Ecuador - Guayaquil and Guayas Province Water Supply Project

CIRCULATmG COPY FILE COPY To BE RETURND TO REPORTS DESK DOCUMENT OF INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT Not For Public Use Report No. P-1424a-EC REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE EMPRESA MUNCIPAL DE AGUA POTABLE DE GUAYAQUIL (EMAP) WITH THE GUARANTEE OF THE REPUBLIC OF ECUADOR FOR A WATER SUPPLY PROJECT FOR GUAYAQUIL AND THE GUAYAS PROVINCE June 13, 1974 This report was prepared for official use only by the Bank Group. It may not be published, quoted or cited without Bank Group authorization.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.  RATE OF EXCHANGE Currency Unit Sucre (S/.) Us$1 S/.25 S/.1 = us$o.o4 S/.1,000 = US$40 S/.1,OOO,OOO = us$40,000 Ecuador Fiscal Year - January 1 to December 31  INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMNT RPORT AND RECOMNDATION OF THE PRESIDENT TO THE ECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE EV:RESA MUNICIPAL DE AGUA POTABIE DE GUAYAQUIL (EMAP) WITH THE GUARANTEE OF THE REPUBLIC OF ECUADOR FOR A WATER SUPPLY PROJECT FOR GUAYAQUIL AND THE GUAYAS PROVINCE 1. I submit the following report and recommendation on a proposed loan to Empresa Municipal de Agua Potable (EMAP) of Guayaquil with the guarantee of the Republic of Ecuador for-the equivalent of US$23.2 million to help finance a water supply project for Guayaquil and the Guayas prov- ince. The loan would have a term of 25 years, including 4 years of grace, with interest at 7-1/4f percent per annum. PART I - THE ECONCKY 2. A report entitled "Current Economic Position and Prospects of Ecuador"' (No. 14a-EC) was distributed to the Executive,Directors on May 18, 1973. An updating economic mission visited Ecuador in October 1973 and its reoort is currently being prepared.Y.. Annex I summarizes the.mrai_n economic and social indicators. 3.' The 1973 economic report concluded that prospects for Ecuador achieving satisfactory growth rates over the medium term were very encour- aging. It was clear that the country's petroleum resources, though impos- sible to estimate in quantitative terms at the time, offered the opportunity for a faster rate,and a more balanced pattern of growth. The year 1972 was a turning point for Ecuador's economic situation. Economic growth in real terms increased from 7.9 percent in 1971 to 9.7 percent. This momentum was maintained through 1973 when growth reached about 10.4 percent. The key element has been the expansion of exports, ($243 million in 1971; $324 million in 1972; $59? million in 1973). Petroleum became Ecuador's largest export in.1973, far exceeding bananas as the main source of foreign exchange. Traditional agricultural export products such as coffee and sugar have also performed well. As a consequence of petroleum exploi.- tation the country's'economic growth prospects, in the medium term, have changed dramatically. Overall growth rates.of.about 11 percent annually during 1974-78 appear very feasible. 'Even assuming a substantial improvement in Ecuador's absorptive capacity, particularly in the public sector, as well as increases in consumption, it is clear that Ecuador will accumulate substan- tial foreign exchange reserves during 1974-78. A substantial improvement in public external debt is also now occurring with the debt service ratio likely to decline from lO4 percent in 1972 to about 4 percent in 1976. 4. With the presently proven petroleum reserves, the opportunity offered to Ecuador by petroleum development is quite limited. Present production is 210,000 barrels per day and would level off at 450,000 barrels per day by 1977 with full utilization of available pipeline capacity. Net foreign exchange earnings from petroleum amounted to about $250 million in 1973  -2- and are expected to exceed $500 million in 1974. If presently known re- serves are utilized at the maximum rate which currently appears feasible, petroleum exports would cease growing by the end of the decade; Ecuador would still remain-a poor country with a GNP per capita of less than $500 million at present prices and would require substantial external capital to maintain .a high rate of economic growth. Ecuador's longer-term development prospects thus depend heavily on whether substantial additional reserves can be found. Prospects of doing so appear favorable provided the Government accelerates current exploration efforts. 