El Salvador - Second Rio Lempa Hydroelectric Project

R E S T R I C.T E D Report No. P-188 FILE Gur T This report was prepared for use within the Bank. In making it available to others, the Bank assumes no responsibility to them for the accuracy or completeness of the information contained herein. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATIONS OF T HE PRESIDENT- TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE COMISION EJECUTIVA HIDROELECTRICA DEL RIO LEMPA (CEL) OF EL SALVADOR February 12, 1959   INTERNATIONAL BANK FOR RECONSTRUJCTION AND DEVELOPMENT REPORT AND RECONMNENDATIONS OF THE PRESIDENT TO THE EXECUTIVE DIRfECTORS OPJ A PROPOSED LOAN TO THE COljTISION EJECUTVA HIDROELECTRICA DEL RIO LEMPA (CEL) OF EL SALVADOR 1. I submit the following report and recomrmendations on a proposed loan in an amount in various currencies equivalent to $3e0 million to the Comision Ejecutiva Hidroelectrica del Rio Lempa (CEL) to help finance the addition of a 15 M1W generating unit at its Guayabo plant and the expansion of its transmission system. PART I - HISTORICAL 2. A loan of $12.5h5 million (22 ES) was made to CEL in 1949 to help finance the construction of the Guayabo hydroelectric plant on the Rio Lempa with an initial installation of 30 WM. In 1957, CEL installed, with its own funds, a third 15 YiW generating unit and built a regulatory dam at the outflow of Lake Guija on the Rio Desague, which is a tributary of the Rio Lempa in its upper watershed. Later in 1957, CEL initiated studies for the installation of a fourth 15 NW unit and for the expansion of its transmission system. These studies were completed in the Spring of 1958. 3. A Bank mission visited El Salvador in July 1958 to appraise the proposed project. The mission concluded that the project was technically feasible and economically justified. 4. Negotiations for the proposed loan began on January 8, 1959 in Washington. The Government was represented by His Excellency Dr. Hector David Castro, Ambassador of El Salvador to the United States, and CEL was represented by Messrs. Roberto Parker and Atilio Garcia Prieto, members of CEL's Board, Mr. Enrique Lima, CEL's Man- aging Director, and Mr. Jorge Sol, adviser to CEL. 5. If the proposed loan were made, it would increase the total amount of Bank loans in El Salvador to $310645 million equivalent. The Bank has already made the following loans to El Salvador:  -2- (Equivalent in $ million) No. Borrower Purpose Amount 22 ES Comision Ejecutiva Hidro- Rio Lempa Power electrica del Rio Lempa Project (CEL) 'pl2, 545, o0o 104 ES Republic of El Salvador Coastal Highway Project 11,100,000 216 ES Republic of El Salvador Feeder Road Pro- gram and Complementary /1 Projects 5,coo,0oo_- 28,645,OO Of which has been repaid . . . . . . . . . . . 1,h95,000 Total now outstanding . . . r * . * * . 27,150,000 Amount sold . w. .. . . . . .$'1,550,000 Of which has been repaid. . . 1,000,000 550,000 Net amount now held by Bank a .. m .. . .. .. 126,600,o0o PART II - DESCRIPTION OF THE PROPOSED LOAN 6. The proposed loan would have the following characteristics: Purnose The loan would help finance the foreign exchange costs of: (a) the installation of a fourth turbo- generator unit of 15 I'i capacity at the Guayabo hydroelectric plant; (b) construction of a new 115 KV trans- mission line from San Salvador to Santa Ana, a distance of about 60 kilometers. As a necessary adjunct to the project, CEL will seal leakage from Lake Guija by means of an earth dike and grout curtain and complete the lake outlet channel to permit greater utilization of the storage within the lake. /1 This loan is not yet effective.  - 3 - Borrower Comision Ejecutiva Hidroelectrica del Rio Lempa (GEL). Guarantor The Republic of El Salvador. Amount The equivalent in various currencies of $3.0 million. Amortization 45 semi-annual instalments, January 1962 to January 1984. Interest Rate 5 3/4 per cent. Commitment Charge 3/4 of 1 per cent per annum. P ment Dates January 15 and July 15. PART III - LEGAL INSTRUMENTS AND LEGAL AUTHORITY 7. A draft Loan Agreement between CEL and the Bank (No. l)and a draft Guarantee Agreement between the Republic of El Salvador and the Bank (No. 2) are attached. Both are in substantially the same form as those usually entered into by the Bank. 8. Also attached are letters from CEL and the Republic of El Salvador to the Bank (Nos. 3 and 4 respectively) and a letter from the Bank to CEL and to the Republic of El Salvador (No. 5). The provisions of special interest in both the letters and the loan documents relate to the financial position of CEL and are discussed in paragraphs 14 through 19 below. 