Honduras - Seventh Highway Project

Document of \E }N The World Bank FOR OMCIAL USE ONLY Report No. P-1937_H0 REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON PROPOSED LOANS TO THE REPUBLIC OF HONDURAS FOR A SEVENTH HIGHWAY PROJECT November 11, 1976 This document has a restricted distribution and may be used by recipients only In the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  Currency Equivalents US$ 1.00 2 Lempiras L 2,00 = US$1.00 Fiscal Year Jariuary 1 - December 31  FOR OFFICIAL USE ONLY INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON PROPOSED LOANIS TO THE REPUBLIC OF HONDURAS FOR A SEVENTH HIGHWAY PROJECT 1. I submit the following Report and Recommendation on proposed loans equivalent to US$35.0 million to the Republic of Honduras. A loan of US$28.0 million would be made for 20 years including 4-1/2 years grace with interest at 8.7 percent per annum. A loan of US$7.o million would be made on Third Window terms of 25 years including 7 years of grace,with interest at 4.7 percent per annum. PART I - THE ECONOMY 2. A report entitled "Current Economic Position and Prospects of Honduras" (1165-HO) was distributed to the Executive Directors on August 23, 1976. The findings of the Report are summarized below, and a country data sheet is attached as Annex I. Development Prospects 3. The long-run growth rate of the Honduran economy has been modest: real GDP per capita grew at less than 1 percent per year between 1950 and 1974. With a per capita GNP of US$350 in 1975 (World Bank estimate), Honduras is the poorest country in Central America and the majority of the population lives on a subsistence income. A major reason for the poor growth perfonnance is the continued dependence of the economy on the production and export of a few agricultural commodities, especially bananas, and thus on fluctuating world market and weather conditions. This was illustrated dramatically when substantial hurricane damage to the banana plantations in September 1974 reduced banana export volumes in 1975 to about half the level of previous years. At the same time the recession-in the developed world affected beef and lumber exports, and rising oil prices led to a severe deterioration in Honduras' terms of trade. In early 1975, an emergency basic grains program designed to offset the consequences of the hurricane destruction failed, largely because of a drought. The-result was a real GDP stagnant in 1974 and down 0.5 percent in 1975. 4. There are many reasons for the continued dominance of bananas in the Honduran economy. Known mineral deposits are not extensive. Land suitable for agriculture is available and the country has sizeable forest resources, but because of a serious lack of basic infrastructure, and of deficient devel- opment policies in the past, these resources have remained underutilized. Some progress has been made during the last two decades, especially in the This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed witho- I World Bank authorinzation.  area of transport development, but the mountainous topography of the country has made the expansion of the road network slow and costly. This limits the size of the domestic market and hampers industrial development. Honduras' participation in the Central American Common Market (CACM) in the early 1960's was an attempt to gain access to a larger market for its industry, but the process was halted by the conflict with El Salvador in 1969. However, even while the expanded protected market of the CACM lasted, Honduras did not receive the expected benefits, as it was unable to compete with its neighbors in attracting new investments or developing new industries. A further obstacle to economic development in Honduras is the severe scarcity of entrepreneurial talent and the low productivity of the labor force. Over 50 percent of the adult population is illiterate and nutrition and health standards are very deficient. 5. The agricultural sector has accounted for about one-third of GDP in the 1970's. While there is considerable potential for improving utiliza- tion of resources and the productivity of the agricultural sector, uneven land distribution and extensive and inefficient livestock operations on the larger holdings have retarded increases in productivity and resulted in considerable peasant unrest. The Government recognizes that a correction of this situation is vital for the future stable development of the country and, although hampered by a shortage of personnel, it is making serious efforts to address the problem. It began substantial land redistribution in i973 under Decree Law 8. This was followed by Decree Law 170 in 1975, which established the operating regulations for the comprehensive agrarian reform program necessary for long run improvements in agricultural productivity. A great deal has already been accomplished. Since 1973, the Government has distributed land to over 30,000 families. The program calls for land distribution to an additional 70,000 families, and peasant organization demands for a rapid as well as an effective agrarian reform process can be expected to continue. The agrarian reform had a dampening effect on private investment, especially in the early stages before the rules for land redistribution were defined, but with the issuance of the law and regulations in 1975 private investment plans are going forward. The private sector is financing a major expansion of sugar produc- tion, with three new sugar mills scheduled to come on stream in 1977 and 1978. 6. The state forest corporation (COHDEFOR) has made some progress towards the further development of the country's substantial forest resources. COHDEFOR is now preparing a project in the Olancho, the area with the coun- try's largest forest reserve, for timber milling and industrialization and for a pulp and paper plant. Decisions are now being taken regarding the im- plementation schedule and the financing package for the first stage of the project (timber milling). In addition, several projects are being prepared for processing installations for rough-sawn lumber; it is expected that these will stimulate the development of intermediate and end-product industries such as furniture and molding. Forest management work is being undertaken through eight district offices and negotiations are underway with Canada for assis- tance with this and other forestry activities. Balance of Payments 7. The balance of payments situation deteriorated sharply during 1974 and 1975, mainly as a result of the combined effects of weakening terms of  - 3 - trade, the world recession, the September 1974 hurricane, and the drought in 1975. Inflows from foreign grants, the IMF Oil Facility, the Venezuelan Investment Fund, along with borrowings from bilateral and international lending agencies financed the bulk of the deficit during these years. Tnere were also sizeable increases in private capital inflows, especially short-term capital, but these were largely offset by factor payments abroad. Balance of payments management is expected to continue to be difficult during the next several years. Net international reserves were equivalent to only six weeks' imports in December 1975. The recent sharp increases in coffee prices have led to a temporary improvement in the balance of payments situation, but, given present expectations, sizeable resource gaps in the balance of payments are projected for the period 1976-81 owing to large import requirements and only moderate export