Peru - Road Reconstruction Project

_-7D L-PdF RESTRICTED FILE COPY Report No. P.-857 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 The report may not be published nor may it be quoted as representing their views.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 THE REPUBLIC OF PERU FOR A ROAD RECONSTRUCTION PROJECT August 26, 1970  INTEThJAT IOATlu. ALIK FOR RECGSTRUCTON A'NT. E7LOP1W4T REPORT AND RECaMMNDATICN OF THE PRESIMiBT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF PERU FOR A ROAD RECONSTRUCTION PROJECT 1. I submit the following report and recommendation on a proposed loan in an amount in various currencies equivalent to $30.0 million to the Republic of Peru for a road reconstruction project. PART I - HISTORICAL 2. From 1952 to 1967, the Bank made 23 loans to Peru, for a total of $234.0 million. Ten of the loans were made for the transport sector, including four ($53.5 million) for highway construction and maintenance. The last Bank loan to the Republic of Peru (Port of Pisco) was made on tay 13, 1966, followed by two loans, in 1966 and 1967, to a private power company (Empresas Electricas Asociadas). After an economic mission to Peru in early 1967, the Bank became concerned about the rapidly deteriora- ting fiscal situation in the country and about a balance of payments crisis which ultimately led to the devaluation of the sol in September 1967. Af- ter the new Government came into power in October 1968, it took over the International Petroleum Company (IPC) properties in Peru, in connection with a dispute which had existed for many years, and this matter has not been resolved. In all these circumstances, the Bank had felt unable to lend to Peru for some three years. 3. This was the situation when, on May 31, 1970, Peru suffered a severe earthquake which cost over 50,000 lives and did extensive physical damage. On June 4, 1970, the Peruvian Government asked the Bank Group, as it did other international agencies, for help in meeting the cost of reconstruction. The total assistance necessary was provisionally esti- mated by the Government at $516 million and the Bank Group was asked to provide $150 million. 4. The request raised again the question of the economic and fi- nancial performance of the Peruvian Government and the existence of the unresolved dispute with the International Petroleum Company (IPC). On the latter, the position is that efforts are still being made on the diplomatic level to find a solution but that the prospects for an early settlement do not appear to be good. The Bank has not determined what position it would take on the question of the resumption of normal lend- ing. It does appear, however, that without prejudicing this issue, the Bank could give some assistance to Peru to help meet some of the conse- quences of the earthquake disaster.  - 2 - 5. Accordingly, two Bank staff members visited Peru for ten days commencing June 17, 1970, as part of a UNDP mission to determine how the Bank might effectively assist in Peru's rehabilitation program. The mission concluded that Bank financing should be for a road reconstruction project in the Department of Ancash,which was most affected by the earth- quake, and for technical assistance for highway maintenance and betterment. 6. Negotiations were conducted in Washington during the week begin- ning August 10, 1970. The Government was represented by Dr. Jose Luis Brousset, Director Superior in the Ministry of Economy and Finance; Mr. Agustin Merea Canelo, Director Superior, Ministry of Agriculture; and Mr. Raul Bolanos, Adviser to the Ministry of Transport and Communications. 7. The following is a summary statement of Bank loans to Peru as of July 31, 1970: Loan Loan No. Year Borrower Purpose Amount Undisbursed -U S$ mrfion)T 1952-60 Various Borrowers Various 82.1 including the Republic of Peru 300 1961 Republic of Peru Roads 10.0 334 1963 Peruvian Corporation Railways 13.0 365 1963 Empresas Electricas Asociadas Power 15.0 373 1964 Republic of Peru Ports 3.0 415 1965 Banco Agropecuario Agriculture 15.0 418 1965 Republic of Peru Irrigation 6.5 1.8 425 1965 Republic of Peru Roads 33.0 16.8 446 1966 Republic of Peru Ports 9.1 2.0 464 1966 Empresas Electricas Asociadas Power 10.0 511 1967 Empresas Electricas Asociadas Power- 17.5 13.9 Total (less cancellations) 214.2 of which has been repaid 57.2 Total now outstanding 157.0 Amount sold 18.2 of which has been repaid 15.3 2.9 Total now held by Bank 154.1 Total undisbursed 34.5 34.5 No IDA credit has been made to Peru.  - 3 - 8. Considerable difficulties have been encountered in two of the four loans presently being disbursed to Peru, and on a highway loan which had been completely disbursed by 1967. There was inadequacy of water supply Go the San Lorenzo irrigation project (418-PE) and the Bank had to agree to a reduction of the project area. The water supply, drainage, and manage- ment problems, however, persisted and disbursements from the Loan Account, other than those for basin study costs, have not taken place since June 30, 1969. While the water supply situation has subsequently improved, efforts are continuing with the Government of Peru to resolve the other issues pre- paratory to a resumption of disbursement. On the Central Highway Project (Loan 425-PE), unforeseen soil difficulties resulted in delayed construc- tion and major increases in costs. The previous Government's inability to provide sufficient counterpart funds, due to the fiscal problems mentioned earlier, added greatly to the delays. The scope of the project was, there- fore, reduced by deferring paving and other improvements in certain sec- tions of the road.!