Honduras - Third Port Project

Document of FI llLE lCDPY The World Bank FOR OFFICIAL USE ONLY Repot No. P-2O2O0HO REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT AND THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE EMPRESA NACIONAL PORTUARIA WITH THE GUARANTEE OF THE REPUBLIC OF HONDURAS AND A LOAN AND A CREDIT TO THE REPUBLIC OF HONDURAS FOR A THIRD PORT PROJECT March 15, 1977 L This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  Currency Equivalents US$ 1.00 2 Lmpiras L 2,00 = US$1.00 Fiscal Year January 1 - December 31  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 TIIE EMPRESA NACIONAL PORTUARIA WITH THE GUARANTEE OF THE REPUBLIC OF HONDURAS A PROPOSED LOAN AND AN IDA CREDIT TO THE REPUBLIC OF HONDURAS FOR A THIRD PORT PROJECT 1. I submit the following Report and Recommendation on proposed loans equivalent to US$12.0 million and a proposed development credit equivalent to US$5.0 million to Honduras to help finance a Third Port Project. A loan of US$7.0 million to the Empresa Nacional Portuaria (ENP) with the guarantee of the Republic of Honduras would have a term of 20 years including 4 1/2 years of grace with interest at 8.5 percent per annum. A loan of US$5.0 million to the Republic of Honduras would be on standard Third Window terms with the first payment due January 15, 1983 and the final payment on January 15, 2001. The development credit would be on standard IDA terms. The Third Window loan and the development credit would be relent to the Empresa Nacional Portuaria on the same terms and conditions as the loan to the ENP. PART I - THE ECONOMY I/ 2. A report entitled "Economic Position and Prospects of Honduras" (1165-HO) was distributed to the Executive Directors on August 23, 1976. The findings of the Report are summarized below, and a country data sheet is attached as Annex I. Development Prospects 3. The long-run growth rate of the Honduran economy has been modest: real GDP per capita grew at less than 1 percent per year between 1950 and 1975. With a per capita GNP of US$350 in 1975 (World Bank estimate), Honduras is the poorest country in Central America and the majority of the population lives on a subsistence income. A major reason for the poor growth performance is the continued dependence of the economy on the production and export of a few agricultural commodities, especially bananas, and thus on fluctuating world market and weather conditions. This was illustrated dramatically when substantial hurricane damage to the banana plantations in September 1974 reduced banana export volumes in 1975 to about half the level of previous years. At the same time the recession in the developed world affected beef 1/ Substantially identical to Part I of the President's Report dated November 11, 1976, for the Honduras Seventh Highway Project. This document has a restricted distribution and may be used by recipients only in the performance of their official duties. l i contents may not otherwise be disclosed without World Bank authorization.  - 2 - and lumber exports, and rising oil prices led to a severe deterioration in Honduras' terms of trade. In early 1975, an emergency basic grains program designed to offset the consequences of the hurricane destruction failed, largely because of a drought. The result was two years of recession, with real GDP stagnant in 1974 and 1975. 4. There are many reasons for the continued dominance of bananas in the Honduran economy. The resource base is small. Known mineral deposits are not extensive. Land suitable for agriculture is available and the country has sizeable forest resources, but because of a serious lack of basic infrastruc- ture, and of deficient development policies in the past, these resources have remained underutilized. Some progress has been made during the last two decades, especially in the area of transport development, but the mountainous topography of the country has made the expansion of the road network slow and costly. This limits the size of the domestic market and hampers industrial development. Honduras' participation in the Central American Common Market (CACM) in the early 1960's was an attempt to gain access to a larger market for its industry, but the process was halted by the conflict with El Salvador in 1969. However, even while the expanded protected market of the CACM lasted, Honduras did not receive the expected benefits, as it was unable to compete with its neighbors in attracting new investments or developing new industries. A further obstacle to economic development in Honduras is the severe scarcity of entrepreneurial talent and the low productivity of the labor force. About 50 percent of the adult population is illiterate and nutrition and health standards are very deficient. 5. The agricultural sector has accounted for about one-third of GDP in the 1970's. While there is considerable potential for improving utiliza- tion of resources and the productivity of the agricultural sector, uneven land distribution and frequent underutilization of larger holdings have retarded increases in productivity and resulted in considerable peasant unrest. The Government recognizes that a correction of this situation is vital for the future stable development of the country and, although hampered by a shortage of competent personnel, it is making serious efforts to address the problem. It began substantial land redistribution in 1973 under Decree Law 8. This was followed by Decree Law 170 in 1975, which established the operating regulations for the comprehensive agrarian reform program necessary for long-run improve- ments in agricultural productivity. A great deal has already been accomplished. Since 1973, the Government has distributed land to over 30,000 families. The program, however calls for land distribution to an additional 70,000 families, and peasant organization demands for a rapid as well as an effective agrarian reform process can be expected to continue. Failure to accommodate their needs on the part of the Government could cause renewed rural unrest and seriously undermine private sector confidence. Thus far, however, this has not happened and the private sector is financing a major expansion of sugar production. Four new sugar mills are scheduled to come on stream in 1977 and 1978.  - 3 - 6. The state forest corporation (COHDEFOR) has made significant pro- gress towards the further development of the country's substantial forest resources. COHDEFOR is now preparing a project in the Olancho, the area with the country's largest forest reserve, for timber milling and industrializa- tion and for a pulp and paper plant. Decisions have now been taken regarding the implementation schedule and the financing package for the first stage of the project (timber milling). In addition, several projects are being pre- pared for processing installations for rough-sawn lumber; it is expected that these will stimulate the development of intermediate and end-product indust- ries such as furniture and molding. Forest management work is being under- taken through eight district offices and negotiations are underway with Canada for assistance with this and other forestry activities. Balance of Payments 7. The balance of payments deteriorated sharply during 1974 and 1975, mainly as a result of the combined effects of weakening terms of trade, the world recession, the September 1974 hurricane, and the drought in 1975. Inflows from foreign grants, the IMF Oil Facility, the Venezuelan Investment Fund, along with borrowings from bilateral and international lending agencies financed the bulk of the def'cit during these years. Balance of payments management is expected to continue to be difficult during the next several years. Net international reserves were equivalent to about six weeks' imports in December 1975. The recent sharp increases in coffee prices have led to improved terms of trade in 1976 and a temporary strengthening of the balance of payments but, given present expectations, sizeable resource gaps in the balance of payments are projected for the period 1977-81 owing to large import requirements and only moderate export growth. During 1977-81, the growth of banana exports will largely reflect'recovery from the 1974 hurricane, and increases in the volume of the other major exports, coffee, beef, and wood, are expected to be modest. Anticipated increases in the prices of wood and beef, added to increased coffee prices, are expected to keep Honduras' terms of trade at their 1976 level through the end of the decade. Other ex- ports are also expected to grow, and sugar may become a significant export item by 1980 if the planned production increases are realized on schedule. The pro- jected recovery of banana-exports and the anticipated increase in sugar, beef, and wood exports will depend, however, on improvements in managerial capaci- ties and efficiency as well as on orderly progress in the agrarian reform program. Public Investment and External Debt 8. The Government plans to accelerate economic growth over the medium term through an ambitious public investment program, which would at the same time alleviate major bottlenecks to long-term development. Large invest- tments are planned in roads, power and communications, and in the area of export production: lumber mills, a pulp and paper plant, a tourism project, and agricultural projects and a sugar mill. Because consumer goods already account for only a small share of imports and cannot be reduced without hard- ship, imports will be growing fairly rapidly as the public investment program  - 4 - is realized. The financing of the projected resource gaps will require substantial capital inflows and the bulk of the foreign capital requirements will have to be met through public borrowing. In the past, Honduras has managed to keep its external debt service ratio fairly low, because foreign loans were almost all on concessional terms. It is important that the country continue to borrow on reasonably soft terms lest the planned public' investment program result in an excessive debt service burden in the future. Even if Honduras is successful in obtaining most of the financing it needs for its investment program on terms similar to those offered by the international lending agencies, the debt service ratio is still likely to rise from about 5 percent in 1975 to about 15 percent by the early 1980's. Because Honduras will continue to depend on exports of a few commodities with volatile price prospects, and because, historically, natural disasters have sharply reduced the volume of exports every few years, prudent debt management will require maintenance of a rather lower debt service ratio than might be considered safe for more diversified economies. Public Finance 9. During the last three years the public finance situation has remained sound because of improvements in tax collection, and because the growth of capital and current expenditures has been limited. Nonetheless, greater demands on the public sector for reconstruction (after the 1974 hurricane) and development expenditures have resulted in an increase of the overall public deficit from about 2 percent of GDP in 1973 to nearly 5 percent in 1975. The Government has taken steps to improve the fiscal outlook and adopted new tax measures in December 1975 estimated to have raised the tax ratio from 12 percent of GDP in 1975 to about 13.5 percent in 1976. Despite the greater tax effort, however, public savings cannot be expected to finance all of the local costs of the public investment program without unduly res- tricting current expenditures, nor can the shortfall be financed out of domestic borrowing without generating unacceptable levels of inflation. Therefore, some local cost financing on the part of official lending insti- tutions will be required to implement the stepped-up public investment pro- gram. External Assistance 10. The Bank is Honduras' largest creditor, holding 25.3 percent of the US$445.5 million external public debt outstanding--including undisbursed-- repayable in foreign currency, as of December 31, 1975. IDA holds an addi- tional 8.0 percent of the total. Although IDB has made loans totalling the equivalent of US$124.5 million, most of this amount is repayable in local currency, so that IDB's share of the public debt repayable in foreign currency is only 7.5 percent. CABEI accounts for 21.6 percent of the total, the U.S. Government for 20.3 percent, Venezuela 7.2 percent and privately held debt for 10.1 percent. 11. In terms of the sectoral thrust of the lending by the principal external agencies, apart from the Bank, AID has concentrated on agriculture  - 5 - and education, the IDB on transport, agriculture, education and housing, and CABEI on transport. It is expected that AID and CABEI will continue lending primarily in these sectors in the future, while IDB is expected to concentrate mainly on agriculture, industry and power. The lending of these agencies from 1950-1975 is as follows: IBRD IDA AID IDB CABEI TOTAL Total Gross Lending 1950-1975 130.4 34.2 94.4 124.5 88.3 471.8 Gross Lending 1950-1965 25.9 12.5 26.7 27.2 8.1 100.4 Gross Lending 1966-1975 104.5 21.7 67.7 97.3 80.2 371.4 Sectoral Lending 1966-1975 Transport 41.2 -- -- 32.1 51.9 125.2 Power 60.3 9.5 -- -- 9.0 78.8 Telecommunications -- -- -- -- 5.6 5.6 Education 3.0 3.0 10.5 14.4 -- 30.9 Health -- -- 2.6 5.2 8.8 16.6 Housing -- -- 5.0 12.5 -- 17.5 Agriculture -- 9.2 37.5 30.9 1.2 78.8 Industry -- -- 1.5 2.2 1.3 5.0 Other -- -- 10.6 -- 2.4 13.0 Eligibility for Third Window Lending 12. Honduras is considered eligible for Third Window financing on the basis of the following considerations: (a) Poverty: Its per capita income was US$350 in 1975 and US$300 in 1972. 