Mexico - Agricultural Credit Project

RESTRICTED FILE COPY Report No. P-449 This report was prepared for use within the Bank and its affiliated organizations. They do not accept responsibility for its accuracy or completeness. The report may not be published nor may it be quoted as representing their views. INTERNATIONAL BANK FOR RECONSTRUCnION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE NACIONAL FINANCIERA, S. A., MEXICO FOR AN AGRICULTURAL CREDIT PROJECT September 7, 1965  INTERNATIONAL BANEK FOR RECONSTRUCTION AND DEVELOPMENT PRESIDET1?T S REPORT AND RECOM4ENDATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO NACIONAL FINANCIERA, S.A. MEXICO FOR AN AGRICULTURAL CREDIT PROJECT 1. I submit the followin3 report and recommendation on a proposed loan in various currencies cquivalent to $25 million to Nacional Financiera, S.A. to assist in the financing of an agricultural credit project in Mexico. PART I - HISTORI CAL BACKGROUND 2. Medium and long-term credit to agriculture has been supplied in Mexico since 1955 by tne "Fondo do Girrantia y Fomento para la Agricultura, Ganaderia y Avicultura" (Fondo), which is a trust fund of the Banco de Mexico (Banco). In order to supplement the Fondo resources and to extend its opera- tion from small farmers to medium and commercial farmers and to businessmen for related food and fiber processing plants, the Government submitted a project proposal in April 1965 for $140 million. In addition the Government had requested funds for a coffee diversification project. 3. An appraisal mission, which visited Mexico in April-June 1965, estimated that a loan of $25 million would cover during the next three years theproba,ble demand, which is expected to include some on-farm investments arising from coffee diversification. Loan negotiations took place in Washington between August 11 and 17. Nacional Financiera was represented by Mr. Alfredo Navarrete, Director, Mr. Luis R. Garcia, Assistant Manager and Messrs. Manuel S. Valladares and Jose HIernandez. Banco de Mexico was repre- sented by Mr. Ernesto Fernandez HIurtado, Sub-Director, Mr. Horacio Garcia Aguilar, Head of the Fondo, Mr. Alfonso Garcia Balaunzaran, Counsel and Mr. Jesus Silva Hierzog, Special Assistant. 4. The proposed loan would increase the Bank's lending to Mexico to $1X96.3 million (net of cancellations and refundings). Thie following is a summary of Bank loans to Mexico: Amount Year No. Borrower Purpose (equivalent in $ miillion) 1949 12 ME Nacional Financiera & CFE Electric Power Development 24.1 1949 13 ME Nacional Financiera & CFE Electric Power Development 10.0 1952 56 ME Nacional Financiera & CFE Electric Power Development 29.7 1958 194 ME Nacional Financiera & CFE Electric Power Development 34.0 1962 316 ME Nacional Financiera & CFE Electric Power Development 130.0  -2- Amount Year No. Borrower Purpose (equivalent in $ million) 1950 24 ME Mexlight Electric Power Development 26.0 1958 186 ME Mexlight Electric Power Development 11.0 1950 33 ME Bank Consortium & Development of Small Nacional Financiera Industrial Projects 10.0 1954 103 IE Ferrocarril del Pacifico RailwJay Rehabilitation 61.0 1960 263 ME Nacional Financiera Road Construction and Improvement 25.0 1963 354 YiE Nacional Financiera Road Construction & Improvement 40.0 1961 275 ME Nacional Financiera Irrigation Improvement 15.0 1963 336 FE Nacional Financiera Irrigation Improvement 12.5 1962 317 WE Caminos y Puentes Federales de Ingresos & Toll Transport Nacional Financiera Facilities 30.5 1965 401 ME Caminos y Puentes Federales de Ingresos & Second Toll Transport Nacional F-nanciera Project 32.0 Total (net of cancellations and refundings) 471.3 Of which has been repaid 72.9 Total now outstanding 394.: Amount sold $38.6 Of which has been repaid 23.5 15.1 Net arnount now held by Bank 383.3 As of July 31, 1965, $89.3 million of the above loans had not been disbursed. Construction and procurement have been generally proceeding according to schedule i7ith the exception of the hir_hwTay Loans 268-HE, 317-P,E anid 354-HE, ulhere delays in disbursements were caused respectively by very heavy rains, by difficulties in obtainini, the right-of-.Tay and by limited budgetary alloca- tions; remedial actions have since been initiated. 5. In addition to the agricultural credit project, an electric power and an irrigation project are in an advanced state of appraisal. The Govern- ment has also expressed an interest in obtaining Bank loans for further irri- gation and road development as well as for water supply and sewerage. PART II - DESCRIPTION OF THE PROPOSED LOAN 6. Borrower: Nacional Financiera, S.A., a financial agency of the Mexican Government winch, under the existing MIexican legislation, has to be the borrower or co-borrower of Bank loans.  -3- Guarantor: The United Mexican States Amount: Zquivalent in various currencies of $25 million. Purpose: To help in providing funds for financing medium and long-term on-farm investments to medium and commercial farmers and-to businessmen for financing plants pro- cessing agricultural products. Amortization: 20 years, including 4 years' grace. Interest rate: 5 1/2 per cent per annum. Commitment charge: 3/8 of 1 per cent per annLum. Payment dates: February 15 and August 15. PART III - LEGAL IUSTRUMENTS AiD AUTHiORITY 7. Tile draft Loan, Guarantee and Project Agreements, as well as the report of the Committee provided for in Article III, Section 4 (iii) of the Articles of Agreement of the Bank are being distributed to the Executive Directors separately. These draft Agreements are in the usual form. PART IV - APPRAISAL OF THE PROPOSED LO-.U 8. A detailed appraisal of the Project (TO-489a) is attached. 