/ Provision of budgetary funds has subsequently im- proved, and although progress on the project continues to be slow, the main problem appear to have been overcome. The Government expected to complete the remaining works on the revised project by the end of 1971. Recent in- formation indicates that completion will be delayed by about six months. The earlier Loan 271-PE for the construction of the section of the Central Highway from Aguaytia to Pucallpa had also run into difficulties. The work had not been finished when the loan was exhausted in 1967 and extensive failures have since occurred in completed sections. The road is located in very difficult terrain, and insufficient allowance was made for the com- bination of poor local soils for construction purposes, the instability of the region traversed, and extremely heavy rainfall. The Government has recently initiated legal proceedings against the consultant, contractors and government staff it believes to be at fault in this project. The Bank has urged the Government to expedite the repair and completion of the road and the Government has undertaken to inform the Bank soon about its plans to complete the road. Disbursements on the other two active loans are pro- gressing satisfactorily. The Port of Pisco project (Loan 446-PE) has been practically completed. The financial position of the Empresas Electricas Asociadas (Loan 511-PE), which had given some cause for concern lately, is now sound; construction of the Matucana project is proceeding at a normal pace and it should be completed by the end of 1971, as expected at the time the loan was made. 9. IFC's gross commitments at July 31, 1970, amount to $8.9 million of which $1.6 million is held by the Corporation. Currently outstanding investments are in two cement companies: Cernento Andino, $1.1 million and Cemento Pacasmayo, $0.2 million; and a fertilizer producer, Fertili- zantes Sinteticos, approximately $0.3 million. No new projects are at present under consideration. 1/ See M4emorandum to the Executive Directors "PERU - Proposed Revision of the Central Highwzay Project," November 14, 1969 (R 69-219).  - 4 - PART II - DESCRIPTION OF THE PROPOSED L0A1' 10. Borrower: Republic of Peru Amount: $30.0 million equivalent in various currencies. Purpose: To assist in financing of (a) the re- construction of selected roads/road sections, (b) the preparatory feasibi- lity study and engineering, (c) techni- cal assistance for road maintenance and bettermen-t, and (d) interest and commit- ment charges over a five-year period. Amortization: In 30 years, including a 10-year grace period, through semi-annual installments beginning December 15, 1980, and ending June 15, 2000. Interest Rate: 7-1/4 percent per annum. Commitment Charge: 3/4 of 1 percent; however, the commit- ment charge on the construction compo- nent of the loan would begin to accrue one year after the Loan Agreement is signed. Estimated Economic Rate of Return on the Project: (See paragraph 20 below.) PART III - THE PROJECT 11. An appraisal report entitled "PERU - Appraisal of a Road Recon- struction Project" (PTR-59a) is attached. 12. A firm estimate of the damage caused to the Peruvian economy by the earthquake has yet to be made. In the meantime, with its own forces and local contractors, as well as with multilateral and bilateral assistarce, the Government has pushed forward with emergency works and the restoration of essential services. It has also formulated a provisional program for permanent rehabilitation and, within that program, identified the most ur- gent requirements. To help finance these requirements, the IDB has already made a loan of $35 million, a good part of which is for housing. A total of $23.5 million of the loan amount will be disbursed in foreign exchange The UNDP is making available technical assistance, on an urgent basis, for study projects designed to help cope with the effects of the earthquake.  - 5 - 13. In the tentative estimates for the penranent rehabilitation pro- gram, transportation requirements take second place only to housing and account for about 20 percent of the proposed expenditures. The present proposal for Bank financing is equal to approximately 30 percent of the estimated outlays in the transport sector. 14. The earthquake is estimated to have affected nearly 9 percent of the entire road network in the country. The maximum damage occurred on roads in the Departments of Ancash and Lima and on the Pan-American highway. In the Department of Ancash, where the proposed project will be located, 30 percent of all asphalt roads, close to 80 percent of gravel roads, and over 60 percent of dirt roads have been affected. Especially hard hit were the middle and upper reaches of the Santa River Valley, knowr.. as the Callejon de Huaylas. The road in the Callejon suffered extensive damage, and all of the three access routes to the valley were seriously dis- rupted. Some of the landslides over two of the routes - Casma-Huaraz and Pativilca-Huaraz - have been cleared to allow resumption of traffic: exten- sive reconstruction and improvement will, however, be necessary before either of these roads can serve as an efficient access to the valley. On the third, northern route, a section of the railroad has been destroyed. Restoring access by this route most economically will entail the abandon- ment of this section and its replacement by a road. 15. The project consists of the reconstruction of one or more of the above access routes to the Callejon, and the restoration of the road within the valley. The selection among the alternatives will be made on the basis of a feasibility study which is also part of the project and likely to tako 4-5 months to complete. In addition, the project includes detailed engineer- ing of the selected route(s), and technical assistance for road maintenance and bettemrent. 