1/ (b) Performance: Honduras has made impressive accomplishments in the last three years in promoting social and economic development. It has undertaken a major agrarian reform program, and has arranged for the financing and begun the last stage of preparation of a major project for the ex- ploitation of its substantial forest resources. Public investment has been substantially increased, from an average level of 4.5 percent of GDP in the 1971-73 period to 8.1 percent in 1975, and should remain at a high level for the next several years in view of the number of projects now in preparation. 1/ World Bank Atlas.  - 6 - (c) Creditworthiness: Honduras' external debt and debt service have been relatively low in the past but can be expected to increase quite rapidly by the early 1980's in line with the increase in public investment necessary to carry out its development plans. At the same time the country's exports are of a quite volatile nature, with bananas and coffee accounting for about one half of total merchandise exports. In these circumstances, Honduras' creditworthiness for conventional and commercial type loans is limited, and external assistance on concessional terms is highly desirable. (d) Alternative Sources of Finance: The projected increase in public investment in Honduras will require substantial borrowing from the major multilateral and bilateral lending agencies (including the Venezuelan Investment Fund); the increase required from agencies other than the Bank, before taking into account the financing requirements of the Third Port Project, is already about the maximum that could be expected given the resource constraints of these agencies. PART II - BANK GROUP OPERATIONS IN HONDURAS 13. Beginning with a loan of US$4.2 million for roads in 1955, Honduras has to date received sixteen Bank loans totalling US$165.2 million and eight IDA credits totalling US$47.6 million, both net of cancellations. The pro- posed loans would raise the total of Bank Group assistance from US$212.8 million to US$229.8 million. Execution of projects financed by the Bank Group has, on the whole, been satisfactory. Annex II contains a summary statement of Bank loans, IDA credits and IFC investments, and notes on the execution of on-going projects. 14. In the past, Bank Group lending was heavily concentrated on trans- port and power, where inadequate facilities hampered the development of the country. The First Livestock Development Credit approved in 1970, how- ever, marked a first step towards the diversification of our lending. Since then, there have been operations for a Second Livestock project; a First Education project, which included as major components primary teacher training schools, support for the national agricultural secondary school and vocational training centers; and a First Agricultural Credit project to finance livestock and crop development with emphasis on assisting agrarian reform settlements through investment credits and a substantial technical assistance program. 15. In future lending to Honduras, we plan to support the priorities of the Government's investment program by giving increased emphasis to investment in the productive sectors and in education, while continuing to lend for phy- sical infrastructure, where there are still deficiencies to be overcome. In addition to the Agricultural Credit project approved last May, preparation  - 7 - efforts are now beginning on a rural development project for the Guayape Valley to help support the agrarian reform program in that area, and a follow on to the First Agricultural Credit project, as well as additional rural development projects which are now being identified, are being planned. Bank Group support is also being considered for COHDEFOR's pulp and paper project. Honduras also has potentially excellent tourism sites which are now being studied to determine whether a project is feasible. As part of its agrarian reform program, the Government wishes to improve its agricultural training program for technicians, and has proposed the creation of rural development centers which would provide comprehensive educational services to rural communities. Bank assistance in this effort will be considered as a possible major component of a second education loan. In transport, after the Seventh Highway Project (approved in November 1976), we will place emphasis on assist- ance in the construction of a network of feeder and access roads to support the Government's agricultural program. The Bank made a US$35.0 million loan for a Sixth Power Project in 1975 and contemplates continuing its assistance to the power sector in the future. 17. It is expected that the Bank Group share of total external public debt disbursed and outstanding will drop to about 21 percent by 1980 because of increasing lending by other external agencies and commercial borrowing. The Bank Group share of debt service in 1975 was 41 percent and this is pro- jected to decline to about 13 percent by 1980. 18. IFC's activities in Honduras have so far included a 1964 loan and a share subscription, of US$295,000 and US$66,750 respectively, in a tannery, Empresa de Curtidos Centroamericana, S.A. (ECCASA); and a US$75,000 share subscription in a pilot promotional company, Compania Pino Celulosa de Centro America (COPINO) in 1969. COPINO was established to develop an industrial project based on timber from the Olancho Forest Reserve, but a series of obstacles to project development arose and efforts to go forward with it were virtually halted in 1971. While current plans for the Olancho forest indus- tries project do not include a role for COPINO, the IFC is assisting the Government in creating an organizational structure for the project and selecting a technical partner. PART III - THE TRANSPORT SECTOR Background 19. The principal agricultural and industrial areas of Honduras are the Sula Valley and the nearby Atlantic coastal strip. San Pedro Sula, which has emerged as the country's main industrial center, and the ports of Cortes and La Ceiba are the principal cities in the area. Further to the south lies Tegucigalpa, the capital city and the second industrial center. The corridor joining Tegucigalpa with San Pedro Sula and Puerto Cortes in the north and the Pacific port of San Lorenzo in the south has been the main conduit of the country's economic activity.  - 8 - 20. Development of the transport sector has taken place only during the last two decades, mainly in the highway and port subsectors. The con- struction of the Inter-American highway in the southern region was started in the mid fifties, and an all-weather road between Tegucigalpa and San Pedro Sula was completed in 1971. Modernization of Puerto Cortes was begun with Bank financing in the late sixties. A second expansion of Puerto Cortes was completed recently, and the construction of a deep water port at San Lorenzo is presently under way, both with Bank financial assistance. Puerto Castilla, to be financed under the proposed loans and credit, would serve the increasingly important agricultural and timber areas of eastern Honduras: the Aguan Valley and the Olancho forest reserve. A number of highway projects are now under construction, or about to begin which would complete most of the country's primary highway network, and the Government is paying greater attention to the improvement and expansion of the feeder and access road system. Honduras can thus look forward to having, in the medium term, a transport system to serve its most important productive areas and to meet the needs of its international trade. Highways 21. Because of the topography of Honduras, road construction, in general, has been difficult and expensive; nevertheless, the road network grew from about 3,200 km (110 km paved) in 1960 to about 6,100 km (1,240 km paved) in 1975. In addition to the principal roads mentioned in the preced- ing paragraph, the primary system includes a road southwest from San Pedro Sula to the El Salvador border and a road along the north coast to La Ceiba. The country's secondary and tertiary road system is not yet well developed. Major road projects now under construction or due to be commenced shortly include three highways from the Tegucigalpa-San Pedro Sula corridor to the central region: the Progreso-Yoro road in the north; the Tegucigalpa- Juticalpa-Catacamas highway in the central area (financed under the Bank's Sixth and Seventh Highway Loans); and the Tegucigalpa-Danli road in the south. The road system to connect the Olancho forest reserve areas with the sites for the planned sawmills, the proposed pulp and paper factory project, and Puerto Castilla are now in the design/engineering phase. Construction of these roads should start in mid-1977 with financial assistance from the Inter-American Development Bank (IDB). Ports 22. Ports are a critical component of the transport sector since they handle nearly 95 percent of the country's international trade. Because of the larger trade with gulf and east coast ports of the United States, port capac- ity has developed mainly on the Atlantic coast, where three out of the four principal ports are located. Puerto Cortes is the principal general cargo port, while Tela and La Ceiba are mainly banana handling facilities. San Lorenzo on the Pacific side is presently a lighterage port, but will soon have alongside facilities to service ocean-going vessels and will be able to handle increased sugar and lumber exports. Puerto Cortes, which handles over 1.8 million tons, or 79 percent, of the overseas traffic, is the largest port of  - 9 - Honduras, with an excellent natural harbor, and provides efficient service. It is quickly adapting to new types of traffic such as roll-on/roll-off, containers, and lighter-aboardship. A gantry crane for handling containers is scheduled to be installed in 1977. 23. The ports of Honduras are administered by Empresa Nacional Portuaria (ENP), the national port authority, established with Bank assistance in December 1965. ENP is an autonomous government entity with an Executive Board of seven members consisting of three Ministers, one representative of the National Planning Council and one delegate each from the Chamber of Commerce and Industry, the trade unions and the shipping companies. The dav-to-day administration is the responsibility of the General Manager. The manage- ment and operations of ENP are considered highly efficient, and its finan- cial position is sound. The port subsector, during the decade since the creation of ENP, has responded adequately to the needs of the growing volume and variety of overseas traffic. 24. Two previous Bank loans approved in 1966 and 1971 (Loans 463 and 767-HO) have provided almost all the external financing for port expansion in Honduras. The ENP has carried out these two previous port projects for improvement of Puerto Cortes and the construction of San Lorenzo, in a very capable manner. There was a long delay in the start of construction of San Lorenzo which resulted in a large cost overrrun and required a US$3.0 million supplemental loan from the Bank (approved July 1975). This, however, was the result of a political objection to the location of the port raised by the government which came into office after the loan had been signed, and was not the fault of the ENP. The succeeding government approved the original site, and since approval of the supplemental loan, project execution has been pro- ceeding normally. The San Lorenzo port is now expected to be completed by September 1977. 25. ENP has the sole responsibility for port planning. Its planning process includes development of a rolling five-year plan that covers econo- mic, engineering and financial analyses, most of which are done by ENP's own staff. The inclusion of a cash flow analysis in the five-year plan effec- tively integrates the ENP's planning and capital budgeting process. Other Transport 26. The railway system consists of three narrow-gauge lines, all located in the north and serving mostly the banana plantations in the Sula Valley, the northern coastal strips, and the upper Aguan Valley. Honduras has two principal airlines; between them they provide adequate domestic and international service. With the improvement of the road system since 1970, domestic air traffic has declined steadily. Little intermodal trans- port planning is done since air and rail transport are relatively unimportant and highway/port coordination is not complex.  - 10 - PART IV - THE PROJECT Project Objectives 27. The primary objectives of the project are (a) to ptovide suitable port facilities at Puerto Castilla and at San Lorenzo for the efficient hand- ling of new export traffic expected to be generated in the near future; (b) to carry out a channel depth study for San Lorenzo; and (c) to train ENP staff in container operations. Project Description 28. To support the above objectives, the proposed project contains the following components: (a) Civil Works At Puerto Castilla: Construction of a 450 m wharf, one transit shed, one warehouse, two lumber sheds, storage tanks for palm oil and petroleum, office building, and miscellaneous services. At San Lorenzo: Extension of the pier (presently under construc- tion) to provide an additional berth 145 m long, and construction of a sugar storage shed and two molasses tanks. (b) Equipment At Puerto Castilla: Provision of general cargo and lumber han- dling equipment, chip-loading equipment, a used tugboat and a launch. At San Lorenzo: Provision of (1) equipment for handling sugar, lumber and general cargo and for pumping molasses; and (2) navigational aids. (c) Consultant Services for Detailed engineering and supervision of construction, and (d) Technical Assistance for (i) Channel depth study at San Lorenzo; and (ii) Training of ENP staff in container operations at Puerto Cortes.  Puerto Castilla 29. The facilities at Puerto Castilla are needed to serve important export development projects now being undertaken by the Government in the Aguan Valley and Olancho Forest Reserve. The first phase of the Aguan Valley agricultural development project, which received financing from IDB, has been completed, and the IDB has recently approved a US$40.0 million loan for a more ambitious second phase. Surpluses of corn and beans are already being produced in the Valley, and production of grapefruit and palm oil from the first phase will become substantial within a few years. Although all of these products except grapefruit would be primarily for the domestic market, those to be consumed internally will all be shipped via Puerto Castilla to Puerto Cortes since land transport is very expensive. The Government is also going ahead with the first stage of the Olancho forest industries project with IDB and Venezuelan financial support to produce timber and chips, for export. In February 1977 the IDB signed a loan for US$59.5 million with the Honduran Government to finance the road infrastructure for this project. Three sawmills will be constructed during the 1979-1981 period. For the second stage a pulp and paper factory is to be constructed in the early 1980's to produce liner board which will then largely replace chips in the export program. San Lorenzo 30. The works proposed at San Lorenzo are related to the expansion of the sugar industry, which is presently under way in the southern region of Choluteca. Since the sugar companies developed their export plan after the present contract for the port works at San Lorenzo was awarded, the facilities currently under construction are inadequate for handling the expected traffic and, therefore, need to be expanded. The sugar companies have contracted with a large international firm to provide technical assistance and to serve as their marketing agent. The exports are expected to be profitable since the cost of production in Honduras compares favorably with the price level at which the world market for sugar is forecast to be within two years (at about USi12 per pound FOB in constant 1974 prices). Because the sugar mills are close to San Lorenzo and expect to export some production to Japan, the owners have requested that facilities be provided at San Lorenzo. In order to justify the provision of the storage and handling facilities, the sugar companies have offered to guarantee ENP a minimum tonnage of exports. It has been agreed that ENP would not sign the contract for the construction of additional facilities at San Lorenzo until an agreement satisfactory to the Bank on minimum tonnages has been obtained from the sugar companies (Section 3.04 of the draft Loan Agreement). 31. Lumber and general cargo-handling equipment for San Lorenzo was originally included in the Second Port Project (Loan 767-HO); however, because of the cost overrun on the civil works, it was agreed, when making the supple- mental loan of US$3.0 million, that the unordered equipment would be deleted and might be considered for inclusion in a subsequent project. Accordingly, since the equipment is still needed, provision for it has been made in this project.  - 12 - Technical Assistance 32. The channel depth study will examine the feasibility of deepening the access channel to San Lorenzo to permit the use of larger vessels than can now enter the port for export of sugar and molasses, and the training will prepare ENP staff for the efficient handling of the growing container traffic. Project Costs 33. The total cost of the project is estimated at US$29.9 million, with a foreign exchange component of US$17.0 million, as summarized below: -------------- US$ million ------------- Percent of Local Foreign Total Foreign Cost Civil Works Puerto Castilla 7.5 6.4 13.9 46 San Lorenzo 1.2 1.9 3.1 60 Sub-total 8.7 8.3 17.0 Equipment Puerto Castilla 0.2 2.8 3.0 95 San Lorenzo 0.1 1.0 1.1 95 Sub-total 0.3 3.8 4.1 Consultant Services Puerto Castilla 0.5 0.8 1.3 60 San Lorenzo 0.1 0.2 0.3 60 Sub-total 0.6 1.0 1.6 Technical Assistance Channel Depth Study 0.1 0.2 0.3 60 Training 0.0 0.1 0.1 60 Sub-total 0.1 0.3 0.4 Contingencies Physical 1.2 1.2 2.4 48 Price 2.0 2.4 4.4 56 Sub-total 3.2 3.6 6.8 Total 12.9 17.0 29.9 57 34. The base cost estimate for civil works and equipment has been obtained by updating to December 1976 the consultant's estimate, which was based on 1975 prices. Contingency provisions include: (a) physical varia- tion in civil works at 15 percent for Puerto Castilla and 10 percent for San Lorenzo; and (b) annual price escalation at 12 percent for civil works, 8  - 13 - percent for equipment and 6 percent for consultant services for the 1977-1979 period. The cost of a total of 440 man-months of consultancy services and technical assistance are estimated at an average, for foreign and local con- sultants, of US$3,900 per man-month. 