Peru - Second Huinco Hydroelectric Power Project

RESTRICTED FILE COPY Report No. P-350 This report was prepared for use within the Bank and its affiliated organizations. They do not accept responsibility for its accuracy or completeness. The report may not be published nor may it be quoted as representing their views. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATIONS OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE LIMA LIGHT AND POWER COMPANY (EMPRESAS ELECTRICAS ASOCIADAS) PERU November 13, 1963 REPORT AND RECOEMENDATIOVS OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON THE PROPOSED LOAN TO THE LIMA LIGHT AND POVER COMPANY (74PRESAS ELECTRICAS ASOCIADAS) PERU 1. I submit the following report and recommendations on a pro- posed loan of an amount in various currencies equivalent to blS million to the Lima Light and Power Company (Empresas Electricas Asociadas), hereinafter referred to as "Lima Light." The loan would help finance the foreign exchange cost of completing the ex- pansion, initiated with the assistance of Loan 260 PE, of power generation and transmission facilities serving the greater Lima area and the expansion of distribution facilities in the area. PART I: HISTORICAL 2. In October 1959, Lima Light asked the Bank to assist in financing the construction of the first stage of the Huinco hydro- electric plant and the associated Marcapomacocha water division scheme. A loan of $24 million for this purpose was made on June 29, 1960 (Loan 260 PE). Lima Light subsequently asked the Bank to con- sider a second loan of $15 million equivalent to help finance the second stares of these two related parts of its program and also the improvement and expansion of distribution facilities in the greater Lima area. A Bank Mission visited Lima in April 1963, and negotiations for the loan began in Washington on October 23, 1963. Mr. Juan Castelli and Dr. Mario Hangartner represented the borrower. The Government of Peru was represented by Mr. Carlos Gibson, Commercial Minister of the Peruvian Embassy in Washington. 3. The proposed loan would increase the loans to Peru held by the Bank from $80.93 million to 595.93 million equivalent. The only other project for which a Bank loan may be proposed within the next two to three months is the Port of Paita, with a foreign exchange com- ponent of slightly under '3 million. 4. The Bank has already made the following loans to Peru: -2- Amount Year Loan No. Borrower Purpose (in US$ equiv.) 1952 57 PE Republic of Peru Port development 2.41 (Callao) 1952 67 PE Republic of Peru Agricultural development 1.30 1954 98 PE Republic of Peru Agricultural development 1.70 1954 105 PE Banco de Fomento Agricultural development 5.00 1955 114 PE Republic of Peru Irrigation project 18.00 1955 116 PE Cemento Pacasmayo Construction of cement 2.50 plant 1955 127 PE Republic of Peru Highway maintenance 4.99 1957 162 PE Banco de Fomento Agricultural development 5.00 1958 208 PE Autoridad Pvrtu- Port development 6.57 aria del Callao 1960 257 PE Banco de Fomento Agricultural development 5.00 Agropecuario 1960 260 PE Lima Light and Power development 24.00 Power Company 1960 271 PE Republic of Peru Highway reconstruction 5.50 1961 300 PE Republic of Peru Highway maintenance 10.00 and improvement 1963 334 PE Peruvian Corp. Railway rehabilitation 13.25 Total (net of cancellations, terminations and refundings) 105.22 of which has been repaid 21.78 Total now outstanding 83.7' Amount sold 9.80 of ohich has been repaid 6.57 2.51 Net amount now held by Bank b0.93* *Includes 31.03 million not yet disbursed. 5. Most of the $31 million balance of effective loans not yet disbursed is for projects which are still being executed and are on schedule. $7 million of this balance reflects unusual delays on disbursements for two projects - the Port of Callao (Loan 208) and the Aguaytia-Pucallpa Highway (Loan 271) - which are traceable to delays both of contractors and of the Government. We have made representations about these delays, and they are being dealt with. These delays do not raise any questions about the ability of Lima Light to carry out its construction program on schedule. PART II: DESCRIPTION OF THE PROPOSED LOAN 6. The loan, which would have the following characteristics, would be similar in most respects to the first loan to Lima Light (Loan 260 PE) Barrower Lima Light and Power Company, (Empresas Electricas Asociadas), a privately-owned corporation. Guarantor: The Republic of Peru. Amount: The equivalent in various currencies of $15 million. Purpose: To finance the foreign exchange cost of the second stage of the Marcapoma- cocha water diversion scheme, the in- stallation of two additional generating units with a capacity of 120 MW at the Huinco powerhouse, and the improvement and expansion of the Lima distribution system through mid-1966. Amortization 44 semi-annual installments from Feb- ruary 15, 1967 to August 15, 1988. Interest Rate 51% per annum. Commitment Charge: 3/4 of 1% per annum. Payment Dates: February 15 and August 15. PART III: LEGAL INSTRUMENTS AND LEGAL AUTHORITY 7. A draft Loan Agreement between the Bank and Lima Light (No.1) and a draft Guarantee Agreement between the Bank and the Government of Peru (No. 2) are attached. 