Mexico - Road Transport and Telecommunications Sector Adjustment Loan

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 12623 PROJECT COMPLETION REPORT MEXICO ROAD TRANSPORT AND TELECOMMUNICATIONS SECTOR ADJUSTMENT LOAN (LOAN 3207-ME) DECEMBER 23, 1993 Country Operations Division I Country Department II Latin America and the Caribbean Regional Office This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY UNIT - NEW PESO (MEX N$) Mexico has a managed exchange rate with a pre-announced devaluation of a maximum of 40 centavos daily. On April 1, 1993, the exchange rate was US$1.00 = MEX N$3. 1381. FISCAL YEAR January 1 - December 31 ABBREVIATIONS BANOBRAS National Bank for Public Works and Services (Banco Nacional de Obras y Servicios Publicos) DGMPT Directorate General for Preventive Medicine in Transportation (Direcci6n General para Medicina Preventiva en Transporte) DGPNC Directorate General of Policies and Norms (Direcci6n General de Politicas y Normas de Comunicaci6n) FNM Mexican Railways (Ferrocarriles Nacionales de Mexico) GDP Gross Domestic Product GNP Gross National Product GoM Government of Mexico IDB Inter-American Development Bank MULTIMODAL A semi public company for transportation of containers NAFTA North American Free Trade Agreement PACTO Economic Solidarity Pact PECE Pact for Stabilization and Growth SCT Ministry of Communications and Transport (Secretarfa de Comunicaciones y Transporte) SECOFI Ministry of Trade and Industrial Development (Secretarfa de Comercio y Fomento Industrial) SHCP Ministry of Finance and Public Credit (Secretarfa de Hacienda y Credito Publico) TAL Technical Assistance Loan TELECOMM Telecomunicaciones de M6xico TELMEX Telefonos de M6xico S.A. de C.V.  FOR OFFICIAL USE ONLY THE WORLD BANK Washington, D.C. 20433 U.S.A. Office of Director-General Operations Evaluation December 23, 1993 MEMORANDUM TO THE EXECUTIVE DIRECTORS AND THE PRESIDENT SUBJECT: Project Completion Report on Mexico Road Transport and Telecommunications Sector Adjustment Project (Loan 3207-ME) Attached is a copy of the "Project Completion Report on Mexico - Road Transport and Telecommunications Sector Adjustment Project (Loan 3207-ME)", pre- pared by the Latin America and the Caribbean Regional Office. The report includes a contribution by the Borrower (Part II). The project was part of an economic reform package to stimulate sector efficiency. It sought to restructure telecommunications and road transport (trucking). Main components were: privatization and regulatory reform in telecommunications; deregulation of trucking; and institutional changes. The project, which had a good footing in preparatory studies, was efficiently processed and implemented according to plans. The loan was fully and quickly disbursed. Visible achievements correspond to the agreed Policy Matrix prescrip- tions with no significant shortcomings. Efficiency gains and improved service in both sectors are beginning to show up. Overall project outcome was satisfactory and institutional development substantial. With a strong government commitment to continue the economic reform process, sustainability is likely. PCR quality is good. The project will be audited. Of particular interest will be the approach to sector reform, complementary actions needed to shore up gains made, effects on economic agents (in particular the general public) and replicability. Attachment This docuxnent has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.   FOR OFFICIAL USE ONLY PROJECT COMPLETION REPORT MEXICO ROAD TRANSPORT AND TELECOMMUJNICATIONS SECTOR ADJUSTMENT LOAN (LOAN NO. 3207-ME) Table of Contents PREFACE . ........................................... i EVALUATION SUMMARY ................................ ii PART I. PROJECT REVIEW FROM THE BANK'S PERSPECTIVE .... 1 Project Identity ................................... 1 Background ..................................... 1 Project Objectives and Description ...................... 4 Project Design and Organization ....................... 5 The Telecommunications Program . ................. 6 The Transportation Program ..................... 7 Project Implementation and Major Results ................. 10 The Telecommunications Program ................. 10 The Transportation Program ..................... 14 Project Sustainability ............................... 21 Bank Performance ................................. 23 Borrower Performance .............................. 24 Project Relationship ................................ 24 Consulting Services ................................ 25 Project Documentation and Data ....................... 25 Lessons Learned .................................. 25 PART II. PROJECT REVIEW FROM THE BORROWER'S PERSPECTIVE ............................. 33 PART III. STATISTICAL INFORMATION ..................... 52 Table 1 Related Bank Loans ............................... 52 Table 2 Project Timetable ................................. 52 Table 3 Loan Disbursements ............................... 53 Table 4 Project Cost and Financing ........................... 53 Table 5 Use of Bank Resources ............................. 53 Table 6 Mission Data .................................... 54 ANNEXES Annex 1 Policy Letter .................................... 55 Annex 2 Policy Matrix ................................... 58 Annex 3 Selected Indicators of TELMEX Performance .... .......... 62 Annex 4 The Efrects of Road Freight Deregulation ................. 69 Annex 5 Action Plan for Road Safety ......................... 73 REFERENCES .......... .............................. 78 This document has a restricted distribution and may be used by recipients only in the performance of their ofFicial duties. Its contents may not otherwise be disclosed without World Bank authorization.   MEXICO ROAD TRANSPORT AND TELECOMMUNICATIONS SECTOR ADJUSTMENT LOAN (Loan 3207-ME) PROJECT COMPLETION REPORT PREFACE This is the Project Completion Report (PCR) for the Road Transport and Telecommunications Sector Adjustment Loan to Mexico (Loan 3207-ME) in an amount equivalent to US$380 million approved on May 29, 1990. It was closed on June 30, 1991, as planned. It was fully disbursed and the last disbursement was made on May 23, 1991. The PCR was prepared by the Mexico Country Operations Division (LA2C1) in the Latin America and the Caribbean Regional Office (Preface, Evaluation Summary, Parts I and III). Part II was prepared by the Ministry of Communications and Transport (SCT). Preparation of this PCR started in January 1993 and is based, inter- alia on the Report and Recommendations of the President, the Loan and Guarantee Agreements; supervision reports; correspondence between the Bank and the Borrower; internal Bank memoranda and sector work performed by the Bank.   ii MEXICO ROAD TRANSPORT AND TELECOMMUNICATIONS SECTOR ADJUSTMENT LOAN (Loan 3207-ME) PROJECT COMPLETION REPORT EVALUATION SUMMARY i. Objective. The Road Transport and Telecommunications Sector Loan was part of a program of Bank support to the Mexican Govemment's plans to promote structural reforms across many sectors of the economy so as to resume sustainable economic growth. The loan supported a comprehensive structural reform program in the road transport and telecommunications sectors to improve their efficiency benefitting all users and, in particular, firms which conduct trade related business, for which communication services are an important input. The framework of the sector programs supported under the project was subscribed to by Government in the National Development Plan for 1989-1994. (para. 9) ii. Implementation Experience. Project implementation went well. The loan was signed 7 days after Board approval and became effective 20 days later, on June 25, 1990. By the end of August the first tranche had been fully disbursed. Approval of second tranche release was given in May, 1991, somewhat behind the target date of November 15, 1990. By the end of May, the loan was fully disbursed, and it was closed on June 30, 1991, as planned. iii. The experience with the implementation of measures to achieve compliance with second tranche conditions was very positive. The key issues under the project were deregulation of transport and privatization of Telefonos de Mexico (TELMEX). In both aspects, achievements exceeded expectations. The cornerstone of the reform process in the telecommunications sector was the privatization of TELMEX. By the end of 1990 TELMEX had been effectively privatized (para. 27). Analogously, in the transport sector the central objective was deregulation, which involved removing entry restrictions, eliminating discretionary freight allocations, allowing freight rates to be market determined and breaking up the MIULTIMODAL (a semi public company for transportation of containers) transport monopoly. All these were achieved well before second tranche release in May, 1991. (para. 41) iv. The loan also sought policy actions in various areas which, though not vital to the project objectives, were perceived to be important to further improve efficiency. Compliance was also achieved earlier than expected for the increase in railway tariffs. In other areas, delays occurred, for example,  iii in the completion of the studies for road safety, the presentation of the action plan for Telecomunicaciones de Mexico (TELECOMM), and the hiring of consultants to strengthen the regulatory capacity of the Secretarfa de Comunicaciones y Transporte (SCT) in the telecommunications sector. (Annex 2) v. Results. On balance, the result of the privatization in the telecommunications sector has been very positive. The privatization process itself has been widely praised and has been the subject of case studies that emphasized the constructive role of labor negotiations, the transfer of control to the Secretarfa de Hacienda y Credito Publico (SHCP), the realignment of tariffs, a clear concession contract, the restructuring of capital, the selling of shares by trenches, etc. The timing of all privatization activities was properly handled, the concession contract itself seems to be adequate and most objectives for privatization have been met. In this regard, the Bank concern about the handling of the sale of TELMEX being the major risk in this operation proved to be unfounded, due basically to the high expertise and seriousness provided by the innovative Mexican team that managed the operation. (para. 28) vi. A further concern relates to the overall behavior of the system from the point of view of competition. TELMEX was allowed to keep a monopoly position in local and long distance services until mid 1996. At the same time the regulatory capacity of ScT has been weak relative to the requirements for enforcement of the concession contract or interconnection issues. No clear indication exists today about whether the Government will effectively grant a new concession for long distance services, and in what terms and when, even though it is reported that a significant number of domestic and foreign companies are interested in participating. The definitive opening of this segment might be the only guarantee for the reform to be consistent with efEciency objectives. (para. 32) vii. Transport deregulation is having a major positive impact in Mexico. All aspects of concern at the time of project appraisal, e.g. entry, tariffs, service, have been positively achieved, in line with expectations of the positive impact that competition would have in this market. Government commitment and the speed of reform implementation were positive factors in the prompt response of all parties involved. The early (July 1989) agreement with truckers' associations was an important element in the speedy implementation of the reforms. (para. 41; Annex 4) viii. The discussion of road safety issues, within the context of the sector loan, helped to raise the level of awareness on safety issues within the Mexican road administration. Better coordination of actions and some indications of improvement in accident indicators have helped in the advancement of policies and measures regarding road safety. This was the primary purpose for the Bank's continuous dialogue with the Mexican government on this issue. However, improving road safety is a lengthy process in an adequate path for further progress, and a proposed highway  iv rehabilitation and traffic safety loan incorporates a major component for safety improvements. (para. 46) ix. The Government made an initial adjustment of rates for railway traffic as agreed with the Bank. Further adjustments were not made, however, so that in 1991 and 1992 rates declined again relative to long run variable costs, contributing to a worsening of Ferrocarriles Nacionales de Mexico (FNM) financial conditions. In essence, the policy was not sustained over time. There are some indications, however, that the Bank's overwhelming concern with prices was excessive in the context of important structural changes in demand and cost conditions that reflect inefficient firm size and operation practices. Since costs were excessive, the rule that prices should cover long run variable costs did not lead to an efficient resource allocation. In this sense, the Mexican response of designing a modernization program for FNM and improving on the use of direct negotiations for price setting seems to have a greater potential for increasing sector efficiency. (paras. 47-49) x. A one time adjustment of the price of diesel fuel, as agreed under the terms of the loan, was effectively carried out during 1990 by the Mexican authorities. Further adjustments were even higher than those required to maintain the level of cost recovery by trucks. Coupled with further increases in other user charges and a decline in the international price of oil ( as reference for the opportunity cost of diesel) the objective of the policy proposal has been met in more recent years. (paras. 52-53) xi. The Govemment of Mexico (GoM) made an important effort in increasing the allocation for its road maintenance expenditures during 1990 and 1991 by doubling the resources allocated to this activity in the latter part of the eighties. The new allocations adequately complied with the loan target. Expenditures on routine maintenance, however, seem to have lagged behind both in relative and absolute terms. (paras. 59-60) xii. Emission norms and inspection procedures were effectively established for trucks and buses operating on federal roads, in compliance with agreed loan conditions. (paras. 63-65) xiii. Sustainability. The sustainability of the project in the telecommunications area is assured by the success of Govemment in developing a comprehensive modemization program directed to increasing investment through private sector participation and promoting efficiency through correct price regulations and through competition. The comerstone of the program was the privatization of TELMEX. In addition a new set of regulations (a Reglamento), for the sector was issued to provide a comprehensive framework for the supply of communications services. At the same time the public sector institutions were reorganized, clearly separating regulatory and planning functions from operational responsibilities. This comprehensive integration of all elements in the design of the reform package is an important contribution to sustainability of the reforms. (para. 68)  v xiv. Sustainability of the transport deregulation policies is assured by Govemment commitment, as proven by the further opening measures negotiated under the North American Free Trade Agreement (NAFTA). The weakest point of the reform program remains the lack of sufficient strengthening of SCT to assume its new roles which has delayed the development of some important norms and policies. (paras. 69, 73) xv. Lessons Leaned. The privatization process of TELMEX, by itself, constitutes an interesting lesson for the privatization of large public sector companies with monopolistic characteristics and good market potential. As has been noted in existing studies', elements like worker's participation through share-holding, the restructuring of capital, the selling of shares by tranches, the use of both the domestic and international stock market, a carefully designed concession contract, the realignment of sector tariffs and taxes, among others, contributed greatly to the success of the selling operation. No less important was the handling of the process by a high level unit linked to SHCP, with accumulated experience from earlier public enterprise sales. (para. 84) xvi. The preparation for privatization of TELMEX yields an important esson. From the operation of TELMEX for two years under private management, the large potential for investment growth and productivity increases is immediately evident. These translate quickly into significant profits. With hindsight, expectations for improvements were too conservative, and therefore more room was in practice available for the setting of investment and quality targets, as well as tariff ceilings. Unforeseen concems associated with high company profits and still low levels of service (particularly the waiting period for installation) appear to be emerging as issues in the development of policies in the sector. However, the tax regime, under which favorable tax treatment is contingent upon reinvestment of profits acts as a safeguard. Provisions for adjustments in the calculation of the price-caps in later years, beyond 1996, also addresses these issues. (para. 85 and Annex 3) xvii. A lesn to be drawn from the experience gained in this project supports the position of promoting free entry for competition in all areas where possible as this policy helps to develop enterprises that will be the only certain guarantee for efficient sector development. From the perspective of competition, the decision of postponing the opening of the long distance telecommunication services until 1996, even though it might have been the only practical altemative available, clearly contributes to the entrenchment of the current operator. With a weak regulatory power, high profits and opportunities for monopolistic practices may in the end limit future competition. In contrast, the licensing of concessions to private operators for cellular services, in competition with TELMEX, will critically contribute to 1. See 'References', p. 59. The studies of Tandon (4) and IDB (1) describe in detail the privatization process and evaluate some of its implications. See also (2) and (6).  vi future real competition. These companies are now in a stage of organization geared towards expanding their role into the long distance service. (para. 86) xviii. Another important Ilessn concerns the difficulties of transforming a public sector agency which has lost previous key functions in the privatization process into a regulatory body. Sustainability of the regulatory policies is potentially at risk due to the slow progress on institutional reorganization and strengthening of the public sector entities related to the telecommunications modernization program. A regulatory body within a ministry, like DGPNC in SCT, is difficult to strengthen from within the normal public sector apparatus, as restrictions on personnel shedding and hiring and salaries slow the pace of the proper development of these institutions. Development of new skills is a long term process and restrictions on the required personnel changeover sets up greater barriers to progress. In view of these constraints, the Bank efforts towards the provision of technical and informational expertise for the formation of this regulatory body, through a specific assistance project, has thus far had limited results. The main recommendation for future operations is to strengthen the identification and proposals for alternatives regarding the institutional arrangements for a regulatory entity like SCT's DGPNC. To solve the administrative inflexibilities (salaries, hiring, etc.) caused by operating within a ministry-type of organization, this regulatory role might be moved to a separate superintendency-type of institution. This or other formulas (contracting external auditors to verify TELMEX's compliance) could be more fully explored by the Bank. (para. 87) xix. In the road transportation area the Mexican experience confirms so far the feasibility and effectiveness of such a massive and quick deregulation process. Major deregulation measures were implemented during 1989 and early 1990. These measures have contributed effectively to the ease of entry, diversity of services and some cost and price reductions for road freight transportation. The analysis shows so far that the market has reacted in the direction predicted by economic theory and that significant improvements in efficiency are taking place. Concerns with excessive instability of prices or services have proven unfounded. Also important adjustments of enterprises are occurring with the significant appearance of one-man truck operations. (para. 88) xx. There is, however, a Ilsn to be learned concerning the risk of pressures to reverse some of the measures taken, since in the deregulation process it is unavoidable that some agents who had enjoyed earlier privileges under protected markets will stand to lose. The emergence of significant opposition by large trucking companies who represent former protected interests and have been negatively affected by deregulation, is still an issue that is present after three and a half years from the first deregulation measures. While it does not seem feasible for the Bank to introduce long- term measures in policy-based projects on such issues, guidance and advice based on international experience may be offered. (para. 89)   1 MEXICO ROAD TRANSPORT AND TELECOMMUNICATIONS SECTOR ADJUSTMENT LOAN (Loan 3207-ME) PROJECT COMPLETION REPORT PART I. PROJECT REVIEW FROM THE BANK'S PERSPECTIVE Project Identity Name Road Transport and Telecommunications Sector Adjustment Loan Loan No. 3207-ME RVP Unit LAC Region Country Mexico Sector Infrastructure Type Loan Sector Adjustment Background 1. Between 1950 and 1974, Mexico enjoyed a remarkable period of high growth, low inflation and moderate external debt accumulation. Real growth averaged 6.4%, and inflation was in single digits throughout the period, in line with the prudent fiscal policies followed. This era of fiscal conservatism came to an abrupt end in the early seventies. Government involvement in the economy expanded rapidly, and increased public expenditure pushed up aggregate demand and the rate of economic growth. However, the higher government expenditure was not matched by rising public sector revenues. As a result, the inflation tax and external debt became increasingly important sources of public finance. At the same time, a decline in private savings incentives (real interest rates tumed sharply downward) prevented a matching increase in private savings; external debt thus increased, increased oil revenues notwithstanding. The period of single digit inflation ended in 1973, the real exchange rate started to appreciate and the accumulation of external debt accelerated above the GNP growth rate. A serious, but comparatively brief, financial and economic crisis in 1976 ended following major oil discoveries in 1977. The ensuing prosperity lasted until 1982, when soaring domestic inflation, falling international oil prices, rising world interest rates and massive capital flight (an estimated US$21 billion in 1981-82) led to a  2 refusal by extemal creditors to roll over the principal of about US$8 billion of Mexico's external public debt and a subsequent suspension of Mexican extemal debt service payments. 