El Salvador - Third Highway Project

RESTRICTED FILE CtPY Report No. P-298 This report was prepared for use within the Bank and its affiliated organizations. They do not accept responsibility for its accuracy or completeness. The report may not be published nor may it be quoted as representing their views. INTERNATIONAL DEVELOPMENT ASSOCIATION REPORT AND RECOMMENDATIONS OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED DEVELOPMENT CREDIT TO THE REPUBLIC OF EL SALVADOR FOR THE THIRD HIGHWAY PROJECT October 24, 1962  IUTERNATIONAL DEVELOP lENT ASSOCIATION REPORT AN'D RECOHIENDATIONS OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED DEVELOPMENT CREDIT TO THE REPUBLIC OF EL SALVADOR FOR THE THIRD HIGHHAY PROJECT 1. I submit herewith the following report and recommendations on a proposed development credit from the Association in an amount of 3A8 million, or its equivalent in other currencies, to the Republic of El Salvador to help finance a highwqay improvement, construction and maintenance project. PART I - HISTORICAL 2. With loans totalling just over ';16 million made in 1954 and 1959, the Bank has assisted in financing the construction of a coastal highway and a system of feeder roads. The coastal highway was com- pleted in January 1962 and the feeder road project is scheduled for completion early in 1963. 3. In 1961, the Government of El Salvador requested assistance in financing a third highway project in addition to projects for tele- communications and power for which studies were under way. A mission visited El Salvador in April 1962 to appraise the new highwTay project. Having concluded that El Salvador should be eligible for assistance from the Association, we decided that of the three projects before us the highway project was the most suitable for Association assistance. 4,. Formal negotiations began in W4ashington on September 4, 1962. The Borrower was represented by Hr. Julio Noltenius, IMinister of Public W4orks, assisted by IMr. Enrique Lima, Executive Director of the Rio Lempa Commission. 5. The proposed credit would be the first by the Association to El Salvador. The following Bank loans have been made to El Salvador: Year Amount of Borrower Purposes (equivalent in Loan $ million) 19h9 Comision del Rio Lempa Electric power development 12.5 1954 Republic of El Salvador Coastal highway project 11.1 1959 Republic of El Salvador Highwmay construction 5.0 1959 Comision del Rio Lempa Electric power development 2.7 1960 Comision del Rio Lempa Electric power development 3.8 Total (net of cancellations) 35.1 2. of which has been repaid 7.7 Total now outstanding 27.4 Amount sold 1.6 of which has been repaid 1.2 0.4 Net amount now held by Bank 27 0 2/ Includes 14.7 not yet disbursed.  - 2 - PART II - DESCRIPTION OF THE PROPOSED LOAN 6. The proposed credit would have the following characteristics: Borrower: Republic of El Salvador Credit Amount: The equivalent, in various currencies, of $8 million. Purpose: To assist in financing the improvement, construction or reconstruction of seven trunk roads and four feeder roads totalling about 364 km in length and the reorganization, equipping and training of the organization charged with the maintenance of the Coastal Highway. Term and Amortization of Credit: 50 years; 80 semi-annual re- payments of the principal: 1/2% of principal amount to be repaid semi-annually be- ginning November 1, 1972 and ending May 17 1982 and 1-1/2% semi-annually beginning November 1, 1982 and ending Nay 1, 2012. Service Charge on Credit: 3/4 of 1% per annum on the amount withdrawn and out- standing, payable semi- annually. PART III - APPRAISAL OF THE PROPOSED PROJECT Justification of the Project 7. A detailed appraisal of the project (TO-340a) is attached (No. 1). 8. El Salvador's highway system, with a total road length of about 3,390 In, of which about 1,910 lm are all-weather roads, is playing an increasingly important role in meeting the countryts transportation needs. Vehicle registration in El Salvador is growing at the rate of over 10%o per year while average annual fuel consumption between 1950 and 1960 increased by approximately 8%. 9. For the past several years, the Government has concentrated on the construction of new roads and little has been done to improve and upgrade the more important existing roads. The rebuilding to higher  - 3 - standards of the seven trunk roads included in the project is now needed to accommodate the increasing traffic and will substantially reduce transportation costs. Three of these roads link the two largest cities with each other and with the country's two chief ports. A fourth provides a shorter, more direct connection between two main sections of the country, by-passing the capital city of San Salvador. The remaining three are being upgraded to provide better links with neighboring Honduras and Guatemala - one of them con- necting with the new road from central Honduras to the El Salvador border which is also built with the Association's assistance. Their importance is enhanced by the movement toward Central American eco- nomic integration in which E1 Salvador, with its over-population, managerial talent and growth of light industries, is particularly interested. These roads will facilitate regional trade and, in par- ticular, imports of foodstuffs into El Salvador and exports of indus- trial products, of which the country expects to be one of the main suppliers. The economic returns on all seven roads is high. 10. The four new feeder roads of the project, serving regions in -which there are about 14,000 farm families, will not only lead to an increase in land under cultivation but also stimulate diversification of agriculture by enabling some land owners to shift production from coffee to food crops. TWhereas the project financed by the 1955 Bank Loan opened up lands mainly in the coastal zone, the proposed new feeder roads would make accessible some of the remaining unutilized or underutilized lands in the central part of the country. 11. The reorganization, equipping and training of the Government maintenance organization to introduce mechanized methods on the Bank financed and now completed Coastal Highway will serve the double pur- pose of protecting the country's large investment in that important road and, at the same time, creating -within the maintenance service a nucleus trained in modern techniques which can be gradually expanded to maintain the entire highway system. 