5. Petroleum production alone will have very little direct effect on employment and private incomes. A measure of the Government's achievement in successfully utilizing its newly-found resources will be the degree to which it can spread the benefits of petroleum earnings through accelerating economic and social development. The economy remains essentially agrarian, the rural population-- nearly 60 percent of the total-- consisting largely of low-income families living in conditions totally lacking in adequate health and educational facilities. Development Strategy 6. The Government is aware of the task ahead and its development strategy is focusing on overcoming the severe constraints to expanding output, particularly domestic agriculture, correcting the unequal income distribution and attacking the current inflationary problems besetting the country. Its immediate task has been to control the strong inflationary pressures which have recently developed as an outgrowth of the large influx of foreign exchange without at the same time curbing the growth potential of critical sectors of the economy such as agriculture. The Government has already shown its willingness to adopt several appropriate measures in the trade, credit and fiscal fields to achieve this objective. In order to reduce the inflationary trends provoked by soaring petroleum prices, the Government has set up a special fund for investment purposesUto be financed by the proceeds of the two increases in petroleum reference price which raised it from $7.30 per barrel to the present $13.70 per barrel. These additional funds -- amount- ing to over $175 million -- are kept separate from the regular budget and are additional to the capital expenditures contained in the budget approved for the current year. They are thus intended to be used only for new investment pro- jects not now contemplated in the budget, as such projects become ready to be financed and actually executed. The Government has also been building up stocks of imported food commodities in anticipation of further increases of import prices. 7. Another major thrust of the Government's development strategy is directed at expansion of domestic output, partielilarly agricultural output. The sluggish performance of agriculture is perhaps the most difficult problem threatening the success of Ecuador's development efforts. The key to success lies in adopting the necessary policy measures -- some of which have already been taken -- through expanding the availability and lowering the prices of agricultural inputs such as fertilizers, improved seeds, farm implements, etc. and through a revision of present price controls on output. Muct. will also depend on the land reform measures, as well as upon the Government's efforts at ensuring a more intensive use of good coastal land, if Ecuador is to break the long-standing backwardness of its domestic food-producing sector.  8. Another important element in the Government's development strategy aims at meeting the urgent need to increase the country's absorptive capacity for investment, especially in the public sector. Substantial progress has already been made in recent months in giving concrete content to the five- year development plan formulated last year. An inventory of specific pro- jects has been compiled by the Planning Agency in collaboration with the different ministries and public sector agencies. In addition, a preinvest- ment fund has been set up to finance prefeasibility and feasibility studies for investment projects. The major thrust of the investment effort is in physical infrastructure, particularly in electric power, irrigation and transportation, designed to strengthen the foundation for long-range expansion of the agricultural and industrial sectors. The immediate need is to improve the capability of the public sector agencies to prepare economically sound projects of high priority. As the process takes time and local capabilities are limited, increased utilization of foreign experts is essential. 9. The final element of Ecuador's development strategy is to improve the inadequate social services, in health, education, water supply and sewerage facilities. These problems are acute amongst the low-income popu- lation of the two largest urban centers, Quito and Guayaquil, as well as in the rural areas. The Government is endeavoring to expand these much- needed social services but progress is slow and severely limited by weak- nesses in the ministries and agencies, as well as in project preparation and planning. PART II - BANK GROUP OPERATIONS IN ECUADOR Bank Group Operations 10. Since the first loan in 1954 the Bank and IDA have made eleven loans and six credits to Ecuador amounting in total to $128.2 million, net of cancellations. The two most recent operations, a $20 million loan for a second development finance companies project and a $5.5 million credit for an irrigation project, became effective at the beginning of 1974. The major proportion of Bank and IDA lending operations - about 40 percent - has been for transportation, mainly for roads but including also one operation for a new port project at Guayaquil. Agriculture and fisheries have received about one fifth of Bank and IDA lending. In recent years Bank Group opera- tions have focussed increasingly on this sector - primarily livestock and irrigation projects --which since 1967 hlave represented more than two-f:ifths of Bank lending. About 22 percent of Bank and IDA lending has been to sup- port the industrial development activities of two development finance com- panies, with about 13 percent for power generation and transmission for the City of Quito. The remaining Bank Group lending has been for education. IFC's total commitments to date have been exclusively in the industrial sector and amount to about $4.3 million. Of this amount about $2.2 million is still held by the Corporation. Annex II contains a summary statement of all Bank, IDA and IFC operations as of May 31, 1974, together with notes on the execution of ongoing Bank and IDA projects.  - h - 11. External development financing is also provided by IDB and USAID. External financing by sector and by source through 1973 is sunmarized below: (In millions of U. S. dollars) IBED IDA IDB AID Lending 195h-64 54.o 8.o 35.3 67.7 Lending 1965-73 37.3 2U9 139.7 42.o Transport 77 Power 6.8 16.2 3.6 Education 5.1 a4.1 5.3 Health and Sanitation 49.3 2.8 Agriculture and Kisheries 9.3 16.0 12.3L 10.8 Industry 28.o 21.2 8.0 Urban Development 14.4 Other 4.2 11.5 91.3 36.9 175.0L 109.7 12 =~~~ IDB is the largest single lender, extending most of its loans to Ecuador from the Fund for Special Operations which normally carries a 2 percent interest rate, a ten-year grace period and repayment terms of up to forty years. AID loans are generally for a similar period of time with interest at 2-3 percent. The social needs, in conjunction with the agricultural sector, have been receiving increasing attention from the international lending agencies in recent years. In future years it is probabjs that IDB will remain the major development lender. New loan commitments by AID are unlikely in 1974 or 1975. On the basis of the planned lending programs of the respective institutions IDB disbursements should average about US$30 million annually and USAID disbursements about US$6 million annually. 12. The prospects for increased fiscal revenues and foreign exchange from the petroleum sector have turned out to be much more favorable than had been anticipated a year ago. Taking into consideration Ecuador's now very favorable external currency earnings prospects and the prospective accumula- tion of considerable reserves, foreign exchange is not likely to be a constraint on future development efforts, at least in the next three or four years. Ecuador is a low income country, however, whose longer term opportunities for utilizing capital are good. Consumption needs are also rising and the demands of the growing population for higher levels of consumption and social services will have to be met at least in part. Moreover, while a substantial increase Ll Another $42.4 million in agriculture was approved in 1973 but not signed ($20.8 million Babahoyo irrigation project; $5.6 million Foot-and-Mouth Disease; $16.0 million for AgriculturalOGredit). 2 No new loan commitments during 1973.  in foreign exchange reserves and other investments abroad should be possible in the next few years, Ecuador would be justified in continuing to plan on net capital inflows for the period thereafter. At the same time Ecuador's capacity to prepare and carry out technically and economically sound invest- ment projects remains very limited. Public sector agencies, with few excep- tions, remain administratively very weak. Some progress has been made to- wards rectifying these limitations by formulating a five-year development plan and providing the resources both to finance the preparation of concrete projects and their subsequent implementation. 13. Bank Group lending to Ecuador is aimed at strengthening planning and project preparation in sectors in which we have already been active and increasingly aiding the poorer segments of the country, both in the rural areas and in the larger urban centers. The proposed loan woujld have the threefold objective of providing much-needed water supply services to low- income communities, strengthening future planning in the sector and attack- ing institutional weaknesses. W,e are well advanced in the preparation of two additional loans, one in education with a special emphasis on Ecuador's needs in technical education, and the other a highway loan which includes components for feeder roads and for technical assistance. PART III - THE WATER SUPPLY SECTOR 14. Sanitation facilities in Ecuador are inadequate to provide for the needs of a rapidly growing population of 6.8 million inhabitants. The urban population alone is almost 3 million, a figure tha: is expected to increase to 4 million by 1980. It is estimated that only two-thirds of the urban population and as few as 10 percent of the rural population have access to public water supply. A-p-cximately 60 percent of the urban population is served by sewerage, a service that is practically non-existant in the rural areas. The present deficiencies in water supply and sewerage facilities are a primary cause of the high incidence of ;i-ater-borne diseases and higih infant mortality rates in the country. 