth Agricultural Credit Project (P-3843-ME of June 4, 1984). - 14 - context of SAM. Farmers respondeA positively, but as consumer prices for the basic products were allowed to rise at much lower rates, consumer subsidies also increased, and the Government program turned out to be too costly to maintain after 1982. 44. The production of export crops (mainly coffee, fruits and vegetables), which has remained relatively free from Government intervention in trade and prices, showed an annual average growth of about 12% up to 1979. In the ensuing three years, exports of these crops stagnated, mainly due to an increasing overvaluation of the Mexican currency. However, indications are that since 1982 growth has resumed. On livestock activities, beef production grew at an annual rate of 7% between 1975 and 1982; pork, poultry and egg production increased at even higher rates, between 1OZ and 12% annually over the same period. These growth rates were sufficient to cover increased domestic demand, and Mexico's traditional beef exports were basically maintained. Milk, however, which is produced under controlled prices, grew only about 1.8% per annum during this period. Milk imports in the ten years before 1982 rose at an annual rate of about 20%, and presently equal about 16% of total production in fluid equivalent. 45. Growth in related sectors has been mixed: (a) the agroindustrial subsector grew 10% during the 1970s, and in 1979 accounted for about 18% of the industrial sector's output; (b) the forestry sector, which includes about 21 million ha of commercial wood, is underexploited, producing only about 9 mil- lion m3 of wood products in 1981; and (c) the fisheries subsector has shown significant growth in recent years rising from an annual catch of about 0.25 million tons in 1970 to about 2 million tons in 1982. Approximately 30% of the value went into exports (mainly shrimp), and about 50% of the total catch went into fish meal. Present Agricultural Policy 46. At the end of 1982, when the new Government took office, there was an urgent need to reassess and reorient agricultural development policies. After substantial devaluations, domestic farm-gate prices had deteriorated in real terms. Strong price increases, especially for the basic commodities, were required if farmers were to maintain and increase production levels. On the other hand, in order to lower high inflation levels, there was a need to contain increased food prices. Also, in view of high public sector deficits, the Government's agricultural subsidy policy needed to be overhauled. 47. The Government's policy, as outlined in the National Development Plan (NDP) for 1983-1988, is designed to accelerate agricultural growth, alleviate poverty, and correct regional economic and social imbalances. The policy emphasizes the importance of agriculture in increasing Nexiran exports and production of import substitutes. The stated policy over the medium term is to guarantee farm prices which are consistent with international prices. However, in the short term, emphasis is being placed on adequate compensation for the increased cost of production and a reasonable profit margin to producers to determine price levels. Prices for basic crops and milk (i.e., mostly the - 15 - controlled sector) increased between 120% and 160% in nominal terms during 1982, 1983 and 1984, and are presently 80-90% of international prices at current cxchange rates. Input subsidies have been substantially reduced; subsidized prices for cash inputs (fertilizer and seeds) are now only available to small farmers holding less than 20 ha each. Interest rates on agricultural subloans, which until now were fixed and generally negative, have been made variable and are expected to approach positive levels in the medium term. The movement in rates has been referenced to the latest average cost of funds to multipurpose banks (ACF)4/. Irrigation water rates were increased an average of about 200% during 198'T and subsequent adjustments are being made toward the stated goal of recovering operation and maintenance costs wherever possible, under a general strategy to improve the use and management of Mexico's water and soil resources. The Government has also taken steps to decentralize planning, programming and implementation of rural development projects to state and local levels and to improve interagency coordination. Agricultural policy dialogue between the Government and the Bank has been intense in the recent past, and both have agreed to a continuous policy dialogue in the future. Previous Bank Projects 48. In the past ten years (FY74-84), Bank participation in the agricultural sector amounted to US$2,823 million distributed among 20 projects as follows: (a) Irrigation: (Panuco 969-ME), Sinaloa I (970-ME), Rio Fuerte/Sinaloa II (1706-ME), Bajo Rio Bravo/Bajo Rio San Juan I (1111-ME), Apatzingan (1858-ME), Ocoroni (1908-HME) and Bajo Rio Bravo/Bajo Rio San Juan II (2100-ME) - US$654 million; (b) Integrated Program for Rural Development PIDER I (1110-ME), II (1462-ME), and III (2043-ME) and Papaloapan Basin (1053-ME) - US$455 million; c) Rainfed Agriculture: PLANAT (1945-ME) and San Fernando (2191-ME)-US$418 million; (d) Agricultural Marketing: FIDEC (2262-ME) - US$115 million; (e) Agricultural Credit: FIRA V (1217-ME), VI (1569-ME), VII (1891-ME), VIII (2454-ME) - US$1,065 million; (f) Area Development: Tropical Agriculture PRODERITH (1553-ME) - US$56 million; and (g) Small-Scale Agriculture Infrastructure Development (1643-ME) - US$60 million. 