Mexico - Ports Project

CIrCULATING Copy RESTRICTED Report No. P- 1036 J BE RETURNED TO REPORTS DESK RprJN P-1036 F rI LL LUPY This report is for official use only by the Bank Group and specitically authorized organizations or persons. It may not be published, quoted or cited without Bank Group authorization. The Bank Group does not accept responsibility for the accuracy or completeness of the report. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO NACIONAL FINANCIERA S.A. WITH THE GUARANTEE OF THE UNITED MEXICAN STATES FOR A PORTS PROJECT April 19, 1972  INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO NACIONAL FINANCIERA, S.A. WITH THE GUARANTEE OF THE UNITED MEXICAN STATES FOR A PORTS PROJECT. 1. I submit the, following report and recommendation on a proposed loan to Nacional Financiera, S.A., with the guarantee of the United Mexican States for the equivalent of $20 million, to help finance a project for improving the efficiency of Mexico's principal ports. The loan would have a term of 25 years, including four years of grace, with interest at 7-1/4 percent per annum. PART I - INTRODUCTION 2. Since 19h9, when the first Bank loan was made to Mexico, the Bank has made 26 loans aggregating $1,074 million net of cancellations, of which at the end of March the Bank held $841 million including $169 million not yet disbursed. Most of these loans have been for power, roads and agriculture. A summary of loans as of March 31, 1972 is attached as Annex I. 3. Execution of Bank-financed projects has, on the whole, been satisfactory. However, as I pointed out in presenting the Zihuatanejo tourism project (President's Report P-998, dated December 7, 1971), there have been some delays in implementing highway and irrigation projects. 4. The power sector, which has received more than half of all Bank lending, has been strengthened by the progressive consolidation of power companies and coordinated planning of power investment. Frequency unification, however, which would result in important economies in invest- ment and operating expenditures, has long been delayed, and no date has yet been set for issue of the Presidential decree establishing the unit which is to be responsible for it. The financial position of the power sector is also a matter of concern at the present time. Although earnings satisfy the Bank's minimum rate of return requirements, cash generation is currently insufficient to make any substantial contribution to the cost of new investment. This is due to higher than expected construction expenditures and rising debt service resulting from heavy reliance on short and medium-term financing. Discussions are under way with the authorities concerned on the measures required to strengthen the secto-w' finances. 5. This fiscal year's first lending operation for Mexico, a loan to help finance tourism infrastructure at Zihnatanejo on the Pacific Coast (Loan 793-ME), marked the beginning of a major diversification of Bank lending. Loans for railways and industrial finance are also expected  - 2 - to be presented during the current fiscal year, along with a further power loan if the problem referred to in the preceding paragraph can be satisfactorily resolved. Additional projects under preparation for pos- sible lending in later years include construction of a new public sector steel plant and investments in forest industries, education, water supply, agricultural credit, irrigation and rural development. 6. IFC has made nine investment commitments in Mexico amounting to $42.5 million,of which as of March 31, 1972, $30.7 million had been sold, terminated or cancelled. The $11.8 million held by the Corporation consists of $10.0 million in loans and $1,8 million in equity. A summary of IFC's commitments as of March 31, 1972 is included in Annex I. New investments under consideration include one in the production of newsprint from bagasse. PART II - THE ECONOMY 7. The most recent economic report (CA-14a) was distributed to the Executive Directors on November 26, 1971. A country data sheet is attached as Annex II. 8. Mexico, with a GDP of around $35 billion a year, ranks closely behind Brazil as the Bank's second largest borrower in terms of loans outstanding. Its economy is co.nparable in size to Brazil and larger than that of any other country to which the Bank Group is lending except India. Mexico has been remarkably successful in sustaining a 6-7 percent annual growth rate over a period of 15 years, with only a moderate increase in the general price level. This achievement is attributable to a unique combination of historical and geographical factors, intelligent economic and financ,ial policies (exhibiting a high degree of pragmatism and freedom from econori.dc dogma) and a continuity in economic management unparalleled elsewhere in Latin America. Taxation has been kept low (around 9 percent of GDP), but private savings have been encouraged, and a considerable proportion of these savings has been channelled into the public sector through the banking system. National savings have been maintained at close to one-fifth of GDP, and although there has been a significant increase in the external deficit on current account since 1968, this still constitutes less than 3 percent of GDP. 9. There is another side of the picture to which attention has been drawn in my previous reports on Mexico. Of all countries in the world with populations of comparable size, Mexico has the fastest demogra- phic growth rate. While per capita income at current prices has risen from $200-250 a