2. The onset of the financial and economic crisis of 1982 brought in its wake explosive inflationary and balance of payments difficulties. Initial strong fiscal and monetary adjustment efforts were altemately not sustained for a sufficiently long period (1983-85) or undermined by external shocks such as the collapse in international oil prices (1986). Despite the severe fiscal adjustment, inflation, rather than slowing down, accelerated, partially in response to the sharp real devaluation of the exchange rate necessitated by the 1986 downtum in the terms of trade. The subsequent de fact targeting of the real exchange rate, together with an increase in the frequency of wage and cost adjustments, introduced an element of inherent instability into the system. In that context, a speculative run on the peso in late 1987 prompted a large peso devaluation and triple-digit inflation. Nonetheless, and despite the sharp fall in oil prices, between 1981 and 1987 the primary deficit (non- interest public expenditure minus public revenues) of 8% was transformed into a surplus of 5.6% of GDP and the US$6 billion trade deficit was transformed into a US$10 billion trade surplus. 3. Domestic adjustment came along with three major commercial debt reschedulings, respectively in 1982-83, 1984-85 and 1986-87. These major reschedulings were linked with three debt restructurings agreed with Paris Club creditors. As a consequence the average maturity of Mexico's foreign debt increased from 8 years in 1981 to 14 years in 1987 and the spread over LIBOR was reduced from 2 and 1/4 to 13/16 points.2 However, despite a substantial drop in the average interest rate on foreign debt (from 14.9% in 1981 to 7.7% in 1987, due mainly to lower international interest rates), the average annual net transfer to creditors over 1983-86 averaged US$5.5 billion, or about 4% of GDP. As a consequence Mexico's foreign debt was unchanged (in real dollar terms) between 1983 and 1987. However, economic growth ground to a virtual halt over 1982-87 along with a sharp deterioration of living standards, a deteriorating infrastructure, high inflation, and a loss of investor confidence. 4. As a result of the 1989-90 debt restructuring under the Brady initiative, a total of US$48.2 billion of commercial bank debt was restructured. Mexico's fiscal performance remained outstanding and was reflected in sizable reductions of domestic and foreign public debt in 1990- 92. Although the current account deteriorated sharply in 1990-91, this was mainly the result of a private sector investment boom and was, in any case, overfinanced by large private capital inflows (primarily portfolio and direct foreign investment) leading to strong reserve accumulation of over US$10 billion in 1990-91. 2. See World Bank Debt Tables, World Bank, 1991.  3 5. Towards the second half of the 1980s a series of measures were taken to reverse Mexico's economic decline. Their most important goals were macroeconomic stability and a rationalized set of incentives for private sector investment. In each of these areas the Mexican Government achieved notable progress. Progress on these fronts, in turn, was required to negotiate a credible financing plan with foreign commercial creditors from a strong bargaining position and to be able to reap the benefits derived from the debt deal thereafter. 6. In late 1987 the Government announced and began implementing the "Economic Solidarity Pact" (Pacto), an agreement between business, labor, and government which called for accelerated structural reform, further tightening of fiscal and monetary policy, a freeze of minimum wages and of basic public and private sector prices, and, the cornerstone of the "Pacto", a freeze of the nominal exchange rate against the U.S. dollar. The Pacto was renewed, with important modifications, by the new Mexican administration under the name of "PECE" (Pact for Stabilization and Growth). Under the PECE and its successive renewals (the latest one in November 1991) public tariffs and minimum wages were revised, controlled prices were revised and most were de facto liberalized, and a daily adjustment of the peso exchange rate against the U.S. dollar was introduced (one peso a day in 1989 which gradually was reduced to 20 centavos a day in 1992 and increased again to 40 centavos in 1993). Contractual wages in the private sector were liberalized as early as 1989. 7. On almost every target that is under direct or indirect governmental control, performance under the PECE has been exemplary, in some instances going far beyond what was originally planned. Inflation dropped from 159% in 1987 to an average of 23% in 1989-91 and to 11.9% in 1992. At the same time, the economy has shown encouraging signs of economic recovery, led by a strong resurgence of private investment and to a lesser extent private consumption. Output growth was 3.2% in 1989, 4.4% in 1990 and 3.6% for 1991. Confidence in the economy was boosted by overall macroeconomic policy consistency and an array of structural reforms including trade, financial and fiscal reforms, the 1990 debt agreement, the privatization of the telephone company described in this report, and steel companies and commercial banks (whose substantial proceeds were allocated mainly to domestic debt reduction in 1991) and, more recently, advanced discussions on a North America Free Trade Agreement (NAFTA) and the flexibilization of the collective rural land tenure system ("ejido"). NAFTA, and associated with it a likely profound transformation of the agricultural system, is crucial both because it would deepen the structural reform process and make it more irreversible. Reflecting improved confidence in the economy, nominal interest rates have declined to record low levels for the last 15 years and Mexico received massive private capital inflows, on average US$9 billion in 1989-90 and an estimated US$17 billion in 1991. The current account balance has deteriorated since 1988 but this is largely due to higher imports caused by accelerating private sector investment and, to a lesser degree, lower private saving. In short, while structural adjustment is by no means  4 complete, the progress which has already been achieved augurs well for a period of sustained growth. 8. Signs of a sustained recovery appeared only since 1991. In the decade of the 1980s, average annual GDP growth was 1.6%. Slow growth occurred also in the transport sector, not surprisingly since transport services are a derived demand. From 1980 to 1988, transport sector output grew only 4%, with the greatest contribution to sector growth coming from road passenger transport (22% between 1980 and 1989). During the mid-eighties, the Government established that in the markets for infrastructure services regulations and interferences were excessive, producing major efficiency losses, inadequate services, both in quantity and quality, distorted price signals and insufficient sector modernization. In the particular case of telecommunications the explosion of technological developments in the area of electronics had opened many new opportunities for competition. Numerous possibilities, focussed primarily on deregulation and privatization policies, were identified to increase efficiency in both the transportation and telecommunication sectors. Project Objectives and Description 9. The loan was part of a series of Bank loans to support the Mexican Government's objectives of promoting private sector development and increasing the efficiency and effectiveness of public sector institutions so as to enable the resumption of economic growth. Between 1987 and 1991, eleven sector loans and one interest support loan were approved by the Board, for a total of US$5.6 billion. The sector loans covered actions in critical areas like trade and export policies, as well as, specific production and service sectors including mainly agriculture, industry and finance. One loan was devoted to the divestiture and improvement of management of public enterprises.3 The Road Transport and Telecommunications Sector Adjustment Loan supported a program of reforms in two sectors (road transport and telecommunications) which have in common that they both provide a vital service to business activities in general and to external trade in particular. By providing an appropriate institutional and regulatory framework, the project was expected to spur competition, thus serving to increase the efficiency of communications services and -- in the case of telecommunications -- greatly expand its coverage. Resource allocation 3. The sector loans approved were: Trade Policy I (Ln 2745-ME) for US$500 million; Export Development II (Ln 2777-ME) for USS250 million; Steel Sector Restructuring (Ln 2916-ME) for US$400 million; Agricultural Sector Loan (Ln 2918-ME) for US$300 million; Fertilizer Sector Loan (Ln 2919-ME) for US$265 million; Trade Policy II (Ln 2882- ME) for US$500 million; Industrial Restructuring (Ln 3047-ME) for US$250 million; Financial Sector Loan (Ln 3085-ME) for US$500 million; Public Enterprise Reform Loan (Ln 3086-ME) for US$500 million; Industrial Sector Policy Loan (La 3087-ME) for US$500 million; and the Agricultural Sector Adjustment Loan (La 3357-ME) for US$400 million. The Interest Support Loan (Ln 3159-ME) in the total amount of US$1.26 billion was part of the Bank's support for the Debt and Debt Service Reduction (DDSR) plan of the Government of Mexico.  5 would be improved through greater reliance on market forces, and (in the case of monopolies) on economic criteria for pricing. The framework of the sector programs supported under the project was subscribed to by Government in the National Development Plan for 1989-1994. The various elements were spelled out in the Government's Policy Letter. (Annex 1) 10. The project was cofinanced by a parallel loan of US$200 million from the Inter-American Development Bank (IDB), which was approved in the same year. The project was also supported by the Bank's Telecommunications Technical Assistance Loan (Ln 3208-ME), a parallel free standing technical assistance loan (TAL) of US$22 million to finance consultants to prepare plans for developing SCT's telecommunications regulatory capacity, including management and monitoring of the radio spectrum, as well as long term experts, training and equipment (computer hardware and software, and radio monitoring facilities) required for the first two years' implementation of these plans.4 The TAL also supported TELECOMM in its start-up phase. 11. The main components of the project included: (i) a program of privatization and regulatory reform to promote competition and improve services and tariff setting in the telecommunications sector and (ii) a program of deregulation of the trucking sector. In both sectors (iii) pricing and taxation distortions were to be eliminated and (iv) the public sector institutions responsible for oversights of the sectors were to be restructured. In addition, in the road transport sector the program included (v) measures to improve highway safety and (vi) measures for monitoring compliance by trucks with air pollution standards. Under the TAL, which is still being implemented, technical assistance was to be provided to strengthen the public sector agency responsible for the formulations of telecommunications policy and for sector regulation. Project Design and Organization 12. Under a series of Bank supported sector adjustment operations, the GoM had already moved far in the implementation of its program of adjustment designed to reduce the involvement of the public sector in activities which can be conducted more efficiently by private enterprises and to provide a liberalized legal and institutional framework which promotes private investment and competition. The reforms already implemented and supported by the Bank in the trade regime, financial and industrial sectors and the program of divestiture of public enterprises reflected these objectives. The Road Transport and Telecommunication Sector Loan was designed to complement and reinforce these adjustment efforts by extending them to two 4. The specific objectives of the loan are: (a) to assist SCT to develop its capability to regulate telecommunications services and networks, (b) to improve SCT's administrative and technical capability for the management of the radio spectrum, and (c) to assist TELECOMM in developing its business activities.  6 sectors of strategic importance -- road transport and telecommunications. Elimination of constraints to entry and of price controls in trucking had already taken place and deregulation of the automotive industry was ahead of the agreed schedule, both with support under the Industrial Sector Policy Loan (Ln 3087-ME). In the case of telecommunications, the Bank played an important role in helping to shape the Government program, which went far beyond what had been expected only one year hence. The privatization of TELMEX, one of the largest parastatals in Latin America, and the opening up of the telecommunications market to private (including foreign) investment were unprecedented steps in Mexico. These measures, and the additional actions proposed under the project, would make transportation and telecommunications services much more efficient. 13. These efficiency gains in the two vital sectors warranted the Bank's assistance to the Govemment's decision to extend its adjustment efforts to transportation and telecommunications. Furthermore, the depth and comprehensiveness of the Mexico's adjustment efforts to help restore growth, at that time limited by a balance of payments constraint (access to external financial markets was still very constrained), justified a significant level of adjustment lending and provided the basis for having the proposed operation as a sector adjustment loan. 14. As a substantial number of actions in the Govemment's program for sector reform, particularly in the transportation area, had already been taken by the time of Board presentation, the first tranche of the loan of US$190 million was available upon loan effectiveness, which only required that the borrower, Banco Nacional de Obras y Servicios Publicos (BANOBRAS), enter into a contractual arrangement with Government for relending of the proceeds of the loan. Second tranche release was contingent upon satisfactory assessment of the medium term macroeconomic framework and the satisfactory implementation of nine specific actions focused on implementing the modernization program for the telecommunications sector and complementing the road transport deregulation program. Some of these measures had been identified by the Bank through its previous involvement in the highway and railway areas, and were supported by specific sector studies carried out in the mid-eighties. A two-volume study of high quality, which brought together and analyzed the results of field work and studies on the major issues in road tranport and telecommunication, was completed in March, 1990, and provided a major input into project preparation. The Telecommunications Program 15. TELMEX, a publicly owned company and sole supplier of telephones services, experienced sluggish growth (5 to 6% per year) during most of the eighties. Even though there was a large unmet demand for lines, the ability of the company to raise financing was seriously impeded by the expenditure constraints associated with tight fiscal policy. Also, the service was of poor quality, unreliable and congested and productivity was low. In addition, major distortions existed in the tariff structure under which prices for  7 international calls and domestic long distance were much above costs (and international standards) while connection rates and local calls were heavily cross-subsidized. 16. A clear conceptual foundation of the telecommunications component resulted from a Sector Policy Paper issued by Government in September, 1989. It presented a diagnosis, objectives and a set of comprehensive actions to be taken in the telecommunications area. For the purposes of modernization and expansion of services the most critical decision was the privatization of TELMEX. This decision was consistent with actions taken in other sectors of the economy and it was expected to provide a significant amount of revenue from the sale of government owned shares. In addition, and with a view to further strengthen efficiency, the roles of the State and the private sector were redefined by allocating to the Undersecretary of Communications and Technology Development, all responsibilities concerning regulations, licensing, norms and certain planning activities, while the private sector would develop and operate the system itself. In this scheme all operational services then under SCT and Telegrafos Nacionales (satellite communications, federal microwave network, telematic, telegraph and other services) were to be transferred to a newly created public entity, TELECOMM. The program also considered price restructuring, including a revised tax structure for TELMEX, and the establishment of a regulatory framework, through a new set of regulations (Reglamento), to promote competition in all areas where possible. 17. Administrative control of TELMEX was transferred from SCT to the unit in SHCP where all privatization efforts were centralized, and a new manager was named to assure the implementation of policies consistent with privatization. In January, 1990, a new tariff and tax scheme was implemented, a concession contract was under preparation and an agent bank, Banco Internacional, was hired to prepare a sale prospectus and value the firm. At the time of loan approval (May 1990), substantial progress had been made towards final design of all major pieces of the institutional reform. Thus the Policy Matrix (Annex II) negotiated to support the loan reflected the interest of the Bank in satisfactory completion and implementation of these reforms. The Transportation Program 18. In Mexico about two-thirds of total cargo is transported through public trucking. Up to July, 1989, this industry was heavily regulated, involving entry restrictions to operate on federal highways coupled with strong restrictions for moving cargo between established transport corridors; a limited number of freight centers with control over cargo assignments; a semipublic company, with the monopoly of container handling; and limited concessions for the handling of cargo movements at railroad stations and customs facilities. A variety of regulations on both the U.S. and Mexico sides impeded efficient cargo handling at the border. Lastly, "official" tariffs were applied to all cargo movements.  8 19. The apparent rationale for such a regulated system was that open competition might: (i) disrupt economic activity through probable high price variability and uncertain service availability, especially to less accessible regions of the country, and (ii) lead to cost cutting practices that might result in increases of accidents and pollution (usage of older trucks, less maintenance, etc.). However, contrary to the expected benefits of a regulated system, a strongly uncompetitive and distorted price system led to costly welfare losses due to inefficiency. Entry barriers were easily transformed into opportunities for the formation of rents and neglect of client demands. Inadequate tariff levels led to misallocation of resources, as price signals were improperly related to costs. Also, the Government had to maintain a sizable bureaucracy to enforce and administer the system. In all, it has been estimated that welfare losses might have amounted to about 1/2% of GNP. 20. In view of the fundamental redefinition of the role of the State and the private sector in all areas of the economy, the relatively recent experience of trucking deregulation in the U.S. and other countries, and strong Bank interest in creating awareness of these issues and in supporting a program of reforms, the Mexican authorities issued a completely new Reglamento for federal road freight transportation in July, 1989. This Reglamento, complemented with further measures taken in early 1990, meant in fact the complete ending of regulation of trucking in Mexico and gave way to total open competition.5 Concessions to operate were transformed into simple permits, route assignments were eliminated, the use of freight centers was no longer compulsory, the handling of containers was opened to other firms and most importantly, the system of official tariffs was totally eliminated in January, 1990.6 Also, further measures to correct inadequate insurance regulations regarding cargo were announced. 