9. Legislation has been passed authorizing CEL to borrow and the Government to guarantee the loan. Under Salvadorean law, the loan documents must also be ratified by the Salvadorean Legislature. 10. The report of the Comrittee provided for in Article III Section 4 (iii) of the Articles of Agreement of the Bank is attached (No. 6). PART IV - APPRAISAL OF THE PROPOSED LOAN Justification of the Project 11. A detailed appraisal of the project (TO-196a) is attached (No. 7). 12. El Salvador is a small but densely populated country, predom- inantly agricultural and heavily dependent upon coffee which accounts for more than 80% of exports. The availability of electric energy  since the Guayabo plant came into operation in 1954 has been an import- ant factor in stimulating a rapid growth, particularly in industry, which has helped to diversify and strengthen El Salvador's economic position. 13, In the past years, the demand for electricity has been increas- ing at an average rate of almost 15% a year. The future annual rate of increase is estimated at 12% and the capacity of existing facilities will be absorbed by 1961. Additional power capacity must be provided if El Salvador is to continue to develop its economy. The installation of a fourth unit in the existing Guayabo plant is the most efficient way of providing 15 MW of additional capacity which will be absorbed by 1963. CEL's Financial Position 14. It was only to be expected that CEL would incur an operating deficit during an initial period required to permit the load on the system to develop. However, due to inadequate rate policies, this deficit has been of a greater size and a longer duration than it would have been if rates had initially been set at a satisfactory level. Only in 1958 has CEL began to earn a profit; meanwhile, the accumu- lated deficit, after depreciation and interest, has reached A4.4 million. In order to achieve a sound financial position, CEL has de- cided to increase power rates. 15. In Section 5.08 of the Loan Agreement, CEL covenants that it will take all necessary action to earn revenues sufficient to cover operating expenses, repayments on long-term debt and to have a surplus for financing a reasonable portion of planned expansion. The Govern- ment, which under Salvadorean law approves CELts rates, covenants under Section 3.06 of the Guarantee Agreement that it will permit CEL to earn such revenues. 16. In letters to the Bank (Nos. 3 and 4) CEL and the Government agree that, to obtain the revenues mentioned in the foregoing para- graph, CEL's rate of return on net fixed assets should be at least 8% under present circumstances. CEL also agrees that in renegotiating its present power distribution contract with the Compania de Alumbrado Electrico de San Salvador (CAESS), which will expire on December 31, 1959, it will obtain a substantial increase in the average rate to that company. As a result, the return on net fixed assets is expected to be in excess of 8.0% in 1960 and to reach about 9.0% by 1965. This should enable CEL to finance about 23% of its future construction program from retained earnings. 17. Section 5.09 of the proposed Loan Agreement provides that CEL shall not incur a debt maturing in more than one year unless its net revenues, with certain adjustments, are at least 1.5 times the max- imum debt service on all of its debt, including the debt to be incurred. Pursuant to the first loan agreement between CEL and the  - 5 - Bank dated December 14, 1949 (Loan 22 ES), CEL could not, with certain exceptions, incur any long-term debt without the Bank's approval. In view of the experience which the Bank has had with CEL, this require- ment now seems too rigid. In a letter to CEL and to the Republic of El Salvador (No. 5), the Bank agrees that CEL need not obtain the Bank's approval on new debt under the 1949 loan agreement so long as it complies with Secticn 5.09 of the proposed Agreement. 