growth. During 1976-81, the growth of banana exports will largely reflect recovery from the 1974 hurricane, and increases in the volume of the other major exports, coffee, beef, and wood, are expected to be modest. However, anticipated increases in the prices of wood and beef, added to increased coffee prices, would lead to a moderate improvement in Honduras' terms of trade beginning this year. Other exports are also expected to grow, and sugar may become a significant export item by 1980 if the planned produc- tion increases are realized on schedule. The projected recovery of banana exports and the anticipated increase in sugar, beef, and wood exports will depend, however, on improvements in managerial capacities and efficiency in the public sector as well as on orderly progress in the agrarian reform program. Public Investment and External Debt 8. The Government plans to improve the economic growth outlook over the medium term through an ambitious public investment program, which would alleviate major bottlenecks to long-term development. Large investments are planned in communications, roads and power, and in the area of export produc- tion: lumber mills, a pulp and paper plant, a tourism project, and agricul- tural projects and a sugar mill. Because consumer goods account for only a small share of imports and cannot be reduced without hardship, imports will be growing fairly rapidly as the public investment program is realized. The financing of the projected resource gaps will require substantial capital inflows and the bulk of the foreign capital requirements will have to be met through public borrowing. In the past, Honduras has managed to keep its external debt service ratio fairly low, because foreign loans were almost all on concessional terms. It is important that the country continue to borrow on 'reasonably soft terms lest the planned public investment program result in an excessive debt service burden in the future. Even if Honduras is successful in obtaining most of the financing it needs for its investment program on terms similar to those offered by the international lending agencies, the debt service ratio is still likely to rise from about 5 percent in 1975 to about 15 percent by the early 1980's. Because Honduras will continue to depend on exports of a few commodities with volatile price prospects, and because natural disasters have sharply reduced the volume of exports every few years, prudent debt management will require maintenance of rather a lower debt service ratio than might be considered safe for more diversified economies.  -4- Public Finance 9. During the last three years the public finance situation has remained sound because of improvements in tax collection, and because, until very recently, the growth of capital and current expenditures has been limited. Nonetheless, greater demands on the public sector for reconstruction (after the 1974 hurricane) and development expenditures have resulted in an increase of the overall public deficit from 1.5 percent of GDP in 1973 to nearly 5 percent in 1975. The Government has taken steps to improve the fis- cal outlook and adopted new tax measures in December 1975 expected to raise the tax ratio from 12 percent of GDP in 1975 to about 13.5 percent this year. Despite the greater tax effort, however, public'savings cannot be expected to finance all of the local costs of the public investment program without unduly restricting current expenditures, nor can the shortfall be financed out of domestic borrowing without generating unacceptable levels of inflation. Therefore, some local cost financing on the part of official lending institu- tions will be required to implement the stepped-up public investment program. External Assistance 10. The Bank is Honduras' largest creditor, holding 25.3 percent of the US$445.5 million external public debt outstanding--including undisbursed-- repayable in foreign currency, as of December 31, 1975. IDA holds an addi- tional 8.0 percent of the total. Although IDB has made loans totalling the equivalent of US$116.4 million, most of this amount is repayable in local currency, so that IDB's share of the public debt repayable in foreign currency is only 7.5 percent. CABEI accounts for 21.6 percent of the total, the U.S. Government for 20.3 percent, Venezuela 7.2 percent and privately held debt for 10.1 percent. 11. In terms of the secioral thrust of the lending by the principal external agencies, apart from the Bank, AID has concentrated on agriculture, education and health, the IDB on transport, power, agriculture and industry, and CABEI on infrastructure and industry; and these patterns are expected to continue. Eligibility for Third Window Lending 12. Honduras is considered eligible for Third Window financing on the basis of the following considerations: (a) Poverty: Its per capita income was US$350 in 1975 and US$300 in 1972. 1/ (b) Performance: Honduras has made impressive accomplishments in the last three year-s in promoting social and economic develop- ment. It has undertaken a major agrarian reform program; and has arranged for the financing and begun the last stage of preparation of a major project for the exploitation of its 1/ World Bank Atlas.  - 5 - substantial forest resources. Public investment has been substantially increased, from an average level of 4.5 percent of GDP in the 1971-73 period to 8.1 percent in 1975, and should remain at a hi'gh level for the next several years in view of the number of projects now in preparation. (c) Creditworthiness: Honduras' external debt and debt service have been relatively low in the past but can be expected to increase quite rapidly by the early 1980's in line with the increase in public investment necessary to carry out its development plans. At the same'time the country's exports are of a quite volatile nature, with bananas and coffee accounting for about one half of total merchandise exports. In these circumstances, Honduras' creditworthiness for conventional and commercial type loans is limited, and external assistance on concessional terms is highly desirable. (d) Alternative Sources of Finance: The projected increase in public investment in Honduras will require substantial borrowing from the major multilateral and bilateral lending agencies (including the Venezuelan Investment Fund); the increase required from agen- cies other than the Bank, before taking into account the financing requirements of the Seventh Highway Project, is already about the maximum that could be expected given the resource constraints of most of these agencies. PART II - BANK GROUP OPERATIONS IN HONDURAS 13. Beginning with a loan of US$4.2 million for roads in 1955, Honduras has to date received fifteen Bank loans totalling US$130.2 million and eight IDA credits totalling US$47.6 million, both net of cancellations. The pro- posed loans would raise the total of Bank Group assistance from US$177.8 million to US$212.8 million. 14. Execution of projects financed by the Bank Group has, on the whole, been satisfactory. Annex II contains a summary statement of Bank loans, IDA credits and IFC investments, and notes on the execution of on-going projects. 