21. An additional important measure taken in January, 1990, was the elimination of tax exemptions for truck operators, and the transportation sector started paying income tax, value added tax, tax on assets and vehicle ownership tax. Additional tax revenues were estimated to be in the order of US$173 million annually from just the first two sources. These reforms put the road transportation sector at the same tax level as all other commercial activities in Mexico thus avoiding distortion and eliminating a commonly used tax shelter. 5. These measures were related to Government's policies to improve the regulatory environment for the Mexican industrial sector including services to industry. Under the Industrial Sector Policy Loan (Ln 3087-ME, approved by the Board on June, 1989) support was given to complete a comprehensive study of the regulatory environment for trucking services to provide the basis for preparing an action program for reform. The measures actually adopted went much beyond this commitment moving rapidly to a broad liberalization of trucking activities. 6. Additional measures were also taken to deregulate passenger and tourist transport.  9 22. In line with these developments, SCT found it necessary to proceed with an internal reorganization. In 1989, about 2,500 employees were involved in regulatory activities. Under the new Reglamento many of these functions were no longer needed. All units formerly involved in issuing permits and concessions and setting tariffs were greatly reduced, while at the same time monitoring activities were upgraded. In mid-1990, an evaluation was still under progress to assess the workload and implement further changes. 23. The purpose of these reforms was to allow increases in efficiency through the promotion of competition. It was expected that 'new" entrants would force existing companies into rationalizing and improving services, to align prices to costs, to identify and exploit various niches for specialized services, and in general to significantly reduce the overall social cost of moving cargo between the different points within Mexico and abroad. 24. The conceptual underpinnings of this project rested on the identification and implementation of measures necessary to complement the deregulation process with adequate policies to internalize some external effects associated with freight transportation (accidents and pollution), to properly price and invest in public road infrastructure (cost recovery, adequate road maintenance and load limits), and to rationalize the use of alternative transportation modes (cost recovery in railroads). In an unregulated environment it is important that private prices reflect social costs, therefore efforts must be made so that truck operators, through proper pricing or regulations, internalize some of the external costs associated with their activities. In large part, these efforts involve measures to improve safety on the roads and the setting of standards and monitoring compliance regarding pollution emissions. It is also necessary for efficiency that proper pricing policies be implemented regarding road usage, as a low level of road usage will tend to result in higher than optimal road utilization. Studies done by the Bank in 1986 indicated that trucks were paying, through yearly ownership taxes, fuel taxes and tolls, less than the effective damage they caused on roads. Similarly, data on railroad rates indicated that for many important products tariffs were not enough to cover long-run variable costs. On both accounts some distortions were present affecting the optimal allocation of cargo between both modes. 25. A final issue of importance dealt with the evident lack of adequate maintenance levels for highways and the related problem of axle weight regulations and controls. Poor road maintenance, aggravated by heavy trucks, increases substantially vehicle operations costs. In an unregulated environment, with expected strong competitive pressures it is important to correct for these conditions. Measures to cover all these areas were agreed to be taken during 1990 and 1991 and constituted the basis for the action program summarized in the Policy Matrix. (Annex 2)  10 Project Implementation and Major Results The Telecommunications Program 26. Privatization of TELMEX. The comerstone of the reform process in the telecommunications sector was the privatization of TELMEX. In terms of loan conditionality, the major policy action supporting the telecommunications part of the operation was the compliance with satisfactory progress towards sale of a controlling interest in TELMEX, including receipt of bids and award decision by Govemment as a condition for second tranche release. 27. From June through December 1990, a series of actions were taken with the result that by year end TELMEX had been effectively privatized. The main actions were: the modification of the TELMEX capital structure, which by creating a number of non-voting shares ("L" shares) reduced the ownership participation needed for control to 40% of the total; the publication of a revised franchise for TELMEX; the invitation and pre- qualification of firms for bids; and the actual reception, evaluation and announcement of the winning bidder, a group of Mexicans headed by the Grupo Carso (51 % share) and Southwestern Bell and France Cable et Radio (24.5 % each). The sale price was US$1.76 billion (including payment for certain options) for a package of 2,163 million shares (all of the voting shares in the hands of the govemment) representing 20.4% of the total outstanding shares. The sale contract was signed on December 20, 1990. Simultaneously, a package of 467 million shares (4.4% of the total stock) was sold to the workers union for US$325 million. The divestiture process has continued as planned, with successive releases geared to maximize total revenues, as the price of the shares increased substantially. In September, 1991, the owners of TELMEX exercised an option to buy an additional 541 million (non-voting) shares. Further public offerings by the Govemment were made in May and June of 1991 and in May, 1992. Overall receipts of all combined sales have reached over US$6.3 billion. To date the Government owns about 4.8% of TELMEX. 28. TELMEX performance has fallen well within the privatization objectives (Annex 3). Overall investment levels have reached US$2.2 - US$2.5 billion annually.7 Lines in service have grown above the target of 12% in 1991 and 1992. Service quality indexes have shown significant improvement. Productivity is reported to have increased about 24.5% in 1991. Coupled with the important restructuring of sector taxes and tariffs since 1990 (which has notably reduced cross subsidization), company profits have reached the level of US$2,600 million in each of the two years under private ownership. Profit rates were 28.7% in 1991 and 25.7% in 1992. 7. US$2.25 billion in 1991; US$2.4 billion in 1992; US$2.4 - 2.5 billion planned for 1993.  11 29. The Bank concern about the handling of the sale of TELMEX being the major risk in this operation proved to be unfounded, due basically to the high quality expertise and seriousness provided by the Mexican team that managed the operation. The privatization process itself has been widely praised and has been the subject of case studies that emphasized some innovative features and the opportune role of labor negotiations, the transfer of control to SHCP, the realignment of tariffs, a clear concession contract, the restructuring of capital, the selling of shares by trenches, etc. The timing of activities was properly handled, the concession contract itself seems to be adequate and most objectives for privatization have been met.8 30. The regulatory framework. The requirement of second tranche release to enact satisfactory regulations governing the licensing of telecommunications networks and services was adequately satisfied through the publication in the Diario Oficial on October 29, 1990 of the "Reglamento de Telecomunicaciones". 31. The Bank reviewed the hiring of consultants and commented on early drafts of the document. An expert analysis confirmed the general adequacy of the Reglamento. However, two major potential weaknesses were cited. One is that no procedures were established for the automatic granting of concessions, i.e. SCI has a totally discretionary role in accepting or not a request for a concession. Thus, no clear commitment for future strengthening of competition is embedded in the Reglamento. A second is that tariff regulation (efficiency pricing rules) is extremely complex, and will impose a heavy burden on SCT. In addition, as ScT remains the weakest link in the system, the largest risk at this point is that regulatory decisions get delayed for such a long period that opportunities for efficient investment are lost, or 8. Tandon, Panjak: Mexico. Background. TELMEX. AEROMEXICO. MEXICANA. World Bank Conference on the 'Welfare Consequences of Selling Public Enterprises. Case studies from Chile, Malaysia, Mexico and the U.K.'. June 11-12, 1992. Washington, D.C. The author suggests a remaining area of concem based on the perception that the combination of tariff, tax and the productivity adjustment factor in the price cap formula might have been too generous, as indicated by the level of profits and return on capital that is being obtained by TELMEX. The actual large rise in productivity was not predicted. In addition traffic has continued to grow at rapid rates, in spite of the significant tariff increases. In view of this, the analyst suggests that the process has represented a massive loss of consumer surplus in favor of all other parties. This perception, coupled with the relatively slow improvement in satisfying unmet demands and service quality, may continue to generate disappointment with the privatization process, a risk expressed at the time of project appraisal. Tandon's conclusions have been severely criticized from within the Bank. Favorable tax treatment is contingent upon reinvestment of profits, thus addressing the concern about the pace of expansion and excessive profits. Also, some basic assumptions regarding the "without project' situation are not sustainable, particularly concerning the ability of TELMEX to grow under the former environment. In this setting, most of the calculations are questionable. However, the study correctly supports the overall perception that benefits to consumers have not been as large yet as had been anticipated, while rates have gone up significantly.  12 that current participants may unduly profit from the inadequacy of the status quo. 32. Current regulatory issues involve the conflict of interconnection of TELMEX with the independent cellular phone services. Although SCT already settled the terms of the payments to be made, cellular companies are insisting that the decision be reviewed. Further problematic areas have evolved in relation to the satellite system where TELMEX is requesting access to alternative systems to reduce costs. A critical upcoming concern is the expected opening of the long distance national and international service to new entrants in mid-1996 or early 1997. Existing cellular firms and many foreign companies are interested in penetrating this market. The Government has not defined publicly its intention or prepared a calendar to proceed with the granting of this concession. The definitive opening of this segment for competition would be the only guarantee for the reform to be consistent with efficiency objectives. 33. Strengthening the regulatory role of SCT. For the purpose of developing regulatory capabilities, given the new institutional context, a condition of second tranche release was that consultants be engaged to strengthen SCT's regulatory capacity in the telecommunications sector and that a satisfactory Action Plan to strengthen SCT's regulatory capacity in the sector be furnished. To support this development, a parallel TAL was approved. As the Action Plan was approved only in April, 1991, it was one of the factors which contributed to the length of time required to comply with the conditions of second tranche release.9 34. In accordance with the Action Plan, the institutional reorganization of the Department of Communications and Technology Development of SCT was implemented in April, 1992. However, more importantly, although according to the estimates presented in the Action Plan, some 50 additional midlevel management positions were needed to cover the requirements of the new regulatory environment, the recommendation was not carried out. The personnel situation is essentially the same as that of 1991. The main constraint faced by SCT regarding personnel originates in the established policies applicable throughout the public sector in Mexico, which focus on retrenchment of personnel and a freeze of mid-level management positions.'" No proposals were under discussion to deal with this problem within SCT. In addition, many weaknesses were reported in the development of some 13 systems, particularly for verification of TELMEX's quality 9. Along with the requirement on the federal highway maintenance budget. Second tranche release had been anticipated for sometime closely following November 15, 1990, but was actually approved in May 1991. 10. A Modernization Unit exists in the office of the Chief Administrator in SCr to deal with all reorgarnization schemes. According to this unit, since the late eighties some 109 - 15% of mnid-level management positions have been reduced in SCT.  13 indexes ", while limited or no advance is reported regarding tariff and costs studies, system of accounts, prospective technological and demand developments, and the evaluation of fundamental plans.'2 By the end of 1992, only limited progress had been achieved regarding the parallel Technical Assistance Loan approved to support SCT. 35. Although second tranche release criteria were met, real progress in developing SCT regulatory capacity has been slow. In looking back at project files it is evident that there was no clear consensus on the part of the Mexican authorities on the need for strengthening this regulatory capacity. Fears were expressed that a strong SCT might conspire against the adequate development of the private sector. The Bank might have taken a stronger stance regarding this issue, but given the overriding importance of a successful TELMEX sale, and the drafting of the regulations, at that time, in 1990, it did not seem appropriate to delay the loan. 36. The Bank has expressed concern that further lagging of the strengthening of SCT might become a problem, in view of the expected regulatory issues that will appear in the next few years. In essence the risks perceived at loan appraisal have not been fully put to rest. Actions taken to provide SCr with technical support to develop its new activities, including the Telecommunications Technical Assistance Loan, although well conceived, have been only partially fruitful as they faced lack of counterpart personnel and a stronger political support. In addition, changes in key officials and heavier workloads seem to have altered priorities regarding the actions agreed to be necessary. 37. For future operations, the main recommendation is to strengthen the identification and proposals for altematives regarding the institutional arrangements for a regulatory entity like SCT's DGPNC. It has been suggested that to solve the administrative inflexibilities (salaries, hiring, etc.) caused by operating within a ministry type of organization, this regulatory role should be moved to a separate superintendency type of institution. This or other formulas, e.g. contracting external auditors to verify TELMEX's compliance, could be more fully explored in the future. 38. Business Plan of TELECOMM. Under the modernization program, in November, 1989, all operational activities under SCT (the federal microwave system and Morelos satellite system) were transferred to TELENALES (then responsible for the telegraph system) and a new state 11. It is unclear what precise procedures have been established to deal with the verification of TELMEX agreements on expansion and quality targets. SCT seems to rely mostly on TELMEX own reports, although it has occasionally conducted sampling studies to measure some quality of service parameters. 12. The former Director General of DGPNC left SCT in February of 1992. Since then, priorities regarding the development of the Action Plan seem to have changed. Also there are indications that the workload of DGPNC has increased considerably, straining the available human resources.  14 company called TELECOMM was created. Under the project, the presentation of a satisfactory business plan (including financial and investment programs through 1994) for TELECOMM was agreed to provide a clear definition of the role this new entity would play in the system. 39. This criterium was met in April of 1991, after the decision made by the Government to reform TELECOMM's functions by eliminating, in October, 1990, its activities related to terrestrial long distance operations. In December, 1990, the federal microwave network was sold to TELMEX.13 This decision also implied that TELECOMM could not participate in the development of a fiber optic long distance network, as intended. Evidently such policy implied a relatively diminished role of this entity by limiting its business to the operation and expansion of the satellite system and telegraph networks. 40. Although TELECOMM is in the process of constructing two new satellites (Solidaridad I and II) to be put in space by early 1994, there are renewed pressures from private operators (TELMEX, cellular companies and others) for further redefinition of State and private roles relative to the satellite system. This is an area where further opportunities for competition exist, particularly with regards to the provision of public long distance service, both national and international. To face this challenge and develop new markets TELECOMM itself is limited by budget and operational constraints that are typical of decentralized agencies in the public sector. In this setting it is difficult to foresee TELECOMM as a major player in the satellite system in the future. The Transportation Program 41. The effects of deregulation. In the tranprt sector the central objective was deregulation, which involved removing entry restrictions, eliminating discretionary freight allocations, allowing freight rates to be market determined and breaking up the MULTIMODAL transport monopoly. There is evidence that transport deregulation is having a major positive impact in Mexico. Even though data are weak (Annex 4), all aspects of concern at the time of loan approval, i.e. entry, tariffs, service, etc. have been positively affected, in line with expectations of the impact that competition would have in this market. Government commitment and the speed of implementation of the reforms were positive factors in the prompt response of all parties involved. The early (July 6, 1989) agreement with truckers' associations was an important element in the speedy implementation of the reforms. 13. The apparent rationale for this sale was that TELMEX would have a less competitive environment to operate its long distance services. In fact TELMEX was itself a heavy user of the microwave network. Additionally SHCP had indicated that no fiscal resources would be available for the much needed upgrading of this network.  15 42. The weakest point of the reform program remains the lack of sufficient strengthening of SCT to assume its new role. This has delayed the development of some important tasks specified in SCT's Action Plan on which little or no progress has been reported. These include tariff and cost studies and a system of accounts. Furthermore, as some pressure groups intensify their opposition to the reforms, a strong SCT would be important to ensure no reversal in policies. A more forward looking project design might have focused more carefully on identifying and developing these new capabilities. Basically, the new deregulated environment has given SCT an important role in the development of policies, programs and norms regarding the transport sector. For these purposes new skills are needed in technical and professional areas and they have not been available. Examples of the new roles that have been assumed and which need to be developed and strengthened are: developing norms for transportation of hazardous materials, hiring and supervision of policy and sector studies, and updating safety norms in roads. Personnel policy within the public sector in Mexico and in SCT has limited the ability of the Road Transport Directorate to hire appropriate personnel. Even today a large number of government officials who used to be responsible for issuing permits remain in place, in spite of the fact that this function has been greatly simplified and transferred to regional centers. At the same time, budget resources and positions have been constrained at the technical and professional levels. No doubt this should be an area of continuing Bank concern and of future support and strengthening. The development of appropriate norms and policies in many areas are a must for the development of an efficient transportation market. 