Mexico - Small- and Medium-scale Mining Development Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 8663 PROJECT COMPLETION REPORT MEXICO SMALL AND MEDIUM SCALE MINING DEVELOPMENT PROJECT (LOAN 1820-ME) MAY 17, 1990 Trade, Finance and Industry Division Country Department II Latin America and the Caribbean Regional Office Thi document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may aOt otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENT Currency Unit - Mexican Peso 1985: US$ - PM 252 1986: US$ = PM 596 Average Exchange Rate for the Project 1981-1986: US$1 - 167.21 FISCAL YEAR Agencies of Government - January 1 to December 31 ABBREVIATIONS CFM - Comision de Fomento Minero (Commission for Mining Development) CRM - Consejo de Recursos Minerales (Board for Hinerales Resources Development) FM - Fideicomiso de Minerales no Metalicos Mexicanos (Trust Fund for the Development of Non-Metallic Minerals) NAFINSA - Nacional Financiera, Sociedad Anonima (National Development Bank) PECAM - Programa Especial Complem-nt;~rio de Apoyo a la Pequena y Mediana Minera (Special Complementary Program of Assistance to Small and Medium Mining) PEMEX - Petroleos Mexicanos, S.A. (Mexican Petroleum Company) SEMIP - Secretaria de Minas e Industria Paraestatal (Ministry of Energy, Mining and Parastatal Industry) SMM - Small and Medium Scale Mining  WTH W ORLD BANK FOR OFMCAuL USE ONLY Wahimgton. DC 20433 U.S A Oik.e d 0Ommtm-Gtwa 0_4wf lvawwn May 17, 1990 MEMORMADUM To THE EXECUTIVE DIRECTORS AND THE PRESIDENT SUBJECT: Project Completion Report on Mexico Small- and Medium-Scale Mining Development Project (Loan 1820-ME) Attached, for information, is a copy of a report entitled "Project Completion Report on Mexico - Small- and Medium-Scale Mining Development Project (Loan 1820-ME)" prepared by the Latin America and the Caribbean Regional Office. No audit of this project has been made by the Operations Evaluation Department at this time. Attachment ThiS document ha a test*icWd dihdbutios and may be used by teip,nu only in the pWefonuanwe of thei oc utwa Its contenu may not ohewse be dismed wthout World lank authumo.  VOlR OCIC USE ONLY PROJECT COMPLETION REPORT MEXICO - SMALL AND MEDIUM - SCALE MINING DEVELOPMENT PROJECT (LOAN 1820-ME) TABLE OF CONTENTS Page No. Preface ............................................. . ...... i Basic Data .............................. ................... ii Highlights .............................................................. vi I. PROJECT DESIGN AND OBJECTIVE Introduction .......................................... 1 Sector Background ........... ..... . ... .. 1 Project Objectives ........... ......................... 1 Project Description . .................................. . 2 Conclusions Regarding Setting Project Objectives ...... 3 Recommendations Regarding the Setting of Project Objectives . .............................. 3 II. INSTITUTIONAL ARRANGEMENTS AND PROGRAM COORDINATION Comision de Pomento Minero ....... . ......... . 4 Fideicomiso de Minerales no Metalicos Mexicanos ...... 5 Consejo de Recursos Minerales ........................ 5 Programa Especial Complementario para la Pequena y Mediana Mineria ................. . 6 Flow of Funds ................................ .............. 8 Subloan Approval Process .......... ............ # ...... 9 Technical Assistance Program ..................zu ...... 9 Summary ............................ .... . 10 III. UTILIZATION OF LOAN RESOURCES Background ........................................... 11 Overall Financing Plan ............................... 13 Uses of Project Funds ................................ 15 Size of Subloans . . ...... ....... . 15 Types of Enterprises . ............ . 16 PM Subprojects .................................... . .. 16 CRM Subprojects .......... ............. . 16 Summary of the Aggregate of PECAM I Operation ........ 16 Aggregate Economic and Social Benefits . ........ 6 Employment Generation ........................ ........ 17 Financial and Economic Rate of Return ................ 17 IV. LOAN PORTFOLIO PERFORMANCE CPM's PECAM Loan Portfolio ........................... 18 CRK/PECAM Loan Portfolio ............................. 18 This document has a ntrkled dWnbutbn and may be used by redpints only in f potfonmaw of thetr offlcnia duties Its contents may not othemie be disclood without Wodd halt authoiationf  TABLE OF CONTENTS (Cont-) Page No. FM's Loan Portfolio.................................. 19 Accounting and Financial Reporting...... .............. 19 V. SUHMAY OF PROJECT AND LESSONS LEARNED............... Project Objectives .... o...................o ....... 20 Project Execution ............. ........ o............ ... 21 Project Results.. ....... .......... - .... ... . 21 Some Lessons for the Future ......................... 22 ANNEX I - A Note on Statement of Project Objective ...... 24 ANNEX II Statistical Tables 26 ANNEX III - PECAN's Comments on the PCR 32 ANNEX IV - Response to the Borrower's Comments on the PCR 34  PROJECT COMPLETION REPORT MEXICO SMALL AND MEDIUM - SCALE MINING DEVmLOPMENT PROJECT (Loan 1820-ME) Preface 1. This report presents an evaluation of the results achieved under the Bank's first loan in support of Mexican small and medium scale mining (SMM), Loan 1840-ME. The US$40 million loan was intended to help advance SMM sector growth and a number of institutional objectives. The loan was made to the Nacional Financiera S.A. (NAFIN). The assistance and cooperation from the Government, the Borrower, the executing agencies and other enterprises, during the project completion mission, is greatly appreciated. 2. The Project Completion Report (PCR) was prepared by the Bank's Latin American and Caribbean Country Department II. The PCR is based on a review of the Staff Appraisal and President's Reports, loan documents, supervision reports, project files and the findings of a mission to Mexico in March 1989. It presents a factual review of the operations of the project (para 2.02), the extent to which the main objectives of the project were achieved (para 2.06), the uses to which PECAM program resources were put and the results of the investments made (para 3.05). A completion report prepared by PECAM was received from NAFINSA. However, the subproject data base presented in the PECAM report cannot be reconciled with the subproject data base for Loan 1820-ME, and an analysis of the outcome of a sample of 25Z of the subprojects financed under the loan, visualized as a centerpiece of the report, was not completed by PECAM. 3. The Project Completion Report has been reviewed by the Government, the Borrower and the participating agencies. Their comments on the PCR and suggestions for inclusions have been incorporated into the document as Annex TII. The Bank's observations on their comments are included as Annex IV.  m.3@X r4|t S1 2} * S f S@ L1I!! ; Ii F [jI1I;a  - iiu - CUJLAATIVE ESTIMATED AND ACTUAL DISSURSEMENT FY81 FY82 FY8$ FY64 FY66 FY68 FY07 FY88 Appraisal Estimt. (USS* million) 2.5 14.5 82.6 40.0 - - - - Actual (USS million) -- 4.6 5.0 18.1 16.0 82.4 82.6 81.4 bh Actual as X of Apprisl (M) 0 11.8 12.6 82.8 82.5 61.0 82.0 78.6 Dote of Final Disburements-: 12/19/88 Prolect Dat.. Original Plan Actual First Mention In Files - 10/01/78 Megoti ati n 02/11/80 02/11/80 Bord Approval 08/25/80 08/25/80 Signing (Loan Agreement Date) 08/18/60 08/18/80 WO.Wt 11/18/8C 09/25/81 Closing DOat 08/80/84 06/81/88 */ Reprsnit refund of a US21.4 million special account balance.  STAFF INPUTS FY79 FY80 FY81 FY82 F88 FY84 FY8 Fy88 FY7 TAL Identitficatlon/ Prep"erlon 25.08 29.05 54,18 Appreisal 22.16 22.15 Nebgeoltlons 8.02 8.02 Supervision 8.70 18.85 2.24 18.62 SS.66 8.80 2.42 87.18 TOTAL 60.25 29.05 8.70 18.86 2.24 16.82 85.56 8.80 2.42 1".48 OTHER PROJECT DATA Borrowers Nacional Financtiers, S.A. Executing Agencieso Comlsion de Fosanto Minero Consejo do Recurseo Minerales Fidelcosiso Mineral.. no Metalico. Mexicano. Follow-on Prolects: Name: bScond Smell and Medium Scale Mining Devolopment Project Credit Number: 256-ME Amount (USS million): 105 Approval Date: 10/16/85  SEIMSION MISSLON ATA Portor.mns. Prtfotance Te of p~ No. Per Total OM Snectalist Status Trend Proble 1ta 2 22 *,e a B n/d 12/8S X b 3 B 1 8/U 2 2 b,d ntr n/r n/d 6/64/ a 20 s*b,c, 2 2 M 9/U 2 a b,b 2 2 M TOTAL 6 o - evlronum f en er b - opertions offiear o - eos'inslet 4 - dlnistretive n/r - ratlng not prepare ft/d - ot df aind M - Manageme Problen UP Mission.  - vi - PROJECT COMPLETION REPORT MXCO SMAEL AND MEDIUM-SCALE MINING DEVELOPMENT PROJECT Loan 1820-ME HLMIGHTS 1. A loan of US$ 40 million to Nacional Financiera, S.A. for a First Small and Medium Hining Project was approved by the Bank's Board on March 25, 1980. The objectives of the project were very broad, and involved exploiting the full market potential of the mining sector, activating some of the least developed regions of Mexico, reversing the sector's slow growth of the 1970's, and generating employment especially among relatively low income groups. In order to carry out these objectives, the project was expected to financet (i) investment in SMM enterprises; (ii) the construction of beneficiation plants and laboratory facilities and the purchase of equipment for the parastatal executing agencies for the project; and (iii) training and technical assistance to the executing agencies. The Programa Especial Complementario de Apoyo a la Pequena y Mediana Hineria (PECAM), was created to manage the project through a coordinating committee supported by a technical secretariat. 2. Bank funds amounting to US$31.4 million were actually disbursed, along with the Government's counterpart contributions, amounting to an estimated US$34 million equivalent in Mexican pesos. These funds were channelled through the PECAM to the executing agencies, Comision de Fomento Minero (CFM), which finances small and medium scale metallic mining operations, Consejo de Recursos Minerales (CRM), Mexico's geological survey institute, and Fideicomiso de Minerales no Metalicos Mexicanos (PM), a trust fund that finances small and medium scale non-metallic mining. PECAM is a special program established for the promotion and coordination of SMM development, which operates as a second tier mechanism approving subloans submitted by CFM and FM for subsequent approval and financing by the Bank. Loan 1820-ME was appraised in September 1979 and approved in March 1980. It became effective in December 1980 after CFM's board and FM's technical committee adopted the PECAM guidelines. The project started slowly. Metal prices had declined sharply, investment demand was therefore limited, and interest rate problems emerged as inflation increased. As a result, loan comnitments were stopped in November 1981. An agreement between the Government and the Bank on interest re.q enabled disbursements to begin again in November 1982. Amendments we:_ subsequently proposed by NAhIN and agreed to by the Bank in December 1983 to replace the interest rate by a floating rate formula and to reduce excessively restrictive and complex loan covenants. 1 Other changes were also introduced to help speed 1/ The Loan Agreement provided for a highly directed credit, with quotas for each financial intermediary and for each type of financing (equipment, working capital, etc.), and the interest rate was fixed and tied to adjustments in the average cost of funds (ACF) index.  - ;vii - utilization oZ the loans a USS 3.5 million special account was established; the Bank's disbursement percentage was raised to a uniform 752 for all subprojects; detailed allocation criteria for different types of goods being financed were dropped and working capital financing was allowed, and CRM was permitted to act as a financial intermediary in lending for exploration programs. 3. As a result of the more flexible financing conditions, disbursements increased rapidly, and most of the loan Was disbursed in 1984-85. As no beneficiation plants were financed and no lease financing was granted, most disbursements involved lending for private sector development. More enterprises were financed (182) than had been estimated at appraisal (135), and the average subloan amount (US$ 280,000) was smaller than the appraisal estimate (US$ 393,000). indicating that the project was more successful in reaching smaller scale enterprises than had been anticipated during appraisal. As metal prices surged in 1984-85, a second SMH project, Loan 2546-ME, amounting to US$105.0 million, was appraised, and approved by the Bank's Board in October 1985. Bank and counterpart funds were scheduled to be channelled under similar institutional arrangements. Loan 1820-ME vas fully committed, but several large subprojects did not go forward, and the loan was closed in November 1986 and an undisburs d balance of US$8.6 million was cancelled. 4. Although the project was successful in channelling most of the loan for private sector SMM development, it suffered from serious flaws which hindered the achieving of other goals. Overall, its objectives were simply too broad to be achievable under the project design that was adopted. Also, they did not reflect constraints on further growth imposed by sector policies, nor was any attempt made to see if they were compatible with existing institutional objectives. Eventually, it became clear that the project's institutional structure was unsuitable for carrying out the project as designed. PECAM was never adequately managed or staffed to carry out its functions; it did not help train CFM, CRM and EM staff, nor did its subproject review lead to any improvement in the quality of the executing agencies portfolio. In addition, neither PECAM nor CRM had the capability to act as financial intermediaries, yet both assumed this role, with the Bank's concurrence, without a proper assessment of what would be needed to prepare them for this role. No system of project monitoring was established which might have been able to assess the impact of the project and to quantify the benefits derived from it, and PECAM failed to carry out a survey of a sample of project beneficiaries, which could have indicated if the project's objectives had been met. 5. One index of performance, is the status of loans made under the project. CFM has about 352 of its project related loan portfolio in non- performance status. PM's direct social lending under PECAM I is about 252 in arrears and CRM has collected on only a nominal percentage of overdue payments. For PM, direct social lending proved to be unsustainable and it became a second tier lending operation. CRM is no longer financing exploration programs, and CFM is moving toward replacing direct lending with second tier operations. While the original project concept proved not to be sustainable, the borrower has made pragmatic adjustments and will continue to provide needed credits to the sector which under the loan is estimated to have increased national mining sector capacity by about 72.  - viii - 6. On January 1, 1989, PM and CFM became a single consolidated operating entity and FM's competent managers and professional staff, who assumed overall responsibility for the merged enterprises have already taken important measures to improve CFM's administration and operations. It is expected that CFM/FM will replace PECAM and will emerge as a second- tier credit facility serving the wide-ranging development needs of the whole mining sector.  PROJECT COMPLETION REPORT MEXICO SMALL AND MEDIUM-SCALE MIMING DEVELOPMENT PROJECT Loan 1820-ME I. PIOJECT DESIGN AND OBJECTIVES Introduction 1.01 The project was identified in October/November 1978 by a Bank mining project preparation mission that evaluated the development potential of the small and medium miinng (SM) subsector and the quality of institutional support available. The project was prepared by the Government in cooperation with the Bank in June 1979 taking into account the findings of the earlier identification mission. The project was approved by the Bank's Board in March 1980, and became effective in December 1980. Sector Background 1.02 Mexico has a long tradition as a mining country and has a broad base of mine workers and well trained engineers and managers. This highly skilled mining labor force receives wages which are well below those of most other mining countries, helping to make Mexican labor costs in mining highly competitive by international standards. Tb-- .echnology of modern Mexican mining, both private (large and medium sized) and state owned also compares favorably internationally. Mexico's small scale mining subsector uses more labor intensive methods, but is also economically very competitive because of the high quality of ore that it exploits. The sector is denominated by large Mexican controlled private companies and by the state-owned enterprises (SOEs). These two groups control 901 of the output of the sector. Small and medium mining (SMK) controls the remaining 10?, with each of these subsectors producing about 52. Although the potential for further growth is considerable, sector policies impose serious constraints on growth of the sector. Existing mining legislation seriously impedes foreign investment, because it constrains foreign shareholding and management control of mining enterprises. It also restricts access of private investors to mineral deposits in reserved areas, requires very lengthy and cumbersome procedures for obtaining concessions coupled with minimal requirements for developing them, and imposes an outmoded mining taxation system on potential Investors. (See Annex III for Borrowers's comuents on recent policy. Prolect Obiectives 1.03 The loan was defined as an important component of a broadly based government initiative to develop SMK. The centerpiece of this initiative, which the Bank helped to formulate, was the PECAN Program. The objectives of the project (and of PECAM) wera very broad and generally of a sector- wide nature, (Annex 1, page 1). Specifically, these objectives were to: (i) exploit the full market potential of the mining sector; (ii) activate some of the least developed regions of Mexico; (iii) reverse the sector's slow growth of the 1970's; and (iv) generate employment, especially among relatively low-income groups.  Project Description 1.04 The project as approved by the Board on March 25, 1980, was designed to provide investment finance: (a) through CFM and FM for the equipment and working capital needs of viable SMM enterprises for the purposes of mine preparation, extraction and the beneficiation/ concentration of minerals; (b) through CFM and FM loans for evaluative exploration on a shared risk or a secured risk basis; (c) the construction by CPM and FM of regional beneficiation/concentration plants to expand SMM access to such facilities; and (d) technical assistance programs to helps (i) expansion of CRM's assistance to SM0 through the acquisition of additional exploration equipment, expansion of laboratories and training of professional staff; (ii) training of CPM and FM professional staff in subproject evaluation, supervision and control, and the expansion of CFM and FM laboratory facilities in about four regions; and (iii) improvements in the quality of technical advise and laboratory assistance provided by CFM, CRM and FM to SMM clients. 1.05 PECAM, a coordinating body establiched within the Ministry of Energy, Mining and Parastatal Industry (SEMIP) to promote the SMM development initiative and to coordinate policy and procedures for the three agencies that would channel resources (paras 2.10-2.15), was considered an essential component of the project. PECAM would also serve as a credit committee with responsibility for review and approval of all subprojects over MP10 million, equivalent to US$417,000 at the time of loan effectiveness. 1.06 The loan was made to NAPINSA, the government development bank acting as the borrowing agent for the government. It was expected that the loan of US$40 million would be used to financet Mi) 130-140 subloans to SM through CFM and PM to finance machinery, equipment and civil works;1 (ii) 150-200 long term equipment leases with options to buy; (iii) construction of 10 regional beneficiation plants; and (iv) purchase of laboratory equipment by CFM, CRM and FM end exploration equipment by CRM. Local cost financing for working capital and ore reserve development were not initially included as the Bank was concerned about not financing more than the estimated foreign exchange content of the project. On that basis, 1/ Small and medium mines were defined as follows: Small mining enterprise had annual production not more than MP20 million (t1S$835,000 equivalent at the time of loan approval) with beneficiation capacity of not more than 100 tons per day (TPD) for metallics and 150 TPD for non- metallic minerals. Medium mines were defined as having an annual production of not more than MP150 million (US$6.3 million at the time of loan approval) with physical capacity of beneficiation plants not to exceed 800 TPD. The production values were to be adjusted periodically for foreign exchange variations for selected baskets of minerals.  - 3 - the loan was expected to cover up to 452 of machinery and equipment costs and 252 of civil works construction of buildings and mine development. Conclusions Regarding Setting Proiect Objectives A. The first three of the four project objectives overstated the potential development impact of this initial SMK lending effort, given: (i) the small size of the loan and the limited segment of the industry it could be expected to serve; (ii) the absence of a significant policy content and provisions for comprehensive institutional reform; and (iii) the lack of significant technical assistance efforts directed to the least developed SMH regions. B. While the fourth objective, to generate employment especially among the lower income groups', was a more manageable objective under the loan, to fully achieve this goal would have required that special mechanisms be established to promote such lending among artisan miners and that special technical assistances measures be taken to fully complement the lending efforts. The project provided neither the specific promotion nor the technical assistance support required and FM's efforts to support small producer cooperatives did not meet with success (para 4.04). Also, the project design failed to take into account the potential environmental impact of the project. C. The project design did not provide for an institutional mechanism for setting operational goals or for measuring the degree of achievement of project objectives. In the final analysis, most project objectives remained statements of intentions essentially unlinked to the design of the project. Had better focussed efforts been made during project design to analyze whether the loan amount and institutional mechanisms established were sufficient to achieve the hroad project objectives, the range of objectives would likely have been more modest in nature and more achievable. Recommendations Regarding the Setting of Proiect Obiectivess 1.07 During appraisal, a review process should have been established to ensure thatt (i) project objectives were realistic in terms of what could be achieved within the scope of the loan and under existing sector policies; (ii) project objectives had been framed as statements of purpose and management intent, rather than as broad generalities; (iii) the design of the project would be adequate to support the achievement of each project goal through specific inclusion of the necessary policies, adequate technical and supervisory support and that the linkages between the proposed project design and objectives had been made explicit; and (iv) periodic monitoring of the project's objectives by its management would ensure that it was moving toward its goals. 1.08 All SARs should include a section on the specific steps that would be taken to monitor project impacts and such monitors should be in place at the outset of the project. Thus, quantitative information on achievement of realistic project objectives and benefits would be gathered as the project advances, to guide management and measure project achievements.  -4- II. INSTITUTIONAL ARRANGEMENTS AND PROGRAM COORDINATION 2.01 To remedy the lack of access by small and medium mining enterprises to bank financing, the Government had established credit facilities within CPM to finance metallic mining and in FM to finance non- metallic mine development. CRM would provide geological survey and exploration services on a fee, credit or percentage of recovery basis. The Bank loan vas designed to integrate these three entities into a broad ranging program to finance the investment requirements of the SM0 sector, under the coordination and direction of a newly formed second-tier assistance unit (PECAM) created within SEMIP (para 2.09). The Comision de Fomento Minero 2.02 CFM was created in 1938 to advance the development and exploitation of Mexico's mineral potential. Its corporate objectives are tot Mi) serve as a holding company on behalf of the Government for investments in mining and related companies and as an executing agency for large-scale projects in the public sector, (ii) develop mining by providing concessional financial assistance to private or mixed-ownership, small and medium-scale mining enterprises, (iii) operate regional beneficiation and other plants designed to process minerals produced by medium and small private mines, and (iv) provide technical assistance to mining enterprises, mostly of medium and small size. CFM's main policy-making body is its Board of Directors, which is headed by SEMIP and includes representatives of the Ministries of Finance and Public Credit and of Commerce, NAPINSA and the private mining industry. At appraisal, CGM maintained twelve regional offices throughout Mexico to provide technical assistance and eight promotion offices. CPM had a staff of 234 professionals, about half of which were stationed in its field offices. CPM's management and staff were considered to be adequately qualified, competent and well-motivated for its tasks, which included operating affiliated companies, mainly mines, beneficiation plants and its credit facilities (para 2.28). 2.03 Up to the mid-1970's, CPM emphasized its roles as a holding company for the Government in mining-related enterprises, and as a promoter of mining projects in the public sector. CFM's financial assistance to private SMM had been small until then, although its regional beneficiation plant and technical assistance services were valued instruments of support to SMl. Starting in 1975, CFM gave greater emphasis to its credit program in support of SMM. Annual approvals of credit and leasing operations during 1978 and 1979 amounted to about US$26 million equivalent, more than twice as high as during the three year period 1975-1977. CFM expected to increase the value of financial commitments to the sector by 30 percent annually between 1980 and 1982. To undertake this task, CFM was to strengthen its policies and procedures for project and credit evaluation and for project supervision and portfolio control. The loan, as it finally developed, provided only nominal support or assistance to CFM's credit operations as CPM's capability to operate a multi-branch development finance institution was substantially overestimated and PECAM's capacity to implement technical assistance and training activities proved to be minimal (para 2.11-2.13).  - 5 - Fideicomiso de MLinerales no Metalicos Mexicanos 2.04 FM was established in 1974 as a Government trust fund adminlstered by NAPINSA to stimulate exploratLon, exploitation and marketing of non- metallic minerals in Mexico. It was considered that a separate organization was required because the mining, processing and marketing of non-metallics is different from that of metallic minerals and because deposits of these minerals frequently occur in eiidos land,2 presenting special mining and other legal problems associated with joint ownership. pHes objectives are to promote the production of non-metallic minerals by assisting the private sector and ejidos through credit, technical assistance, creating infrastructure and, when necessary, taking the lead in carrying out projects. 