Document of The World Bank FOR OFFICIAL USE ONLY Report No. 4908b-ME STAFF APPRAISAL REPORT MEXICO SECOND HIGHWAY SECTOR PROJECT April 26, 1984 Projects Department Latin America and the Caribbean Regional Office This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. Currency Equivalents Currency Unit = Peso (Mex$) US$1.00 = Mex$ 25 in December 1981 = Mex$ 55 in February 1982 = Mex$ 70 in August 1982 = Mex$ 120 in June 1983 = Mex$ 150 in December 1983 = Mex$ 157 (controlled market rate); Mex$ 173 (free market exchange rate) in April 1984 Fiscal Year January 1 - December 31 Weights and Measures Metric: British/US Equivalent 1 meter (m) = 3.28 feet (ft) 1 kilometer (km) = 0.62 mile (mi) 1 kilogram (kg) = 2.20 pounds (lb) 1 metric ton (m ton) = 2,205 pounds 1 liter (1) = 0.26 gallons (gal) Abbreviations AADT Average Annual Daily Traffic BANOBRAS National Bank for Public Works and Services CNCP Comision Nacional Coordinadora de Puertos CyPF Caminos y Puentes Federales, Toll Road and Bridge Authority DGAF Directorate General of Auto Transport DGC Director General for Maintenance DGOM Directorate General of Port Works DGT Directorate General for Tariffs EDNC Esquema Director Nacional de Carreteras, National Highway Plan ERR Economic Rate of Return ESP Empresas de Servicios Portuarios, Publicly Owned Operating Companies IDB Inter-American Development Bank N de M Ferrocarriles Nacionales de Mexico, National Railways of Mexico PEMEX Mexican Petroleum Monopoly SAHOP Secretariat of Human Settlements and Public Works SCT Secretariat of Communications and Transport SHCP Secretariat of Finance and Public Credit SPP Secretariat of Programing and Budgeting FOR OFFICIAL USE ONLY STAFF APPRAISAL REPORT MEXICO SECOND HIGHWAY SECTOR PROJECT TABLE OF CONTENTS Page No. I. PROJECT SUMMARY ................................. *........................ 1 II. THE TRANSPORT SECTOR .. . ............................... ... 3 A. General Background ......3. *..... ........ ....... ....... 3 B. Transport Development and the Economy ..........................3 C. Institutional Framework and Planning...................... 5 D. Land Transport Pricing ...0..0.........................00.0 . 6 (i) Fuel Pricing ... . ..... . . . .... 6 (ii) Road User Charges 7................ ..7 (iii) Railway Tariffs ..........0 ..........000...0000 ..0..000000 8 E. Railway Operational Efficiency 9. .0.9 F. Road Freight Regulation 0000 9.. ...0000.00000.. G. Port Charges 0......0..000 ............0000000000..11 H. Past Bank Participation and Experience ........................11 I. Role of the Bank andLndding Strategy .......................13 III. THE SCT INVESTMENT PROGRAM AND THE PROJECT .......................13 A. Development of the Highway Network ............13 B. SCT Highway Investment Program 1984-1988 .....................15 C. SCT Road Maintenance Program ............................... ,16 D. Financing of the Road Investment Program ....................17 E. Economic Evaluation of the Investment Program ................18 F. The Bank Project 19............................19 G. Assessment of Risk ..... 000.000 020000000..0.0..000.. 0......20 IV. PROJECT IMPLEMENTATION ................................000000.... 2 1 A. Subproject Selection 21.....000.0........... .21 (i) National and Toll Roads 0.00.000.00..........21 (ii) Rural Roads 0..00000.0..00...00000020000..00.00.00.0.0...22 B. Procurement .........00..00...00000000 .....o . ......... o.... .22 C. Disbursements 20....0...... .............. . . o..0.24 D. Retroactive Financing 25......................0....0 *0..25 E. Special Account .25..00............00......000.000 F. Auditing 00.0......000 0 .0 ..00.000.000 .................. 0.00. 025 G. Accounting and Budgeting at CyPF 6.. H. Semi-Annual Consultations and Project Monitoring .......6.....26 V. AGREEMENTS REACHED AND RECONNENDATION ...... ......28 This report is based on the findings of an appraisal mission which visited Mexico in October 1983. The mission comprised Messrs. J. Gutman (Economist), A. van Dijck (Engineer), F. Chapman (Financial Analyst) and S. Hertel (Engineer). The report has been edited by Miss V. Foster. This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. - ii - TABLE OF CONTENTS (Continued) TABLES Page No. 2.1 Historic Transport Investment .................................... 30 2.2 Fuel Prices ...................................................31 2.3 Fuel Price Structure .................... . ... ... 32 2.4 Ferrocarriles Nacionales de Mexico - Income Statements 1980-1983..... o. .o.*. .. . , 33 2.5 Major Rail Freight Commodities - Comparison Revenues/Variable Cost 1983 ........- ..... 34 2.6 Operational Targets for N de M . ................-35 2.7 General and Specialized Freight Truck Fleet with Federal Permits ........... -o- - ... 36 2.8 Prior Highway Lending ...... -. . .... .... . .. . .37 3.1 Development of the Road Network ............ ....38 3.2 SCT Highway Infrastructure Investment 1977-1984 .............. o ....39 3.3 Indicators of Highway Demand 1970-1980 . .............40 3.4 Average Annual Daily Vehicles on Mexican Toll Roads 1971-1982 .. ............. 41 3.5 Growth of Annual Vehicle Production in Mexico 1970-1983 ......... 42 3.6 SCT Road Investment Program 1984-1988 .......o ................43 3.7 Subprojects with Likely Bank Participation - Ongoing ..... o... 44 3.8 Subprojects with Likely Bank Participation - New .........45 3.9 Breakdown of All Subprojects with Likely Bank Participation .................................46........o ... 46 4.1 Estimated Schedule of Disbursements ..............................47 ANNEXES 1 Impact of Diesel Price Subsidy on the Transport Sector ...........48 2 Financial Performance of the Toll Road Authority oo .......oo....53 3 Draft Terms of Reference for Road User Charges Study ............. 63 4 Composition of the SCT Road Investment Program 1984-1988 ..o....66 5 Guidelines and Targets for the Rural Roads Maintenance Component.. . . .........72 6 Economic Evaluation Guidelines for the Preparation of the 1984-1988 SCT Road Investment Program ....... o .... 76 7 Potential Topics for Technical Cooperation Component .....o .... 82 8 Related Documents and Data Available in the Project File .........83 CHART 25805 Organization of SCT ..... ..o... . ..... .o.o.o.o.o.o. ... . 84 MAP IBRD 17957 - Mexico Second Highway Sector Project MEXICO SECOND HIGHWAY SECTOR PROJECT I. PROJECT SUMMARY Borrower: Banco Nacional de Obras y Servicios Publicos, S.A. (BANOBRAS) Guarantor: United Mexican States Project Executing Agency : Secretaria de Comunicaciones y Transportes (SCT) Amount: US$200 million, including a capitalized front-end fee of approximately US$500,000. Terms: Repayment in 15 years, including three years of grace at the standard variable interest rate. Project The proposed project is a part of SCT's 1984-1986 highway Description: program. The program components supported by the loan are: (i) construction, reconstruction and expansion of national and toll roads and bridges and urban bypasses; (ii) rehabilitation and periodic maintenance of rural roads; and (iii) consultants' services. The project will help to: (i) improve seriously congested sections of the national network, upgrade substandard pavements and extend the road network to developing areas; (ii) strengthen the planning and execution of rural roads periodic maintenance and determine appropriate budgetary allocations; (iii) strengthen the newly organized SCT Planning Directorate for all modes; and (iv) facilitate a dialogue on land transport pricing and road freight regulatory policies. Beneficiaries: Because of the geographic dispersion of the investment program, project benefits will accrue to the economy at large in the form of vehicle operating cost and time savings. While the benefits will initially accrue to road users, it is expected that such benefits will subsequently be broadly distributed to consumers through improved transport costs and service levels. The technical cooperation component will provide significant support to improving the general planning capabilities of the newly organized SCT. Risks: Although a prolongation of the economic recession could reduce sectoral investment levels below those assumed for this project, the flexible format of the sector loan and the setting of the loan amount at a relatively small percentage of the projected investment budget should minimize the risk - 2 - of delay in project execution. For the rural roads component, potential monitoring difficulties have been minimized by concentrating financing within a limited number of states. Finally, future progress on policy issues such as land transport pricing may face political resistance. The lending program for the sector has been timed to permit progressive monitoring and assistance on such issues. Estimated Cost: The total cost of the SCT highway investment program for 1984-1986 is estimated at US$1.6 billion equivalent with a foreign exchange component of US$541 million equivalent. The Bank loan represents 12% of the total program and 37% of the foreign exchange requirements. SCT Highway Investment Program 1984-1986 (in current US$ million equivalent) Investment Items Total Cost Foreign Exchange Civil Works 768.0 300.0 Trunk Roads Maintenance 662.0 200.0 Rural Roads Maintenance 170.0 40.0 T'echnical Cooperation 1.0 0.7 P'rogram Cost 1601.0 540.7 Front-End Fee 0.5 0.5 Total Cost 1601.5 541.2 Financing Sources IDB 45.0 45.0 Proposed IBRD Loan 200.0 200.0 National Treasury 1356.5 296.2 Total 1601.5 541.2 Estimated Disbursements: Fiscal Year Annual Cumulative (US$ million) 1985 60 60 1986 60 120 1987 50 170 1988 30 200 Rate of Return: Highway subprojects to be financed under the proposed loan would be appraised according to agreed technical and economic criteria and would have a minimum rate of return of 12%. Rural road periodic maintenance subprojects would be approved based on a technical evaluation of road condition, population served and traffic. - 3 - II. THE TRANSPORT SECTOR A. General Background 2.01 The accelerated development generated by the oil boom in the late 1970s resulted in unprecedented growth in transport demand and revealed serious deficiencies in transport operations and infrastructure affecting international trade between 1978 and 1982. Prior to that period, transport had declined as a percentage of public sector investment from 21% in 1972 to under 10% less than a decade later. The Government responded to the new demand by increasing real investment in the railways by 173%, ports by ten-fold and highways by 86% between 1978 and 1981 (Table 2.1). The budgetary restrictions which accompanied the economic crisis in 1982 and 1983, however, resulted in reducing transport investment to 1979 levels, postponing major investments which were not near completion and focusing upon maintenance and rehabilitation. The lull in transport demand caused by the economic situation has given the Government some leeway, in terms of timing, to reorder its transport priorities, but critical investment decisions will have to be made within the next few years in order to serve any economic recovery effectively. The Second Highway Sector Project is the initial element in a comprehensive lending strategy for the transport sector which is designed to provide assistance in meeting the immediate financial needs of the sector, as well as to help in developing medium- and long-term investment programs and policies for the sector. Because of prior transport lending operations to Mexico, the discussion of the sector in this Chapter focuses upon transport development during the past administration and the major issues which face the present administration. B. Transport Development and the Economy 2.02 Mexico has developed an extensive transport network which comprises over 200,000 km of roads (including 67,000 km of paved and over 80,000 km of rural roads with the rest being state and local unpaved roads); about 20,000 km of railways (all except 500 km being standard gauge); some 30 ports, of which 13 serve international traffic; about 50 airports capable of handling medium or larger size aircraft; and over 20,000 km of crude oil, refined products and gas pipelines. From 1972 to 1982, traffic on the nation's roads grew by about 10% annually with road traffic representing an estimated 48% of total traffic in ton-km and over 90% in passenger-km. Railway freight traffic, representing about 14% of total ton-km, experienced a growth of 7% annually. Even more significant growth rates were registered by coastal shipping and pipelines, with annual growth rates of between 13% and 15% in ton-km because of increased oil production, resulting in an estimated 15% and 21% share respectively of all ton-km in 1982. After only limited growth prior to 1977, the ports registered average annual increases of almost 17% in cargo tons handled from 1977 to 1982. In passenger transport, domestic aviation traffic increased by over 17% annually, with total passenger-km generally equal to that of the railways. - 4 - 2.03 During the 1960s and early 1970s, substantial amounts were invested in transport, particularly roads, railways and aviation. The transport sector was receiving about 20% 1/ of all public investment. The network was generally in place at that time and was considered sufficient to meet expected demand. The sector, therefore, did not pose a constraint to economic growth.2/ Emphasis was placed on operational improvements and pricing and on using transport investment to foster decentralization and the development of outlying areas. As a consequence, the sector's share of public investment declined from 21% in 1972 to 9% 3/ in the early 1980s. In 1977 and 1978, transport experienced real reductions in investment levels as other sectoral priorities prevailed. 2.04 This investment policy, however, proved to be untenable with the surge in economic activity in the late 1970s. Between 1978 and 1981, serious bottlenecks emerged, clearly affecting the operation of basic industries and the conduct of international trade. Transport problems were evident with respect to the importation of basic grain and the movement of iron ore and pellets to the steel industry. The problem centered on the railways and the ports. In addition to the increase in general economic activity in 1980 and 1981, the poor local grain harvest led to the importation of 7 million tons in each of those years, double the average of the previous five years. The bottlenecks at the ports and on the railways were costly. 2.05 It was evident that the transport network was unable to cope with the accelerated growth and that, even with operational improvements, capacity restrictions would continue to be severe. The industrial ports program was one of the proposed investment solutions. Although conceived mainly as a means to decentralize industrial activity, it would also be expected to resolve port capacity problems for containerized and general cargo and many bulk commodities. It was initiated in 1979, and investments grew quickly thereafter. The railways were also targeted for improvements, and real investments, primarily related to track improvements where capacity bott:Lenecks were occurring, increased by 62% in 1979, 37% in 1980 and another 23% in 1981. Except for a one-year increase in 1981 covering various types of projects, the roads' budget was maintained at a relatively constant level. By 1981, roads' share of transport investment declined from 68% in 1972 to 51%, compared with rails' share rising from 15% to 30% during the same period, and ports' share increasing from 8% to 15%. Major airport construction and reconstruction outside of Mexico City were also carried out between 1979 and 1981. Although there were instances of premature investment and some works suffered from poor programing, the overall response of the Government to the situation in those years was appropriate. 1/ Excluding urban transport. 2/ The Transport Sector, Mexico, May 13, 1971 and Mexico Transport Sector Brief, October 1975. 