43. Highway safety. Road accidents account for about 3 % of all deaths in Mexico, and this rate compares poorly with countries with a much higher rate of motorization and traffic'4. About one-quarter of the total number of road accidents take place in the Federal Highway Network. These amounted to about 67,000 in 1992, with casualties reaching about 110,000 persons, of whom 5,500 were killed and 37,000 injured. Direct damages were estimated at US$200 million in 1992. From 1988 to 1991, the yearly growth rate of accidents was 6.8%. In 1992 this trend was reversed as accidents declined by 0.5%. 44. To address a number of issues identified by the Bank regarding the sources of the problems, the Mexican Government agreed that a group would be set up"5 to develop an action plan and to strengthen coordination on safety issues. This group was formed in April, 1990, prior to Board approval of the loan. In addition, a study was started in 1990 on the subject of vehicle size and weight limits. For second tranche release it was agreed to complete the first phase and initiate second and third phases (policy recommendations) of the study and to present a satisfactory action plan to improve road safety. 14. World Bank. Mexico. Road Transport and Telecommunications Sector Adjustment Project. Road Transport Technical Report. Volume I. March 5, 1990. 15. By SCT's General Directorate for Preventive Medicine (DGMPT).  16 45. Regarding the size and weight study, most of the first phase (statistical data collection) was concluded, although after some delay. The studies have shown so far that about 25 - 30% of trucks are overloaded, according to current norms. The second and third phases regarding policy options and implementation measures were never adequately completed. SCT suggested that mainly problems with timely availability of resources to acquire measurement equipment (weighing scales) were the main causes for the poor results of the study. Notwithstanding this problem, SCT has drafted a new Reglamento on weight limits which is currently being reviewed with users and transportation organizations before approval at the Government level. 46. The development of policy actions under the Action Plan for Road Safety presented in September, 1990, 16 most of which were effectively carried out, provided a basis to raise the level of discussion about safety issues within the road administration. Better coordination of actions and some indications of improvement in accident indicators have helped in the advancement of policies and measures regarding road safety. This was the primary purpose for the Bank's continuous dialogue with the Mexican government on this issue. Improving road safety is a lengthy process and SCT is now in an adequate path for further progress. The Action Plan was a simple grouping of activities put together by adding the individual actions of all the institutions involved, without priorities, periodic reporting of the status of actions, and measurement of impacts. A better defined set of objectives and measures is needed. A proposed new project for the road sector incorporates a major component for safety improvements"7. 47. Railway tariffs. Railways account for some 13% of total tons of cargo transported in Mexico. Its relative importance has been steadily declining since the mid-eighties, as total cargo transported has been reduced about 20% between 1985 and 1990. A further 9% decline occurred in 1991. Ferrocarriles Nacionales de Mexico (FNM), a publicly owned company, has for the last twenty years been unable to generate enough revenues to meet even current costs. A study done in the second half of the eighties'8 and data from FNM indicated that railway tariffs were not adjusted properly to long run variable costs. For some of the most important products (coal, iron, cement) average tariffs were 5% to 10% below average costs. As railway tariffs are regulated, this situation reflected, basically, pricing policies implemented by SHCP and Secretarfa de Comercio y Fomento Industrial (SECOFI) to meet guidelines for macroeconomic stabilization. 16. A brief summary of the proposed actions and their current implementation status is presented in Annex 5. 17. Highway Rehabilitation and Traffic Safety Project, expected to be presented to the Board in fiscal year 1993. 18. World Bank. Mexico. Transport Pricing Study. Report No. 6580-ME. Projects Department. Latin America and the Caribbean Regional Office. February 20, 1987.  17 48. With the view that proper pricing for railways was an important complement to road deregulation, it was agreed that the Government would furnish the Bank the complete study on railway rates and increase FNM rates for selected commodities, which account for about 70% of cargo revenues, by no less than 25% (in real terms). The increase was to be effective not later than January 1, 1991, provided however that rates would not be increased beyond the level of long run variable costs. 49. A study contracted by FNM on railway costs and tariffs was finished in November, 1990, while rates were increased by 23%, in nominal terms, in July and a further 15% in October, 1990. Available data indicate that the balance between tariffs and costs reached 97% on average in 1990. (Table 1) Evidently, this figure was much higher after the October increase. Further data for 1991 and 1992 indicate, however, that this policy of matching tariffs with long run costs was not sustained. No further increases in base tariffs have been authorized since October, 1990. The results of the above policies were that during 1991, the relative ratio of revenues to costs fell to 87%, and with a few exceptions, all products were charging below average costs. The situation worsened further during 1992. 50. There are indications however that the Bank's overwhelming concern with correct price setting was misplaced in the context of important structural changes in demand (due in part to road freight deregulation and the privatization of client companies) and cost conditions that reflect inefficient firm size and operation practices. Given these inefficiencies, the simple rule that prices should cover long run variable costs would not lead to an efficient resource allocation. 51. Subsequent to this loan, the Mexican government started to implement an important modernization program in the railway sector. This program, covering the 1992 - 1994 period, addresses specifically the issue of improving marketing and pricing policies, allowing direct contract negotiations for most cargoes with total liberalization expected by 1994, which has been a long sought Bank policy goal. Additional issues addressed are improving operations through revised work rules and rationalization of the use of locomotives and repair shops; giving priority to track maintenance and eliminating service in areas with low demand and available alternatives; rationalizing personnel (so far 18,000 workers have joined a voluntary retirement program); and, improving of management practices. No doubt this approach to the railway sector is much more conducive to overall efficiency in the transportation area.'9 52. Cost recovery. Updated estimates of road user charges at the time of project appraisal suggested that, although they had increased substantially since the mid-eighties due mainly to a large increase in the implicit fuel tax, trucks still were not paying their full costs of road usage. The deficit, relative to expected expenditures in 1990, was on the order of US$250 19. A proposed Railway Restructuring Project is under preparation for FY94.  18 million per year. On this basis, under the project it was agreed that satisfactory observation of the commitments to significantly improve cost recovery from trucks would be carried out through an increase of 10% (in real terms) in the price of diesel fuel. This increase would cover about 57% of the required shortfall of truck cost recovery. 53. Mexican authorities complied with the agreement as prices for diesel were raised 17% at the end of May, 1990, and a further 10% in November of that year. With these changes, the real price (in dollar terms) was effectively increased by 21 % during 1990. 54. The price of diesel has continued to be adjusted above the exchange rate variations in later years as shown in Graph 1. When compared to domestic inflation, the real price increase has been much lower. Graph 2 shows the evolution of the implicit fuel tax, as measured by the difference between the border price of diesel and the domestic price. The base value of the border price is taken as Mex$450 per liter as established for January - March, 1990, during appraisal. This value is updated in accordance with the evolution of the price of oil exports by Mexico which is used as the reference price for the opportunity cost of diesel. The resulting comparison with domestic prices indicates that during the second semester of 1990, due to the large increase in international oil prices, there was an effective subsidy to diesel users. However, as the international price of oil has declined since 1992, the effective tax has been positive and substantially above the level of Mex$20 estimated in early 1990. In fact, since March, 1991, the tax has been five to seven times above of what it used to be in real terms. Under conditions of 1990, the cross subsidy between trucks and automobiles for the financing of roads still remains although it is significantly smaller. It was estimated during appraisal that full coverage of costs by trucks would require a total tax on diesel of Mex$103/lt. Throughout 1991 and 1992 this figure has been significantly exceeded. 55. Other user charges have also increased significantly. Ownership taxes for trucks are reported to be 3 to 5 times higher than those of 1989. Furthermore revenues from licenses were estimated in 1991 to be some 7 times above 1990. Similarly taxes on new vehicles have contributed to higher cost recovery. In all, the latest estimates made in 1991 show an increase in cost recovery from these sources, and from toll roads, of 55% relative to those of 1990. Total revenues that year reached about US$427 millions. 56. The proper implementation of a cost recovery policy requires a much deeper policy design. Analyses addressing questions related to the recovery of highway costs from users in Mexico were done for the proposed highway rehabilitation and safety project. The results indicate that: (i) in the aggregate, road users are contributing at levels sufficient to cover desirable road maintenance and rehabilitation costs. The real increases in gasoline prices in recent years have made a major contribution to this; and (ii) heavy vehicle users are still cross-subsidized by automobile users. Recently, the  19 GoM has made progress in redressing this imbalance through adjusting tolls. Diesel prices, while increasing substantially, are only now approaching international levels, and therefore diesel taxes do not yet contribute to road maintenance cost recovery. This situation, coupled with the increasing importance of the private road network, warrants a more thorough review of road financing strategies and instruments. Such a study to be carried out by SHCP would be supported under the proposed highway rehabilitation and maintenance project. 57. Road Maintenance Budget. Fiscal restraints associated with the requirements of macroeconomic polices implied that resources for the road sector were substantially reduced throughout the eighties. As total resources declined a constant proportion between total investments and maintenance was observed, with maintenance activity averaging some 31 % of the total. This policy led to a substantial backlog of deferred maintenance and rehabilitation needs by the end of the eighties. Data available for 1991 confirm that by that time about 60% of the roads in the Federal Highway System (about 36,000 km.) were rated in poor or very poor condition. At the time of project appraisal, maintenance needs on the Federal Highway System were estimated to be about US$400 million annually. Actual expenditures for the period 1986 to 1989 had reached on average about US$114 million per year, equivalent to less than 30% of estimated needs. 58. Given the high social return of expenditures on maintenance and its impact on vehicle operating costs, particularly those of truckers, the Government agreed with the Bank to review its priorities on road expenditures and focus an increasing the share of the budget on this activity. The Government agreed, during early 1990, to an increase above the approved budget allocation, of Mex$155 billion for highway maintenance activities in that year. 59. Further targets were set, and for second tranche release the Government agreed to submit a budget proposal for highway maintenance for 1991, with a further increase of Mex$45 billion (in real terms). Of the total allocation for maintenance activities, at least 40% would be for routine maintenance. The base figure for this calculation was actually exceeded during 1990, i.e. the real increase was in fact implemented during 1990. Therefore, although no additional real increases were granted in 1991, the real target negotiated for second tranche conditions for that year (Mex$593 billions in 1990 pesos) was met. 60. Available data indicate that with the further increases in the budget granted during 1990, total expenditures on maintenance reached Mex$609 billion, representing about two-thirds of total road expenditures. During 1991, this level was maintained in real terms. However, during 1992 the level of expenditure on maintenance activities apparently fell about 21 %.2" 20. 1992 data provided by SCT. However, they may represent preliminary budget aLmounts. No definite data have been made available.  20 61. While the target for the budget for the routine maintenance share in the total maintenance budget (40%) was met, the large increases in reconstruction and rehabilitation expenditures since 1990 have meant a lower priority for routine maintenance. It appears that the share of expenditures for routine maintenance declined from over 60% in the latter eighties, to 51% in 1990 and 35% - 25% in 1991 and 1992.(Table 3) Even in absolute terms, during 1991 and 1992 there was a 17% and a 35% real decline, respectively for each year on these expenditures. The postponement of routine maintenance usually implies significantly higher repair and rehabilitation costs in the future. Normally a reduction in the level of expenditures on routine maintenance is not optimal2". 62. It is worth noting that SCT has continued to improve its planning capabilities related to maintenance works n. A study was contracted with consultants to establish an optimal strategy for road maintenance from which not only the level of required maintenance will be obtained, but also the optimal mix between reconstruction, periodic and routine works given expenditure constraints. Unfortunately, given new data on the condition of the road network, estimated annual needs for maintenance have increased to about US$700 million per year to eliminate the existing backlog of highway rehabilitation, resurfacing and routine maintenance expenditures by the year 2001. Although the budget allocation for maintenance for 1993 of about US$320 million is 82% of the budget for the highway sector (a 33% increase over the 1991 maintenance budget), and shows the Government's commitment to fund maintenance even in a period of macroeconomic constraints, it still falls significantly short of the estimated amount needed annually to eliminate the backlog. 63. Emission controls. Air pollution is a big problem in Mexico, particularly in its metropolitan area. A recent Bank study found that some 260,000 trucks operate daily in Mexico City. Many of these are federal public trucks for which the city is a center for origin or destiny of cargo. It has been estimated that about 37% of toxicity-weighted pollutant emissions attributable to the transport sector in Mexico City originates from long-haul and local trucks. It is likely that trucks also contribute significantly to pollution in other cities of Mexico. 64. At the time of appraisal, regulations were drafted requiring trucks and buses operating on federal highways to be inspected twice per year for air and noise pollution. In terms of emissions, only a smoke opacity standard for diesel engines was to be enforced. In the case of gasoline engines additional 21. It is difficult to draw firm conclusions on this point due to weaknesses in the data. Conceptually 'periodic maintenance' is a wandering variable in the sense that it is not clear whether, in any one year, it is included in 'reconstruction and rehabilitation' or 'routine maintenance'. 22. The Highway Maintenance and Traffic Safety Project would focus on addressing the institutional (SCT planning capacity) and financial (measures to improve funding) issues that are required to improve road conditions.  21 controls were established for carbon monoxide and hydrocarbons. These regulations were to be issued as a condition for second tranche release. 65. Mandatory emission inspections were issued in May, 1990. To date, 368 centers for emission inspection have been established throughout the country. They operate as private concessionaires approved by SCT. In 1992 about 200,000 units were inspected, about half of them in Mexico City. Further measures have been taken to inspect and control evident polluter vehicles on the roads. Data from these point checks indicate that the level of detected non-compliance has declined from 50% in early 1991 to about 10% - 20% in early 1993. 66. Further complementary measures have been taken by the Government which have meant that since 1991 catalytic converters are required for new cars and light trucks. Also in Mexico City, a low sulfur content diesel was introduced that significantly reduces particulate and Noxa emissions.3 However, further work is needed in the area of setting and enforcing stricter standards as required by the standardization rules agreed under NAFTA. Project Sustainability 67. The Road Transport and Telecommunications Sector Loan was designed to support the GoM in the areas of macroeconomic stability, through the provision of opportune external funding, and in the significant structural reforms that were being carried out to increase efficiency, competition and private sector participation in selected infrastructure areas. Regarding the first objective of the loan, Mexico has successfully emerged from the critical macroeconomic conditions of the 1980s. This loan, as part of a broader financial package, contributed significantly to alleviate the external debt burden, as it provided much needed resources at a time of debt renegotiation and rescheduling under the auspices of the Brady Plan. Besides its direct financial effect, the loan package and other measures of fiscal constraint and careful macroeconomic management, contributed to restore investor's confidence and capital repatriation. Today inflation indexes approach the one digit level, while growth is being sustained at a 2% - 4% level. In spite of a worsening of the trade balance, associated with the trade liberalization policy and the appreciation of the peso, the capital inflow of the last four years has allowed Government to maintain an adequate balance of payments account. 68. The sustainability of the project in the telecommunications area is assured by the success of Government in developing a comprehensive modernization program directed to increasing investment through private sector participation and promoting efficiency through correct price regulations and through competition. The cornerstone of the program was the 23. The Bank's Transport Air Quality Management Project for the Mexico City Metropolitan Area (Ln 3543-ME, signed on December 18, 1992, for US$219 mnillion equivalent) supports these measures.  22 privatization of TELMEX. In addition a new Reglamento for the sector was issued to provide a comprehensive framework for the supply of communication services. At the same time the public sector institutions were reorganized clearly separating regulatory and planning functions from operational responsibilities. This comprehensive integration of all elements in the design of the reform package is an important contribution to sustainability of the reforms. Competition and tariff policies are well defined by clearly establishing the areas subject to competition versus regulation. And in this latter case, the rules for tariff setting, expansion targets, interconnection obligations are well established. The TELMEX concession contract is by itself a significant piece of work. In spite of some weaknesses due to the complex nature of the telecommunications business, the existence of an integrated framework for the provision of services is an important contribution to sector development. 