15. In the past, Bank Group lending was heavily concentrated on trans- port and power, where inadequate facilities-hampered the development of the country. The First Livestock Development Credit approved in 1970, how- ever, marked a first step towards the diversification of our lending. Since then, there has been a Second Livestock project; a First Education project, which included as major components primary teacher training schools, support for the national agricultural secondary school and vocational training centers; and a First Agricultural Credit project (approved in May of this year) to finance livestock and crop development with emphasis on assisting agrarian reform settlements through investment credits and a substantial technical assistance program.  - 6 - 16. In future lending to Honduras, we plan to support the priorities of the Governmeut's investment program by giving increased emphasis to investment in the productive sectors and in education, while continuing to lend for physical infrastructure, where there are still deficiencies to be overcome. In addition to the Agricultural Credit project approved last May, the Bank Group contemplates undertaking other rural developoment projects to help support agrarian reform and productivity objectives.' Batk Group support is also being considered for COHDEFOR's pulp and paper project. Honduras also has potentially excellent tourism sites which are now being studied to deter- mine whether a project is feasible. As part of its agrarian reform program, the Government has proposed the creation of rural development centers which would provide comprehensive educational services to rural communities. Bank assistance in this effort will be considered as a possible major component of a second education loan. 17. In transport, after the proposed project, we would place emphasis on assistance in the construction of a network of feeder and access roads to support the Government's agricultural program. In addition we hope to continue our support for port expansion programs which will facilitate the growth of Honduran exports, and a project for the construction of Puerto Castilla on the Atlantic Coast to serve the forest industries project has recently been appraised. The Bank made a US$35.0 million loan for a Sixth Power Project in 1975 and contemplates continuing its assistance to the power sector in the future. 18. IFC's activities in Honduras have so far included a 1964 loan and a share subscription, of US$295,000 and US$66,750 respectively, in a tannery, Empresa de Curtidos Centroamericana, S.A. (ECCASA); and a US$75,000 share subscription in a pilot promotional company, Compania Pino Celulosa de Centro America (COPINO) in 1969. COPINO was established to develop an industrial project based on timber from the Olancho Forest Reserve, but a series of obstacles to project development arose and efforts to go forward with it were virtually halted in 1971. The Government's intentions regarding a role for COPINO in the COHDEFOR forest industries project remain to be determined. PART III - THE TRANSPORT SECTOR Background 19. The Honduran transport system is dominated by roads and road trans- port. Because distances are short and the terrain rugged, railways are non- competitive, except in the northern coastal strip where specialized banana railways operate. Road transport carries 86 percent of the freight tonnage and 96 percent of the passenger traffic in the country. The primary road network connects the two principal cities, San Pedro Sula in the north and the capital, Tegucigalpa, in the south, and is designed to service the most important agricultural areas, the Sula and Choluteca Valleys and the Atlantic coastal strip.  20. Aside from infrastructure to serve the banana industry, major devel- opment of the transport sector began only in the mid-fifties with construction of the Inter-American highway in the southern part of the country; a modern all-weather road betwen Tegucigalpa and San Pedro Sula was not completed until 1970. Modernization of the principal port, Puerto Cortes on the Atlantic, did not begin until the creation of a National Port Authority in 1965, and, with Bank assistance, a deepwater Pacific Coast facility is only now being con- structed at San Lorenzo. Investment in transport infrastructure increased significantly in the 1970's, and highway projects are now planned, or under construction, to complete most of the country's primary highway network. When complete in the early 1980's, these projects will provide modern all-weather access to the increasingly important agricultural and timber areas of eastern Honduras, including the rich Aguan Valley in the north, the Guayape Valley and the Olancho forest reserve in central Honduras, and the Danli area in the south. With the improvement and expansion of the feeder and access road system, to which the Government will be giving increasing emphasis over the next five years, the country will, for the first time, have an internal transport network adequate to serve its most important productive areas. Highways, 21. Because of the topography of Honduras, road construction, in general, has been difficult and expensive; nevertheless, the road network grew from about 3,200 km (110 km paved) in 1960 to about 6,100 km (1,240 km paved) in 1975. In addition to the principal roads mentioned in the preceding para- graph, the primary system includes a road southwest from San Pedro Sula to the El Salvador border, and a road along the north coast to La Ceiba. The country's secondary and tertiary road system is not yet well developed. 22. The road transport industry, operating in an environment of virtually no regulation, expanded rapidly in the decade from 1964 to 1974. During that period, the vehicle fleet grew from 16,000 to 43,900, an increase of 174 percent. The most notable growth occurred in the number of trucks, which increased by 230 percent. The road transport industry is generally adequate in the sense that it does not constitute a serious bottleneck to the develop- ment of other sectors of the economy. However, ,tDhe poor organization of the local trucking market and the large discrepancy in managerial and financial resources between small domestic operators and the large international oper- ators has led to a partitioning of the industry in which Honduran truckers have not had access to lucrative international traffic. This situation together with the serious problem of overloading of trucks, led to enactment of a revised Land Transport Law (February 1976) which permits the detailed regulation of road passenger and freight traffic. At present, the Government is restricting its regulatory activity to passenger transport and a gradual program ofPcontrol of truck loading, but it is now cons1idering what is feasible and desirable in other areas; so far it has refrained from imposing regulations that might harm what to date has been a reasonably adequate truck and bus industry. 