3/ Excluding urban and PEMEX-related transport investments. - 5 - 2.06 The budgetary restrictions which accompanied the economic recessions in 1982 and 1983 again shifted the emphasis in the transport investment program. Transport investment was reduced in real terms to about US$1 billion, roughly equivalent to 1979 levels. This reduction, however, was not as great as the reduction in the overall public investment program, leaving transport with an increase from a 9% to an 11% share (excluding urban transport), the apparent rationale being the ability of the sector to quickly generate short-term productive employment during this critical period of economic contraction. The approved investment budget thus focuses on maintenance and reconstruction of existing infrastructure and on the completion of ongoing construction at minimum cost, deferring the initiation or continuation of major investments such as the full-scale industrial ports program, railway electrification and new rail line construction. 2.07 The lull in transport demand caused by the economic situation is giving the Government some time to reorder its transport investment priorities. In 1982, rail traffic fell by 12% and the ports registered declines of 25% at Tampico and 19% at Veracruz. Highway authorities are reporting traffic declines of 10-15% in 1983. Industries which experienced transport bottlenecks in the past do not anticipate difficulties in the near future. In addition to the limited traffic, this improved situation can be attributed to the investments carried out in 1979-1981, particularly with regard to rail track improvements (Mexico City-Veracruz) and the acquisition of rolling stock and locomotives. 2.08 The 1984 budget basically represents a holding strategy with no major new investments. The Government', in establishing its six-year plan, must still face major decisions concerning the deferred large transport investments. The rail infrastructure investment program is expected to receive a full economic and technical review in preparation for the proposed Railway Sector Project, particularly to determine priorities between new projects such as a new line between Guadalajara and Monterrey, the coastal line between Tampico and Veracruz and various major rail yards. The Mexico City-Queretaro electrification, because of prior commitments, cannot be delayed further and will require substantial budgetary allocations between 1984 and 1987. For the ports, the major decision will be to determine what further investments are justified at Lazaro Cardenas and Altamira (with assistance to be provided under proposed Bank-financed port projects) and to establish the timing of the remainder of the industrial ports program and industrial decentralization. In the roads subsector, Mexico faces a significant backlog of modernization (widening) works on the trunk network, particularly on the toll roads. In addition, capacity limitation problems at Mexico City Airport would require substantial investments. Most of these decisions will depend upon the expected timing and structure of the economic recovery, the projected level of import substitution and its impact upon grain imports and related transport facilities, the transport requirements of non-traditional exports, and the prospects for industrial decentralization and urban deconcentration efforts. C. Institutional Framework and Planning 2.09 The first major positive action affecting transport taken by the current administration was the incorporation of all transport modal agencies under the Secretariat of Communications and Transport (SCT). Prior - 6 - to this incorporation, port and railway investments, as well as all transport tariff and regulatory policy, were handled by SCT, while highway and airport development was under the jurisdiction of the Secretariat for Human Settlement and Public Works (SAHOP). This dispersed institutional arrangement hampered efforts at coordinated planning and investment and limited Bank dialogue on cross-modal issues. Under the new organization (Chart 25805), there is a Subsecretary for Infrastructure with responsibility for road, rail, port and airport infrastructure development and a Subsecretary for Operations with responsibility for operational, regulatory and tariff matters for all modes. There is a Directorate General for Planning which reports directly to the Secretary. 2.10 SCT is presently reorganizing the Directorate General for Planning and the other modal planning offices within the Subsecretariats for Infrastructure and Operations. Once fully implemented, it is expected that planning units in the various modal directorates will be responsible for identifying and proposing capital investments and will provide the technical details required for the analysis of such investments. The Directorate General for Planning will have the responsibility for carrying out the economic feasibility analysis and providing a consistent multimodal analytical framework to the preparation of the medium- and long-term investment program. The Bank is reviewing SCT staff training requirements for planning and is already providing assistance to SCT under ongoing loans (1671-ME, 1929-ME and 1964-ME) to improve planning capabilities and determine resource requirements; further assistance would be provided under the proposed project (para 3.18(c)). 2.11 In addition to SCT, the Secretariat for Programing and Budgeting (SPP) plays an important role in ensuring consistent and complementary modal planning. The Directorate for Public Infrastructure of SPP is responsible for reviewing and approving the proposed SCT investment and operating budgets and conducts a serious review of all major investments in the sector. Although small, this unit has proven effective and capable during the first year of this administration. D. Land Transport Pricing 2.12 The Government of Mexico has traditionally played an active role in the setting of prices for major goods and services. In transport, road, rail and air tariffs and port and terminal charges are regulated by the Directorate General for Tariffs in SCT. In addition, fuel prices are set by the Government. In the past, road and rail tariffs and charges for land transport have been set below marginal costs, resulting in substantial subsidies to transport users. The present administration has taken substantive actions in the past year to reduce subsidies in the sector, and further needed price and tax increases are planned in order to fully implement this rationalization policy so that all transport users pay the appropriate cost of the services they require and the drain on the public treasury is minimized. The main issues and actions in land transport pricing and taxation are discussed in the following paragraphs. (i) Fuel Pricing 2.13 A Bank-financed road user charges study in 1975 found that refined petroleum products were being priced at the pump well below world market - 7 - prices. This situation worsened as domestic inflation surged and gasoline and diesel prices remained no higher than US$0.42 and US$0.18 per gallon respectively during 1981. Since December 1981, however, the Government has followed a policy of gradually raising domestic fuel prices toward international levels (Table 2.2). From December 1981 to April 1984, gasoline prices have risen from Mex$ 7/liter to Mex$ 54/liter (US$1.30/gallon) for extra and Mex$ 2.8/ liter to Mex$ 40/liter (US$0.96/gallon) for regular, a real increase of 84% and 240% respectively. Diesel prices have been raised even more significantly from Mex$ 1.17/liter to Mex$ 26/liter (US$0.63/gallon) for a real increase of over 430%. In dollar terms, however, while gasoline prices are above international levels (US$0.82/gallon for regular), diesel prices are still below international levels (estimated at US$0.80/gallon 4/). 2.14 The Government has shown that it is taking serious action to resolve the fuel pricing issue and is trying to reduce the price differential between diesel and gasoline while approaching international levels. Understandably, political concerns have determined the timing of the price increases. With the present level of prices, no major distortions are evident (Annex 1); rail tariffs as well as costs are still well below road tariffs and costs for the main railway commodities (para 2.19) so that no significant competitive distortion is apparent. One concern has been the effect of low diesel prices on the selection of construction techniques, i.e., labor-intensive versus equipment-intensive, for rural roads. Recent analyses, however, show that the impact is not significant. The Bank, through its macro-economic discussions with the Government and its economic and sector work, will continue to monitor progress on the fuel pricing issue and help the Government to assess the implications of its pricing policies. (ii) Road User Charges 2.15 Related to the issue of fuel prices is the question of whether the various road-related tolls and taxes imposed on road users sufficiently cover the cost of providing road infrastructure. The general principle to be applied in determining a minimum equitable distribution of user charges should be that users pay the full costs of owning and operating the vehicle and the attributable costs of operating, maintaining and reconstructing the roadway, which vary in accordance with the number and weight of the various types of vehicles. The charges which enter into this calculation in Mexico include road and bridge tolls, fees for licensing, permits and public transport concessions, producer taxes for tires and vehicles (over and above normal taxation level), special import duties on vehicles and special taxes on fuel. None of these charges are directly assigned to roads or identified as road user charges, and all enter the federal treasury to be distributed in accordance with general budgetary practices. Even road and bridge tolls collected by the Toll Road and Bridge Authority, Caminos y Puentos Federales (CyPF), are defined as being a tax and are turned over to the federal treasury. 2.16 With the surge In inflation, the subsequent devaluations and price changes, an updated analysis of road user charges is required. Prior studies and Bank estimates showed that the gross receipts from user taxes covered all 4/ Based on mid-November 1983 Caribbean market prices, FOB. - 8 - administrative, construction, reconstruction and maintenance costs for the federal, state and local networks. However, fuel tax revenues represented the major contribution in these analyses, based on the fact that special taxes on fuel represent about 45% of the total pump price (Table 2.3). Since pump prices are generally at or below international levels or their opportunity costs, fuel tax revenues, in economic terms, cannot be considered as a contribution to road infrastructure. Without this element, the results of the prior analyses would be negative, with economic road user charges covering little more than maintenance and administration. The deficit is apparently not equally distributed over the network. A Bank-sponsored sector study of the Mexican toll roads found that, with the increases in tolls along the 1,000-km toll road network of almost 500% in the past year, gross toll revenues (about US$135 million) should be sufficient, in 1984, to cover all administrative, operating and maintenance costs of CyPF and all debt service as well as contribute to capital extensions and widenings (para 3.13 and Annex 2). 2.17 As fuel prices near international levels, it is time for the Government to attempt to resolve the road user charges issue. The proposed study on road user charges should be directed at the interurban road user and should focus on the overall balance between tax receipts and road expenditures, and on the allocation of taxes and costs by type of road user. Prior analyses concluded that diesel-powered commercial vehicle operators, particularly for heavy trucks, were paying a lower percentage of the costs they impose upon the network than were other types of road users. The study should also recommend additional taxes to resolve observed deficiencies. SCT has already initiated Phase I of the draft terms of reference provided in Annex 3. It was agreed at negotiations that SCT would, by December 1985, complete a study on the allocation of road costs and revenues by type of user and would subsequently discuss with the Bank (during the early 1986 semi-annual review meeting (described in para 4.24)) alternative policy options and timing for resolving identified deficiencies. (iii) Railway Tariffs 2.18 Among the objectives of the present administration is the improvement of the financial status of the Mexican railways 5/ through a well planned combination of operational improvements and tariff actions. As discussed in paragraph 2.02, unlike railways in many other developing countries, Mexican railways have experienced consistent growth in traffic over the last decade. The Government's pricing policy and failure to permit tariffs to keep up with inflation, however, limited improvements to the railways' financial status, and working and operating ratios improved only gradually from 149 and 172 in 1980 to 132 and 154 in 1982. A more substantial improvement occurred when the new administration increased freight tariffs by over 100% in real terms during 1983. The working ratio is expected to fall to 114 and the operating ratio to 139 despite the decline in traffic levels caused by the economic recession. These results are generally in accordance with the targets established under the ongoing Fourth Railway Project (Loan 1929-ME) (Table 2.4). 5/ Actually there are four railways in Mexico, but they are gradually being incorporated within the largest one, Ferrocarriles Nacionales de Mexico (N de M). The discussion in this report, then, relates to N de M. 2.19 While the prior tariff increases have been across the board, the railways and the Government are now preparing to raise tariffs on selected commodities for which present tariffs are not covering variable costs. 6/ These commodities represent 30% of rail tonnage and include coal, coke, limestone, iron-ore, cement, sugarcane and lime. In Table 2.5, it is clear that certain commodities are carried at tariffs well beyond variable costs, while others are charged as low as 61% of variable costs. It is also evident that, for those commodities priced below variable costs, there is a significant differential between road and rail tariffs, providing competitive room for tariff increases. The Government and the railways are in agreement on the need to restructure railway tariffs and, as part of the jointly developed National Rail Modernization Program (September 1983), have proposed a plan of action on tariff restructuring to be initiated during 1984. Progress on this plan of action will be monitored during the preparation of the proposed Railway Sector Project. 