69. In the road transportation area, policy sustainability is assured by Government commitment, as proven by the further opening up measures negotiated under the NAFTA agreement. 70. Within the context of the transport sector adjustment program, additional measures geared towards better allocation of resources were implemented. Regarding safety issues, many important activities in the Action Plan were effectively developed, and the level of awareness at higher level management was raised, thus providing a good basis for further improvements to be undertaken in the proposed Highway Rehabilitation and Traffic Safety Project. Cost recovery has improved significantly, by the continuous increase in the real price of diesel and other user charges such as ownership taxes and license fees. It is probable that trucks contribute significantly to cover the road expenditures associated with their usage, but the data collected on cost recovery have not been sufficiently disaggregated to say that full cost recovery for trucks is happening consistently over time. Road maintenance expenditures were greatly expanded in 1990 and 1991 relative to earlier years, and contractual conditions were met. These levels of expenditures however were not sustained during 1992. Routine maintenance seems to have lagged behind indicating higher priority for investments in rehabilitation. 71. Railway rates for all significant products were effectively increased above long run variable costs during 1989, as agreed with the Bank, but the policy has not been sustained over time, and currently prices are on average well below long run variable costs, contributing to a worsening financial position of FNM. Here, however, the Government implemented a structural reform of FNM that focuses, rightly, on the issues of downsizing and rationalization of operations, private sector participation and use of direct negotiations for contracting cargo, therefore, addressing the deeper company problems which go well beyond pricing policies.  23 72. Effective actions were taken and sustained for the control of vehicles for air pollution, and these policies are supported further in a follow-up Bank project (Ln 3543-ME). 73. The weakest link in the sustainability of the process of sector modernization seems to be SCT. The new environment requires a new set of skills and views for the proper support, monitoring, issuance of norms, etc. needed for sector development. Such abilities have not been sufficiently strengthened as personnel and budgeting restrictions have not allowed it. Institutional strengthening would continue under the proposed highway rehabilitation and traffic safety project. Bank Performance 74. The Road Transportation and Telecommunications Loan followed a pattern of sector adjustment loans made to Mexico in the late 1980s and early 1990s in support of policy reforms in critical areas. As Mexican authorities identified sectors as an area where reforms were needed, the Bank in its on- going dialogue with the Govemment and its previous involvement in the transportation sector agreed that this operation become a candidate for a sector loan. By the time of project identification (mid-1989), the Bank had already raised some of the pertinent issues in the transportation area, through its previous and ongoing involvement in the road and railroad sectors and through the development of specific sector studies. Volume I, "Road Transport Technical Report", of a two-volume report undertaken during project preparation, gathered together past data and new information (from individual consultant reports, field surveys--of truckers and users, state regulations--and Bank staff reports) to analyze the results concerning trucking deregulation and complementary actions to enhance sector efficiency, including taxation, cost recovery, highway maintenance expenditures, highway safety, cargo insurance, trucking income and value added taxes and trucking deregulation implications for SCT's organization and future institutional adjustments. 75. In the area of telecommunications, previous Bank involvement had been minimum, but Bank staff quickly made up for the gap. Volume II of the two-volume report discussed above, "Telecommunications Sector Technical Report", focussed on major issues in the Government's sector reform program: privatization, competition, regulation and divestiture of SCT operations. A series of documents were prepared by the Bank at various stages of helping the GoM formulate a sector policy and reform program. Particularly influential was the report "Policy Options for Telecommunications Industry Structure and Regulation in Mexico", distributed to selected senior Government and TELMEX officials in October, 1988. The report provided the basis for the initial development of a policy dialogue on the telecommunications sector. In September, 1989, another paper, "Discussion Paper on Transitional Arrangements for the Restructuring of the Mexican Telecommunications Sector", was distributed to a number of agencies involved in the reforms. This paper highlighted aspects  24 other than privatization of TELMEX, which occupied almost all of the Government's attention, in particular pricing, development of competition and regulation, and innovative modalities to attract private resources for infrastructure development and the need for all these to converge with privatization. On the basis of this thorough and outstanding work in transport and telecommunications, the Bank was able to identify and help prepare a timely sector adjustment program. 76. The Bank supervised closely the evolution of the various events. Four supervision missions were sent to review progress throughout the execution period. These missions were fielded by 2 - 4 Bank staff and were carried out in August and November of 1990, and February and April of 1991. At least one visit to Washington D.C. by Mexican officials was made during which progress in a specific matter (SCT's strengthening Action Plan) was discussed. There is no doubt that continued Bank involvement contributed greatly to the successful and expeditious execution of the project. Borrower Performance 77. The Government has followed through consistently with its policies of privatization, price adjustments and deregulation, under this project as well as under other fast-disbursing structural adjustment loans provided by the Bank. The overall positive but uneven results of the project in some areas, summarized above, clearly reflect the varying degree of commitment of the Government to the specific measures in the agreed policy matrix. This, however, would not seem to be unusual in the context of an ambitious reform process, especially when the economic reforms seek to bring about so dramatic a change in the economy as Mexico's. As the sector reforms gave rise to personnel issues in the effected agencies, such as SCT, successful implementation of the Government policies to reduce the size of government and to maintain tough fiscal constraints were clearly overriding. Project Relationship 78. During the preparation of the project and implementation, the relationship between the Bank and the executing agencies was very productive. In one sector (transportation) the principal executing agency was SCT, a well known Bank counterpart institution, whereas for the reforms in telecommunications, responsibility was mainly in SHCP's newly created privatization unit. In this latter program, the Bank clearly followed what the Mexican Government had already under way and provided, through consultants, some technical advise on specific issues and was able to establish a high level dialogue on the general nature of the reforms. 79. In the transportation sector more specific and detailed actions were possible given the previous Bank involvement in the sector. The relationship between the Bank and SCT continued to be productive.  25 80. The Bank had a close collaboration with the IDB which provided parallel financing for the transport sector reform program. This productive relationship started during preparation of the project and continued through the implementation period, with joint supervision missions. Consulting Services 81. The performance of consultants used in several aspects of the project to carry out studies was satisfactory. A TAL was approved concurrently to support the strengthening of SCT and TELECOMM, but progress has been slow. A number of conditions, including the lack of qualified SCT staff delayed the development of the activities to set up all the information, evaluation and control systems. During 1991, support consultants and a study for setting the regulatory system for tariffs were contracted. In 1992 progress was limited as no agreement had been reached between SCT and the Bank on the nature, program and procedure for hiring additional needed support. Project Documentation and Data 82. The President's Report provided a useful framework for both the Bank and the executing agencies during project implementation. Data relevant for preparation of the PCR were available. 83. To verify compliance with eligibility conditions, the Bank requested that external auditors be hired. Two reports from these auditing procedures are available indicating total conformity of payment conditions and eligibility criteria for a large sample of the import requests. Lessons Learned 84. The privatization process of TELMEX, by itself, constitutes an interesting lesson for the privatization of large public sector companies with monopolistic characteristics and good market potential. As has been noted in existing studies of this privatization', elements like worker's participation through share-holding, the restructuring of capital, the selling of shares by tranches, the use of both the domestic and intemational stock market, a carefully designed concession contract, the realignment of sector tariffs and taxes, among others, contributed greatly to the success of the selling operation. No less important was the handling of the process by a high level unit linked to SHCP, with accumulated experience from earlier public enterprise sales. 85. The preparation for privatization of TELMEX yields an important lesn. From the operation of TELMEX for two years under private management, the large potential for investment growth and productivity 24. See 'References', p. 59. The studies of Tandon (4) and IDB (1) describe in detail the privatization process and evaluate some of its implications. See also (2) and (6).  26 increases is immediately evident. These have translated quickly into significant profits. With hindsight, expectations for improvements in profits were too conservative, and therefore more room was in practice available for the setting of investment and quality targets, as well as tariff ceilings. Unforeseen concems associated with still low levels of service (particularly the waiting period for installation), at the same time as TELMEX is eaming such profits, appear to be emerging as issues in the development of policies in the sector. However, the tax regime, under which favorable tax treatment is contingent upon reinvestment of profits acts as a safeguard. Provisions for adjustments in the calculation of the price-caps in later years, beyond 1996, also addresses these issues. (Annex 3) 86. A lesn to be drawn from the experience gained in this project also supports the position of promoting free entry for competition in all areas where possible as this policy helps to develop enterprises that will be the only certain guarantee for efficient sector development. From the perspective of competition, the decision of postponing the opening of the long distance telecommunication services until 1996, even though it might have been the only practical alternative available, clearly contributes to the entrenchment of the current operator. With a weak regulatory power, high profits and opportunities for monopolistic practices may in the end limit future competition. In contrast, the licensing of concessions to private operators for cellular services, in competition with TELMEX, will contribute to future real competition. These companies are now in a stage of organization geared towards expanding their role into the long distance service. 87. Another important lesn concems the difficulties of transforming a public sector agency which has lost previous key functions in the privatization process into a regulatory body. Sustainability of the regulatory policies is potentially at risk due to the slow progress on institutional reorganization and strengthening of the public sector entities related to the telecommunications modernization program. A regulatory body within a ministry, like DGPNC in SCT, is difficult to strengthen from within the normal public sector apparatus, as restrictions on personnel shedding and hiring and salaries slow the pace of the proper development of these institutions. Development of new skills is a long term process and restrictions on the required personnel changeover sets up greater barriers to progress. In view of these constraints, the Bank efforts towards the provision of technical and informational expertise for the formation of this regulatory body, through a specific assistance project, has thus far had limited results. The main recommendation for future operations is to strengthen the identification and proposals for alternatives regarding the institutional arrangements for a regulatory entity like SCT's DGPNC. To solve the administrative inflexibilities (salaries, hiring, etc.) caused by operating within a ministry-type of organization, this regulatory role might be moved to a separate superintendency-type of institution. This or other formulas (e.g. contracting extemal auditors to verify TELMEX's compliance) could be more fully explored by the Bank.  27 88. In the road transportation area the Mexican experience confirms so far the feasibility and effectiveness of such a massive and quick deregulation process. Major deregulation measures were implemented during 1989 and early 1990. These measures have contributed effectively to the ease of entry, diversity of services and some cost and price reductions for road freight transportation. The analysis shows so far that the market has reacted in the direction predicted by economic theory and that significant improvements in efficiency are taking place. Concems with excessive instability of prices or services have proven unfounded. Also important adjustments of enterprises are occurring with the significant appearance of one-man truck operations. 89. There is, however, a lesn to be leamed concerning the risk of pressures to reverse some of the measures taken, since in the deregulation process it is unavoidable that some agents who had enjoyed earlier privileges under protected markets will stand to lose. The emergence of significant opposition by large trucking companies who represent former protected interests and have been negatively affected by deregulation, is still an issue that is present after three and a half years from the first deregulation measures. While it does not seem feasible for the Bank to introduce long- term measures in policy-based projects on such issues, guidance and advice based on international experience may be offered.  28 TABLE 1 RATIO OF INCOME TO VARIABLE COSTS BY MAIN PRODUCTS MAIN PRODUCTS 1990 1991 1992 Soybeans 1,01 1,11 1,01 Maize 0,85 0,79 0,74 Sorghum 0,90 0,93 0,83 Wheat 1,07 1,06 0,96 Charcoal 1,00 0,98 0,87 Iron Ore 0,85 0,84 0,75 Oil Fuel 1,46 1,37 1,22 Limestone 0,91 0,89 0,75 Sugar 0,94 0,97 0,84 Cement 0,80 0,87 0,78 Fertilizers 1,25 1,27 1,14 Vehicle Assembly Parts 1,29 1,14 0,98 Paper and Cellulose 0,90 0,99 0,82 Industrial Chemicals 1,77 1,63 1,51 Other Industrial Products 0,71 0,33 0,55 -TOTAL 0,97 0,87 0,86 AVG. INCOME PER TON 57038 56919 50882 Growth (%) -0.2% -10.6% AVG. COST PER TON 58534 65171 58880 Growth (%) 11.3% -9.7% Source: Ferrocarriles Nacionales de Mexico Avg. Income and cost per ton. in dec. 1992 prices  29 TABLE 2 EVOLUTION OF DIESEL PRICE AND OF UNIT DIESEL TAX PRICE OF DIESEL ( ex$/f ) ESTIMATED BORDER PRICE ESTIMATED UNIT TAX NOMINAL REAL IPC REAL US$ CRUDE EXPORT PRICE (c) BORDER (d) NOMINA REAL IPC 12mo. FM (a) (b) (US$1barrel) INDEX (Mex$/ft.) (Mex$/t) (Mex$/ft) (e) 1190 470 489 480 16,65 116,9 = = = 2/90 470 478 475 15,78 110,8 3190 470 470 470 14,24 100,0 450 20 20 -55 4/90 470 463 466 12,40 87,1 396 74 73 -47 5/90 480 465 471 12,08 84,8 389 91 88 -46 6/90 550 521 534 11,27 79,1 366 184 174 -46 7/90 550 512 532 14,49 101,8 474 76 71 -53 8/90 550 503 530 23,07 162,0 757 -207 -189 -53 9/90 550 496 528 29,11 204,4 959 -409 -369 -32 10/90 550 489 523 28,43 199,6 945 -395 -351 3 11190 585 507 553 26,11 183,4 872 -287 -249 34 12/90 605 508 570 21,62 151,8 725 -120 -101 63 1/91 605 495 567 16,45 115,5 554 51 41 86 2/91 1 605 487 565 13,20 92,7 446 159 128 97 3/91 605 480 563 13,43 94,3 456 149 118 101 4/91 605 475 560 14,55 102,2 496 109 85 105 5/91 605 470 558 14,31 100,5 490 115 89 109 6/91 605 466 556 14,06 98,7 483 122 94 111 7/91 605 461 554 14,98 105,2 517 88 67 111 8/91 605 458 553 14,94 1 04,9 517 88 67 114 9/91 605 454 549 15,63 109,8 544 61 46 119 10/91 605 449 547 16,48 115,7 576 29 21 126 11/91 647 468 587 14,32 100,6 499 148 107 133 12191 665 470 602 12,26 86,1 428 237 167 133 1/92 675 469 612 12,24 86,0 427 248 172 128 2/92 685 470 622 12,37 86,9 430 255 175 3/92 695 472 631 12,93 90,8 450 245 166 4/92 705 475 636 14,32 100,6 501 204 137 5/92 715 478 642 15,69 110,2 552 163 109 6192 725 482 646 16,48 115,7 584 141 93 7/92 735 485 657 16,27 114,3 575 160 106 8/92 745 489 674 15,86 111,4 554 191 125 9192 755 491 675 15,45 108,5 546 209 136 10/92 685 442 610 15,03 105,6 534 151 98 11/92 685 439 612 14,62 102,7 517 168 107 12/92 685 433 611 14,21 99,8 503 182 115 Sources. Diesel prices, SCT Direccion de Programas y Evaluacion. Crude Oil Prices Estadisticas Basicas de Comercio Exterior. Last quarter of 1992 projected. Notes: (a): Deflated to March 1990 by domestic price index (b) Deflated to March 1990 by US$ exchange rate (c). Average monthty export pnce for crude oil (d): Estimated by apptying to base price of March of 1990, index of crude oil price adjusted by exchange rate. (e): 12 month forward moving average  30 TABLE 3 FEDERAL HIGHWAYS: ROAD MAINTENANCE EXPENDITURES (Billions of Current Mex$) ITEM 1986 1987 1988 1989 1990 1991 1992 Planning 5.984 7.412 4.152 6.500 5.500 17.094 21.270 Reconstr. & Rehab. 12.802 10.472 71.242 95.110 290.885 462.080 481.407 Routine Maintenance 58.174 132.747 153.724 172.903 312.292 258.968 168.210 |TOTAL 76.960 1 50.631 229.1188 274.513 608.677 738.142 671.255 % Routine Maintenance a/ 75.6% 88.1% 67,1% 63.0% 51.3% 35.1% 25.1% (Billions of 1990 Mex$) ITEM 1986 1987 1988 1989 1990 1991 1992 Planning 45.156 24.127 6.311 8.232 5.500 13.936 15.012 Reconstr. & Rehab. 96.606 34.087 108.282 120.459 290.885 376.709 339.777 Routine Maintenance 438.990 432.101 233.649 218.985 312.292 211.123 118.723 I TOTAL 580.752 490.315 348.242 347.676 608.677 601.768 473.772 Notes: 1986 - 1990 data are actual expenditures. 1991 and 1992 expenditures are preliminary data. a/ Routine Maintenance is a recurrent expenditure and refers to local repair of roadway and pavement; grading of shoulders; regular maintenance of road drainage, side slopes, verges, traffic control devices, and furniture; roadside cleaning, dust and vegetation control, and maintaining rest areas and safety appurtenances. Preservation improvements, which are capital expenditures, include: (i) resurfacing, i.e. the placing of one or more new asphalt overlays on an existing paved road to preserve its structural integrity and ride quality. Resurfacing is often called periodic maintenance; and (ii) rehabilitation which refers to selective repair, strengthening, and shape correction of pavement or roadway (including minor drainage and shoulder improvements) to restore structural strength and ride quality. Expenditures for preservation improvements and for routine maintenance are frequently mistakenly classified in the SCT data on Federal Highways Road Maintenance Expenditures, thus making it difficult to come to firm conclusions on the level of budget expenditures on routine maintenance only.  31 Graph 1 EVOLUTION OF PRICE OF DIESEL (Base March 1990) 800- 750- 700- 650- _--/ . s00- No so 500- 450- - 400- 1/90 5/90 0 9/90' 1/91 5/91 9/91 1/92 5/92 ' 9/921 3/90 7/90 11/90 3/91 7/91 11/91 3/92 7/92 11/92 -U-- Nominal i Real IPC -1- Real US$ I  32 Graph 2 EVOLUTION OF UNIT TAX OF DIESEL (Base March 1990) 1000- 0 6 00- A 40- X a -200- t / - 3/90 7/90 11/90 1 13/911 7/91 ' 11/91 '3/92 . 