Mexico - Baja California Tourism Project

Document of The World Bank FILE COPY FOR OFFICIAL USE ONLY Report No. P-2060-ME REPORT AND RECOMMENDATIONS OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO NACIONAL FINANCIERA, S. A. WITH THE GUARANTEE OF UNITED MEXICAN STATES FOR THE BAJA CALIFORNIA TOURISM PROJECT April 22, 1977 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 authoriatIon.  Currency Unit - Peso (Mex$) The fixed exchange rate of US$ 1 = Mex$ 12.50 which had prevailed since 1954 was abandoned on August 31, 1976 and the Mexican peso has been floating since then. In recent weeks the rate of exchange has fluctuated in the range of Mex$ 21 - 23 to the US dollar. On April 22, 1977 the peso traded at 22.47 per US dollar. Fiscal Year - January 1 to December 31 Glossary of Abbreviations FONATUR 2 National Fund for Tourism Development SAHOP = Ministry of Human Settlements and Public Works SARH = Ministry of Agriculture and Hydraulic Resources NAFINSA = Nacional Financiera, S.A. CFE = Federal Electricity Commission TELMEX = Telecommunications Corporation of Mexico IDB = Inter-American Development Bank ASA = Airports and Auxiliary Services RAMSA = Aeronautical Radio Corporation of Mexico NACOA = National Company of Aviation Combustibles  FOR OFFICIAL USE ONLY INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO NACIONAL FINANCIERA, S.A. WITH THE GUARANTEE OF UNITED MEXICAN STATES FOR THE BAJA CALIFORNIA TOURISM PROJECT 1. I submit the following report and recommendation on a proposed loan to Nacional Financiera, S.A. with the guarantee of United Mexican States for the equivalent of US$42 million to help finance a tourism project in Baja California. The loan would have a term of 17 years, including 3-1/2 years of grace with interest at 8.2 percent per annum. 1/ PART I - THE ECONOMY 2. Some of the major features of the Mexican economy were analyzed in "An Updating Report on the Economy of Mexico" (1110-ME), distributed to the Executive Directors on March 23, 1976. Country data sheets are contained in Annex I. Past Performance 3. For the three most recent decades, the Mexican economic system has been outstandingly successful in achieving sustained and rapid growth while maintaining stability in prices and the balance of payments. Since 1940, the annual average GDP growth rate has exceeded 6 percent. Inflation averaged less than 5 percent a year from the mid-1950s to 1972, and the dollar value of the peso fixed in 1954 was maintained at that level until the August 1976 devaluation. 4. The Mexican strategy for development has relied on a combination of public action and private profit. The Government has played an important role, both in promoting key industries such as power, steel and petroleum, and in creating a regulatory and institutional framework within which private groups could compete but with assurance of overall continuity and stability. As a formula for growth, this system has served Mexico well; it has however led to a sharpening of contrasts between people and among regions. This was not entirely coincidental; the share of the Government in the economy was kept low for many years, and the scope of redistributive policies was necessarily limited as long as tax revenues remained under ten percent of national income. 1/ In the attachment to my memorandum on Grace Periods and Final Maturities on FY77 Bank Loans (R76-206 of August 9, 1976) Mexico was included in the group of countries with a 1975 GNP per capita of over US$1,075. The classification was then based on the official parity rate of Mex$12.5 per US$, but subsequent float of the currency has established a more appropriate rate (currently around Mex$22.5 per US$) and Mexico is now included in the group of countries with GNP per capita in the range of US$521 - 1,075, with the corresponding loan terms. This document has a rstricted distribution and may be used by recipients only in the performance of their offcial duti. Its contents may not otherwise be disclosed without World Dank authoriation.  - 2 - The Government played a crucial role in the development of private commer- cial agriculture (through irrigation and credit policies), industry (through the provision of infrastructure and protection from imports), education, social legislation, and financial policies, but it did not concern itself primarily with the problems of the poorest sections of the population. While the land reform of 1915 was sustained, fiscal resources were in- sufficient to develop major programs to improve the economic status of its beneficiaries. Moreover, in spite of rapid and sustained economic growth over this long period, a very high demographic growth rate--about 3.4 percent per year--made an adequate absorption of the labor force in productive employment extremely difficult. It is estimated that 40 per- cent of the labor force is still engaged in marginal occupations, rela- tively unproductive and hence poorly paid--or openly unemployed. 5. The Echeverria Government (1971-1976) combined past growth policies with greater efforts in favor of the poor. Attempts made in these years to alleviate the poverty of the countryside and to redress some of the imbalances between rural and urban Mexico included, on the rural side, a revised Agrarian Reform Law (1971) and a new Federal Water Law (1972), both of which were intended to promote a more equitable distribution of basic agricultural resources. These measures were complemented by changes in the sectoral allo- cation of agricultural credit in order to increase the share of low-income farmers and ejidatarios (members of ejidos, which are a form of collective land tenure based on usufruct), and the introduction of remunerative support prices for basic foodcrops. The Government also increased outlays for agri- cultural research, training and extension services, with particular regard to the needs of small farmers. Perhaps the most significant innovation was a new program for integrated rural development with which the World Bank has been associated from an early stage. 6. Urban-industrial development was also promoted by heavy public investment in basic industries--petroleum, chemicals and steel being out- standing examples--and an innovative workers' housing program has been financed with a five percent payroll tax. Productive investment was thus complemented, in the urban as well as the rural economy, by institutional changes and public expenditures designed to improve the living conditions of the poor. 7. The Government's efforts to improve both the country's productive base and the living conditions of the poor led to a doubling of public sector expenditures in real terms over the period 1970-1976. Tax revenues were also substantially increased, from 9.6 percent of GDP in 1970 to more than 13 percent in 1976, but as this was insufficient to compensate for the increase in expenditures, the difference had to be financed by internal and external borrowing. Such policies, together with the frequent and large wage increases that took place over the period--especially since 1974-- led to high inflation and rapidly increasing balance of payments' current account deficits. Growing inflation, rising labor costs, preemption of credit for financing rapidly growing public expenditures, and some official pronouncements against private entrepreneurship, led to a virtual stagnation of private sector fixed investment, a reduction in financial savings and speculative behavior by domestic savers. The rate of growth of GDP slowed  - 3 - down from an annual average of 6.8 percent during 1965-70 to about 5.0 percent during 1971-76. Preliminary estimates show that it dropped to 2 percent in 1976, the lowest growth rate experienced by Mexico since the mid-thirties. 