2.05 When PM started operations in 1976, it concentrated on establishing and operating mining companies to carry out projects LdentLfied by the Government as having high priority. The volume of its credit operations for non-affiliated companies amounted to a low US$2.2 mlllion (equivalent) up to 1980. In compliance with the Government's desire to extend support to small and medium mines, PM planned to expand its credit operations and to start equipment leasing. The latter was expected to fill an important need, particularly for small mining enterprises which were unable to obtain financing for equipment because of an insufficient credit record. PM also considered diversification of its operations to include the installation of regional beneficiation plants. It was expected that this function would enable it to offer services in the non-metallic mineral field parallel to those provided by CFM in the metallic mineral sector. 2.06 FM is governed by a Technical Committee headed by SEMIP and Includes representatives of the Ministries of Finance, Commerce and Programming and Budgeting, CFM and NAPINSA, and other concerned Government departments. FM's management and staff of 52 professionals were correctly judged to be reasonably well prepared, competent and suitably motivated. PM was to carry out training programs to improve its professional staff's skills in project evaluation and control, financial analysis and management. Its socially oriented direct lending to eildos turned sour as loan arrears mounted. At about the mid-point of the loan implementation period, PM's management decided to stop direct financing and moved toward second-tier lending operations through commercial banks. It concentrated Lts external resources on second-tier operations and reserved selected Government resources for its diminished, more political and higher risk social lending operations. Conseio de Recursos Minerales 2.07 CRM was created in 1957 as a decentralized agency operating under SEMIP to carry out geological surveys, exploration and mineral evaluation programs and to advise the Government on various aspects of mining development, such as the establishment of National Mineral Reserves, the granting of concessions, and on all matters related to the exploration, exploLtation and preservation of mineral resources. Promising deposits are turned over to CFM or PM for exploitation. CRM also provides geological 21 Blidos are cooperatives created under the agrarian reform laws.  advice and services to mining enterprises in the private sector through its field offices and technical assistance through its laboratories. The latter provide assaying services and carry out mineralogical studies, for a fee. It also contracts to undertake exploration programs for a fee or on a risk-sharing equity investment basis. CRM's operations are directed from its head office which moved to Pachuca from Mexico City in late 1988. Three quarters of its staff are presently based at 27 regional offices distributed throughout the country; it employs about 625 professionals, more than half of whom are geologists. Programa Especial Complementario para la Peauena y Mediana Mineria 2.08 PECAM is headed by a Coordinating Committee established within SEMIP to coordinate the activities of CFM, FM and CRM under the program. The Coordinating Committee, which consists of the Subsecretary of SEMIP and representatives of the Ministry of Finance and Public Credit, NAFINSA, CFM and FM, sets policy for PECAM and serves as a credit committee to approve subloans submitted by CFM and FM to PECAM for its approval. The Coordinating Committee is in turn served by a Technical Committee which administers the PECAM directorate. PECAM functions as a second- or third- tier financial facility with substantial overall authority in implementing the program by modifying procedures, managing funds flow, and approving all subprojects (for all loans more than MP10 miliion and at PECAM's discretion for smaller loans). PECAM also was granted responsibility for training CFM and FM staff in project identification, appraisal and supervision. 2.09 The SAR stated that PECAM would, in the future, be adequately staffed to perform its second-tier functions of subproject review and approval, and to provide technical assistance to the executing agencies on financial, credit or administrative matters. However, the Bank's expectations with respect to the quality of performance of PECAM's contract staff were not fulfilled (para 2.13). Finally, the SAR did not clearly established the logic or the necessity of setting up a second-tier development banking facility within SEMIP or the rationale for placing this development banking responsibility under the technical leadership of SEMIP's General Directorate of Mines and Metallurgy.3 2.10 In line with the regulations and function approved for PECAM (Annex 5, SAR) the following organizational structure emerged for the PECAM operations 3/ The President's Report differed from the SAR and did not fully reflect the important role that PECAM was expected to play in the project.  -7- PECAM Coordinating Committee Pres. Subsecretary of Mines & Energy - Policy Rep. Secretary of Hacienda & Credit - Credit Committee NAPINSA (approval of subloans) FM . 1 1 - Appraisal and Approval Technical Committee of Subprojects Subsecretary General - PECAM - Technical Studies for PECAM - Data Base & Coordination with NAFINSA - Channel for Program Funds - Liaison with Bank Director - PECAM : _ _ __ I Subdirector - P'".AM Proiect Withdrawals and Evaluation Dept Records Dept -Chief -Chief -Prof. Staff -Prof. Staff -Support Staff -Support Staff PECAM consisted of about 10 professional and support staff. With the ezepction of the Director and Subdirector, most of the professional staff was hired on a temporary basis, with no tenure or other incentives to build up a corps of motivated and efficient professionals. 2.11 PECAM, acting as a second-tier facility for CFM's and FM's direct operations, and as a third tier facility for FM's operations with commercial banks, reviewed 19 "Al subprojects (i.e. subprojects above the subloan *free limits of US$400,000) submitted by CFM and 18 'A' subprojects sent by FM. Prior to presentation to PECAM, CFM's Credit/Technical Committee had to approve subprojects. In the case of FM's second-tier operations, both the commercial banks and FM's credit committees had approved the subprojects prior to their submission to PECAM's Technical  - 8 - Committee. In line with its interpretation of regulations, PECAM's staff reviewed the credit application/appraisal reports and rewrote the loan application/appraisal documents and presented their interpretation of the subproject to the Technical Committee and then to the Coordinating Committees for its consideration. Under the multi-layered approval procedures established, the total approval-to- reimbursement process averaged about three months to complete ("B' projects took a little less time and "Al subprojects, which needed to be approved by the Bank, took a little more time). 2.12 Flow of Funds. The management of project funds illustrated the complexity of the system established to manage a single FM transaction. 1) H}>">Contral Dank of Meaxco (#l)S ) )) . (Borrower) 2) <(Request. funds for Project "Am(( <(-National Trasury (NT) Special (C (Countrpart Funds) Loon Account > )>) Special Funds >>NAFISA snds CFI Tr"sury check for Projct 'A'>> >>Sends 'AO subprojot for approval>> ))>>> -Approves 'A' FM )) )>) PECAN I Subprojoct (($Snde check for *A<(( -Advises CFN Tressury to pay FM <<Sends Advise on Report CFP CRU of Counterpart from NT<( ireausury Project unit D pertment ) CFM Project Unit - Speciol Counterpart funds relesed to aenceos In accordane with a fined schedule. - CFP Treasury rec lved advise on *aI recelpt. of counterpart fund. - Upon repaymnt, Principel and Interet wont to PECAN'. Speciol Fund. While the SAR contemplated that NAFINSA would channel funds directly to CFM, CRM and PM, reality was more complex as PECAM ultimately became involved as the agency of financial control, using CFM's treasury department as its financial agent.  -9- 2.13 Subloan Approval Process. As the project was implemented, PECAM took control over the pace of subloan approvals and flow of funds. At the outset of the project it was contemplated that the specific approval of PECAM would be required for all investment operations of over MP10 million (then about US$417,000 equivalent). However, PECAM had authority to review a selective sample of smaller subprojects and it decided to exercise this authority and reviewed 80 of the total of 94 subloans which exceeded US$200,000. For most subloans, PECAM staff reappraised and presented a new report to the PECAM Coordinating Committee, which met approximately once a month as the senior credit committee. PECAM was never staffed to serve as an advisory agency to the CFM or FM, as was contemplated in the design of the loan. Rather, it became simply another processing layer. 2.14 There is no evidence to conclude that PECAM's subproject review procedures led to any improvements in the quality of CFM's or FM's loan portfolio. Indeed, a Bank supervision mission during 1984 found that PECAM's interventions in the subloan review processes were inadequate and a major bottleneck to the reactivation of Loan 1820-ME. In late 1984, a Bank follow-up supervision mission proposed that PECAM's expanding role as the central agency responsible for the operation of the loan be reduced. The mission reported that PECAM had emerged as la political and bureaucratic 'institution' that neither has the capability nor the staff to centralize decision-making and program actions.' The mission proposed that PECAM accept a reduced role as advisor. To speed up disbursements the Bank's mission proposed, 'in view of the poor technical capability of its (PECAM's) staff and its administrative inadequacies," that PECAM's role in the subproject review cycle be substantially reduced. 2.15 It was never clearly defined how PECAM's technical secretariat, that consisted of a temporary contract staff of geologists and economists (no bankers), located within the General Directorate of Mines and Metallurgy in the mining subsecretariat, could be expected to provide technical leadership to a credit project. During 1982-88, PECAM's leadership turned over some four times and its contract staff also changed frequently. It became clear that PECAM could not positively assist the implementing agencies because they did not have qualified financial professionals to do the job. 2.16 In September 1984, a Bank supervision mission presented a well- documented proposal to reduce PECAM's bureaucratic impediments to more efficient project operations by cutting back on PECAM's operational responsibilities, but this was not acted upon, and under a Second Small and Medium Mining Project, PECAM was granted even greater operational authority, making it responsible for managing a technical assistance program designed to improve the overall technical quality of CFM's and FM's credit operations. 2.17 The Technical Assistance Program (TAP) for Loan 1820-ME contemplated total disbursements of MP235 million (equivalent to about US$9.5 million at loan signing). Of that amount the Government would provide 582 and the Bank 42Z. In line with the perceived needs of the project at time of appraisal, 93.7? of total TAP funds were allocated for procurement of laboratory and exploration equipment and a nominal 6.32 was dedicated to consulting services and training. Almost 66T of total TAP funds were earmarked to upgrade CRMI's geological survey and exploration  - 10 _ activities while only 22 of total TAP funds were dedicated to training CFM or FM staff that would be engaged in the credit operations. This clearly proved to be an inappropriate allocation of TAP resources. Technical assiatance proved to be mainly budgetary support for equipment purchases and largely ignored the institution building needs of the executing agencies until 1984. 2.18 The SAR substantially missed the mark in its assessments of the capabilities of CFM's and FM to rapidly and efficiently expand their SMM credit operations. A large amount of work was devoted to the preparation of operating guidelines for CFM and FM which could have formed the basis for a detailed evaluation of, inter alia, actual operating procedures and managerial functions, accounting policies and branch coordinating mechanisms. In the end, much of these detailed operational and managerial control mechanisms proved to be inadequate or incorrect, at least in-so-far as they related to credit operations. Thus, the TAP was inadequate to address the wide range of staff and management training requirements and to implement the policy and procedural changes that would be required to advance the program in line with expectations. Loan 1820-ME sharply underestimated human resources training needs and overestimated the ability of CFM to organize itself and its widespread branch network to carry out a program of for-profit lending based upon strong portfolio performance and loan recovery. The SAR also overestimated the capability of SEMIP to mount a second- and third-tier discount facility (PECAH) that would be capable of helping CFM and FM to become efficient and effective development lending institutions, and under Loan 1820-ME little technic&a assistance support was provided for PECAM so that they might learn to efficiently operate as a second- and third-tier credit facility. 2.19 Summary: During 1983-1984 the Bank mounted a determined supervision effort and reappraised CPM's capabilities, defined managerial and communication problems and launched a series of technical assistance programs to resolve the problems identified. As a result of these efforts, in October 1983, effectiveness of the proposed loan amendments were conditioned on the formal approval by Mexican authorities of a satisfactory Project Execution Document highlighting the following points to be executed by PECAM and its participating institutions (CRM, PM and CRM) as followst (a) development of a collective action program to advance the project; (b) implementation of a promotional and technical assistance program with a more active involvement of the regional offices of CFM, FM and CRM; (c) establishment of a personnel development and training program; (d) implementation of a portfolio control and financial information system; and (e) establishment by mid-1984 of a program of assistance to PECAM staff to help them to plan and program credit operations and to increase their managerial, administrative and promotional skills. On that basis, it was expected that there would be more rapid disbursement by CFM and FM of funds for higher quality projects. Technical training and consultative planning efforts were undertaken in 1985 but were too little and too late to have any real impact upon the outcome of the project. Preparation and execution of Loan 1820-ME was flawed in that it did not provide for substantial training of CFM, FM and PECAM staff prior to and during early project Implementation stages. 