4/ The weighted average of interest rates paid by financial institutions on bonds, notes and certificates of deposit, excluding checking and savings accounts. The ACF is established monthly by the Bank of Mexico. - 16 - 49. Since issuing the Staff Appraisal and President's Reports for the Eighth Agricultural Credit Project (Loan 2454-ME) on June 4, 1984, the Bank has issued completion reports on two irrigation projects (Panuco, Loan 969-ME; Sinaloa, Loan 970-ME; and a rural development project (Papaloapan, Loan 1053-ME). It is currently processing the completion reports for the Bajo Rio Bravo Irrigation Rehabilitation Project (Loan 1111-ME) and the Second Inte- grated Rural Development Project (PIDER II, Loan 1462-ME). The lessons learned and taken into consideration in designing the proposed project have been that: (a) in preparing irrigation projects, the alternative of developing rainfed agriculture should always be considered; (b) a strong extension service is necessary for the development of agriculture; (c) projected agricultural production targets should be based on tested models; (d) large civil works components require advanced preparation before appraisal; (e) phasing should be considered for large projects with expected long implementation periods; (f) complex multi-sectoral projects, such as PIDER, with many components and executing agencies, are difficult to manage and implement; and (g) projects in new areas especially where experience and knowledge are limited, should be modest in scope and design, reflecting a pilot approach. In Chiapas, however, a pilot approach is not considered necessary because of experience gained with ongoing projects in the area (para. 59). 50. Implementation of ongoing agricultural projects, with the exception of credit, is currently slow because budgetary counterpart funds are limited and also because of cumbersome financial control procedures. The Government, in cooperation with the Bank, is now reviewing the financial control procedures in order to accelerate disbursements. Also, under the Bank's Special Action Program (SAP), all ongoing projects have been reviewed, cost estimates have been revised, an increased share of the project cost is being financed by Bank funds for two years and partial loan cancellations have been made, totalling US$220.4 million in 1984, where implementation was lagging substantially. PART V - THE PROJECT Project Origin 51. The proposed project is part of a long-term development strategy for the State of Chiapas first formulated with Bank assistance in 1981 and subse- quently embodied in the Government's Chiapas Development Plan (1983) (paras. 35 and 38). Subsequently, the Bank selected two priority areas as crucial to the initial stages of the Plan: agriculture and rural roads development and a Bank mission identified the proposed Chiapas Agricultural Development Project and the Chiapas Rural Roads Project in 1983. The proposed project -- which is part of the first phase of the Chiapas Development Plan and associated with the proposed Chiapas Rural Roads Project - was prepared by SARH. It was appraised in March 1984 and negotiated from February 25 through March 20, 1985, together with the Chiapas Rural Roads Project (Report No. P-4022-ME dated March 29, 1985. The Mexican delegation was led by Mr. Luis Nava, NAFINSA, and included representatives from the Secretariats of Programming and Budgeting (SPP), - 17 - Finance and Public Credit (SHCP), Agriculture and Water Resources (SARH) and Communications and Transport (SCT). A Staff Appraisal Report entitled "Chiapas Agricultural Development Project" (No. 5167b-ME, dated March 25, 1985) is being distributed to the Executive Directors separately. Supplementary Project data are included in Annex III. Project Objectives and Description 52. The proposed project would support the Government's strategy to increase agricultural production, accelerate economic growth, alleviate poverty, and address issues of regional and social development. The objectives of the proposed project would be to (a) increase the area available for rainfed crop production and intensify crop and livestock production on existing land; (b) improve agricultural productivity and exports; and, (c) generate rural employment and increase family incomes. 