9. Agricultural development in Mexico has suffered from a paucity of credit, particularly medium and long-term. This has resulted both from competition for available credit resources from other sectors of the economy and from a basic conservatism of the private banks toward agricultural lendin-. In 1955 the Banco set up the Fondo to mobilize more credit for farmers thrcugh private banks. This program grew slowly but steadily through 1962. In 1962 the U.S.Agency for International Development (AID) made a US$20 million loan for the purpose of accelerating this program to small farmers. The results have been positive and have exceeded expectations. 10. The Project consists of supplementing th-ie resources of the Fondo to make medium and long-term loans to agriculture through private banks which carry all the risk except the foreign exchange risk which is borne by the Government. Whereas AID funds would be used by the Fondo for loans to farmers earning under pesos 100,000 per annum, the Bank's funds would be used for lcans to farmers normally farming 50 to 100 ha. of irrigated land or its equivalent in dry land farming or ranching, with an annual income of pesos 100,000 or more, as well as for loans to businessmen processing foods and flbers. About one-half of the Bank funds have been earmarked for livestock industry  - h - investments, 20 per cent for general crops industry investment, 10 per cent for processing facilities, 8 per cent for tree crops .a-d uho balance for tecltiical s6rvices and unallocated. 11. The Fondo is a suitable medium for channeling funds through private- ly owned banks to individual farmers. Apart from external loans, it obtains its funds from Government institutions and rediscounits from the Banco. A new agreement between the Government and the Banco, acceptable to the Bank, has been concluded recently; it extends the operations of the Fondo and endows it with additional government funds. The Fondo has its own offices and staff both in the capital and in field agencies and has been working well. The Banco agreed to strengthen further the Fondo's staff and organization. 12. Procurement of all items financed would be through regular com- mercial channels. Mexico has a well organized system of dealerships, with good repair facilities, and private contractors are available to do custom work with their own machinery. This system is working well under the current Fondo programs. Procurement of technical services to be imported by the Fondo would be open to qualified international firms and individuals. 13. Disbursement of the Bank loan would be for fifty per cent of all expenditures under eligible loans. Documentation would be presented periodically by the private banks to the Fondo showing disbursements agairst -esc loans. Reimbursement requests to the Bank would be accompanied by a certifica- tion by the Fondo that these loans had qualified under the Project. 14. The Fondo, whose staff will carry out the Project is a trust fund established by the Banco. The latter cannot contract loans other than for monetary purposes and, thus, could not be a co-borrower of the proposed Loan. The Project Agreement between the Bank and the Banco defines the obligations of the Banco with regard to the Project. 15. One of the primary objectives to be achieved through the Project is to stimulate participation of the private banks in the agricultural credit field with their own resources, with the resultant increase on a regular basis of total loan funds available to agriculture. This would be the first opera- tion of the Bank in ,rhich funds would be channeled to agriculture through and with the participation of privately owmed banks. 16. The principal direct benefits from this Agricultural Credit Project would be: (1) the increased production on farms from l-vestock, crops and tree crops; (2) reduction in cost of production by better management, equipment, machinery and irrigation; and (3) increased returns from related processing industries. In addition to these direct benefits there would be an increase in employment opportunities and a general improvement of the economy in the areas directly affected. The over-all internal rate of return to the eccnonry from the proposed project has been estimated at about 27 per cent. 17. Most of the increased farm production resulting from the Project would be absorbed by expanding markets within Mexico. Some beef and fruit would be available for export to the U.S. and other countries where markets appear to be good. The Project would also finance related processing indus- tries such as storage facilities, milk processing plants, and plants for canning fruits and vegetables.  - 5 - PART V - ECONO1IIC SITUATION 18. In April 1965 a M4emorandum on Recent Economic Developments in M4exico (WaH-147) was submitted to the Executive Directors, in which the findings of a Bank mission which visited M4exico in February 1965 were summarized. The mission confirmed the conclusions of a previous report (WH-137a) regarding the underlying strength and flexibility of the Mexican economy and the reason- ableness of the target growth rate of 5 to 6 per cent for gross domestic prod- uct in real terms, even though developments during 1964 were not entirely as expected. A significant increase in medium-term foreign indebtedness occurred and debt service on the external public debt outstanding at the end of 1964 equals about 25 per cent of foreign exchange earnings in 1965, subsequently declining to 18 per cent in 1966 and to 7 per cent by 1970. Unforeseen large public investments also resulted in higher imports, substantial public sector borrowing from the banking system, as well as in an unusually high growth rate of GNP (10 per cent in real terms and 16 per cent in money terms). The special factors that had caused these developments were not expected to con- tinue to operate and corrective measures were planned by the Government to control capital expenditures and borrowing by the public sector. 19. Present indications are that these measures are indeed taking effect. The new powers given to the Ministry of Finance to control the budgets and the borrowing of the decentralized public sector and state enterprises, and to act as their cashier, have begun to be applied vigorously. It is not yet pos- sible to obtain precise information on public sector capital expenditures in 1964, but they appear to have been of the order of Mex.$16-17 billion. On the basis of present trends the corresponding figure for 1965 may be between Yex.$13.0 and Mex.$14.0 billion. At the same time current revenues of the Federal Government have risen by more than 20 per cent during the first half of 1965 while current expenditures rose by only 6 per cent. Considerable savings were achieved in current expenditures by modifying the agricultural price support program; the subsidy to the agency in charge of this activity (COMASUPO) may be only half in 1965 of what it was in 1964. The support price for corn was reduced by more than 12 per cent and the export losses as well as the carrying charges resulting from the wheat supports are now being borne by the producers rather than the Government. 20. While the public sector thus appears to have retrenched in the first half of 1965, the investment boom of the private sector - particularly buildinj construction - proceeded and helped to maintain an over-all high level of activity. Real GNP in the current year is now expected to rise by ati least 6.5 per cent. According to preliminary information receipts from tourism rose by about 14 per cent in January-May 1965, while commodity exports and imports increased slightly. International reserves declined moderately, partly because of seasonal factors and partly because of a much lower level of foreign loan utilization. Reserves now total about $480 million and are the equivalent of about two and a half months' payments. 21. The improved public sector savings and the reduced level of capital expenditures permitted a reduction of almost US$50 million in the oultstanding disbursed public debt, as well as substantially less borrcwing from the domest' banking system by the public sector. Partly in consequence of this, and of opt market operations by the Central Bank - as well as of seasonal factors - the money supply fell by about 5 per cent in the first half of 1965. Tf trends continue along the 1I.es indicated above it should be possible to avoid either  - 6 - substantial inflationary pressures or a shortage of credit for the private sector. The Government is presently engaged in formulating an investment program for the main spending agencies in the public sector for the next 5 1/2 years. The progress of the Government in developing this program and assuring its sound financing will substantially affect the aggregate volume of external lending which would be appropriate in future years. In the mean- time, Mexico continues to remain creditworthy for carefully selected Priority project loans. PART VI - COMPLIANCE WITH ARTICLES OF AGREEI'IENT 22. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank. PART VII - RECOINRMiDATION 23. I recommend that the Executive Directors adopt the following resolution: RESOLVED: THAT the Bank shall grant a loan to Nacional Financiera, S.A., to be guaranteed by the United Mexican States, in an amount in various currencies equivalent to twenty five million United States dollars (U.S.$25,ooo,0oo), to mature on and prior to August 15, 1985, to bear interest at the rate of five and one-half per cent (5-1/2%) per annum, and to be upon such other terms and conditions as shall be substantially in accordance with the terms and condi- tions set forth in the form of Loan Agreement (Agricultural Credit Project) between the Bank and Nacional Financiera, S.A., the fonmn of Project Agreement (Agricultural Credit Project) between the Bank and Banco de Mexico, S.A. and the form of Guarantee Agreecaent (Agricultural Credit Project) between the United Mexican States and the Bank, which have been presented to this meeting. George D. Woods President Attachment liashington, D.C. September 7, 1965