Mexico - Third Railway Project

Report No. 957a-ME Mexico: Appraisal of a Third Railway Project FILE COPY March 15, 1976 Latin America and Caribbean Projects Department FOR OFFICIAL USE ONLY Document of the World Bank 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 Currency Unit = Peso (Mex$) US$1 = Mex$ 12.5 Mex$ 1 3 US$0.08 Mex$ 1 million US$80,000 Fiscal Year January 1 - December 31 Weights and Measures Metric: British/US Fquivalent 1 meter (m) = 3.28 feet (ft) 1 kilometer (km) = 0.62 mile (mi) 1 kilogram (kg) = 2.2 pounds (lb) 1 metric ton (m ton) = 2,205 pounds Abbreviations and Acronyms AAR - American Association of Railroads ALALC - Latin America Free Trade Association CN - Constrtuctora Nacional de Mexico hacienda - Secretar!a de Hacienda, Secretariat of Finance N de M - Ferrocarriles Nacionales de Mexico PFf.EX - Petr6leos Mexicanos Presidencia - Secretar!a de Presidencia-, Secretariat of the Presidency SCT - SecretarAa de Comunicaciones y Transportes, Secretariat of Communications and Transportation SOP - Secretarta de Obras Pdblicas, Secretariat of Public Works  MEXICO FOR OFFICIAL USE ONLY APPRAISAL OF A THIRD RAILWAY PROJECT TABLE OF CONTENTS Page No. SUMMARY AND CONCLUSIONS ..................... i-iii 1.INTRODUCTION ................... .... . . ........ 1 2. BACKGROUND ... ...... .... .... 2 A. Economic Setting .........* 2 B. The Transport Sector . .2 C. Transport Coordination, Policy and Planning ............2 D. Outstanding Problems .. . 3 E. The Search for Solutions .. . 4 3. THE RAILWAY SYSTEM 5 .. .................. 5 A. Introduction ..... .. ... .. . I ... 5 B. National Railways of Mexico (N de M) .... 6 4. THE PLAN AND THE-PROJECT ........ . 8 A. The Investment Plan . . 8 B. The Project.. 9 C. The Proposed Loan . 12 D. Execution, Procurement and Disbursement . 12 EF. Ecology . .13 5. ECONOMIC EVALUATION .................... c .... 13 A. General ................ 13 B. Traffic Forecasts . .................... 14 C. Cost-Benefit Analysis ... 15 D. Overall Economic Evaluation ...... 1 6. FINANCES ... . .......... ..................... 17 A. Financial Position .... ................. 17 B. Tariffs and Costs .. .................... 18 C. Future Prospects ...... ................. 19 D. Financing Plan . ...... ..*. ............ .. 21 E. Accounts, Budget and Audit ............. 22 7. AGREEMENTS REACHED AND RECOMMENDATION ....... 23 This Appraisal Report has been prepared by Messrs. Mahendra Lal (Railway Engineer), N. Rasheed (Financial Analyst), A. Soto, H. Woltman, and R. Burns (Economists), and U. Aguirre (YP) and has been edited by Miss V. Foster. 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.  TABLE OF CONTENTS (Cont'd) TABLES 1. Current Rolling Stock Data 2. Operating Statistics 3. Investment Plan (1975-1979) to Project (1976-1977) 4. Project and Bank Loan 5. Diesel Locomotive Requirements 1975-1979 6. Freight Car Requirements 1977-1979 7. N de M Freight Traffic in 1966, 1970, 1974 and Forecast for 1976, 1978 and 1980 8. Revenues, Expenses and Net Loss 1974-1979 9. Summary Balance Sheets 1972-1979 10. Cash Flow and Financing Plan ANNEXES 1. A Review of SOP Works 2. N de M Organization Diagram 3. Staff Data - N de M 4. Property, Maintenance and Operations 5. Track Renewal Program - 1975-1979 6. N de M's Plan of Action 7. Action Program of Second Railway Project 8. Project Implementation Schedule 9. Track Maintenance Machinery - 1976-1977 10. Proposed Telecommunications Network - N de M 11. Workshop Machinery 12. Consultants' Services 13. Estimated Loan Disbursement Schedule 14. Economic Justification 15. Assumptions Used in flaking Forecast Income Account 16. Details of Financing Plan MAPS Map IBRD 3655R - Mexico Railways Map IBRD 11843 - N de M P'rincipal Traffic Routes Map IBRD 11844 - N de M Railway Track, Rail Freight Traffic Flow  MEXICO APPRAISAL OF A THIRD RAILWAY PROJECT SUMMARIY AN1D CONCLUSIONS i. The railway system of Mexico has played a crucial role in the development of the country by providing low cost transport for the bulk long-haul traffic. Mexico has relied Ipon the railways to export, mainly to the USA, its agricultural and rmineral products; to import machinery and engineering hardware for its industrial centers in Monterrey, Guadalajara and Mexico City; and to provide the means for hauling, within the country, the agricultural produce, raw materials and manufactured goods required by its industrial and population centers. ii. The implementation of the Mexican Government's plans in the agri- cultural and industrial areas, aimed at some dispersal of the economic activity in the country, has contributed to a rapid increase in railway traf- fic which is expected to grow steadily over the next few years as a result of the major expansions under way in the agricultural, steel, cement and petro- chemical sectors. iii. This report appraises a project to renovate and modernize the plant and equipment of Ferrocarriles Nacionales de Mexico (N de M), to improve its operations and to reduce the financial deficits of the railway. N de M is state-owned and is by far the largest railway in Mexico, operating 71% of the route-km and carrying 80% of the total railway traffic of the country. iv. The proposed loan of US$100 million would be the third railway loan to Mexico and the twelfth in the transport sector. Loan 103-ME in 1954 (US$61 million) was the first railway loan for the rehabilitation and modern- ization of the Ferrocarril diel Pacifico. The second railway loan, 825-ME in 1972 (US$75 million), was made to finance a project aimed at strengthening N de M's competitive position through equipment modernization, operating improvements and a progressive reduction of its financial deficits. Seven highway loans totaling IfS$266.8 million have so far been given to Mexico for construction of highways, toll roads and bridges, one loan (US$20.0 million) for the ports and one loan (US$25.0 million) for regional airports. v. The second railway loan (to N de 14) enabled the railway to renovate its track, to acquire new rolling stock, to make a start toward a modern telecommunications network and to generally improve its financial condition by focusing attention on the need for tariff adjustments and reduction of passenger train deficits. Although substantial improvements were made both in the operations and financial condition of the railway, much remains to be done to enable N de O` to carry the increasing volumes of traffic and to achieve financial viability.  - ii - vi. The proposed loan to N de M, which would be a logical followup of the Second Railway Project, aims at: further improvements in the areas where a beginning was made in the second project. The proposed project combines the 1976-1977 portion of a Five-Year Investment Plan for 1975-1979, prepared by N de M and modified in accordance with Bank recommendations, with a Plan of Action prepared in collaboration with N de M. Investment will be mainly for the acquisition of more rolling stock and motive power to enable N de M to carry the increasing traffic and to reduce its dependence on foreign cars, the improvement of track and bridges by providing heavier rails in keeping with the heavier rolling stock, and the installation of the VHF/UHF tele- communications network and the car zontrol system to improve the railways' communications and control systems. Improvement and expansion of yards, stations, and other facilities and consulting services to assist N de M in carrying out the proposed improvements are also included. vii. The Plan of Action focuses attention on the reduction of operating costs by the improvement of locomoti.ve and car utilization; on control over the staff employed by better organization and by preparation of a long-term manpower plan; on adjustment of freight rates and fares in keeping with the rise in costs and on the reduction and rationalization of passenger and other unremunerative services to reduce operating losses. During negotiations, agreement was reached on the implementation of the Plan of Action. viii. The financial situation of N de M has been deteriorating, and the operating ratio increased from 148 in 1972 to 173 in 1974 against the Second Railway Project target of 127. In 1974, freight revenues failed to cover even the long-run variable costs. The loan agreement for the Second Railway Project called for an increase of freight