year in the middle 1950's to about $700 a year today, the increase in income has been very unevenly distributed. While organized workers and the growing middle class have shared in the benefits of economic development and a few people have become very rich, relatively  - 3 - little has been done to alleviate rural poverty. Some 40 percent of the population still depends on agriculture for a living, but agriculture accounts for only 11 or 12 percent of the national income. Within the agricultural sector itself there is a sharp contrast between the prosper- ous conditions of the larger private farms, particularly in the irrigated north and along the coast of the Gulf of Mexico, and the desperate poverty of the small farmers in the central plateau and along the central and south Pacific Coast. Rural education and health have not been given much attention; and away from the main roads, communications in most parts of the country are still quite primitive. 10. The administration of President Echeverria, which took office at the end of 1970, has laid great stress on the need to improve the conditions of the poor and to correct inequalities in income. At the same time, however, the Government has been forced to recognize the constraints imposed on the growth of the economy by the widening gap between imports and exports and the increasing external debt which has kept the debt service ratio above 20 percent in recent years. First priority has accordingly been given to changes in economic policy and improvements in economic management required to maintain a satisfactory overall growth. As noted in my last report on Mexico, a series of new tax measures was enacted in late 1970, sugar prices were increased, and steps were taken to strengthen central control of public borrowing. At the same time, new emphasis was given to export promotion, and a scheme was introduced under which manufactured exports are entitled to tax rebates up to 10 percent of export value. A second fiscal package was adopted early this year, including a new tax on income from fixed-interest securities, an increase in marginal rates of personal income tax and tax incentives for industrial investment. There is also a new tax, equivalent to 5 percent of enterprise payrolls, the proceeds of which are to be used to finance workers' housing through a National Housing Fund. The two tax packages togather, excluding the housing tax, are expected to increase federal tax revenues by about 10 percent and should raise the ratio of taxes to GDP by approximately one percentage point. II. Public investment was deliberately held down in 1971 to protect the balance of payments, and this was one reason why the real growth of GDP slowed down to 3 or 4 percent, producing something of a recession from which industry may now be slowly recovering. On the more positive side, there appears to have been a net reduction in medium and long-term external public indebtedness during 1971, made possible in part by a small improvement in the current balance of payments, but more importantly by a large inflow of short-term funds. International reserves increased by $200 million during the year and now stand at well over $1 billion. 12. Improved external debt management has been reflected in the terms on which the Mexican authorities borrowed in international capital markets during 1971. For example, loans with maturities of 1 - 5 years,  - 4 - which accounted for over 40 percent of total external public borrowing in 1970, made up only 12 percent of such borrowing during the first 9 months of last year. Two major operations concluded with consortia of foreign banks for a total of $220 million carry final maturities of 8 and 10 years from signing, with a grace period of 4 years in each case. The public issue of DM100 million in Germany in November 1971 had a term of 15 years, including 5 years of grace. Another issue of $40 millicn marketed in New York a short tirne ago has a term of 15 years. This improvement in the terms of borrowing from private sources will make it easier for Mexico to support a continued high rate of economic expansion without endangering its credit standing abroad. There is, however, little prospect of the country obtaining all the external capital it needs on extended terms without substantial contri- butions from the IPRD and the IDB which are the only official lending agencies in a position to offer development assistance on non-commercial terms. 13. Public savings in Mexico must also be increased if expenditures on rural development and social services are to be raised to more adequate levels, and this has been a constant theme of the Bank's econ- omic reports. As a result of the tax measures already described, there does appear to have been some increase in federal government savings during 1971, and the savings of the Federal District also improved slightly. On the other hand, there has been a decline in the total savings of the three major public enterprises (the national petroleum company, the federal power commission and the railroads) from Mex$3 bil- lion in 1970 to Mex$2.1 billion in 1971, and tnis trend needs to be reversed - a matter of special concern to the Bank in view of the proposed loans for railways and power. 