8. The Loan Agreement is similar to the previous loan agreement with Lima Light. 9. Lima Light already has outstanding debentures, including de- bentures issued under the previous loan agreement, which were issued pursuant to an Indenture administered by ichroder Trust Company in New York. The Loan Agreement provides (Sections 4.Ol, 4.02 and 5.0) that the proposed loan will be evidenced by additional debentures issued under the same Indenture. The Indenture establishes a first floating charge upon all tangible and intangible property of the Borrower and provides that additional debentures may beissued only if Lima Light satisfies the trustee that it meets the following tests: a. that the actual net income of Lima Light before interest and income taxes for a recent 12 months period is not less than 150% of the aggregate amount of the annual interest charges on existing and proposed debentures and all other funded indebtedness; and b. that the net tangible assets of Lima Light at the time of the proposed issue are at least equal to 150% of the aggregate principal amount of all existing and proposed debentures and all other outstanding funded debt. 10. Other Loan Agreement provisions of interest are: a. The usual form of the Bank's negative pledge covenant has been changed to accommodate it to existing liens permitted under the Indenture which governs the issue of Lima Light's debentures (Section 5.05). b. A default under Loan 260 PE will be a default under the Loan Agreement (Section 6.02 a). c. A default under the Indenture which governs the deben- tures will be a default under the Loan Agreement (Sec- tion 6.02 b). d. A default under the proposed loan will be a default under Loan 260 PE (Section 7.01). 11. The Guarantee Agreement is similar, in substance, to previous Guarantee Agreements given by the Republic of Peru. Since the Bor- rower is a private corporation, the guarantee would extend only to the payment of principal, interest and other charges. 12. Execution of the Loan Agreement will be authorized by the Board of Directors of Lima Light. By a Supreme Decree issued under Law No. 11636 of November 13, 1951, the Government is authorized to guarantee the proposed loan. 13. The report of the Committee provided for in Article III, Section (iii) of the Articles of Agreement, is attached (No. 3). PART IV: APPRAISAL OF THE PROPOSED LOAN 1h. A detailed appraisal of the project, TO-383, is attached (No.Q), Borrower 15. Lima Light is a public utility corporation which was originally incorporated under Peruvian law in 1910. About 56% of its shares is held by a group of Swiss investment companies and banks. The balance of the shares is widely distributed, with a large number held by shareholders in Peru. Most of the fifteen members of the Board of Directors are resident in Lima. The company is well managed. 16. Lima Light has a good earnings record and a long record of dividend payments. In recent years it has earned a return of at least 10% annually on net fixed assets in service, valued at replacement cost. The Electric Industry Law of 1955 allows tariffs to be estab- lished at a level sufficient to produce revenues to cover all opera- ting costs, interest and a return of 114% on share capital and reserves. Justification of the Project 17. The project consists of three related parts: the second stage of the MarcapcmDcocha water diversion scheme, which would increase generation in existing power plants by 450 million kwh yearly and also increase the drinking water supply to Lima and make possible the irrigation of 5,000 hectares of arid land south of Lima; the second stage of the Huinco hydroelectric plant, which would increase the generoting capa- city of the plant from 120 MW to 240 MW; and the strengthening and expansion of the Lima distribution system through mid-1966. The first stages of the Marcapomacocha scheme and the luinco plant are -6- now under construction, on schedule, and are being financed with the help of Loan 260 FE. After the completion of both stages, the generating capacity of the system should be adequate to meet demand until sometime in 1969. 