2.20 Regarding CPM, the design of the project did not adequately take into accounts (i) the relatively low level of banking skills available in  - 11 - CFM, which should not have been surprising given its historic orientation and its staffing as a mining company; (ii) the lower than adequate levels of credit management experience and the absence of financial and accounting skills in the area of banking; (iii) the high degree of difficulty inherent in building an efficient decentralized development finance organization that would be staffed mainly by professionals oriented toward mining technology and mill operations; and (iv) the fact that CFMas credit philosophy was socially oriented and that it had no policy or concept in support of profitability or cash management. Thus, unlike the credit operations of a bank, there was no professional accountability in CFM for bad loans approved or for financial losses sustained. III. UTILIZATION OF LOAN RESOURCES Background 3.01 The implementation of Loan 1820-ME started slowly in 1981, and disbursements were less than 202 of the expected levels as of December 31, 1982, in large measure due to the program's inability to fully comply with the loan's interest rate covenant. According to an amendment to the Loan Agreement on January 16, 1981, peso-denominated sub-loans would bear fixed interest rates whose average would equal the average of ACF (average cost of funds to the banking system) for the preceding twelve months, plus 1.5 percentage points. Rates would be adjusted whenever the ACF index for the three consecutive months differs by at least three points from the twelve- month average ACF used for the previous adjustment, but at least once a year. Between November 1981 and September 1982, the ACF index was not adjusted by the Government, and PECAM was therefore not in a position to comply with the interest rate covenant and, therefore, voluntarily refrained from presenting subloans for Bank financing. An agreement between the Bank and the Government on interest rates for a six-month period which brought the rate established under the project into line with the ACF, enabled PECAM to present withdrawal applications between September 1982 and February 1983. 3.02 Although the interest rate problem was resolved by September 1982, because of sharp declines in international metal prices, demand for credit had dried up. In early 1983, subproject presentation to the Bank stopped once again because of lagging interest rate adjustments. This difficult problem was once again resolved on the baais of close coordination between NAFINSA and the Bank, but, as the project had applied almost all of its counterpart funds to keeping the program going while the Bank funds were not available, PECAM ran short of funds to cofinance subprojects under the Bank loan. 3.03 Against this background of stop and go, the Bank and NAFINSA negotiated several major changes in the project which were adopted under an agreed Project Execution Document (PED) whose submission to the Bank, in acceptable form in October 1983, was a condition of effectiveness of the Special Action Program (SAP) designed to restructure the loan. To speed project lending activities the PED provided for the following: (i)  - 12 - strengthening of regional offices of the executing agencies and their preparation of plans and promotion programs to increase lending and technical assistance activity; (ii) selected changes in the organizational structures of the PECAM institutions; (iii) manpower training programs for PECAM and the executing agencies; and (iv) development by the PECAM institutions of needed information systems and computer processing capability to provide their managements with operational and financial information. 3.04 An interim fixed interest rate adjustment formula was also agreed to, which would be replaced by a floating rate formula. In line with Government policy to direct credits to sectors using interest rate incentives, interest rates for loans to metallic mineral operations were set at 402, and non-metallic are 432 and 57Z, depending upon geographic location. The interest rate on equipment leasing was set at 602. Given the interest rate bias in favor of borrowing and lack of institutioual preparation in this special area of activity the loan's leasing component never got off the ground. 3.05 Additional steps implemented under the SAP to improve loan implementation and help accelerate disbursement were the followings (i) a US$3.5 million revolving fund (special account) was established; (ii) the Bank's disbursement percentage was raised to an appropriate uniform level of 75X for all subloans from the restrictive 452 for equipment and 25Z of civil works; (iii) detailed allocation formulae for loan funds under which maximum lending limits were set for equipment, civil works, technical assistance, etc., were dropped; (iv) working capital was made financiable under the project; and (v) CRM was permitted to participate as a financial intermediary. Items (i), (ii), (iii) and (iv) removed unwarranted restraints on lending that had been established by the Bank under the initial project design. The aggregate financing limit (i.e., that the Bank not provide more than 502 of total project financing) was not surpassed as a result of raising the percentage of subproject financing restriction (para 3.03 (ii)] as the Bank financed only about 432 of total project costs (Table 1). The notion to declare CRM, Mexico's institution for geological survey, a financial intermediary (item v) proved to have its problems, as CRM's capability to serve as a credit facility was neither appraised nor assisted, and the idea that exploration lends itself to high interest non-guaranteed lending, was never the subject of a careful review that was warranted. 3.06 CRM's management was not equipped to supervise a credit operation, which is reflected ia the fact that as of mid-1988 total interest and principal due under its exploration loans amounted to almost MP774 million of which only MP50 million was repaid. Regarding the financing of initial exploration, normally such operations are too risky to be the subject of a loan. Generally, in both independent mining and petroleum operations, they are financed as risk capital ventures.  - 11 - CFM, which should not have *een surprising given its historic orientation and its staffing as a mining company; (ii) the lower than adequate levels of credit management experience and the absence of financial and accounting skills in the area of banking; (iii) the high degree of difficulty inherent in building an efficient decentralized development finance organization that w:uld be staffed mainly by professionals oriented toward mining tectinology and mill operations; and (iv) the fact that CFM's credit philosophy was social7y oriented and that it had no policy or concept in support of profitability or cash management. Thus, unlike the credit operations of a bank, there was no professional accountability in CFH for bad loans approved or for financial losses sustained. III. UTILIZATION OF LOAN RESOURCES Background 3.01 The implementation of Loan 1820-ME started slowly in 1981, and disbursements were less than 20S of the expected levels as of December 31, 1982, in large measure due to the program's inability to fully comply with the loan's interest rate covenant. According to an amendment to the Loan Agreement on January 16, 1981, peso-denominated sub-loans would bear fixed interest rates whose average would equal the average of ACF (average cost of funds to the banking system) for the preceding twelve months, plus 1.5 percentage points. Rates would be adjusted whenever the ACF index for the three consecutive months differs by at least three points from the twelve- month average ACP used for the previous adjustment, but at least once a year. Between November 1981 and September 1982, the ACF index was not adjusted by the Goverxnent, and PECAM was therefore not in a position to comply with the interest rate covenant and, therefore, voluntarily retrained from presenting subloans for Bank financing. An agreement between the Bank and the Government on interest rates for a six-month period which brought the rate established under the project into line with the ACF, enabled PECAM to present withdrawal applications between September 1982 and February 1983. 3.02 Although the interest rate probl'm was resolved by September 1982, because of sharp declines in international metal prices, demand for credit had dried up. In early 1983, subproject presentation to the Bank stopped once again because of lagging interest rate adjustments. This difficult problem was once again resolved on the basis of close coordination between NAFINSA and the Bank, but, as the project had applied almost all of its counterpart funds to keeping the program going while the Bank funds were not available, PECAM ran short of funds to cofinance subprojects under the Bank loan. 3.03 Against this background of stop and go, the Bank and NAFINSA negotiated several major changes in the project which were adopted under an agreed Project Execution Document (PED) whose submission to the Bank, in acceptable form in October 1983, was a condition of effectiveness of the Special Action Program (SAP) designed to restructure the loan. To speed project lending activities the PED provided for the following: (i)  - 12 - strengthening o' regional offices of the executing agencies and their preparation of plans and promotion programs to increase lending and technical assistance activity; (ii) selected changes in the organizational structures of che PECAM institutions; (iii) manpower training programs for PECAM and the executing agencies; and (iv) development by the PECAM institutions of needed information systems and computer processing capability to provide their managements with operational and financial information. 3.04 An interim fixed interest rate adjustment formula was also agreed to, which would be replaced by a floating rate formula. In line with Government policy to direct credits to sectors using interest rate incentives, interest rates for loans to metallic mineral operations were set at 402, and non-metallic are 43? and 57?, depending upon geographic location. The interest rate on equipment leasing was set at 60%. Given the interest rate bias in favor of borrowing and lack of institutional preparation in this special area of activity the loan's leasing component never got off the ground. 3.05 Additional steps implemented under the SAP to improve loan implementation and help ac-elerate disbursement were the following: (i) a US$3.5 million revolving fund (special account) was established; (ii) the Bank's disbursement percentage was raised to an appropriate uniform level of 75? for all subloans from the restrictive 45% for equipment and 25? of civil works; (iii) detailed allocation formulae for loan funds under which maximum lending limits were set for equipment, civil works, technical assistance, etc., were dropped; (iv' working capital was made financiable under the project; and (v) CRM was permitted to participate as a financial intermediary. Items (i), (ii), (iii) and (iv) removed unwarranted restraints on lending that had been established by the Bank under the initial project design. The aggregate financing limit (i.e.. that the Bank not provide more than 50? of total project financing) was not surpassed as a result of raising the percentage of subproject financing restriction [para 3.03 (ii)] as the Bank financed only about 432 of total project costs (Table 1). The notion to declare CRM, Mexico's institution for geological survey, a financial intermediary (item v) proved to have its problems, as CRM's capability to serve as a credit facility was neither appraised nor assisted, and the idea that exploration lends itself to high interest non-guaranteed lending, was never the subject of a careful review that was warranted. 3.06 CRM's management was not equipped to supervise a credit operation, which is reflected in the fact that as of mid-1988 total interest and principal due under its exploration loans amounted to almost MP774 million of which only MP50 million was repaid. Regarding the financing of initial exploration, normally such operations are too risky to be the subject of a loan. Generally, in both independent mining and petroleum operations, they are financed as risk capital ventures.  - 13 - 3.07 On the basis of the October 1983 agreement, the Closing Date was extended to December 31, 1986 (the loan was actually closed on May 31, 1986), and the foundation for reactivating Loan 1820-ME was firmly established. With the financial structure of the loan more flexible, the mining sector and participating commercial banks were presented with a more attractive loan product and despite the subsequent problems that emerged as a result of PECAM's institutional inadequacies (paras 2.12-2.15) US$27 million in loan funds were disbursed over tae next 28 months. Overall Financing Plan4 3.08 The outcome of Loan 1820-ME proved to be different from what had been initially expected with respect to the level, distribution and end uses of loan funds. Total subproject financing amounted to an estimated US$73.3 million (equivalent) for 168 mining projects (excluding CRM procurements) compared with the US$122 million expected for 222 subprojects by the SAR. Both the Bank and the Government's potential contributions to the project were under-utilized. Although the entire Bank loan was fully committed, several large subprojects did not go forward, and the Bank cancelled US$8.6 million in unutilized funds. The Government used portions of its counterpart to finance about 15 subprojects to maintain project continuity when Bank funds were not available. Had counterpart and Bank funds been used on an equal percentage basis for all of the subprojects financed under PECAM I, the first phase of PECAM I total project size could have reached about US$125 million as the borrowers, intermediaries and suppliers contributed more to subproject financing than was expected (Table 1). 