Mexico - Lazaro Cardenas Conurbation Development Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. P-2286-ME REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO BANCO NACIONAL DE OBRAS Y SERVICIOS PUBLICOS, S.A. WITH THE GUARANTEE OF UNITED MEXICAN STATES FOR THE LAZARO CARDENAS CONURBATION DEVELOPMENT PROJECT April 12, 1978 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 September 1, 1976 and the Mexican peso has been floating since then. In recent weeks the rate of exchange has fluctuated in the range of Mex$22-23 to the US dollar. On March 30, 1978, the peso traded at 22.75 per US dollar. FISCAL YEAR January 1 to December 31 ABBREVIATIONS AND ACRONYMS BANOBRAS - National Public Works and Services Bank (Banco Nacional de Obras y Servicios Publicos, S.A.) CFE - Federal Electricity Commission (Comision Federal de Electricidad) FLC - Trust Fund Lazaro Cardenas (Fideicomiso Lazaro Cardenas) LCCC - Lazaro Cardenas Conurbation Commission LCCD Project - Lazaro Cardenas Conurbation Development Project SARH - Ministry of Agricultrire and Hydraulic Resources (Secretaria de Agricultura y Recursos Hidraulicos) SAHOP - Ministry of Human Settlements and Public Works (Secretaria de Asentamientos Humanos y Obras Publicas) SICARTSA - Steel Mill Lazaro Cardenas - Las Truchas (Siderurgica Lazaro Cardenas - Las Truchas)  MEXICO FOR OFFICIAL USE ONLY LAZARO CARDEENAS CONURBATION DEVELOPMENT PROJECT LOAN AND PROJECT SUMMARY Borrower: Banco Nacional de Obras y Servicios Publicos, S.A. Beneficiary: Fideicomiso Lazaro Cardenas. Amount: US$16.5 million. Terms: The loan would be repaid over 17 years including four years of grace and carry an interest rate of 7.5 percent. Project Description: (i) Objectives (a) Support the development of the Lazaro Cardenas conurbation (see Map IBRD No. 12488R), one of the fastest growing areas in Mexico, by: strengthening insti- tutional arrangements for urban develop- ment programs, providing low-cost shelter and other urban services to the poorer sections of the population, and creating employment by assisting small enterprises through credit and technical assistance programs. (b) Help create a replicable institutional model and prepare additional urban projects in Mexico. *(ii) The major components are: (a) Shelter and related physical elements (urban upgrading, sites and services, construction materials loans, training centers, and technical assistance); (b) A credit line and the construction of industrial premises to promote and diversify economic activities in the region; (c) Regional feeder roads and river control works; and, (d) Technical assistance to strengthen the Fideicomiso (Trust Fund) Lazaro Cardenas (FLC), and studies to prepare additional urban development projects for possible assistance from the Bank. This document has a restricted distribution and may be used by recipients only in the performance of their omcial duties. Its contents may not otherwise be disclosed without World Bank authorization.  - ii - (iii) Benefits About 50,000 people are expected to benefit directly from the shelter related programs (urban upgrading, sites and services, con- struction materials loans) and the programs carried out in the training centers. This corresponds to about 60 percent of the population projected for the Lazaro Cardenas Conurbation in 1981, when the project will be completed. The project is expected to demon- strate the feasibility of providing adequate shelter and urban services to the lowest income groups, with provision for cost recovery from the beneficiaries. The agencies concerned with the execution of the project are ade- quately experienced and qualified and FLC's reorganization will improve coordination and monitoring. Taking into account FLC's lack of experience in respect of production credits, adequate screening and evaluation procedures have been adopted to minimize the risk of uneconomic investments. Estimated Cost: Local Foreign Total ----In US$ millions---- Urban Upgrading 3.8 1.6 5.4 Sites and Services 1.1 0.4 1.5 Construction Materials Loans 1.5 0.5 2.1 Training Centers 0.2 0.1 0.3 Production Credits 2.8 2.2 5.0 Industrial Premises 0.5 0.1 0.6 River Control 1.7 2.0 3.7 Feeder Roads 2.6 1.7 4.3 Studies - 4.5 4.5 Technical Assistance - 0.3 0.3 Total Baseline Cost 14.1 13.5 27.6 Design and Supervision 1.8 /1 1.9 Contingencies 3.7 3.0 6.7 Total 19.6 16.5 36.1 /1 less than US$50,000.  - iii - Financing Plan: Local Foreign Total ----In US$ millions---- Bank loan - 16.5 16.5 Government 18.0 - 18.0 Beneficiaries 1.6 - 1.6 Total 19.6 16.5 36.1 Estimated Disbursements: FY Annual Cumulative -----US$ millions---- 79 3.2 3.2 80 5.7 8.9 81 4.3 13.2 82 3.3 16.5 Rate of Return: The economic rate of return on the urban upgrading, sites and services, construction materials loans, training centers, feeder roads, and river control components, making up about two-thirds of the total cost, is estimated at 24 percent. No rate of return was calculated for the other components (production credits, industrial premises, studies and technical assistance) because the associated economic benefits are difficult to quantify; these components are well justified, however. Appraisal Report: No. 1904-ME, dated April 4, 1978.   INTERNAT1ONAL IBANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT ANI) RECOMMENDATION OF [HE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO BANCO NACIONAL DE OBRAS Y SERVICIOS PUBLICOS S.A. WITH THE GUARANTEE OF UNITED MEXICAN STATES FOR THE LAZARO CARDENAS CONURBATION DEVELOPMENT PROJECT 1. I submit the following report and recommendation on a proposed loan to Banco Nacional de Obras y Servicios Publicos, S.A. (BANOBRAS) with the guarantee of United Mexican States for the equivaleait of US$16.5 million to help finance the Lazaro Cardenas Conurbation Development Project. The loan would have a term of 17 years, including 4 years of grace, with interest at 7.5 percent per annum. Of the proceeds of the loan, US$0.8 million would be used for construction materials loans with a term of 15 years and interest at 15 percent per annum and US$2.2 million for production credits to artisans and small- and medium-scale enterprises with terms of up to 12 years including up to one year of grace, and interest at 15 percent per annum. PART I: THE ECONOMY 1/ 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. An economic mission visited Mexico in April-May 1977 and its report is now in preparation. The discussion which follows reflects the preliminary findings of the mission. Past Performance 3. For most of the three decades preceding the mid-seventies, Mexico was outstandingly successful in achieving rapid economic growth while main- taining stability in prices and the balance of payments. From 1940 to 1970, average GDP growth exceeded 6 percent per year in real terms, inflation averaged less than 5 percEnt per year from the mid-1960s to 1972, and the dollar value of the peso, fixed in 1954, was maintained until the September 1976 devaluation. The Government's role in this achievement was to carry out direct investments in infrastructure and in key industries such as power, steel and petroleum, while creating a stable regulatory and institutional framework, as well as goodl profit prospects, to induce private sector growth. 