7/92 ' 11/92 5/90 9/90 1/91 5/91 9/91 1/92 5/92 9/92 -U- Domestic Price - Border Price -l Real Unit Tax  33 Unofficial Translation MEXICO ROAD TRANSPORT AND TELECOMMUNICATIONS SECTOR ADJUSTMENT LOAN (Loan 3207-ME) PROJECT COMPLETION REPORT PART II. PROJECT REVIEW FROM THE BORROWER'S PERSPECTIVE MINISTRY OF COMMUNICATIONS AND TRANSPORT PROJECT COMPLETION REPORT FOR THE ROAD AND TELECOM- MUNICATIONS SECTOR ADJUSTMENT PROJECT, LOANS 3207-ME AND 594/OC-ME, SIGNED BETWEEN THE FEDERAL GOVERNMENT AND THE WORLD BANK AND THE INTER-AMERICAN DEVELOPMENT BANK April 1993  34 TABLE OF CONTENTS A. INTRODUCTION B. PROJECT DESCRIPTION AND OBJECTIVES C. COMMITMENT FULFILLMENT D. DISBURSEMENTS E. LESSONS LEARNED F. CONCLUSIONS AND COMMENTS G. ANNEXES: * G. 1 Modernization of Federal Road Transport and Perspectives G.2 Accident Statistics for 1989-1992 G.3 Organizational Manual of the General Directorate of Road Transport G.4 Program to Increase Safety on the Roads G.5 Annual Report 1990, Telephones of Mexico G.6 Annual Report 1991, Telephones of Mexico G.7 Publicity about Permanent Campaign for Accident Prevention G.8 Preventive Medicine in Transportation in Mexico G.9 Official Gazettes from January 24, 1990, October 29, 1990, and February 4, 1991 G. 10 Official Announcements of Authorization for Investment for Highway Reconstruction and Conservation, 1991 * Annexes and Original Spanish text available in LAC Information Center -  35 A. INTRODUCTION The program financed by Loans 3207-ME and 594.OC-ME of the World Bank and the Inter-American Development Bank had the objective of supporting and deepening measures, initiated by the Federal Govemment, that had already been identified and agreed for implementation in the telecommunications and transportation sectors in the framework of the policy of deregulation of the economy to promote free competition and the entering of new enterprises into these sectors; to improve resource allocation through the reform of policies on tariffs and prices; to privatize the most important enterprise in telecommunications, TELMEX; and, in general, to restructure the regulatory framework of the country. The project consisted of financing the imports of the public and private sectors of Mexico, through a quick disbursing mechanism and in two equal tranches, provided that the various requirements previously agreed upon for each tranche were fulfilled. These loans were for an amount of US$680 million: US$380 million from the World Bank and US$300 million from the IDB. The Federal Government's intention in obtaining these loans was to support the country's balance of payments: therefore, it committed itself to the task of accelerating the implementation of agreed measures and also accelerating the deregulation process for entry into the country, as soon as possible, of the committed foreign exchange. B. PROJECT DESCRIPTION AND ITS OBJECTIVES Loans No. 3207-ME and 594-OC/ME, were arranged jointly with the World Bank and the IDB to support the economic deregulation program for transportation and telecommunications which the government was already implementing through the Ministry of Communications and Transport. These loans were agreed upon to finance the acquisition of goods by the public and private sectors that would be purchased through competitive bidding and that would not be included in the negative list of goods. This negative list referred to alcoholic beverages, tobacco, radioactive materials, precious gems, nuclear reactors, jewels, etc., in addition to goods with contracts for less than US$10,000 and goods that already had foreign exchange financing. The disbursements took place in two equal tranches; the first one, no later than 60 days after the date of effectiveness of the respective (loan) contracts and on presentation of the following documents: a. eligibility of the expenditure b. signature of independent publics accountants who would continue with the auditing functions of the project  36 c. the agreement for the transfer of funds between the Borrower and the Guarantor be signed The second tranche would be disbursed upon agreement by the Banks on: i) progress achieved on implementation of the program and ii) the congruence between this program and the macroeconomic framework of Mexico. The following obligations would also have to be met: 1.- To increase the price of diesel by at least 10% in real terms, over the prices of March 30, 1990, with the purpose of improving the level of recovery of costs for expenditures related to improvements and maintenance of highways used for trucking transportation. 2.- (a) To complete a study to establish the variable long-term costs related to transport of goods by the National Railroads of Mexico (Ferronales); and (b) to make effective, no later than January 1, 1991, an increase of national railroad tariffs for transport of goods such as the following: iron mineral (10.1%), cement (7.9%), fertilizers (5.5%), paper and cellulose (4.0%), wheat (5.0%), corn (4.4%), sorghum (4.5%), carbon (4.1%), sugar (2.9%), soybean 2.1%, beans (2.0%) oleoginose oils (1.4%), wheat (1.2%), spare parts for vehicles (1.2%), salt (1.1%), calcium carbonate (6.0%), chemical products (3.2%), silica sand (1.6%) and laminated steel (1.3%). The percentages indicated for each of the goods, corresponded to their participation in the total income of Ferronales for freight transport. Such increase, in total, should represent at least 70% of the total income for freight transport, to an equivalent level, in real terms, to 125% of the tariffs for each of the selected goods prevailing as of March 30, 1990, or at the long term variable cost related to the transport of each of the mentioned goods, whichever is lower. 3.- To take the necessary measures in order that SCT submit to the Programming and Budgeting Ministry (SPP),' and later to the Congress for consideration, a budget for FY91 where the allocation for highway maintenance expenditures (reconstruction and routine maintenance) would be an amount, in real terms, of at least MEX N$475,000 million, of which at least 40% would be allocated for routine maintenance. 4.- To put into effect a regulation that would require the periodic and mandatory inspection of trucks, with the purpose of achieving the fulfillment of the federal requirements on emission of contaminants, including toxic gases. 5.- To improve the level of safety on highways, through the following measures: 1. Now Ministry of Finance and Public Credit.  37 a) To present to the Bank an action plan to improve the level of highway safety. b) To complete the first phase of a study, for which terms of reference would be previously agreed upon with the Bank, on the size of the vehicles and the practices related to loading of merchandise by truck transport; and to have initiated the second and third phases of such study, for which terms of reference would have been equally agreed upon with the Bank, with the purpose of recommending measures for highway transport to conform with the regulation on the size and weight of trucks. 6.- To demonstrate that progress has been made in the implementation of the privatization of Telefonos de Mexico, S.A. de C.V. (TELMEX). 7.- To submit to the Bank a program for commercial development of Telecommunications of Mexico (TELECOMM) which would include financial plans and investments which would last through FY94. 8.- To hire consultants, according to terms of reference previously agreed to with the Bank, to provide technical assistance to SCT with the purpose of developing its regulatory capacity in the telecommunications sector and so that the mentioned Ministry could put into effect regulations for the granting of concessions or permits to operate networks and telecommunications services. 9.- To submit to the Bank an action program for the strengthening of the regulatory capacity of SCT in the field of telecommunications. Based on the fulfillment of these commitments, the deregulation of transportation and telecommunications was advanced. Hence, many barriers that interfered with the free development of these branches of the economy were removed, resulting in substantial improvements in the economy, and, in addition, setting the basis for the negotiations of the free trade agreement. C. FULFILLMENT OF COMMITNTS The various requirements established in the loan and guarantee agreements were satisfactorily met during project implementation, and they had a direct impact on this Ministry of Communications and Transport which made possible the second tranche release. Following is the way in which these requirements were handled: 1.- ADJUSTMENT OF THE PRICE OF DIESEL COMMITMENT.- To increase the diesel price by no less than 10%, in real terms, with respect to the prevailing level of March 30, 1990.  38 This item was satisfied by an increase of 10.4%, on average, with respect to the price of fuel in nominal terms in May, 1990. Also, on November 11, 1990, the price of diesel was increased by 10%, thus covering the agreement with the Banks. 2.- COMPLETION OF THE TARIFF STUDY BY FERRONALES AND ADJUSTMENT OF THE TARIFTS BY 25% IN REAL TERMS COM]lMIENT.- To complete a study to determine the variable costs associated with the transport of freight of FERRONALES, and to have authorized the increase of freight tariffs for certain selected products by 25% in real terms, in comparison to those prevailing on March 30, 1990. The study "Evaluation of the System of Costs and Integration of a Systematic Model of Tariffs," was completed and sent to the Banks in its summarized version. With respect to the tariffs, these were increased by 23% on July 23, 1990, and, additionally, on October 5, of the same year, an increase of 15% on average was authorized for 12 products which included the four products whose prices lagged behind. With this increase the commitment was met. 3.- BUDGETARY INCREASE FOR MAINTENANCE OF HIGHWAYS COMMITMNIT.- To allocate within the budget for 1991 an amount equivalent to MEX N$475,000 million, in real terms, for reconstruction and routine maintenance, of which 40% will be towards routine maintenance. The investments made during 1991 reached MEX N$721,047 million, at current prices. By deflating this amount at constant prices of December, 1989, an investment of MEX N$555,078 million was achieved, as described in the following table: COMPARISON BETWEEN THE 1990 AND 1991 BUDGET, ALLOCATED TO RECONSTRUCTION AND CONSERVATION WORKS -MILLIONS OF PESOS- CHANGE AUTHORIZED IN 1991. AGREED WITH WB AT CONCEPT $ CURRENT SDEC.89 (1) PRICES OF DEC.89 RECONSTRUCTION WORKS 462,079 355,719 285,000 CONSERVATION 258,968 199,359 190,000 TOTAL: 721,047 555,078 475,000 (1) Inflation factor of 29.9% from December 1989 to December 1990.  39 From these numbers it can be seen that the 1991 budget was higher, in real terms, by 17% compared to the 1990 budget allocation for the same purposes. The condition was that it be at least MEX N$475,000 million, therefore, the condition was fully met. With respect to the allocation, 40% of the 1991 budget was for routine conservation; it can be appreciated that the real factor was 36%, therefore, this commitment was satisfactorily met. 4.- REGULATION FOR THE PERIODIC AND MANDATORY INSPECTION OF TRUCKS COMiMITMENT.- To have made effective a regulation that requires periodic and mandatory truck inspection, with the purpose of achieving the fulfillment of the federal requirements about emission of contaminants, including toxic gases. This requirement was considered satisfied within the text of the aide memoir of November 8, 1990; however, it was requested that the General Directorate of Road Transportation prepare a succinct report about the inspection of vehicles, which was submitted at the time and a copy of which is attached. 5.- COMPLETION OF THE FIRST PHASE OF THE STUDIES OF LOAD AND SIZE OF VEHICLES AND PREPARATION OF AN ACTION PLAN TO IMPROVE HIGHWAY SAFETY COMMITMENT.- (a) To submit to the World Bank an action plan to improve highway safety. (b) To have completed the first phase of a study, under TORs satisfactory to the Bank, about weight and dimensions of the freight vehicles and the practices related to loading and to have started phases two and three of the same study. With respect to the action program to improve highway safety, the Banks were satisfied with the final version officially published in March, 1991. During the study of implementation of weight and dimensions, there were several problems both administrative as well as in delays in the necessary assessments of the weight and dimensions analyses. The results obtained do not allow for precision as far as the optimal weight and dimensions of vehicles, but they do show that this type of study should be made on a regular basis in order to readjust the existing regulations. With the results obtained as of today, the regulations for weight and dimensions will be updated. The final project proposal (for such regulation) is already available and only the "appendix' terms, or 'guidelines', are being revised as well as those related to classification of highways. It is expected that the new regulations on "weight, dimensions and capacity of vehicles of road transport that transit on roads of federal jurisdiction" will become effective next July.  40 6.- SALE OF TELMEX COMMITMENT.- That the guarantor should have made progress in implementation of the plan to privatize TELMEX. On August 13, 1990, the information relevant to the sale process of TELMEX shares, owned by the Federal Government, as published. On December 9, 1990, the decision was announced for the sale of 20.4% of TELMEX's social capital to the Carso Group, in the amount of US$1,757.6 million, with the remainder to be adjudicated during the month of January, 1991. However, the commitment was completely met. 7.- PROGRAM TO STRENGTHEN THE REGULATORY CAPACITY OF SCT IN THE TELECOMMUNICATIONS SECTOR. COMMITMENT.- That consultants be hired, under terms of reference acceptable to the Bank, to provide technical assistance to SCT in the development of its regulatory capacity in the communications sector and to present to the Banks the respective program. According to the information provided by the Directorate General of Policies and Guidelines for Communications, the study called "Program to strengthen the regulatory function of SCT, through the Directorate General of Policies and Guidelines for Communications," was assigned to ITSA Consultants, S.A. of C.V. The proposal was approved by the World Bank on November 15, 1990. However, it was calculated that the contracting, execution, and revision of the program could take at least as long as to June 1991. With the purpose of not delaying until then the disbursement of the second tranche of financing, it was proposed to a joint WB-IDB mission that the condition be accepted as fulfilled on presentation of a preliminary plan in January, 1991, and the government's commitment to execute it. This study was undertaken during 1991. As of yet, however, it has not been possible to implement the proposed actions for the reinforcement of the sector's regulatory capacity as a result of the macroeconomic policies aimed at reducing the sector's current expenditures and due to the limited budget for implementation of projects. Nonetheless, progress has been made in the installation of the software for the radioelectric spectrum and, radiomonitoring equipment is being purchased, which will result in accomplishing substantially the programmed goals. This project will be in operation in mid-1994. 8.- REGULATION WITH RESPECT TO THE CONCESSION OF THE NETWORKS AND TELECOMMUNICATIONS SERVICES COMMITMENT.- That the Guarantor issue regulations with respect to the concession of the networks and telecommunications services.  41 On October 29, 1990, the regulations of telecommunications that regulate the concession of the networks and telecommunications services was published in the Official Gazette. This regulation was given to the joint WB- IDB mission, thereby satisfying this commitment. 9.- PREPARATION OF A PLAN FOR THE COMMERCIAL DEVELOPMENT OF TELECOMM CONM1TMENT.- The Guarantor will have sent to the Bank a program for the commercial development of TELECOMM, including investment and financial programs up to FY94. The final version of this report was given to the February, 1991, mission. D. DISBURSEMENTS The total amount of the loans was US$680 million, disbursed as follows: D. 1- BY THE WORLD BANK (LOAN NO. 3207-ME) FIRST TRANCHE (THOUSANDS OF PESOS AND DOLLARS) DATE OF 1 AMOUNT IN | EXCHANGE J AMOUNT IN DISBURSEMENT US DOLLARS | RATE MEX N$ 11-VI- 90 75,483 2,829.00 213,541,775 13-VIII-90 492 2,855.40 1,404,857 31-VIII-90 114,025 2,871.40 327,411,012 TOTAL 190,000 _ 542,357,644 SECOND TRANCHE (THOUSANDS OF PESOS AND DOLLARS) DATE OF AMOUNT IN EXCHANGE AMOUNT IN DISBURSEMENT US DOLLARS RATE MEX N$ 21 -V-91 170,556 3,003.00 512,179,668 23-V-91 19,444 3,005.00 58,429,220 SUB-TOTAL 190,000 570,608,888 TOTAL 380,000 1,112,966,532  42 D.2- BY THE INTER-AMERICAN DEVELOPMENT BANK (CREDIT 594/OC-ME) FIRST TRANCHE (THOUSANDS OF PESOS AND DOLLAR) DATE OF | AMOUNT IN EXCHANGE |AMOUNT IN DISBURSEMENT US DOLLARS RATE MEX N$ 28-IX-90 150,000 2,880.00 432,000,000 150,000 __432,000,000 SECOND TRANCHE (THOUSANDS OF PESOS AND DOLLARS) DATE OF AMOUNT IN EXCHANGE AMOUNT IN DISBURSEMENT US DOLLARS RATE* MEX N$ 30-IX-90 375 2,880.00 1,080,000 31-XII-90 375 2,890.00 1,083,000 31-111-91 375 2,900.00 1,087,500 30-VI-91 375 2,920.00 1,095,000 30-VIII-91 147,000 3,015.00 443,205,000 13-IX-91 750 3,040.00 2,280,000 31-III-92 750 3,100.00 2,325,000 SUB-TOTAL 150,000 452,156,250 TOTAL 300,000 884,156,250 GRAND TOTAL 680,000 1,997,122,782 Estimated Parity In general, disbursements were carried through satisfactorily and did not involve problems. E. LESSONS LEARNED The implementation of the project substantially reinforced the Federal Government's decision to invigorate the opening of the national economy and commercial competition, to increase the efficiency of its enterprises and to promote the opening of foreign markets.  43 The applied policies and measures have together contributed fully to development of the economy, eliminating inefficiencies in several sectors and excessive protectionism and the subsidies that the consumer was obligated to pay for production inefficiency. Consequently, competitiveness was encouraged and the nation in general has been strengthened. The aforementioned was based on the completion of several studies about the earlier structures, with the objective of determining the best ways to reformulate them and to benefit from eliminating inefficiencies and promoting competitiveness. For this reason, it became necessary to undertake actions that would allow the achievement of these goals. Such is the case of the issuance of new regulations, formulation of new specific action plans and the increase of taxes and tariffs. In order to make the deregulation process possible it was necessary to maintain a dialogue and collaboration with the agencies involved. For the case that involves us, we will talk about road transport and telecommunications. - ROAD TRANSPORT In the case of federal transportation the efforts culminated in the issuance of new regulations for federal freight transport and for international multimodal transport, published in July 1989, as well as those applied to exclusive tourism service and regular passenger service, published in March and May 1990, respectively. Also, in January 1990, the new regulations for the service (for laborers) in zones of federal lands was published. The impact of the implementation of earlier regulations in the framework of deregulation of the economy was immediate in eliminating administrative barriers and several deficiencies in operations which discouraged new investors and generated unjustified price increases for services. Consequently, the main beneficiaries have been the users (consumers) who now have available to them safer, efficient and better quality transport services. They also have a broader universe of service providers from which they can hire the best bidder without having to go mandatorily to the freight services main offices, as before. In another aspect, the road transporters, by elimination of the restrictions of circulating on specific routes, are authorized to transit in the country with all types of goods (except explosives, toxics and chemical products which are regulated in a specific manner), as well as to load and unload at any point in the country with no restriction. Also, with the elimination of tariff control, a healthy competition was promoted among road transporters, allowing open negotiation of the service fee and establishment of medium and long-term commitments, that lead to a clearer perspective for investment and, for the user, a more adequate service and better quality.  44 Given this perspective, the automotive industry grew considerably, due, among other factors, to: i) the increase in the number of service providers; ii) the equipment program established between the authorities and the National Chamber of Freight Transport, the national automotive industry and the Bank of Foreign Trade (BANCOMEXT). It is sufficient to say that the program designed originally to acquire 4,200 tractor-trailer trucks for an estimated amount of Mex N$1.0 billion has been expanded by another 5,200 units. Consequently, the fleet of transport vehicles which grew historically at an average annual rate of 0.6% between 1980 and 1988, during 1989-1991 registered growth rates of 23.2% annually. With respect to the level of production, the following indicators have become available: 1) During 1989, production reached 10,600 units, mainly heavy trucks of 7 and 15 tons and tractor-trailer trucks. 2) For 1991, the production reached 23,000 units, registering an increase of 116% in only three years. 3) Passenger buses, greatly exceeded expectations, as the 680 units produced in 1989 increased to 2,100 in 1991, registering an increase of 310%. The boom in the automotive industry has awakened the interest of investors and foreign enterprises to invest in our country; with the consequent advantages involved. Additionally, with the total flexibility in the operation of services, the global cost of distribution of products has been lowered and the delivery time has been optimized; therefore, the enterprises producing intermediate goods and consumer goods can establish "just in time" programs. As regards the exclusive tourism service, among the results should be noted: the elimination of exclusiveness for its operation to enable the users to negotiate the price of service with the travel agency, operators or wholesalers, except in the excursion modality, and transportation enterprises that when directly negotiating with the user, encourage a better flow to national touristic points of interest through the operation of chartered road trips for international chartered trips. The mandatory agreements between the foreign enterprises and the only Mexican enterprise authorized to operate the exclusive tourism service was eliminated. In passenger service, the access to new service providers was facilitated, new routes were authorized and the establishment of the number of trips became flexible. Also, the types of service were diversified at competitive prices and better level of services, safety and comfort.  