2.20 N de M reduced passenger services by 43% between 1974 and 1978 and entered into an agreement with the Government whereby it continues to run certain services for social reasons and claims the specific working losses from the Government. The expected loss of US$22.5 million for 1983 is small compared to N de M's net deficit of US$400 million. As part of its preparation for the proposed Railway Sector Project, N de M is carrying out a comprehensive review of passenger services, tariff policies and investment to help determine appropriate future actions. E. Railway Operational Efficiency 2.21 To improve the railways' financial position as well as to minimize investment requirements, the Government and N de M have put the primary emphasis of the National Railway Modernization Program (para 2.19) upon operational efficiency. The core of the Program is to negotiate with the railway unions regarding the revision of work rules, job reclassification and training. These negotiations have been made possible by the pending retirement of almost 20,000 railway employees (of a total workforce of 64,000) over the next two to three years. A series of operating targets have been set for 1984-1988 to help direct and monitor improved productivity efforts (Table 2.6). Among the more critical targets is that for the improved availability of locomotives, which declined from over 85% in 1975 to under 70% in 1983, to the extent that traction power is a major constraint in rail capacity. Through the ongoing Fourth Railway Project and the preparation of the Railway Sector Project, the Bank is assisting N de M in analyzing the problem and in finding solutions. F. Road Freight Regulation 2.22 Over the past decade, the Mexican Government has moved to expand and tighten its regulatory authority over road freight haulage, in contrast to the general international tendency toward deregulation. Prior to 1971, the Government had substantial regulatory authority, but had not exercised that authority nor enforced the existing regulations. It believed that the trucking industry had become chaotic, with a growing number of individuals 6/ Including the capital cost of locomotives and rolling stock and some proportion of track costs. - 10 - providing substandard service at below-cost tariffs, which caused an unstable environment for vehicle operators in financial terms, as well as for shippers in terms of service. In response to this problem, the Government, through SCT and its Directorates for Motor Transport (DGAF) and for Tariffs (DGT), established and enforced a series of regulations covering entry, capacity, commodity restrictions, geographical operating rights, tariffs and corporate structure. The regulations apply to all trucks operating on Federal highways with a load capacity of over three tons, and they distinguish between four types of service: (a) general freight service for which a permit is issued to carry any freight within a specified corridor; (b) specialized freight service for which a permit is issued to carry a specific commodity, usually one which requires special handling or equipment, e.g., tank or dump truck. This permit has no geographic limitation; (c) non-processed farm and animal products service, which is treated as specialized freight service and which is flexibly defined to p,ermit the transport of agricultural inputs to the farm; and (d) private own-account service for which a permit is provided to a non-transport company to carry its own goods. 2.23 One of the major objectives was to improve the organization of the truckers. All operators had to organize themselves into companies or cooperatives, and no new permits are to be issued to an individual unless he joins one of the existing firms. To avoid monopolistic practices, no individual could receive more than five permits (one for each vehicle) in his name. From 1976 to 1982, the number of vehicles with general or specialized freight permits rose from 85,000 to 128,000, which represents over 90% of interurban road freight traffic (Table 2.7). 2.24 Although the Government is relatively satisfied with its road freight regulatory system, there are several questions on the economic benefits and costs of the system which warrant further analysis: (a) How effective is rate regulation and is it worth the effort? (b) To apply for a permit, a potential operator must apply to the route or commodity committee related to the service he is offering. The committees comprise the other operators and represent a delegation of responsibility by SCT. What capacity and utilization measures and other criteria are applied by the committees and are they serving the national interest? (c) The number of routes for general freight has been reduced from 40 to 9, which gives the operator a broad geographic area within which to find traffic. What purpose do the route restrictions serve and how much cross-route traffic is there? (d) Are costs higher than they would be under deregulation and are returns reasonable? - 11 - (e) What service benefits are provided by regulation? (f) What is the administrative cost of regulation? 2.25 To answer these questions, the Government has agreed to participate with the Bank in a study. The terms of reference, timing and resource requirements are to be defined during a Bank mission scheduled for June 1984. While there have been theoretical discussions between the Bank and the Government, no detailed analyses have been conducted to measure the benefits and costs of the regulatory system and to help design possible regulatory reform. G. Port Charges 2.26 Cargo-handling services in most of the ports are provided by publicly owned operating companies - Empresas de Servicios Portuarios (ESP). Since these companies are operated on a commercial basis, the tariffs charged for their services are cost-related and subject to frequent adjustment. They do, however, require approval by SCT's Directorate-General for Port Administration and the Directorate-General for Tariffs before they are officially published and become effective. This means that there is often a considerable time lag between the application by an ESP for a tariff change and its eventual implementation. With the rapid inflation of the last two years, this has meant that cargo-handling tariffs have steadily been falling behind the increasing costs, often eroding profits and reserves of the port operating companies. Ship dues, berthage and wharfage are paid by ship operators to SCT's local Superintendent of Port Operations and deposited in the Federal Treasury. They bear no evident relationship to the capital investment in port infrastructure and, according to a recent estimate of the Directorate General of Port Works (DGOM), currently amount to only about 10% of port dredging costs and make no contribution toward construction. Pilotage is paid for separately to the quasi-private Pilot Cooperatives and is, therefore, cost-related, as are towage charges, with tug services given either by the ESP, private operators or the Navy. 2.27 The Comision Nacional Coordinadora de Puertos (CNCP) recently proposed a greater decentralization of port administration, beginning with the relatively new port of Lazaro Cardenas as a prototype for the rest, including commercial ports. By this scheme, a local administrative body, with its own board of directors, would have control over its own budget (although it would still require Federal approval) and all aspects of port development, equipping, operations, maintenance and tariffs. The Region is presently appraising a project to finance part of the Lazaro Cardenas Industrial Ports development (Mexico Ports III); if the project is approved, it would help to further the process of reform of the port subsector. H. Past Bank Participation and Experience 2.28 The Bank's major lending activities in transport have been in highways and railways. Eight highway loans have been made, the first in 1960 and the eighth (a First Highway Sector Loan) in 1979 (Table 2.8). There have been four railway loans, one for Ferrocarril de Pacifico and three for N de M, helping to finance track rehabilitation, locomotives, rolling - 12 - stock and equipment, and promoting improvements in planning, operational and financial 'performance. The first loan (103-ME) of US$61 million was made in 1954, and the fourth loan (1929-ME) for US$150 million was made in 1980. The first port loan (820-ME) was made in 1972, and a port preparation loan (1964-ME) was made in 1981 which is expected to lead to an Industrial Ports Project. In addition, an airport loan (1022-ME) was made in 1974 and completed in 1982. 2.29 The total Bank participation of about US$387 million for the development of the Mexican highway network has had a great impact upon the improvement of the primary highway system; out of a total length of about 44,000 km of federal and toll highways, the Bank has assisted, or is assisting, in the improvement or construction of about 15,000 km (Map IBRD 17957). Although the quality of works executed is satisfactory, cost increases, construction delays, and insufficient budget allocations have generally resulted in delayed completion of the projects. 2.30 The Seventh Highway Project (Loan 968-ME) was signed in March 1974, and substantial delays were encountered from the onset because of shortage of budgetary allocations in the face of sharply higher bid prices caused by rapid inflation. Macroeconomic control measures were taken to reduce the impact of the public sector deficit upon inflation, the road budget was cut in real terms, and the allocation for all projects was reduced. After the Mexican peso was devalued late in 1976, SCT reevaluated its programs and proposed a reduction of the project from 16 to ultimately 11 sections. The project continued to experience large cost increases, caused mainly by inflation but exacerbated by design modifications due to increased traffic projections and to difficulties in mountainous areas; the loan was fully disbursed by July 1981. 2.:31 The problems encountered with the Seventh Highway Project 7/ illustrated the limitations of conventional project lending in Mexico despite a mature and well developed highway authority. With Bank funds tied to a few large subprojects, there is little flexibility to meet changes in priorities. The Government may face great difficulties in allocating domestic funds for the Bank-financed subprojects, which can lead to slow disbursing projects. The approach followed in the Highway Sector Loan to Mexico (Loan 1671-ME) was designed to overcome those limitations and to allow the Bank to better adapt its contribution within SCT's planning and budgeting process. 2.32 The Highway Sector Project was signed in March 1979. The initial progress was relatively slow because contracts related to approved subprojects had first to be tendered and execution started, often with small initial annual budget allocations, but, by mid-1981, progress was such that it was expected that funds would be fully disbursed by end-1982. However, the devaluations, the severe budgetary restrictions in real terms, and thie consequent much smaller amounts expressed in dollars allocated to Bank- financed subprojects caused delays in construction and in disbursements, aggravated by a slow processing of disbursement applications. With the approved subprojects now in execution, full commitment of loan funds was reached in December 1983, so that full disbursement may be expected by June 1984, although not all individual subprojects will be completed. The 7/ Documented in Project Completion Report, June 22, 1982. - 13 - potential rapid execution of highway sector lending will be apparent during the execution of the proposed second sector loan through the financing of the 1984-1986 time-slice of 24 subprojects initiated during the earlier loan. Even with the restricted budgets for 1984, and possibly for 1985 and 1986, a very quick disbursing loan may be expected. I. Role of the Bank and Lending Strategy 2.33 The potential Bank role in the sector has been expanded because of several important actions taken by the administration which assumed office in late-1982. As a first step, the Government combined all modes under one Ministry, SCT, and then proceeded to establish a Planning Directorate in SCT covering all modes (para 2.09). Most important, the Government has made it clear that its official policy is to reduce subsidies and has taken direct action affecting the transport sector, such as raising fuel prices and rail tariffs and eliminating tax benefits to the automotive industry. Following the new Government's indication that it wished to have a substantial lending program for the transport sector, a sector lending strategy for Bank operations was agreed. In terms of investment, the strategy is to develop relatively quick disbursing lending operations which focus upon short-term investment in maintenance, rehabilitation and modernization and upon making prior investments operational while assisting the Government, through the new Planning Directorate, to reassess the medium- and long-term need for major new investments. 2.34 With respect to non-investment policies such as land transport pricing, railway financing and highway transport regulation, earlier Bank projects have been less successful. The lending and sector work programs will raise the awareness of the Government and will help in assessing the issues and in developing appropriate actions. The timing of the lending program permits the Bank to effectively monitor incremental progress on studies or specific actions concerning these policy issues. The main policy focus in the rail and road projects will be on railway tariffs and road user charges. III. THE SCT INVESTMENT PROGRAM AND THE PROJECT A. Development of the Highway Network 3.01 The Mexican highway network has evolved rapidly (Table 3.1). In 1952, there were only 27,000 km of roads, of which 16,000 km were paved. By the 1980s, the network had grown to over 212,000 km, of which about 67,000 km are paved (including 1,000 km with four or more lanes). The slower annual rate of growth of paved roads, from 6.6% per year between 1952-1960 to 2.4% from 1975-1980, is a sign that the network has reached relative maturity and that, with the exception of some areas, the trunk network is in place. Road investment in the past ten years has shifted from the extension of the trunk network to rural access roads and, more recently, to the widening of existing trunk roads to relieve congestion. 3.02 Administration of the road network is principally under the jurisdiction of the Federal Government, with the exception of state and municipal roads. 8/ 8/ Other background information on the Highway Subsector is included in the Project File (Annex 8). - 14 - (a) Federal Highways: SCT is directly responsible for the planning, construction and maintenance of all federal highways; financing is 100% from federal funds. The network consists of 42,500 km, with 93% paved. (b) Toll Facilities: While SCT plans and constructs toll roads and bridges, they are operated and maintained by CyPF. The toll road network consists of about 1,000 km, of which 49% are four or more lanes. (c) State Highways: Planning, construction and maintenance of the 49,300 km of state roads (49% paved) are the responsibility of each state's highway administration. Coordination with the federal authorities is carried out by state highway boards (Junta Local de Caminos), of which the state Governor is chairman and on whiclh SCT is represented through its Centro SCT, the fully staffed and equipped dependency of SCT in each state. Federal funding is provided for 50% of maintenance and construction costs. (d) Local Roads 9/: The 3,200 km of local roads are also the responsibility of the state highway boards, and financing is provided on a tri-partite basis between the federal government, the state and local authorities and private enterprises. (e) Rural Roads: Since 1971, a very large rural roads program has been carried out, aimed at joining small towns and villages with the nearest main road and providing temporary employment through the application of labor-intensive construction methods. Over 80,000 km have been built in the last 12 years under a variety of federal programs. By 1984, all rural roads programs are expected to be consolidated under SCT, with SCT having responsibility for construction and maintenance and the states participating in the selection and planning; financing is 100% from federal funds. 3.03 Federal road investment has declined over the past 12 years from 68% to less than 50% of transport investment as the Government attempted to resolve critical ports and railways problems which were evident in 1979-1981. In real terms, road investment increased by 95% between 1977 and 1981 and has since declined to the 1977 level. 3.04 Within the highway subsector, there has been a substantial shift in emphasis in the last few years (Table 3.2). While the rate of construction of new roads has remained relatively constant since 1977 (with the exception of 1983), reconstruction and "modernization" (road widening) works have received substantial real increases, rising from 5% to over 30% of the highway budget. No additions or widenings of the toll road network have been carried out since the early 1970s, and rural roads allocations increased substantially until the reductions of 1983. Road maintenance allocations remained relatively constant until 1983 despite the growing network and 9/ Those that, for administrative reasons, are not defined as rural roads. - 15 - increases in traffic. In 1983, however, SCT's maintenance budget was raised by 76% in real terms, and, in 1984, reconstruction and maintenance represent almost 50% 10/ of the road budget as compared with less than 25% in 1981. 