4. This strategy produced rapid growth, but led to a sharpening of contrasts within the Mexican economy. While land redistribution under the reform of 1915 was continued, most of the peasants who received land could not improve their economic status in the absence of basic infra- structure, credit and technical assistance. Rapid population growth made social equity even more difficult to achieve. Population growth in Mexico 1/ Part I is substantially unchanged from the President's Report for the Tourism Development Project (R78-35 of February 16, 1978).  - 2 - accelerated steadily, primarily as a result of reduced death rates, and reached 3.5 percent per year by 1970. Despite economic growth, the high demographic growth rate made adequate absorption of the labor force in productive employment difficult. Some 40 percent of the labor force is either relatively unproductive and poorly paid, or openly unemployed. 5. During the 1970s, Mexico experienced increasing public sector deficits, inflation, large balance of payments deficits, capital flight and a marked slowdown in the real rate of growth of GDP, which dropped to 2 percent in 1976-- the lowest annual growth rate experienced by Mexico since the mid-thirties. On September 1, 1976 the authorities abandoned the fixed exchange rate of 12.50 pesos per dollar that had remained unchanged since 1954 and let the peso float; in recent months it has remained rather stable at rates fluctuating between 22 and 23 pesos per dollar. Following the devaluation, Mexico obtained major support from the IMF. In the last quarter of 1976, Mexico was able to draw on the Fund for US$480 million. For 1977-79, an Extended Fund Facility accompanied by a comprehensive three- year stabilization program was negotiated, which could provide as much as an additional US$861 million once the increase in Fund quotas becomes effective. Thus, total IMF support for the Government's program may exceed US$1.3 billion. The new Government ratified the agreement with the IMF shortly after taking office on December 1, 1976, and to date has complied with the program agreed upon with the IMF. Current Economic Policy 6. The present Government inherited a difficult situation upon taking office on December 1, 1976. High inflation, large public sector deficits, in- creasing foreign indebtedness and lack of confidence in economic management indicated a need for economic stabilization. However, the situation also called for more expansionary policies; economic activity had slowed down, net private investment was virtually nil, and the gap between new job creation and growth of the labor force was increasing. High world prices for petroleum offered profitable investment opportunities in the petroleum sector; indeed, increased production for export of these products seemed by far the best way to meet a large part of Mexico's high debt service requirements in the coming years. 7. Faced with these conflicting needs and opportunities, the Mexican authorities are adopting a mixed strategy aimed at reducing lower-priority public expenditures and increasing public revenues, while proceeding with petroleum and other high-priority investments. The objectives of the Govern- ment's program include progressive control of inflation together with a return to high rates of economic growth by the end of 1978. Better manage- ment of public sector expenditures, more rational pricing and cost control in public sector enterprises, promotion of private savings, limiting wage increases to justifiable levels, and more effective cooperation with the private sector are important parts of the Government's economic strategy. 8. The measures instituted by the new Administration have already produced good results. Inflation in the twelve months of 1977 slowed to 20.7 percent (January-December) as compared to an annual rate of 60 percent in the last three months of 1976. The deficit in the current account of the  -3- balance of payments has been reduced, and is estimated preliminarily at US$2.2 billion for 1977, compared to US$3.5 billon in 1976. Total public sector financial requirements dropped from 10.3 percent of GDP in 1976 to 7.9 percent in 1977. Mobilization of savings by the banking system is increas- ing. Perhaps most importanatly, there is a general feeling of increased confi- dence in the Government's economic policy. 9. The stabilization effort during 1977 was absolutely necessary, but its price has been the continuation of economic stagnation; for a second year in a row GDP grew only by about 2 percent in real terms, implying a further decline of real per capita income. While control of inflation will remain as the overriding short-term objective--the Government's announced target is to reduce inflation to about 12-15 percent during 1978--the 1978 economic program aims at a simultaneous recovery of economic activity, through a recovery of private and public investment. Increased public sector savings, further strengthening of the financial system and therefore in- creased availability of credit to the Drivate sector, and continuation of a carefully managed wage policy (the annual increase in minimum wages agreed upon in January 1978 averaged about 14 percent) are the main means the Government will rely upon to attain the above objectives. Economic Issues and Prospects 10. As Mexico looks ahead, the key problems that its economic policies must address would seem to include the following: (a) Many Mexican families have not participated in the sustained economic growth of the last several decades. As of 1975, about 4,600,000 Mexican families--45 percent of the total-- receive incomes equal to less than one-half the national average. The members of most of these families work--more than half of them in agriculture--but they produce little and receive little. Mexico's labor force is now growing even more rapidly than in the past--it is expected to grow at about 3.6 percent per year over the next decade, which implies an average annual increase by some 670,000 workers during 1978-82; during the 1960s the growth rate was 2.7 percent per year. The challenge of providing productive jobs for both new entrants and existing under-productive workers is an awesome one. (b) Crop and livestock production in Mexico, which had grown by 6 percent per year during 1945-55 and 4.2 percent per year during 1955-65, grew at only 2.1 percent per year during 1965-75. This near-stagnation of agricultural production signals the end of the strategy in which growth of agricul- tural production came from newly irrigated land, while rain- fed agriculture was relatively neglected. The continued expansion of large-scale irrigation, so successful from 1945 into the 1960s, has brought lower and lower returns as the works became costlier and easily accessible export markets for high-value crops became more nearly saturated. New approaches are required now to assure both production growth, and increases in income for Mexico's poor rural families.  - 4 - (c) The size and role of the State in the economy has been a subject of much discussion in Mexico in recent years. During 1970-76, private investment slowed down, and virtually stagnated since 1975. This was, in part, a consequence of the pre-emption of credit by the public sector (during the six-year period, the share of the public sector in the economy grew from 15.0 to 21.5 percent), combined with infla- tionary financing and accompanied by what some perceived as an "anti-business" attitude. Public statements by the present Administration indicate that it wants to reverse this trend. (d) The present large foreign debt and sizable public finance deficit are mainly the direct outcomes of past public sector inability to mobilize adequate financial resources. By the early 1980s, large increases in export revenues, mainly from petroleum and related products, should make both the foreign debt problem and public finances easier to manage. In the meantime, however, larger public sector savings are required to reduce inflationary pressures and to release credit for the private sector. (e) The rapid growth and heavy concentration of people and production in Mexico City, and the scarcity of employment opportunities and services in rural areas, are important challenges which have to be confronted. Both equity and efficiency considerations imply a need for diversion of some of Mexico City's future growth to other regions, as well as the provision of basic public services and enhanced employment opportunities in selected villages and small towns. 11. In the medium term the prospects for resumption of economic growth with relative price stability are good. Poverty will remain a problem but the Government is taking steps to address it. The alleviation of the external constraint on growth brought about by the expected petroleum earnings (para. 14), together with the Government's efforts to increase public sector savings and to stimulate private investment, could produce economic growth of 7 to 8 percent per year in the remaining five years of the present Administration. Resumption of economic growth combined with the intensification of the Government's family planning program (on October 28, 1977 President Lopez Portillo announced the ambitious goal of reducing the population growth to 2.5 percent per year by 1982, then progressively to 1.8 percent by 1988, 1.3 percent by 1994, and 1 percent by the year 2000), the new emphasis on rainfed agriculture, and the implementation of specific programs aimed at increasing productive employment should help to address the structural problems mentioned above (para. 10). 12. In agriculture, the Government's quick action to defuse tensions created by land invasions and expropriations at the end of 1976, and its decision to review the legislation concerning land and water use, should reduce uncertainty and induce a better use of the available land and water resources. In addition, the new emphasis on rainfed agriculture--which had been relatively neglected in the past--should lead to an increase in the  -5- production potential of vast areas currently under-exploited and to a reversal of the past trend towards larger income disparities between the modern and traditional agricultural subsectors. Development of intensive agriculture in the tropics and of a nationwide program to construct small irrigation and drainage works are also new features of the Government's agricultural policy. These initiatives, together with the more realistic exchange rate and remun- erative support prices, promise a resumption of growth of production for both domestic and export markets and increase the possibilities of an improvement in the living conditions of the rural poor. 13. Industry has potential for considerable growth in many sectors, including efficient import substitution in chemicals, petrochemicals and capital goods as well as exports of many different manufactured products. Increases in tourism export earnings are also expected. 14. Among the benefits of recent public sector investments are the new possibilities opened to the Mexican economy through the recent discover- ies of rich petroleum fietlds. The Government has decided to use these large hydrocarbon resources to help manage Mexico's heavy debt service burden and to enhance the country's over-all development prospects. To meet this objective, PEMEX (Petroleos Mexicanos, the State-owned oil monopoly) has launched an ambitious six-year investment program amounting to US$17.0 billion in 1977 prices (about 25 percent of total public investment). This program would: (a) almost triple the production of oil and condensates, from 292 million bbl/year in 1976 to 818 million bbl/year in 1982; (b) more than double the country's primary distillation capacity, from 270 million bbl/year in 1976 to 577 million bbl/year in 1982; (c) substantially increase production of primary petrochemicals (ammonia, ethylene, benzene, etc.) as well as downstream products (styrene, vinyl-chloride, polyethylene); and (d) enable export of natural gas at a rate of 2.0 billion cubic feet/day by 1982. Under this program, the value of exports of oil and related products would increase over ten times, from about US$0.9 billion in 1977 to more than US$10.0 billion in 1982. If this program were to be carried out on schedule, and incentives maintained for non-petroleum exports, the balance of payments on current account would shift from a deficit of US$2.1 billion in 1977 to a surplus of about US$3.0 billion in 1982. 15. The prospect of rapidly rising petroleum exports, as well as previously mentioned prospects for increases in tourism earnings, recovery of agricultural production and exports, and resumption of growth of manu- factured exports, have greatly strengthened the balance of payments outlook.  