12. The project is technically sound and cost estimates are real- istic; it is adequately justified economically by the future savings in transportation costs and by the prospective increase in agricultural and industrial production. Organization and Procedure 13. The Ministry of Public Works, with the assistance of external consultants, will be responsible for the execution of the project. All road work will be carried out by contractors, under the direct supervision of the Consultants. All contracts for road work and all major purchases of equipment will be executed on the basis of inter- national, competitive bidding.  Arrangements for Financing l4. Of the total project cost of 113.5 million, the credit of t8 million would cover the foreign exchange cost of the project. Local currency requirements of the project would be covered by national budget appropriations. PART IV - LEGAL INSTRUMENTS 15. Draft of Development Credit Agreement is attached (No. 2). 16. The agreement is substantially in the form currently used by the Association for projects of this kind. Provisions of the Develop- ment Credit Agreement of special interest are: (a) Section 4.01 (g) providing for the adoption of an extra- ordinary budget appropriating the minimum amounts needed in the next four years for the estimated local currency cost of the project; (b) Section 6.01 which makes the employment of consultants by the Borrower and the adoption of the extraordinary budget conditions of effectiveness of the Credit. 17. The report of the Committee provided for in Article 5, Section l(d) of the Articles of Agreement of the Association is attached (No. 3); PART V - ECONOMIC POSITION 18. A report, "The Current Economic Position and Prospects of El Salvador"(SEc_41-6272)was distributed on April 11, 1962. 19. El Salvador is one of the poorer countries of Latin America. Average per capita income is estimated at about $200, and has de- clined in recent years. Its distribution is very uneven. More than 70% of the population live under primitive conditions, and about 60g are illiterate. IWith a total area of only 8,061 square miles and a population of 2.6 million, population density (325 persons per square mile) is about the same as that of India. Average annual population increase (3.5%) is one of the highest in the world. Unlike most countries of Latin America, land resources are scarce and there is very little new land that can be economically brought into cultivation. El Salvador has no known mineral resources of any importance. 20. Despite poor natural conditions El Salvador has displayed a real capacity for economic growth when external conditions were favorable. Modern agricultural techniques have been adopted and yields are high. During the period of rising coffee prices, gross  - 5 - capital formation rose from 12% to 16% of GNP, and a considerable share of private sector profits were invested in production facili- ties which expanded and diversified the production structure, both for export and for domestic consumption. 21. El Salvador's financial position has been substantially weakened by the decline of coffee prices. Although the increase in cotton production in recent years has reduced her former complete dependence on coffee (89% of total exports in 1950), coffee still accounts for two-thirds of total exports and coffee and cotton to. gether for about four-fifths. Foreign exchange earnings from coffee have fallen by more than 50% since l957 and public revenues - dependent largely on foreign trade - have also substantially declined. To compensate for this decline the Government has drawn on the cash surpluses accumulated in the boom and has accelerated its effort to promote the production of other products. However, with earnings from coffee exports likely to decline even further, and with the possibility of further expansion of cotton limited by land resources, it will be difficult to increase foreign exchange earnings by more than 3 to 312% a year for the next 5 years. The long term growth of exports may be more favorable if the industrial sector, which already has a relatively capable entrepreneurial group, can be stimulated. 22. A more rapid expansion of the industrial sector is likely to require a rate of investment and capital goods imports well in excess of recent levels. El Salvador has the managerial and administrative talent to carry out an intensified program. While new tax measures have been introduced, El Salvador wrill have to depend to a greater extent than in the recent past on foreign loans to finance economic development. El Salvador enjoys very little room for maneuver since foreign exchange reserves are now at a very low level. 23. Service on existing debt is not high (6% in 1964), mainly because of the pruident policies followed by the El Salvador authori- ties in the period of the coffee boom. However, any increase in fixed debt servicing obligations in the decade ahead is likely to impose a considerable burden. In the last two years alone El Salvador has obtained loans amounting to $34 million. Borrowing at this rate would soon impose an undue burden for servicing if this borrowing were not being arranged, as some of it has been, on special terms. In addition to the proposed IDA Credit for highway construction, we are currently considering a telecommunications project requiring a loan of $8 million (foreign exchange cost) and expect soon to receive a power project (next stage of CEL program) which would require a loan of about $4 million. It is appropriate, in view of El Salvadorfs economic position, for the Bank and IDA to provide a blend of loans and credits.  - 6 - PART VI - COMPLIANCE WITH ARTICLT'S OF AGREEMNT 24. I am satisfied that the proposed development credit would com- ply with the Articles of Agreement of the Association, PART VII - RECOMMENDATIONS 25. I recommend that the Association make available a development credit to the Republic of El Salvador in an amount in various cur- rencies equivalent to $8 million for a total term of 50 years with a service charge of 3/4 of 1% per annum and on such other terms as are specified in the draft Development Credit Agreement and that the Executive Directors adopt a resolution to that effect in the form attached (No. 4). Eugene R. Black President IWTashington, D. C. October 24h 1962