3.05 The shift within the road investment program is an appropriate response to the unprecedented continuous traffic increases and to the budgetary restrictions since 1982. Traffic indicators for 1970-1980 (Table 3.3) show that the vehicles in circulation increased at an annual rate of 13% from 1970-1975 and 12% from 1975-1980, compared to the growth in GDP of about 6.5% annually. The rate of motorization was so significant that the number of automobiles per 1,000 inhabitants rose from 26 to 63 over the decade, compared with 70 in Brazil and 200 in Spain. Traffic counts along the toll roads (Table 3.4) confirm the remarkable rate of growth, with an average increase of 10% per year from 1971 to 1982. Because of this accelerated traffic development, light pavements were insufficient to meet the heavier demand and severe congestion occurring along the trunk network. With limited budgets, however, SCT spread investment throughout the network to resolve the most critical congested road segments and increased maintenance outlays to provide emergency measures until the reconstruction budget could be raised. Today, road surface conditions appear adequate, but deferred reconstruction needs are growing, and periodic maintenance will not be sufficient on many routes. Traffic congestion is a continuing problem since SCT estimates that there are over 6,400 km of roads with over 6,000 vehicles per day and only 1,000 km of four-lane highway. Recent fuel price and toll increases, along with the economic recession, have relieved some of the problems as traffic has declined, but will provide a respite of only a few years. An indication of the recent declines is evidenced in the manufacture of vehicles, which today is generally at 1973 levels (Table 3.5). B. SCT Highway Investment Program 1984-1988 3.06 Potential road works for the SCT road investment program are identified from three sources: the continuous road inventory which provides sufficiency ratings on the structural and geometric characteristics of the national network; the state offices of SCT and local authorities based on their observation of local road conditions and their knowledge of local development requirements; and the national highway plan called the Esquema Director Nacional de Carreteras (EDNC). The EDNC is the primary basis for the modernization program. It was originally prepared in 1975, with consultant assistance, and was updated in 1981. It includes a projection of traffic flows and determines what investment levels would be required to maintain different levels of service (based on speed and congestion). Important corridors were identified for investment by the study, and all works in the 1984 road-widening program have originated from the EDNC. 3.07 SCT prepared a draft investment program for 1984-1988 assuming that, while 1984-1986 budget levels would remain restrictive, substantial real increases would be forthcoming after 1986. The general breakdown of the projected investment program is along the lines shown in Table 3.6, as confirmed at negotiations. No real increases are projected for bridge 10/ This does not include the reconstruction elements of the modernization program, which would raise the proportion even higher. - 16 - construction, while new road construction, reconstruction and modernization, trunk and rural road maintenance and bypasses will receive real increases from 1985 to 1988. The major additions to the investment program will be the inclusion of high priority toll road widenings. The total investment program would require US$3.6 billion, including routine and periodic maintenance but excluding rural roads construction. About US$420 million has been allocated for 1984. Although these budget levels will not be sufficient to significantly relieve the problem of congestion, they should be sufficient to serve the most critical reconstruction needs. If maintenance budgets for trunk roads are kept at 1984 levels, the general surface condition of the network should be adequate. Further increases in the roads budget will depend upon overall increases in the public sector investment budget. More details on the composition and major works included in the investment program are provided in Annex 4. C. SCT Road Maintenance Program 3.08 While the 1984 highway investment budget will experience a decrease in real terms from 1983 levels, the share allocated to trunk road maintenance will increase from 33% to 38% of the federal trunk road investment budget, representing US$3,400 per km (including routine and periodic maintenance tasks). The relatively high proportion reflects two facts: first, the network is aging and upgradings have been postponed, requiring more maintenance; and second, trunk road maintenance quality is good. Routine maintenance is carried out by force account; only major betterment or periodic maintenance works on the trunk network are contracted. Maintenance requirements traditionally have been identified on the basis of separate annual visual inspections by the Directorate General for Technical Control and by the Directorate General for Maintenance (DGC). More recently, DGC has instituted a program for measuring roughness and deriving an index representing the geometric and structural adequacy of the road. Road sections with low indices are identified for more detailed analysis, including deflection measurements. 3.09 SCT equipment is maintained, operated and allocated by DGC, and equipment investment is included within the DGC budget. Systematic records are kept of each item of equipment and each vehicle, specifying its use and maintenance data and forecasting the timing for replacement. Although abouit half of the equipment and vehicles are older than their rated economic life, almost 80% are still in use because of good workshop facilities and an innovative equipment rehabilitation program. In 1983, about US$15 million worth of equipment was procured locally, and the budget for 1984 provides about US$20 million which, in view of the overall restricted budget situation, is satisfactory. SCT has managed to fulfill some of its equipment needs through the rental of contractors' equipment, much of which is idle or under-utilized because of the recession. 3.10 Rural road maintenance under the Directorate General for Maintenance is not as satisfactory and has been neglected in the past. Since 1971, the Government's attention has been directed at the construction of rural roads with minimum design standards. With over 80,000 km built in ten years, the requirements for maintenance, particularly periodic maintenance including spot improvements, are accumulating rapidly. Rural road inventory procedures have been inappropriate for identifying maintenance requirements, - 17 - and it is clear from limited field inspections that the need is significant and that the US$300/km allocated in 1983 hardly met 50% of the needs. In the state of Chiapas, estimates were made on the cost of routine and periodic maintenance which showed that US$650-750/km is required, of which about 60% represents periodic and emergency maintenance (Annex 5). Taking into account the deferred maintenance works, it is expected that the budgetary requirements in the coming years may be even higher in several states. It was agreed at negotiations that the Government would provide adequate resources to maintain rural roads appropriately. Already, for 1984, the Government has increased the rural roads maintenance budget by over 45% in real terms and has projected substantial increases in future years by allowing rural road construction funds to be used for reconstruction purposes as well. To assist in defining the specific level of resources required, the Government has initiated a rural roads inventory which is expected to cover 40% of the network by the end of 1984, 75% by the end of 1985, and 100% by June 1987, applying agreed upon inventory procedures. The Government would develop a program of periodic maintenance works from the inventory data and would review progress with the Bank during the semi-annual project meetings (para 4.24). The format for the inventory and review is provided in Annex 5. D. Financing of the Road Investment Program 3.11 There are three principal sources for financing road investments: the federal treasury, the Inter-American Development Bank (IDB) and the Bank. Although various road-related taxes are collected from road users, including highway tolls, they are incorporated into the general treasury and not assigned to any specific sector (para 2.15). For the period 1984-1986, of a total estimated investment budget of US$1.6 billion, including maintenance but excluding rural roads construction, IDB is expected to provide US$45 million through an ongoing loan directed mainly at new road construction; the Bank is to provide US$200 million under this project, and the rest is to be provided through annual budgetary outlays. 3.12 Major improvements to the toll road network have been delayed because of the Government's uncertainty over how such works should be financed. The original concept was that CyPF should be self-financing, but the toll levels permitted in previous years were barely able to cover operating and maintenance costs, and, in recent years, CyPF registered significant deficits as the devaluations affected its debt situation (Annex 1). The new administration changed the situation by declaring that tolls were a form of federal taxation, to be collected by CyPF but deposited in the federal treasury. The operating and investment budget for CyPF is determined with Government approval and funded from Government allocations. Investments for widenings and extensions are to be determined and executed by SCT, which will then turn them over to CyPF for maintenance and operation (the impact of this policy upon CyPF accounting and operational efficiency is discussed in paragraph 4.22). This treatment is similar to that of major railway infrastructure investments, which are executed by SCT and turned over to N de M. The Government's policy is a sound one, providing maximum flexibility to optimize investment options. - 18 - 3.13 The policy for setting tolls is determined by SHCP in consultation with CyPF, SCT and SPP. In the past 12 months, tolls have increased by about 500% and now vary not only by vehicle type, but also by day of the week, with higher tolls imposed on weekend leisure traffic. The toll levels are equivalent to those required to cover all costs, including debt service. Government policy is for current tolls to be maintained in real terms so that toll road and bridge users will also be contributing substantially to new investments. Concern over the need for investment on the toll network and the effect of recent toll increases led the Bank to sponsor a Toll Road Sector Study in 1983, the recommendations of which have been accepted in principle by the Government. 11/ The study concluded that the full cost recovery tolls did not appear to be causing significant diversion of traffic to parallel free roads, and, thus, the system is considered acceptable in economic as well as financial terms. The study did recommend, and the Government has instituted, a program of traffic counts on competing roads to monitor the situation continuously. A report on these counts and toll levels will be included for the semi-annual discussions (para 4.24). For new toll roads, the study recommends that the Government begin by fixing tolls at the level of marginal costs to determine the baseline traffic attracted to the road and then to increase the tolls toward full recovery until significant diversion is apparent. To help monitor the efficiency of toll collection, CyPF will annually calculate agreed upon indices for Bank review (para 4.22). E. Economic Evaluation of the Investment Program 3.14 SCT carried out an economic evaluation for all road works in the construction and modernization program whether or not they were candidates for external financing; the procedures applied were those agreed to under Loan 1671-ME. Estimated economic rates of return for the 1984 investment program cover 94% of the construction and road widening budget and range from 13 to 86% as shown in Annex 4, with over 80% of the funds invested in workcs with estimated rates of return of over 20%. The principal benefits are vehicle operating cost and time savings because of reduced congestion in the modernization and bridge works. For new road construction, development benefits are often significant. Reconstruction works are selected and evaluated on the basis of engineering criteria, reviewed through annual inventories. At present, no economic analysis is carried out for such works, but, under the project, SCT is expected to develop appropriate analytical procedures (Annex 6, para 6). 3.15 Based on discussions during project preparation, SCT has updated, upgraded and revised its economic evaluation methodology, taking into account recent technical findings on vehicle operating costs in other countries and the results of local surveys to better estimate vehicle speeds and time values. At negotiations, the economic evaluation procedures and methodology, as well as the general economic criteria, to be applied in the annual updating of the road investment program were confirmed (Annex 6). All candidate civil works subprojects for financing must have a minimum economic rate of return of 12%. For rural road maintenance works, however, only a technical analysis will be carried out (para 3.10), and traffic counts will be made to confirm the degree of utilization of the road. II/ Mexico Transport Sector Study: Mexico Toll Roads, September 9, 1983 (Yellow Cover). - 19 - 3.16 Traffic forecasting procedures depend upon the scale and type of project. For new construction, origin and destination surveys serve-as a basis for projecting traffic. Otherwise, SCT depends upon the results of the EDNC study (para 3.06) and general social and economic indices for the various states. For the great majority of modernization and reconstruction subprojects, traffic forecasts are not a significant element since, with existing traffic, the first year benefits are sufficient to meet the minimum economic selection criteria. F. The Bank Project 3.17 The Second Highway Sector Project would continue to help finance works initiated under the First Highway Sector Project as well as other works initiated under the SCT investment program. The quick disbursing nature of this followup sector loan would provide virtually immediate assistance to the Government in alleviating its continued foreign exchange shortage. The objectives of the project are the following: (a) to improve seriously congested sections of the national highway network including sections of the toll network, upgrade substandard pavements and extend the paved network to developing areas; (b) to strengthen the planning and execution of rural road rehabilitation and periodic maintenance and help the Government to determine and allocate an appropriate maintenance budget; (c) to strengthen the newly organized SCT Planning Directorate for all transport modes; (d) to facilitate a continuing dialogue on land transport pricing policies and monitor progress with regard to road and rail pricing issues; and (e) to assess the costs and benefits of existing road freight regulations in order to assist the Government in policy formulation. 