15. In terms of structural organization and administrative efficiency the sector suffers from many of the ailments afflicting almost all of Ecuador's public sector agencies. Planning is weak, project preparation needs strengthening and, until recently, there has been a serious shortage of financial resources. The Ecuadorian Institute for Sanitary Works (IEOS) and the National Planning Board are together responsible for project prepara- tion and for the financing and construction of water supply and sewerage systeris in communities of 2,000 inhabitants or more. In the larger urban centers, especially Quito and Guayaquil, IEOS has responsibility only for approving feasibility studies. The water supply and sewerage services in these centers are the responsibility of autonomous municipal entities (Empresas); in smaller urban communities they form a part of the responsi- bilities of the Municipal Councils. In the rural areas of Ecuador water supply and sewerage come under the local councils whose services are super- vised by the Ministry of Health.  - 6 - 16. A share of the oil royalties has recently been earmarked for IEOS, a factor which should reduce present financial constraints and assist in the implementation of the second national sanitation program (1973-1977). The objectives of this program are to serve 50 percent of the total population with water (80 percent in the urban area, 25 percent in the rural areas) and 40 percent with sewerage (70 percent in. the urban areas, 14 percent in rural areas). Approximately $2.2 billion sucres (US$88 million) are to be invested over the five-year period. Investment in this sector is expected to double its share of total Dublic investment from a little over 5 percent in the period 1967-72 to over 10 percent in the period 1973-76. There is, however, reason to doubt whether this highly decentralized subsector, con- sisting of independent and autonomous agencies, has at present sufficiently high absorptive capacity to be able to implement such large investment pro- grams within the time framework of the Government's development plan. At the request of Ecuador, a Bank/WHO cooperative program mission will visit Ecuador later this year to review the sector's institutional and training needs and propose improvements. Guayaquil Water Supply Services 17. The Empresa Municipal de Agua Potable de Guayaquil (EMAP) is an autonomous municipal entity which sucplies water to the city of Guayaquil and to other towns in the Province o' Guayas. EMAP presently supplies about 50 percent of the population of Guayaquil (476,000) and about 48 percent of the population of the sul-rounding rural communities. The Santa Elena peninsula towns are without a water supply system. The Guayaquil water distribution system is inadequate and a large part of the water is unaccount- ed for. In addition to excessive leakage in the network about half of EMAP's customers are servec' by connections without meters. Existing reservoir capacity in Guayaqa-' -s adequate, as are the operation and maintenance of present production facilf-ties; water meter maintenance and repair, however. are not satisfactory. Sewerage services for the city of Guayaquil are provided by the Municipality through the Guayaquil sewerage company (EMIAG). Th-iis is an autonomous o-ntity pr2-s9rntly ctng as the administrative age-ncy r a loan from 1DB. 18. There is a conspicuous lack of' municipal urban planning in the expansion of public utilityr services in the city of Guayaquil. The guiding factor in the extension o^n r --.- a-.d se-w3rage services to residential and industrial areas has more `,rtc b-e-n pclitical pressure rather than rational planning. A number of important decisions need to be made as to how and where future water supply and se-e-age systems should be extended. Municipal planning is weak, however, and there is a lack of coordination between the various institutions responsible for the urban development of Guayaquil. To meet these needs UNDP is planning to make a grant of US$600,000 to the Municipality of Guayaquil for a comprehensive urban dev- elopment study of the metropolitan area. These studies would include, inter alia, an analysis of the costs and benefits of upgrading squatter areas, land tenure in low income a-eas, and the extension of sanitary facilities and other community services such as transport and electricity.  - 7 - PART IV - THE PROJECT 19. A report, entitled "Appraisal of Water Supply Project for Guayaquil and Guayas Province", No. 384a-EC, dated June 13, 1974, is being cir- culated separately to the Executive Directors. A loan and project summary is presented in Annex III. Negotiations took place from April 24 to 26, 1974. The Borrower, the Empresa de Agua Potable de Guayaquil, was represented by a team headed by Mr. Rafael Robles, the General Manager. The Republic of Ecuador was represented by Dr. Orlando Gabela from the Ecuadorian Enbassy. Project Description 20. The major components of the project, which constitutes the first stage of a long-range program and the first Bank loan for water supply in Ecuador, are: a) the provision of distribution system works within the city of Guayaquil, involving the replacement of corroded pipes and the expansion of the present distribution network to the poorer sections of the city. The precise location of about a third of the distribution system will be determined by studies still to be carried out. It is expected that by 1977, the end of the project period, 80 percent of the population (960,000 inhabitants) will be provided with adequate water supply; b) providing the nearby towns of Duran and Daule with an adequate water supply service to serve an additional 35,000 people; c) construction of a water supply system for the Santa Elena peninsula towns and nearby rural communities in-Guayas province to supply 43,000 permanent and 24,000 seasonal residents with water; d) the provision of additional transmission and treatment facilities designed to serve the needs of the city of Guayaquil and the Guayas Drovince; e) the purchase and installation of 30,000 water meters for the prospective consumters of a low-income area in Guayaquil ("Suburbio" West); and f) studies to prepare a water supply master plan for Guayaquil and the neighboring areas up to the year 2000. Also included are funds for a feasibility study which -would cover the area's needs up to 1985.  Project Execution 21. The Enpresa Municipal de Agua Potable de Guayaquil (EMAP), the proposed Borrower, will be responsible for project execution. EKAP is an administratively independent municipal entity responsible for supplying potable water to the city of Guayaquil and the Guayas province. It owns its assets, prepares the budget, generates its own funds and is authorized to receive financial assistance from othe sources. EMAP is governed by a board of directors consisting of five members; the Chairman of the Board is the Mayor of Guayaquil. The Board is responsible for preparing water tariffs which then require the approval of the Planning BDard and the Ministry of Finance. EMAP is ably managed by a competent and efficient administrator. The present staff is adequate in size, and although somewhat limited in technical experience2 is generally of good quality. EKAP's engineers have received specific training abroad. Finance department personnel will require training in the new accounting and computerized billi:g systems. Salaries are competitive with equivalent positions in the private sector except for the salary of the manager, which is somewhat lower. Goverrment intentions are to make the manager' s salary competitive0 22. The first stage of the long-range program, which the proposed project would help finance, would last three and one-half years and would be completed at the end of 1977. EHAP would be directly responsible for all aspects of project execution. The part of the project serving the Santa Elena peninsula was orepared on the basis of studies which concluded that no ground- water was to be found in the peninsula and that therefore it would have to be served by a pipeline from GuayaquiL. More racenrly, however, some ground- water has been found at Playas. E4AP has therefore employed consultants to re-examine whether the peninsula might be served to some extent from ground- water sources wthin ia Tha' most likely outcoma is that the pipeline now planned from C'uayaquil will ba shown to be nAcess8ary. There is, however, still some possibility its size may be reduced or even that it will be eliminated. In these cases the investment now proposed for the peninsula could be reduced somewhat, Assurances have been obtained during negotiations that nq, construction work would be started on this part of the project until the studies are satisfactorily concluded (see Sections 2.02 and 3.01(b), draft Loan Ag&eement). 