8. The short-run disequilibria affecting the country at the end of 1975, social and labor unrest, and loss of confidence in the economy led to strong devaluationary expectations, which in turn led to large capital out- flows during 1976. Under these circumstances, on August 31, 1976, the authorities decided to abandon the fixed exchange rate of US$1 = Mex$12.50 which had prevailed since 1954. For several weeks thereafter the peso traded in the range of 19-20 per US$. However, a general wage increase of about 22 percent was granted shortly after the devaluation and in October a new wave of speculation forced the Government to let the peso float freely. After some sizable fluctuations before the inauguration of the new Adminis- tration the peso has remained rather stable at rates fluctuating between 21 to 23 pesos per dollar since December 1976. 9. In support of its economic program Mexico has obtained major support from the IMF. In the last quarter of 1976 Mexico was able to draw on the Fund for US$480 million (including US$113 million from the gold and super-gold tranches, US$213 million from the Compensatory Facility and US$154 million from a first credit tranche drawing). For 1977-79 an Extended Fund Facility (EFF) accompanied by a comprehensive three-year stabilization pro- gram has been negotiated. This could provide as much as an additional US$861 million once the increase in Fund quotas becomes effective. A first drawing of US$100 million under the EFF was made early in 1977. Thus total IMF support for the Government's program may exceed US$1.3 billion. Recent Economic Policy 10. The Mexican program aims at reducing inflation by the end of 1979 to levels similar to those prevailing in countries that are Mexico's major trading partners, and simultaneously inducing economic recovery. This is to be achieved through a combined effort to increase public sector savings, to maintain real wage growth in line with productivity changes, to increase exports, to promote financial savings and intermediation and to reestab- lish a favorable climate for private investment. The Government attaches particular importance to increased public sector savings in order to reduce the rate of growth of external and domestic borrowings for financing the public sector. 11. Within its first month in office the new Administration launched several initiatives aimed at improving management of the public sector. A far-reaching administrative reform aimed at achieving a greater degree of cohesion between Agencies and Ministries in formulating policy and in carrying out programs in various fields was announced and immediately put into effect. A new law giving the Treasury authority to limit the growth of public sector external borrowings and to ensure the efficient use of Mexico's overall  - 4 - borrowing capacity was approved by the Congress. Simultaneously another law containing provisions to improve and modernize the budgetary process and to centralize it under the new Secretariat of Programming and Budgeting was also put into effect. Direction of government programs related directly to production activities were concentrated in two ministries, the Ministry of Agriculture and Irrigation (Agricultura y Recursos Hydraulicos) and the Ministry of National Property and Industry (Patrimonio Nacional y Promocion Industrial). 12. With only a few weeks in which to submit its budget for 1977, the Government made slight modifications in the proposals prepared by the out- going Administration, but stated its intentions to revise them further, if appropriate in the light of its own priorities, the effects of the admin- istrative reform and the requirements of the stabilization program. The tax base has been broadened, the prices of some goods and services produced by the public sector have been recently increased (examples: power rates went up by 52%, petroleum product prices increased by 25%, steel by 15%, telephone by 30%), expenditures of several public sector agencies have been reduced in real terms, and a further overall reduction is expected with the imple- mentation of the administrative reform. 13. In the annual minimum wage negotiations in January, the Government was able to negotiate an increase of only 10 percent, which has been viewed as a demonstration of the serious nature of the Government's intentions to stabilize prices, and its support from labor. There is therefore every reason to expect that the situation experienced in 1976 -- when nominal wages increased by 31 percent compared with a much smaller increase in consumer prices, 16.1 percent -- will not be repeated. An excess profits tax was introduced and improved cooperation between business and Government was signalled in January by the announcement of a package of price, production, and investment agreements with the private sector to encourage domestic production of wage goods at low prices and to promote an investment package of about Mex$100 billion over the next several years. As a result of these factors and their positive effects on restraining inflationary expectations, the rate of price increases has been declining steadily. Thus, while the average monthly increase in wholesale prices was 7.0 percent, and in consumer prices 3.4 percent, during the four months following last year's devaluation (i.e. during September-December 1976), the monthly price increases were only about 2.0 percent during the first quarter of 1977. 14. At the beginning of March, the Government moved a step further in the process of implementing its stabilization program by announcing a set of measures aimed at inducing a recovery of financial savings and intermediation and thereby loosening somewhat the extremely tight credit situation affecting the private sector. Reserve requirements were modified so as to allow a greater share of increased savings to be available for lending to the private sector; interest rates on term deposits are being gradually allowed to increase so as to better reflect market conditions; new limits on the liabilities and assets of the banking system were imposed so as to increase its stability and independence and to avoid undue concentration of credit, and new financial assets were created--specifically an issue of  Mex$2.0 billion of "Petrobonds" (indexed to the international price of petrol- eum). Mobilization of resources by the banking system attained the unusually high rate of about US$750 million in the first quarter of 1977, signalling the return of a considerable part of the previous year's private capital outflow. 