18. The project is the most efficient means by which Lima Light can expand power generation and distribution facilities needed to serve the rapidly growing greater Lima area, which is Peru's center of government and business and home for about one-fifth of the Peru- vian population. Power sales in the area have been growing by about 10% per year, and are expected to continue to increase by at least 8% annually during the coming years. Lima Light -olds an exclusive concession, valid to 2006, for the distribution of power in this area. Arrangements for financing 19. Capital expenditures, including interest during construction and net additions to working canital, would total 463 million equiv- alent in the four year period ending 1966 during which the two stages of Huinco and the second stage of Narcopomacocha would be com- pleted. Under its financial plan, Lima Light would finance about 56% of its requirements from borrowings and about hL% from its own resources, contributions from customers, sales of share capital, and advances from Iidrandina. Hidrandina is a corporation, controlled by the same financial ;roup that holds the controllitg interest in Lima Light, which generates electric power, all of which is purchased for distri- bution by Lima Light. 20. The proposed loan completes all arrangements needed for carry- ing out Lima Light's financing plan, except for the sale of about $3.5 million of common shares which have to be arranged within the next two years but for which the placement prospects are good. The financial plan is reasonable, and the project could be completed even were the Company to experience unexpected delay in placing the common stock or an unexpected shortfall in revenue. Procurement 21. Procurement procedures under Loan 260 PE have been satisfactory. Apart from two alternators which have already been ordered and financed on reasonable terms by a supplier's credit, all major electrical and mechanical equipment for the project is to be procured by Lima Light through international competitive bidding. -7 The economic situation 22. A report on the "Current Economic Position and Prospects of Peru" (WH-121) dated September 28, 1962, was distributed to the Executive Directors on October 2, 1962 (Seci62-192). 23. The information that has become available since the date of that report confirmsts general conclusion, namely, that Peruts econ- omic position is, on the whole, good and warrants further external borrowing for high priority projects. The Gross National Product has been growing at a rate of about 6.5 per cent per year since 1959, sparked primarily by a very rapid increase in exports, particularly fish products,ninerals and agricultural staples. Exports are expected to grow more slowly in the future, but planned increases in public investments, particularly if they are adequately programmed, and a generally favorable climate for private investment, should provide the basis for further fairly rapid growth of the economy. 24. Since 1959 the country has been able to maintain internal and external financial stability. The budget deficit has been rcducecl to manageable proportions and Government borrowing from the Central Bank has declined. Overall credit expansion has also been slower, and while monetary expansion has been :omewhat more rapid than the growth of the economy, thore has been no drastic increase in prices. This conduct is all the more remarkable considerihg that the period was one of political instability, during which the country had two elections and a military coup. While Government savings are still lox, there are reasonable prospects for a continuation of the rela- tively cautious monetary policies followed since 1959, and conse- quently for continued monetary stability. The new Government, which came into power in July of this year, is planning substantial increases in expenditures in 1964, but these are accompanied by proposals to in- crease revenues, and also to improve the allocation of capital expen- diture through a new and improved planning mechanism. 25. Peru still has unresolved political and social conflicts be- tween different groups of the population and between different regions of the country. Any protracted political difficulties would, of course, be bound to impede the country's economic and financial stab- ility and growth. The new Government appears to be aware of and sen- sitive to this problem, and is seeking new ways to deal with it. Among these is the transfer from the Central Government to newly- elected municipal governments of appropriate responsibilities hither- to centralized in Lima, including responsibility for local public works, to generate participation at the local level which has been lacking in the past. - 8 - 26. The maintenance of monetary stability and the spectacular growth of exports have contributed to virtual balance in the exter- nal current account and to a rapid recovery of the gold and foreign exchange reserves. Free convertibility has been maintained and the foreign exchange rate has remained stable since 1959 despite a flurry of capital flight in mid-1962 and during the 1963 election. Foreign exchange earnings are likely to grow at a slower rate than in the past, but the greatly increased diversification of exports which Peru has achieved in the past few years makes these earnings less subject to sharp changes. The outlook for the key commodities (agricultural, marine and mineral) also appears favorable, which augurs well for continued economic growth and balance in Peru's external accounts. 