14. The primary objective of Bank lending to Mexico has always been to support the growth of the economy by providing long-term capital for projects that can both benefit from the Bank's special expertise and promise high developmental returns. At the same time, in the case of the power program and the steel project now under consideration, both of which have large import components, Bank participation helps Mexico to organize financing from other sources on the basis of broad international competitive bidding. The Bank has been associated with the power sector since 1949, and while the federal power commission, with the Bank's encouragement, now looks to export credits to meet a significant propor- tion of its external capital requirements under joint or parallel fin- ancing arrangements, the Mexican authorities attach great importance to a continuation of Bank lending for power, particularly for financing the foreign exchange costs of civil works and equipment for transmission and distribution. The Mexican Government has also sought the Bank's financial and technical assistance for the development of the transport sector, initially mainly for roads, but since the 1970 sector study, for ports and railways as well (see paragraphs 18-19 below).  - 5 - 15. Power and transport apart, the Bank is giving special emphasis to projects which directly help to strengthen the balance of payments, since the balance of payments is liable to be a critical constraint on economic development in an economy tied to free convertibility of its currency and heavily dependent at the margin on private capital inflow. This has been an important consideration in past lending for irrigation (cotton) and tourism and in the lending now proposed for a new industrial fund. Additionally, now that it is the declared policy of the Mexican Government to give more attention to the quality of economic develop- ment, especially in rural areas, the Bank is interested in giving what support it can to programs for education and rural development, and a considerable amount of staff time is currently being devoted to the identification of possible projects in these two sectors. However, the capital expenditures involved are likely to be quite small. Finally, in view of the great potential scarcity of water in Mexico, plans are going ahead for a national water study to be carried out with the Bank's help, possibly with some financing from the UNDP, and a project for the supply of water to Mexico City and adjacent urban areas is scheduled for appraisal shortly. 16. The choice of Bank projects in Mexico is naturally governed to an important extent by the priorities of the Mexican Government and by the availability of financing from other sources. Since in the past the Inter-American Development Bank has been able to provide soft loans for projects of a social character, and has also been moro liberal in financing local costs, Mexico has sought its assistance in preference to that of the IBRD for such projects as feeder roads and minor irrigation works. The main contribution to the external financing of industrial development in Mexico has come from export credit agencies and private sources. Over the period 1966-70, as shown in the fo"1owing table, the Bank accounted for 11 percent of the flow of medium and long-term capital to Mexico and the IDB for 5 percent. These proportions are likely to be significantly higher in future in conformity with the Mexican Government's aim of improving its external debt structure, but the greater part of the capital which Mexico requires from abroad will continue to come from private financial institutions and export credit agencies. 17. The loan now before you, and the other loans to Mexico scheduled for presentation during the next few months, total ovar $250 million, and I have givon careful consideration to the question of Mexico's credit- worthiness for such a large amount of additional Bank lending. The country faces difficult long-term structural problems, and there is immediate need for the mobilization of additional public savings if necessary investments are to be carried forward without excessive reliance on external borrowing. Further action in this direction is presently  - 6 - Disbursements of External Medium and Long-Term Loans to Public Sector in Mexico (1966-70) ($ million) Average Percent Source 1966 1967 1968 1969 1970 1966-70 Composition Suppliers' credits 78 132 112 199 141 132 18 Private fin. institutions 173 286 343 496 399 339 46 Bond issues 45 85 127 45 - 60 8 IBRD 86 65 62 72 98 77 11 IDB 11 20 23 53 63 34 5 Export credit agencies 80 108 104 77 80 90 12 Gross Disbursements 43 69 5 771 941 781 32 100 Amortization -365 ON 7017 427 -- 5 Net Inflow 108 _337 292 481 307 305 42 under consideration in Mexico, and so long as this is taken without undue delay, the near-term prospects for the economy should be quite favorable. Manufactured exports, which grew by 20 percent last year, are expected to continue expanding rapidly in spite of some restrictions in the U.S. market; cotton export prospects for 1972-73 are good; and the impact of accelerated economic activity on the flow of imports could be somewhat delayed to the extent that inventories were built up last year. With Mexico's international reserves at close to a record level and a distinct improvement in the external debt profile as compared with a year ago, I believe that the proposed lending is fully justified. PART III - THE PROJECT The Sector 18. Mexico's basic transport infrastructure now generally meets present needs; in the last three decades a modern road network and an air transport system were added to an extensive network of railways and ports. Each transport system, was, however, organized essentially by mode of trans- portation and developed without adequate consideration of the other modes, because the responsibility for operating and maintaining existing and designing new transport facilities has been dispersed among numerous government departments and agencies without proper coordination. This  -7- lack of coordination led to some misalnocation of resources, which was further aggraviated by'a large number of ad-hoc subsidies which prevented an optimal division of traffic among various transport modes. Furthermore, the transport sector, in particular the railroad deficit, represents a large burden gri the Federal Govgrnment. 