53. The project would include a total area of about 317,500 ha covering 255,000 ha on the Coast, 55,000 ha in the Central Depression, and another 7,500 ha in the Central Highlands (the Altos). Specifically, it is designed to support Government efforts to: (a) improve infrastructure by constructing river control dikes, farm service roads and drains; (b) strengthen administra- tion of the rainfed districts operations by providing field offices, housing, workshops, equipment and vehicles for operation and maintenance; (c) provide on-farm development works, including drains, land clearing, and land smoothing; (d) provide for construction of soil conservation structures; (e) strengthen production support services, extension, research, training, fellowships, and related technical services (including local and foreign consultants); and (f) carry out studies (basic, feasibility, marketing and storage, environmental and socioeconomic) to provide data for this project and identify future agricul- tural development potential in the State. (i) Infrastructure Component The proposed project provides for (a) construction of about 350 km of flood control dikes along the rivers flowing into the Pacific Ocean, to protect farmlands and rural communities located in the Coastal area; (b) construction and rehabilitation of about 475 km of farm service roads in the Coastal and the Central Depression areas; (c) construction of about 600 km of primary and secondary drains to remove excess surface water in the coastal areas, as well as of about 300 km of drains with roads and some 300 related auxiliary structures; and, (d) soil conservation works (terraces, gully erosion control, reservoirs and waterways) mostly in the Altos subregion. (ii) Administration and Operation Component For implementation, operational and maintenance purposes, the project includes: (a) provision of six field offices, including workshop, storage and staff housing facilities, as well as the required equipment and tools; (b) provision of all heavy equipment required for the maintenance and operation of the road networks, drainage and dike systems in the project area; and, (c) acquisition of vehicles required for the research, extension and adminis- trative activities included in the project. - 18 - (iii) On-farm Development Component To assist on-farm development needs, the Government would provide adequate medium and long-term credit for construction of drains, terraces, land smoothing, and land clearing on about 30% of the project area. (iv) Production Supporting Services Component To promote a higher level of production and efficiency, the project would support (a) employment of 345 incremental staff to strengthen services in the subproject areas and to ensure a rapid transition from traditional exten- sive livestock to intensive crop and livestock production; (b) carrying out a research program to improve yields, test new crop varieties, and improve farm management practices; (c) training of staff and farmers and provision of fellowships; and (d) consulting services to strengthen SARH operations in soil conservation, environmental and sociological evaluations, and to conduct basic and feasibility studies. (v) Related Studies Component Since this project represents the initial phase of a longer-term development program, the project would support a major studies component to promote future development objectives. Specific areas of study would cover: pre-investment and basic studies on about 630,000 ha, soil surveys, bathymetric and hydrographic surveys, marketing and storage studies, periodic socioeconomic and environmental reviews (including, in particular, areas in the Altos subregion) to help monitor and correct the impact of the proposed and future development activities in the State. Project Costs and Financing 54. The total project cost would be about US$181.6 million, net of taxes, including a foreign exchange component of about US$57 million, or 31% of the total. The base cost is estimated at about US$131 million, and physical contingencies are about US$13 million, based on an estimate of 15% for civil works and 10% for equipment, vehicles, goods and materials. Price contin- gencies, estimated to be about US$38 million, or 29% of base costs, are calculated at 5% for 1985, 7.5% for 1986, 8% for 1987-1990, and 5% thereafter, based on Bank guidelines. The project completion date is September 30, 1992. 55. The proposed Bank loan of US$90.0 million would be made to NAFINSA and would finance about 50% of total project costs, including US$33 million (26%) of local costs, in accordance with Bank policy for Mexico during the current recessionary period to expedite implementation of this key component. The Borrower would, through contractual arrangements on the same terms and conditions as those of the Bank loan, transfer loan funds to the Government for the carrying out of the project (Section 3.01 of the draft Loan Agreement). The balance of the project's cost would be funded through regular SARH budget allocations. At negotiations, the Government confirmed that adequate counter- part funding had been earmarked for 1985 and would be provided on a priority basis for the subsequent years of project implementation. - 19 - 56. Retroactive financing of up to US$9 million is included to cover eligible civil works expenditures incurred by SARH after July 1, 1984 but prior to the estimated date of loan signing (Schedule 1, para. 2 of the draft Loan Agreement). Project Administration and Execution 57. The proposed project would be carried out by SARH under the organiza- tional framework for rainfed districts and that established by the Government for the coordination of the Chiapas Development Plan (para. 36) (Section 3.01 of the draft Guarantee Agreement). 