Uruguay - Fourth Power Project

RESTRICTED FILE coPY Report No. P-873 This report was prepared for use within the Bank and its affiliated organizations. They do not accept responsibility for its accuracy or completeness. The report may not be published nor may it be quoted as representing their views. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT. AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO ADMINISTRACION GENERAL DE LAS USINAS ELECTRICAS Y LOS TELEFONOS DEL ESTADO TO BE GUARANTEED BY THE REPUBLICA ORIENTAL DEL URUGUAY FOR A FOURTH POWER PROJECT November 6, 1970  I2TET'.ATIO'TAYT, BANK FOR RECOiiSTRUCTION AND DEVELOPMEN4T REPORT AND RECONUENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO ADMINISTRACION GENERAL DE LAS USINAS ELECTRICAS Y LOS TELEFONOS DEL ESTADO TO BE GUARANTEED BY THE REPUBLICA ORIENTAL DEL URUGUAY FOR A FOURTH POWER PROJECT 1. I submit the following report and recommendation on a proposed loan in an amount in various currencies equivalent to US$18 million to Administracion General de las Usinas Electricas y los Tel6fonos del Estado (UTE) for a power project, with the guarantee of the Republic of Uruguay. PART I - HISTORICAL 2. The Bank has been associated with the electric power sector in Uruguay since 1950, when the first Bank loan in the country, for US$33 mil- lion, was made to finance the foreign exchange costs of a four-year power and telecommunications expansion program of UTE. Subsequently a loan of US$5.5 million was made in 1955 to finance the installation of additional thermal generating capacity in Montevideo and, in 1956, a third loan of US$25.5 million was made for the Baygorria hydroelectric project and asso- ciated transmission lines. The proposed fourth loan would help finance the foreign exchange cost of the most urgent investments in generation and distribution facilities which UTE must make during 1971-73. 3. In the latter part of the 'fifties, severe inflation and economic stagnation beset the Uruguayan economy and UTE was one of the institutions which suffered most in these circumstances. UTE's financial performance deteriorated sharply as successive governments denied the enterprise timely and adequate tariff adjustments despite rapid inflation, while political interference in UTE's administration led to overstaffing and inefficiency. The negative trends in the economy and in UTE were not reversed until 1968, when the present government instituted an effective stabilization program and undertook a series of financial and institutional reforms in key sectors of the economy. In 1969 a consultant, provided by the Bank, assisted UTE in drawing up a program of essential measures to restore the operating efficiency and financial health of the enterprise. In the following months, UTE's administration was reorganized along the lines proposed by the con- sultant, new tariff regulations consistent with Bank reconmnendaticns were introduced, and power rates were sharply increased. By early 1970, impressive progress had been made in laying the groundwork for a resumptiion of Bank lending to UTE.  4. The project was appraised by a mission which visited Uruguay in March 1570 and negotiations for the proposed loan took place in Washington from August 28 to September 8, 1970. UTE was represented by Messrs. Yanuel Mendiola, General Manager; Pedro Rivero, Manager, Finance Division; Juan Bado Hamilton, Legal Adviser; and Miss Marta Casabo, Assistant to the General Manager. The Government of Uruguay was represented in these negotiations by Mr. Hector Luisi, Uruguayan Ambassador in Washingt(n, and IMr. Alfredo Platas, iLinister of the Embassy. 5. The proposed loan would increase the Bank's total lending to Uru- guay to US$126.5 million. The following is a summary statement of the Bank loans to Uruguay as of September 30, 1970: Loan mUillion) Number Year Borrower Purpose Amount Undisbursed 30-UR 1950 UTE Power 33.0 - 132-UR 1955 UTE Power 5.5 - 152-UR 1956 UTE Powier 25-5 - Republica Oriental 245-UR 1959 del Uruguay Agriculture 7.0 - Repu'blica Oriental 324-UR 1962 del Uruguay Roads 18.5 1.9 Republica Oriental 407-UR 1965 del Uruguay Agriculture 12.7 - Repuiblica Oriental 698-UR?' 1970 del Uruguay Agriculture 6.3 6.3 Total (less cancellations) 108.5 of which has been repaid to Bank and others 49.8 Total now outstanding 58.7 Amount Sold 3.3 Of which has been repaid 3.3 0.0 Total now held by Bank 58.7 Total undisbursed 8.2 Not yet effective.  - 3 - 6. The road construction project financed by the loan the Bank made in 1962 has suiffered a variety of delays, the most important of which was occasioned by a lengthy disagreement between the design consultant and the government on the final designs. However, recent performance on the pro- ject has been satisfactory and construction is now moving ahead toward com- pletion. After review of a progress report from the Government, the Closing Date was recently postponed to flay 31, 1971, by wthich time it is expected that iwork on all road sections will have been satisfactorily completed. 