15. The current account balance of payments can also be expected to improve, with the exchange rate at a more realistic level and the April restoration of excise tax reimbursements (CEDIs) for manufactured exports. Export revenues have already picked up in the first quarter of this year, because of higher prices for coffee and tomatoes and easier entry of Mexican products in the US. Combined with lower imports caused by the slack in private demand and slower public investment, this has already reduced the trade deficit to about US$100 million in the first quarter of this year, compared to about US$660 million during the same period in 1976. Prospects 16. In the few months since it took office, the Government has thus already taken a number of important steps. Indications are favorable for slowing inflation, reduced speculative behavior and recovery of private savings. If the Government continues to implement the necessary policies, economic recovery should also continue; this will provide the necessary basis for accomplishing important social objectives. 17. While there are reasons to believe that the prospects are improving, it will nevertheless be necessary to follow events closely. A mission to study manufacturing sector prospects and policies visited Mexico in October- November 1976; the report will be completed shortly. A mission is now in Mexico to analyze further the current economic situation and the Government's program. 18. Even with the best of policies, adjustment from the disequilibria of the recent past will require several years. The public sector deficit cannot be eliminated overnight, and even with reduced new external borrowing the debt burden will be heavy. The debt service ratio was 36.4 percent in 1976, and is expected to increase over the next several years. However, the continued application of measures such as those described above should keep the immediate situation manageable and return the economy to an equil- ibrium growth path. The Bank currently holds about 8% of total medium and long term public sector borrowings; the Bank's share of public debt service is about 4%. These ratios are not likely to change appreciably in the coming years. 19. The strengthening of the productive base of the economy over the last six years, through large investments in agriculture, petroleum, petro- chemicals, electricity, steel, cement and basic infrastructure, enhances Mexico's long term potential for attaining high GDP growth rates. An out- standing example of the benefits of some of these investments are the new possibilities opened to the Mexican economy through the recent discoveries of rich petroleum fields. As of December 1976 proven oil reserves were estimated at about 11.0 billion barrels which gives a production/reserve ratio  - 6 - (computed at the 1977 production rate) of more than 30 years. On the basis of these known reserves, the Government is analyzing alternative investment, production and export plans for Pemex (state owned monopoly in charge of exploration, production and marketing of petroleum and related products). Under the high-production alternative, production of petroleum could grow at an average annual rate of 19 percent between 1977 and 1982, reaching 2.2 million b/d in 1982 (1976 production was 0.8 million b/d); exports might increase at an annual average rate of almost 50 percent over the period, reaching 1.1 million b/d in 1982, the equivalent of US$7.8 billion in projected 1982 prices (1976 exports were 94.7 thousand b/d). 20. The prospect of rapidly rising petroleum exports has greatly strengthened the balance of payments outlook. Even on the basis of somewhat more conservative projections of petroleum production and exports than those mentioned above (see Annex I), the current account deficit can be expected to decline steadily over the next several years, thus reducing Mexico's net external borrowing requirements. The debt service ratio should begin to decline after 1980 (although it will increase somewhat in the next few years because of past borrowing). Thus, Mexico remains creditworthy for external borrowing on conventional terms. PART II - BANK GROUP OPERATIONS IN MEXICO Bank Operations 21. As of March 31, 1977, Mexico had received 47 loans from the Bank amounting to US$2,607.7 million net of cancellations; of these, 28 loans totalling US$1,286.7 million were fully disbursed. As of March 31, 1977, the Bank held US$2,164.3 million of which US$909.5 million had not yet been disbursed. Some 35 percent of Bank lending has been for agriculture and rural development (14 loans for US$903.7 million), 27 percent for power (12 loans for US$704.8 million) and 21 percent for transportation projects (12 loans for US$546.7 million); the remaining 17 percent has been for industry (US$300.5 million), water supply (US$130 million) and tourism (US$22 million) projects. The implementation of several projects fell behind schedule during 1976 due to a scarcity of counterpart funds. The situation has since been reviewed with the Government and adequate support for the ongoing projects has now been assured. Annex II contains a summary statement of Bank loans as of March 31, 1977 and notes on the execution of ongoing projects. 22. Bank lending was active in FY75 with four loans totalling US$360 million, and in FY76 with four loans totalling US$315 million. In July 1976 the Executive Directors approved a US$95 million loan for a second steel project but, as stated in a memorandum distributed to the Executive Directors on April 5, 1977 (SecM77-258), the new Mexican Administration has reconsidered its investment program for the immediate post-devaluation years and decided to concentrate a greater share of its investment resources in fields which have a rapid impact on output and foreign exchange earnings, such as agriculture, petroleum and tourism; considering the magnitude and long gestation period of the second steel project, the Government has decided to postpone it sine die, and the loan was consequently cancelled on April 15, 1977. The proposed tourism project will thus be the first loan for Mexico in FY77.  -7- IFC Operations 23. As of March 31, 1977, IFC had made 13 investment commitments in Mexico, for a total of US$69.2 million, of which US$37.5 million had been sold, repaid or cancelled. The balance held by the Corporation, US$31.7 mil- lion, consists of US$27.2 million in loans and US$4.5 million in equity. A summary statement of IFC investments as of March 31, 1977 is presented in Annex II. Bank Strategy 24. The main objectives of Bank lending in Mexico have been to: (i) support policies and programs leading to a wider distribution of the benefits of economic growth; (ii) strengthen policies and programs leading to continued economic growth, by helping to finance projects that are to make directly or indirectly significant contributions to output, exports, and employment; (iii) help resolve critical adjustment problems induced by Mexico's continued economic growth; and (iv) complement Mexico's domestic savings by helping to finance economic and social investments in a framework of internal and external financial stability. In support of the new administration's austerity measures to overcome a short-term balance of payments constraint, it is proposed that limited financing of local costs be provided for priority projects of a social nature in which the foreign exchange costs are low. In the coming years, the Bank will preferentially support projects that make relatively modest demands on budgetary resources and have a strong positive balance of payments effect, and projects of high social priority that improve health standards, attain higher levels of employment and help to decentralize economic activity. 