58. As under previous Bank-financed agricultural development projects, infrastructure design, tendering, construction and supervision would be carried out under SARH's Secretariat for Large-Scale Irrigation Works, through the district offices. Operation and maintenance of the facilities and the project's technical services component would be the responsibility of SARH's Secretariat for Agriculture and Operations. The representative of SARH in the State of Chiapas would, with the assistance of management and technical commit- tees, coordinate, supervise, monitor and evaluate project implementation in each rainfed district. The committees would have representatives from among producers and the Federal, State and local Governments. COPLADE would coordinate activities between SARH and the other participating Federal and State institutions and would be responsible for the overall planning and evaluation of all activities under the Chiapas Plan, including those of the proposed project. 59. Design standards and construction specifications would be those developed under a Bank supported PRODERITH pilot pLoject and which are satisfactory. Based on corapleted final engineering, SARH would prepare and furnish to the Bank, not later than December 1, 1986, and every year thereafter during project implementation, an execution program of infrastructure improvement works to be carried out during the subsequent calendar year (Section 3.04(a) of the draft Guarantee Agreement). The first year's investment program, which would be submitted to the Bank prior to the proposed loan's Board presentation, would help a smooth start-up for the project by focusing on the acquisition of rights-of-way, final engineering designs of dikes, drains, service roads and office and workshop buildings, as well as the hiring of new technical staff. Project Area Selection and Beneficiaries 60. Although the areas to be developed under the proposed project have a good potential for rainfed agriculture and adequate surface and ground water for future irrigation development, they are not sufficiently cultivated. This is especially true on the Coastal Plain which offers the largest and easiest area to augment production significantly in the State of Chiapas. In the Coastal and Central Depression regions, rivers dominate the topography, causing extensive flooding and disrupting communications. In some areas of the Central Depression, yields may be reduced by as much as 60% due to flooding and poor - 20 - drainage. To achieve the stated project objectives (para. 52) and to help cope with these constraints, investments in the project area would be directed, as a matter of priority, to improving rainfed agricultural development. Both the Central Depression and the Coastal land are suitable for a wide variety of crops, and the Altos is excellent for fruit productior.. 61. While the areas to be included in the project in the Central Depression region have been well defined during project preparation, in the Coastal area, of the total 255,000 ha to be protected from flooding, some 90,000 ha would be fully developed through the project. Selection of these full development areas has not yet been completed and a proportion of such areas will be identified through the annual SARH execution programs of infrastructure improvement works in the State (para. 59). Therefore, during negotiations, agreement was reached that, in the programming of the areas for full development, the following criteria would be followed: (a) the lands are primarily occupied by 'ejidos"5/ and private smallholders; (b) the areas are technically and economically suitable for agricultural production; and (c) production support services are already established in the areas (Section 3.04(b) and (c) of the draft Guarantee Agreement). In the Altos, most of the 7,500 ha to be included in the project would grow tropical fruits, and the specific areas would be selected by SARH, in coordination with the National Fruit Commission (CONAFRUT), through an ongoing program, the technical features of which are satisfactory. 62. The project is designed to focus on -ejidos" and smallholders. How- ever, each of some 76 holdings -- comprising 10Z of the project area -- exceeds the individual legal limit of 200 ha established by the 1981 Agricultural Development Law. In selecting areas for full development under the project, SARR would, as far as practical, avoid these large holdings. If, for technical reasons, it is not practical to avoid infrastructure works on large holdings, SARH would, together with the Secretariat of Agrarian Reform (SRA) and within the existing agrarian legislative framework, redistribute holdings in excess of the legal limit before any such holdings were incorporated for full agricul- tural development under the project. Through these measures the proposed project's social objectives would be considerably strengthened (para. 83). Coordination with the Chiapas Rural Roads Project 63. The project, together with the proposed Chiapas Rural Roads project, aims at promoting the adoption of uniform design and maintenance standards for all roads (service and access) to be constructed in the areas of influence of botl, the proposed projects, so as to ensure that SARH and SCT, in coordination with COPLADE, would take all necessary