7. The proposed loan is the only one I expect to present to the Executive Directors in the current financial year. In FY-1972 another, larger livestock loan is planned to follow up the US$6.3 million loan made in June 1970; the latter was intended as an interim loan which would meet the credit needs of Uruguay's ranchers for only 12-18 months. Prepa- ration has begun on a tourism project and another loan to UTE to help finance the expansion of its generating capacity after 1973 is in prospect. PART II - DESCRIPTION OF THE PROFOSED LOAN 8. Borrower: Administracion General de las Usinas El6ctricas y los Telefonos del Estado. Guarantor: Republica Oriental del Uruguay. Purpose: To assist in financing a project for the expansion of powTer generating capacity and extension and rehabili- tation of distribution facilities. Amount: In various currencies equivalent to US$18 million. Amortization: In 25 years, including a 4-1/2 year period of grace through semiannual installments beginning August 15, 1975 and ending August 15, 1995. Interest Rate: 7-1/4 percent per annum. Commitment Charge: 3/4 of 1 percent per annum. Incremental Financial Generation expansion 14%. Return on the Project: Distribution rehabilitation 10%.  - 4 - PART III - THE PROJET 9. A detailed description of the project is given in the attached report entitled "Usinas y Telefonos del Estado (UTE) Appraisal of the Fourth Power Project" (PU-49a). 10. UTE, the proposed borrower, is an autonomous government enter- prise which manages power supply and telephone services in Uruguay. UTE now operates generating plants having a reliable installed capacity of some 464 IIW and supplies 95 percent of the country's electric energy requirements, the remaining 5 percent being produced in "captive" plants owned by large industries in Montevideo. On the telecommunications side, UTE operates 320 telephone exchanges and services about 150,000 subscribers. It also pro- vides international telephone services as well as a telex service. 11. Over the past five years electricity consumption has grown at a rate of 3.2 percent per annum, but with the recovery in the Uruguayan eco- nomy and the increased tempo of development now under way it is expected that the rate of growth of demand for electric power will increase to 6 per- cent per annum. The commissioning of the fifth 80 HMA unit at the Batlle plant earlier this year alleviated an acute power shortage in the Montevi- deo-Rio Negro system (which accounts for 90 percent of UTE's sales) and gave UTE sufficient generating capacity to meet estimated consumption requirements until 1973. By the latter year, however, consumption is expected to have grown to the point where UTE's reserve capacity will be inadequate and additional generating capacity will be needed to assure the maintenance of a reliable power supply. 12. The proposed project includes the additional generating capacity in which UTE must now invest, plus the most urgent investments which must be made in the distribution network. The major component of the project is the installation of a 100 MW sixth steam unit at the Batlle plant in Montevideo, to be commissioned in 1973. The other major item is the rehabilitation and extension of the Montevideo distribution system which includes installation of underground cables, overhead lines and transformers. The loan will also finance the services of consultants who will assist UTE in the following three key areas: (i) the development of long range plans for the expansion of generating capacity; (ii) the reorganization of the accounting system; and (iii) improving management and operating efficiency- 13. UTE's Board of Directors consists of five members appointed by the President for a four-year term coinciding with that of the Government. In addition to considering broad policy matters, the Board has in the past directly controlled day-to-day operations with the result that decisions were often long delayed and UTE's management made unduly cumbersome. Last year, however, following one of the principal recommendations of the Bank consultant, the Board established the position of General Manager to which  it delegated certain important operating responsibilities. This was an important step forward in making more agile and effective management possible, and during negotiations assurances were obtained that the existing Board resolutions governing the position of General Manager would not be modified without the Bank's concurrence. The present General Manager is well qualified and UTE has agreed to consult with the Bank prior to making any new ap- pointments to this post. The further strengthening of UTE may also be expected as a result of the work of the consultants who will be employed under the project to advise on the improvement of organization, management and operating procedures. During negotiations UTE agreed to consult with the Bank on the consultants' recoimendations and to implement an improvement program satisfactory to the Bank. During negotiations UTE also outlined a program under which it intends to progressively eliminate overstaffing, mainly by not filling vacancies arising from normal staff attrition. It is expected that total staff can be reduced by at least 10 percent by 1974, despite the fact that UTE would be greatly expanding both its telecommunica- tions and power operations during the intervening years. 