Even on the basis of somewhat more conservative projections of petroleum pro- duction and exports than those mentioned above, the current account deficit can be expected to decline steadily over the next several years and become slightly positive by 1982, thus reducing Mexico's net external borrowing requirements (Annex I). The debt service ratio has been increasing over the recent past, reaching 46 percent in 1977. It is expected to peak in 1979 at slightly over 50 percent and decline sharply thereafter to levels around 30 percent in the early 1980's. Debt service on Bank loans amounts to about 4 percent of public debt service; this ratio is projected to decrease over the next two years and to increase to some extent afterwards. The Bank currently holds about 8 percent of Mexico's total medium- and long-term public debt, and this ratio is likely to increase to some extent over the next few years. Mexico remains creditworthy for borrowing on conventional terms considering the country's strong medium- and long-term potential and the comprehensive economic strategy which the Government has adopted to realize it. PART II: BANK GROUP OPERATIONS IN MEXICO I/ Bank Operations 16. As of February 28, 1978, Mexico had received 50 loans from the Bank amounting to US$2,624.4 million net of cancellations and terminations; of these, 33 loans totalling US$1,486.4 million were fully disbursed. As of February 28, 1978, the Bank held US$2,142.2 million of which US$787.2 million had not yet been disbursed. Some 35 percent of Bank lending has been for agriculture and rural development (15 loans for US$923.4 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$205.5 million), water supply (US$130 million) and tourism (US$114 million) projects. Mexico is carrying out a stabilization program and because of scarcity of counterpart funds, some projects have fallen behind schedule during 1976 and 1977. Following review with the Government, a steel loan was terminated (Sec M77-258 of April 5, 1977), the scope of an irrigation project was reduced and US$100 million from the original US$150 million loan were cancelled (R77-305 of December 13, 1977) and the scope of several other projects has been modified. Other projects under implementation and affected by the stabilization program are being reviewed by the Government and further dis- cussions will be held with the Bank shortly. By and large, adequate budget support for the ongoing projects has now been secured. Annex II contains a summary statement of Bank loans as of February 28, 1978 and notes on the execution of ongoing projects. IFC Operations 17. As of February 28, 1978, IFC has made 13 investment commitments in Mexico, for a total of US$69.5 million, of which US$38.3 million had been sold, repaid or cancelled. The balance held by the Corporation, US$31.2 million, consists of US$26.2 million in loans and US$5.0 million in equity. A summary statement of IFC investments as of February 28, 1978 is presented in Annex II. 1/ Part II is substantially unchanged from the President's Report for the Tourism Development Project (R78-35 of February 16, 1978).  -7- Bank Strategy 18. The main objectives of Bank lending in Mexico have been to: (i) sup- port 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; and (iii) help resolve critical adjustment problems that Mexico is currently facing. The Bank is preferentially supporting projects that make relatively modest demands on budgetary resources and have a strong positive balance of payments effect, projects of high social priority that help the rural or urban poor, projects that promote higher levels of employment and those that help to decentralize economic activity. The proposed Lazaro Cardenas Conurbation Development Project fulfills several of these criteria (see paras 56 and 57). 19. In view of the difficult structural problems of Mexico's agriculture and the sector's crucial importance to the country's further development, 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 infrastructure development and agri- cultural credit programs so as to meet the demands of a rapidly growing popula- tion 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, support and social infrastructure investments. Third, to strengthen Mexico's institu- tional capability to use scarce agricultural resources more efficiently. In support of this strategy, the Bank has made seven loans over the past four years, totalling US$579 million, for irrigation, rural development and agricul- ture and livestock credit programs. In FY77, the Executive Directors approved a US$120 million loan for an Integrated Rural Development Project--PIDER II-- under which some 46,000 poor farm families will benefit from directly produc- tive activities. This fiscal year, an agricultural and livestock credit project has been appraisecL and will be submitted to the Executive Directors in the coming months and an agricultural development project focusing on the humid tropics is being submitted for consideration on April 25. 20. Bank lending for industry has been aimed at assisting the Government'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 US$50 million loan in FY75 to support a fertilizer project which promotes new poles of development in the resource-rich southeast region and the north central area. A third Industrial Equipment Fund project is currently being processed for submission to the Executive Directors in the coming months and a project to promote small- and medium- scale enterprises is being submitted for consideration on April 25.  -8- 21. 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: the Airports Develop- ment Project (FY74) was designed to support the Government's policy of regional integration; the Third Railway Project (FY76) supported improvements of insti- tutional aspects and financial management of the sector. The Mexico City Water Supply Project (FY73) has been instrumental in the establishment of a specialized institution for efficient supply of bulk drinking water in the Mexico Valley, and in the pricing of water at levels more closely related to costs. 22. To reduce the external deficit on current account, the Government is giving emphasis to the tourism sector to increase foreign exchange earn- ings. Promotion of the sector, which requires only limited budget support, will help increase employment opportunities, especially in a number of regions where the scarcity of jobs encourages migration to the alteady over-burdened metropolitan areas. In support of this policy, a Tourism Development Project, approved earlier this fiscal year, will provide resources for tourism invest- ments needed to tap more fully the country's tourism potential. 23. The Government and the Bank have long recognized the large regional disparities in welfare and economic development that exist in Mexico in the context of rapid urban growth. The Government has identified high-priority urban centers, the development of which it wants to encourage and support. Studies are under way to prepare projects designed to provide shelter, urban services, and new employment opportunities in these centers, with special emphasis on the needs of the lower income groups. The proposed Lazaro Cardenas project would be the first such project. PART III: URBAN AND REGIONAL DEVELOPMENT IN MEXICO Trends and Problems 24. In thirty years Mexico has changed from a rural country with only weak economic links among its diverse regions, to an urbanized and geograph- ically integrated society. Mexico's population growth has been among the most rapid in the world, and this growing population has migrated to cities at an even greater pace. The percentage of the population living in places of 2,500 or more inhabitants grew from 35% in 1940 to 59% in 1970. 