steps to coordinate their work in the State of Chiapas. To strengthen this process of coordination, the Government agreed at negotiations that it would, by December 31, 1987, carry out a review 51/ Ejido," a form of group land tenure based on usufruct. - 21 - of rural roads construction and maintenance practices by SARH and SCT in the State with a view to rationalizing design, construction and maintenance practices and defining the allocation of maintenance responsibilities between these two agencies (Section 3.05 of the draft Guarantee Agreement). Operation and Maintenance 64. Operation and maintenance of existing drains, dikes and roads, as well as those to be provided under the project, would be the responsibility of SARH's Secretariat for Agriculture and Operations. In its annual project implementation plan for the State, SARH would include financing and execution of a regular periodic operations and maintenance program for infrastructure and equipment. Initially, emphasis would be given to rehabilitation and maintenance of existing infrastructure, with new works to be taken over as they are completed under the project. To determine the growing volume of road maintenance requirements under the project, SARH would conduct a statewide review and formulate a road maintenance and rehabilitation program (para. 63). Beneficiaries would be encouraged to contribute labor for operation and maintenance to reduce costs. On-Farm Development Credit 65. To enable the project's beneficiaries to carry out the required on-farm development activities, the Government would, as a matter of priority, provide credit to farmers through existing credit sources from banking institu- tions operating in the State, such as the Agricultural Trust Fund (FIRA), the Trust Fund for Credit in Rainfed Districts (FICART), the National Rural Credit Bank (BANRURAL), and commercial banks, all of which are adequate to meet these needs. This credit would be granted under the same terms and conditions as those of the ongoing Bank-assisted FIRA VIII credit project (Loan 2454-ME) and would benefit mainly ejidos and smallholders in the State. SARH would, through its extension, promotion and farmer organization services, assist these lending institutions. During negotiations, the Government agreed to ensure the timely availability of funds for the provision of financial assistance to the project's beneficiaries for on-farm development and the acquisition of inputs (Schedule 1, Part C of the draft Guarantee Agreement). Cost Recovery 66. Most on-farm development costs would be recovered through the credit program. Recovery of infrastructure investment, and operation and maintenance costs is regulated through the Federal Water Law of 1972 and the Agricultural Development Law of 1981. These laws, when complemented with appropriate administrative measures, allow for different procedures to recover costs in irrigated, drainage and rainfed districts, but - to determine the amount to be recovered - both provide for a study of the beneficiaries' capacity to pay. Similar arrangements would be required to achieve cost recovery in the State. The Government has stated their commitment to recover operation and maintenance costs in full and as much as feasible of the investment costs. The mechanism and instruments for such recovery under the project are being reviewed within the Government. The Government further confirmed that they would inform the Bank in a timely manner of the pertinent arrangements for establishing and putting into effect promptly thereafter a cost recovery mechanism. Therefore, - 22 - during negotiations, the Government agreed to take all necessary measures to recover infrastructure operation and maintenance costs upon completion of infrastructure in each subproject area and, to the extent possible, the investment costs of such infrastructure (Section 3.07 of the draft Guarantee Agreement). Consulting Services 67. The limited development of Chiapas, the high potential for agricul- tural production, and the existence of some delicate environmental and socio- logical problems, generate an urgent need to acquire data and consolidate knowledge to steer the State's future development. To meet these critical needs, the proposed project includes some 180 man-months of local and foreign consultants to provide expertise for carrying out programs which would (i) address the identified environmental and sociological constraints in the State; (ii) help develop essential soil conservation programs to sustain agricultural development and production in the humid tropics, and related assistance programs for rural communities; and (iii) strengthen the technical services required for carrying out the specific studies under the proposed project (para. 53(v)). During negotiations, it was agreed that SARH would employ consultants with qualifications and terms of employment satisfactory to the Bank (Schedule 2, Section II of the draft Guarantee Agreement). Special Studies 68. The project is designed to support a series of specific studies to determine future agricultural development requirements in the State of Chiapas (para. 53(v)) and which will be executed in the course of SARH's normal operations in the State. These