27. Peru's external public debt has increased rapidly in the re- cent past. As of December 31, 1962, it amounted to $501 million, including ?82 million undisbursed, and an additional .30 million were contracted between January 1 and Aarch 15, 1963 (see Annex). The com- parable figure for December 31, 1961 was 1291 million. Of the 216 million of new debt contracted during 1962, 85% was in the form of sup- pliers' and bank credits. Service payaients on Peru's present external public debt will amount to 958 million in 1963 and ".59 million in 1964, equivalent to about nine per cent of estimated foreign exchange earnings in both these years. This debt burden does not appear excessive. 28. Approximately half of the new debts contracted during 1962 were incurred by the previous Government for two large projects - the Mantaro hydroelectric project and the Santa Corporation's steel mill - whose economic justification had not been fully studied. The new Government has been concerned to define what the next steps on these two projects should be in the light of the commitments that had been undertaken, and to this end has initiated a thorough review of the feasibility and economic justification of these projects. At the request of the Govern- ment, the Bank has been assisting in this review. Until these reviews have been completed it is too early to say what steps the Government will finally take. A general measure to improve control over commitment of the public credit has also been introduced: one of the early measures taken by the new Government was to tighten radically the procedures for reviewing proposals before authorizing new Government borrowing or guarantees. Prospects of Fulfillment of Obligations: 29. The project has been planned by Lima Light's own civil engi- neering staff. These plans were reviewed and a detailed design pre- pared by the Swiss consulting firm, Motor Columbus. Satisfactory arrangements have been made for the construction of the project. The management is qualified to execute the proposed project and to operate the expanded power system. 30. The market prospects for the power to be produced by the project, the interest coverage and earnings test specified in the existing Indenture and the favorable Peruvian electric power legis- lation offer assurances that Lima Light jill be able to provide the funds needed to cover its share of the cost of the project and to service the proposed loan. 31. The service of the loan, together with Peru's other foreign exchange obligations, should not impose an undue burden on the Peru- vian edonomy. PART V: COMPLIANCE WITH ARTICLES OF AGREEMENT 32. 1 am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank. PART VI: PECOMMNDATIONS 33. 1 recommend that the Bank make a loan to the Lima Light and Power Company (Empresas Electricas Isociadas) with a guarantee of the Republic of Peru in an amount in various currencies equivalent to $15 million for a total term of 25 years with interest (including commis- sion) at 5zN per annum and on such other terms as are specified in the attached draft Loan and Guarantee Agreements, and that the Execu- tive Directors adopt a resolution to that effect in the form attached (No. 5). C. M. Wilson Vice President for George D. ioods President Washington, D. C. Novemberl3, 1963 jtNNEX PERU: EXTERNAL PUBLIC DEBT (Debt repayable in foreign currencies, in thousands of U.S. dollar equivalents) DEBT OUTSTANDING Debt Outstanding Dec. 31, 1962 Major reported Net of Including additions Jan. 1- Undisbursed Undisbursed iarch 15, 1963 TOTAL L18,819 500,518 29,600 Publicly-issued Bonds 52,995 52,995 Privately-placed Debt 281,036 287,960 - Loans from: IBRD 47,246 74,197 13,250 IDB - 3,950 - U.S. Government 10,341 4,21 16,350 Argentine Govern- ment 6,241 6,241 - Federal Republic of Germany 21,000 21,000 ESTIMATED CONTRWCTUAL SERVICE PAY- MENTS ON TOTAL OF DEBT SHO! ABOVE / Debt Outstanding Payments during year Dlus undisbursed Amorti- Year January 1 zation Interest Total 1963 85,801 49,023 9,263 583,286 1964 46,762 39,843 19,368 59,211 1965 423,339 36,564 19,303 55,867 1966 385,235 37,092 17,603 54,695 1967 346,643 37,945 15,543 53,488 1968 307,242 41,557 13,289 54,846 1969 26,279 L2,641 10,903 53,544 1970 220,279 43,332 8,316 51,6488 1971 175,643 20,890 6`127 27,017 1972 153,504 19,oho 5,227 2h,267 1973 133,273 19,039 4,732 23,771 1974 113,103 19,108 7,84 23,232 1975 92,887 18,049 3,287 21,336 1976 71,729 15,548 2,576 16424 1977 59,077 13,510 2,000 15,510 /1 Includes service on all debt shown above except for two loans, total- ing $14.7 million, for which amortization terms are not available,