35. The proposed Bank Group financing would cover the estimated foreign costs. The local currency costs (US$12.9 million equivalent) would be met partly by ENP's own resources and partly by domestic bond issues with a 10-year term. It has been agreed that the Government would underwrite the ENP bond issues, or make other financial arrangements satisfactory to the Bank, in order to ensure that the local resources necessary to complete the project are available (Section 2.02 of the draft Guarantee Agreement). Project Implementation 36. ENP would be the Borrower and the Executing Agency. As demon- strated in the case of the two previous Bank financed port projects, ENP has a capacity to execute the project satisfactorily. For carrying out engineering and supervision of construction, the channel depth study and the training of ENP staff in container operations, ENP would contract for consultants whose qualifications, experience and terms of reference would be acceptable to the Bank. Construction on both ports is expected to commence in mid-1977. The work at San Lorenzo would be completed by March 1978 and that at Puerto Castilla by September 1979. Financial Analysis 37. The ENP's financial performance for the five years from 1971 through 1975 has been good. During this period, ENP's operations were profitable, and the return on unrevalued net assets was above 16 percent. Since 1971, revenues have grown by 70 percent, partly because ENP has assumed responsi- buility for the operation of additional ports and partly because of the growth in traffic handled. Net income during this time, however, has increased only by 41 percent because increases in expenses have not been matched by increases in tariffs. As a result, the operating ratio increased from 44 percent in 1971 to 63 percent in 1975. The debt equity ratio at the end of 1975, although higher than the 35/65 ratio in 1971, was a satisfactory 44/56. 38. Forecasts for the 1977-1983 period indicate that there are good prospects for satisfactory financial performance by ENP. A tariff increase was implemented in February 1977 which should enable ENP to achieve an 8 percent rate of return on revalued assets in 1977. While this tariff increase was accompanied by some restructuring of tariffs, there is need for further restructuring so as to relate tariffs to the present value of assets and to the real cost of providing port services and facilities. ENP has agreed to make such further adjustments to its tariff structure not later than July 1, 1978 (Section 5.09 of the draft Loan Agreemenet), based upon a full revaluation of its assets to be completed by October 1, 1977. ENP also agreed to carry out further asset revaluations at least once every three years  - 14 - (Section 5.04 of the draft Loan Agreement). Information regarding the cost of port services and facilities will be provided by a cost accounting system which ENP is now preparing and has agreed to put into operation by October 1, 1977 (Section 5.05 of the draft Loan Agreement). Furthermore, ENP has agreed to increase tariff levels as necessary to maintain an annual rate of return of not less than 8 percent on revalued assets (Section 5.06(a) of the draft Loan Agreement), and in order to maintain a satisfactory cash flow, it has agreed that it will limit capital expenditures during the construction period for items not included in the Second and Third Projects to a maximum of US$500,000 per annum (Section 5.08 of the draft Loan Agreement). 39. The total planned investment of ENP during the period 1977 to 1983 is US$49.3 million. Of this total US$29.5 million relates to project items, and the balance of US$19.8 million is for the ongoing construction of San Lorenzo/Amapala under the Bank's Second Port Project and the new free trade zone at Puerto Cortes. Free trade zone investment is not related to port operations, and in order to insure that non-port operations do not become a financial burden on port operations ENP has agreed to the following: (i) ENP will retain each year an amount equivalent to 8 percent of net fixed port assets for investment in port services and facilities (Section 5.06(b) of the draft Loan Agreement); (ii) ENP will use its best efforts to ensure that non-port operations earn sufficient revenue to cover their expenses (Section 5.07 of the draft Loan Agreement); (iii) ENP will advise the Bank prior to any changes in port tariff levels in order, among other things, to afford the Bank an opportunity to comment on increases which might not be related to port operations (Section 5.09(b) of the draft Loan Agreement). 40. As a result of the present project and other investments being made, ENP assets are forecast to increase by 140 percent, or US$41.7 million, by 1979, pushing up the debt/equity ratio to a peak of 56/44. However, after 1979, because the rate of growth is expected to decline and ENP will generate substantial amounts of surplus funds, the debt/equity ratio will decline to a satisfactory level of 35/65 by 1983. With these projected surpluses, ENP will be in a position, and has agreed, to set aside funds each year sufficient to retire the local bond issue (para. 35) at maturity (Section 5.11 of the draft Loan Agreement) . With the intended revision of tariffs, debt service coverage will be at least 1.75 to 1 throughout the 1977-83 period, and ENP has agreed that, as has been provided in prior Loan Agreements, no debt will be incurred without Bank agreement unless net cash generation for the preceding 12 months is at least 1.75 times the maximum total debt service requirements for any succeeding fiscal year. 41. Although ENP accounting procedures and control are generally satis- factory, individual accounts separate from ENP's over-all accounts should be established and maintained for each of the major development projects. It has been agreed that such separate accounts would be set up and maintained (Section 5.01(b) of the draft Loan Agreement).  - 15 - Procurement and Disbursement 42. All contracts for civil works and equipment for Puerto Castilla and San Lorenzo would be awarded on the basis of international competitive bid- ding, except that the used tugboat for Puerto Castilla, for which sources of supply are expected to be limited, would be procured by international shop- ping. With regard to the civil works for San Lorenzo, ENP proposes to negotiate with Colombus Latinoamericana (the contractor which is carrying out ongoing port works at San Lorenzo) an extension of the existing contract. ENP's proposal is practicable and would result in the facilities being ready earlier than would be the case if new bids were invited. It is doubtful that international contractors would be interested in the new bid, not only because of the modest size of the contract (estimated cost US$3.1 million), but also because of the effective competition which Columbus Latinoamericana is in a position to offer because it is already on the site. Since the current contract with Columbus Latinoamericana was awarded in 1975 on the basis of international competitive bidding, and the prices applicable thereto would provide a basis for negotiating the price of the new contract, ENP's proposal is considered acceptable and the terms of the revised contract will be subject to Bank approval. 