14. As a result of increases of 30 percent in 1969 and 45 percent in 1970, UTE's power rates are now adequate to enable the enterprise to earn a satisfactory rate of return and make a reasonable contribution to the financing of its investment requirements. The Government and UTE agreed during negotiations to maintain power rates at a level that will produce a minimum return of 10 percent on an appropriately revalued rate base until the completion of the project. It was also agreed that the existing elec- tricity rate regulations, which provide for a rate of return of 8-10 percent, will not be materially modified without the Bank's concurrence and that, for the period following the completion of the project, rates will be set after consultation with the Bank so as to assure UTE a rate of return within the stipulated range. Telecommunication tariffs have been generally adequate in the past and to insure UTE's overall financial viability it was agreed during negotiations that they would in the future be maintained at a level which would provide a minimum rate of return of 10 percent on UTE's appro- priately revalued telecommunications tariff base. In addition to the maintenance of adequate tariffs, measures to assure the collection of substantial past due accounts owed by public sector agencies are essential to the restoration of UTE's financial health. Good progress has been made in recent months in collecting these accounts and UTE has agreed to continue to take steps satisfactory to the Bank for this purpose. UTE may borrow only if debt service including the service of the proposed borrowing is covered at least 1.5 times by the sum of net operating income and depreciation. 15. The total cost of the project is estimated at US$22.6 million, ex- cluding interest during construction. Contracts for equipment and for erection of the steam unit will be put to international bidding and are likely to go to foreign firms. The proposed Bank loan of US$18 million would be used to pay for the foreign exchange cost of these items as well as interest of US$1.5 million on the loan. Civil works and erection contracts for distribution equipment are too small to be likely to attract foreign bidders and they will be financed entirely by UTE.  - 6 - PART IV - LEGAL INSTRUM12TS AND AUTHORITY 16. The draft Loan Agreement between the Bank and UTE, the draft Guarantee Agreement between Republica Oriental del Uruguay and the Bank, the report of the Conmittee provided for in Article III, Section 4(iii) of the Articles of Agreement of the Bank and a draft resolution approving the proposed loan are being distributed to the Executive Directors sepaiately. The draft agreements conform substantially to the pattern of agreements relating to power projects. PART V - THE ECONO1MY 17. A report on the 'TCurrent Economic Position and Prospects of Uru- guay" (WH-198a) was distributed to the Executive Directors in April 1970. The report concluded that the policies being pursued by the present Gov- erment had brought about a significant improvement in Uruguay's economic performance and creditworthiness. It found that monetary, fiscal and incomes policies had succeeded in slowing inflation and that the balance of payrents had been strengthened. The continuation of these favorable trends in the first eight months of this year was confirmed by an Economic Mission which visited Uruguay in August to update and expand our information. This mission is now preparing its report. 18. The recent mission found that there was increasing evidence that the Uruguayan economy had finally broken out of its prolonged stagnation. In 1969, GDP is estimated to have grown by 5.3 percent in real terms, with improved price incentives to livestock producers and the impact on internal demand of the Government's incomes policy, which had tended to redistribute income in favor of labor, playing an important role in raising the level of economic activity. Industrial productivity and profits have improved with the utilization of excess capacity and recent large increases in capital goods imports appear to indicate that the private sector is beginning to respond to the Government's policies by stepping up investment. The revival of the economy has also been reflected in a significant decline in reported unemployment in Montevideo; in addition, real wages rose significantly in 1969 and labor-management relations have been relatively tranquil for the past year. 19. The cost of living rose by less than 10 percent in the first six months of this year, despite increases in public sector tariffs and other corrective price adjustments. The increase over the full year is likely to be held to about 15 percent, the level to which inflation was brought dowl in 1969, after having averaged about 100 percent in the preceding two years. Although a 13 percent general wage increase was permitted in 1969, it is estimated that by the beginning of this year more than half of the increased unit cost of labor had been absorbed by improved productivity. Through  - 7 - June 1970, public sector operations were contractionary as the housing authority accumulated large balances of unspent earmarked taxes and the Central Government covered its modest cash deficit with sales of Treasury bills and bonds. Monetary expansion during the first semester was held to about 7 percent despite a substantial increase in net foreign exchange reserves. 