25. In 1975 there were some 11 million people living in and around Mexico City, making it the third largest metropolitan area in the world (after Tokyo and New York). Its population has been growing annually at over 5% and U.N. projections based on recent trends show it growing to be the largest city in the world, with a population of over 30 million people, by the year 2000. In 1975, the Mexico City metropolitan area had 19 percent of the nation's population, and accounted for over 40 percent of the nation's production of goods and services.  -9- o.u. lo slow down the growth of Mexico City by promoting growth in other parts of the country would be beneficial. Mexico is now sufficiently develuped for a strategy of selective decentralization to succeed. The nation has many cities that are reasonably large and growing, where additional workers could be absorbed in productive activities. The second and third largest cities in the country, Guadalajara and Monterrey, each with population of over one million, are major industrial and service centers, and have been growing even faster than Mexico City. Forty-four other Mexican cities had over 100,000 inhabitants in 1970; most of these cities have the infrastruc- ture, transport and communications links, labor pool, and other advantages for inducing future growth. Measures to increase such growth and to manage it in an orderly fashion, paying due attention to the needs of low-income residents and immigrants, hLave a double pay-off: the growth of the capital can be reduced (at least slightly), while efficiency from the national point of view is increased. 27. Promoting faster growth in selected medium and smaller cities would be far more than a means to reduce growth in the largest cities. Other impor- tant goals are to provide more productive work in many parts of the country, to bring markets, credit, health and other services nearer to neighboring small towns and rural areas (the "hinterlands" of the cities), and thus to improve the economic and personal welfare of people who now live in places that are not close to the major cities of the nation. 28. Mexico has large regional disparities in welfare--as do other large semi-industrialized countries. Per capita income per month in 1969 ranged from Mex$628 in the FederaL District to Mex$109 in Oaxaca--a range of almost six to one. Access to heaLth care, education, potable water, and other basic needs also varies dramatically from one region to another. Among the poorest and least-developed regions that have a good resource base and economic develop- ment potential are: (a) parts of the coast of the Gulf of Mexico in the states of Veracruz and Tabasco, (b) the Isthmus of Tehuantepec, in the same states and also in Oaxaca and Chiapas, and (c) the Lazaro Cardenas-Zihuatanejo region of the states of Michoacan and Guerrero. 1/ 29. Promoting growth in promising medium-sized urban areas such as those on the Gulf Coast, the Isthmus, and the Lazaro Cardenas area serves the dual purposes of: (a) bringing employment and urban services to less developed regions and guiding growth in these places so as to be orderly and productive, and (b) shifting growth, albeit modestly, to places other than the largest cities. 1/ Recent Bank studies of regional strategy options in Mexico, based on studies conducted in early 1974, are: Economic Development of the Isthmic Region of Mexico (IBRD 1080-ME), March 30, 1976; Spatial Develop- ment in Mexico (IBRD 1081a-ME), January 31, 1977; and Urban Development in Mexico (IBRD 1449-ME), January 31, 1977.  - 10 - Spatial Policy 30. Until very recently, Mexico, like most other nations, did not have a well coordinated and explicit spatial policy, but a series of important measures were adopted, including: (i) Tax reforms established in 1972 that exempt from some levies industries located outside the three largest metropolitan areas. However, the objective of attracting new industries to outlying areas has had a limited success; (ii) The establishment, since 1971, of industrial parks and new urban complexes; (iii) Financial programs to assist small- and medium-sized industries outside the three largest cities. About one third of all eligible firms have been helped by these programs; and (iv) The "maquila" 1/ program. Several border cities have grown rapidly because of this program. 31. Within -the last two years, Mexico has moved towards establishing a stronger, more coherent and explicit spatial policy. The Law of Human Settle- ments, adopted in June 1976, provides the legal authority for planning and implementing programs to achieve spatial goals. The stated objectives of the law include improved rural-urban integration, more balanced growth among cities and regions, promotion of growth in medium-sized cities as alternatives to the largest cities, greater citizen participation in solving urban problems, land use control, better provision of urban services, and improvement of the housing location-job location-commuting situation within cities. The most important objectives that seem to be emerging are: (i) At the national level, to reduce the growth of Mexico City, and to concentrate resources to develop promising alternative regions, instead of continuing the past practice of generalized incentives mentioned in paragraph 30 above. (ii) At the state level, to establish priorities for allocating investment among cities or regions within each state. (iii) At the local level, to plan for more orderly urban growth and to implement these plans with public investments and land use controls. 32. At the national level, the new Ministry of Human Settlements and Public Works (SAHOP) has already completed (January 1978) a National Urban 1/ Assembly of products for export to the United States using at least in part inputs imported from the United States. US tariffs on such products are levied only on the value added in assembly.  - 11 - Development Plan; a Plan to convert a significant part of the objectives enunciated in the Law of Human Settlements into operational goals. In order to implement Government policies in this sector, SAHOP is also conducting a series of background and preparatory studies and advising state and municipal governments on their own relevant laws and plans. Perhaps the most important part of its coordination rosle is to review investment plans of the government and public sector agencies for consistency with the National Urban Development Plan. 33. The Law of Human Settlements provides for new institutions to facilitate coordination and planning--the conurbation commissions. Any contiguous urban area that is in more than one state, or that simply consists of more than one municipality, can be declared a conurbation, by the national or state governments, respectively. The commissions for interstate areas are chaired by the Secretary (Minister) of SAHOP, and composed of relevant state governors, mayors, and other officials as appropriate. Although the develop- ment plans prepared by these commissions are not binding, they are a powerful guiding instrument for all federal, state and local authorities. Conurbation zones will be established mainly in cases of large metropolitan areas (Mexico City was the first), and of smaller areas where either present structure or desired future growth crosses state boundaries (Lazaro Cardenas and the other two conurbation zones established so far, Torreon-Gomez Palacio-Lerdo, and Tampico-Ciudad Madero). 