43. The proposed Bank Group financing will be disbursed to cover the estimated foreign exchange costs of the various project items as shown in paragraph 33. In order to meet the tentative schedule for completing the port works at Castilla by the end of 1979, work on the detailed engineering of the project has already been started. Also, because of the possibility of utilizing, at a favorable price, the services of a dredging contractor (which would be financed by ENP) who is scheduled to complete a job in Corinto, Nicaragua in the latter half of 1977, ENP has also begun the channel depth study. Retroactive financing of up to US$500,000 is therefore recommended to meet foreign expenditures incurred on consultant services for engineering and technical assistance after November 1, 1976. Environmehtal Impact 44. Since no dirty or dusty cargoes would be handled at either of the project ports, and since normal precautions would be taken in handling the small quantities of petroleum at Puerto Castilla, there should be no adverse effect upon the ecology as a result of the port development proposed under this project. The ecological implications of the proposed sawmills and the paper and pulp factory have been considered by the Government and IDB, and suitable provision for controlling air and water pollution would be included in their design. Economic Analysis 45. Traffic projections for Puerto Castilla are based on the Government's program for export of forestry products (sawn timber, woodchips and eventually liner board) from the Olancho forestry reserve, and of agricultural products  - 16 - (corn, beans, citrus fruit and palm oil) from the Aguan Valley, and the esti- mate of imports is based on the projected inputs (machinery, chemicals, ferti- lizers, petroleum) to the forestry and agricultural development projects. Major financial commitments have already been made in both these development schemes. The port, which will handle the traffic generated by the Aguan and Olancho projects, is justified as part of this larger package of investments. The fundamental economic issue is whether the agricultural and forestry development programs are economically viable, and the question has been answered affirmatively by formal economic and financial analyses. Thus, the analytical task for the port project was to identify the least cost solution for the required infrastructure, i.e., the optimal location, timing, and size of the port facility. This exercise, together with the determination of an appropriate port tariff structure that will generate revenues to cover the full cost of the port, has established that the investment is justified. 46. Starting at a level of 264,000 tons in 1980, the total traffic is expected to increase to 1,049,000 tons in 1983, when the export of chips will reach a peak of 643,000 tons. With the expected startup of the pulp and paper factory in 1984, chip exports will decline rapidly and will be replaced by a smaller tonnage of liner board (133,000 tons), bringing the total traffic to 794,000 tons in 1986. These traffic projections are conservative since they include only the reasonably firm traffic related to the forestry and agricultural projects, and do not take into account export traffic such as hardwood products, sugar from the Aguan Valley and bananas from the Isleta area, which is likely but not yet certain. 47. At San Lorenzo, the traffic is expected to rise from the 1976 level of 172,000 tons to 240,000 tons in 1978, when the export of sugar and molasses is to commence. Thereafter, the traffic will gradually build up to 276,000 tons in 1986. Based on firm figures of export traffic which the sugar industry will guarantee and on a conservative estimate of growth of lumber and general cargo, these projections are considered to be realistic. 48. The overall rate of return for the project is 25 percent, with first year benefits of 23 percent. The benefits attributable to the proposed facili- ties at Puerto Castilla are mainly the avoided cost of the closest alternative to the proposed investment, i.e., (a) land transport of the export cargo to Puerto Cortes and (b) a wharf and ancillary facilities at Puerto Cortes which would be needed for handling the additional traffic at that port. These benefits yield an internal rate of return of 27 percent with first year benefits of 25 percent for this investment which accounts for 80 percent of project costs. 49. In the case of San Lorenzo, if the proposed extension of the pier is not carried out, the least cost alternative would be to divert the sugar and molasses traffic to Corinto in Nicaragua, which is the nearest suitable port on the Pacific side. The avoided cost of land transport and port charges at Corinto would be the benefits from the proposed investment at San Lorenzo. In addition, there would be savings in waiting time for lumber and general  - 17 - cargo vessels. Together, these benefits yield a return of 14 percent, with first year benefits of 14 percent for this investment which accounts for 20 percent of project costs. 50. Sensitivity analysis in which the cost and benefit streams are varied by 25 percent indicate that the return would be no lower than 22 percent for Puerto Castilla and 10 percent for San Lorenzo. Project Risks 51. A delay in the startup of the first of the three proposed sawmills at Corocito is a possible uncertainty associated with the project. This delay might result from (a) slow progress in preparation of the sawmill phase and (b) the necessary road infrastructure, which is being financed by IDB, not being ready in time. In order to expedite construction of the sawmill, the Government has assigned it high priority and has appointed a ministerial committee to monitor progress and resolve any problems that may arise. Also, IDB has provided a senior executive to assist COHDEFOR in preparing and executing the project. Design of the sawmills is now proceeding on schedule. Financing for the sawmills will be provided by the Government, IDB, and suppliers. Preliminary discussions have begun with a number of bilateral export finance agencies, and final arrangements are expected to be concluded by September, 1977. In order to ensure that there are no administrative delays in the forest roads project, the Minister of Public Works has expanded an existing project execution unit for the forest roads. 