23. The Ministry of Communications, Public Works and Transport (MCOPT) is in charge of planning, designing, constructing, and maintaining all roads  - 8 - in the countzy, except for a few being built by the Honduran Forestry Devel- opment Corporation (Corporacion Hondurena de Desarrollo Forestal, COHDEFOR) for forestry development. MCOPT's highway activities are carried out through two Directorates: the Directorate for Highways (DGH), which plans, designs, and supervises construction of roads; and the Directorate for Highway Maintenance (DGHM), which maintains the road network. All major construction works are implemented by contracts awarded after competitive bidding. Some minor improvement works and construction of a few feeder roads, totaling an average yearly investment- of about US$1.5 million equivalent, are pe'rformed by force account. A research program is currently being carried out with Bank assistance to determine the appropriate labor capital mix for constructing such roads. Government-financed works are normally supervised directly by DGH staff, while externally financed construction works are supervised by consultants. Despite considerable technical assistance over the years, DGH is still heavily dependent upon consultants for implementation of major projects, and still requires additional technical assistance, particularly to improve the quality of its professional staff. High staff turnover which results from low civil srvce salary levels has been the major factor in limiting the effectiveness of past training programs. Recently, civil service salaries have improved somewhat and there has been greater staff stability. Additional measures will be taken to provide the MCOPT with better qualified, experienced staff. 24. Highway maintenance continues to be the most serious problem in the transport sector, accentuated by the overloading of trucks, particularly in the timber industry. DGHM carries out routine maintenance by force account through its seven maintenance districts. Each district has its own technical staff, equipment and repair facilities, and two main workshops are located in Tegucigalpa and San Pedro Sula, but the facilities in these, as well as in the other district workshops, are inadequate. MCOPT has received assistance from several external sources for improving and strengthening its maintenance operations and for the purchase of maintenance equipment. In spite of such assistance, routine maintenance is deficient, and more equipment is needed to replace wornout units, many of which are 15 years old or older. The inade- quacy of road maintenance has been due to tinsufficient annual budgetary allo- cations, the use of maintenance equipment for works other than maintenance and lack of trained staff. Over the past two years, however, there have been sub- stantial increase in expenditures for maintenance and equipment renewal. Also, the installation of 12 weighing stations has recently been completed and regula- tions for controlling truck weight and dimensions have been enacted. Thus, the Government will shortly be in a position to enforce load limits which should, over time, reduce deterioration of the country's major highways. 25. Although the development of a local construction industry was encouraged by the impetus provided by the road construction prqgram of the 1970's, the industry still faces a number of problems, caused mainly by the deficiency of technical and managerial skills, the uneven level of highway works; improvements in these and other related areas are therefore needed. Honduras has no restrictions on foreign contractors, who normally submit bids and obtain contracts for major construction works.  - 9 - 26. During the 1970-1975 period, about 70% of highway investments were externally financed. All local funds are provided through the normal budget- ary process, and there is no road fund or earmarking of user charges. Road users are currently paying taxes and user charges at about L 18 million annually, of which fuel taxes account for more than L 12 million. With annual road maintenance expenditures of approximately L 12 million, this is considered generally adequate. However, with increased maintenance expendi- tures expected in the future appropriate adjustments will be required. The precise nature and level of these charges will be one of the issues to be considered in a highway master plan to be prepared under the Project. Transport Subsectors other than Highways 27. The railway system is comprised of three narrow-gauge lines, all located in the north and designed originally to serve the banana plantations in the Sula Valley, the northern coastal strips, and the upper Aguan Valley. The Government-owned railway, Ferrocarril Nacional de Honduras (FNH), with a total length of 114 km of main line, runs from the Atlantic port of Puerto Cortes to San Pedro Sula and into the upper Sula Valley; it hauls sawn timber and banana exports and agricultural imports, mainly rice. The Tela Railway, recently acquired by the Government, operates over 179 km of main line, serv- ing the banana plantation areas of the eastern side of the Sula Valley and part of the coastal strip. The Standard Fruit Company Railroad still operates over 157 km of main line and serves the banana plantations of the north coastal strip as well as the upper Aguan Valley. Its gauge is different from that of the other two, thus precluding interconnection. Consideration is now being given by the Government to reconstruction of an abandoned Aguan Valley rail line to haul bananas produced by the Isleta agrarian reform settlement and other producers to the proposed port at Puerto Castilla. 28. The port system includes Puerto Cortes, Tela, La Ceiba and Puerto Castilla on the Atlantic coast and a shallow draft port, San Lorenzo, on the Pacific; the latter is currently served by lighterage but is being developed into a deepwater port under the Bank-financed Second Port Project (Loan 767-HO). All ports are operated by the Empresa Nacional Portuaria (ENP), *an autonomous Government organization which was highly successful in developing the port of Puerto Cortes and which was subsequently given control of all ports in the country. Puerto Cortes remains the principal port and accounts for about two-thirds of all dry cargo movements of the country. It has adequate capacity and a good operating record. Puerto Castilla is the least developed and as yet carries no significant traffic. It is, how- ever, the natural outlet for the Aguan Valley and is a crucial infrastructure element for the Valley development plan. The Bank has recently appraised a project to improve facilities at Puerto Castilla to serve prospective exports of agricultural products, timber, and, eventually, paper from a proposed paper mill in the lower Aguan Valley at Corocito. 29. Honduras has two major airlines; between them they provide adequate domestic and international service. The Villeda Morales airport at San Pedro Sula has a good runway of 2,800 m; the Toncontin Airport at Tegucigalpa is  - 10 - less satisfLctory, with only 1,980 meters of runway, and is barely adequate for modern jets. However, traffic levels are so low that a major expansion of the Toncontin Airport will not be economically feasible for many years to come. With the completion of the road between San Pedro Sula and the El Salvador border and that between Tegucigalpa and San Pedro Sula, private automobiles and a good inter-city bus and truck service have captured a large portion of the earlier air traffic, and domestic air traffic generally has declined steadily since the peak year of 1970. Transport Planning and Coordination 30. Responsibility for highway planning lies with MCOPT. The main bases of the highway investment plan are a long-term highway master plan, which was prepared almost ten years ago, and a long list of proposed projects which reflects a variety of local interests as well as national development priorities. Some of these projects have well prepared engineering and economic feasibility studies associated with them; some others are integral parts of larger agricultural and forestry development plans and have -received attention only in terms of preliminary engineering analyses and cost esti- mates. Still others are merely lines on a map. The main deficiency of the present "plan" is that it is not feasible in