studies would cover the following areas: (a) pre-investment studies (including basic and feasibility) and soil studies and surveys; (b) socioeconomic and environmental reviews on a continuing basis in collaboration with the Secretariat of Urban Development and Ecology (SEDUE) and COPLADE; (c) marketing study to determine marketing and storage requirements in the State at full development of the agricultural activities under the Chiapas Plan, including those under the proposed project. During negotiations it was agreed that SARH would prepare and submit to the Bank by July 31, 1988, the study to determine the marketing and storage requirement in the State, and review on a periodic basis the socioeconomic and environmental impact of the activities proposed under the project (Section 3.06 of the draft Guarantee Agreement). Project Monitoring, Evaluation and Reporting: 69. Successful execution of the proposed project would hinge on SARH's ability to pull together the administrative efforts of various agencies and offices within the project area. To accomplish this task, SARH would have to monitor, in a timely manner, the contribution of each project implementing agency. SARH would maintain a multi-disciplinary group to monitor and evaluate prcject execution, beneficiary acceptance and response to the investments, changes in land use and production -vstems and to environmental and socio- logical adjustments. The monitoring and evaluation group will report to SARH and keep COPLADE informed of the results of such monitoring and evaluation activites. SA-RH would also furnish to the Bank semi-annual reports on the monitoring and evaluation of the project. - 23 - Procurement 70. Major civil works (principal roads, dikes and drains) estimated to cost about USS35 million, would be packaged in contracts of not less than US$2 million, and procured by International Competitive Bidding (ICB) in accordance with Bank guidelines for procurement. Other small civil works (buildings, roads, soil conservation structures, and drains) would normally be packaged in contracts of more than US$200,000 and be procured in accordance with Local Competitive Biuding (LCB) procedures acceptable to the Bank. These works are estimated to cost about US$45 million and would be scattered in time and place. Minor civil works not suitable for packaging in contracts larger than US$50,000, estimated to cost an aggregate of not more than US$6 million, would be purchased according to Government/SARH procedures for force account or direct contract acceptable to the Bank. For any civil works contracts expected to exceed US$1 million, the Bank's prior approval would be required before invitations to bid are issued and contracts awarded (Schedule 2 of the draft Guarantee Agreement). 7i. Equipment for operation and maintenance, estimated to cost about US$6 million, would be procured under ICB procedures in accordance with Bank guidelines. Vehicles, equipment, spare parts and materials for administrative services, operation and production services and training, expected to cost about US$10 million, would as far as practical be packaged in contract amounts not less than US$150,000; each would be procured according to LCB procedures acceptable to the Bank. Equipment, goods and material contracts costing less than US$150,000 would be procured according to Government/SARH procedures acceptable to the Bank, and would not exceed in the aggregate US$4 million. Qualified domestic manufacturers for the supply of equipment, goods and materials, would receive a preference of 15% or the import duty, whichever is lower. For all contracts for equipment, goods and materials expected to exceed US$250,000, the Bank's prior approval would be required before invitations to bid are issued and contracts awarded. Consultants for technical services would be selected in accordance with Bank Guidelines (Schedule 2 of the draft Guarantee Agreement). 72. Local procurement procedures used in Mexico were reviewed in detail and were found to be generally satisfactory. During negotiatiors, agreement was reached with the Government that certain procedures now followed would be modified in order to agree more closely with the Bank's procurement guidelines and policies. In particular, the time for prequalification of contractors and for bid advertisement and preparation will be increased to permit more bidding opportunities and bid preparation. Disbursements and Special Account 73. The loan is expected to be disbursed over seven and one-half years, in accordance with the profile for agricultural projects in Mexico. Based on this profile, the closing date for the loan would be March 31, 1993. The Bank would disburse against: (i) 70% of total expenditures for civil works; (ii) 100% of the total costs of consulting services required for production support services, training, and studies; (iii) 90% of local and 100% of foreign exchange expenditures for equipment, materials, spare parts and vehicles; and, - 24 - (iv) salaries for incremental extension and research staff, on a declining basis, as follows: 100% until June 30, 1987, 50% until June 30, 1989 and 25% thereafter (Schedule 1 of the draft Loan Agreement). To help speed up loan