18. A substantial part of CEL's capitalization consists of Govern- ment contributions in the form of loans which are interest-free, have no fixed dates of repayment, and rank junior to all other obligations of CEL. These contributions are virtually equivalent to equity. However, if they are considered debt, the very small equity in CEL would be more than offset by the accumulated deficit. 19. The Government has agreed that it will convert into equity all of its contributions to CEL, including those which, under existing laws, are to be made between now and 1967. Section 7.01 of the pro- posed Loan Agreement provides that the agreement will not become effective until all corporate and governmental action shall have been taken to effect that conversion. Assuming this is done, CEL's debt/equity ratio is expected to be about 73/27 by the end of 1959 and would gradually improve and become about 6V/36 in 1965 (after allowing for additional borrowings to finance planned expansion). Arrangements for Financing 20. The total cost of the project is estimated at the equivalent of $6.531 million. The foreign currency requirements, amounting to the equivalent of $4h715 million would be covered partly by the pro- posed Bank loan and partly by CEL's earnings and Government contrib- utions. The local currency requirements will be met by a /5-million loan from the Government. Procurement 21. The procedures followed by CEL in procuring equipment have been in line with sound utility practice. All major pieces of equip- ment for the project are expected to be procured through international competitive bidding. HOwever, exception may be made for some items like electrical switchgear and controls where standardization of equip- ment is important. CEL's Management 22. CEL's organization is on the whole sound and its management well qualified. It has talken steps to ensure the adequate execution and operation of the project, including the retention of an experienced engineering firm to design and supervise construction. CEL also plans to engage outside experts to assist in strengthening the organization of its accounting department and improving its accounting system.  - 6- International Aspects of the Project 23. As part of the project, CEL will seal leakage and deepen the discharge channel from Lake Guija -- three-tenths of the surface of which is located in Guatemala. These works are entirely in Salva- dorean territory. The control works at Lake Guija were constructed by CEL follow7ing receipt of a letter w-ritten in 1952 to the President of El Salvador by the President of Guatemala, stating in effect that Guatemala had no objection. Econcmi c Situation 24. A review of recent economic developments in El Salvador was contained in my report to you (R 58-141) which was considered at the meeting of the Executive Directors held on January 6 last, No sig:i- ficant changes have taken place in the Salvadorean economy since then. Prospects of Fulfillment of Obligations 25. CEL's management is experienced and has made the necessary ar- rangements to ensure the successful execution of the project. Satisfactory arrangements have also been made for financing the ccsts of the project not covered by the loan. As indicated in the paragraphs relating to CEL's financial position, it is reasonable to expect that CEL will have suff-Lcient earnings to service the proposed loan. 8or- vice of El Salvador's external debt, including the proposed loan, would be lao and, at its peak, would not exceed 4 to 5% of prospective export earnings. El Salvador should be able to provide the foreign exchange needed to meet payments on the proposed loan in addition to its exist- ing debt. PART V - COMPLIANCE WITHT ARTICLES OF AGREEMENT 26. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank. PART VI - RECONNENDATIONS 27. I recommend that the Bank make a loan to the Comision Ejecutiva Hidroelectrica del Rio Lempa with the guarantee of the Republic of El Salvador in an amount in various currencies e quivalent to $3.0 mil- lion with interest (including commission) at 5 3/4% per annum and on such other terms as are specified in the attached draft Loan and Guarantee Agreements and that the Executive Directors adopt a Resolu- tion to that effect in the form attached (No. 8). W. A. B. Iliff, Vice President for Eugene R. Black President Washington, D. C.