rates by early 1974, but this was delayed until January 1975. The main reasons for the delay were: (a) that the Govern- ment wanted to apply common tariffs across the entire railway system with a revised rate structure which would cover at least the variable cost of railway operations and (b) that the Government was concerned about the slowdown of economic growth in Mexico. However, the tariff increases in January 1975 were substantial and not only covered the variable cost but also contributed toward fixed costs. As a result, the financial situation improved in 1975, and the operating ratio was 136 as against the target of 130. ix. The passenger services are operating at low fares and occupancy ratios. In 1974, the passenger revenues were only 5% of total revenues but 22% of the variable cost. This poor situation has long been noticed. In February 1975, although there was some increase in passenger fares, this was totally inadequate to solve the critical financial situation of passenger services. The second project called for N de M to submit to the Government a program for curtailment of passenger services and fare increases, or com- pensation for losses on uneconomic services which would otherwise have been avoided. Out of some 54 intercity passenger train services, N de M discontinued 14 in 1974 and received approval from the Government to discontinue or modify  - iii - 10 more services in 1976. Considering the difficulty around the world of eliminating uneconomic passenger trains and the recent favorable position of railways in relation to other modes resulting from the energy crisis, the action taken so far by N de M is satisfactory. N de M will also review each year the financial condition of the remaining passenger trains with the objective of reducing, progressively, their financial deficits. The Government will grant specific compensation to N de M for uneconomic passenger trains which will continue to operate for social reasons. x. The financial projection for 1975-1979, based on forecast traffic increases, the tariff increases of 1975 and the Investment Plan, indicates that there will be a gradual improvement in the financial situation. The operating ratios will improve from 136 in 1975 to 110 in 1979. N de M should be able to obtain sufficient revenues to cover, by 1983, all operating costs and interest on debts and, by 1986, all operating costs and debt service charges. It is, nevertheless, crucial to the attainment of financial viabil- ity that N de M and the Government take all necessary action, including increases in tariffs, to cover rises in costs, particularly staff costs, due to inflation. xi. The total estimated cost of the project, including contingencies, is US$576 million equivalent, with a foreign exchange component of US$253 million. The proposed loan of US$100 million will finance about 40% of the foreign exchange cost. Included in the foreign exchange cost of the project and in the loan will be the purchase of rails and some track machinery, the VHF/UHF telecommunications equipment, consultants' fees, and the components for local construction of about 5,300 freight cars; these components will be procured through international competitive bidding in accordance with Bank guidelines. The cars will be built by Constructora Nacional (CN), the state- owned railway car construction company, in line with optimum utilization of its existing capacity. All goods financed under the proposed loan would be acquired on the basis of international competitive bidding in accordance with the Bank's Guidelines on Procurement. Local bidders would be granted a margin of preference by adding 15% (or the applicable customs duties, which- ever is lower) to the CIF value of the foreign bids. For the important pur- chases outside Bank financing, N de M proposes to arrange bilateral financing for items such as locomotives and mail/passenger cars. xii. The economic rate of return would be at least 17%. The main economic benefits would be derived from greater traffic carried at reduced cost, the decrease of railway operating costs and the avoidance of costly diversion to road of freight traffic. Because not all benefits could be easily quantified, this is a conservative estimate, and a higher return can be expected. xiii. The project would provide a suitable basis for a Bank loan of US$100 million for a term of 25 years, including a four-year grace period.   MEXICO APPRAISAL OF A THIRD RAILWAY PROJECT 1. INTRODUCTION 1.01 The Government of Mexico and the Ferrocarriles Nacionales de Mexico (N de M) have asked the Bank for assistance in financing N de M's investments during 1976 and 1977, estimated at Mex$ 7,201 million (US$576 million equivalent). 1.02 The technical, economic and financial analyses of this report deal with N de M's Plan of Action for its operational and financial rehabilitation and with the 1976-1977 portion of its Five-Year 1975-1979 Investment Plan, which forms the basis of the proposed project. The project for 1976-1977 includes the expenditure of Mex$ 7,201 million (US$576 million), of which the proposed loan would contribute US$100 million. The consultants, TOPS On-Line, USA, have been studying the problems of N de M since 1972. The implementation of their recommendations has already produced several improvements in the railways' working and has prepared the way for detailed action plans, described in this report. 1.03 This would be the third railway loan to Mexico. The first loan (103-ME) of US$61 million for the rehabilitation and modernization of the Ferrocarril del Pacifico was made in 1954, and the works were completed successfully in the late fifties. The second loan (825-ME) of US$75 million for the modernization of N de M was made in 1972 and is progressing satis- factorily within the estimated costs, except for the telecommunications pro- gram and rails - the former on account of a redefinition of the telecommuni- cations package and the latter due to a rise in the price of steel rails following the oil price increases. The telecommunications portion of the project was redefined since N de M decided, in consultation with and on the advice of TOPS On-Line, in favor of a modern telecommunications system com- prising VHF and UHF radio instead of a mere reconditioning of the old open wire system (para. 4.09). The preparation of the specifications and tender documents for the telecommunications package, and the bidding, procurement and installation of the new equipment have caused the closing date of the second railway loan to be extended from December 31, 1975 to June 30, 1977. 1.04 The second railway loan has helped N de HI to renovate its track, to acquire new rolling stock and to make a start toward a modern telecom- munications network. The proposed third railway loan is intended to pursue this trend, with improvements in track, operations, and telecommunications systems and with the procurement of more rolling stock to increase N de M's capacity and to improve its financial viability. 1.05 This report is based on (a) N de M's Investment Plan for 1975-1979; and (b) the findings of the appraisal mission of April-May 1975, consisting of Messrs. J. Kesson (Consultant), A. Soto (Economist), N. Rasheed (Financial Analyst) and Mahendra Lal (Railway Engineer); it has been edited by Miss V. Foster.  -2- 2. BACKGROUND A. Economic Setting 2.01 The demand for intercity transportation in Mexico is derived not only from growth in production and consumption but also from the spatial dis- tribution of economic activity. Among the more relevant facts for transporta- tion is the dominance of the Mexicc City Metropolitan Area as a traffic generator. Out of an estimated 1975 national population of 60 million, almost 10 million reside in the Mexico City Area. The only other cities with a population in excess of one million are Monterrey and Guadalajara, with approximately 1.7 million each. With 17% of the national population and 42% of the national manufacturing employment, the spatial distribution of pro- duction and consumption is highly skewed toward the capital city, and the transport network has been constructed to serve the existing pattern of flows. Policies have been designed to discourage further concentration in the national capital and to overcome the momentun built into the present spatial order. Low cost rail transportation will, among other factors, be important to the achievement of the long term objective of more even dispersal of economic activity throughout the country. B. The Transport Sector 2.02 The Mexican transport system followed the classical pattern of development. The railway era of 188I0-1910, during which the bulk of the system was constructed, was financed largely by foreign investors interested in exploiting the mineral and agricultural resources of the country, and the current rail system continues to cater to the movement of bulk agricultural and mineral products as well as a substantial amount of industrial products. The route length of the railway network has changed very little since 1910, but investments have been made in the upgrading of track, motive power and rolling stock. Rapid growth of the road system from 1930 on has duplicated major routes and extended the transport network to areas not served by rail. Because Mexico's modern development has been basically inward-looking, port requirements for foreign trade have been relatively modest; nevertheless,: significant port improvements have been made. Exploitation of the nation's petroleum resources has generated a large coastal traffic in petroleum and its products, and a much larger development of pipeline transportation. A growing middle class and expanding foreign tourist trade have fed the growth of air transportation. Mexico now has 20,000 km of railways; 122,000 km of paved and graveled roads; 37 public ports, of which 11 have some commercial significance; 84 commercial airports, of which 43 can handle medium or larger jet aircraft; and over 12,000 km of gas, oil and petroleum product pipelines. C. Transport Coordination, Policy and Planning 2.03 Federal (primary) highways are planned, built and maintained by the Secretariat of Public Works (SOP), except that toll roads are operated and maintained by an independent agency. SOP also has a controlling influence on state and local roads through its participation in their financing and planning.  The Secretariat of Communications and Transportation (SCT) has an advisory role in highway planning, and it is responsible for the regulation of common carrier highway transportation. To date, these regulations have not prevented the development of a highly competitive trucking industry. 2.04 The two largest railways (Nacionales and del Pacifico) are auto- nomous Government Agencies (para. 3.02) and have played an important role in the transportation system of the country; the other three railways are operated by a Directorate of SCT under general managers appointed by the Secretary of Communications and Transportation. There has been considerable railway unification (there were 11 companies in 1964), and progress continues to be made in this direction. Major railway construction projects are de- signed and built by SOP in collaboration with the railways and SCT. 2.05 Three separate departments within the Secretariat of the Navy (Marina) are respectively responsible for planning and building port works; construc- tion and maintenance dredging; and operation and maintenance of the ports, except for cargo handling, which is managed by recently established "empresas," owned jointly by port workers and the Government, or by independent unions. 2.06 Airports are operated by Aeropuertos y Servicios Auxiliares (ASA), an autonomous Government agency. Airport construction and major maintenance are performed by SOP. Airport planning appears to be dominated by SOP, although other agencies, including SCT, participate. The two trunk airlines are roughly of equal size: one is a Government enterprise and the other a private operation. 2.07 Like other major oil companies throughout the world, PEtEX, the state petroleum company, is a major transportation agency in its own right, with a tanker fleet, pipeline, tank trucks, and railway cars. 2.08 Regulation of transportation tariffs is formally under the juris- diction of the Department of Tariffs of SCT, but tariff decisions are usually politically determined at higher Government levels. D. Outstanding Problems 2.09 While the present transport system is a major acihievement, it is not without problems. Uneconomic railway passenger services have been heavily subsidized, while urgent requirements for additional freight cars have, until recent years, gone unsatisfied. Selective railway capacity expansion should be accompanied by improved operations, rational and timely pricing of services, and abandonment of uneconomic services. Further trunk highway construction will be needed, especially in the south and east, but Lhe future emphasis must be placed upon maintaining and strengthening the existing trunk system and supplementing it with secondary and tertiary roads. A rational road user charge policy is needed: at present, for example, there is no user tax on diesel fuel, the fuel most used by intercity truckers and bus operators. There is overcapacity in most of the smaller ports, and, in some of them, no reasonable level of ship or shipper chargec can cover current depreciation expenses. Expansion or modernization of a Lew major ports will be required  - 4 - to handle an expected increase of foreign trade, but, in general, stress needs to be placed on avoidance of uneconomic investments and on substantial improve- ments in operating and financial performance. Airport investment and pricing policy should question the present degree of cross-subsidization and whether extensions of it are warranted by social benefits. Finally, the problem of national coordination of transport investments and policies must be mentioned, since a rational approach to the problems of the transport sector is at least partially dependent on a larger view of national transport needs. E. The Search for Solutions 2.10 The problems outlined above are well known from previous Bank appraisals. The rail passenger deficit is a serious drain on public resources. A major objective of Bank lending for railroads in Mexico is to bring this deficit under control. The issue of road pricing has recently been addressed in an ambitious study of road user charges, financed under the Second Railway Project and about to be completed by the SCT. Preliminary findings indicate that, although the road user charges, as a whole, largely cover construction and maintenance of the urban and inter-city road network, diesel-driven trucks are receiving a substantial subsidy. Discussions of the findings and recommen- dations of the recent study will take place in the near future. A major objec- tive of Bank lending for ports is to curb the excesses in new port developments and to improve the operations and financial performance of existing ports. The possibility of embarking on major new investments in any mode without careful consideration is always a danger, especially when the primary transport network configuration is nearing maturity, as Mexico's is. Consequently, the Bank has insisted that it be advised of any major construction projects in modes receiving Bank support. 2.11 The problem of national transport policy is complicated by the existence of various, poorly coordinated government organizations (paras. 2.03- 2.08). Nevertheless, some progress has been made recently. Within the ports sector, the National Ports Coordination Commission has been established to harmonize the port activities of the Government and the other entities involved in port operations and to produce a national port development plan. An avia- tion subgroup with similar objectives has been added to the inter-agency Trans- port Coordinating Committee within the Secretariat of the Presidency. The Transport Coordinating Committee itself is a recently established group in which all Government agencies normally interested in transportation are repre- sented at the Ministerial, Director General, and working levels. Its coordi- nating function is advisory and largely concerned with reviewing and seeking inter-agency consensus on specific short-run transportation problems, includ- ing budget plans of the transportation enterprises and agencies. The Planning Directorate of SCT has been strengthened and given responsibility for a long- range national transportation plan. Since all these efforts, most of which were initiated with Bank support, are relatively recent, their effectiveness is just beginning to be felt in the field of transport planning and coordina- tion.  - 5 - 3. THE RAILWAY SYSTEEi A. Introduction 3.01 N de M is the largest of the five separate state-owned railways; their extent is indicated below and shown on Map IERD 3655R. Route - Km Standard Narrow Total Z Gauge Gauge (1.435 m) (0.914 m) Autonomous Operation Nacionales de Mexico 13,583 440 14,023 71 Del Pacifico 2,284 - 2,284 11 SCT Lines Chihuahua al Pacifico 1,515 - 1,515 8 Sonora-Baja California 539 - 539 3 Unidos del Sureste 950 420 1,370 7 Total 18,871 860 19,731 100 3.02 N de M and del Pacifico are autonomous Government agencies. Both are managed by the same General Manager and have Boards of Directors repre- senting the various Secretariats, the Chambers of Commerce and the Union of Railway Workers. The other railways are operated as a Directorate of the Secretariat of Communications and Transport (SCT) and are controlled by General Managers appointed by the Secretary of Communications and Transport, who also acts as Chairman of the Board of all Government railways. Through the SCT, the Government controls safety and engineering standards and tariffs of all railways. 3.03 The Sectoral Planning Directorate of SCT, in its capacity as coordi- nator, examines the long-term investment plans of N de M, but approval of the investment budgets is given by the Presidencia and the Hacienda. The Railway Directorate in the SOP has separate annual budgets for major construction works, such as new railway lines, realignments and regrades, which, on completion, are handed over to N de M for operation. There is good coordination between N de M, SCT and SOP on the broad planning, and on technical standards used; there is also agreement that any item likely to involve considerable interference witih N de M's daily traffic operations shall be carried out by N de i1 and included in the N de M budget. Each project is examined by SOP with regard to techni- cal, financial and economic considerations, and a minimum rate of return of 12% is required. However, during negotiations, it was agreed that the Govern- ment shall, during the period covered by N de M's Investment Plan, and before  - 6 - undertaking any investment in new projects for the railways estimated to cost more than US$10 million equivalent in any one year, afford the Bank a reason- able opportunity to review and comment upon the feasibility studies for such investment. This is necessary since new projects without adequate economic justification can adversely affect the financial viability of N de M. A re- view of SOP works in progress and proposed for the coming years is given in Annex 1. B. National Railways of Mexico (N de M) (i) Management, Organization, Staff and Training 3.04 The present organization diagram is given in Annex 2. The manage- ment of N de M is competent. Under the General Manager, the Deputy General Manager is in effective charge of the operating departments, with other de- partments such as staff administration, finance and planning reporting direct- ly to the General Manager. One of the weaknesses of the system, however, has been the division of the railway into 17 districts with the various depart- ments in each district supervised by the different heads of departments under the Deputy General Manager. This ratlher strong vertical and departmental division of responsibility and managernent often led to lack of coordination at the district level and is now being remedied on the advice, and with the aid, of the consultants TOPS On-Line. The earlier 17 districts have been regrouped into four regions, each under a regional manager, to ensure better control and coordination and improved liaison with headquarters. 3.05 Staff data are given in Annex 3. Staff has increased to keep pace with the increase in traffic, and the total number of full time regular employees rose from 59,000 in 1970 to 63,263 in 1975 (against 59,000 through to 1976, as agreed to in the Plan of Action for Loan 825-ME). However, the increase in traffic during this period has been phenomenal and, at 50.1 mil- lion tons in 1974, far exceeded the expectations of the second loan appraisal mission of 47.3 million tons for 1976. In terms of ton-km, it was expected that N de M would carry 21.26 billion ton-km in 1974, whereas the actual traffic in 1974 was 25.45 billion ton-km and is expected to reach 29.63 bil- lion ton-km in 1976. The productivity per man in terms of traffic units has actually improved from 375,000 units in 1970 to 459,242 units in 1975, a figure which compares favorably with the productivity of more advanced rail- way systems. However, N de M should be cautious in making further increases in staff to ensure that the effect of the operational improvements foreseen in the proposed project, on the one hand, and the increase in traffic, on the other, are carefully weighed before any projections are made for the staff required for the future. 3.06 N de M has a large training establishment (Instituto de Capacitacion), which provides training programs at the main railway centers and by means of miobile schools and correspondence courses for (a) maintenance and track struc- tures; (b) operation of stations, yards, trains and locomotives; (c) mainte- nance of diesel locomotives and rolling stock; and (d) general administration, including middle and top management training. Although the training establish- ment is well organized and the training courses are managed competently, the U -oes not have a modern recruitrment and training scheme, and there is  - 7 - need for modernizing both the recruitment and training practices in order to keep in step with the new systems and equipment being introduced on the railway. 3.07 As part of the Plan of Action (para. 4.01), N de M agreed to prepare and submit to the Bank for comments, not later than June 30, 1977, a manpower plan which will include, inter alia: (a) the departmental distribution of manpower year by year up to 1980 in accordance with the improvements in the operations of N de M as set forth in N de M's Investment Plan and Plan of Action; (b) a scheme for the solution of the problem arising from over-aged personnel and for the long-range financial burden of pensions; and (c) a scheme for the improvement of recruitment and training standards for the staff of N de M. (ii) Railway Property 3.08 N de M operates approximately 14,CO route-km of railway: main traffic routes total about 7,600 km (Map IBRD 11843), and, on these, N de M is proceeding with a program of renewal, using heavy rail, concrete sleepers, welded rail joints and new stone ballast, to give a good standard of track to take the increasing traffic and heavy axle load locomotives and freight cars now in use. Secondary lines are being renovated using released rail, while arrears of timber sleepers and stone ballast replacements are being made good on these and other lines. The main routes between the Mexican sea- ports and the central highlands were built in the 19th century with steep gradients and sharp curves which now present operating and maintenance problems under progressively increasing gross tonnage of traffic. Proposals for regrad- ing and realigning such sections are being investigated jointly by N de M and SOP. Track maintenance, especially on the renovated tracks, needs to be improved, and this will be done by a program for the provision of mechanical aids and the regrouping of the labor forces. Further data regarding N de M track and property are given in Annex 4, and information regarding the relay- ing programs in Annex 5. 