disbursements, NAFINSA, the Borrower, would set up a Special Account which would be operated in accordance with terms and conditions satisfactory to the Bank (Section 2.02(b) and Schedule 3 of the draft Loan Agreement). Satisfactory auditing arrangements for the Special Account were agreed during negotiations (Sections 4.01 of the draft Loan and Guarantee Agreements). Auditing 74. Appropriate auditing arrangements were agreed during negotiations for project accounts maintained by SARH adequate to reflect the operations, resources and expenditures of the project (Section 4.01 of the draft Loan Agreement and 4.01 of the draft Guarantee Agreement). Benefits and Justification 75. The proposed project is a cornerstone of the Government's regional development strategy for improving social and economic conditions in depressed areas of the country and complements other economic and social investments under the Chiapas Development Plan. As part of the first phase of this Plan, the project would address poverty problems and help expand agricultural production. At full development, yearly incremental production of the principal products--mainly maize, rice, soybeans, and fruits--would amount to about US$45 million in 1983 prices, which the country would earn or save in foreign exchange. Directly benefiting some 32,000 farm families, the project would provide jobs to about 15,000 farm labor, and help stem migration from the project area to Mexico's already over-populated cities. Increased employment opportunities on the beneficiary farms would help improve income distribution, as the average farm earnings are expected to rise from about US$1,900 to US$4,800 per family at full project development. 76. Improvements in the flood control and drainage infrastructure, as well as the service roads, would also benefit the urban population by reducing spoilage of goods and damage to property and by improving communications with the project area. In addition, the project would strengthen SARH's institu- tional capacity in five rainfed districts, including the delivery system for extension, research, credit, soil conservation and environmental protection, and provide the knowledge and experience required to develop similar areas in Chiapas. 77. The overall economic rate of return of the proposed investments has been estimated at about 19% on the basis of measurable benefits from crop and livestock production over the next 20 years. Other benefits, such as those discussed above (paras. 75 and 76) have not been quantified in the economic evaluation. The prices of traded commodities were taken from 1983 Bank projec- tions, adjusted for handling, processing and transport; for other products, prevailing farm-gate prices were used. Because of the high underemployment and unemployment in Chiapas, family and unskilled labor were valued at 80% and 70%, respectively, of the going market wage for unskilled labor. - 25 - 78. The sensitivity of the project's economic return to changes in costs and benefits has also been tested. Benefits, for instance, could decrease by 36% and the economic rate of return would still remain at above 12% - the estimated opportunity cost of capital in Mexico. Prices would have to drop by about 19% and yields by 20X to lower the economic rate of return to about 12%. A switching value test of delays in reaching full agricultural development showed that benefits from the project could be postponed by three to four years before the economic rate of return drops to 12%. Project Risks 79. The proposed project will be executed within the institutional framework set up for the implementation of the Chiapas Development Plan (para. 36). Despite the noted commitment of the Government, the execution of the activities under the Plan would entail a certain degree of risk with implications for the availability of adequate and timely counterpart funding. These risks would be, however, considerably lower than those which would exist if no attempts were made to control, in a planned fashion, the ongoing uneven development of the State. Furthermore, the Government has confirmed its commitment to strengthen the institutional and budgetary capabilities of the various agencies involved (para. 40). 80. Other risks are the possible reluctance of intended beneficiaries to adopt modern yield increasing technologies and, in certain areas, to switch from extensive livestock to intensive crop production. The project's design would help reduce each of the above risks to acceptable levels. The project implementing agencies would strengthen the extension, research and promotional services in the project area. In addition, the major target groups under the project - 'ejidos" and small farmers - are likely to respond positively to incentives under the project, especially after drainage and river control infrastructure, land transport, marketing and storage facilities are improved. 