34. The Lazaro Cardenas Conurbation Development (LCCD) project is part of Mexico's first attempt to improve urban planning and administration, to promote growth in selected priority areas so as to provide jobs and services for low income residents, and to reduce migration to the largest cities. The Bank can play an important role in connection with this ambitious attempt by supporting this first project. The experience gained in the process would be a valuable contribution and provide aL basis for the expansion of this scheme into a nation-wide program. PART IV: THE LAZARO CARDENAS CONURBATION DEVELOPMENT PROJECT ProAect History 35. In the context of its new Law of Human Settlements and the National Urban Development Plan (paras. 31 and 32), the Government of Mexico has requested a Bank loan to help finance the LCCD Project. The project was appraised in December 1976, but reappraised in October 1977 to take into account the intervening postponement of the second stage of the Las Truchas steel mill, the largest employer in the area, and to review institutional arrangements. Negotiations took place in Washington, D.C. from March 27 to 31. The Mexican negotiating team was led by Mr. Garcia (BANOBRAS). A Staff Appraisal Report, entitled "Lazaro Cardenas Conurbation Development Project," No. 1904-ME, dated April 4, 1978 is being circulated separately to the Executive Directors.  - 12 - Objectives 36. The main objectives of this project are to support Government efforts to initiate a process by which shelter and urban services affordable by the low-income groups can be provided in an efficient and replicable manner; and to promote the development of new regional growth centers. The institutional arrangements for the project would assist in overcoming some of the weaknesses of past urban-related programs in Mexico in general, and in the Lazaro Cardenas area in particular. These arrangements may provide an effi- cient model for the implementation of additional regional development projects in other areas of the country and the project includes provision for studies to prepare additional projects. The Lazaro Cardenas Region 37. The Lazaro Cardenas region is among the fastest-growing conurbations in Mexico, with a zone of influence of approximately 12,000 km spread over Michoacan and Guerrero (see Map IBRD No. 12488R), two of the least developed states in the country. Both states have traditionally been "exporters" of unskilled emigrants to already overcrowded Mexico City. The urban population is concentrated in the towns of Lazaro Cardenas and Guacamayas with about 29,000 and 17,000 inhabitants respectively. The most important economic factor in the area is the Las Truchas steel mill, operated by Siderurgica Lazaro Cardenas - Las Truchas, S.A. (SICARTSA), a Government-controlled corporation. Construction of the plant, which the Bank helped finance under Loan 934-ME, began in 1972 and the plant came into operation in late 1976. Prior to the construction of the mill, the area had a population of some 10,000, largely dependent on farming. Construction attracted a large number of workers and their families from around the country and induced the ex- pansion of many tertiary activities, as well as a few secondary enterprises. The population in the region, now estimated at about 59,000 people, increased by about 85% between 1971 and 1974 (about 23 percent per year). Since 1974 it has grown more slowly, at an average of about 18% per year. A major problem in the area has been the lack of coordination among the few and fragmentary urban programs that were established, particularly affecting the new low- income immigrants that flocked to the area in search of employment and better living conditions. 38. The area was relatively isolated before the construction of the steel mill began but accessibility has been substantially improved: a deep water port was established; a link to the national railway network and a new highway leading directly to the Mexico City region will be opened this year. Finally, the road network in the vicinity of the SICARTSA plant is also being improved and roadways within the area are being upgraded. 39. The region's many natural advantages are now actively being developed. Chief3among these are: abundant water supply (the Rio Balsas has a flow of 350 m /sec); mineral deposits including iron, lead and zinc; and potentially rich agricultural land and forests. Power projects which would ensure  - 13 - s;.ficient electricity supply for local industries have been completed. The port is being expanded and aL number of important industries are beginning to be established in the adjacent industrial area, including a fertilizer plant and petrochemical storage facilities. Project Description (a' Shelter and related urban infrastructure 40. This component includes urban upgrading, sites and services, construc- tion material credits and training centers. The urban upgrading program would improve about 6,800 p:Lots in Guacamayas, Playa Azul, La Mira and other small towns, at a unit cost between about US$800 and US$1,100 equivalent. In line with the paying capacity of the beneficiaries, the program would provide for two levels of upgrading; namely a fully serviced level in Guacamayas and a reduced level (e.g., simpler sewerage disposal systems) for the smaller towns. The sites and services program will be concentrated in the two largest urban centers, Lazaro Cardenas and Guacamayas (see IBRD Map No. 12489R), where urbanized land available to low-income groups is scarce and squatter settle- ments are increasing rapidly. Some 1,800 serviced plots will be provided at an average unit cost of about US$1,100 equivalent. In designing the above mentioned shelter related components, special attention was given to the needs and the financial capacities of the lower income segments of the population. About three-fourths of the proposed shelter units will be affordable by households between the 7th and 22nd percentile in the region's income distri- bution. Practically the whole population will be able to afford the lowest cost units and about 70 percent the most expensive units (the corresponding yearly household incomes are estimated at about US$670 and US$1,350 equivalent, respectively). By contrast, the lowest priced units now available in the Lazaro Cardenas region are accessible to only about one-fourth of the popu- lation. In combination with the previous programs, construction materials loans will be made available to encourage self-help construction on terms suiting the repayment capacity of the lowest income groups (see para. 51). To complement this lending program, four training centers will be opened to ?rovide professional training and technical assistance. The centers will also be used to implement the proposed credit line for productive activities (see para. 41 below). In addition, they will house community programs to provide vocational training, and to promote improved health and nutrition, general education and cultural programs. The centers will be located so as to be readily accessible to low-income residents. (b) Productive Activities 41. This component is composed of two elements. A line of credit will be made available for artisans and small- and medium-scale enterprises that are not reached by existing credit programs. The average credit for artisans would be about US$1,400 equivalent. The project will also finance a number of workshops and buildings for rentals to credit recipients. (c) Regional Infrastructure 42. About 200 km of access roads linking 40 neighboring agricultural villages to the urban centers of the region would be constructed or upgraded.  - 14 - Only one section of the projected roads, between Guacamayas and Lazaro Cardenas would be paved. The roads would replace existing dirt paths which become unpassable during the rainy season. The project also makes provision for river control works (construction of a large culvert and dredging) on the Rio Balsas. The river is the most important single natural factor in the region and the proposed works are the least cost scheme that would: (i) provide an adequate water supply for SICARTSA and other industries; (ii) reduce the siltation of the port; (iii) reduce the erosion along the left branch of the river; and (iv) provide for the safe disposal of sewerage effluents. (d) Technical Assistance and Studies 43. The project makes provision for the recruitment of an adequate number of qualified and experienced staff to strengthen the Fideicomiso (Trust Fund) Lazaro Cardenas (FLC) and to help carry out the project. This would be in conformity with the implementation responsibility of FLC (see para. 48 below) and with a plan of action including detailed administrative and personnel changes, approved by the Government in January. 44. Provision is also made for (i) studies to be carried out by LCCC to complete the Development Plan for the area, and (ii) studies to prepare additional urban development projects in other regions of the country under the supervision of SAHOP's Project Unit; priority will be given to the pre- paration of additional projects for possible consideration by the Bank. The target urban areas selected by the Government are consistent with the National Urban Development Plan (paras. 31 and 32), and the findings of recent Bank studies (para. 28); they are centered around Coatzacoalcos-Villahermosa, Queretaro- Leon, Tampico-Ciudad Madero, Guaymas-Ciudad Obregon, and Manzanillo (see IBRD Map No. 13454). The proposed studies would result in integrated urban develop- ment programs (including the necessary institutional framework) up to 1988. Preliminary terms of reference have already been prepared by SAHOP, reviewed in the Bank and found to be satisfactory. The final terms of reference will be approved by the Bank (Section 3.03, draft Loan Agreement). Project Cost and Financing 45. The total cost of the project is estimated at US$36.1 million, including contingencies. The proposed Bank loan would finance the US$16.5 million required to cover the foreign exchange costs. The Government contri- bution will amount to US$18 million and the beneficiaries would finance the remaining US$1.6 million. The cost estimates of the various project components are detailed in the Loan and Project Summary at the beginning of this Report.  - 15 - Execution and Administration 46. FLC will be the major executing agency of the project. It was created in 1973 with Nacional Financiera, S.A., the major Mexican public bank, as trustee. The latter's role was subsequently transferred to BANOBRAS, the Borrower. FLC's main responsibility then was to build housing units and related urban infrastructure needed by SICARTSA's workers. The General Manager of FLC reports directly to the agency's Board (Comite Tecnico), chaired by the Secretary of Human Settlements and Public Works; BANOBRAS, the state and local governments and other national agencies concerned are also represented in the Comite Tecnico. FLC has now a staff of about 400; about half of the staff is composed of workers engaged in construction activities and the rest is made up of professionals, technicians and administrative staff. 47. The Government has designated FLC as responsible for execution and coordination of the works and programs under the project as well as for admin- istration, including cost recovery. To carry out these tasks, FLC's adminis- trative structure has been rearranged for increased efficiency and adequate new staff has been hired. To set up a strengthened financial base, the Government is now taking the steps necessary to dispose of arrears of a number of public agencies, particularly SICARTSA. As a condition of effective- ness, the Government is to take all necessary action to ensure payment of all debts owed to FLC by SICARTSA (Section 7.01, draft Loan Agreement). In the event that this matter shall have been settled before the proposed loan is signed, Section 7.01 would be deleted from the Loan Agreement. FLC has pre- pared selection criteria for the beneficiaries of the urban upgrading, sites and services and construction materials loan components; these criteria will be formalized by December 31, 1978 (Section 3.09, draft Loan Agrement). 48. FLC will execute directly all project components except for the regional feeder roads, to be carried out by SAHOP; the river control com- ponent, under the responsibility of the Ministry of Agriculture and Hydraulic Resources (SARH), and the studies, under the responsibility of SAHOP and LCCC. SARH, SAHOP and LCCC are adequately staffed and their respective experience well-suited to implement the project components under their responsibility. 49. The operation and maintenance of the electric and water networks would be under the responsibility of the Comision Federal de Electricidad (CFE) and the local Junta de Agua Potable (Water Board), respectively, as required by Mexican law. The Lazaro Cardenas municipality will be responsible for the operation and maintenance of the sewerage and storm drainage networks. SAHOP will maintain the feeder roads and SARH the river control works. 50. Special attention would be paid to monitoring the progress of the project and evaluating its impact. FLC will be responsible for gathering all field data and monitoring the implementation of the various components, analyzing the data and work progress, and evaluating the project impact. A complementary monitoring system, which would deal primarily with management and financial matters related to the implementation of this project, would also be established (Section 3.07, draft Loan Agreement). A monitoring unit has been recently established in FLC for these purposes.  - 16 - Cost Recovery 51. Under this project, adequate steps will be taken to ensure that costs are recovered to the maximum extent feasible. Investments of some US$15.8 million can be related directly to identifiable beneficiaries, and of this, FLC will recover about US$14.6 million (93 percent); FLC will apply these funds towards similar programs in the Lazaro Cardenas region (Section 3.02(c)(i), draft Loan Agreement). Specifically: (i) in the case of the sites and services and urban upgrading programs, the costs of land, earthworks, and on site infrastructure (except for access roads) would be recovered directly from the beneficiaries. The sale of lots will be on the basis of 10 percent down payment and monthly repayments for the balance over 15 years, with interest at 15 percent per annum (Section 3.09 (a), draft Loan Agreement); (ii) construction material loans will be repaid over 15 years and carry an interest rate of 15 percent (Schedule 5, draft Loan Agreement); (iii) produc- tion credits to artisans and small- and medium-scale enterprises will carry an interest of 15 percent and will be amortized over a period of up to 12 years, including a grace period of up to one year; interest charges on credits to medium- and small-scale enterprises will be reviewed annually by FLC in consultation with the Bank (Schedule 5, draft Loan Agreement); and (iv) rents charged for the industrial premises included in the project will cover all operational and administrative expenses, including adequate maintenance and depreciation (Section 3.08(c), draft Loan Agreement). Procurement and Disbursement 52. Civil works for the river control component will be awarded under international competitive bidding, except for contracts not exceeding US$250,000 equivalent each, which would be let under the Mexican public sector's ordinary procurement procedures (subject to an aggregate limit of US$1.25 million), which are considered satisfactory. The rest of the civil works are of minor scope, scattered over several locations and thus unlikely to attract foreign contractors. Purchases of equipment will also be of limited scope and there- fore contracts will also be awarded under the Government's usual procurement procedures. 53. With a view to accelerate the implementation of the project, engineer- ing studies for civil works and several studies (para. 44) have already been started. It is proposed that retroactive financing, not exceeding US$350,000, be allowed in respect of expenditures incurred on or after August 1, 1977. The Bank will disburse (i) 45 percent of the cost of civil works; (ii) 40 per- cent of the amount of construction materials loans and productive credits; (iii) 50 percent of local expenditures or 100 percent of foreign expenditures on equipment; and (iv) 100 percent of FLC's promotional expenditures, and of the cost of the studies carried out by SAHOP and LCCC. 54. About one third of the 600 ha affected by the LCCD project is now being expropriated. Almost all this land is composed of urban upgrading areas; expenditures in respect of the urban upgrading component will become eligible for disbursement on completion of the expropriation procedures (Section 3.06 and paragraph 4(b), Schedule 1, draft Loan Agreement).  - 17 - Risks 55. This operation does not present unusual risks. The agencies con- cerned with the execution of the project are experienced and qualj.ied anld FLC's reorganization will improve coordination. Taking into account FLC's lack of experience in respect of production credits, adequate screening and evaluation procedures will be followed to minimize the risk of uneconomic investments (Section 2.03, draft Loan Agreement), and adequate steps have been taken to strengthen FLC. Project Benefits and Justification 56. The project has been conceived as an integrated approach to the needs of the urban poor in the Lazaro Cardenas area, by relieving a critical shortage of low cost shelter and other basic urban services, by adopting design standards that the lowest income groups can afford, and by providing increased job opportunities. This approach and the underlying institutional arrange- ments can be replicated in other priority areas around the country. The project, the first of its kind in Mexico should help establish an efficient model for future integrated urban programs designed to improve the living conditions of the urban poor. 57. The project would fill some 75 percent of the low cost shelter needs of the conurbation through 1981. Based upon a survey of the potential beneficiaries and experience with comparable credit programs in Mexico, it is estimated that the production credit component would generate about 1,200 additional permanent jobs; the average investment cost per job would be about US$4,200. Another 16,000 mnan/months of construction employment would be directly generated by the execution of the LCCD project's physical components. About 50,000 people are expected to benefit directly from the shelter related programs (urban upgrading, sites and services, construction materials loans) and the programs carried out in the training centers. This corresponds to about 60 percent of the population projected for the Lazaro Cardenas Conurbation in 1981, when the project wil be completed. The feeder roads will significantly help to integrate the agricultural hinterland with the main urban centers of the Lazaro Cardenas region; newly opened areas for cultivation and grazing will total 30,000 ha and 44,000 ha respectively. An economic analysis was carried out for the shelter and related urban infrastructure, the feeder roads, and the river control components. The rates of return are presented below: Rate of Return Cost (US$ million) (in percent) Urban upgrading 22 7.7 Sites and services, construction material loans and training centers 28 4.9 Feeder roads 22 7.2 River control works 28 5.7  - 18 - The overall rate of return of these components, making up about two-thirds ($25.4 million) of the project's total cost is estimated at 24 percent. No rate of return was calculated for the other components (production credits, indus- trial premises, studies and technical assistance) because the associated eco- nomic benefits are difficult to quantify; these components are well justified, however. PART V: LEGAL INSTRUMENTS AND AUTHORITY 58. The draft Loan Agreement between the Bank and BANOBRAS, the draft Guarantee Agreement between United Mexican States and the Bank, and the Report of the Committee provided for in Article III, Section 4(iii), of the Articles of Agreement are being distributed to the Executive Directors separately. Special conditions of the project are listed in Section III of Annex III. As a condition of effectiveness, the Government will take all necessary action to ensure payment of all debts owed to FLC by SICARTSA (para. 47). An additional condition of disbursement in respect of the urban upgrading component would be that expropriation procedures be suitably completed (para. 54). 59. 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 by I.P.M. Cargill Attachment April 12, 1978  ANNEX I Page 1 of 4 pages TABLE 3A MEXICO - SOCIAL INDICATORS DATA SHEET LAND AREA (THOU KM2) ----------------