3.09 A short section of line, about 100 km, on one of the steep hill sections is electrified; otherwise, the system is wholly diesel operated. There are nine electric locomotives, 1,014 diesel locomotives and 40 diesel railcars; 261 locomotives, a large number of which are of small horsepower, are to be withdrawn for scrapping on an age/condition basis during the period 1975-1979, and 299 locomotives are to be purchased during this period, which, for reasons of standardization, will be confined to the GE/GM brands. The freight car fleet of 26,262 units is relatively modern and of good design. About 2,000 units are 40 or more years old and are to be withdrawn for scrap- ping at the rate of some 400 cars per year. About 5,500 freight cars are presently on order for delivery in 1975-1976. To cater for the increase in traffic forecast, new cars are proposed for ordering at the rate of approxi- mately 2,500 per year from 1976 througlh 1979. Of the passenger cars, total- lin- 1,390, on the standard gauge tracks, about 640 are 30 years old or more and are unsatisfactory for service and maintenance. N de M is replacing 176 of these during 1975-1976. The maintenance of locomotives and of a large propor- tion of the car fleet has been reorganized and improved (with the assistance of TOPS On-Line) during the past three to four years, and the percentage of  - 8 - rolling stock out of commission shows a promising trend. This work must be continued, and particular attention will need to be paid to the introduction (a start has already been made) of a scheme for maintenance of cars on a program basis. Details of the locomotive and rolling stock fleet are given in Table 1. (iii) Operations 3.10 The most important operating statistics are given in Table 2. Freight traffic increased from 38._3 million tons in 1970 to 44.1 million tons in 1973 and to 50.1 million tons in 1974. Freight train loads increased, with the introduction of higher horsepower diesel locomotives, from 931 net tons in 1970 to 1,168 net tons in 1974. There was also an increase in average car loads from 39.3 tons in 1970 to 47.6 tons in 1974. However, freight car turnaround time deteriorated from 13.9 days in 1970 to 19.2 days in 1973. Although there was some improvement in turnaround time in 1974, an analysis of wagon time indicates that detentions in terminals and intermediate yards have increased considerably. Some measures have already been taken to tighten up control of wagons in yards, and the introduction of the PICL System (Perma- nent Inventory Control of Car Location) at Valle de Mexico is a step in the right direction. This system is to be extended to other yards. The start of unit and through trains, introduced after careful planning, has also increased wagon utilization since iron ore, limestone, petroleum products and other minerals are now being carried in unit trains working to timetables. 3.11 Locomotive and car availability has improved on account of better maintenance, and locomotive utilizalion has also improved; the average loco- motive-km per diesel locomotive increased from 89,800 per year in 1970 to 97,600 in 1974. It is expected that, with the increase in the number of unit and through trains and with the improvement in telecommunications facilities, there will be further improvements in locomotive and car utilization. These projected improvements were taken into account in determining the requirements of additional rolling stock for meeting the demands of increased traffic in future years. (iv) Signal and Telecommunications 3.12 The existing telecommunications system is quite antiquated and, except for the comparatively small sections worked by Centralized Traffic Control (CTC), trains are operated on the train-order system, and the rail- way has no signals. This has necessitated the proposed installation of VHF and UHF radio systems, together with the required exchanges and tele- printing equipment (para. 4.09). 4. TEE PLANI AN:) TlHE PROJECT A. The Investment Plan 4.01 Based on the forecast of traffic, on the anticipated operational improvements as set out in the Plan of Action (Annex 6), and on a program of  rehabilitating and improving parts of its track, rolling stock and associated assets, N de ItI has prepared an Investment Plan for 1975-1979 which is set out in Table 3. This plan continues and supplements the plan originally prepared for 1972-1976, of which the Bank financed the 1972-1973 portion under the Second Railway Project. Total investment in the 1975-1979 Plan is estimated at Mex$ 17.5 billion (US$1,401 million equivalent) with a foreign exchange com- ponent of Mex$ 7.0 billion (US$560 million). It was agreed during negotiations that N de M will implement the Plan of Action and will carry out all itermls of the Investment Plan and will make no additions or new investments over US$20 million without consultation with the Bank. 4.02 Cost estimates for the Investment Plan are based on prices at the beginning of 1975. Local material, labor and contract data for similar work carried out on N de M have been used where appropriate. Recent quotations for imported material and equipment to Mexico and elsewhere have been reviewed and utilized. Physical contingencies have been taken at 5% only when the quantities/works are not clearly defined. Price contingencies on local items have been taken at 17% for 1975, 15% for 1976, 12% for 1977 and 10% for the years 1978-1980. On foreign material and equipments, contingencies have been provided at 12% for 1975, 10% for 1976, 8% for years 1977-1979 and 7% for 1980. Overall, the price contingency element allows for cost increases during 1975- 1979 averaging 30%. 4.03 A detailed evaluation of the progress in the implementation of the previous Plan of Action for the Second Loan (825-ME) is given in Annex 7. Operating performance of the railway improved, and the freight rate increases of 1975 helped to better its financial position. Passenger fare increases were inadequate, and, clearly, much remains to be done in this area. However, the Second Railway Loan achieved its objective of improving the railway's working by renovating its track, adding rolling stock anid motive power, and, above all, by focusing attention on the problems of freight rate increases and unremuner- ative passenger services. B. The Project 4.04 The project combines the Plan of Action with the 1976-1977 portion of N de M's 1975-1979 Investment Plan. The cost estimates are detailed in Table 4 and are summarized below:  Project Proposed Loan Local Foreign Total Amount % of Loan -------------- (in US$ Million) ------------- Track and structures 52.9 39.6 92.5 30.0 30% Signalling and telecommunica- tions 16.5 25.5 42.0 15.0 15% Construction works 42.2 0.2 42.4 - - Locomotive and rolling stock 132.1 154.9 287.0 30.0 30% Consulting services 2.2 0.8 3.0 0.6 0.6% Sub-total 245.9 221.0 466.9 75.6 75.6% Contingencies - physical 7.8 4.5 12.3 3.3 3.3% - price 69.6 27.3 96.9 21.1 21.1% Total 323.3 252.8 576.1 100.0 100% 4.05 The objectives of the project, together with the Plan of Action, are: (a) to enable N de M to cope with the increasing traffic it is required to carry by the improvement of its operating efficiency, the rehabilitation of its track, the modernization of its telecommunications system and the acquisi- tion of urgently needed rolling stock and machinery; and (b) to achieve finan- cial viability by a gradual reduction of its operating deficits. 4.06 A brief description of the main items of the project is given below, and a Project Implementation Schedule is included in Annex 8. (i) Track and Structures 4.07 N de M has in hand a program of (a) complete track renewal on prin- cipal traffic lines, (b) partial replacements using recovered rail on secondary lines, and (c) making good arrears in replacing timber sleepers and stone ballast on other lines. The track renewal program for 1975-1979, as proposed by N de M, after amendment in agreement with the mission, is set out in Annex 5 and illustrated on Map IBRD 11844. During 1976-1977, N de M proposes to renew about 660 km of track with rnew rail, to renovate 400 km with second- hand recovered rail and to continue its program of replacing wornout sleepers and of reballasting wherever required. Also planned is the provision of various items of track machinery and equipment to accelerate maintenance and track renewal works in order to improve the standards of maintenance, to maximize sectional capacity and to make the track suitable for the increased traffic requirements. The proposed equipment is listed in Annex 9. 4.08 Several bridges on the railway system are not strong enough for the load imposed by the new locomotives and freight cars, and the Investment Plan provides for the strengthening and renovation of such bridges to remove capacity constraints. Sidings at stations, terminals and intermediate yards are also being enlarged or remodeled to enable longer and heavier trains to operate.  - 11 - (ii) Signalling, Telecommunications and Electrical Supplies 4.09 During the Second Railway Project, N de M decided, on the advice of the consultants TOPS On-Line and in agreement with the Bank, to provide a new VHF/UHF radio communications system instead of renovating the existing open wire system; a detailed plan was consequently drawn up for a VHF/UHF radio system, which, in conjunction with SCT's microwave network, would provide a modern telecommunications network for the system. Bids were received by N de M in April 1975, and contracts were awarded for the VTF equipment to Motorola (USA) and for the UHF equipment to Nippon Electric (Japan). An agree- ment was also made with the labor union to ensure that the new system would be introduced without any difficulties. Part of the work was included in the Second Railway Project. It is intended that the foreign exchange cost of the remaining items be financed from the proposed third loan. Details of the pro- posed telecommunications system are given in Annex 10. The proposed system would provide a basis for much needed improvements in operation and for the modern, computer-based car control system included in the project. In addi- tion, CTC facilities would be extended to cover more high density sections, and the existing communications equipment in workshops, stores, terminals and yards would be replaced by modern equipment more in line with the overall improvements in the communications network. (iii) Construction Works 4.10 Provision is made for earthworks, drainage and other services required for station, terminal and marshalling yard extensions, for building works in connection with additions to workshops, station buildings, goods depots, and offices, and for housing facilities for N de M staff (mainly for the regrouping of track maintenance staff with mechanization staff). Allowance is also made for hospital and staff welfare facilities, which N de M is required to provide under Government and labor contract require- ments. (iv) Locomotives and Rolling Stock 4.11 The project includes the purchase of about 124 new diesel locomotives (Table 5), ranging from 2,000 to 3,600 HP, and about 5,800 freight cars. These new freight cars are intended not only to meet the demands of increased traffic but also to cover the scrapping of old and obsolete units and to reduce the utilization of foreign cars to a reasonable level (Table 6). In addition, N de M is obtaining 30 mail vans and 176 passenger coaches under contracts recently placed in Switzerland and Canada, mainly to replace over-aged units. It is also proposed to purchase breakdown cranes required to deal with derail- ments and accidents to the heavier locomotives and cars now in service. 4.12 For the workshops and service depots, additional machinery and equipment are to be procured to improve efficiency (list in Annex 11).  - 12 - (v) Consulting Services 4.13 N de M plans to utilize local consultants to assist in the design and preparation of documents for its bridge strengthening, general works construction and operational improvement programs. Provision is also made for consultants to continue technical assistance as part of the project in the areas of telecommunications and car/train control systems (Annex 12). C. The Proposed Loan 4.14 A loan of US$100 million is proposed to finance about 40% of the foreign exchange cost of the project. The items proposed for financing wfould include: (a) Rails - 76,000 tons of 115 lb/yd (para. 4.07); (b) Track maintenance equipment (para. 4.07); (c) VHF/UHF communications system, second part (para. 4.09); (d) Imported components for 5,300 cars for local manufacture (para. 4.17); (e) machinery and equipment for workshops (para. 4.12); and (f) Consulting services (para. 4.13). The above items have been selected mainly because they are suitable for inter- national competitive bidding and because N de M does not have other sources of finances for them. D. Execution, Procurement and Disbursement 4.15 N de M, assisted by consultants, will carry out the project. All goods financed by the proposed loan would be procured through international competitive bidding, under which suitable goods produced within Mexico would enjoy, as usual, a margin of preference of 15% on CIF prices or the prevailing customs duty, whichever is lower. 4.16 For the VhF/UHF and associated communications equipment (para 4.09), part of the foreign exchange cost (approximately US$10 million) will be met from the Second Railway Loan (825.-ME), with the balance to be met from the proposed loan. Funds from Loan 825-ME will be adequate to meet payments through 1976, and, thereafter, the provision made in the proposed loan would finance the balance. 4.17 The freight cars, for which components will be imported under the proposed loan, will be manufactured by Constructora Nacional (CN), a state-owned enterprise which operates efficiently on a conmmlercial basis and produces good quality cars. Under the Second Railway Project, this enterprise secured the contracts not only fcr the cars reserved for manufacture within the country but also for the cars tendered through international bidding. CN's factories have the capability to produce 3,000 to 3,500 cars per year; therefore, the Mexican Government and N de M have requested, in keeping with the Government's policy of utilizing the optimum installed capacity, that 5,300 cars be purchased  - 13 - from Constructora. For these cars, the prices of which are subject to adequate Government control, the imported components will be financed by the Bank. The components, which are estimated to cost 18% of the price of the cars to be manufactured by Constructora, will mainly comprise some steel sections, door fittings, brake equipment, roller bearings, and axles, and will be purchased by international competitive bidding (ICB). 4.18 At the same time, Mexico is a member of the Latin America Free Trade Association (ALALC) and has negotiated preferences for the importation of lists of products originating in member countries of ALALC. Should offers be submitted in international tenders from suppliers in ALALC countries, they would be awarded a preference of 15% or the difference in tariffs applied to goods from within the ALALC countries and other external suppliers, which- ever is lower. 4.19 For imported goods, disbursements would be made on the basis of CIF costs and, with respect to bids won by local suppliers under ICB disburse- ments, would be made on the basis of 100% of the exfactory costs. The Bank would also finance 100% of the foreign exchange cost of consulting services. Any savings in the loan amount resulting from prices lower than estimated might be utilized to finance similar items in the ongoing program subject to the agreement of the Bank. Annex 13 shows the estimated quarterly disburse- ments. E. Ecology 4.20 The project does not envisage the construction of any new lines or the acquisition by the railway of any equipment or machinery that would contribute signficantly to the pollution of the environment. 5. ECONOMIIC EVALUATION A. General 5.01 The sustained growth of the Mexican economy in the period from 1940 to 1970 was supported by the existence of a railway system which provided adequate capacity, at very low cost, to the increasing traffic volumes. N de M, by far the largest railway carrier, has played a crucial role in facilitat- ing the export and import of goods to the country and in connecting the various internal production and consumption centers. The prospects for continued growth in the economy of Mexico depend partly on the success of the Govern- ment's efforts to strengthen the agricultural and industrial sectors, to promote exports and to encourage spatial decentralization in the country. In achieving these objectives, the transport sector, particularly the railways, has an important role to play. Accordingly, the Government has placed in- creasing emphasis on strengthening and modernizing the railway system, espe- cially N de M. 5.02 Revenue from freighlt tonnage on all railways increased at the rate of 5% per annum from the latter half of the 1960's to 1974. There has been  - 14 - a higher rate of increase of freight ton-km; for N de M, traffic grew from 11 billion ton-km in 1961 to about 25 billion ton-km in 1974, or at about 6.5% per annum, reflecting an increase of the average haul from about 440 km in the early 1960's to more than 500 km in 1974. As a result, N de M, for the first time, faced capacity problems to meet existing demand. Passenger traffic on N de M fluctuated from 34 million passengers and 3.1 