3.09 Of the US$73 million total project financing under Loan 1820-ME, PECAM (CFM, FM and CRM) financed 68? of the total. The Bank's loan provided for 43? of total resources instead of the hoped for 5O while Government counterpart accounted for 25S. Sub-borrowers contributed 252 to total investment and financial intermediaries and suppliers credits accounts for the final 7X. The Bank's estimated project plan (Table 1) postulated a larger project (US$122 million vs. US$73 million actual), that would be very highly leveraged (about 8 to 1), with no contributions by financial intermediaries or by suppliers and US$55.4 millicn by the Government, US$32.6 million by the Bank and US$12 million by the borrower. The very high leverage ratio, implicitly assigned to the project was not questioned during project preparation, and should have been. As it turned out the borrowers leveraged their project financing on a 3 to 1 basis. This was not as high as contemplated, but it was high enough to make subloans highly vulnerable to project implementation delays and to any negative mineral price trend. Highly leveraged financing may have 4/ PECAM prepared a Project Financing Plan for PECAM I (see PCR files) which reports that total financing equalled US$107 million, including the use of US$40 million in Bank funds. It appears likely that these data were prepared based on the subloan commitment documents, not on an actual disbursement basis. It also appears to include, under PECAM I, subloans financed with Government funds only duriag the periods of the loan when Bank funds were not being committed. The PCR's data base defines the project size on the basis of disbursements and includes where possible the subprojects in which the Bank participated.  - 14 - PROJECT COMPLETION REPORT MEXICO LOAN 1820-ME TABLE 1 Project Financing Planh/ (million of US$) APPRAISAL ESTIMATE2/ CPH CXM FM Total 2 Total Z Sub-borrowers 6.5 - 11.7 18.2 24.8 15.0 12.0 Govt Contribution 10.0 1.1 7.1 18.2b/ 24.8 67.0 55.4 World Bank 11.7 3.3 16.3 31.3 42.7 40.0 32.6 Fin. Intermediary - - 3.2 3.2 4.4 - - Suppliers/Other 2.4 - - 2.4 3.3 - - Total $30.6 $4.4 $38.3 $73.3 100.0 122.0 100.00 No. of Subloans 74 50a/ 94 218 Sources% World Bank, CFH, CRM, FM and PECAM Audit Reports 1, US dollar values of contributions to the financial plan for all participants except the World Bank are estimates based upon conversions into dollars of peso loan values. The estimates of FM participation are converted from the peso values presented and are consistent with Bank data. The estimates prepared by PECAM and by CPH vary substantially from Bank data. PECAM estimated that the Loan financed 222 mining projects and 42 PECAM infrastructure projects with a total value of USS 107.3 million. CFH reported that their subprojects had a total value of US$44 million of which the World Bank financed US$22.6 million. US$11.7 million is the actual amount of Bank disbursements for CFM subprojects. 2/ The SAR does not provide a standard project financing plan. Estimates were derived from the SAR that estimated total project size to be US$122 million. Subborrowers were estimated as providing for about 20Z of total financing or US$24.4 million. This would not be feasible as the difference between the SAR's estimate of US$107 million of Bank and Government total contributions, and the SAR's estimated total project financing of US$122 is equal to US$15 million or 12Z of projected total. a/ CRM reported 50 subloans of which 36 were for individual procurements of laboratory equipment. bl The Government contributed an equal amount in its financing of about 100 additional PECAM projects during 1981-86.  _ 13 - 3.07 On the basis of the October 1983 agreement. the Closing Date was extended to December 31, 1986 (the loan was actually closed on May 31, 1986), and the foundation for reactivating Loan 1820-HE was firmly established. With the financial structure of the loan more flexible, the mining sector and participating commercial banks were presented with a more attractive loan product and despite the subseque'nt problems that emerged as a result of PECAM's institutional inadequacies (paras 2.12-2.15) US$27 million in loan funds were disbursed over the next 28 months. Overall Financing Plan4 3.08 The outcome of Loan 1820-HE proved to be different from what had been initially expected with respect to the level, distribution and end uses of loan funds. Total subproject financing amounted to an estimated US$73.3 million (equivalent) for 168 mining projects (excluding CRM procurements) compared with the US$122 million expected for 222 subprojects by the SAR. Both the Bank and the Government's potential contributions to the project were under-utilized. Although the entire Bank loan was fully committed, several large subprojects did not go forward, and the Bank cancelled US$8.6 million in unutilized funds. The Government used portions of its counterpart to finance about 15 subprojects to maintain project continuity when Bank funds were not available. Had counterpart and Bank funds been used on an equal percentage basis for all of the subprojects financed under PECAM I, the first phase of PECAM I total project size could have reached about US$125 million as the borrowers, intermediaries and suppliers contributed more to subproject financing than was expected (Table 1). 3.09 Of the US$73 million total project financing under Loan 1820-ME, PECAM (CFM, FM and CGM) financed 68Z of the total. The Bank's loan provided for 432 of total resources instead of the hoped for 502 while Government counterpart accounted for 25Z. Sub-borrowers contributed 252 to total investment and financial intermediaries and suppliers credits accounts for the final 7X. The Bank's estimated project plan (Table 1) postulated a larger project (US$122 million vs. US$73 million actual), that would be very highly leveraged (about 8 to 1), with no contributions by financial intermediaries or by suppliers and US$55.4 million by the Government, US$32.6 million by the Bank and US$12 million by the borrower. The very high leverage ratio, implicitly assigned to the project was not questioned during project preparation, and should have been. As it turned out the borrowers leveraged their project financing on a 3 to 1 basis. This was not as high as contemplated, but it was high enough to make subloans highly vulnerable to project implementation delays and to any negative mineral price trend. Highly leveraged financing may have 4/ PECAM prepared a Project Financing Plan for PECAM I (see PCR files) which reports that total financing equalled US$107 million, including the use of US$40 million in Bank funds. It appears likely that these data were prepared based on the subloan commitment documents, not on an actual disbursement basis. It also appears to include, under PECAM I, subloans financed with Government funds only during the periods of the loan when Bank funds were not being committed. The PCR's data base defines the project size on the basis of disbursements and includes where possible the subprojects in vhich the Bank participated.  - 14 - PROJECT COMPLETION REPORT MEXICO LOAN 1820-ME TABLE 1 Project Financing PlanlI (million of U1$) APPRAISAL ESTIMATE2/ CFM CRM FM Total z Total 2 Sub-borrowers 6.5 - 11.7 18.2 24.8 15.0 12.0 Govt Contribution 10.0 1.1 7.1 18.2b/ 24.8 67.0 55.4 World Bank 11.7 3.3 16.3 31.3 42.7 40.0 32.6 Fin. Intermediary - - 3.2 3.2 4.4 - - Suppliers/Other 2.4 - - 2.4 3.3 - - Total $30.6 $4.4 $38.3 $73.3 100.0 122.0 100.00 No. of Subloans 74 5Oa/ 94 218 Sourcest World Bank, CFM, CRM, FM and PECAM Audit Reports US dollar values of contributions to the financial plan for all participants except the World Bank are estimates based upon conversions into dollars of peso loan values. The estimates of FM participation are converted from the peso values presented and are consistent with Bank data. The estimates prepared by PECAM and by CFM vary substantially from Bank data. PECAM estimated that the Loan financed 222 mining projects and 42 PECAM infrastructure projects with a total value of US$ 107.3 million. CFM reported that their subprojects had a total value of US$44 million of which the World Bank financed US$22.6 million. US$11.7 million is the actual amount of Bank disbursements for CFM subprojects. 2/ The SAR does not provide a standard project financing plan. Estimates were derived from the SAR that estimated total project size to be US$122 million. Subborrowers were estimated as providing for about 20X of total financing or US$24.4 million. This would not be feasible as the difference between the SARs estimate of US$107 million of Bank and Government total contributions, and the SAR's estimated total project financing of US$122 is equal to US$15 million or 12X of projected total. a/ CRM reported 50 subloans of which 36 were for individual procurements of laboratory equipment. bt The Government contributed an equal amount in its financing of about 100 additional PECAM projects during 1981-86.  _ 15 - contributed to the relatively high rate of loan defaults experienced (Annex 1, Table 6 and 7).5 Uses of Proiect Funds 3.10 The project contemplated the following subproject lending and leasing activities: (i) Leasing Operations: About 150-200 equipment leasing subprojects amounting to US$29 million (equivalent) were expected to be financed. The typical leasing subproject was supposed to average about US$165,000 in amount and provide for the needs of smaller miners with less acceptable guarantees. As a result of discriminatory interest rate provisions on lease financing and the lack of active preparation of this component, leasing played no role under Loan 1820-NE. (ii) Subproject Financing; About 135 subloans would be granted to finance subprojects which consist of the procurement of machinery and equipment, working capital and ore body development. It was expected that such credits would amount to US$53 million (equivalent) and average loan size would be about US$393,000. Under Loan 1820-ME about 182 subloans (amounting to US$52 million [equivalent]) were actually granted to finance machinery and equipment, et'., with a smaller than expected average subloan size of about US$280,000. In the absence of leasing operation and beneficiation plant financing, these project loans accounted for 94S of total lending instead of the 502 expected.6 (iii) Ten regional beneficiation plant were expected to be financed requiring US$10 million (equivalent) under Loan 1820-ME. None of these plants were presented for Bank financing during the course of the project. (iv) The loan did not originally contemplate that CRM would become a financial intermediary providing credit for exploration loans. 3.11 Size of Subloans. Overall, the loan achieved a high degree of success with respect to the uses to which loan funds were put in terms of size distribution of the subloans (Table I). There were more loans and smaller average size projects and subloans financed under Loan 1820-ME than had been expected. The average size of all subloans was about US$252,000 and fully 442 of the subloans granted were in the range between US$15,000 5/ The aggregate 3 to 1 debt to equity ratio, for the project as a whole, presented the lending institutions with a higher than average portfolio risk profile, since many of these high (nominal) interest rate loans were heading into an uncertain mineral pricing future. 6/ There were 50 subloans through CRM of which 36 were for individual procurements of equipment for CRM's own laboratories or field operations. These 36 subloans are not included in the above analysis of subproject financing.  - 16 - to US$100,000. The average size of subproje,t was only US$336,000 as many smaller, labor-intensive non-metallic mining operations were reached by the project (para 3.14). 3.12 Types of Enterprises. With respect to the types of enterprises financed, almost 952 of CF's projects were to finance the expansion of existing mixed ore (gold, silver, copper, lead and zinc) mining properties while 712 of FM's subprojects were for expansion of a wide range of non- metallic minerals, with construction materials and minerals used by the petroleum, chemical and paper industries playing a large role in financing. Almost all of CFM's subprojects would produce minerals for direct or indirect export, while FM's non-metallic subprojects were essentially split between domestic and export purposes (Table 4). The project would clearly result in increased foreign exchange earnings. In line with the fact that most projects were for expansion, the average term of subloans was about 48 months, with non-metallic mining projects operating on shorter schedules than metallics. About 30X of metallic projects had schedules of over 5 years compared with 102 for non-metallic mining projects. Based upon the essential lower risk nature of financing expansion projects and projects with high export prospects it would be expected that the risk elements in CPM's and FM's loan portfolio would be aubstantially reduced. This proved not to be the case (paras 4.01 and 4.04). 3.13 FM Subproiects. The non-metallic mineral sector financed through PM was the major user of loan funds as FM disbursed 522 of total project resources as compared with the 22S expected. Some 35 different types of non-metallic minerals were involved in the program. About half of the investment was made to expand output of silica sands, barite (used in the petroleum industry), hydrated lime, dolomite, marble, rock phosphate and several other major industrial and construction minerals. The loan had a very major impact on the reactivation of the construction materials industry and especially the exploitation of high quality marble. 