23. A water demand and system improvament study encompassing the area of the project and a long-range water supply master plan would be carried out with the aid of consultants contracted for the purpose by SMAP. These studies will be closely interconnected with a comprehensive urban development study of the Guayaquil metropolitan area which is being aided by the UNDP. Consultants would be contracted to assist and train personnel in replac- ing EMAP's present unsatisfactory accounting system. They would supervise the implementation and coordination of the new accounting system which would come into operation no later than December 1974. During the negotiations EMAP agreed: a) to introduce a satisfactory commercial and cost accounting system; b) to employ external commercial auditors on an annual basis; c) that any future merger of EMAP and any other public utility service would take place under conditions satisfactory to the Bank; d) to establish a satisfactory water meter maintenance  -9- program by the end of 197h; e) to complete ongoing construction works by March 1975; and f) to reduce substantially delays in incorporating the readings of newly-installed meters in the billing cycle (see Sections 4.01(c), 7.07(a)(i), 5.02(i), h.05(i), 4.04, 3.07 and 5.08 respectively, draft Loan Agreement). In addition, the Government agreed to ensure that the water flow of river sources supplying EMAP would not be reduced by irrigation or other works below a level that would affect the mainten- ance of sound technical and sanitary standards (see Section 3.03(ii), draft Guarantee Agreement). Project Cost and Financing 24. Total project costs (which are summarized in Annex III) are estimated at the equivalent of $38.3 million. This figure has been adjusted for 1974 prices and includes 15 percent for physical contingencies, and price contingencies of 10 percent for local costs and 6 percent per annum for the foreign exchange component of the project. The foreign exchange component is estimated to be approximately $23 million, or 60 percent of the total project cost, and would be financed by the proposed Bank loan. Interest during construction on the loan and local costs would be financed by EMAP. The following table summarizes the finacing plan for 1974-1977. CAPITAL INVESTMENTS t US$ % ---- million ----- IBRD Project 958.o 38.3 83 Existing Projects 87.9 3.5 8 Interest during Construction 108.9 4.h 9 Total Capital Investments 1 100 FINANCED BY Net Internal Cash Generation Internal Sources of Funds 630.7 25.2 55 Less: Tncrease in Working Capital (34.0) (1.4) (3) Less: Debt Service (284.2) (11.3) (25) Funds Available for Capital 312.5 12.5 27 Investments Long-Term Financing IBRD Loan 580.0 23.2 50 Suppliers' Credits 67.2 2.7 6 Total Borrowings 647. 25.9 N Government Grants 195.1 7.8 17 Total Long-Term Financing 77_3 _T3T 73  - 10 - 25. E4AP's large investment program, which was started in 1971, is mainly being financed with supplier's credits and the company's net internal cash generation. A government decision to assign taxes and municipal contributions to the company helped EMAP to cover its participation in the financing of the investment program. As a result, EMAP was able to maintain a satis- factory financial position. Under the proposed project EMAP's revenues from water sales would increase significantly, which would allow the above taxes and municipal contributions to be phased out as a means of financing water expansion. After 1980, such taxes will no longer be necessary for this purpose and could be used to finance projects such as rural water supply programs. Tariffs 26. Present water tariffs in Guayaquil came into effect in 1973. The tariff structure is progressive and based on consumption. The minimum charge is the same for all categories though additional consumption charges are a function of the type of consumer. The average price for metered water (S/. 3.80 per m3) is amongst the highest in Latin America though it will decrease as service is extended to an increasing number of low-income consum- ers. Charges are made for installation and connection, and are reviewed every six months. Present tariff levels are expected to be sufficient to cover EMAP's financial needs during 197T and 1975. However, tariffs will need to be raised in 1976 so as to provide EMAP with additional funds to maintain its participation in the program of works. During negotiations it was agreed that tariffs would be reviewed annually, and adjusted if necessary, to produce revenues from the sale of water sufficient to achieve rates of return of 6 percent beginning in 1976 and 8 percent by 1980 on properly revalued net fixed assets. (Section 5605(a) and (b) (i), draft Loan Agreement). The rate covenant takes into account that Guayaquil is a comparatively high-income part of the country and would enable EMAP to generate sufficient income to finance around 40 percent of the construction investment required up to the year 1984. 27. The Santa Elena component of the project will provide benefits to the poor res:tdent population, as well as to the high-income seasonal population. During negotiations it was agreed that a differential water tariff would be designed to ensure that the seasonal population pays the full cost of provid- ing water dui7ing the peak tourist period (see Section 5.05(b)(ii) - Schedule 5B, draft Loan Agreement). A subsidy to this high-income group will therefore be avoided. 28. The debt service coverage ratio has been satisfactory during 1972 and 1973. The projected values up to 1