terms of finances or implemen- tation capacity. Perhaps the most critical need is to place a realistic cost estimate on each project in the current plan and to phase these projects five years into the future subject to a realistic forecast of fund availabi- lities. The immediate result of such an effort would be the realization that very difficult decisions are required concerning priorities. Such an exercise is within the capacity of the MCOPT staff and would allow them to focus their limited planning resources on a core of projects instead of dispersing them over a large number, many of which are of low priority. The economic analysis of projects is reasonably well understood within MCOPT, and, with some help, the road investment program could be put on a sound economic basis. The data and analytical requirements of such an exercise are modest, and past Bank assistance has been helpful in improving the data base and the techniques of project analysis. The benefits of such assistance are potentially large, and the effort should be continued, bearing in mind the severe personnel con- straint in MCOPT and the consequent need to keep the effort modest and feasible. 31. Port planning is the responsibility of ENP (see paragraph 28). Its management has been good and is not subject to frequent change, thus allowing the development of a rolling five-year plan that includes economic, engineer- ing, and financial analyses, most of which are done by the port staff itself. The inclusion of a cash flow analysis in the five-year plan avoids the most serious deficiency of the highway plan and effectively integrates the annual budget exercise for the ports into a longer term plan. 32. Both railway and airport planning are of minor importance due to stagnant or declining traffic, and major ir,n-sstments in these modes are not anticipated. The possibility of a short, specialized banana railway to serve the Aguan valley and the possible improvement of the airport in Tegucigalpa (largely because of safety considerations) would require specialized planning expertise, but this can be obtained through consultants.  - 11 - 33. The formal transport coordination mechanism involves both MCOPT and the Consejo Superior de Planificacion Economica (CONSUPLAN), attached to the President of the Republic, which works with the Ministry of Finance in harmonizing the transport investment proposals of the various modes. For this purpose, CONSUPLAN prepares both five-year national investment plans and an annual operational plan for the public sector. However, because of CONSUPLAN's shortage of staff and the relative independence of the Ministries, the basic coordination effort now takes place between MCOPT and the Ministry of Finance. PART IV - THE PROJECT 34. A report entitled "Staff Project Report - Honduras Seventh Highway Project" (No. 1253-HO, dated November 11,1976) is being distributed separately. The main features of the loans and project are summarized in Annex III. The project was appraised in February-March 1976. Negotiations were held in Washington from October 20-22, 1976. The principal representative for the Government was the Minister of Public Works. Project Objectives 35. The main objectives of the project are: (a) To provide an economic and safe road connection between the northeastern part of the country, the consumption centers and the export outlets; (b) To determine the complementary investments needed for the development of the Guayape Valley; (c) To assist in the preparation of an updated highway investment program to serve as a basis for annual budget decisions; (d) To assist in the improvement of highway maintenance opera- tions; (e) To achieve institutional improvements in the Highway Department; and (f) To improve the management and operational capacity of the local construction industry. Project Description 36. To support the above-mentioned objectives, the proposed project contains the following basic elements: (a) Reconstruction, including supervision, of the Talanga- Juticalpa-Catacamas road;  - 12 - (b) A study for an integrated development program for the Guayape Valley; (c) Preparation of a Highway Mlaster Plan; (d) Purchase of maintenance equipment, including spare parts, workshop, and laboratory equipment; (e) Technical assistance for training the staff of the Directorates of Highways and of Highway Maintenance, including fellowships; and (f) Technical assistance to the local construction industry. 37. The Talanga-Juticalpa-Catacamas road is part of the main link be- tween Tegucigalpa and the northeastern part of the country, usually referred to as the "Olancho Region". The present gravel road serves as an outlet for forest exploitation in the mountainous area to the north and connects the third largest valley of the country (the Guayape) to the main population centers. It was constructed almost 20 years ago and, because projected traffic volumes at that time were low, it was constructed to minimal stand- ards with steep grades and sharp curves in order to keep the investment costs reasonable for what was essentially a penetration road. Current traffic volumes (about 400 vehicles per day (vpd), 50 percent being heavy trucks on the most trafficked section) make it impossible to maintain the gravel surface to appropriate standards, and vehicle operating costs are high. Reduced grades and a paved surface would greatly reduce vehicle operating costs and stimulate production in the area of influence of the road. Reconstruction of the Tegucigalpa-Talanga section is currently nearing completion, partly financed by Loan 896-HO. Reconstruction of the Talanga-Juticalpa-Catacamas section to extend the Tegucigalpa-Talanga works to Olancho would be the major comrponent (85 percent of total cost, including contingencies) of the project. 38. The Talanga-Juticalpa section of the proposed project crosses rugged terrain, while the topography along the Juticalpa-Catacamas section is generally flat. The latter section passes through the Guayape Valley, the area with the most potential for increased agricultural production in the zone of influence of the proposed road works. A joint IBRD/IDB/USAID Agricultural and Rural Sector Study indicates that to fully achieve this potential, however, a development program must be un-dertaken which should include irrigation and feeder road infrastructure, agricultural credit, extension, and marketing facilities, and a progressive land reform and settlement policy. Although some information is available regarding the valley, there is a need to update and supplement it in order to develop a project for the area. The Government has advised the Bank that it wishes to give priority to preparing and under- taking a rural development project for the rCiayape Valley. An IBRD/FAO Cooperative Program mission which visited Honduras in September 1976 has concluded that there is potential for a rural development project to benefit small fariners and agrarian reform settlements. The IBRD/FAO Cooperative Program will assist the Government in preparing terms of ref3rence, acceptable to the Bank, for project preparation studies to be financed under the nropused loan.  - 13 - 39. Unless the scarce planning, financial, and implementation resources of the country are focused on a feasible, time-staged road investment plan, the annual budget exercise will continue to be unrelated to longer term consideraticns. The collection of basic data for a Highway Master Plan is being carried out under the ongoing Sixth Highway Project (Loan 896-HO). The present project provides for preparation of a Highway Master Plan based on these data, and the focus under the project would be on a realistic effort within the personnel constraint of MCOPT so that the planning process can be continued with M1COPT staff alone at the end of the period of technical assis- tance. It is proposed that the consultants who have prepared the preliminary work for the highway master plan be retained to assist in the actual prepara- tion of the plan. To achieve this continuity, a small amount of retroactive financing would be required. 40. A number of organizations have attempted to support the development of road maintenance in Honduras, and some progress has been made, particularly, in changing the structural organization of the DGHM so that it is generally appropriate. Much remains to be done, however, and the proposed project includes financing for urgently needed maintenance equipment as well as further technical assistance. The technical assistance would take the form of the development of a pilot maintenance district with the help of consul- tants. Personnel from the other maintenance districts would then have access to training experience within an actual functioning operation in Honduras. The consultants would, in addition, assist MCOPT in specifying the equipment to be purchased under the proposed project. It has been agreed that the two maintenance equipment repair shops in Tegucigalpa and San Pedro will be improved in a manner satisfactory to the Bank prior to the disbursement of funds for equipping them. (Subsection 4.03(iii) of the Standard Loan Agree- ment.) The level of expenditures for highway maintenance and equipment renewal during the 1977-1980 period has also been agreed to. (Subsection 4.03(a) (iv) of the Standard Loan Agreement.) Further, in order to reduce road damage caused by overloaded vehicles, it has been agreed that weight and dimension regulations for all vehicles, which are satisfactory, will be en- forced beginning not later than June 30, 1977. (Section 4.03(b) of the Loan Agreement.) 41. The local road construction industry faces a number of problems generated in part by the industry itself and in part by the Government's treatment of it. These problems (mainly a deficiency in the firms' technical and managerial expertise and a lack of regulations for dealing with the industry by government agencies) have been identified by the Bank, and the project includes a technical assistance component to finance a study to make recommendations designed to remedy the present shortcomings of the industry. It has been agreed that the Government will enter into a cooperation agreement, acceptable to the Bank, with the Camara Hondurena de Construccion, the local construction industry association, to provide for their participation in these studies. (Section 3.04 of the Loan Agreement.) Project Cost and Financing 42. The total estimated cost of the project is US$51.2 million equivalent, as detailed below:  - 14 - Foreign US$ Million Exchange Local Foreign Total Cost % (a) Road Reconstruction, including right-of-way 10.1 21.0 31.1 68 (b) Supervision of Construction 1.2 1.3 2.5 50 (c) Study of an Integrated Development Program for the Guayape Valley (33 man months) 0.1 0.5 0.6 80 (d) Preparation of a Highway Master Plan (56 man months) 0.1 0.3 0.4 80 (e) Procurement of: - Maintenance, Workshop and Laboratory Equipment 0.3 2.2 2.5 90 - Spare Parts - 0.3 0.3 100 (f) Technical Assistance to MCOPT (65 man months) 0.1 0.3 0.4 80 (g) Technical Assistance to the Local Construction Industry (20 man months) - 0.1 0.1 80 /1 Total Base Costs 11.9 26.0 37.9 68 (h) Contingencies: Physical (about 10% of Item a) 1.0 2.1 3.1 Price Adjustments (about 27% of base costs): - For Civil Works 3.0 6.3 9.3 - For Equipment Purchases - 0.3 0.3 - For Consulting Services 0.3 0.3 0.6 TOTAL 16.2 35.0 51.2 68 /1 Local cost component of about $20,000 not shown because of rounding. The cost estimate is based on the assumption that reconstruction works will be carried out by foreign contractors with some local participation; that equip- ment will be procured abroad; that the Highway Master Plan, technical assis- tance and study of the valley will be carried out by foreign consultants with some local participation; anQ that supervision of construction will be carried out by local consultants with some foreign participation. Physical contingencies have been estimated at 10 percent of the construction costs, and price adjustment contingencies have been estimated at 12 percent p.a. for 1977-1979 and 10 percent for 1980/81 for the reconstruction works, 8 percent p.a. for the equipment, and 6 percent p.a. for the consulting services. The unit costs for road construction vary between US$134,000 and US$223,700 per km (excluding contingencies), depending on terrain conditions. Consultant services are estimated at an average of US$5,000 per man-month.  - 15 - 43. The foreign exchange component of the project, estimated at US$35.0 million (about 68% of project costs) would be financed by the proposed loans, with disbursements scheduled to take place from March 1977 through December 1981. All local costs, estimated at US$16.2 million equivalent, would be met from Government budgetary allocations. Project Implementation 44. Project implementation will be the responsibility of MCOPT, except for the Guayape Valley study which will be the responsibility of the Ministry of Natural Resources. Implementation will commence in 1976 and is scheduled for completion by mid-1981. Civil works are expected to be implemented over a period of about four and a half years, beginning in early 1977 and ending in mid-1981. Acquisitioni of right-of-way would be handled by MCOPT before con- struction contracts are let; existing legislation is adequate for the acquisi- tion. 45. The preparation of a Highway Master Plan, the technical assistance to MICOPT and to the local road construction industry, and the study of an integrated development program of the Guayape Valley are scheduled to commence in mid-1977, after the selection of suitable consultants, and to be completed by mid-1979. Agreement has been reached on a detailed implementation schedule for the project. In order to strengthen the MCOPT staff, it has been agreed that, as a condition of effectiveness, the MCOPT would establish a project unit consisting of three engineers and two administrators, acceptable to the Bank, who would be respon- sible for carrying out this project. (Section 3.03 of the Loan Agreement.) Also the MCOPT will prepare, by June 30, 1977, a plan, acceptable to the Bank, for providing incentives designed to assist in recruiting and retaining qualified personnel. (Section 3.08 of the Loan Agreement). Included in this plan will be provisions for fellowships to be granted to MCOPT personnel who wiLl be attached to highway authorities abroad or to specialized consultants; in either case attachments will be for short periods in order tco avoid disrup- ting the operations of the Highway Directorates. Procurement 46. The civil works will be carried out by contracts awarded through international competitive bidding in accordance with the Bank's "Guidelines for Procurement"; prospective bidders will be prequalified. MCOPT proposes that, for bidding purposes, the works be divided into four lots and bids be invited on a "package" basis, whereby the contractors may bid separately for each of the four lots or for any combinations thereof; contracts will be awarded on the basis of the lower of (a) the lowest evaluated bid for the four lots and (b) the lowest combination of evaluated bids for each lot. The esti- mated cost of each lot varies between US$5.5 and US$9.5 million, and it is likely that the contracts will be won by foreign firms in joint venture with local firms or subcontracting part of the works to local firms.  - 16 - 47. Read maintenance and workshop equipment will be procured through internationial competitive bidding in accordance with the Bank's "Guidelines for Procurement". In bid evaluation, consideration will be given to the need for standardization of equipment, which is especially important in a country such as Honduras, with a modest economy, limited facilities for repairs and a scarcity of qualified mechanics and operators. Items (e.g. tools, workshop equipment) that cannot be grouped in packages of at least US$30,000, and would not in the aggregate exceed the equivalent of US$300,000 will be advertised locally and procured in accordance with local procedures which are acceptable to the Bank. Local procedures will also be applied for the purchase of urgently needed spare parts, and laboratory equipment which only a few special- ized firms supply, up to an aggregate of US$300,000. 48. The consulting services will be carried out by qualified consul- tants acceptable to the Bank and engaged by the Government under terms and conditions satisfactory to the Bank. Disbursments 49. Disbursements will be made for 68 percent of construction costs representing the estimated foreign exchange costs of construction,and for the actual foreign exchange costs of equipment; for consulting services, the dis- bursement percentages will reflect the foreign exchange costs of the different types of services required (para. 42). Any funds remaining in the loan account after project completion would be used for the purchase of additional mainte- nance equipment. Retroactive financing of about $40,000 is contemplated for payment of consulting services (para. 39). Economic Evaluation 50. The economic evaluation considers, in quantitative terms, the pro- posed investments in (a) civil works and (b) maintenance equipment. The other components are dealt with in qualitative terms. Civil Wiorks 51. For the economic evaluation of the investment in the proposed civil works, the benefits have been assumed to be savings in vehicle operating costs from (a) improved surface condition and (b) length reduction of the road sec- tions. Benefits accruing to normal and generated traffic have been estimated as separate benefit streams and include time savings for only professional drivers and helpers on buses and trucks (these savings account for no more than 3 percent of the total benefits). 52. Traffic projections lfor normal traffic were based on recent traffic counts, past trends, and estimates of the future of the lumber industry in the area. The most recent traffic counts (1976) indicate that traffic on the Talanga-Juticalpa section averages 400 vnd, of which 50 percent are heavy trucks. For the Juticalpa-C;'A-acainas section, the figures are 380 vpd, with 32 percent heavy trucks. For tl:e past ten years, traffic on thesct t'.;X sections has been growing i. a_,ut 5 percent per ye- -, and the evaluation assumes t!F.t traffic will contii-e to grow at this rate until 1986, when the nios. accessible  - 17 - timber areas will have largely been exhausted. There is little information on the sustainable yield of timber from the area, and it may well be that timber traffic after 1986 will remain constant or even decline. It is expected, however, that the growth of normal traffic will, on a conservative basis, proceed at 4 percent after 1986, even without very substantial increases in the rate of growth for agricultural traffic from the Guayape Valley. How- ever, if integrated development of the Guayape Valley materializes, it should raise the economic return on the project. 53. Generated traffic has been estimated on the basis of reasonable estimates of demand elasticities, and unit benefits for generated traffic have been assumed at half those for normal traffic. Reconstruction of the road is expected to yield a 28 percent increase in bus traffic and a 17 percent increase in truck traffic in the year after its completion, with subsequent growth rates the same as those for normal traffic. 54. The economic evaluation shows that the reconstruction of the road will be well justified and appropriately timed. Based on an economic life of 20 years, a construction period of four years for the first section and three years for the second section, the economic return for the road recon- struction element of the project has been estimated at 15 percent, with a first year return of 13 percent. Separate analysis of the Talanga-Juticalpa section indicates an economic return of 16 percent, with a first: year return of 14 percent. For the Juticalpa-Catacamas section, the economic return is estimated at 11 percent, with a first year return of 9 percent. The greatest element of risk for this project is the traffic projection. The conservative estimate of growth after 1986, based on the declining importance of lumber traffic and an assumed slow development of the Guayape Valley, reflects this risk. A sensitivity analysis indicates that, with variations in the major cost (+ 15 percent) and benefit (- 15 percent) streams, the reconstruction would still yield an economic return of at least 13 percent. Distribution of Benefits 55. An analysis of the organization of bus and trucking operations in the area, together with information on land tenure patterns, provides a general indication of the distribution of the savings in vehicle operating costs. 56. The common carrier bus operations in the area are generally organ- ized on a cooperative basis, both for scheduling purposes and for protection of the operators' interest; buses are privately owned, and entry into the market is free. The operators may try to maintain tariffs at current levels after the road is completed, but this will be difficult because other opera- tors, perceiving profits, will enter the market, thus increasing the frequency of service. Even if current tariff levels are maintained, the effect of inflation would mean a reduction in tariffs in real terms and most of the savings will eventually be passed on to bus riders who come from the lower income groups. Of total project benefits, it is estimated that those accruing to bus riders would be about 5 percent.  - 18 - 57. Cost reductions for owners of automobiles and pickup trucks would, in general, go directly to the owners, who are usually the most affluent elements of the population. These benefits are estimated at 13 percent of the total. 58. Truck operating costs will be influenced the most by the improved surface and gradients, and reduction in these costs will be responsible for 82% of the total benefits of the investment even though trucks represent only 50% of vehicular traffic on the Talanga-Juticalpa section and 32% on the Juticalpa-Catacamas section. About 35 percent of the trucks haul timber, and saving attributable to this traffic will account for 29% of total benefits of the investment. These benefits would initially be passed on to sawmill owners who serve as middlemen in the lumbering operation, contracting for trucking at the lowest possible rate in a competitive market. The recent takeover of the lumber marketing operation by the Government will, however, allow eventual capture of the benefits by COHDEFOR through truck tariff agreements and price adjustments for the sawmill outputs. A truck tariff agreement, which is currently being negotiated, will make it possible for the Government to implement weight restrictions without major tariff increases on the project roads and would allow the state to benefit in the form of longer life for the roads and reduced maintenance costs. 