25. In view of the difficult structural problems of Mexico's agricul- ture and the sector's crucial importance to the country's further develop- ment, the Bank has made agriculture the leading sector for its lending. Consistent with the overall framework of country and sector objectives, a three-tier approach has been developed. First, to strengthen irrigation and agricultural credit programs so as to meet the demands of a rapidly growing population more adequately and to generate the foreign exchange needed for rising import requirements. Second, to raise the incomes of the rural poor and improve their standards of living through a combination of directly productive, productive support and social infrastructure investments. Third, to strengthen Mexico's institutional capability to use scarce agricultural resources more efficiently. 26. Bank lending for industry has been aimed at assisting the Govern- ment's efforts to reduce the balance of payments deficit and decentralize industrial activities away from the major (and increasingly congested) urban areas. Thus, the Executive Directors approved a Second Industrial Equipment Fund Loan in FY76 for US$50 million, aimed at financing industrial projects with a positive effect on the balance of payments; a US$50 milion loan made in FY75 to support a fertilizer project is promoting new poles of development in the resource-rich southeast region and the north central area and will help make Mexico independent of imported urea fertilizer in the medium term.  - 8 - 27. As regards infrastructure, the Bank's operations have been focused on investments in key areas of the country as well as on institutional reforms and sector policies aiming, inter alia, at suitable pricing mechanisms to help generate additional resources for investment financing. For example, the Airports Development Project (FY74) of US$25 million was designed in support of the Government's policy of regional integration; the railway loan (FY76) of US$100 million supported improvements of institutional aspects and financial management of the sector. The Mexico City Water Supply Project (FY73) of US$90 million has been instrumental in the establishment of a specialized institution for efficient management of water resources in the Mexico Valley, and in the pricing of water at levels more closely related to costs; a follow- up project is now being prepared. 28. The Government is now reviewing with the Bank its borrowing prior- ities, and pressed to reduce the external deficit on current account, is giving emphasis to the tourism sector to generate higher foreign exchange earnings. The proposed project, composed of tourism investments and related -urban infrastructure in two attractive sites in Baja California, will provide the opportunity to further tap the west and the southwest U. S., which are among the largest and richest tourist generating markets. By supporting two strategically located development poles in the southern part of the Baja California peninsula, the project will also promote the Government's regional policy. Urban infrastructure investments and related community development programs will be important components of this operation, aiming to integrate tourism and urban development and to improve the quality of life of the local population, with particular provisions for the poorer sections. The proposed operation would be the second tourism project in Mexico - experience with the first tourism project is discussed in para. 40 below. A third project to assist tourism development through a line of credit in support of hotel facilities is under preparation. In addition an integrated rural development project (PIDER II), a maternal and child health project and a regional development project have been appraised. PART III - THE TOURISM SECTOR 29. Mexico stands out as one of the world's most richly endowed tourism destinations. It offers an impressive array of tourism resources, including the architectural remains of a series of major civilizations; an agreeable climate; and excellent and unspoiled beaches along the Pacific and the Carib- bean Coasts. Climatic conditions make Mexico a year round destination and visitor flows show only a minor degree of seasonality. Nearly 90 percent of visitors to Mexico originate in the United States and Canada and for them it is one of the most accessible truly foreign destination. 30. Between 1960 and 1974 foreign tourism to Mexico grew at an average rate of about 11.5 percent a year. In 1975 the number of visitor arrivals declined by about 4 percent to 3.2 million (the first decline since 1953) largely because of recession in the US, and Mexico's uncompetitive position  - 9 - resulting from an overvalued peso. The growth of tourist traffic to desti- nations such as Acapulco, Puerto Vallarta, Guadalajara and Cancun has been particularly rapid, and the composition of tourist traffic is also changing, as more low and middle income visitors are attracted than in the past. 31. In recent years an important development has been the growth of domestic tourism and this market will continue to grow in the coming years as foreign travel has become more expensive for Mexicans. In 1975, it is esti- mated that 14.8 million Mexicans took vacation and spent a total of 28.4 mil- lion visitor nights away from home (this compares with a total of 34 million nights by foreign visitors in the country). Economic Importance of Tourism 32. Tourism plays a major role in Mexico's economy by its contribution to foreign exchange earnings and employment generation and towards a more balanced regional distribution of economic activities. Mexico's gross foreign exchange earnings from tourism, excluding border traffic earnings, amounted to US$800 million in 1975, and represented more than 13 percent of exports of goods and non-factor services. 33. It is estimated that the tourism sector currently employs directly some 400,000 persons, mainly in the hotel and restaurant trade. Significantly, most of those employed are drawn from the unskilled sector of the population and have obtained relatively well-paid jobs after little training. Moreover, tourist demands for handicrafts, transportation and other services spread economic benefits; for example, it is estimated that the production and marketing of crafts, with sales of about US$130 million in 1975, involved at least 5 million Mexicans in the lower 40 percent income segment of the popula- tion. Tourism Sector Institutions 34. Until the late 1960s the Government expenditure on tourism develop- ment was modest and its promotional role minimal, but the private sector was successful in building upon the country's unique assets. Such private develop- ment tended, however, to stress short-term profitability with little regard to the longer run impact on the economy, the environment and the social situation. To correct these deficiencies and recognizing the growing importance of the sector, the Government created in 1969 a special trust fund under the Banco de Mexico to develop and promote integrated tourism resorts. This institution was merged in 1974 with another trust fund established under NAFINSA to finance hotels and other tourism superstructure, and a new fund, the Fondo Nacional de Fomento al Turismo (FONATUR) was thus created, integrating most activities of the public sector in the tourism field. The Government also established in 1974 the Ministry of Tourism, entrusted with a coordinating role on all aspects of sectoral development, including promotion and training. Another institution active in the field is the National Council of Tourism whose principal task is the promotion of tourism abroad.  - 10 - 35. FONATUR has so far concentrated its infrastructure development ef- forts on two new sites, Cancun in the Yucatan peninsula (with IDB assistance) and the Zihuatanejo-Ixtapa area on the Pacific Coast (with Bank assistance), investing Mex$1.1 billion in Cancun and Mex$0.7 billion in Zihuatanejo-Ixtapa. Cancun started to operate in 1975 and Zihuatanejo-Ixtapa in 1976; a total of 4,000 hotel rooms are expected to be available at these two sites by the end of this year. The volume of FONATUR's credit operations has grown at a rapid pace; as of August 31, 1976 FONATUR had approved 378 credit applications for a total of Mex$2.8 billion to finance 19,000 new hotel rooms throughout the country. The sources of funds for FONATUR's credit operations have been appropriations from the federal budget, Banco de Mexico bond issues and retained earnings. The overall financial position of FONATUR is sound; assets amounted to Mex$5.1 billion in August 1976, of which Mex$1.8 billion were invested in the development of infrastructure and Mex$2.9 billion in hotel credit operations. FONATUR now employs 275 persons (of which 75 on a temporary basis to complete the infrastructure projects now underway); from the start, it has been able to attract highly qualified individuals and is considered to be one of the more efficient government agencies. 36. To support a growing tourism industry, the Government has recognized the importance of training, and about 80 training institutions are now in operation in the country. The Government and the National Hotel Association are now in the process of improving coordination of these training facilities and propose to set up a single organization to prepare and implement a com- prehensive training program to serve the industry. Investment Priorities 37. During the period 1961-1975, hotel and other accommodation capacity has more than doubled from 91,000 in 1961 to 191,000 rooms in 1975. The fastest increase in capacity has been in hotel rooms of international class, which in spite of the slow down in the growth of visitor traffic in 1974 and 1975, have continued to enjoy high occupancy rates. Following the devaluation of the peso, the prospects for continued growth of tourism are bright. The Government is stepping up its promotion efforts to attract more visitors, to the extent possible during the off-season, so as to achieve a higher utiliza- tion of existing capacity. Overall, with tourist arrivals projected to increase by 9 percent per year, and assuming higher occupancy rates, it is estimated that in the next four years some 25,000 additional hotels rooms of international standards will be needed. 38. With regard to existing destinations, further expansion of newly developed resorts such as Cancun and Zihuatanejo-Ixtapa would be possible at a relatively small cost. However, it would be unrealistic to assume that in the long term these destinations alone will be able to fully tap Mexico's tourism market. In these circumstances the Mexican authorities have rightly considered the need to encourage development at other sites, particularly where some infrastructure facilities are already available. The proposed project is the highest priority operation in this category.  - 11 - 39. Although debt financing for hotel and other superstructure invest- ments with foreign borrowings, suppliers' credit and domestic bond issues might be envisaged, it appears that for the time being the industry will have to continue to rely primarily on term loans from FONATUR. The Government and the Bank are now considering a tourism development project to channel into the sector, through FONATUR, long term funds not otherwise available for the above purposes to the private investors or public institutions involved. Execution of the First Tourism Project 40. The first tourism project (Loan 793-ME), approved in 1972, focused on the development of the Zihuatanejo-Ixtapa area, on the West Coast of Mexico. This project had goals similar to those of the operation now proposed and was carried out by the trust fund under the Banco de Mexico which was absorbed by FONATUR in 1974. The execution of the Zihuatanejo-Ixtapa project was delayed in its initial stages mainly because of land rights problems, but with FONATUR's expertise and efficient coordination of the numerous other agencies involved, implementation is now proceeding successfully. Infrastruc- ture works have been substantially completed; two hotels are already open for business, and several others are under construction; over 1,500 rooms are expected to be available by June 1977. To avoid delays similar to those experienced with this operation, the Government and FONATUR have arranged to complete property transfer proceedings early in the course of preparation of the proposed Baja California project. PART IV - THE PROJECT 41. The project was prepared by FONATUR and appraised by a Bank mission which visited Mexico in October 1976 and February 1977. A report entitled "Appraisal of the Baja California Project" No. 1483-ME dated April 18, 1977 is being circulated separately. A loan and project summary is presented in Annex III. Negotiations took place in Washington from April 5 to 8, 1977. The Mexican team was led by Messrs. Arroyo (FONATUR) and Torres (NAFINSA). Project Resorts 42. Loreto, one of the earliest settlements in Baja California, is located on the Sea of Cortez, 360 km north of La Paz, the state capital (see maps IBRD 12647 and 12648). Its population of 3,000 engages primarily in fishing and agriculture. Despite inadequate tourism facilities, visitors have long been attracted by the scenic charm of the area. The Sea of Cortez is suitable for water sports and fishing and the weather is pleasant throughout the year. Air access to the area is poor as the Loreto airport is capable of accommodating only small aircraft. Most visitors arrive by road, using the recently completed transpeninsular highway. The principal tourism zone would be located in a site of great natural beauty, along the wide crescent beach at Nopolo, 7 km to the south of Loreto. Further south of Nopolo is Puerto Escondido, a protected natural harbor, which is already popular with foreign visitors.  - 12 - 43. The San Jose del Cabo site is located about 200 km south of La Paz on the southern tip of Baja California (see maps IBRD 12647 and 12650). About 3,500 people live in San Jose del Cabo, a city with narrow, hilly streets, reminiscent of small Mediterranean towns. Beautiful beaches stretch for kilometers on both sides of the town, and an attractive sweet-water lagoon--a rarity in a desert region--offers special interest. The climate is like that of Loreto and the sea is suitable for boating and fishing. Road access is provided by the recently completed transpeninsular highway and an inter- national airport is under construction. The main works for water supply have been recently completed. Project Description 44. In each of the Loreto and San Jose del Cabo sites, the proposed project is composed of the following main elements: (1) infrastructure and other facilities (electric power; roads; telecommunication facilities; and environmental sanitation) for the tourist zones; (2) a medium category 250-room hotel; (3) infrastructure for the towns, including water supply and sewerage, electric power and telecommunications facilities; (4) airport facilities; and (5) community development activities, conservation studies and programs, and a tourism market and economic study. 45. Private investors have in the past proven reluctant to build the first hotel in a new destination before all tourism infrastructure is in place and have delayed hotel investments vis-a-vis what would appear desirable from a financial or economic standpoint. For this reason, and to set the archi- tectural tone of the resorts, the project provides for construction of two pilot hotels with 250 rooms, one for each site; these hotels are expected to be in operation by the end of 1980. In addition, for successful launching of the resorts, the Government and FONATUR will take all appropriate actions (including the provision of adequate financing) to ensure: (a) construction and operation of 150 additional rooms at each site, to be opened at the same time as the pilot hotels; and (b) the availability of at least 600 additional rooms at each of the sites three years thereafter. The Government and FONATUR will also make their best efforts to have in operation, not later than seven years after the pilot hotels start to operate, 900 additional rooms at each site (Section 3.07, Draft Guarantee Agreement). About 3,000 rooms are expected to be in operation at each site by the end of 1987; most of the rooms would be constructed by entrepreneurs, the Government and FONATUR's roles being largely promotional and of direct intervention only as a last resort.  - 13 - 46. It is estimated that tourism development will attract about 22,000 new residents in each of the towns over the next ten years and to accommodate them, urban infrastructure facilities will be upgraded and expanded. In particular, housing for new residents will be financed through existing federal programs; to help immigrant workers and the very poor who do not qualify under these programs, special arrangements will be made under the project to provide land and infrastructure, as well as construction materials at cost, and technical assistance for self-help housing programs. Project Cost and Financing 47. The total estimated cost of the project is US$84 million including physical and price contingencies, with a foreign exchange cost component of US$42 million. The proposed loan would cover the estimated foreign exchange requirements and the balance would be provided through budgetary appropria- tions by the Federal Government, which would also meet any cost overruns. For 1977, the necessary provisions have been made in the Federal Government's budget. The proceeds of the Bank loan, excluding those disbursed against the airport components will be channeled by NAFINSA to FONATUR as equity contribu- tion. 48. The project makes provisions for consultants' services to assist FONATUR in design and supervision. For the project as a whole, consultants services are estimated to total 1,075 man-months and to cost about US$3.9 million. The average cost of the consultants' services is US$4,500 per man- month for foreign consultants and US$2,100 for local consultants. Execution and Operation 49. FONATUR will be responsible for carrying out the project and will submit to the Bank for approval final designs, plans, specifications and regulations for this undertaking. FONATUR has acquired valuable experience in developing Cancun and Zihuatanejo-Ixtapa and will be able to focus on Baja California now that the other infrastructure development projects are com- pleted or nearing completion. 50. FONATUR will manage two trust funds, one for each resort, which will be given title to the ejidal land acquired by the Government; establishment of these trust funds will be a condition of effectiveness of the loan (Section 6.01(b), draft Loan Agreement). FONATUR will be responsible for urban invest- ment activities and the sale of land to private investors for the construction of hotels, restaurants, villas and other facilities. During negotiations, agreement was substantially reached on a statement of operating policies in this respect. This statement will be finalized by FONATUR in consultation with the Bank and adopted by June 30, 1978 (Section 3.16, draft Loan Agreement). FONATUR intends to have the pilot hotels operated and managed by Nacional Hotelera, S.A., a hotel operating company controlled by FONATUR. Arrangements made for locating, financing and operating the pilot hotels will be submitted to the Bank for approval (Section 3.12, draft Loan Agreement).  - 14 - 51. FONATUR will contract with the Federal Electricity Commission (CFE) and the Telecommunications Corporation of Mexico (TELMEX) for design and construction of the electric power and telecommunications networks, respect- ively (Sections 3.04 and 3.05, draft Loan Agreement). Assurances have been obtained that the project areas will receive adequate aviation, water supply, electric power, telecommunications, health and education services (Section 3.03, draft Guarantee Agreement). The investment cost of the water supply and sewerage facilities will be fully recovered through sale price of land and user charges (Section 3.13, draft Guarantee Agreement). 52. A large and modern hotel training center which includes a 109-room practice hotel has recently been completed by the Ministry of Tourism at La Paz. These facilities are considered adequate for the needs of the proposed project. Details of the training arrangements are being worked out by the Government which has undertaken to satisfy the staff requirements of the hotels in the project areas (Section 3.12, draft Guarantee Agreement). Coordination 53. A project unit would be set up within FONATUR to ensure proper supervision of design and construction and to coordinate the other agencies involved. A project manager and a chief engineer with a staff of technicians, accountants, community development organizers, and procurement officers would be stationed at each site. These arrangements have been successfully tested in the case of other infrastructure projects implemented by FONATUR. To facilitate coordination FONATUR is preparing a critical path chart for the project. The chart will be promptly completed and reviewed by all parties concerned every three months; the results of such