16. The project will be executed by the General Directorate for Land Transport in the Ministry of Transport and Communications. Until recently, management of the transport sector in general, and of the department respon- sible for highways in particular, left much to be desired. However, over the last year the new Government took steps to improve the situation by bringing all the various subsectors together under the newly constituted Ministry, by increasing maintenance outlays, and by concentrating on the completion of well-justified, ongoing projects. 17. Of the proposed loan of $30 million, $22 million would cover two-thirds of the estimated total cost ($33 million) of the roads to be reconstructed. Since the foreign exchange costs of the works are estimated at about 50 percent of total costs, or the equivalent of $16.5 million, the loan would thus be covering about $5.5 million in local costs of the road reconstruction component of the project. The proposed loan would also f- nance 80 percent of the cost of consultants for the feasibility study and detailed engineering ($1.8 million), and for technical assistance ($1.2 million) most of which would probably be foreign. I consider that cover- ing local costs to the extent described above is justified in view of the exceptional circumstances surrounding this loan.  18. Since the use of loan proceeds for reconstruction works cannot take place for at least a year, pending the ccmpletion of the feasibility study and detailed engineering, the coniiatment charges on the undisbursed amount for road reconstruction would commence on a date one year after the loan is signed. 19. Should the cost of the access road or roads selected as a result. of the feasibility study be lower than presently estimated, the balance of the loan proceeds would be used on priority roads elsewhere in Peru, sub- ject to agreement between the Government and the Bank. 20. In the absence of a feasibility study and precise cost and bene- fit estimates for the road or roads to be taken up for reconstruction, no economic rate of return for the project can be calculated at this stage. A prima facie justification, however, exists in the economic topography of the project area. The three routes mentioned earlier afford the only sur- face links between the costa and the earthquake-stricken area in the sierra. and their reconstruction is vital to the economic and social integration of the region. In recognition of this fact, improvements to the Pativilca- Huaraz and Casma-Huaraz roads were already included by the Government of Peru prior to the earthquake in its investment plan for 1971-75. 21. The technical assistance component of the loan would similarly assist in solving one of the most pressing transportation problems in the country. Over a number of years, Peru has invested large amounts in the development of its highway network. However, available funds and techni- cal capacity have, until recently, been concentrated on construction, to the detriment of maintenance and resulting in the buildup of a large main- tenance backlog. This reflected, in part, the deteriorating fiscal situa- tion in the mid-1960's. Beginning this year, the Government is allocating larger sums for road maintenance and betterment; the Government's efforts would benefit from the proposed technical assistance program. 22. Consultants acceptable to the Bank would be employed to conduct the feasibility study and detailed engineering, to supervise construction, and for the technical assistance program mentioned above. Agreement was reached during negotiations upon the terms of reference for the feasibility study and subsequent detailed engineering. Construction contracts for the project will be procured on the basis of international competitive bidding. PART IV - LEGAL IhTSTRUT aNTS AND AUTHORITY 23. The draft loan Agreement between the Republic of Peru and the Bank, the Report of the Committee provided for in Article III, Section hiiii of the Articles of Agreement of the Bank, and the tect of a draft Resolu- tion approving the loan are being distributed to the Executive Directors separately.  - 7 - 24. The draft Loan Agreement contains the standard provisions com- mon to Bank loan agreements for highway projects, and provides for the necessary flexibility in respect of the allocation of the proceeds of the iloan among categories other than the allocation for capitalized interest and commitment charges, which is fixed at a maximum of $5 million. PART V - THE ECONOMY 25. A memorandum dated August 21, 1970, entitled "The Economic Sit- uation in Peru" is attached. It summarizes the findings of a Bank econo- mic mission which visited Peru earlier this year and whose report is cur- rently under preparation. 26. Peru's fiscal management has improved notably during the past two years. The balance of payments has also benefited greatly from sharply rising prices for Peru's major exports, fishmeal and copper- especially for the latter. Although external debt management has improved, the debt serv- ice ratio on the existing external public debt will rise sharply to 17 per- cent by 1973 as a consequence of earlier debt rescheduling and refinancing, The debt service burden may be somewhat reduced over the next few years through new refinancings. Great uncertainties exist, however, in respect of future exports of minerals which will depend in large measure on the extent to which fresh foreign capital will help develop large new mines. Nevertheless, given the Government's greatly improved fiscal, balance of payments and external debt management policies, and the country's basically favorable resource endowment, Peru may be regarded as creditworthy for the loan under consideration. PART VI - COMPLIANC3 T7qITH ARTICLES OF AGREEMENT 27. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank. PART VII - RECO12,MDATION 28. I recommend that the Executive Directors approve the proposed loan. Robert S. McNamara President By S. R. Cope Attachments ABugust 26, 1970 Wishington, D.C.