3.18 The proposed loan of US$200 million would be made to BANOBRAS with SCT as the executing agency and would help to finance the 1984-1986 time-slice of the 1984-1988 SCT investment program, based on the expected rate of execution for candidate subprojects. In 1984-1986, SCT expects to spend US$1.6 billion on-road works (excluding rural road construction) with a foreign exchange component of about US$541 million (as shown in Table 3.6 and the tabulation on the following page). The loan would represent 12% of the total program and 37% of the foreign exchange requirements. The main components would be as follows: (a) the civil works component would help to finance the construction, reconstruction and modernization of sections of the federal road network including the toll roads; (b) the rural roads component would help to finance the rehabilitation and periodic maintenance 12/ of sections of the SCT rural roads network; and 12/ Including regraveling, spot improvements and betterments. - 20 - (c) the technical cooperation component would provide funding for individual high level consultant services on a range of issues to be agreed upon by the Government and the Bank (Annex 7). Bank Project (in millions of current US$) 13/ Pro jected Bank Financing Budget Foreign Bank as % of Category 1984-1986 Exchange Financing Projected Budget Civil Works 768.0 300.0 184.5 24% Trunk Roads Maintenance 662.0 200.0 - - Rural Roads Maintenance 170.0 40.0 14.0 8% Technical Cooperation 1.0 0.7 1.0 100% Front-End Fee 0.5 0.5 0.5 100% Total 1601.5 541.2 200.0 12% 3.19 About 55% of the civil works component is related to the 1984-1986 investment time-slice for roads on which works were started under Loan 1671-ME (Table 3.7). Many sections of these works, however, are still to be tendered. The potential new candidate works included in the SCT investment program are listed in Table 3.8. It is estimated that 65% of the subprojects to be financed (whether new or in execution) would pertain to modernization works, 5% to reconstruction and 30% to other types of civil works (Table 3.9). Final engineering has been completed for the first year's candidate subprojects. G. Assessment of Risk 3.20 This Second Highway Sector Project has been prepared on the basis of the experiences of the First Project and has been designed in accordance with the present economic circumstances of Mexico and the projected outlook for 1984 to 1986. One risk to the project is that, if the economic situation does not improve at the rate predicted or if inflation accelerates, further restrictions to transport investment may be required, delaying the investment program and interrupting ongoing investments. With the experience of the past few years, SCT has shown its ability to respond to such situations by redirecting limited funds toward priority works, and particularly toward maintenance. In addition, SCT is now programing road works such that contractors are directed to focus on completing shorter segments which can be made fully operational. If investment funds are cut, at least the benefits of the initial investment can be realized without significant delay. As for the impact of further budgetary restrictions on loan disbursement, it was shown in 1982-1983 that the flexibility of the sector loan format minimizes such risks by not tying the loan to predetermined subprojects; sector loans are more responsive to changing investment requirements during such critical periods. The loan amount has been set well below the full potential for eligible subprojects, and the disbursement estimates include a delay factor in subproject execution. 13/ Including price contingencies estimated using an annual international inflation rate of 7.5% in 1985 and 9% per year for 1986-1988. - 21 - 3.21 Another risk to the project concerns the counterpart funding required to carry out the rural roads maintenance component and the technical difficulty of monitoring a large number of relatively small subprojects. To minimize such risks, the project component is designed as a pilot exercise, geographically concentrating efforts on a limited number of states which will be progressively increased during the course of the project. Detailed inventories and program preparation and review procedures have been established which will facilitate the setting of physical targets and financial accountability (Annex 5). These actions will help to document the financial requirements for rural road maintenance and support SCT's request for sufficient budgetary levels. 3.22 One uncertainty is the extent to which the Bank will be able to influence sector policies and to which the Government will be able to maintain its course toward the rationalization of pricing policies. The Second Highway Sector Project has been presented at this time in response to the substantive actions, in terms of pricing and institutional organization, taken by this administration on sector policy issues which have traditionally been of concern to the Bank. The lending program for transport has been timed in such a way as to be able to monitor further incremental progress on these policy issues. Furthermore, technical cooperation funding and the sector work program are oriented toward assisting the Government in analyzing important issues and formulating appropriate policies. IV. PROJECT IMPLEMENTATION A. Subproject Selection (i) National and Toll Roads 4.01 Two important concepts to be considered during the execution of the project are the individual subprojects and the associated contract(s). The subproject is the unit considered for purposes of selection, preparation and evaluation, while contracts for the implementation of specific subprojects are the basis for disbursements. 4.02 Bank financing would be restricted to the continued execution of civil works contracts pertaining to eligible subprojects approved under the First Highway Sector Project (1671-ME) and to the initiation of additional civil works contracts pertaining to eligible subprojects to be awarded before March 15, 1987. The proposed loan would consequently finance a time-slice (1984-1986) of expenditures on subprojects approved by the Bank. Not all of these subprojects would be financed until their completion since loan funds would be depleted earlier. Full disbursement is expected by end-FY1988 (Table 4.1), but the actual timing would depend upon the annual budget allocations. Although most subproject contracts would be completed within six months of the full disbursement of the loan, SCT would agree to complete the works still under construction when loan funds are exhausted in accordance with a schedule defined for each subproject. At negotiations, agreement was reached that the Government would provide adequate financing to complete all subprojects assisted under the loan. - 22 - 4.03 SCT would prepare, for each subproject, a technical and economic evaluation summarized on a basic data sheet (Annex 6), which would include information on the rationale for the proposed works, the design standards, the alternatives considered, the cost, the results of the economic evaluation and the proposed tendering schedule. The Bank would study this evaluation, request additional information as required, and, if appropriate, confirm eligibility. An estimated rate of return of 12% or more would be required unless otherwise agreed to by the Bank. 4.04 Declaring a subproject eligible would mean agreement by the Bank, in principle, to help finance contracts related to the subproject, provided budget funds are allocated, the tender process has been executed according to agreed procedures and the detailed engineering has been carried out in accordance with the agreed design standards. Agreement on the above procedures for subproject identification and evaluation was confirmed by the Government at negotiations. (ii) Rural Roads 4.05 The Government, after discussions with the Bank, would select the states which would be targeted for financing under the rural roads rehabilitation and periodic maintenance component of the project. The selection would be based on the maintenance needs of the state and the ability of SCT to carry out a condition inventory and to develop an annual periodic maintenance program in a timely manner. It is expected that the number of states included under this component would increase from three in the first year to from five to seven in subsequent years. The maintenance programs would be developed by the Government in accordance with agreed upon procedures (Annex 5) and reviewed by the Bank on an annual basis. Once the works and cost estimates are approved by the Bank, the program would be considered eligible for financing. The procedures for the selection and approval of subprojects under this component were agreed to during negotiations. The monitoring of results would be carried out through annual follow-up road inventories conducted by the Government. B. Procurement 4.06 General. Civil works having an estimated contract value of more than US$1.0 million equivalent, and which are related to the federal and toll road networks eligible for financing under the proposed loan (US$185 million equivalent), would be procured through international competitive bidding in accordance with Bank guidelines. Eligible works valued at less than US$1.0 million equivalent would be procured using local competitive bidding, with the total of such contracts not to exceed US$15 million equivalent. In the case of civil works related to the rehabilitation and periodic maintenance of rural roads (US$14 million equivalent), the Bank would finance a fixed percentage of the expenditures related to specific works in the approved budget for rehabilitation and periodic maintenance of rural roads in the selected states (para 4.05). Because of the nature of these works (low cost per kilometer and geographically dispersed), they would be carried out, principally, by force account or, in exceptional circumstances, contracted through local competitive bidding. Local competitive bidding procedures used by SCT have been reviewed and found to be generally acceptable. Experts for techn:Lcal cooperation (US$1 million equivalent) would be contracted by SCT in accordance with Bank guidelines and subject to Bank approval. - 23 - 4.07 Contractor Registration. For civil works for federal highways and toll roads, contractors would be subject to prior registration (prequalification). For Mexican contractors, the system of registration now in use would be continued. For foreign contractors, invitations to be registered would be published in the Development Forum annually during the course of the project and would be sent to embassies; the notices would contain information on the program as a whole. In addition, notices for specific tenders would be advertised locally. SCT would keep the Bank informed on the list of registered foreign contractors and those refused registration, if any, and the reasons therefor, and on the interest shown by contractors for specific tenders. The prequalification procedures were confirmed during negotiations. 4.08 Tender Process. Once a subproject has been declared eligible, SCT, because of its proven capabilities and long experience with the Bank, would prepare tender documents and final cost estimates, advertise tenders, open and evaluate bids, and award and sign contracts without the Bank being involved at this stage. However, if the data supplied in the original basic data sheet would essentially change during the detailed engineering stage of the subproject, causing the cost to increase by more than 20% or the estimated rate of return to decrease below the 12% threshold, SCT would send a revised form to the Bank for its confirmation prior to inviting tenders. The time allowed for preparation of bids would be 45 days for tenders having an estimated contract amount of less than US$5 million equivalent, 60 days for those with estimated contract amounts of more than US$5 million equivalent but less than US$20 million equivalent, and 90 days for larger contracts. 4.09 Bank Acceptance of Contracts. After the signature of each contract, SCT would send to the Bank two conformed copies of the contract together with the tender evaluation report indicating the award decision. The Bank would review this information and, if satisfied, indicate no objection, thereby declaring the specific contract accepted, or request further information. The Bank would have the right to reject the contract if agreed tender procedures were not followed, and to cancel the related loan amount. In case a higher-than-expected tender amount would make the project economically not feasible, SCT and the Bank would review the possibility of lowering the design standards of the subproject. Also, if the design of a subproject is materially modified after initiation of construction, Bank concurrence would be required. 4.10 Technical Cooperation. The technical cooperation program with SCT financed under the project would provide a global amount which would finance the contracting of individual experts with international experience for limited periods of time to provide high level assistance during the course of the project. As the need for specific consulting services arises, terms of reference and consultant selection would be prepared subject to Bank approval. Potential uses for this fund are listed in Annex 7, and an amount of US$1.0 million has been provided. Loan funds would cover the full costs of the experts. Local consultants with international experience would also be eligible for financing under this component and would represent about one-third of total man-months. - 24 - C. Disbursements 4.11 For civil works related to federal highways and toll roads, after Bank acceptance of the contract(s) of an eligible subproject, funds can be withdrawn from the Special Account on the basis of statements of expenditures (para 4.18). For civil works related to rural roads, after Bank acceptance of the detailed annual program for periodic maintenance in a State, funds can be withdrawn from the Special Account on the basis of statements of expenditures on works detailed in its approved program. Disbursements for technical cooperation would be made upon full documentation being provided to the Bank. 4.12 Disbursements would be made on the following basis: (a) 70% of total expenditures of civil works contracts related to national highways and toll roads up to June 30, 1985, and 35% of total expenditures thereafter; (b) 70% of total expenditures of the works contained in the detailed annual program for rehabilitation and periodic maintenance in selected states up to June 30, 1985, 50% of expenditures incurred from July 1, 1985 until June 30, 1986, and 30% of expenditures thereafter; and (c) 100% of the costs for technical cooperation. 4.13 The foreign exchange component for civil works is estimated to be 45% of total costs (excluding value added taxes). The Government, through the Borrower, BANOBRAS, has requested that the Bank apply the facilities of the Special Action Program and increase the disbursement percentage. In view of the continuing shortage of foreign exchange and considering that the Bank will be financing only 24% (US$185 out of US$768 million) of the 1984-1986 time-slice of SCT's civil works investment program (para 3.18), a disbursement schedule is proposed in which disbursements on expenditures made up to June 30, 1985 would be on the basis of 70% of total costs (excluding value added taxes) and 35% of expenditures thereafter. 4.14 The foreign exchange component for rural roads maintenance has been estimated at about 25% of total costs. The proposed loan amount of US$14 million represents about 8% of the total rural road maintenance costs for 1984-1986. In order to facilitate physical monitoring and financial auditing, disbursements would be concentrated in selected states at an average rate of 45% of expenditures, rather than providing a broader coverage at a lower disbursement percentage. As with civil works (para 4.13), a disbursement schedule is proposed in which disbursement on expenditures made up to June 30, 1985 would be on the basis of 70% of total costs. Thereafter, from July 1, 1985 to June 30, 1986, disbursement would be calculated on the basis of 50% of expenditures, and 30% of expenditures after June 30, 1986. 