59. Truckers carrying agricultural commodities in the area are com- petitive, and operating cost savings should be passed on to shippers in the form of lower tariffs. Larger farmers, who hold over 40 percent of the land in the Guayape Valley would benefit the most initially since they are geared to commercial production. However, there are many small holders in the valley (under 50 ha), and recent (1976) figures indicate that progress on land reform is being made there. Sixty-six agrarian reform settlements with about 1,400 families have been established. Depending on how far the policy is carried out, more peasants are likely to gain control of valley land, and the implementation of a rural development project will enable them and existing small holders to increase their share in the benefits of the road. Since agricultural trucking benefits are estimated at 53 percent of the total benefits of the civil works investment, progress on land reform and the development of a project for the valley will be important determinants of the distribution of benefits from the project. Maintenance Investment 60. Based on an analysis of the entire road network, it has been deter- mined that the level of maintenance expenditure in Honduras is not sufficient to keep the current road network at a reasonable standard, and premature re- construction and high vehicle operating costs have been the result. Consi- deration of the present backlog and the future net additions to the main- tenance load indicates that the current expenditures of approximately L 11.0 million per year should be stepped up to about L 19.0 million by 1979. The economic analysis carried out was designed to determine whether the expendi- ture of an extra L 8.0 million per year for maintenance would be justified, since the Bank contribution would be a part oL this increase. This stream of extra expenditures was compared only with the estimated annual savings in  - 19 - avoided reconstruction costs and yielded a benefit-cost ratio of 1.7 over a 15-year period. As is the case with most investments in an adequate mnainte- nance program, the expenditure is well justified, and the Bank contribution to the overall program would yield a satisfactory return. Studies and Technical Assistance 61. Benefits from the studies to be carried out under the project and from the technical assistance have not been quantified. These elements, how- ever, are clearly justified since they would assist the Government in deter- mining investment priorities in the subsector, in preparing a program of complementary investments for the area of influence of the road and in im- proving operations in the transport sector as a whole. Conclusions 62. The proposed road reconstruction is one of the links of the primary road network that has been developed, for the most part, during the last ten years. It will provide efficient access to one of the largest valleys in the country and to the southern part of the Olancho forestry reserve. Access from the north coast is unlikely to be completed in less than ten years, making the project road the sole outlet for products from this area. While COHDEFOR has a program under way for managing the forest reserve, the development of the Guayape Valley is less certain, and the proposed study of the valley would ensure that the Government will have the necessary information as to the practicable potential of the valley and the investments and institutions required to realize that potential. 63. The investment in maintenance equipment is a part of a larger prog- ram that is well justified economically and should be of very high priority. The loan conditions specified above (paragraphs 40-41) are designed to ensure that all actions necessary to the effectve execution of this program will be taken. The technical assistance associated with the maintenance component of the loan is designed to improve the implementation capability of the road maintenance organization. 64. The other technical assistance elements are designed to help streng- then the planning and implementation capability of MCOPT, an organization that must be improved if it is to deal effectively with the more demanding and sophisticated planning requirements of the future, and to improve operations of the local construction industry. PART V - LEGAL INSTRUMENTS AND AUTHORITY 65. The draft Loan Agreements between the Republic of Honduras and the Bank, the Report of the Committee provided for in Article III, Section 4 (iii) of the Articles of Agreement and the text of the Resolutions approving the  - 20 - proposed loans are being distributed to the Executive Directors separately. A special condition of effectiveness is the creation of a project unit within the MCOPT to administer the project (para. 45). A condition of disbursement for laboratory and workshop equipment is the improvement of facilities where they are to be installed (para. 40). 66. Special conditions of the project are listed in Section III of Annex IV. 67. I am satisfied that the proposed loans would comply with the Articles of Agreement of the Bank and with the established criteria for Third Window operations. PART VI - RECOMMENDATION 68. I recommend that the Executive Directors approve the proposed loans. Robert S. McNamara President by J. Burke Knapp  ANUEX I TABLE SA HONDURAS - SOCIAL INDICATORS OATA SHEET LAND AREA (THOU 21 ...- HONOURAS REFERENCE COUNTRIES (19t0) TlTAL 112.1 MOST RECENT AGRIC. .. 1960 1970 ESTINATE PARAGUAY DOMINICAN REP. COSTA RICA i GPN PER CAPITA (USs) 170.0 290.0 350.0 /d 350.0 380.0 560.0 ___ _....__ .. A.._..... POPULATION AND VITAL STATISTICS ............. ...................... POOULATION (RIO-YR. tILLION) 1.9 2.5 2.9 d 2.2 4.1 1.? POPULATION DENSITY PER SQUARE KR. Ir.0 22.0 26.0 /d 6.0 83.0 34.0 'ER SQUARE KM. AGRIC. LAND .. .. 168.0 106.0 VITAL STATISTICS CRUDE BIRtH RATE PER THOUSAND 54.0 51.5 49.3 01.8 47.3 11.1 CRUDE DEATH RATE PER THOUSAND 26.5 19.1 14.6 10.8 13.1. 8.3 INFANT NORTALITY RATE C/THOU) .. .. 118.0 / 67.0 103.0 5. 62.0 LIFE EXPECTANCY AT BIRTH tYRSI 41.0 49.4 53.5 60.1 55.1 65.4 GROSS REPROOUCTION RATE .. 3.4 3.3 3.2 3.5 3.4 POPULATION GONTH RATE (t) TOTAL 3.0 2.T * 2.7 / * 2.5 /a 2.9/i I.3 JRsAN 0.3 r.9 5.0 3.4 5.6 4.r UR8AN POPULATION (Z OF TOTAL) 23.0 32.0 31.0 36.0 40.0 46.0 AGC STRUCTURE (PERCENT) 0 TO 14 TEARS 47.8 46.? 45.7 46.4 47.5 49.0 1 TO 64 YEARS 49.? 50.9 52.1 50.4 49.4 48.0 6S YEARS AND OVER 2.5 2.4 2.2 3.2 3.1 3.0 AGE DEPENDENCY RATIO 1.0 1.0 0 9 1.0 1.0 1.1 ECONOMIC DEPENDENCY RATIO 1.6/a 1.5 / 1.5/ 1.6 1.Y/ 1.6 FAMILY PLANNINGC ACCEPTORS (CUMULATIVE. THOUI .. 20.7 80.1 36.8 35.5 USERS (I OF MARRIED WOMEN) .. .. .. EMPLOTMENT TOTAL LABOR FORCE (THOUSAND) 570.0 600.0 880.0 700.0 1100.0 540.0 LABOR FORCE IN AGRICULIURE (ID 6?.0 65.0 66.0 53.0 55.5 *LO UNEMPLOYED tx OF LABOR FORCE) 6.0 8.e .. 1.5 14.0d 5.1 I/ INCOME DISTRIBUTION _ _v__.......... ___------ I 3F PRIVATE INCOME REC*0 BY- HiMBT 5% OF HDUUSSHLDS ,, 28.0 b .. 30.0 26. 3 23.0 /c HIGiiST 205 OF IDuxeis .. 60.6 .. 62.0 54.34! 50.- Lj WSST 20% OF Hl0SIEOLS 2.5