3.14 CPM Subprojects. CFM investment's in silver, lead, zinc, copper and gold mining operations accounted for almost 922 of total metallic investment programs. Because of the unexpected high demand for credits to expand non-metallics, the mineral sector, through CFM, used only 372 of loan funds compared with the 72Z expected. Financing of machinery and equipment accounted for 672 of total fund use by FM and CFM while civil works accounted for 112, working capital 8X and land for 2X. Traditional project financing accounted for a full 882 of the total, compared with the 422 predicted. 3.15 Summary of the Aggregate of PECAM I Operations. Under the first stage of PECAM, subprojects were financed under Loan 1820-ME (Table 1) as well as by the Government alone using the counterpart resources that it had granted to PECAM (para. 3.01). The combined numbers show that under the first stage of PECAM the executing agencies (CFM, CRM and FM) supported total financing of US$107.3 million (equivalent) to finance 222 mining projects and the 42 individual subloans to themselves to finance procurement of equipment and facilities and technical assistance. Almost 702 of PECAM I financing (US$73.3 million equivalent) for 218 subloans was provided for under Loan 1820-ME (Table 1). 3.16 Aggregate Economic and Social Benefits. PECAM has estimated that total investment would result in an increase in mining output at the  - 17 - national level of 21,713 tons per day, which could amount to an increase of about 72 of estimated national installed capacity as of 1988. On that basis the loan would prove to be exceptionally productive. As the value of national mining output is almost US$1.8 billion per annum an increase of 7? in output would result in an estimated annual increase in value of output of about US$40 to US$60 million equivalent based roughly on the product mix increases experienced under Loan 1820-ME. Part of the reason for the estimated high productivity of the project is that almost 95? of CFM metallic projects and 71? of FM non-metallic projects were for expansion projects (Annex 1, Table 3) and not for 'greenfield' projects where failure rates are higher and costs of original mine openings greater. 3.17 Employment Generation. Regarding employment generation, PECAM estimated, based upon the data provided by borrowers in their loan application, that about 4,600 jobs would be created in the 222 mining projects, or about 20 jobs per average project. Based upon total PECAM costs of US$107.3 million this implies a cost of about US$23,300 per job created, which is about one-third less than the cost of creating a typical industrial job. In addition, as a result of mine and mill expansion programs, the existing 6,300 workers would maintain their posts, for without prospects for mine expansion, output in old mines would decline and jobs would be lost as ore bodies were exhausted. On that basis it would be reasonable to argue that the cost of creating new jobs and saving old jobs, would approach US$10,000, which would be very satisfactory. 3.18 Financial and Economic Rates of Returnt Financial rates of return calculated for the subprojects financed were high in nominal terms, averaging almost 35?. However, with average annual rates of inflation ranging around 15? during project implementation, real financial rates of return expected for subprojects did not differ widely from the appraisal estimates of 20? p.a.in real terms. Because of the high number of export projects expected economic rates of return over 552 were not unusual. Vith respect to project outcome FM has reported that a high 98? of its second- tier medium-scale projects have repaid their debt on time. These companies are faced with even higher demand and market prices than expected for the range of construction and chemical industry non-metallic minerals financed and that the economic rate of return for these medium-size projects would be equal to or higher than estimated during appraisal. Estimated economic returns averaging 35? are offset by the heavy losses sustained by the early direct lending operations, involving small miners financed under the social programs. These accounted for about 20? of FM's early lending operations (Table 6) and most are in arrears. There exists no corresponding data on subproject financial or economic performance for CFM whose loan portfolio is suffering from high arrears (para 4.01). CFM's new management is in the process of evaluating the repayment capacity of the portfolio in arrears to determine the percentage of willful defaulters and failed and unreconstructed subprojects. If the portfolio arrears data represents the real financial situation of the companies in CFM's loan portfolio (rather than willful defaults) then about 35? of the original subloan amounts under CPM's component of Loan 1820-ME would not have achieved financial and economic results expected, which would imply a low or even negative economic rate of return for the aggregate metallic mining portion of the project. CFK's new management expects, however, that the willful default rate is high (see para 4.01) and that a significant percentage of portfolio arrears may be cleared up.  _ 18 - IV. LOAN PORTFOLIO PERFORMANCE 4.01 CFM's PECAM Loan Portfolio. As of December 31, 1988, CFM reported that it had outstanding interest and principal due of MP4,153 million. Of the original of MP4,086 million that had been disbursed over the life of the project, MP2,066 million represented the remaining principal due (plus some penalties), of which 40? was in substantial arrears, 29g had been renegotiated because of the financial problems and 29? was current. Thus, about MP1,425 million, or 35? of the original total loan portfolio was in arrears or renegotiated and not performing as initially contemplated. Regarding interest due, as of December 31, 1988, 69? was substantially in arrears and 272 was in suspension. Thus, CFM was facing a substantial shortfall of MPl,900 million (about US$850,000) on interest income from accounts that were substantially in arrears. CFM's total interest and principal that are substantially in arrears (over 180 days) or in suspension, amounts to about MP2,800, about 602 of the original total of loan disbursement. It is expected by CFM's new management that the high (69?) percentage of loans that are in substantial arrears can be reduced by more aggressive collection practices than had been practiced in the past especially as they intend to move rapidly to judicial action for collection. 4.02 The PCR does not provide a detailed review of the status and condition of the major problem subprojects nor does it provide an analysis of their probable causes for failure. Provisions were made for a review of a sample of about 50 subprojects, to measure their outcome and to determine the major controllable reasons why subprojects did not perform as expected. PECAM, which had agreed to initiate this task, disintegrated during the last quarter of 1988, following a change in government. All PECAN management and contract staff left and the agreed upon detailed portfolio review and the appraisal quality review was not implemented. CFM's new management will undertake a review of subprojects in conjurction with expected increased loan collection activity, and information on reasons why subprojects failed to achieve objectives is expected to be made available to the Bank in the future, to be used for the preparation of the PCR for the Second Small and Medium Mining Project. 4.03 CRMIPECAM Loan Portfolio. During 1982-86 CRM undertook to completed 37 exploration programs financed under PECAM subloans. An additional reported 1,000 reconnaissance level visits were undertaken using own and Government resources. Of the 37 financings under PECAM I amounting to a reported MP325 million, all are substantially in arrears and CRM has essentially abandoned efforts to collect on exploration program loans as there were no real guarantees to enforce repayment of these high risk exploration credits. As the CRM credit program was an ad-hoc addition to the SMK program agreed to during the 1983 loan amendment, the issue of the appropriateness of this credit component was never examined in detail. Exploration activity is high risk, and results in a positive find of an economic ore body in fewer than 251 of the cases. Even then, the time frame between exploration and mine development and extraction can usually be measured in 3 to 8 year intervals. On the basis of the recognized high risk and low immediate cashflow repayment capacity, the industry practice is that initial exploration financing is generally done with risk equity, not loan money. CRM management has reported that it has withdrawn from granting credit for exploration subloans.  - 19 - 4.04 PM's PECAM Loan Portfolio.7 Under PECAM I PM disbursed MP4,913 million to finance 111 projects of which 94 were partially financed by the Bank under Loan 1820-ME and the balance with government counterpart resources, mainly during periods when Bank funds were not available. As of December 31, 1989, subborrowers under PECAM I had repaid MP2,843 million, equal to 58? of their original total loan amount of MP4,913 million. Of the outstanding balance of the original loan amount (NP2,070 million), MP1,050 million or 51? is in current status. FM's total exposure with respect to PECAM I loans that are in judicial action (more than 90 days overdue) amounts to MP2,528 million, which includes overdue principal and capitalized interest, interest overdue and penalties (Table 6). Of these amounts due about 75? are from FM's direct operations with eiidos made in the early stages of PECAM I. The balance of overdues also result from direct lending. 4.05 FM's total portfolio amounted to about MP96,000 million as of December 31, 1988, of which about 872 was amounts due from second-tier operations with commercial banks. Total FM direct operations amount to about MP17,900 million of which about MP2,570 million are in legal action. PECAM I represents a high percentage of these overdue loans. Consistent with a sound portfolio management policy, FM has made reserves for bad debt of MP2,478 million, equal to about 2S of total portfolio. This provision is equal to about 15? of direct operations and 1002 of overdue amounts, which is ample. FM currently operates a reduced direct social program which it funds out of a portion of its annual net profits. Direct social program lending is currently 8.6a of total portfolio down from about 45Z during PECAM I. 4.06 Accounting and Financial Reporting: PECAM's required annual external audits of the status of the Special Account and the Project Account was adequately prepared and submitted to the Bank with delays. CPM's external auditors prepared annual reports for the Bank, which were unacceptable and which in spite of repeated demands for improvement by the Bank, were never improved. 4.07 CFM is a c,%plex holding company with assets amounting to about US$1.5 billion. The Bank loan represents a very small 1.5Z of its assets and CPM had little incentive to forge major changes in audit policy and practice. The accounting problem arose because CFM's consolidated financial statements carried major qualifications which resulted from the fact that the CPM had about a dozen different auditors dealing with parts and pieces of its operations -- in line with the recommendations of the Auditor General of Mexico. Thus, no single audit firm could attest to the carrying value of CFM's assets or the accuracy of its total accounts. These accounting issues were not addressed during project preparation or handled adequately during supervision. 4.08 The value of CFM's income accounts, which are annually audited by an external auditor and presented to the Bank, is open to question because income accruals continue to be taken until an account is wiped off the books through judicial action and sale of assets, often three or more years 7/ PM maintains a rigorous portfolio management policy. It classifies all loans over 90 days in arrears and within weeks thereafter movep delinquent loans to judicial action for collection.  - 20 - after payment of interest has stopped. Provisions for interest on bad loans are not periodically made nor is past income booked, reversed from past income accounts. CFM's income recording policy is therefore inappropriate for a financial intermediary. 4.09 Recently, the Bank and CFM's new management agreed on a process of ensuring that CFM would submit required clean financial statements to the Bank. Starting with the 1988 Audit CFM's accounts will be recast by its new management. As of January 1989, CFM's new financial managers initiated a program that established CFM's beneficiation plants as cost centers and new classes of data were available, as of November 1988, that reflected CFM's true operating income and cost situation. The new management has a full understanding of the problems and issues they confront to get CFM accounts into meaningful and operationally useful condition. It is expected that by 1989-90 the long-standing problems of establishing meaningful valuations of properties will be resolved and that the Auditor General will permit CFM to take the measures needed to produce an acceptable and auditable consolidated balance sheet. V. SUMMARY OF PROJECT AND LESSONS LEARNED Proiect Objectives 5.00 The objectives spelled out in para. 1.03 were simply too broad to be ach_evable under the project design that was adopted for Loan 1820-ME, and, in the final analysis, these objectives remained statements of intention essentially unlinked to the design of the project. The amount of resources involved, the beneficiary group that was targeted, the institutional mechanism adopted, and the failure to assess whether existing sector policies would constrain further growth of the sector, were all factors which ensured that such broad objectives could not be carried out under the project as designed. The appraisal process should have ensured thats (i) project objectives coincided with the scope of the project as well as the constraints imposed by the sector; (ii) project design was adequate to support achieving each project goal through the proper mix of appropriate policies, adequate institutional structure and technical assistance support to executing agencies; (iii) quantifiable benefits had been established as a means of assessing performance in the achieving of project objectives; and (iv) continuous monitoring of the achievement of project benefits would be carried out. 5.01 Also, no attempt was made to see if existing institutional objectives were compatible with project objectives, and this was particularly evident in the executing agencies strong "social' orientation towards making loans primarily for promotional purposes, with project viability assuming secondary importance. FM realized at an early stage that financial viability was incompatible with lending to eiidos, and it dropped this activity in favor of financing commercially sound ventures financed througn commercial banks. CFM never did seem to comprehend this distinction, and only after FM's management took over CFM, did a serious re-consideration of lending policies take place. In the case of CRM, the introduction into an institution with no understanding or capability for carrying out financing operations, of credit facilities for the financing  - 21 - of high risk exploration activities, and without assessing the potential risks and probable loses involved, resulted in defaults for about every exploration program financed. 