45 In summary, the package of actions implemented in federal road transport has lead to increasing its economic importance, estimating that its participation in the gross domestic product increased from 1.4 to 1.6% during 1990-1991. Notwithstanding the accomplishments, it is important to point out that the enterprises are at an adjustment stage in which the "atomization" phenomenon is present. This situation has created the disappearance of some enterprises which were not able to face the changes; and, those enterprises that grouped a large number of road transporters, that in a great majority of the cases acted as mere processors without providing any benefit to their partners, had to face the loss of an important number of their members or the disintegration of the society. With respect to transport by railroad, with the increase of tariffs, cost recovery was improved remarkably, especially in the transport of freight. However, these increases still do not allow total cost recovery and even less the equitable competition between railroad and road transport. For this, it will be necessary to strengthen the measures in the future for the modernization of railroad transport and the application of tariffs that would allow for an adequate economic profitability of this service. Regarding the national program of mandatory verification of low emission of contaminants, starting in 1990, the Ministry of Communications and Transport, in coordination with the Ministry of Urban Development and Ecology, established the "national program of mandatory verification of low emission of contaminants by vehicles used for transport of passengers and freight that circulate on the roads of federal jurisdiction," which applies to enterprises and persons using federal and private transport, as well as those that are the property of the federal, state and local governments, with the exception of the units of private transport of up to nine passengers and those for freight with capacity of no more than 4,000 kilograms. For that purpose, the Ministries of Communications and Transport and of Urban Development and Ecology, on May 3, 1990, signed a joint agreement in which the provisions are established for the mentioned national program for mandatory verification of emission of contaminants. Also, on May 11, 1990, the national program of verification was announced to the general public through the news media, along with the invitation to establish and operate centers for verification, documents in which are indicated the period of verification in the first phase (from June 15 to November 30, 1990) and the requirements for obtaining the respective authorization. During 1990, the Ministry of Communications and Transport authorized 308 verification centers that were equipped with 348 opacimeters, 197 gas analyzers and 311 sonimeters. Out of these centers, 140 are located  46 in the metropolitan area of Mexico City and the remaining 168 in the interior of the country. During June and November of this period, 188,154 units were verified, out of which 153,720 were for diesel engine vehicles and 34,434 for gas engine vehicles. During 1991 and 1992 the program for mandatory verification of freight and passenger vehicles was continued. With respect to highway safety in the country, the campaigns for the prevention of accidents have been intensified, through television and advertisements along the highways, as well as through the publication of posters and pamphlets to make drivers more conscious about: not driving with excessive speed, with drinking beverages -- before or after a trip, using the safety belt, coming to a full stop before entering a railway crossing and inspecting the vehicle before getting on the highway. Annex G.7 contains a set of the pamphlets published by the General Directorate for Preventive Medicine in Transport. Also, a series of seminars have taken place about highway safety, the last one in Mexico City during November, 1992. This was an international seminar, with national and international participants as well as speakers of the highest quality and experience at world levels. - TELECOMMUNICATIONS: With the sale of Telefonos de Mexico and the concession to operate several substations for radiodifusion, the quality and modernization of the service have been improved. In another area, SCT is acting on several measures to improve its regulatory capacity, through the installation and operation of the software for the radioelectric spectrum, the acquisition of equipment for radiomonitoring, as well as through the construction and launching of satellites (SOLIDARIDAD satellites), which is planned for the end of this year. On deregulation, the regulation for telephone service is probably the one that has undergone the greatest changes, given that the service has been substantially modernized, its coverage has been broadened and the quality has been improved. In addition, the costs to the consumer were lowered and administrative inefficiencies were eliminated in delivery of the service. As of today, a sustained increase in the coverage of service can be observed, as well as the application of the most advanced technology. In the same manner, a logarithmic increase of cellular phones is observed. The above can be observed in the physical and financial goals reached by Telefonos de Mexico during the 1991-1992 period.  47 AT THE END OF 1991: The consolidated income was a total of Mex N$16.3 billion pesos, an amount which is 21.1!% higher in real terms than the goal achieved in 1990; the net consolidated and adjusted profits rose to Mex N$7.0 billion pesos, an amount which is 77.8% higher than that obtained during 1990. During this year Telefonos de Mexico, consolidated its access to the international capital markets, as a result of the public offering, national and international, of 1725 million shares of series "L" of Telefonos de Mexico, owned by the Federal Government, which took place on May 13, 1991. This operation was the first time in history that a Mexican enterprise put shares in the markets of more than 20 countries and, due to the amount it was the most important in the history of Mexico and the seventh largest in the world. With respect to service lines, during this year 670,000 lines were placed in service, representing an accumulated total of 6,024.8 miles of lines in service, 12.5% higher than that of the previous year. For the outside plant, when the year was over 7,040.3 kilometers of ducts for cable were built which is 23.9% more than in 1990, and the works for enlargement and rehabilitation of the outside plant were continued, to improve the quality of service and reduce complaints by consumers. The long distance system was increased by 9,676,126 circuit- kilometers, with which the accumulated goal of 68,465,140 circuit-kilometers was reached, representing 16.4% of growth with respect to the previous year. During this year, Telefonos de Mexico made progress in the modernization of the long distance network by implementing the construction of 13,500 kilometers of optic fiber cable, initiating the modernization of traffic by operator through the installation and start-up of 1,300 digital ports and 32 long distance centers. Regarding the integrated digital network, the commercialization of this network was started and covered 17 cities and was complemented by the satellite network installed during the year. By the end of the year, 2,200 companies were being serviced. Also, the networks of important private enterprises as well as government agencies were installed and the financial network which interconnects the stock exchange and financial institutions of the country were put into service. 12,192 public telephones were installed in the country and provide long distance service through the use of coins, tokens, credit cards, collect calls and debit cards. With respect to cellular phones, by the end of the year, Radio Movil DIPSA, a subsidiary of Telefonos de Mexico, provided service for 70,663 users in 23 cities in the country.  48 Finally, 2,648 rural phones were incorporated into the telephone service, to reach the goal of a total of 12,869 towns, namely, 25.9% more than the previous year. AT THE END OF 1992: Telefonos de Mexico had a total of 6,753,652 service lines, representing a growth of 12.1 % over the total lines at the end of 1991 and 26.1 % with respect to the service lines at the end of 1990. Additionally, in an effort to incorporate new users into the system, 449,592 lines of obsolete technology were replaced during the 1991-1992 biennium, which, added to the construction activity, resulted in 52% of the installed lines being digital as of December, 1992. In another area, to eliminate bottlenecks that made the work of macrocenters more difficult, during the 1991-1992 period, 21 new centers were built; also, to improve user services, 14 new commercial offices were built, 12 information and consultation (via telephone) centers were opened and mechanized systems were provided to the 294 branch offices. In the long distance service, the installation of a system of 1,420 digital ports was initiated that will be located in 39 centers distributed throughout the country and will improve service by operator, as well as have the capacity to offer other services. During this year the telephone traffic for national long distance increased 12.1%, compared to 1991, to reach a number of 5,294 million billed minutes. On one side the international long distance traffic showed a growth of 30.5%, in terms of billed minutes, including traffic between the border cities of Mexico and the United States that, until 1991, was charged and registered as local but, since January 1, 1992, is registered and billed as international service. For cellular telephones, TELCEL, the cellular service company, reached a total of 145,894 users at the end of 1992, representing an increase of 75,231 users and 106% growth with respect to 1991. As of this date cellular telephone service is offered in 48 cities in the country. The total consolidated income increased 13.7% in real terms when compared to the equivalent revenues as of December 31, 1991. Out of total income, revenue associated with international long distance service represents 21.2%, reflecting an increase of 4.4% in real terms, as a result of the growth of telephone traffic, the tariffs for these services, as well as the effect of a lower devaluation rate of the Mexican peso compared to the inflation rate, which impacts on cash revenues. The revenues from national long distance, which represent 34.8% of the total, grew 8.6%, in real terms. Regarding the revenues for local service, they are 40.0% of total income, and showed a real increase of 24.8%, attributable to the existing lines in service, to the incorporation of new users, to the tariff increase and to the higher volume of local traffic.  49 As can be appreciated in the details in earlier paragraphs, the development of telecommunications has been rapid. Nonetheless, it is thought that this phase of modernization and improvement of service will continue in its process of consolidation during the next two years, until optimization of the service is achieved. In another area, presently, the Ministry for Communications and Transport is making efforts to improve its regulatory capacity and to strengthen the standards in the area. For this reason, it continues to work on the software for the radioelectrical and radiodifussion spectrum, as well as the installation of a radiomonitoring system. To conclude, the progress achieved is judged to have been very considerable and it had an impact on the deregulation of transport and telecommunications in a substantial and irreversible manner and, therefore, the economy of the country is improving rapidly. The deregulation of the economy is in the process of adjustment and it is expected that during the 1993-1994 biennium it will be consolidated, until the optimal conditions for the country are met. F.- CONCLUSIONS AND COMMENTS. 1.- The support of the referenced loan contributed to the communications and transport sectors' achievements in undertaking programs that promote healthy competition in road transport, through the implementation of measures to cancel restrictions that used to interfere in the system's growth as well as the strengthening of the privatization process and the modernization of the telecommunications system. 2.- The current situation of multimodal transport is characterized by the elimination of protectionist schemes that used to impede participation of new entrepreneurs in the market, inhibit competition and generate few incentives to improve the service' and the more efficient use of resources. Thus, (the new scheme) avoids monopolistic operations in the provision of road services and allows more flexibility to modernize and increase the provision of services. 3.- The process of deregulation of federal transport was brought about through dialogue and coordination of government policy, accompanied, as a consequence, by the creation of new regulations. The impact of deregulation had immediate effects such as the elimination of several administrative and operational deficiencies which limited the incorporation of new investors and generated an unjustified increase in the price of services. 4.- The main beneficiaries of deregulation have been the users who now have available to them safer, more efficient and higher quality transport services and who can hire the provider that best meets their needs. The transporters, for their part, are authorized to transit through all national  50 routes with all types of merchandise, except explosive toxic and chemical products, which are regulated in a specific manner. 5.- The elimination of tariff control has led to a healthy competition among transporters, allowing them to negotiate the price of their services and to establish medium and long-term commitments. 6.- The automotive and autoparts industry has grown enormously following deregulation, due, among other factors, to the increase in the number of service providers as well as to the program for equipment established between the federal authority, the National Chamber of Freight Transport, the national automotive industry and the Bank of External Trade. 7.- The fleet of vehicles for freight transport grew historically at an average annual rate of 0.6% between 1980 and 1988. In the last three years, it registered an average annual rate of growth of 23.2%, which practically doubled the fleet; the passenger service fleet grew at an average annual rate of 5.7% from 1989 to 1991, and reached 18.2% in 1992. 8.- In the case of production of first class buses, growth was greater than the expectations, growing from 680 units produced in 1989 to 2,000 in 1991, representing an increase of 310%. 9.- The boom in the automotive industry has meant 100% utilization of installed capacity, and it has awakened the interest of investors and foreign enterprises to invest in our country. 10.- With the advantage of great flexibility in operations and services, it has been possible to lower the overall cost of product distribution and faster deliveries have taken place. 11.- Together, the measures implemented in federal transport have led to an increase in its economic importance, resulting in an estimated increase in participation (of federal transport) in GDP from 1.4% to 1.6% in the last two years. 12.- With respect to fuels, diesel reached international price levels by the end of 1992. To avoid delays in this respect, a monthly adjustment program has been implemented. These measures guarantee a flow of resources that, added to other support such as the growing participation of private investment, the financing from abroad, and the greater quantity of budgetary resources given by the Federal Government, will allow greater attention to the conservation of the highway network. 13.- For railroad transport tariffs, it should be noted that between 1989 and 1990 a considerable restructuring took place both in the transport of persons as well as of bulk freight, in order to cover medium-term variable costs.  51 14.- In reference to environmental contamination, the national program for verification of emission contaminants of passenger and freight vehicles that circulate on the roads of federal jurisdiction was implemented in 1990. The ecological technical standards establishing the maximum permissible levels of smoke emissions were updated. 15.- In the telecommunications sector, the sale of TELMEX went faster than what had been originally planned and the results obtained during the last two years show the success of the decision, since considerable improvements in quality and scale of the services offered have already been achieved. The new TELMEX set goals for expansion and modernization with the objective of accelerating the quality of telephone service both for marginal populations as well as in the large cities. 16.- In the telecommunications sector, the policy has appropriately focused on the privatization of non-strategic activities. This has allowed for the competitive boom of cellular telephone enterprises, in order to provide an alternate service and to complete the turnover of communications of this type at the national level. 17.- With the objective of continuing with the modemization of telecommunications, and given that the "Morelos I" and "Morelos II" satellites are working at full capacity and have entered the period of obsolescence, for 1994 the system of "Solidarity" satellites, which belongs to a more modem generation, will be placed in orbit. This will result in a higher quality, reliability and transmission capacity of signals of large scale and speed. 18.- The transport and the telecommunications deregulation program is in its consolidation stage, and it is expected that in the 1993-1994 period, it will reach the optimal point of development.  52 MEXICO ROAD TRANSPORT & TELECOMMUNICATIONS SECTOR ADJUSTMENT LOAN (Loan 3207-ME) PROJECT COMPLETION REPORT PART m STATISTICAL INFORMATION 1. Related Bank Loans FY of Loan Amount Approval Loan No. Loan Title (US$ million) Sau 1984 2428-ME Highway Sector II 200 Completed 1987 2875-ME Highway Maintenance 135 Disbursing 1989 3087-ME Industrial Sector Policy 500 Completed 1990 3208-ME Telecomm. Technical 22 Disbursing Assistance 2. Project Timetable Item Date Planned Actual Dat Identification June 20, 1989 June 20, 1989 Preparation July 30, 1989 July 30, 1989 Preappraisal November 5, 1989 November 5, 1989 Appraisal Mission Dep. January 15, 1990 January 15, 1990 Start of Negotiations March 26, 1990 March 26, 1990 Board Approval May 29, 1990 May 29, 1990 Signing Date June 5, 1990 June 5, 1990 Effectiveness Date June 25, 1990 June 25, 1990 Closing Date June 30, 1991 June 30, 1991  53 3. Loan Disbursements Cumulative Estimated and Actual Disbursements (US$ million) FY90 FY91 Appraisal estimate 190 190 Actual 190 190 Actual as % of estimated 100 100 Date of Final Disbursement: May 23, 1991 4. Project Costs and Financing Project Financing Source Planned Loan Agreement IBRD Expenditure Categories General Imports 380 TOTAL 5. Use of Bank Resources Staff Utilization (in staff weeks) Task FY89 FY90 FY91 FY92 TQt_ Identification 13.9 - - - 13.9 Preparation - 77.3 - - 77.3 Appraisal 22.8 - - 22.8 Negotiations - 5.4 - - 5.4 Sub-total 13.9 105.5 - - 119.4 Supervision 0.2 13.8 0.5 14.5 Total 13.9 105.7 13.8 0.5 133.9  54 6. Mission Data No. of No. of Total Date of l gMonth/Year bY Weeks Staff Weeks Ret Identification June 1989 89 1 4 4 July 12, 1989 Preparation July 1989 90 1 4 4 Preappraisal I Oct. 1989 90 1 2 2 Nov. 19, 1989 Preappraisal II Nov. 1989 90 2 11 22 Jan. 19, 1990 Appraisal Jan. 1990 90 2 8 16 Feb. 6, 1990 Supervision I Aug. 1990 91 1.2 3 3.6 Sept. 7, 1990 Supervision II Nov. 1990 91 1.2 2 2.4 Dec. 5, 1990 Supervision III Feb. 1991 91 1.2 3 3.6 Feb. 25, 1991 Supervision IV April 1991 91 1 4 4 April 19, 1991 Completion Feb. 1993 93 2 2 4  Annex 1 55 Unofficial Translation Mr. Barber Conable President The World Bank Washington, D.C. 20433 U. S. A. Dear Sir: The Government of Mexico hereby requests a loan from the World Bank to support its modernization program in transportation and telecommunications, as described in the National Development Plan for 1989-1994. The Plan establishes that the legal and institutional framework will be updated, so that the Government will be better able to undertake its responsibilities to modernize, increase the efficiency and improve the quality of transportation and telecommunications services as well as promote competition and avoid the development of monopolies. Road Transport In the context of the Plan, on July 6, 1989 the Government issued new regulations for federal road transportation which allow free entry to the trucking market and eliminate various provisions which constrained an efficient market operation. At the same time, new regulations for multimodal transportation were also issued which will promote increased competition in this important activity. More recently, further steps were taken to improve the efficiency of various activities that are auxiliary to trucking, such as loading and unloading and drayage services, through the deregulation and promotion of competition. Other regulations that interfered with market efficiency, such as setting tariff ceilings for trucking or constraining the ability of in-bond assemblers to transport their goods with their own truck fleets, were repealed this past January. We have also decided to allow containers temporarily brought into the country to transport domestic cargoes on their return trips to ports, which should foster a better utilization of these containers. Also, during the next twelve mouiths we intend to reach agreement with the state governments on measures to align their regulations with the new national framework. Finally, we have taken steps to reorganize SCT's structure to better reflect its new role in light of the revised policies in the road transport sector. The various measures outlined above redefine,the legal framework for road transportation in Mexico. They will be supported by various actions in other fields so as to help achieve the final objective, which is to modernize transportation so that Mexican producers will have access to a service that is efficient and of good quality. 