4.15 Standard disbursement profiles prepared by the Bank in the LAC region and in Mexico indicate that a seven-year period is required to obtain full disbursement, but they pertain to standard project lending, which is not considered appropriate for the proposed project. The First Highway Sector Project in Mexico will likely be fully disbursed before the Closing Date of - 25 - June 30, 1984, requiring a five-year disbursement period, and it is estimated that disbursement of the Second Sector Project would require about four years since many subprojects are already under execution (Table 4.1). The progression of disbursements assumes annual budget increases for Bank- financed subprojects of, on average, 10% in real terms, as indicated by SPP. D. Retroactive Financing 4.16 A considerable amount of retroactive financing is required under this project. The First Highway Sector Loan supports financing of a time-slice of an investment program containing subprojects in various stages of execution. The proposed project would help finance a subsequent time-slice which would include subprojects approved and initiated under the earlier project as well as new subprojects. This situation could lead to substantial retroactive financing when there is a gap between the date of signing of the second loan and the date when disbursements under the first loan are fully committed. There will be a hiatus between the date on which all funds have been committed (December 1983) under Loan 1671-ME and the date on which the new loan would be signed, presently estimated as July 1984. 4.17 There will be a likely shortfall of funds of Loan 1671-ME for works of about US$20 million executed between January and July 1984. During negotiations, it was agreed that retroactive financing of up to US$20 million would be provided for civil works under the loan. E. Special Account 4.18 In order to reduce the interval during which SCT would finance the Bank's share of project costs with its own resources, the Government may request the Bank to make advance payments from the loan account into a Special Account, to be opened in US$ in the Central Bank, and which would be available for reimbursing SCT, through BANOBRAS, for the Bank's share of the project cost. The total amount in the Special Account would be that required for project execution, but would not exceed US$15 million. BANOBRAS would be entitled to make withdrawals from the Special Account in pesos at the exchange rate applicable on the day upon which payments were incurred on Bank-approved contracts and Bank-approved rural roads programs. The withdrawal applications would be on the basis of statements of expenditures covering the payments made for these specific contracts and works executed in these specific programs respectively. Supporting documentation would not be submitted to the Central Bank and the Bank, but would be retained by SCT; it would be made available for inspection during audits (para 4.19) and project supervision missions. The Bank would replenish the Special Account upon request of BANOBRAS on the basis of the withdrawals made. At negotiations, the Government confirmed its intention to arrange payment in foreign exchange to foreign civil works contractors through the Bank's direct payment procedure. F. Auditing 4.19 Under the project, the Bank would require three types of audits: an annual audit of the Special Account in the Banco de Mexico; an annual audit of the accounts of CyPF; and an annual audit of the accounts of SCT on which the statements of expenditures are based. Procedures have been agreed - 26 - to between the Government, BANOBRAS and the Bank which would govern the auditing of all Special Accounts established for loans with BANOBRAS. The external auditor for BANOBRAS would carry out the required audit each year. These procedures were confirmed at negotiations. For the accounts of CyPF, there is a satisfactory external audit carried out annually in addition to a system of internal auditing checks. It was confirmed at negotiations that an external audit of CyPF would continue to be carried out annually in accordance with sound auditing principles applied consistently by an independent auditor, and that, beginning with the fiscal year ending December 31, 1984, the Government would forward the audit report of CyPF to the Bank not later than six months after the close of the fiscal year. 4.20 With regard to the auditing of SCT accounts, SPP will carry out the control and verification of accounts under the project and will report on such verification annually. There is also a General Directorate of Control in SCT, independent from the operational departments, carrying out physical as well as financial audits of SCT expenditures. The auditing procedures are satisfactory, and SPP is considered to be an appropriate agency for carrying out such audits as it has under other ongoing Bank loans for public sector investment. At negotiations, the auditing procedures to be applied to the related SCT accounts were confirmed and agreed upon. G. Accounting and Budgeting at CyPF 4.21 In preparing the Second Highway Sector Project, the accounting and budgeting practices of CyPF were reviewed, and some improvements have been implemented. The Government agreed that a review of CyPF depreciation procedures and asset valuation would be completed by December 1985 and that the results would be discussed with the Bank. 4.22 Since CyPF is dependent upon the Government for budgetary allocations, its financial statements will be largely theoretical, and indices will have to be generated to help measure and monitor the efficiency of its operations. One measure is toll collection costs as a percentage of gross revenues for each road and bridge. A review of this index, taking into account the recent increases, showed that the toll road system average is at 7%, well below the 10-15% maximum accepted in other countries. However, five roads had indices of over 15%, which raises questions concerning the efficiency of toll collection on such roads. It was agreed at negotiations that CyPF would annually (for the semi-annual reviews, para 4.24) prepare the indices of collection costs to revenue and would review possible cost reductions or other options for roads with excessive indices. H. Semi-Annual Consultations and Project Monitoring 4.23 With regard to project monitoring, the Government confirmed at negotiations that it would prepare periodic reports for the Bank providing: the listing of eligible subprojects; the listing of contracts relating to eligible subprojects; the progress of execution of Bank-financed civil works subprojects; the status of rural road inventories; the progress of execution of rural road maintenance programs in the selected states; the status of disbursement requests; and the schedule of estimated withdrawals of the proceeds of the loan. - 27 - 4.24 Furthermore, in order to monitor progress on the objectives of the Sector Project, it was agreed at negotiations that the Government would, at least semi-annually, meet with representatives of the Bank and would provide information generally in accordance with the following scope and schedule and any other reports as the Bank may reasonably request from time-to-time. (a) During the first semester of each year, SCT would provide information on: - level of completion during previous year of road works in the investment program; - level of completion during previous year of the rural roads maintenance program in the selected states; - summary of financial status of CyPF for previous year; - use of technical cooperation funds during previous year; - final investment and operating budget for transport for coming year and investment objectives; - indices of toll road collection costs compared with gross revenue for each toll road for previous year; and - toll road traffic compared with that of parallel free roads. (b) During the second semester of each year, SCT would provide information on: - updated medium-term road investment program and objectives; - proposed investment and operating budget for transport for coming year; - status of selection and execution of Bank-financed subprojects; - estimated application of funds for technical assistance for coming year; - update of road freight regulation; - status of road and rail tariffs; and - results of rural roads inventories for all states and proposed rural road maintenance program, particularly for selected states. - 28 - V. AGREEMENTS REACHED AND RECOMMENDATION 5.01 During negotiations, agreement was reached with the Government on the following: (a) a study on the allocation of road costs and revenues by type of user (para 2.17); (b) Government provision of adequate resources to maintain rural roads (para 3.10); (c) carrying out of a rural roads inventory (para 3.10); (d) adequate financing by the Government to complete all subprojects assisted under the loan (para 4.02); (e) procedures by which foreign civil works contractors would be paid in foreign currency (para 4.18); (f) annual external audit of CyPF and the Special Account (para 4.19); (g) auditing of the SCT accounts (para 4.20); (h) review of procedures for valuing assets and estimating depreciation by CyPF (para 4.21); (i) annual preparation by CyPF of indices of collection costs to revenue and review of possible cost reductions (para 4.22); (j) submission of periodic reports to the Bank for project monitoring (para 4.23); and (k) semi-annual meetings between the Government and the Bank and appropriate reports as requested by the Bank on project execution and on specified policy issues (para 4.24). 5.02 During negotiations, confirmation of agreement on the following was obtained: (a) the highway investment program for 1984-1988 (para 3.07); (b) economic evaluation procedures and methodology as well as general economic criteria to be applied under the project (para 3.15); (c) the procedures for subproject identification and evaluation (paras 4.03-4.05); - 29 - (d) the procedures for international and local competitive bidding, for prequalification, tendering and contracting; and disbursement procedures for loan funds (paras 4.06-4.15); and (e) the amount of retroactive financing required (para 4.17). 5.03 Subject to the above, the project provides a suitable basis for a Bank loan of US$200 million. The terms would be 15 years with a three-year grace period. April 26, 1984 MEXICO SECOND HIGHWAY SECTOR PROJECT Historic Transport Investment (in millions of 1983 Mex$) 1/ Subsector 1977 1978 1979 1980 1981 1982 1983 1984 (Projected) Highways 56,600 59,500 65,100 72,700 110,400 79,200 71,700 54,500 Railways 27,000 23,600 38,300 52,300 64,400 55,500 54,100 50,500 Ports 2/ 3,400 3,200 6,700 15,300 33,200 29,200 11,900 11,700 Aviation 3/ 4,200 4,400 4,700 4,900 8,200 2,500 2,600 3,900 Total 91,200 90,700 114,800 145,200 216 200 166,400 14O,300 120,600 1/ US$1.00 = Mex$ 120 2/ Excludes dredging except in 1983 and 1984 and PEMEX port investments. 3/ Only infrastructure. For equipment in 1983 Mex$ 30,586 million was spent and Mex$ 9,900 million is budgeted for 1984. Source: SPP, SCT and Bank estimates April 1984 -31- TABLE 2.2 MEXICO .SECOND HIGHWAY SECTOR PROJECT Fuel Prices International December 1981 April 1984 April 1984 2/ Price 3/ (Mex$/liter) (Mex$/ liter) (US$/gallon) (US$/gallon) Gasoline (Extra) 7.00 54.00 1.30 NA Index 100 771 Gasoline (Nova) 2.80 40.00 0.96 0.82 Index 100 1429 Diesel 1.17 26.00 0.63 0.80 Index 100 2222 Inflation Index 1/ 100 419 1/ Consumer Price Index to end of March 1984. 2/ US$1.00 - Mex$ 157. 3/ Mid-November 1983 Caribbean market prices, FOB. Source: SHCP and Bank estimates April 1984 -32- TABLE 2.3 MEXICO SECOND HIGHWAY SECTOR PROJECT Fuel Price Structure (%) Gasoline Diesel Retained by PEMEX 38.9 40.2 Value Added and Production Taxes 13.0 13.1 Distribution Commission 2.6 2.5 Special Taxes 45.5 44.2 100.0 100.0 Source: SHCP January 1984 MEXICO SECOND HIGHWAY SECTOR PROJECT Ferrocarriles Nacionales de Mexico - Income Statements 1980-1983 (Figures in Mex$ Millions) 1 9 8 0 1 9 8 1 1 9 8 2 I/ 1 9 8 31 Appraisal Appraisal Appraisal Appraisal Forecast Actual Forecast Actual Forecast Actual Forecast Estimated OPERATING REVENUES Freight 10,524 10,456 13,612 13,133 17,888 20,154 23,240 Passengers 421 398 526 508 642 1,048 770 Express 518 541 648 598 790 778 949 N/A Mail 245 180 301 269 363 450 436 Demurrage 353 552 373 1,862 409 2,251 448 Other 424 462 467 511 482 1,010 498 Subtotal 12,485 12,589 15,927 16,881 20,574 25,691 26,341 64,282 Government Compensation for Unprofitable Passenger Services 1,016 977 1,259 1,260 1,527 1,911 1,873 2,700 Total Operating Revenues 13,501 13,566 17,186 18,141 22,101 27,602 28,214 66,982 OPERATING EXPENDITURES Staff Costs 11,965 11,595 14,855 15,056 18,321 26,617 21,683 38,546 Materials and Other Expenses 4,614 5,404 5,605 6,846 6,797 7,295 8,086 Car Rentals (Net) 350 1,781 250 1,263 150 112 50 34,895 Less-Cost Savings - - - (291) - (1,081) - Total Working Costs 16,929 18,780 20,710 23.165 24,977 34,024 28,738 73,441 Depreciation 2,491 2,925 2,386 3,179 2,160 5,473 4,617 16,008 Total Operating Costs 19,420 21,705 23,096 26,344 27,137 39,497 33,355 89,449 Net Working Revenue (Loss) (3,428) (5,214) (3,524) (5,024) (2,876) (642) (524) (6,459) Net Operating Revenue (Loss) (5,919) (8,139) - (5,910) (8,203) (5,036) (11,895) (5,141) (22,467) Interest Charges 2,519 2,904 3,578 6,261 4,900 16,742 6,040 28,122 Net Deficit (8,438) (11,043) (9,488) 14,464 (9,936) 2,863 (11,181) (50,589) Loss on Mexican Peso Devaluation - - 661 - 14,912 - - Other Non-Operating Profit/(Loss) - - - - - - - 210 2/ Net Loss for Year (8,438) (11,043) (9,488) (15,125) (9,936) (43,549) (11,181) (50,379) Working Ratio: With Government Compensation 125 138 120 128 113 123 102 110 Without Government Compensation 134 149 129 137 121 132 109 114 Operating Ratio: With Government Compensation 142 160 134 145 122 143 118 134 w Without Government Compensation 154 172 144 156 131 154 126 139 1/ 1982 and 1983 Actual and Estimated figures include those for "del Sureste" railway. 2/ Details not available. February 1984 MEXICO SECOND HIGHWAY SECTOR PROJECT Major Rail Freight Commodities - Comparison Revenues/Variable Cost 1983 1/ Total Percentage Estimated Total Estimated Percentage Average Variable Revenue to Tons Estimated Variable Highway to Tariff Haul Cost Revenue Variable 1983 Revenue Cost Rail Revenue Commodity Class (km) Per Ton Per Ton Costs 2/ (000) 1983 1983 Per Ton (Mex$) (Mex$) ---(Mex$ million)--- Iron Ore 20 884 1,175 999 90 6,900 6,893 8,108 267 Cement 18-19-20 - 205 452 400 87 5,575 2,228 2,512 284 Limestone 17-18 65 330 307 90 2,978 915 981 280 Coal 19-20 121 422 303 70 2,760 836 1,166 338 Coke 14-15 457 1,145 901 76 1,291 1,163 1,478 192 Sugar Cane 20 57 390 238 61 728 173 284 385 Lime 16-17 220 598 521 89 406 212 237 241 Fluorite 19-20 685 1,018 957 92 495 474 504 236 Barita 19 819 1,164 1,126 96 424 477 494 225 Dolomite 18 190 509 449 88 273 123 136 266 Wood Pulp 11 733 1,588 1,520 95 210 319 333 142 ---------------------------------------------------------------------__------__---------------------------------------- Maize 13-14-15 761 1,016 1,300 128 3,060 3,977 3,110 172 Wheat 8-9-10 572 835 1,345 159 2,562 3,447 2,139 137 Sorghum Seed 15-16-17 813 1,059 1,263 118 2,761 3,488 2,924 183 Petroleum 13 494 669 1,070 157 3,059 3,273 2,047 158 Sulphur 12-13 295 429 739 183 1,116 875 479 168 Gypsum 14-15 289 607 701 112 751 527 456 201 Sugar 9-10 452 750 1,147 150 1,696 1,945 1,273 140 Fertilizer 8-9-10 656 991 1,584 158 2,421 3,835 2,398 139 Iron&Steel Bars 8-9 822 1,120 1,744 152 867 1,512 971 145 Iron&Steel Plate 7-8 761 1,167 1,754 147 950 1,666 1,108 148 Iron&Steel Tubes 5-6 645 1,448 2,001 135 636 1,272 921 126 Beans 12-13 969 1,295 1,753 134 787 1,380 1,019 163 Silica Sand 12-13 679 734 1,322 180 635 840 466 169 > 43,341 1/ Data and calculations prepared by N de M's costing unit as of August 20, 1983. Revenues take into account September 1 tariff increase, costs include assumptions regarding wage award and other inflationary effects. 