5.02 Project objectives did not take into account the constraints imposed by sector policies on overall sector growth. Existing mining legislation imposes serious constraints on foreign shareholding and management control of mining enterprises, restricts Rccess of private investors to mineral deposits in reserved areas, has very lengthy and cumbersome procedures for obtaining concessions coupled with minimal requirements for developing them, and imposes an outmoded mining taxation system on potential investors. Proiect Execution 5.03 The project's institutional structure was not only inappropriate for carrying out the project's objectives, but was also unsuitable for implementing the project as designed. The key to the fuactioning of the new system was PECAM, composed of a coordinating committee supported by a technical secretariat, which had been created to function as project manager, subproject reviewer, source of technical assistance and channel for Bank financing, but it was never adequately managed or staffed to carry out any of these functions, and the establishing of a credit facility within SEMIP's General Directorate of Mining and Metallurgy. had no institutional rationale. 5.04 The project design should have clearly linked investment objectives with the institutional structure intended to carry it out. This would have necessitated a real appraisal of institutional capability, a determining of where institutional weaknesses existed, and the ordering of required functions and associated responsibilities. as well as the training of staff and managers required to carry out the project. 5.05 Another flaw in the project design was the lack of a monitoring system to provide continuous follow-up on project results. Since training and technical assistance were vital to the success of the project, the design of a monitoring system should have been an integral component of the project. In addition, the fact that no real effort was made to monitor the progress of subprojects or to assess their impact and the stream of benefits derived from their implementation, and then to compare the result with the benefits projected at appraisal, meant that no real assessment could be made of the achievements of the project in terms of its investment objectives. Also, the fact that CFM could not produce a satisfactory credit report, make it very difficult to access the financial viability of that entity. Project Results 5.06 There is no evidence that the existence of PECAM had a significant effect on the success of the project. PECAM's subproject review did not lead to any improvements in the quality of CFM's or FM's loan portfolio, and the lack of a core of permanent, well qualified and trained management and staff, practically ensured that PECAM would not be able to carry out the functions it had been assigned, and PECAM became just another processing layer.  - 22 - 5.07 Technical assistance under the project was almost all (94X) directed towards providing physical assets to the executing agencies, and only 2S was earmarked for training purposes. Until the end of 1983, technical assistance provided budgetary support for equipment purchases and ignored the institution building needs of the executing agencies. This was followed by a greater emphasis on improving institutional systems, training and guidelines for PECAM, CFM and FM, but which in the end proved inadequate to address the wide range of institutional problems which still existed. The Project Execution Document and the Strategic Action Program were more statements of intention rather than plans of action, and when they were finally implemented in 1985, they were too little too late to have a major impact on project performance. 5.08 New procedures were adopted to make financing terms and conditions more flexible and more responsive to conditions in the mining sector. As a result, disbursements increased rapidly in 1984-85, and four-fifths of all disbursements actually took place during that time. All of this financing involved lending for private sector investment, and another of the achievements of the project was in reaching more enterprises (182 versus 135 projected) than had been anticipated at appraisal. The lower average subloan size (US$ 280,000 versus US$ 393,000), indicates that project financing was reaching smaller scale enterprises than was expected at appraisal, another laudable result. Conversely, the leasing component was a complete failure, because interest rates on lease financing were considerably higher than on loan financing, and because this form of financing was never adequately promoted. In addition, no CFM-owned beneficiation plants were presented for Bank financing, although it had been expected at appraisal that ten such plants would be financed under the project. Perhaps because CFM was using its beneficiation plants as promotional instruments to foster development of small and medium metallic mining, these plants would not have passed the fkmancial scrutiny of the appraisal process. 5.9 At appraisal, the benefits to be achieved by the project were expected to be high. Mining output was expected to increase by 7Z, 4,600 jobs were expected to be created at a cost of US$ 23,300 per job, and many existing jobs would be saved as depleted ore bodies were abandoned and new reserves developed. Real rates of return were expected to average 20? p.a., with returns from export projects even higher, given Mexico's relatively low wage structure and high grade ore reserves. Unfortunately, PECAN was unable to carry out a review of subproject performance, which would have provided evidence to indicate whether any of these goals had been achieved. If CFM's portfolio arrears data represents the real financial situation of the mines it financed (rather than willful defaults), then at least one- third of the mining enterprises financed by CFH, would not have achieved the financial and economic results expected. The far superior repayment record of the non-metallic mines financed by FM, would indicate that these enterprises had been much more successful in achieving the results projected; however, in the absence of subproject performance data, we have no way of verifying these results. Some Lessons for the Future. 5.10 The project's chances for success would have been greatly improved if the following had been taken into account:  - 23 - (i) project objectives should reflect the constraints imposed by sector policies, be achievable within the framework of the project concept, and be closely linked to project design; (il) quantifiable benefits should be established as a means of assessing performance in the achievement of project objectives; (iiI) institutional objectives must be compatible with project objectives; this is particularly important when an entity with no firm basis as a financial institution, is given respoasibility for channeling credit; (iv) the allocation of funds to specific investment components should be based on a clear identification of the need for such financing; and (v) continuous monitoring of the progress of project performance is essential to establishing the project's impact and to determining if the anticipated benefits are being achieved.  ANNEX I - 24 - Page 1 of 2 PROJECT COMPLETION REPORT MEXICO LOAN 1820-ME A Note on Statement of Proiect Objective 1. The SAR that was distributed to the Board of Directors in March 1980 was exceptional in that it did not contain the standard well- formatted, explicit statement of the Bank's objectives. Project objectives had to be inferred from the text of the SAR. Para 3.01 (Background and Objectives of the Project) confirms the Government's interest in mounting a broadly based, integrated program for SMM development under the PECAM system, and enumerates the aims of the PECAM program regarding: (i) exploitation of full mining sector potential; (ii) reversing the sector's low growth trend; (iii) generating employment, especially in low-income groups; and (iv) activating least developed regions. 2. The SAR did not examine the prospect for the achievement of the Bank's (PECAM) project objectives in the context of Mexico's: (1) mining sector policies and the limitations these imposed on the pace and direction of investment and (2) Mexico's capacity to finance inter alia the infrastructure of roads, energy, public health water and technical support facilities that are preconditions to activating for investment in the least developed regions of Mexico. 3. An underlying assumption for achieving potential was that the PECAM project operating in support of SMM, wihin the framework of Mexico's mining policies, could channel the funds and technical support required to 'develop on an economically viable basis an important part of the Mexico's mining resources" (see SAR para 1.2). Vhile the term "important" is undefined, it is unlikely that Mexico's potential can be fully realized in the next several decades without major external investment, ranging in the thousands of millions of dollars and the introduciton of large amounts of additional risk capital for exploration over a substantial period of years. 4. The statement of project objectives regarding achieving of potential gave implicit support to the notion that an adequate pace of risk capital investment and investment in mines and mills could be sustained under the then existing mining laws that are highly restrictive of the introduction of external risk capital and fixed asset investment and limit the strategic areas for exploration and exploitation. Conclusions: (1; The PECAM and the loan objectives were unrealistic in scope, given the size and sector orientation of the loan and the sectoral issues that were yet to be addressed.  - 25 - ANNEX,I Page 2 of 2 (2) The loan objectives implicitly supported the notion that important progress could be made in the mineral sector in the absence of policies that would attract and release large amounts of external risk capital for exploration and for investment in mines and mills.  - 26 - Annex IS Tables 2,1,4 PROJECT COMPLETION PROJECT MEXICO LOAN 1820-HE Terms of Loans Granted (I Distribution) CPM PK Less than 3 years 11.7 11.3 3 to 5 years 57.4 78.3 5 to 7 years 23.4 7.8 7 to 9 years 6.4 2.6 Over 9 years 1.1 0.0 100.0 100.0 Tine of Enterprise (2 Distribution) CFM PK NOW 5.3 28.7 Expansion 94.7 71.3 100.0 100.0 Destination of Sales (I Distribution) CYL 11 pH Export-Direct 93.0 9.6 gEport-lndirect - 13.0 Import Substitution 7.0 11.3 Combination - 66.1 100.0 100.0 11 CPM could not provide sales destination data. However, 931 of its projects were directed toward silver, lead, zinc, tin and gold metallices almost all of which are directly or ldirectly exported. Thus, a bigh percentage of its projects were forelgn exchange generators.  - 27 - Annex I1 Table 5 PROJECT COMPLETION REPORT HEXICO LOAN 1820-ME Apnlication of Loan Funds (2 of Total Disbursements) PERCENTAGE Land 1.8 Civil Works 11.1 Machinery and Equipment 67.0 Working Capital 8.0 Pre-Operating Costs 10 5 Misc. /Others 1.6 Total Applications 100.0 Source: World Bank estimates based upon PECAM information on total projects financed by CFM, CRM and FM during 1981-85.  - 28 - Annes II Table 6 PROJECT COMPLETION REPORT MEXICO LOAN 1820-ME Comision de Fomento )inerol Analysis of Portfolio Status - PECAM I (December 31, 1988) (millions of pesos) CURRENT LOAN BALANCE INTEREST PRINCIPAL TOTAL LOAN CLASSIFICATION DUE I DUE S DUE Z Current (less than 90 day overdue) 51.0 2.4 588.0 28.5 639.0 15.4 Renegotiated and Current 25.0 1.2 596.0 28.8 621.0 15.0 Arrears 90 to 180 days 10.0 O).5 51.0 2.5 61.0 1.5 Arrears 180 t6 360.days 197.0 9.4 159.0 7.7 356.0 8.6 Arrears 360 and over 1,246.0 59.7 672.0 32.5 1918.0 46.1 Grace/Morstorio/Other 558.0 26.7 -.- -.- 558.0 13.4 Total Dues 2,087.0 100.0 2,066.8 100.0 4,153.0 100.0 1/ Original loan'balance was MP4,086. million, current balance of principal inclules capitalized Interest, etc.  - 29 - Annex I$ Table 7 PROJECT COMPLETION REPORZ MEXICO LOAN 1820-ME FM Analysis of Portfolio Status, PECAM I (December 31, 1988) (million of Pesos) CURRENT LOAN BALANCE ORIGINAL LOAN PRINCIPAL INTEREST TOTAL LOAN CLASSIFICATION AMOUNT 1/ DUE DUE DUE Fully Repaid 2,843 Current 1,050 1,050 -.- 1,050 (less than 90 days arrears) Loans in Judical Action 21 1.020 1.605 933 2.538 Total 4,913 2,655 933 3,588 Source: FMNH 1/ Total loan amount based upon III PK loans made during PECAM I of which 94 are Bank financed loans. 2_ These loans are mainly direct operations undertaken by FMNM at an early project stage. 3/ Includes capitalized interest and penalties.  - 30 - Annex II Table 8 PROJECT COMPLETION REPORT MEXICO LOAN 1820-ME Fideicomiso Minerales No Metalicos Balance Sheet (December 31, 1987-1989) 1988 1987 ASSETS Short Term Cash and Banks 16,470.00 10,064.00 Loans 24,958.00 6,065.00 Accounts Due 3,813.00 1,683.00 (Less% Provisions for Bad Debts) (2,478.00 Total 45,242.00 17,813.00 Long Term Loans 96,470.00 22,252.00 Fixed Assets (Net) 403.00 465.00 Other 11 124.00 26,994.00 Totai 96,99i.00 49,712.00 TOTAL ASSETS 142,239.00 67,525.00 LIABILITIES Short Term Current Portem Long Term Debt 3,876.00 1,686.00 Provisions 1,965.00 513.00 Accounts Payable 123.00 100.00 Other 41.00 205.00 Total 6,007.00 2,503.00 Long Term PECAM (Contracted) 32,215.00 16,272.00 PECAM (In Process) 54,658.00 4,497.00 Total 87,374.00 20,769.00 TOTAL LIABILITIES 93,381.00 23,272.00 CAPITAL Paid In 3,644.00 3,644.00 Accumulated Surplus 13,004.00 3,409.00 Surplus for the Period 31,020.00 10,097.00 Revaluation Reserves 1,189.00 27,101.00 Total 48,858.00 44,251.00 TOTAL LIABILITIES AND CAPITAL 142,239.00 67,525.00 11 For 1987 includes Reserves for Revaluation of Bonds $26,256 million as offset to capital account dropped in 1988.  AIINE7. III - 3i - Pave 1 of 3 90E0505 February 16, 1990 Spanish (Mexico) LA2TF JCB:mec Gerencia de Financiamientos Multilat, tes Mr. Alexander Nowicki January 18, 1990 Chief, Policy-Based Lending, Industry, Public Utilities and Urban Sectors OED World Bank Washington, D.C. I refer to Loan 182t4-ME, the first stage of the Programa Especial Complementario de Apoyo a la Pequeiia y Mediana Mineria (PECAM). In reply to your letter of November 17, 1989, requesting our comments on the Project Completion Report, we wish to highlight the following points for consideration in the final version of the PCR: Generally speaking, we agree with your evalurtion that the basic project objectives were satisfactorily accomplished. {owever, the PCR points out several flaws noted during project execution. We feel it is necessary to identify the responsibilities of the each of the pai ies involved, including at the design stage, when the problems arising during project preparation were already evident. Also, we feel that the PCR's evaluation of PECAM I does not tWake account of the real situation of the loan: while it was contracted in August 1980, our country was faced with various domestic and external problems from 1981 onward, which hampered our economic activity and consequently changed the original context within which the loan was negotiated, with adverse effects on project execution. With respect to the technical personnel, we wish to point out that the staff assigned to PECAN was not actually hired, but remained on the payroll of the Ministry of Energy, Mining and Parastatal Industry (SENIP). With respect to your comments on policy reform in the mining sector, we ask that you delete these, since PECAN I was negotiated under other criteria, as noted during execution of the program. We would point out that the reforms referred to in the Report are currently being considered in the Mining Sector Program. Attached please find comments on the PCR made by the agencies involved in the project. Very truly yours, sl/ Lic. Jos6 Garcia Torres Manager Attachment: As above  - 32 - ANNEX III Page 2 of 3 PECAM I PROJECT - COMMENTS ON THE WORLD BANK'S PCR OF OCTOBER 28, 1989 1. Regarding the functions and activities of PECAM's Technical Secretariat, the Coordinating Committee proceeded last August to authorize its incorporation into the Mining Development Commission (CFM). We would point out that CFM's External Financing Directorate is responsible for carrying out certain of the functions that used to be assigned to PECAN. It is essential to have an area that can coordinate, supervise, and provide general support for the other institutions in the mining sector in all their proceedings involving financial and technical assistance. Thus CFM's External Financing Directorate is the link with Nacional Financiera for all proceedings and consultations on lines of credit financed by the World Bank. 2. In relation to the absence of any policies introducing institutional reform during PECAM I, we woujld point out that a number of changes and adjustments were made to the Mexican mining sector, with a view to bringing it into line with international standards of competitiveness and efficiency, a fact that IBRD did not consider in either PECAN I or PECAM II. In addition, there were a number of consultations with experts to ensure that the new project would take account of environmental impact. 3. The document mentions that almost 66 percent of the Technical Assistance was used by CRM, evidence of inappropriate resource allocation under this heading. In PECAM II, the technical assistance component was used for several purposes, including seminars, training courses at the executing agencies, reconnaissance trips, modernization of the Directorate General of Mines, etc. 4. With respect to CFM's shortcomings, the document mentions its merger with PM. By turning it into a second-tier lending institution, this should result in a notable improvement in its activities. The commercial banks have recently been discounting loans to metallic mining, a process that is expected to pick up gradually. 5. FM's overdue portfolio under PECAN I was always kept within the margins regarded as acceptable among financing agencies (below 8 percent). With respect to social program loans, it is pointed out that these were all funded out of FM's own resources, with only a very small percentage provided by PECAN I. 6. It is mentioned that in PECAN I no beneficiation plants were financed. During PECAM It, IBRD authorized several investments in physical assets for the executing agencies. 7. With respect to the conclusion that the PECAM I objectives were not realistic, since neither the size and nature of the sector, nor the sector policies, were properly taken into account, it is pointed out that the program was implemented in accordance wi-h the guidelines of the National Mining Program in effect at that time. At present, the government's economic strategy includes, among others, the following actions to modernize the  - 33 - ANIIEX III Page 3 of 3 sector: diagnosis and proposal for a new Regulation to the General Law of Mining; study of the tax system; policies on the disincorporation of reserves and elimination of allocations; National Mining Program; publication of geological maps; presidential approval of the proposal to create a Mining Development Fund; Five-year Business Program for CFM; Portfolio Recovery and Credit Monitoring Plan for CFM; CFM Accounting and Management Information 'System; plan to decentralize CFM's functions; Five-year Operating rrogram for CRM; Aerial Reconnaissance Program for CRM; CRM Laboratory Modernization; CRM Information Center; CRM Data Bank; retention of fees for CRM's services. 8. In relation to the second conclusion of the document, to the effect that the objectives of PECAM I implicitly defend the notion that progress must be made in the mining sector in the absence of any policies to attract large amounts of risk capital for exploration and investment, we wish to point out that the present government's policy for modernization of the mining sector assigns particular importance to foreign capital participation in the development of the country's mining industry. Efforts are in progress to devise a formula for facilitating and expanding foreign investment in the sector. 9. The World Bank's evaluation of PECAM I largely refers to subsequent situations, so that in some places it looks more like an evaluation of PECAM II. 10. Since the report takes into account references and experiences arising after PECAM I, rather than looking at the situation prevailing while the program was actually ir. effect, it loses much of its usefulness. 11. The evaluation was supposed to take place immediately following completion of the program, so that it would show positive experiences, draw lessons from mistakes made, and thereby serve as a basis for an improved PECAM II. 12. Several of the opinions offered disregard the fact that PECAM I was a new program, requiring a major effort of promotion in order to become known. The fact that it was so new was the reason that requests for aid were geared less to new projects than to the expansion of existing ones.  ANNEX IV - 34 - Page 1 of 2 PROJECT COMPLETION REPORT MEXICO LOAN 1820-ME Response to the Borrower's Comments on the PCR 1. Project Objectives. The PCR points out on pages 2 and 3 that three of the four project objectives were not achieved, for two main reasons. First, they were excessively broad and substantially overstated the potential development impact of this relatively small lending effort. Second, the levels of investment required to achieve these objectives for the mining sector would have been unattainable in the context of sector policy constraints, especially those on foreign investment, that prevailed in the period under review (from mid-1982 until early 1988, when the project closed). To the extent that the main project objectives were unachievable and unrelated to the main challenge of the project (i.e., institution building and development of small and medium scale mining) focus was shifted from institution building and technical assistance and thereby contributed to the operational problems experienced by the project. The acceptance of the stated project objectives (Par&. 1.03) represented a failure in the project quality control process. 2. Responsibility for Project Preparation. Normally, Bank staff would depend heavily on the government to prepare, or assist the Bank to prepare the design of a project especially in the areas of institutional development, where Bank staff would rely on the specialized knowledge of the counterpart staff regarding local institutional and human resource capability. However, for new operations like Loan 1820-ME, where there was little or no prior experience to rely on, the Bank generally takes on a major preparatory role. Nevertheless, local counterparts would be expected to actively participate in project identif3cation and design, and should bring an open and skeptical attitude to th.. preparation process. 3. For Loan 1820-ME, the Borrower has commented that design problems were already evident during the preparation stages of the project. However, the PCR mission in the field was not made privy to this fact, and there was nothing in the correspondence files to indicate that (a) local advice or recommendations regarding issues of project design was offered or ignored, or (b) there existed unresolved project design issues that were not fully and fairly aired during loan negotiations. The major conceptual and design problems of the subject loan are fully identified in the PCR and are translated into lessons learned for future operations (Section V). From the Bank's perspective, the underlying assumption of the PCR is that involved Bank staff and management had total control over the design of the project, acquiesced to all of the changes during negotiations and were fully responsible for the design and the outcome of a project, including the failure to initiate major revisions in design or even cancel for due cause. From the Borrowers' managerial perspective, we assume that similar assumptions are made about the responsibilities of their own staffs.  35 - ANNEX IV - ~ Page 2 of 2 4. Proiect Externalities. Regarding the PCR's recognition of the impacts of external and internal events upon the operations of the project, the impact of macroeconomic events and the decline in metal prices starting in 1981 are noted in the PCR (Paras. 2 and 3.02) along with the effects of major policy constraints (Para. 1.02), interest rate problems (Paras. 3.02) and project design flaws (summarized in Para. 4). All of these negative impacts contributed to the problems that the project faced and then partially overcame prior to achieving an increase in the pace of disbursement in 1985-87. 5. PECAM's Professional Staff. In Para. 2.08 the relationship of PECAM to SEMIP is briefly described. It was not specified in Para. 2.08 that the Director and Subdirector of PECAM were senior managerslprofessionals employed by SEMIP. However, the rest of PECAM professional staff were, to the best of our knowledge, term contract employees engaged by SEMIP. Turnover among project staff was substantial, and it posed a quality control and efficiency problem that was never resolved. Finally, at the end of the project, vhen staff contracts had expired, there was no one available on the professional staff of PECAM to complete the agreed upon subproject survey work and the report required for preparation of the PCR. 6. Sector Policy Constraints. The brief review of sector constraints was made in the context of the PCR's examination of the appropriateness of two of the Bank's main project objectives, namelys (i) to exploit the full markrt potential of the mining sector; and (ii) to reverse the sector's slow growth of the 1970's (Para. 1.03). The PCR concluded, inter alia, that the policy framework prevailing during the preparation and appraisal of the loan was sufficiently restrictive, that the loan's objectives were in fact not attainable and were inappropriate for a project whose main concerns would prove to be institutional (Para 5.00). In that context, the review of the status of sector policy at the time of loan appraisal proved to be important to the conclusions of the PCR and provided important lessons on how to think about setting appropriate and realistic goals for future loans (Para. 5.10). The point made by the Borrower that the Government is currently considering a range of major reforms in the mining sector is appreciated and is noted in the Preface of the PCR and referred to in appropriate places in the text. 7. The comment that the report looks more like an evaluation of PECAM II than PECAM I, misses the point that the latter continued to disburse after the former became effective. This is an normal disbursement profile for successive line-of-credit loans which are granted in support of the same sector and for similar long term objectives. In short, PECAM I and II clearly overlap, and no distinct separation can be made between the two. 8. Other Comments. The financing of parastatal beneficiation plants was included under both PECAM I and II; however, in no case was any plant actually financed. Other staff comments focused on the PCR's discussions of past sector policy and on the fact that the new administration has adopted a different view regarding foreign investment, as an example of new attitudes. These comments are covered by the response in Para. 6 above.