20. As regards the balance of payments, exports have continued to rise sharply this year, mainly as a result of substantial increases in both the volume and value of meat exports reflecting the improvement of producers' incentives in Uruguay as well as the favorable trend in world prices. While imports have been rising even more sharply than exports, Uruguay is expected to be able to maintain the trade surplus which, together with a substantial inflow of long-term capital, has made it possible to rapidly amortize the short-term debt in the form of rescheduled commercial and financial arrears accumulated in the mid--l9601s. Net foreign exchange reserves (excluding official liabilities of more than one year), which reached the equivalent of almost seven months' imports at the end of 1969, continued to rise in the first six months of this year. However, in recent months substantial foreign exchange losses have occurred, apparently as the result of speculative capital movements following the devaluation of the Argentine Peso. Much now depends on whether such speculation will abate, and on the behavior of Uruguayan tourist earnings with the advent of the tourism season in December; the outcome of the latter is doubtful due to the high level of Uruguayan prices. The present uncertainties underlie the continuing need for the government policies to respond with flexibility and speed to changing circumstances. Also, there is a need to assure an adequate level of public sector savings and an expanded flow of credit to the commodities-producing sectors, as well as to improve project identification and preparation activities. 21. Uruguay's public and publicly-guaranteed foreign debt amounted at the beginning of 1970 to US$320 million. Service on this debt has been very heavy in recent years, due to the excessive concentration of maturities, and the ratio of debt service to foreign exchange earnings was 23 percent in 1969. However, it is reasonable to assume that Uruguay will be able to borrow over the next five years on more favorable terms than in the past and that debt service will be manageable. On this basis Uruguay can be regarded as creditworthy for further borrowing on conventional terms.  - 8 - PART VI - 011PLIANCE WITH TI-E ARTICLES OF AGREEMENT 22. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank. PART VII - RECOIMMEDATION 23. I reconmend that the Executive Directors approve this loan. Robert S. McNamara President Attachments Washington, D.C. November 6, 1970  ANNEX Page 1 URUGUAY BASIC DATA Area: 187,000 square kilometers (72,000 square miles) Population (1969): 2,850,000 Rates of Growth: 1.2 percent per annum Gross National Product (1968): US$1.7 billion GNP per capita: US$595 Gross Fixed Investment as % of GDP, 1969: 14.6 National Savings as % of GNP (1969): 13.8 Annual Rate of Growth in CTGP: 1946/50-1951/55: 4.3 % 1956/60-1961/65: 0.3 % 1966: 3.3 % 1967: -6.7 % 1968: 1.2 % 1969: 5.3 % Output by Sectors, 1969: Livestock 11.5% Crops 4.1% Manufacturing 24.3% Construction 4.0% Transport and Commerce 22.3% Communications, Electricity, Gas, Water and Sanitary Services 3.4% Housing 5.9% Other Services 24.5% Total 100.0%O Consolidated Cash Operations of the Central Government (in millions of Pesos) 1969: Revenues 61,802 Current Expenditures -66,202 Surplus/Deficit -4,400 Capital Expenditures -8,290 Overall Deficit -12,690 Financing (Net) 12,690 (a) Monetary Authorities 8,311 (b) Treasury Bills 773 (c) Treasury Bonds 3,474 (d) Other 132  ANNEX Page 2 Bal.ance of Payments in Millions of U.S. Dollars (1969): Exports of Goods and Services 257.8 Imports of Goods and Services -240.4 Resource Gap (- = inflow) 17.4 Interest Payments -14.3 Other Factor Income -15.6 Donations and Transfer Payments 10.9 Current Account Balance -1.6 Official Donations 1.1 Foreign Direct Investments - Loan Disbursements 57.2 Loan Amortizations -37.7 Short-Term (Net) 3.3 Other Transactions -2.7 Net Short-Term Reserves 19.6 Net IMF Position, June 1970: (- = debt) $-4.5 milli.on Commodity Concentration of Exports: 1960 1965 1969 Wool 51.6% 47.3% 33.6% Meat 23.8% 31.8% 31.0% Hides 12.2% 8.3% 11.9% Foreign Exchange Reserves, June 1970 Central Bank and Banco de la Repuiblica (in millions of U.S. dollars) Gross: 215.3 Net: 189.4 External Public Debt: December 31, 1969: US$320.1 million External Public Debt Service Ratio, 1969: 23.1% Money, Prices and Exchange Rate: Money Supply Cost of Living Index Exchange Rate In millions of current Percent (Percent Change, Pesos/US$ Percent pesos Change Dec.-Dec.) End of Year Change 1966 21,378 32.5 49.3 75.88 26.7 1967 41,773 95.4 135.9 200.00 163.5 1968 67,207 60.9 66.3 250.00 25.0 1969 98,084 24.2 14.5 250.00 - November 6, 1970