reviews will be communicated to the Bank (Section 3.08, draft Loan Agreement). Procurement 54. Major civil works and equipment contracts would be awarded on the basis of international competitive bidding. While most of the building materials required for the project are produced in Mexico, a large portion is likely to be procured from the United States or Canada, because of the duty- free status of Baja California. Some civil works and equipment contracts (e.g. landscaping, environmental sanitation) would be too small to attract foreign bids. It is therefore proposed that these civil works contracts, each not to exceed US$500,000, and equipment contracts, each not to exceed US$100,000, would be awarded after local competitive bidding; the total value of such contracts would not exceed US$4 million equivalent. Likewise, a small amount of civil works for wildlife conservation, gardening, landscaping, and environmental sanitation will be procured through force account; the aggregate cost of the civil works sC) procured will not exceed US$1 million. The navi- gational aid equipment for the airports will have to be compatible with equipment used in other Mexican airports, and therefore procurement of this equipment, valued at US$700,000, would be negotiated directly with the manu- facturer (Schedule 4, draft Loan Agreement). Telecommunications works will be undertaken by TELMEX in accordance with its procurement practices but would  - 1 5 - not be monitored. TELMEX, an efficient organization with sole responsibility for telecommunications services in Mexico will purchase for the project areas equipment compatible with system requirements in the rest of the country; these will be bulk purchases not related to this or any particular project. TELMEX will employ specialized contractors for carrying out the civil works. Disbursements 55. The proposed loan is expected to be fully disbursed by December 31, 1980. In order not to delay implementation of the project, it is proposed that a part of final design and engineering expenditures incurred after December 1, 1976, and not exceeding US$300,000 equivalent, be financed retroactively. Disbursement of funds from the loan would be on the following basis: (a) 100 percent of foreign expenditures for directly imported equipment and furniture or 100 percent of the ex factory cost of locally manufactured equipment and furniture; (b) 50 percent of total expenditures for civil works, consulting services, community development activities, investment promotion and project administration; and (c) 100 percent of total expenditures for wildlife conservation and market and economic studies. No disbursements are envisaged for the telecommunications component. The estimated schedule of disbursements of the loan is shown in Annex III. Baja California Tourism 56. With respect to foreign visitors, FONATUR market studies indicate that the project resorts will be particularly appealling to the West and South West US markets and will be in a good position to compete with Southern California (U.S.) and Hawaii sites - Mexican visitors attracted to Baja California will come mostly from Mexico City, Guadalajara and Monterrey. As a result of Baja California's relative proximity to the US, roughly 70 per- cent of visitors to Loreto and San Jose del Cabo are expected to be foreigners, a higher share than at other Mexican resorts. During the first year of oper- ation (1980/81), when only 800 hotel and apartel rooms will be available, FONATUR market studies project about 70,000 visitors, accounting for about 250,000 visitor-nights. These would increase to 800,000 visitors and 3.9 million visitor-nights by 1990 when about 6,200 rooms in hotel/apartels and 2,300 rooms in condominiums and villas will be available. 57. Land access to the tourism areas is adequate; about one-third of the visitors will arrive by road, using the recently completed 1700 km trans- peninsula highway that connects the US border with the tip of Baja California. Ferry services (some will soon begin operation) connect the project areas with Guyamas, Mazatlan and Puerto Vallarta on the West Coast of Mexico.  - 16 - 58. An important factor in the success of this operation is good air access as about two-thirds of foreign visitors are expected to arrive by air. Experience at other resorts, particularly in Acapulco, has demonstrated that attracting large numbers of foreign tourists requires provision of direct flights from major US markets. The airport at San Jose del Cabo is already included in the bilateral air agreement with the U.S. and can be served by both US and Mexican scheduled airlines from Los Angeles, Tucson, Phoenix, Atlanta and Dallas. The Government will make its best efforts to include or retain, as the case may be, Loreto and San Jose del Cabo in future bilateral agreements on air transportation. Additionally, scheduled Mexican carriers will serve both sites on domestic segments of their international routes to and from major tourism generating countries so that scheduled international air service can be provided by the time the first hotels open for business. (Section 3.04, draft Guarantee Agreement). Justification 59. The loan will help FONATUR finance infrastructure investments and one pilot hotel at each of the two tourist resorts, at a total cost of US$84 million; private investors will put up the other superstructure works--hotels, apartels, condominia, villas, restaurants and other tourism facilities-- involving an estimated investment of about US$129 million; the economic analy- sis has been conducted for the entire investment of US$213 million. About 53 percent of the total investments will be undertaken in Loreto and 47 percent in San Jose del Cabo. The internal economic rate of return on the investments in Loreto is 19 percent and in San Jose del Cabo 21 percent. The internal economic rate of return for the whole operation is 20 percent. 36% of the project's net financial benefits would be captured by the Government, 27% by unskilled labor and the remainder would accrue to owners of hotels, shops, restaurants and other facilities. The project would be justified even if only 1,900 rooms are in operation at each site by the end of 1987. 60. The proposed project and related investments are expected to increase Mexico's foreign exchange earnings substantially. Of the total tourism related investment--public and private--in the project areas of US$213 million, about US$158 million will be in foreign exchange. In 1982 the project's gross for- eign exchange earnings will be US$34 million increasing to US$110 million in 1990. On a net basis, foreign exchange earnings will increase from US$17 mil- lion in 1982 to US$89 million in 1990. 61. The proposed project supports the Government's regional development policy by inducing a rapid economic development in the southern part of Baja California, a region with a tourism potential hitherto untapped because of lack of adequate facilities. 62. The direct employment created by the proposed facilities is estimated at about 12,000 jobs. In addition, an estimated 13,000 jobs would be generated in sectors such as handicrafts, food processing and transportation. Unskilled labor would account for more than 60 percent of the jobs; some 40 percent of the jobs is expected to be filled by women. 