billion pass-km in 1966 to a high of 35 and 3.5, respectively, in 1969, and to a low of 25 and 3.1, respectively, in 1974. This entails an average decrease in the number of passengers of 3.8% per annum in the 1966-1974 period; pass-km have not decreased, on average, reflecting an increase in average distance traveled from 91 km in 1966 to 124 km by 1974. Very generally, there are major movements of food, domestic and imported raw materials, and consumer goods into the densely populated central region (the temperate south central portion of the interior plateau centering on Mexico City), and outward movements of manufactured products to all parts of the country and for export. In terms of ton-km, about 30% of the traffic comprises mineral products (mainly iron ore), another 30% industrial products, about 20% agricultural products (mainly corn, wheat and sorghum), and the remaining 20%, inorganic, petroleum and miscellaneous products (Table 7). The heaviest trafficked corridors include the Mexico-San Luis Potosi-Monterrey-Nuevo Laredo lines (US border), the Mexico-Guadalajara Manzonillo lines (Pacific Ocean port), and the Mexico- Veracruz line (Atlantic Ocean port:). B. Traffic Forecasts (i) Freight 5.03 Freight traffic is expec:ted to grow between 1975 and 1980 at a faster pace than hitherto as a result of major expansions under way in the steel, cement and oil sectors. A number of steel plants are doubling their existing capacity, and a new one (Las Truchas) is being built, including the construction of a new railway line to connect it with N de M's network. Sizable expansions are also contemplated in the cement industry. The share of oil products moved by N de M is low, and it is expected to remain low in spite of large increases foreseen in oil production because new pipelines are expected to absorb such increases. However, a number of industrial products tied to the development of the oil sector, such as fertilizers and petrochemicals, will increase their production as well; a major portion of these commodities are being transported by N de M and are expected to continue moving by rail. 5.04 N de M prepared a detailed study for 41 commodities, showing the changes in traffic volumes since 1964 and those foreseen between 1974 and 1980. Freight traffic is expected to increase by about 7.8% per annum in ton-km during the 1974-1980 period and by about 5% per annum (close to the historical long-term growth trend) thereafter. The expected traffic growth in the initial six-year period fluctuates from a low of 0.8% per annum for the group of commodities comprising petroleum products to a high of 12.7% for mineral products, which is acceptable. Iron ore and steel related traf- fic will account for 64% of the increase in ton-km. These forecasts are, to a large extent, insensitive to tariff variations since minerals, steel-related products, fertilizers and bulk cereals--which will account for about 65% of  - 15 - the 1980 traffic--constitute a captive traffic which can be carried at tariffs above long-run marginal cost. For other commodities, which are mostly of bulk type, projections have been made conservatively, assuming generally low traf- fic increases. (ii) Passengers 5.05 Forecast passenger traffic is conservatively estimated to increase moderately from 1974 to 1980. It is expected that, with a badly needed increase in fares (para. 6.09) and further canceling of several passenger trains, the decreasing trend in passengers in N de M will be compensated only by improved quality of service. It is also expected that the decreasing vol- ume of intercity traffic will be partially compensated by a moderate increase in suburban traffic in the Mexico City area. C. Cost-Benefit Analysis (i) Methodology 5.06 The economic evaluation prepared by N de M focuses on the 1975-1979 Investment Plan globally and on particular components of the Plan, whenever possible. For evaluation purposes, the Plan has been divided into six cate- gories depending on the type of investment and its economic effects (Annex 14). These categories were evaluated separately, and, from the results, an overall evaluation of the Plan was derived. Details of the methodology and the criteria adopted for the economic evaluation are given in Annex 14. Sensi- tivity analysis and first year benefits are in the same annex. Since the two- year Project is an integral part of the Five-Year Investment Plan and since most of the benefits will accrue only if the related investments in the Plan are carried out, the Project itself has not been evaluated separately. It was agreed during negotiations that N de M will carry out all items of the Investment Plan (para. 4.01). (ii) Track Renewal 5.07 The Plan contemplates the purchase and installation of new rail of 115 lb/yd on some 1,600 km of main line with a total cost estimated at Mex$ 1,600 million in 1975 prices. Second-hand rail, set free because of the installation of new rail but which has not reached the end of its useful life, will, in turn, replace wornout rail; an additional 1,000 km of line will thus be improved. In both cases, the improvements include the replacement of rails, ties and switches, after ballasting and reshaping of the embankments. An improved track will avoid delays due to speed restrictions presently existing on most of the lines being improved because of the poor state of the track; without this investment, further reductions in travel speed are expected. Sizable savings in future maintenance and renewal costs are also expected from the proposed investments. The quantification of these benefits is ex- plained in Annex 14. A separate economic analysis was carried out for each of the nine lines being improved. Based on these benefits, the above invest- ment yields a rate of return of 14% for the entire program, with individual rates of return fluctuating from 12% to 23%, which is acceptable.  - 16 - (iii) Track Rehabilitation 5.08 In spite of recent efforts in conjunction with the Second Railway Project, N de M's network still faces a backlog of deferred maintenance. Ballasting and replacement of ties and switches are included in this component of the project, as well as the purchase of track maintenance equipment, with a total investment of Mex$ 885 million. The quantified benefits include impor- tant savings in future renewal costs and in track maintenance expenditures. The proposed investment yields a rate of return of 21%, which is satisfactory. (iv) Realignments and Bridges 5.09 Although practically all civil works associated with the construc- tion of railway lines in Mexico are normally the responsibility of SOP (para. 3.03), N de M, in exceptional cases, carries out such works on its own. This is the case for the realignment of several minor sections of a number of main lines and the construction of a number of bridges, culverts and retaining walls included in the Plan. The realignments reduce transport costs by reducing the present steep grades in the corresponding sections. The new structures will increase the capacity of the corresponding main lines to carry the heavier cars and locomotives purchased in recent years. The economic returns vary from 12% to 26% for the realignments and amount to 13% for the structures. (v) Locomotives and Rolling Stock 5.10 One of the main components of the 1975-1979 Investment Plan is the program for acquisition of rolling stock and motive power, indispensable in order to meet the forecast traffic demand by 1979. Unless the proposed investment is carried out, 4.2 billion ton-km would have to be transported by truck at higher cost (details are given in Annex 14). The savings in transport costs yield a rate of return of 16% on the proposed investment. (vi) Shop Equipment 5.11 The Plan also contemplates the purchase of Mex$ 150 million worth of shop equipment and the investment of Mex$ 500 million to continue the ongoing program of rationalization, modernization and expansion of shop installations. N de M estimates that the proposed improvements should conservatively avoid a reduction in the availability of motive power and rolling stock of not less than 3% and 2%, respectively, as a result of fewer delays in the shops and smaller frequency of non-programmed repairs due to better equipment mainte- nance. On such a basis, this component of the Plan would have an economic return of 22%. (vii) Telecommunications