19. In view of these transport sector problems the Government of Mexico invited the Bank to make a major survey of the entire transport sector and a Bank mission visited Mexico in April 1970. Its report (PTR-88) dated May 13, 1971, was distributed to the Executive Directors on June 7, 1971. The Government concurred in the report's conclusions and accepted its major recommendations. The Government acted promptly on the Bank study's recommendations in respect to ports, which fitted well into the broader development objectives, notably to decentralize industry and disperse population from the central plateau, undertake a general export drive and expand fisheries. One of the initial decisons of President Echeverria on taking office in December 1970 was to modernize Mexican ports and attack organizational problems, the first major step being the issuance of a decree creating a National Ports Coordinating Commission which is responsible for policy formulation and overall planning and the coordination of all public and private interests relating to ports. The Gover?nxnnt also reacted quickly to the recommendations relating to the railways, especitaly by a decision in the early months of the new Adminis- tration to attack the problem of the large and growing operating deficit by holding total employment of the National Railways to then existing levels and by increases in efficiency and economies. A package of measures to strengthen tho institutional framework of the sector, particularly by buildi.Q-, a secto- planning office within the Ministry of Communications and Transport, and studies to help improve the division of traffic among the various modes is being worked out in connection with the railway loan which I expect to propose to the Executive Directors within the next few weeks. In addition, both the port and the railway projects include measures to increase the efficiency of operations and improve t'heir financial viability. The Project 20. The objectives of the project are to provide high priority installations and equipment, mainly in the ports of Tampico, Veracruz, Guaymas, Mazatlan and Manzanillo (referred to as the Project Ports) and to improve country-wide port planning, administration and operation. The project consists of: (i) a grain-handling installation at Veracruz and consequent resiting of tanker berths; (ii) two self-propelled dredgers and other dredging equipment; (iii) warehouses at Veracruz, Tampico and Manzanillo and a transit shed at Veracruz;  - 8 - (iv) fire-fighting and port communications equipment; (v) mobile cargo-handling equipment; (vi) consultants' services for: (a) operations and accounting; (b) a national port development study including feasibility studies; and (c) dredging organization and equipment; (vii) staff training. The total cost of the project is estimated at $27.6 million. The pro- posed loan of $20 million would cover the estimated foreign exchange cost of the project and possibly a small amount of local costs (para. 24). 21. The principal contribution of the project to Mexico lies in its institution building. In contrast with the past dispersion among numerous ministries, agencies and groups, responsibility for policy formulation and overall planning of ports is now centered in the National Ports Coordinating Commission (CNCP). Responsibility for operational matters, which had previously been distributed among the various depart- ments of the Ministry of the Navy, has now been centered within a newly created Department of Port Operations. It will be represented in each major port by a superintendent, aided by qualified staff to improve its management and operation. CNCP and the Ministry of the Navy will be the principal executing agencies of the project. All work connected with construction of installations and improvement of ports operations will be executed by the Ministry of the Navy. Consulting services for opera- tions and accounting and the National Port Study will be the responsi- bility of CNCP. Mobile cargo-handling equipment financed under the Loan will be administered through a trust fund which has been established within Nacional Financiera to make available cargo-handling equipment to con- cessionnaires under leasing or purchasing contracts on reasonable terms in order to ease the present shortage of mechanized equipment and help improve efficiency. 22. Mexican ports have been operated without proper regard to financial considerations. There has been no cost accounting in the ports and the generally low tariffs are unrelated to costs. Only the port of Veracruz appears to have operated with a surplus. Port revenues and expenditures appear under various headings of the Federal Budget. In the Project Ports, one-third of the tonnage handled has been paying some 90 percent of all port charges levied by the Government. Consultants, to be financed retroactively from the Loan (maximumn $120,000), are now studying the introduction of an accounting system and reviewing the tariff structure.  -9- 23. Through a series of steps agreed upon during the negotiations, port charges levied by the Ministry of the Navy in the five Project Ports will be reasonably cost-related, except in specific cases where economic loss might result from applying such a policy. The same cost related pricing policy will also be introduced for cargo-handling, which is a major item of the cost of port services and usually performed by concessionnaires at rates approved by the Ministry of Communications and Transport. Beginning in 1974, the rate of return for each Project Port on the value of its net fixed assets will be set at such a level that internally generated funds would cover debt service and finance a reasonable portion of its future capital expenditure. The minimum rate of return required for each Project Port will be determined in consulta- tion with the Bank by the end of 1972 when the valuation of fixed assets has been completed and future capital requirements have been identified. The Government will prepare plans to extend the above defined policies to other major ports. 24. All contracts for construction and equipment would be awarded under interniational competitive bidding. For purposes of this compar- ison domestic suppliers would have a margin of preference of 15 percent, or actual customs duties, whichever is lower. Some equipment conitracts may be won by Iccal manufacturers, resulting in a small amount of financing of local currency expenditures under the Loan. 25. Disbursements would cover: (a) 27 percent of the cost of civil works, including grain-handling equipment erection, corresponding to the estima,ted foreigi exchange component; (b) the c.i.f. cost of imported equipment or the ex-factory cost net of taxes of equipment manufactured by any successful local bidder; (c) the foreign exchange component of consultants' services; and (d) the foreign exchange costs of staff training. 26. The proposed project shows high economic returns for all of its main components ranging from 28 percent for the grain-handling instal- lation to 14 percent for mobile cargo-handling equipment. In the absence of reliable traffic forecasts these returns are based either on the current level of use or commaodity forecasts for the specific facility concerned. They are not, however, sensitive to quite wide variations in traffic forecasts. PART IV - LEGAL INSTRUMENTS AND AUTHORITY 27. The draft Loan Agreement between the Bank and Nacional Financiera, S.Ao, the draft Guarantee Agreement between the United Mexican States and the Bank, thse Report of the Conmittee provided for in Article III, Section h(ili) of the Articles of Agreement, and the text of a Resolution approving the proposed loan are being distributed to the  - 10 - Executive Directors separately. Sections 4.01-4.03 of and Schedule 1 to the draft Guarantee Agreement set forth the Guarantor's undertakings designed to achieve financial viability for the Project Pbrts. 28. I am satisfied that the proposed loan would camply with the Articles of Agreement of the Bank. PART V - RECCMMENDATDN 29. I recommend that the Executive Directors approve the proposed loan. Robert S. McNamara Attachments President April 19, 1972  Annex I Page 1 of 2 MEXICO: Summary of Bank Loans - at March 31,, 1972 (US$ Millions) Amount less Cancella- Un- Loan Year Borrower Purpose tions disbursed Loans fully disbursed 759.0 - 450-ME 1966 Nacional Financiera, S.A. Irrigation 19.0 1.9 5274ME 1968 Nacional Financiera, S.A. Irrigation 25.0 17.5 528-NE 1968 Nacional Financiera, S.A. Roads 27.5 4.3 659-ME 1970. Comision Federal de Electricidad and NAFIN Power 125.0 35.6 695-ME 1970 Nacional Financiera, S.A. Roads 21.8 20.9 747-ME 1971 Nacional Financiera, S.A. Agriculture 75.0 67.1 793-ME 1972 Nacional Financiera, S.A. Tourisn 22.0 2.0 1/ Total 1,074.3 169.3 Of which has been repaid to Bank and others 229.0 Total now outstanding 845.3 Amount sold: 50.7 Of which has been repaid: 46.0 41.7 Total now held by Bank 840o6 = = = Total undisbursed 169.3 = = = 2/ Not yet effective.  Annex I Page 2 of 2 MMfLO): Summary of IFC Investments at March 31, 1972 Year Company Purpose Loan Eguty Total ($i Milions) 1958/1959 Indu.strias Perfect Circle, Industrial 0.8 _ 0.8 S.A. * equipment 1958 Bristol de Mexico, S.A. * A/C Engine 0.5 - 0.5 Overhaul 1961 Acero Solar, S.A. * Twist Drills 0.3 - 0.3 1962/ 'Compania Fundidora Fierro Steel 2.3 21.4 23.7 5/6/8 y Acero de Monterrey, S.A. 1963 Tubos de Acero de Mexico, S.A. Seamless 0.9 0.1 1.0 steel Pipes 1963 Quimica del Rey, S.A. * Sodium 0.7 - 0.7 Sulphate 196b4966 Industria del Hierro, S.A. Const. - 2.0 2.0 Equipment 1970 Minera del Norte, S.A. Irn Ore Mining 1.5 - 1.5 1971 Celanese Nexicana, S.A Textiles 12.0 - 12,0 Total gross cormmitnents 19.0 23.5 42.5 Less cancellations, terminations, repayments and sales 9.0 22.7 30.7 Total commitments now held by IFC 10.0 1.8 1148 Total undisbursed 2.9 - 2.9 * Investments which have been fully cancelled, terminated, written off, sold, redeemed or repaid are indicated with an asterisk.  Annex II- Page 1 of 4 MEXICO: COUNTRY DATA SHEET Area: 2 million square kilometers Population: 52 millinn (1971) I. ECONOMIC INDICATORS Calendar Years 1960 1970 1971-/ (Mex$ billion) GDP 151 423 440 Per capita (in ourrent US,) 334 668 708 Real growth rates (percent) - 7.7 4.0 Structure of GDP (percent) Agriculture, livestock, forestry 15.9 11.4 - fisheries Mining 1.5 1.2 - Industry (including petroleum and 20.4 26.0 _ petrochemicals) Construction 6.2 5.1 - Power 1.0 1.5 - Commerce 31.1 3003 _ General services 20.5 22.0 - Other 3