63. The simple ratio of investment to direct permanent employment is about US$18,000 (US$213 million:12,000) per job. While this is in the range  - 17 - usually experienced with this type of operation, it does not take into account a large but not permanent increase in construction jobs. Over the life of the project, some 158,000 man-years of direct employment would be generated (in- cluding 15 percent of this total in ccnstruction). If both investment costs and man-years are discounted at 10%, the investment cost per man year comes to US$1,800. Project Risks 64. Taking into account the experience gained by FONATUR in promoting newly developed resorts, the attractive location of the project sites and the arrangements made to provide adequate and timely air access (see para. 58 above), the risks that there would be an inadequate number of rooms in operation and/or insufficient tourist interest are considered relatively low. Another normal risk of tourism development lies in the establishment of enclave type resorts, which isolate the tourists and makes no provision for the well being of the local population. The proposed operation, which aims at integrating tourism and urban development in both the Loreto and San Jose del Cabo areas, is well protected against this risk. Aside from increased employ- ment and income, the local population will benefit from improved and expanded infrastructure facilities such as parks, plazas and market places. Social services will be provided including day-care centers for working mothers, schools, health clinics and training centers. Finally, drawing on its expe- rience in Cancun and Zihuatanejo-Ixtapa, FONATUR has assembled a community development team to handle day-to-day problems and ease the transition from rural settlements to modern urbanized centers. To minimize these and other project risks, arrangements have been made to (i) promote timely hotel invest- ments (see para. 45 above); (ii) ensure proper project execution by and coordination between the agencies involved (see para. 53 above); and (iii) complete property transfer proceedings early in the course of preparation (see para. 40 above). Environmental Considerations 65. Special attention has been paid by FONATUR to protection of the environment and no significant adverse environmental impact will result from the project. Appropriate land use and zoning regulations will be adopted by June 30, 1978 (Section 3.05, draft Guarantee Agreement). The project makes provision for (i) water management studies; (ii) preservation of the rare sea fauna and wildlife found in the area; and (iii) programs and studies for conservation of the environment around Loreto and Puerto Escondido, including the outer islands. The final recommendations of the wildlife conservation and coastal zone water management studies will be discussed with the Bank for effective implementation (Section 3.07, draft Loan Agreement). PART V - LEGAL INSTRUMENTS AND AUTHORITY 66. The draft Loan Agreement between the Bank and Nacional Financiera S.A. the draft Guarantee Agreement between the United Mexican States 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 a resolution approving the  - 18 - proposed loan are being distributed to the Executive Directors separately. Special conditions of the project are listed in Section III of Annex IV. 67. As a condition of loan effectiveness, the trust funds referred to in para. 50 of this report will be established and NAFINSA, as trustee of FONATUR will enter into contractual arrangements, satisfactory to the Bank, with the trustees of these trust funds, for purposes of the project. 68. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank. PART VI - RECOMMENDATION 60. I recommend that the Executive Directors approve the proposed loan. Robert S. McNamara President Attachments April 22, 1977  TOLN SA ~ ~ ~ ~ ~~I Ip Mexico SOCIA. INOICATIRS DAUT 1NIT LAND AREA lTHOU KN21 -------- -NIxICO REFERENCE COUNTRIES 419010 TOTAL 1972.5 MOST RECENT. AGRIC. 948.9 1960 1970 ESTIMATE BRAZIL CHILE SPAE7 " GNP PER CAPITA IUSS) h200 710.0 I ".0 54Q.O 640.0 1560.0 _ __ __ -- _ _---- - - POPULATION AND VITAL STATISTICS POPULATION (MID-YR, MILLIONI 36.0 50.4 59.5 92.6 9.7 33.6 POPULATION DENSITY PER SQUARE KM. 18.0 26.0 30.0 11.0 13.0 6T.0 PER SQ. KM. AGRICULTURAL LANO 35.0 52.0 63.0 49.0 60,.0 105. VITAL STATISTICS AVERAGE BIRTH RATE I/THOU) 4h6 43.0 42.0 30.4 32.9 Z1.0 AVERAGE DEATH RATE 4/THOU) 14.0 10.2 B.6 9.9 11.0 3.1 INFANT MORTALITY RATE I/THOUI 74.0 66.5 52.0 110.0 79.0 27.9 LIFE EXPECTANCY AT BIRTH IYRS) 56.3 62.4 64.7 59.7 60.6 70.5 GACSS REPRCDUCTION RATE 3.2 3.1 3.0 2.b 2.2 1.4 POPULATION GROWTH RATE (2) TOTAL 3.1 3.4 3,3 2 9 2.4 1- URBAN 4.9 4.8 5.9 5.0 3.5 2.0 URBAN POPULATION It OF TOTAL) 50.7 58.7 62.Si 56.0 76.0 59.1 AGE STRUCtURE (PERCENTI 0 TO 14 YEARS 44.2 46.2 46.3 42.0 39.0 27.8 15 TO 64 YEARS 52.1 50.1 50.3 55.0 56.3 62.5 65 YEARS AND OVER 3.1 3.7 3.4 3.0 4.7 9.7 AGE DEPENDENCY RATIO 0.9 1.0 1.0 0.8 0.8 0.6 ECONOMIC DEPENDENCY RATIO 1.1 2.0 1.8 & 1.5 1.6 1.1 FAMILY PLANNING ACCEPTOPS (CUMULATIVE. THOU) . 55.5 321.1 250.0 403.5 USERS IS OF MARRIED WOMEN) .. .. 13.1 1.6 EMPLOYMENT TOTAL LABOR FORCE (THOUSAND) 11300.0 13000.0 I6600.0 29600.0 2900.0 11900.0 LABOR FORCE IN AGRICULTURE II) 54.0 4s5.0 41.0 44.0 21.0 25.0 UNEMPLOYEO (I OF LABOR FORCEI . .. .. .. 4.1^ 1.1 INCQME OISTRIBUTION a OF PRIVATE INCOME RECD BY- HIGHEST 5s OF HOUSEHOLDS 39.Z Ia 37.8 .. 35.0 31.0 HIGHEST 20 OF HOUSEHOLDS 62.5 7; 63.2 . 62.0 55.8 LOWEST 201 OF HOUSEHOLDS 4.4 4.2 . 3.0 a 4.8 LOWEST 40X OF HOUSEHOLDS 10.9 10.2 .. 10.0 13.0 DISTRIBUTION OF LAND OWNERSHIP _ ---- -_ ---_---_-__ - - ___ --- _- _ _ X OWNED BY TOP lOX OF OWNERS . 37.1 .. 45.0 s OwNED BY SMALLEST 101 OWNERS .. 0.3 .. 1.5 HEALTH AND NUTRITION POPULATION PER PHYSICIAN 1800.0 1480.0 .. 1910.0 2210.0 740.0 d POPULATION PER NURSING PERSON 2830.0 /b 162O.0 / 3220.0 /b 5830.0 - POPULATION PER HOSPITAL BED 590.0 /a 960.0 830.0 ' 260.0 270.0 220.0 PEP CAPITA SUPPLY OF - CALORIES (2 OF REQUIREMENTS) 107.0 110.0 118.0 109.0 101.0 107.0 PROTEIN (GRAMS PER DAY) 65.0 65.0 61.0 b4.0 71.0 81.0 -OF WHICH ANIMAL AND PULSE 29.0 d 28.0 / .. 39.0 32.0 40.0 DEATH RATE I/THOU) AGES 1-4 12.7 9.8 8.4 .. 3.9 0.9 EDUCATION ADJUSTED ENROLLMENT RATIO PRIMARY SCHOOL 81.0 106.0 107.0 /d 87.0 103.0 131.0 SECONDARY SCHOOL 11.0 23.0 24.0 0 28.0 36.0 57.0 YEARS OF SCHCOLING PROVIDED' (FIRST AND SECOND LEVEL) 12.0 12.0 12.0 13.0 12.0 11.0 VOCATIoNAL ENROLLMENT (I OF SECONDARY) 24.0 24.0 ,, 17.0 33.0 20.0 ADULT LITEPACY RATE (2) 62.0 A 76.0 78.D 68.0 90.0 94.0 HOUSING _- -- -N 2.2 PERSONS PEP ROOM (AVERAGE) 2.6 2.2 .. 1.0 1.3 OCCUPIED DWELLINGS WITHOUT PIPED WATER (Xi 76.0 L, 61.0 . 73.0 / 40.0/c ACCESS TO ELECTRICITY (2 OF ALL DWELLINGS) .. 59.0 .- 48.0 RURAL DWELLINGS CONNECTED TO ELECTRICITY (2) .. 28.0 .. 8.0 CONSUMPTION _ _ _ -----_- RADIO RECEIVERS (PER TNOU POP) 95.0 276.0 311.0 60.0 143.0 214.0 PASSfNGER CARS IPER THoU POP) 14.0 21.0 31.0 25.0 11.0 71.0 ELECTRICITY (KWH/YR PER CAPI 313.0 567.0 707.0 491.0 04.0o 1634.0 NEWSPRINT (KG/TR PER CAP) 2.8 3,2 2.5 2.7 5.0 5.8 SEE NOTES AND DEFINITIONS ON RVEfRSE  t 3