2/ This column relates to the period August-December 1983. February 1984 -35- TABLE 2.6 MEXICO SECOND HIGHWAY SECTOR PROJECT Operational Targets for N de M Actual 1982 1983 1984 1985 1986 1987 1988 Freight Locomotives Daily km/locomotive 228 244 260 280 300 320 340 Utilization (%) 42 44 45 49 50 53 55 Availability (%) 70 71 73 75 76 78 80 Wagons Trip Cycle (days) 20 19 18 17 16 15 14 Daily km/wagon 54 56 57 59 61 63 65 Ratio of loaded:empty 1.7 1.7 1.8 1.8 1.9 1.9 2.0 Ton-km/wagon-day 1495 1639 1758 1929 2096 2282 2500 Freight Trains Commercial speed (kph) 22.5 23 24 24 25 25 26 Gross ton-km/train-hour 50,050 51,160 53,380 53,380 55,600 55,600 57,800 Wagon hours in terminals/ wagon hours on trains 9.2 8.9 8.5 8.2 7.9 7.6 7.3 Net ton-km/train-hour 26,573 27,100 28,800 28,800 30,000 30,000 31,790 Net ton-km/gross ton-km 0.53 0.53 0.54 0.54 0.54 0.55 0.55 Passenger Trains Commercial speed (kph) 46 48 49 50 55 60 60 On-time performance (%) 63 68 74 81 87 95 95 Source: SCT, "Modernizacion del Sistema Ferroviario Nacional", September 1983. January 1984 -36- TABLE 2.7 MEXICO SECOND HIGHWAY SECTOR PROJECT General and Specialized Freight Truck Fleet with Federal Permits Type of Truck 1976 1977 1978 1979 1980 1981 1982 Single Unit (2 axle) 51,400 53,700 56,000 58,400 60,900 62,600 69,000 Single Unit (3 axle) 15,900 16,700 17,700 20,500 23,100 24,800 27,000 Tractor (2 axle) 2,800 3,000 3,100 3,600 4,200 4,200 4,800 Tractor (3 axle) 14,400 15,200 17,000 18,400 22,600 25,500 27,000 Total 84,500 88,600 93,800 100,900 110,800 117,100 127,800 Source: SCT January 1984 -37- TABLE 2.8 MEXICO SECOND HIGHWAY SECTOR PROJECT Prior Highway Lending Loan No. Date Amount Works Present Status (US$m) 268-ME Oct. 1960 25.0 3,160 km of federal roads Completed 1968 317-ME June 1962 30.5 385 km of toll roads, 5 toll bridges & 1 ferry boat Completed 1967 354-ME Sept.1963 40.0 6,000 km of federal highways & maintenance equipment Completed 1972 401-ME Feb. 1965 32.0 350 km of toll roads and 3 toll bridges Completed 1970 528-ME Jan. 1968 27.5 2,200 km of federal highways Completed 1973 695-ME June 1970 21.8 1,040 km of federal highways Completed 1977 968-ME Mar. 1974 90.0 1,216 km of federal highways, initially 1,875 km Completed 1982 1671-ME Mar. 1979 120.0 Highway sector project Completion in 1984 Source: Bank staff January 1984 -38- TABLE 3.1 MEXICO SECOND HIGHWAY SECTOR PROJECT Development of the Road Network (Km) 1952 1960 1970 1975 1980 Federal Roads 13,033 23,828 29,358 38,292 42,521 Earth 479 974 620 901 757 Gravel 1,517 2,623 1,310 1,590 2,063 Paved - 2 lanes 11,037 20,231 27,299 35,427 39,153 Paved - 4+ lanes - - 129 374 548 Toll Roads 113 290 868 1,028 932 Paved - 2 lanes 52 229 496 552 480 Paved - 4+ lanes 61 61 472 476 452 State Roads 10,830 15,137 29,984 37,102 49,302 Earth 1,560 1,756 2,986 2,967 7,831 Gravel 4,388 7,325 15,091 15,437 17,176 Paved 4,882 6,056 11,907 18,698 24,295 Local Roads 3,356 2,787 7,530 13,489 3,194 Earth 591 1,130 2,544 3,175 787 Gravel 2,619 1,255 3,353 6,378 1,050 Paved 146 402 1,633 3,936 1,357 Rural Roads - - 2,160 64,777 83,268 Earth - - 429 15,443 15,360 Gravel - - 1,708 49,310 67,273 Paved - - 23 24 635 Earth Tracks NA 2,850 1,520 22,486 33,409 TOTAL 27,332 44,892 71,520 186,218 212,626 Tracks NA 2,850 1,520 31,530 33,409 Earth 2,630 3,860 6,579 22,486 24,735 Gravel 8,524 11,203 21,462 72,715 87,562 Paved - 2 lanes 16,117 26,918 41,358 58,637 65,920 Paved - 4+ lanes 61 61 601 850 1,000 Source: SCT January 1984 MEXICO SECOND HIGHWAY SECTOR PROJECT SCT Highway Infrastructure Investment 1977-1984 (in millions of 1983 Mex$) 1/ Type of Investment 1977 1978 1979 1980 1981 1982 1983 1984 (Projected) Construction 10,000 9,700 10,200 10,800 13,200 10,800 14,600 10,600 Reconstruction/ Modernization 2,600 4,700 6,600 9,600 19,400 14,500 19,400 13,900 Toll Road Construction/ Modernization 2/ - - - - - - 1,000 Rural Roads Construction 7,700 8,400 11,200 23,000 34,300 22,500 6,800 6,600 Other Roads 3/ 22,400 22,700 24,300 16,500 29,000 20,200 3,000 2,500 Trunk Road Maintenance 4/ 14,000 14,000 12,800 12,800 14,600 11,200 16,900 15,800 Rural Road Maintenance NA NA NA NA NA NA 2,800 4,100 Total 56,700 59,500 65,100 72,700 110,500 79,200 63,500 54,500 1/ US$1.00 Mex$ 120.00 2/ Toll road reconstruction included with general reconstruction category. 3/ Transfer of budget for bipartite roads out of SCT budget occurred after 1982. 4/ Includes rural road maintenance in 1977-1982. Source: SCT and SPP April 1984 -40- -TABLE 3.3 MEXICO SECOND HIGHWAY SECTOR PROJECT Indicators of Highway Demand 1970-1980 Average Annual Increase (%) 1970 1975 1980 1970-1975 1975-1980 Population (thousands) 48,225 57,537 67,406 3.6 3.2 GDP (millions of 1970 pesos) 444,271 609,976 841,855 6.5 6.7 Vehicles in Circulation (thousands) 1,792 3,340 5,828 13.3 11.8 Automobiles (thousands) 1,234 2,401 4,255 14.2 12.1 Trucks (thousands) 525 888 1,489 11.1 10.9 Buses (thousands) 33 51 84 9.1 10.5 Gasoline Consumption by Road Vehicles (million liters) 7,856 10,865 18,316 6.7 11.0 Diesel Consumption by Road Vehicles (million liters) 3,599 5,499 8,215 8.8 8.4 Passenger Cars/ 1000 Inhabitants 26 42 63 10.1 8.4 Source: Asociacion Mexicana de la Industria Automotriz, "La Industria Automotriz de Mexico en Cifras, 1982". January 1984 MEXICO SECOND HIGHWAY SECTOR PROJECT Average Annual Daily Vehicles on Mexican Toll Roads 1971 - 1982 (thousands) Average Annual Rate of Increase (%) ROAD SECTION 1971 1975 1976 1977 1980 1981 1982 1971-82 Mexico Cue navaca 10.4 14.6 15.4 15.8 19.5 21.5 22.9 7.4 Cuernavaca-Amacuzac 4.4 6.2 6.6 6.5 8.7 9.7 10.5 8.2 Amacuzac-Iguala 2.4 3.5 3 .7 3.9 5.0 5.6 6.0 8.6 Me xico - Qu e retar o 9.7 15.4 16.4 16.3 23.5 27.3 28.4 10.2 Queretaro-Celaya 5.1 7.1 7.6 7.3 10.0 11.7 12.6 8.6 Mexico-Puebla 13.5 19.1 22.1 20.1 28.4 32.7 35.8 9.2 8 Mexico-Teotihuacan 15.9 22.3 27.4 27.0 42.0 47.2 54.8 11.9 La Pera-Cuautla 2.6 4.5 4.4 4.1 6.2 7.7 8.2 10.8 Puebla-Orizaba 3.5 *6.8 7.3 6.7 11.9 13.7 15.0 14.2 Tijuana-Ensenada 3.3 4.5 4.4 4.5 5.2 6.9 5.9 5.4 Apaseo-Irapuato 3.2 4.4 4.1 3.7 7.0 8.3 8.8 9.7 Orizaba-Cordoba 4.9 7.4 8.4 8.3 12.2 13.8 14.4 10.3 Guadalajara-Zapatlanejo 3 5 5 .7 6.2 6.3. 7.3 8.6 9.9 10.0 Compostela-Chapalilla 0.6 0.7 0.7 1.0 1.2 1.3 12.5 TOTAL 82.6 122.1 134.9 131.4 187.8 216.2 234.5 10.0 Source: Caminos y Puentes Federales January 1984 -42- TABLE 3.5 MEXICO SECOND HIGHWAY SECTOR PROJECT Growth of Annual Vehicle Production in Mexico 1970 - 1983 (1970 = Base Year) Year Total Automobiles Trucks Tractor Trailers Buses 1970 100 100 100 100 100 1971 111 115 102 122 104 1972 121 122 118 126 103 1973 150 250 151 158 128 1974 185 187 180 242 144 1975 188 178 210 251 180 1976 171 160 199 193 158 1977 148 141 166 93 142 1978 202 182 252 195 164 1979 234 210 289 402 201 1980 258 227 326 628 177 1981 314 267 424 757 152 1982 1/ 277 236 379 428 2/ 1983 T/ 148 147 154 50 2/ 1/ 1982 and 1983 based on comparison of January to September production statistics with those of January to September 1981. 2/ Included with tractor-trailers. Source: Asociacion Mexicana de la Industria Automotriz, Bol. 214, Oct. 1983. January 1984 -43- TABLE 3.6 MEXICO SECOND HIGHWAY SECTOR PROJECT SCT Road Investment Program 1984-1988 (Millions of 1984 Mex$) Provisional Budget Subprojects with Likely Bank Participation % of Program Time-Slice L984-1986 US$ Category 1984 1984-1988 1984-1986 1984 1984-1986 Time-Slice Million New Construction 1/ 9,000 63,300 29,200 1,070 5,750 20% 33 Major Bridges 2/ 7,900 18,200 16,200 3,400 7,000 43% 40 Federal and Toll Road Reconstruction and Modernization 3/ 21,900 154,100 69,600 12,830 57,510 83% 329 Bypasses 4/ 2,500 18,600 9,800 840 1,800 18% 10 Trunk Road Maintenance 25,200 205,900 107,600 - - - - Rural Road Rehabilitation and Maintenance 6,500 59,500 27,500 - 5,400 5/ 20% 31 Subtotal (Mex$) 73,000 519,600 259,900 18,140 77,460 30% Subtotal (US$) 6/ 420 2,970 1,490 104 443 443 Price Contingencies (US$) 7/ - 610 115 - 47 47 Total (US$) 420 3,580 1,605 104 490 490 1/ IDB lending (US$45 million remaining in loan account) is concentrated in new construction work. 2/ World Bank financing not provided for main spans of bridges at Tampico and Coatzacoalcos which were awarded after limited competitive bidding. 3/ The main Bank program item is reconstruction and modernization (providing 2 extra lanes). 4/ Bank financing not normally provided for urban bypasses. 5/ Although the Bank will review programs in all states, Bank financing will be concentrated in a few selected states to ensure appropriate monitoring. 6/ Applying a projected exchange rate for June 1984 of US$1.00:Mex$ 175 as used in SPP budget forecasts. 7/ Annual international inflation rates of 8% in 1985, and 9% annually from 1986-1988 were applied. Source: SCT April 1984 -44- TABLE 3.7 MEXICO SECOND HIGHWAY SECTOR PROJECT Subprojects with Likely Bank Participation - Ongoing - Average Annual Estimated Daily Economic Type Tentative Budgets Traffic Rate of Section Work 1/ 1984 1984-1986 1983 Return (Million Mex$ of June 1984) 2/ Work under Financing Matamoros-Reynosa M4 420 1070 10000 22 Guadalajara-Chapala M4 200 1200 9000 45 Queretaro-S.L.Potosi M4 910 5100 15000 65 Coatzacoalcos-V. Hermosa M4 1000 4000 13000 32 Irapuato-Leon M4 580 2400 18000 42 Tihuatlan-Alazan R2 200 710 1300 33 Chilapa-Tlapa R2 130 400 280 19 Tampico-Mante M4 450 1750 9300 31 Puebla-Ocotoxco M4 100 300 7000 26 Mexicali-Tijuana M4 150 850 3800 17 Morelia-Salamanca M4 200 1000 6400 26 Ecatepec-Pachuca M4 1150 2100 11000 49 Guadalajara-Tepetongo C2 170 500 400 16 Bridge Tampico B 1300 4000 9500 16 Bridge Coatzacoalcos B 2100 3000 10000 25 Empalme-Hermosillo M4 550 1950 11000 49 Bypass Tampico L4 100 300 5200 14 Bypass Cuernavaca L4 640 1300 13800 29 Bypass Acayucan L2 100 200 5200 58 Manzanillo-Colima M4 700 3600 6900 27 Mexico-Toluca M6 800 2800 40100 38 Iguala-Acapulco M4 450 3400 9400 33 Jalapa-Veracruz M4 300 1050 11200 38 Morelia-Patzcuaro M4 150 900 6700 29 Total Work under Financing - 12850 43880 - - 1/ M = Modernization (widening, realignment, additional lanes) R = Reconstruction C = Construction L = Urban Bypasses B = Major Bridges 2, 4 or 6: Number of Lanes 2/ US$1.00 = Mex$ 175 Source: SCT and mission estimates April 1984 -45- TABLE 3.8 MEXICO SECOND HIGHWAY SECTOR PROJECT Subprojects with Likely Bank Participation - New Average Annual Estimated Daily Economic Type Tentative Budgets Traffic Rate of Section Work 1/ 1984 1984-1986 1983 Return (Million Mex$ of June 1984) 2/ Identified Free Road Subprojects Chihuahua-Delicias M4 180 630 17600 46 Chihuahua-Juarez M4 280 970 6600 28 Irapuato-Zapotlanejo M4 250 950 9400 49 Zapotlanejo-Lagos R2 180 930 7000 60 Ent.Ameca-Mazatlan M4 300 1350 5000 24 Monterrey-Linares M4 250 400 6400 38 Salina Cruz-Acayucan R2 500 1400 5600 40 Zacatepec-Jalapa R4 500 1100 9000 40 Mazatlan-Guasave M4 350 1200 8300 27 Guadalajara-Colima C4 900 5250 7300 36 To Be Identified - - Reserve - - Total Identified Free Road Subprojects 3690 14180 Identified Toll Road Subprojects Estimated Ecatepec-Piramides M4 500 3000 11700 28 Queretaro-Irapuato M4 600 6000 12200 29 Puebla-Orizaba M4 500 5000 9400 17 Zapotlanejo-Guadalajara M4 - - 11500 33 Cuernavaca-Iguala M4 - - 11300 25 Mexico-Cuernavaca M6 - - 38900 79 Cordoba-Veracruz C4 - - 14000 33 Total Toll Road Subprojects 1600 14000 1/ M = Modernization (widening, realignment, additional lanes) R = Reconstruction C = Construction L = Urban Bypasses B = Major Bridges 2, 4 or 6: Number of Lanes 2/ US$1.00 = Mex$ 175 Source: SCT and mission estimates April 1984 -46- TABLE 3.9 MEXICO SECOND HIGHEWAY SECTOR PROJECT Breakdown of All Subprojects with Likely Bank Participation (Million Mex$ of June 1984) 1/ Tentative Budgets US$ million Summary 1984 1984-86 1984-86 Work in Execution 12850 43880 250 - Reconstruction 330 1110 6 - Modernization 8110 33470 191 - Construction 170 500 3 - Bypasses 840 1800 10 - Bridges 3400 7000 40 Identified Free Road Subprojects 3690 14180 81 - Reconstruction 1180 3430 20 - Modernization 1610 5500 31 - Construction 900 5250 30 Identified Toll Road Projects 1600 14000 80 - Modernization 1600 14000 80 - Construction - - Total Subprojects 18140 72060 411 1/ US$1.00 = Mex$ 175 Source: SCT and Mission estimates April 1984 -47- TABLE 4.1 MEXICO SECOND HIGHWAY SECTOR PROJECT Estimated Schedule of Disbursements (Millions of US$) Cumulative Disbursements Disbursements for the at end of Cumulative IBRD Fiscal Year Semester Semester Percentage 1985 December 31, 1984 20 20 10 June 30, 1985 40 60 30 1986 December 31, 1985 35 95 48 June 30, 1986 25 120 60 1987 December 31, 1986 25 145 73 June 30, 1987 25 170 85 1988 December 31, 1987 25 195 98 June 30, 1988 5 200 100 Source: Mission Estimates April 1984 -48- ANNEX 1 MEXICO SECOND HIGHWAY SECTOR PROJECT Impact of Diesel Price Subsidy on the Transport Sector A. History of Fuel Prices in Mexico 1. During the 1970s, Mexico followed a policy of maintaining fuel prices at levels well below international market prices, with a substantial differential between gasoline and diesel pump prices. Between 1974 and 1981, fuel prices actually declined in real terms, with regular gasoline ("nova") down 65% and diesel down 33% (Table 1 of this Annex). Since 1981, however, the Government has taken action to raise fuel prices toward international levels in response to the country's fiscal crisis. Regular gasoline prices rose over 240% in real terms and diesel prices by over 430% from December 1981 to April 1984. The gap between gasoline and diesel prices has also been reduced, with diesel being 65% of regular gasoline price levels compared with 21% in 1974. The Government's policy is to continue raising fuel prices toward international levels. 1/ 2. At the exchange rate and price levels prevailing in April 1984 (Table 1 of this Annex), it is evident that gasoline prices (regular and extra) are above international price levels. Regular gasoline is US$0.25/liter compared with the FOB price in the Caribbean of US$0.22/liter. Diesel, however, is about 80% of the FOB price in the Caribbean (US$0.17/liter compared with US$0.21/liter) and will require further real increases to reach international levels. The remainder of this annex focuses on the probable impact of increases in diesel prices on the transport sector. The general conclusion is that no substantive distortions are evident in the sector as a result of prices being below international levels. A broader macro-economic review is necessary, however, to assess the combined impact of fuel prices on other sectors and the country's fiscal situation. 3. The assessment focuses on three potential distortions in the sector because of underpriced diesel: (a) Effect on road traffic demand and investments; (b) Effect on modal split between road and rail; and (c) Effect on selection of construction techniques (labor-based versus equipment-based construction). 1/ Address by the Secretary of Finance and Public Credit to the Fifty-Second Legislature on underlying assumptions for Law on Revenue of the Federation for the Fiscal Year 1984, November 1983. -49- ANNEX I B. Road Transport Demand and Diesel Prices 4. It is estimated that the transport sector in Mexico represents about 27% of commercial energy consumption and about 50% of domestic petroleum product consumption, which is equivalent to transport's share of energy and petroleum consumption in the U.S. (Table 2 of this Annex). Road transport represents about 97% of the sector's diesel and gasoline consumption and about 89% of all diesel consumption by the sector. 2/ Between 1974 and 1981, as fuel prices declined in real terms, fuel consumption, both diesel and gasoline, grew at about 10% per year, which is equal to the average rate of growth of traffic on the interurban highway network. Despite the substantial fuel price increases in 1982 and the beginning of the economic recession, traffic on the toll road network continued to increase by almost 9% (although down from 15% in 1981). 3/ 5. The elasticity of demand for gasoline for cars, with respect to the price of gasoline, is in the range from -0.04 to -0.40 based on data from a wide range of countries. 