and Signalling 5.12 The consultants TOPS On-Line have prepared an economic evaluation for the entire telecommunications package financed under the Second Railway Project (Loan 825-ME) and the proposed Third Railway Project (para. 4.09). The economic return on the total investment for the VHF and UHF communications network and for a car control system to be installed under the Third Railway  - 17 - Project is estimated at not less than 25%. The CTC system included in the Five-Year Plan for control of operations on three high density lines is expected to yield a rate of return of 35%. Details on the computation of benefits for these investments are given in Annex 14. (viii) Other Miscellaneous Investments 5.13 About 11% of the investments in the Five-Year Plan have not been incorporated into the above groups. They include the construction or improve- ment of parking lots, stations, warehouses, social facilities for staff, hospitals and health centers, and housing for laborers, in accordance with labor agreements. They have not been included in the economic analysis. D. Overall Economic Evaluation 5.14 Based on the benefits for the six groups mentioned above, which account for 89% of the proposed Plan, the Plan would yield an economic return of 17%, which is satisfactory. A sensitivity analysis indicates that, in the event of an increase in costs of 15%, the total Plan, as well as its compo- nents, would still be economically justified (Annex 14). 6. FINANCES A. Financial Position 6.01 From the time of N de M's creation in the late 1960's until late 1974, its financial position had been deteriorating. Operating deficits increased from Mex$ 1,030 million in 1970 to Mex$ 2,218 million in 1974, a net increase of 115% in current pesos. Freight rates were not increased between 1959 and 1974; passenger fares were increased once in 1970, by 30% for first class and 20% for second class. However, the increase in salaries and material prices has more than offset the financial benefits of increased fares. The income statement and the balance sheet for the years 1972 to 1974 are shown in Tables 8 and 9. The working costs have increased by Mex$ 1,542 million but the revenues increased only by Mex$ 556 million as a result of traffic increases during the 1972-1974 period. 6.02 Failure to increase tariffs deteriorated the operating ratio from 148 in 1972 to 173 in 1974 against the target of 127. The following results are observed from a traffic costing- study of 1974 N de M operations conducted by the Bank.  - 18 - -------------------- - 1974 - _-_________ Long-Run Revenues Gross Margin Variable or (Loss) Costs - --------------------(Mex$ Million)----------------- Freight 2,665 71% 2,635 89% (30) (4%) Passenger 822 22% 151 5% (671) (84%) Express 240 6% 110 4% (130) (16%) Mail and Other 34 1% 70 2% 36 4% 3,761 100% 2,966 100% (795) (100%) Total fixed costs 1,907 Total deficit for 1974 2,702 The above table indicates that, while the passenger revenues were 5% of total revenues, the variable costs were 222 of total variable cost. Further, although passenger train operations are much smaller than freight operations, the deficits created by passenger trains are the largest--about 84% of the difference between total revenues and total long-run variable costs. The chronic deficit situation of the passenger services has long been noticed, but, in 1974, even freight revenues failed to cover long-run variable costs. 6.03 The financial projection -in the appraisal report for the Second Railway Project (825-ME) assumed that freight tariffs were going to be increased in early 1974. Such increase, however, was delayed until January 1975. The reasons for delay were: (a) that the Government wanted to apply a common tariff across the entire railway system in the country in accordance with Section 3.05 of the Guarantee Agreement (825-ME) and to revise the freight rate structure with adequate classification of the commodities and conduct cost studies in order to increase rates sufficient to cover at least the long-run variable cost, as suggested by the Bank; and (b) that the Government was concerned about the slowdown of economic growth in Mexico and, for this reason, could not implement a railway tariff increase in 1974 as it did in other public utility areas such as water, electricity, and gas. It maintained that tariffs could not be increased for all these essential inputs at the same time. Therefore, tariffs were increased only in January 1975 (para 6.04) and were applied uniformly across the whole railway system. As a result, the financial situation is showing considerable improvement, and the expected operating ratio of 136 for 1975 is fairly close to the target of 130 projected for the Second Railway Project. B. Tariffs and Costs (i) Freight 6.04 N de M increased the freight and express rates by an overall weighted average of 44% and 40%, respectively, effective January 1, 1975. There are 20 rate classes for carload freight, varying from 34.25 centavos (2.7 US cents) per ton-km at class 1 to 9.9 centavos (0.8 US cents) per ton-km at class 20, for an average haul of 500 km. Individual commodities have been carefully  - 1 9 - allocated to the various rate classes according to the long-run variable cost af tranisportation, demand, and competition with other modes. Although the carload freight rate increase was 44% on the average, the increase for indivi- dual commodities varied widely. The new rates will also absorD a part of fixed costs in addition to fully covering variable costs. 6.05 Less than carload (LCL) traffic was about 0.2Z of total ton-km in 1974. LCL operating costs are muclh higher than carload freight because of the uneconomic use of freight cars and the high terminal documentation and handling costs. In 1974, its revenues were only about 17% of variable costs in spite of high rates, varying from 125% to 300% of the highest class rate (class 1) of carload freight. Included in the Plan of Action is the provision that N de M should carry out, no later than December 31, 1976, a study on the economic impact of LCL traffic, and should progressively eliminate the losses on such traffic. (ii) Passenger 6.06 Passenger fares were increased, effective February 1, 1975, by an overall weighted average of about 22%. This increase was insufficient to solve the critical financial situation of passenger services. Even after fare increases, the costing study (para 6.02) indicated that the 1975 estimated revenues would only be about 31% of immediately avoidable cost and about 19% of long-run variable cost. If further increases are not made or uneconomic services are not reduced, rising costs will further deteriorate the financial situation in the coming years. 6.07 It was agreed in the Second Railway Project that a program would be presented by N de M to the Government for the curtailment or abandonment of, and for fare increases for passenger services or for compensation of losses on, uneconomic services. Out of some 54 intercity passenger train services, 1N de M has already discontinued 14 services and has received approval from the Government to discontinue or modify an additional 10 services during 1976. This leaves about 30 services, or 55% of the total services existing in mid-1974, to be continued in operation. These services are difficult to discontinue because of social reasons. In view of the worldwide difficulty of eliminating uneconomical passenger train services and the improved position of the railways in relation to other modes resulting from the energy crisis, the action taken so far by N de M is considered satisfactory. N de M agreed, during negotiations, to review further each year the operational and financial condition of the remaining passenger trains in order to rationalize services and/or increase fares with the objective of reducing, progressively, their financial losses. The Government has also agreed to pay N de M a specific subsidy to compensate for the losses of those passenger trains which are not curtailed. C. Future Prospects 6.08 Based on the 1975 tariff increases, the traffic forecasts discussed in Chapter 5, and the proposed Investment Plan, a forecast of operating  - 20 - revenues and expenses was prepared for the years 1975-1979. It is shown in Table 8, and a summary is presented as follows: 1975 1976 1977 1978 1979 ------------(Mex$ Million)