52. In view of the steps taken, and progress made so far on meeting pre- paration schedules and arranging the necessary financing for the sawmill and forest road projects, it appears that there is little risk of significant delay. However, since the usefulness of having the proposed port facilities at Castilla in operation by the end of FY1979 is dependent to a large extent upon the completion of the supporting road system, it has been agreed with the ENP that bid documents for the port works at Castilla would be issued only after satisfactory bids have been received for the forest road works (Schedule 4, Part A.3 of the draft Loan Agreement). Conclusion 53. The proposed project fully merits Bank Group support. It will pro- vide suitable 6utlets for export commodities which will help Honduras to earn valuable foreign exchange and will yield acceptable rates of return of 27 percent and 14 percent on its two main components. The facilities proposed at Puerto Castilla are essential for the success of two important projects of the Honduran Government, i.e., the Aguan Valley Agricultural Development Project and the Olancho Forest Industries Project, which have been undertaken with the object of developing the northeastern region. Without the proposed facilities at San Lorenzo, sugar enterprises, which have already committed considerable investment to expansion of capacity, will face higher costs in exporting their products.  - 18 - PART V - LEGAL INSTRUMENTS AND AUTHORITY 54. The draft Loan Agreement between ENP and the Bank, the draft Third Window Loan and Guarantee Agreements between the Bank and the Republic of Honduras, the draft Development Credit Agreement between the Association and the Republic of Honduras; the Report of the Committees provided for in Article III, Section 4(iii) of the Articles of Agreement of the Bank and in Article V, Section 1(d) of the Articles of Agreement of the Association, respectively; and the text of the resolutions approving, respectively, the proposed loans and the proposed development credit are being distributed to the Executive Directors separately. The effectiveness of the Loans and Credit are condi- tioned on the execution and delivery of a subsidiary loan agreement on behalf of the ENP and the Republic of Honduras, and in addition, the effectiveness of the draft Development Credit Agreement, the draft Third Window Loan Agree- ment and the draft Loan Agreement are conditioned on the effectiveness of each other. Special conditions of the project are listed in Section IIl of Annex IV. 54. I am satisfied that the proposed loans would comply with the Articles of Agreement of the Bank and with the established criteria for Third Window operations, and that the development credit would comply with the Articles of Agreement of the Association. PART VI - RECOMMENDATION 55. I recommend that the Executive Directors approve the proposed loans and development credit. Robert S. McNamara President by J. Burke Knapp Attachments March 15, 1977  AMJEX I Page 1 of L pages TAB'LE SA HoNouRtAS- SOCIAL IMlOICATORS DATA SHEET LAND AREA (THOU KN2) .. ..........------- - ------- ------------- ~~~~~~HONDURkS REFERENCE COUNTRIES (1910) T)TAL 112.1 MOST RECENT LOgIC. .. 1960 1970 ESTIMATE PARAGUAY DOMINICAN RIEP. COSTA RICA ' GOP N'ER CAPITA (USI) 170.0 290.0 350.0 ~d 350.0 310.0 560.0 POPULATION AND VITAL STATISTICS PO'ULATION (HIO-SR. HILLION) 1.9 2.5 2.9 Ld. 2.2 4.1 1.7 POPULATION DENSITY PER SQUARE KAN. 17.0 22.0 26.0 /d 6.0 83 .0 34.0 'ER SQUARE KM. AGRIC. LAND *.. . 68.0 106.0 VITAL STATISTICS CRUDE B IRTH RATE PER THOUSAND 5L.0 51.5 4L9.3 h1 .8 1j7.3 0i.1 CRUDE DEATM RATE PER THOUSANO 26.5 19.1 1L.6 10.1 13.L 8.3 INFANT MORTALITY RATE C/THOU) .... 18./a 67.0 103.0 ~A. 62.0 LIFE EXPECTANCY At BIRTH (YRS) L1:; 4;.i 53.50 60.1 55.L 65.b GROSS REPRODUCTION RATE ..3.4 3.3 3.2 3.5 3.41 POPULATION GROWTH RATE (Ih TITAL 3.0 2.? 2.7 /e 2.5 /a 2. 9 b 3. 3 JRBAN 0.3 7. 9 5.0 3.4 5.6 4.r URBAiN POPULATION (I OF TOTAL) 23.0 32.0 31.0 36.0 40.0 46.0 AG-' STRUCTURtE (PERCENT) 0 TO 14 YEARS 4r.8 46.7 45.7 46.4 47.3 49.0 1S TO 64 YEARS 49.7 50.9 52.1 50.4 49.4 48.0 61 YEARS AND OVER 2.15 2.4 2.2 3.2 3.1 3.0 AGE DEPENDENCY RATIO 1.0 1.0 0.9 1.0 1.0 I. EC3NOHIC DEPENDENCY RATIO 1.6/a 1.5 /a 1.5/ 1.6. .L . FAMILY PLANNING- ACCEPTORS (CUMULATIVE. THOU) . 20.7 80.1 . 36.8 35.5 USERS (I Of HARRIED WOHEN) . .. EM PLOYM E NT TOTAL LABOR FORCE (THOUSAND) 570.0 800.0 860.0 700.0 1100.0 540.0 LABOR FORCE IN AGRICULTURE (1) 67.0 65.0 66.0 53.0 55.5 43.0 UNEMPPLOYED (I OF LABOR FORCE) 6.0 8.0 ..3.5L t4.o0&d 5.1 Lb. INCOME DISTRIBUTION I 3F PRIVATE INCOME REC*O BY- IO(AI=T 5% OF IIDUSEIED * 28.0~ .3. 2 6.3e/ Q/ HIG0lW 2C~07 OF HUSEHI)LDS *. 60.6 ..062.0 54. 3 5,*3 7k UAWEST 20% cr )H3UT.LS * 2.5~ .4.0 4. 4s .1l IWBvT 40s OF HiUSHmKzS 8.4~ . . 12.4 I.1. . DISTRl8UT1iO OF LAND OWNoERtSHIP ...-.-....q--------- I OWIED 87 TOP 102 07 DWNERS ........ 6.7 I OWNED 8Y SMALLEST 101 OWNERS ... .1.8 HEALTH AND NUTRITION POPIJLATION fIR PHYSICIAN. 3710.0 /. 37100 [2340.0 /e 2100.0 1630.0 POPULATION fiE NURSING PERSON 2190.0 . 2070.0 j2 310.0 7- 3930.0 1690.0 POPULATION PER HOSPITAL BED 590 .0 cS 570.0 800.0 620.0 350.0 250.0 PER CAPITA SUPPLY OF - CAtLORIES (I Of REQUIREMENTS) 84.0 96.0 94.0 121.0 91.0 110.0 PROTEIN (GRAHS PER DAY) 53.0 5. 6. 74.0 '30.0 63. 0FWHICH ANIHAL AND PULSE 21.0 /d 2S.0 ..41.0 29. 35. DEAT RATE 04THOU) AGES t-4 14.0 1 0. 0 9.0 -6..9 1T6.0 EDUCATION ADJUSTED ENROLLMENT RATIO PIRINARY SCHOOL. 61.0 86.0 81.0 /a 93.0 /d 507.0 108.0 SECONDARY SCHOOL 6.0 10.0 18.0 Z 17.0 19.0 28.0 YEARS OF SCHOOLING PROVIDED (FIRST AND SECOND LEVEL) 12.0 1.2.0 12.0 120 12.0 11.0 VOCAIT INAL ENROLLMENT (I OF SECBONARY) 24.0 18.0 ..6.0 5.0 1. ADULT LITERRCY RATE (2) 4s7.o 52.0 79.0 50.0 890,O HOUSINMG PERSONS PER NOON (AVERAGE) 1.8 .. .. . OCCUPIED DWELLINGS WITHOUT PIPED WATER (Z) 88.0 /e . 60.0 /a ACCESS TO ELECTRICIrY (3 oF ALL DWELLINGS) 15.0 .. RURtAL OVELLOUGS CONNECTED TO ELECTRICITY (1) 2.0 .. CONSOIMPT ION RADIO RECEtIERS (PER THOU POP) 68.0 57.0 56.0 71.0 38.0 r1.0 PAkSSENGER CARS (PER THOU POP) 3.0 5.0 6.0 1.0 10.0 23.0 ELECTRICITY (UMH/YR PER CAP) 52.0 127.0 14S.0 91.0 227.0 591.0 NEWSPRINT (MG/YR PER CAP) 0.4 1.0 0.7 1.? 1.0 6.2 .a.-- - - - - - - - - - -- - - - - - - - - - - - - -- - - - - - - - - - - - - -- - - - - - - - - - - - - - SEE NOTES AN9DOEFINITIONS ON REVERSE  ANNEX I Page 2 of ,Pages Uo lsoher-se noted, data for 1960 refer to any year betwee 1959 and 1961, for 1970 betwee 1968 and 1970, and for Moat Re.cnt EstLimate between 19 71 aod 1973. * L-rgely doe to m-gr-tb- s-..e 1969 of Ei Solvadore-n resident in Hondoras, population gr-th ratrei I - oe thee the rate of -alore increas. Cost Rica h.. b-e selectd as on ebjec.ive .o.a.t-y for Hend-,a becsause both onsatri.. are -1ai, open anonoie-, dependent on citalualeports and both have special trade relationahips with othar Central Atmericar, cosntriea. Yet, Costa Rica has aebhivd a ouch higher tst.noard of l1ivig anda more eve distribution of the benefita of devlopmen t than Honduran. HNtlDCRAS 1960 /a Ratio of popslation sader 11 and 65 end over to total labor force, lb 1963, including midwioe and ...agstant -onree, F. 1962, /d 1961-63, /n Piped water inaide. 1970 /a Ratto of popslatin under 15 and 65 and over to total labor force. lb 1967-68, Staff "tiUSt*j Le 1.g