4/ In the particular case of Mexico, it is not possible to estimate this elasticity using time series data because of the lack of substantial increases in fuel prices until 1982 and the influence of other variables such as economic recession, toll rates, etc. As stated above, only in 1983 were there substantial increases in fuel prices, so that an indication of the implicit elasticity could be obtained only by relating the change in traffic in the toll roads in that year with the changes in the cost of using these roads, which, in turn, can be defined as being the toll rates plus vehicle operating costs (including fuel). The implicit elasticity of traffic to changes in fuel prices (gasoline and diesel) which result from that analysis is -0.08, which is well within the range mentioned above and is equivalent to an overall elasticity of traffic to changes in total transport costs of -0.77. 6. To bring diesel near to international price levels, an increase of 28% would be required, or an increase of about 3% in average truck costs. With the estimated elasticity of -0.08 (para 5), this would result in a 2% decline in truck traffic, or an average 1% decline in overall traffic, which would not affect road congestion or investment priorities, because normal traffic growth would compensate for such losses within a period of six months. C. Road versus Rail Modal Split 7. One concern is that low diesel prices would lead to underpriced road transport and divert traffic from the railways despite the comparative economic cost advantage of rail transport. A review of rail versus road 2/ Asociacion Mexicana de la Industria Automotriz, La Industria Automotriz de Mexico en Cifras, 1982, pp 30-31. 3/ See Tables 3.3 and 3.4 of the Appraisal Report. The focus in this paper is on the toll roads because these represent 1,000 km of the country's most highly traveled roads with detailed historic traffic counts. These roads are considered to be representative of what occurs on the rest of the network. 4/ World Bank, Energy and Transport in Developing Countries, Towards Achieving Greater Energy Efficiency, February 1983, page 14. -50- ANNEX 1 tariffs and costs, however, reveals that road tariffs are already more than 20% above rail tariffs for about 90% of all rail tonnage. Thus, rail already has a substantial tariff advantage for its major commodities. The remaining 10% of railway tonnage (about 5 million tons/year) is carried at tariffs which are much closer to those charged by truckers and mostly cover commodities classified as "industrial" products including sugar, fertilizers and automotive components. 5/ For sugar, the railways' share of transported tonnage declined from 50-54% in 1978 to 1981 to 42% in 1982. For fertilizers, the railways have steadily lost their share to road, declining from 58% in 1971 to 27% in 1982. Price, however, does not appear to be the major factor in this decline, with truck tariffs still 17% above rail tariffs, and, in the case of fertilizers, the railways began recovering traffic in 1983 despite the tariff increases. Similarly, for the other industrial commodities, the value per ton is higher than average for most rail tonnage and less sensitive to tariff changes which hardly influence final product prices. Railway marketing studies point to the sensitivity of these commodities to the quality of service more than any other factor. Thus, a 28% increase in diesel prices, which would raise the relative price of trucks over railways by about 1.5% (taking into account the increase in rail costs and tariffs due to diesel), should not, in itself, enhance the railway market significantly. However, in the medium term, a combination of increased fuel prices and road user taxes, along with improved railway service, should be encouraged in order to help capture a larger share of Long distance industrial commodity movements. D. Construction Techniques 8. The Government spends about US$75 million per year for the construction of rural roads throughout the country. It began as a labor-intensive works program, but, by the late 1970s and early 1980s, it shifted from force-account labor-intensive works to contracted equipment-based construction. With the recession, the feasibility of labor- intensive works has increased, and the question arises whether contractors, with cheap fuel prices, inappropriately favor equipment over labor. A recent review of the comparative cost of labor-based versus equipment-based methods showed that labor-based methods are now financially and economically competitive with equipment-based methods for rural roads under certain terrain conditions and where underemployed labor is available. However, contractors still favor equipment-based methods for reasons which will not be overcome by raising diesel prices. 6/ The two major reasons are that the contractors already own the equipment and must pay off related debt whether or not they use it and, second, they lack the flexibility to organize work schedules around labor's seasonal planting and harvest requirements, which is essential to attracting underemployed labor to such works. A 28% increase in diesel prices will raise equipment-based construction costs by only 3%, not enough to alter contractor preferences. Thus, the Government directly selects those works which are appropriate for labor-intensive construction and carries out such works by force account. 5/ The railway tariffs for these commodities are virtually all above railway variable costs including capital cost of rolling stock, locomotives, a percentage of track costs and interest. 6/ Mexico, Rural Roads Sector Report, Chiapas Case Study, January 27, 1984. -51- ANNEX 1 Table 1 MEXICO SECOND HIGHWAY SECTOR PROJECT History of Fuel Prices P R I C E S 1/ Mex$ per Liter (April) 1974 1977 1981 1982 1983 1984 Current Prices Gasoline Nova 2.10 2.80 2.80 10.00 30.00 40.00 Gasoline Extra 3.00 4.00 7.00 15.00 41.00 54.00 Diesel 0.45 0.65 1.17 4.00 19.00 26.00 Constant Prices 2/ Gasoline Nova 4.24 3.29 1.47 2.63 4.39 5.00 Gasoline Extra 6.06 4.70 3.66 3.95 5.99 6.75 Diesel 0.91 0.76 0.61 1.05 2.78 3.25 Exchange Rate (Mex$/US$) 12.5 22.5 25.0 70.0 150.0 157.0 1/ As of end of the year. 2/ Applying end year consumer price index (CPI) with 1978 as base year, except for 1984 which incorporates the cumulative change in the CPI for January through March. Source: SHCP and World Bank April 1984 -52- ANNEX 1 Table 2 MEXICO SECOND HIGHWAY SECTOR PROJECT Energy Consumed by the Transport Sector 1977 Percent of Total Percent of Total Commercial Energy Petroleum Product Consumed by the Consumed by the Country Transport Sector Transport Sector Kenya 56 60 Sri Lanka 51 56 Nigeria 41 46 Venezuela 39 74 Argentina 38 55 Brazil 38 47 Peru 38 46 Thailand 35 71 Colombia 32 54 Indonesia 32 35 Nepal 32 55 Malawi 29 55 Mexico 27 50 India 26 42 Egypt 19 22 Pakistan 18 39 Algeria 16 25 Bangladesh 15 28 Korea 11 18 U.S.A. 26 54 EEC 15 26 Sources:- "Workshop on Energy Data of Developing Countries." International Energy Agency, December 1978. - Bank Appraisal Reports - Energy Assessment Reports - For Korea - 1980 figures What links these two relations is the high dependence of developing countries on petroleum for their commercial energy (Table 2). -53- ANNEX 2 MEXICO SECOND HIGHWAY SECTOR PROJECT Financial Performance of the Toll Road Authority A. Tariffs 1. The tariffs charged on vehicles using CyPF's toll roads and bridges were unchanged between 1960 and 1974. Although tolls were raised in 1975, 1976 and 1977, there was a gap in 1978 and 1979. However, rising costs forced increases in the following years (about 10-15% in 1980 and 1981 and 20-40% in 1982) which, until 1983, were still not sufficient to halt the decline in CyPF's ability to finance all operating, maintenance and financial costs. 2. In 1983, there were across-the-board increases of 200% in January, followed by 40% in May and again in September. Different rates are charged for motorcycles, autos, panel and pick-up trucks, autos pulling trailers, buses and trucks, with rates increasing with the number of axles. Rates vary with road sections and bridges, and with day of week. 3. The basis on which individual rates have been set is not clear; overall levels have probably been determined on the basis of achieving financial objectives, in particular that CyPF be financially viable. B. Operating Results 1978-1982 4. Revenues from operating its toll roads and bridges enabled CyPF to earn annual net incomes until 1981 and 1982. Road and bridge toll revenues have always more than covered full operating, maintenance and administration costs, including depreciation and, until 1981, loan interest costs. Table 1 of this annex gives a breakdown for the years 1979-1982, over toll roads and bridges, of revenues and the major expense categories. Because of CyPF's depreciation policy, bridges bear a much greater depreciation burden than roads. However, since road construction was financed by foreign loans to a much greater extent than were bridges and, consequently, the book value of roads has been increased by the effect of currency devaluation to a much greater extent than that of bridges, the burden of loan interest, which has been apportioned on the basis of fixed asset values, is much greater for the toll roads. Administration costs have been apportioned on the basis of total working costs for each activity. The overall net results are shown on the next page. 1/ Actually, there was a small net loss in 1979, due to the loss on ferry operations (now discontinued). -54- ANNEX 2 Summary Toll Road and Bridge Operating Accounts 1979 1980 1981 1982 (Mex$ Millions) Toll Roads Total Revenues 1445 1605 1967 2722 Total Costs 1103 1516 2348 3878 Net Income (Loss) 342 89 (381) (1156) Toll Bridges Total Revenues 295 371 456 567 Total Costs 189 265 440 1175 Net Income (Loss) 106 106 16 (608) The main reasons for the declining results in 1981 and 1982 are: (a) inadequate tariff action to counter the rapid rise in cost levels; and (b) the rise in loan interest caused by local currency devaluation. 5. Other activities carried out by CyPF include gasoline sales at stations either owned or leased by CyPF; sales of asphalt, paints and other materials; and the hire of maintenance equipment. Rents are also received from commercial property owned by CyPF. The operation of gasoline stations has consistently resulted in losses. CyPF's position is that their expenses are higher than those of comparable commercial gas stations in that: (a) CyPF provides a full 24-hour service; (b) as required by union rules, each eight-hour shift is fully manned, even though sales during the night are low; and (c) CyPF has to pay union rates - higher than those paid by most commercial stations. The response to a suggestion that CyPF cease to operate the stations, and either sell or lease them on a franchise basis, was that the service to the public would very likely deteriorate, and that it was CyPF's responsibility to ensure that the toll road customers could always get gasoline. CyPF also cited difficulties in disposing of surplus staff if the operation were terminated. The other activities generally earn net revenues, except for sale of paints in 1982. 6. One measure of operational efficiency is the estimation of toll collection costs as a percentage of toll revenues for specific roads. Taking into account toll increases in 1983, the average for the CyPF system is about 7%, which is well below the internationally accepted rule of thumb of 10-15%. However, the percentage varies significantly and, for five roads, is greater than 15% (Table 2 of this annex), suggesting that CyPF should explore ways of reducing collection costs on such roads or consider the elimination of tolls when the percentage reaches extreme proportions. The Government will keep the Bank informed, on an annual basis, regarding the toll collection cost index and will study alternatives which would reduce that percentage on roads with unacceptably high indices. C. Financial Position 7. Summary, audited, balance sheets as of December 31, 1979-1982 (Table 3 of this annex) illustrate the rapid deterioration of CyPF's finances and the erosion of its equity. Equity, as a result of the losses in 1980 and 1981, has become a negative figure, and CyPF has only been able to maintain -55- ANNEX 2 its current assets at a reasonable figure, sufficient to cover payables and accruals, by delaying reimbursement of debt service. While the net value of fixed assets rose from Mex$ 6.5 billion in 1979 to Mex$ 17.7 billion in 1982, long-term debt has risen from Mex$ 4 billion to Mex$ 11.5 billion and the short-term portion of long-term debt increased from Mex$ 1.2 billion to Mex$ 6.4 billion. If CyPF had revalued its fixed assets to reflect replacement costs instead of merely adjusting the foreign financed element of costs in line with currency devaluation, the addition of the resulting revaluation surplus to equity would have restored the latter account to a more healthy balance. In addition, of course, future operating results should be improved with the aid of more timely tariff increases. D. Future Financial Outlook 8. CyPFts operational performance improved considerably in 1983 because of the tariff increases of about 200% in January, 40% in May and a further 40% in September. Preliminary unaudited figures, summarized in Table 4 of this annex, show total annual revenues for 1983 of Mex$ 12.9 billion, with net operating revenues of Mex$ 7.6 billion, and a net income, after loan interest, of Mex$ 4.65 billion. This very satisfactory result indicates a times-interest-earned ratio of 2.6, debt service coverage of 1.3 times, and a return on net fixed assets of 33%. This latter ratio overstates the position due to the undervaluing of fixed assets. With only Mex$ 382 million being spent on capital investment, the increased cash generation resulted in working capital being improved, although still not satisfactory, with current and liquid ratios of 1/1.5 and 1/1.6 respectively. 9. Projections for the years 1984-1987 have been based on estimates made by CyPF. 2/ The increase of 30% in toll rates, effective on February 1, 1984, has been taken into account, but the forecasts exclude any provisions for further inflation or for further devaluation of the Mexican Peso, other than assuming an average exchange rate of Mex$ 176/US$1.00. The results of these forecasts are that annual net income would rise from about Mex$ 4,650 million in 1983 to about Mex$ 22,100 million in 1987. Times interest earned would improve from 2.6 times in 1983 to 8.4 times in 1987. The debt service coverage ratios given in Table 4 overstate the position because of a moratorium on loan repayments. The return on average net fixed assets rises from 33% to 79% in 1985, falling to 65% in 1987 as the project assets come into operation. These figures overstate the position, because of the fixed assets being undervalued. CyPF intends to spend, on average, about Mex$ 3,700 million annually to make up for deferred maintenance on roads and bridges. These amounts are shown in Table 4 and reduce the net annual surpluses accordingly. 10. Table 5 of this annex shows the forecast summary annual cash flows over the period 1983-1987. Annual expenditure on CyPF's portion of the proposed project is estimated at Mex$ 2,350 million in 1984, and Mex$ 5,600 million in each of the years 1985-1987. These costs will be financed by CyPF. 2/ The assumptions applied are described in a report in the Project Files (Annex 8). -56- ANNEX 2 11. Since CyPF's cash generation in the early part of 1983 was not sufficient to cover debt service and other requirements, the cash shortfall was subsidized by the Government. However, later in the year, the situation improved because of tariff increases, and CyPF's working captial increased accordingly. In subsequent years, cash generation, together with accumulated cash balances, will be sufficient to cover debt service and investment needs, with resulting annual cash balances rising from about Mex$ 230 million at the end of 1983, to over Mex$ 30,400 million at the end of 1987. Since CyPF's revenues are regarded as Government revenues, these large funds will obviously be taken as public funds. 12. Forecast balance sheets, given in Table 6 of this annex, are summarized below. 1983 1984 1985 1986 1987
Группа Всемирного банка · Staff Appraisal Report
Mexico - Second Highway Sector Project
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