1/ Original of signed letter, in Spanish, dated May 4, 1990, available in Legal Files.  Annex 1 Among the further actions considered, we should highlight ongoing and planned efforts on highway maintenance and rehabilitation. We have assigned priority in our budget to expenditures for these purposes and we have already approved an increase that exceeds 40Z over the amount that had originally been planned for this fiscal year. The Government is committed to continue further increasing the budget for highway maintenance and rehabilitation, within the constraints imposed by macroeconomic considerations, until the needs of the network are fully met. This decision is linked to the Government's present policy to continue attracting private investment to the road sector, by granting concessions for the construction and operation of toll roads and Iridges; this will free financial resources so that other needs, particularly highway maintenance, may be met. We will seek an improved distribution of cargo transportation between the railways and the trucking fleet. The distribution should be based on economic criteria, since this will result in a more efficient use of installed capacity and will result in a better allocation of future investments, both public and private. To achieve this, within the context of the PECE (Stabilization and Economic Growth Program), we will periodically adjust railway cargo tariffs so as to align them with long run variable costs as soon as possible. Likewise, we will also periodically adjust diesel fuel prices and other charges on truckers so that by 1991 the maintenance and renewal costs which they cause to the highway network are fully recovered. Recently the Mexican Congress approved changes to the tax treatment of trucking, which was aligned with the general tax framework for all business activities, thus improving the equity of the system. We are particularly concerned about road safety and are undertaking actions to improve it. Higher expenditures on highway maintenance should contribute towards this objective. At the same time, we will encourage truckers to purchase third party liability insurance which should provide a market incentive to maintain their vehicles in safe operating conditions. Likewise, we will increase to realistic levels and adjust periodically the truckers' responsibility for cargo damages, which should improve cargo handling. These measures will be complemented by actions that the Government will undertake to improve highway safety. We have already set up a coordinating committee cf all agencies involved in road safety issues and have engaged consultants to conduct a study on vehicle sizes and loads, which should provide a sound basis for the formulation of future action plans. Telecommunications In the telecommunications sector the modernization and expansion of services will require major investments, and the Govermnent has decided to attract private capital to the sector. Thus. fiscal resources will be freed to fund other priority needs, such as health, education and housing. In this context, we wish to highlight the Government's decision to sell its shares in TELMEX, so that in the future TELMEX's management and financing will be in private sector hands. The Government of Mexico is well aware that technological changes now allow expanded room for competition in the  Annex 1 57 telecommunications field, and the regulatory framework will be adjusted so as to allow and promote competition wherever this proves to be feasible. Thus, we expect that many firms will he able to develop data transmission services, cellular telephony and data bank and other services. Towards the end of 1989 bidding competition for the provision of cellular telephony in various regions of the country was undertaken and awards were made. The process confirmed the great interest of the private sector to operate telecommunication services. In order to adequately protect the public interest in the provision of telephone services, the Government needs to build up its regulatory capacity and we are developing technical assistance and training programs for this purpose. As regards to tariffs, the Government will only set them for services provided under monopoly conditions. In such cases the tariffs will be based on economic criteria and we will seek to assure a fair rate of return to the service provider. The Government will also regulate the tariffs and technical conditions for the interconection between monopoly and free market services. Operating resp)onsibilities in the telecommunications sector for various activities that were being handled by the Ministry of Conmunications and Transport have now been transferred to a newly established independent public enterprise, TELECOMM. This should help avoid conflicts of interest between the Government's role in policy formulation and regulation and the provision of services. We expect TELECOMM to operate as a financially autonomous institution and to be readily responsive to technological advances. Best regards, Pedro Aspe Andres Caso Lombardo Minister of Finance Minister of Communications and Public Credit and Transport  WEXICO MEXICO - ROAD TRANSPORT AND TELECOWUIICATIONS SECTOR ADJUSTkENT PROJECT Policy Matrix Actions to be Taken Objectiv-s Actions Already Taken by Second Tranche Status I. SCT 1. Improve the institutional A modernization unit has been set-up to arrang eme nts, organization, undertake the reorganization. staffing and training for regulatory activities within SCT. Doveloped and substantially implemented a plan to reorganize SCT's functions in the trucking sector. Consultants should bo engaged to . Contracted Oct. 1990; strongthen SCT's rogulatory capacity delayed from program for in the tel-cos unications sector. may 1990. * Satisfactory action plan to . April 1991 SCT furnished strengthen SCT's regulatory capacity approved Action Plan. In the telecommunications sector should be furnished II. Road Transport 2. Ellminot, regulatory barriers Eliminated system of concessions. to competition and efficiency. Eliminated systoe of route rostrictions. Eliminated system of freight centort. Eliminsted Multimodal's monopoly on *ulti- model transport. * Eliminated restrictions to access into cargo handling. Eliminated restrictions on D msaquiladoras to own and operate their x own trucks.  * Eliminated restrictions on return loading of international containers. * Developed a plan of action to enter into trucking deregulation agreements with all states. 3. Allow trucking prices to be Eliminated 16S surcharge on imported detereined by mirket forces, ard goods. eliminate distortions on costs. E Eliminated Government involvement in setting tariffs. * Eliminated preferential tax treatment for truckers. Provided comitment to achieve full Increase diesel fuel prices by 10% Prices, in real terms, incroased by 21% during cost recovery from truckers and increased (in real terms) so as to 1990. diesel prices by 6.6%. significantly improve cost recovery from truckers. 4. Ensure that the price of Provided comitent to adjust Furnish to the Bank a completed Study completed Nov. tn competing mode (railways) is based FERRONALES rates for key commodities to study of railway rates based on 1990; rates increased July and October 1990. on economic criteria), long run variable cost lovels and economic criteria and increase approved a more agile system for rate FERRONALES rates for key comodities, revision. Initisted study to improve which account for 70S of cargo data base for tariff setting decisions, revenues, by 26% (in real terms) or to long run variable costs; such increase to become effective not later than January 1, 1991. 6. In,prove allocation of highway Provided comitment to increase highway expenditures. maintenance budgets, taking into account macroeconomic constraints. Increased SCT's budget for maintenance Submit budget proposal for highway Budget increase target expenditures in 1990 by Mext 166 billion, maintenance for 1991, furthor met. increasing it by Mext 46 billion (in real terms); of the total at least 40% should be for routine mo 1ntenance. x K)  S. Improve quality and *nforcement . Strengthened group to coordinate safety of necessary regulations for policies. safety, weight controls and environment. Work done on First Started study on vehicle sizes and Complete first phase and initiate Phase satisfactorily and loadings, second and third phases (policy met condition of loan, recommndatios) of tudy.with comnpletion due June r-comendotionc) of study. 1993. Second and Third Present satisfactory action plan to phases started. improve road safety. . Action Plan presented Sept. 1990. Drafted regulations requiring periodic Issue regulations requiring . Mandatory emissions inspection of trucks to monitor periodic inspection of trucks to inspection issued May 1990. complionce with environmental standards monitor compliance with environmental and initiated a program to improve fuel standards. quality. III. Teleco_mmunications 7. Promote increased private Public announcement of policy goals in ON sector participation and sector, including promoting competition competition in telecommunications. and privatizing TELLEX. Engagement of investment bankers to handle sale of TELLEX's shares. Engaged foreign investiment banker to assist in handling sale. Prepared program and tim_table for handling privatiration of TELMEX. Furnished a satisfactory draft franchise. Satisfactory progress towards sale Sale of controlling of a controlling intereat in TELMEX, interest completed Dec. 20, 1990; earlier than including receipt of bids and award expected. decision by Government. (D  * Awarded concessions for cellular telephony in Federal District and in rest of the country. Issu regulations governing th . "Reglamento de reguatins overingthe Telecomunlicaciones" licensing of telecomunications publiBhed in Diario Oficial networks and services. on Oct. 20, 1990. B. Improve resource allocation in Rates were adjusted in January 1990, the market for telecomunications reducing cross subsidies and increasing services. average level by 70X * Tax treatment of sector has been realigned. 9. Improve the efficiency of Decree setting up TELECOUM has been sector institutions, issued, and SCT's operating functions have been transfered to TELECOUM. Furnished a statement of TELECOMM Furnish satisfactory business plan Provided April, 1991; policy and objectives. (including investment end financing) delay from expected date of Nov. 1990. for TELECOMM. IV. Macroeconomic Management 10. Macroeconomic consistency. Satisfactory assessment of the For tranche release May medium term macroeconomic framework. x D'  62 Annex 3 SELECTED INDICATORS OF TELMEX PERFORMANCE 1. It is of interest to evaluate some aspects of TELMEX performance under the new ownership and to review compliance with some terms of the concession contract. This concession contract gave TELMEX a monopoly on all fixed-link telephone services until August 1996, and specified rules for maximum prices, for minimum investment plans, for minimum service quality and obligations regarding the interconnection of other service providers. These rules are normally designed to protect consumers from monopolistic practices. 2. Pricing. The formula used for price regulation requires in essence that the cost of a basket of services including installation and rental charges, measured local, domestic and international long distance calls be maintained constant in real terms between 1991 and 1996. Data from 1991 indicate that due to the application of annual adjustment of rates, rather than quarterly adjustments, and other specific changes in some rates, the effective price cap was exceeded in real terms. Results were not yet available for 1992. 3. Changes in prices of individual services are also subject to restrictions. In general the criteria are that for each service recovery of long term incremental costs must be achieved and that cross-subsidies must be eliminated, this being a major objective of the policy reform. Tables 1 and 2 present the actual evolution of tariffs, in nominal and real terms, since 1989 for the different services. A summary of the patterns of change, in real terms, indicates that in effect a substantial realignment of rates has occurred in the direction of eliminating the cross-subsidies between services. In essence, rates for local services and domestic long distance have increased substantially while international long distance charges have declined. 4. The pricing formula adopted for regulating TELMEX rates' has the apparent advantage of being simple, easy to monitor and is objective with no possibilities for undue outside interference. At the same time the criteria established for setting individual rates conform to basic efficiency considerations. However, monitoring is made difficult as in reality for each service tariffs represent a large number of subcategories and the corresponding weights required to compute the basket are not easily obtained. In addition, the estimation of long run incremental costs per service is an extremely complex task. The presence of common costs, externalities, economies of scale and of scope and technological change require a large 1. Pricing. The formula used for price regulation is an RPI minus X price-cap type. In this method a basket of services is subject to price control which in the case of TELMEX include installation and rental charges, measured local calls and domestic and intemational long distance calls. Every quarter the weighted average price can only rise at the retail price index (RPI) minus an X percentage that is set periodically. For TELMEX this value is zero for the period 1991-1996 and 0.74% per quarter for the period 1997-98. After that, X will be set every four years in accordance with the method of incremental costs specified in the concession contract.  63 Annex 3 amount of information, analysis and judgement. This puts a heavy burden on both TELMEX and the regulators.2 5. Price adjustments have not followed strictly those established in the concession contract. Variations with respect to the maximum price levels according to the price-cap and of specific rate changes established in the concession contract are reasons for concern as there seems to be no strict adherence to the contract, giving room for direct negotiations between TELMEX and SCI. Also, while a substantial realignment of rates has occurred in the direction of eliminating the cross-subsidies between services, it is not evident that the structure of rates is moving at the estimated pace towards a better balance between local and long distance charges. Transparency, competition policies and SCT's regulatory power seem to be endangered by these practices. 6. Investment plan. The concession contract requires that TELMEX meet certain specific investment targets. A review of 1991 and 1992 data indicates that in most accounts TELMEX has been able to comply with its growth targets, thereby satisfying one of the main purposes of the privatization program. The total investment levels have reached US$ 2.25 billion in 1991 and US$ 2.4 billion in 1992. US$ 2.4 - 2.5 billion are planned for 1993. This compares extremely favorably with investment levels of the 1980s. Most importantly, the rate of increase in lines was 12.5% in 1991 and 12.1% in 1992, above the average target of 12% for the 1991 - 1994 period. Still, casual observations suggest that the lack of prompt response to connection requests (30 months delay) continues to be a major source of complaints by customers. 7. Ouality of service. The concession contract specifies the need to meet certain minimum quality standards.3 Table 3 presents the available data on 2. TELMEX was required by the concession contract (Clause 6-6) to present periodically a 'study on the appraisal of incremental costs for regulated services'. The first such study was to be made available on December 31, 1992. To date no such study has been contracted. SCT indicated that estimated costs exceeded US$1.1 million and therefore recommended a review of the terms of reference. A 6 month extension of the deadline was agreed. 3. The first is a 'Service Continuity Index' including fault rate and proportion of faults repaired in the same day and in three days. The second index represents 'Service Quality and combines time to obtain dial tone, proportion of calls completed at the first attempt, operator response time, and number of public phones in service. Table 3 presents the available data on compliance of these targets. Regarding continuity of service the overall ICON index is well above target, however, deficiencies exist in the rate of lines with failure. Actually some geographical areas reported significant increases in the failure rate during 1992. In view of this, SCT reports that a special program was set up by TELMEX, dealing specially with integral replacement of lines by district, and at the same time had to compensate customers for the time that lines were not operational. The service quality index (ICAL) reports an overall satisfactory index, with deficiencies in the speed of response of special services operators. However, measurement problems and methods swem to hide the real availability of public telephone booths and some of the other quality indexes. SCT does (continued...)  64 Annex 3 compliance of these targets. Regarding continuity of service the overall ICON index is well above target, however, deficiencies exist in the rate of lines with failure. To correct for this, SCT reports that a special program was set up by TELMEX, dealing specially with integral replacement of lines by district, and, at the same time, TELMEX had to compensate customers for the time that lines were not operational. The service quality index (ICAL) reports an overall satisfactory level, with deficiencies in the speed of response of special services operators. However, measurement problems and methods seem to hide the real availability of public telephone booths and some of the other quality indexes. SCT does not report an independent audit of these indexes. 8. Productivity. It was expected that privatization and foreign participation would improve operational efficiency. On this account productivity estimates indicate that during 1991 total factor productivity increased by 24.5%, with a large share due to specific labor productivity increases (36%). In this area TELMEX has promoted an active policy of personnel attrition and retraining. More sources of productivity increases are expected in the area of capital goods. Having a well defined investment plan and being more aggressive in bidding procedures should improve prices for these goods. No productivity data are available for 1992. 9. Management practices have been significantly changed. A single senior director concentrates all responsibilities regarding telephone service. Six out of eleven senior managers come from outside the telecommunications sector. Foreign participation has implied the presence of about 40 professionals from Southwestern Bell and France Telecomm, whose main involvement has been the revision of the technical aspects related to network design and support in training for higher-level management. 10. Financial returns. A simple comprehensive picture of the evolution of TELMEX is obtained by analyzing the financial statements since 1989, presented in Table 4. Overall after tax profit has reached a level of US$ 2,600 million in each of the two years under private ownership. This represents a large increase relative to the 1990 level (78%) which by itself was 82% higher than 1989. The basic reason for these results is that the modifications in the tariff structure have doubled revenues from sales in real terms since 1989. With constant receipts from international long distance, 2/3 of the increase is due to local service and 1/3 to domestic long distance. 11. A notable consequence of these results has been the ability of TELMEX to reduce its debt position (liabilities/assets ratio declined from 35% in 1991 to 28.9% in 1992) while at the same time financing fully its investment program and providing an increase in distributed shares to its owners. 3.(. . .continued) not report an independent audit of these indexes.  TABLE 1 TELMEX. EVOLUTION OF TARIFFS BY SERVICE (Current Mex$) a/ Item 1989 1990 |%