81. Finally, given the prc,oect design and relatively small size with respect to the whole Chiapas Development Program, and, in case of counterpart funding restrictions, the Government would have flexibility to reassign limited budgetary resources and continue with implementation of the priority project activities. Environmental and Sociological Impact 82. In accordance with current legislation, SARH and SEDUE have already initiated stueies evaluating environmental problems in the project area. The proposed project, and in particular its drainage system, has been designed to protect the environment by: (a) controlling the silting of permanent wetlands and lagoons; (b) controlling the run-off and use of water contaminated with fertilizers and chemicals; and (c) maintaining the depth and flow of water in the drains to control mosquitos and water-spawned insects. To enhance the project's environmental impact, SARH would, with assistance from SEDUE and COPLADE, design and set up a monitoring system, including the establishment of stations for periodic water analysis throughout the project area. Research - 26 - would also be conducted to determine fertilizer and chemical application rates and methods compatible with obtaining optimum yields and protecting the environment from chemical contamination. The extension services would advise farmers on the safe and proper application of fertilizers and chemicals. 83. According to sociological surveys, "ejidos and smallholders -- the project's main target groups -- are most likely to take advantage of drainage and flood control by intensifying crop and livestock production and converting grazing land to produce crops. The expected response of project beneficiaries would help reduce the concentration of livestock and crop production on a few large holdings, create temporary employment during construction, generate some 15,000 permanent jobs, as well as part-time work opportunities in weed control and harvesting. Thus, the project would help address some of the social problems in the rural areas of Chiapas and stem migration of rural labor to the generally over-crowded urban areas of Mexico. PART VI - LEGAL INSTRUMENTS AND AUTHORITY 84. The draft Loan Agreement between the Bank and NAFINSA, the draft Guarantee Agreement between United Mexican States and the Bank, and the report of the Committee provided for in Article III, Section 4 (iii) of the Articles of Agreement are being distributed to the Executive Directors separately. Special conditions of the project are listed in Section III of Annex III. 85. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank. PART VII - RECOMMENDATIONS 86. I recommend that the Executive Directors approve the proposed loan. A. W. Clausen President Attachments March 29, 1985 -27- ANNEX I Page 1 of 5 * O *L L_= ZAILI 3 Wacls MEXICO - SOCIAL INDICIATOR DATA INST 1OB (MOlT 53013W R8TIAN^T) LW RUCENT NIBBLE lNOS HUD ino&! l970Lk umnnfr LT. auuc & an uan Mu (T0634 SQ. 0) TOtA 1972.3 1972.5 1972.3 ICULTURAL 963.2 976.4 979.5 CW N CAPT (U) 360.0 730.0 2270.0 2106.6 2343.3 m mnsam mm mmr KTILCRANS OF OIL KQUIVALEKN) 539.0 773.0 1340.0 99.3 1122.8 Pr0ULATI0N NID-TuAR (T0SA0S8) 37073.0 51176.0 73122.0 138AM POPULATION (I OP TOTAL) 50.6 59.0 68.0 66.5 46.8 POPULATION PROJCTIONS POPULATION IN TUR 2000 (HILL) 109.4 STATIONMRT POPULATION (HILL) 198.: MPPATION NONPNION 1.9 POPULATION DENSITY PEtR SQ. M. 18.6 25.9 36.1 35.7 62.9 ER SQ. Xl. ACRI. LAND 37.7 52.4 72.6 92.4 156.9 POPULATION AGE STRUCTURE (2) 0-14 nS 45.6 46.5 44.3 39.9 31.4 15-64 IRS 51.0 50.0 52.2 56.0 61.1 65 AND ABOVE 3.4 3.5 3.4 4.1 7.1 POPUIATION GROT RATE (C) TOTAL 3.0 3.2 3.0 2.6 1.6 tIURW 6.8 4.7 4.2 3.6 3.7 CIIDC BltlH RATE (PERI TNOUS) 45.4 43.4 33.9 31.3 23.4 CRUDE DEATH RATE (PER THO) 12.2 9.7 7.1 8.1 8.8 GROSS REPRODUCTION RATE 3.3 3.2 2.2 2.0 1.6 FAMILY PLANNING ACCEPTORS. ANNUAL (THDS) *- 25.1 1145.0 /C USERS (I2 OP HAeEo WUEN) *- *- 39.0 kr 40.3 FM A- NITION INDEXOF FOOD PROD. PER CAPITA (1969-71-100) 97.0 100.0 104.0 114.3 114.5 PER CAPITA SUPPLY OF CALORIES CE OF ItEDIRIETS) 117.0 112.0 121.0 110.6 128.6 PEINS (CANS PER DAY) 69.0 66.0 74.0 67.3 89.7 OF 111CR ANM AND KLSE 29.0 27.0 26.0 /d 34.1 34.5 CIILD (AGES 1-4) DEATH RATE 10.3 6.5 4.0 5.7 3.2 LIFE EXPECT. AT DI9TN (YES) 57.0 61.3 65.4 64.7 67.4 INFANT ICT. RATE (PeR TAU) 91.1 73.6 52.9 60.6 54.2 ACCSS TO SAFE WATER (POP) TOTAL 23.5 49.0 /a 58.0 /. 65.4 URBAN .. 6.5 /. 61.4 / 78.1 RURAL .. 21.0 77 Sl.0 7r 46.2 ACCESS TO EXCEETA DISPOSAL (E OF POPULATION) TOTAL .. 37.0 1. 38.0 /a 52.9 URBAN .. 6C.o7* sO.i T 67.0 RURAL .. *.0 13.0 W7 24.5 POPULATION PEA PHYSICIAN 1830.0 l510.0 *- 1917.7 1065.8 POP. PE NURSINC PERSON 3650.0 1390.0 . 815.8 764.4 POP. PER HOSPITAL BED TOTAL 590.0 970.0 .. 367.2 326.3 URBAN 570.0 If 1170.0 .. 411.5 201.5 RURAL .. 1370.0 .. 2636.3 ADWISSIONS PER HOSPITAL DEC .. .. .. 27.3 20.0 AVERAGE SIZE Of HOUSSEOLD TOTAL 5.4 5.7 URBAN 5.7 5.7 AURAL 5.2 5.8 AVEAE NO. OF PRSONS/ROU TOTAL 2.9 2.5 LURAN 2.6 2.2 RORAL 3.4 3.2 ACCESS TO ELECT. (C OF DELLINGS) TOTAL 58.96.9 URBAN .. 60.7 RURAL .. 27.8 - 28- ANNEX I T ACL% 1 Page 2 of 5 M"E SOCIA- ICL INDIC
Groupe de la Banque mondiale · Memorandum & Recommendation of the President
Mexico - Chiapas Agricultural Development Project
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Groupe de la Banque mondiale
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Memorandum & Recommendation of the President
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Mexique
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Banque mondiale