Colombia - Fourth Bogota Water Supply and Sewerage Project

Document of The World Bank FOR OMCIAL USE ONLY Repot No. P-3966 REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE IKNERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN IN AN AMOUNT EQUIVALENT TO USt129 MILLION TO EMPRESA DE ACUEDUCTO & ALCANT&RILLADO DE BOGOTA WITH THE GUARANTEE OF THE REPUBLIC OF COLOMBIA FOR A FOURTH BOGOTA WATER SUPPLY AND SEWERAGE PROJECT March 14, 1985 his d_cumeat hs a restricted distribution and my be used by recipiats dy in the perfommnce of tb effie dutie Its coateos may not otherwise be disdosed without Wodd Bnk usirimadzon.  CURRENCY EQUIVALENTS Currency Unit n Colombian Peso (Col$) Col$101.8 - US$1.00 (1984 average) Col$115.31 - US$1.00 (exchange rate effective Jan. 21, 1985) Col$1 - US$0.0087 (exchange rate effective Jan. 21, 1985) . WEIGHTS AND MEASURES Metric System FISCAL YEAR January 1 to December 31  FOI OFFIAL USE. ONLY GLOSSARY OF ABBREVIATIONS BCR Banco Central Bipotecario (Central Mortgage Bank) CAR Corporacion Autonoma Regional de la Sabana de Bogota y de lo0 Valles de Ubate y Chiquinquira (Regional Bogota Plains Autonomous Corporation) DANE Departamento Administrativo Nacional de Estadistica (National Bureau of Statistics) DNP Oepartamento Nacional de Planeacion (National Planning Department) EAAB Empresa de Acueducto y Alcantarillado de Bogota (Bogota Water and Sewerage Company) EEEB Empresa de Energia Electrica de Bogota (Bogota Electric Energy Company) EMPOS Empresa de Obras Sanitarias (Sanitation Works Company) EPM Empresa Publicas Municipales (Municipal Public Works Company) FVDU Fondo Financiero de Desarrollo Urbano (Fund for Urban Development) INCOMEX Instituto de Comercio Exterior (Institute of External Comerce) INAS Instituto Nacional de Salud (National IAstitute of Health) INSFOPAL Instituto Nacional de Fomento Municipal (National Institute of Urban Development) JNT Junta Nacional de Tarifas (National Tariff Board) MSP Ministerio de Salud Publica (Ministry of Public Health) This document has a restricted distribuuion and may be used by recpienus only in the performance of their official duties. Its contents may not otherwis be disclosed without World Bank: authorintion.  COLOMBIA FOURTH BOGOTA WATER SUPPLY AND SEWERAGE PROJECT Loan and Project Summary Borrower: Empresa de Acueducto y Alcantarillado de Bogota (EAAB) Guarantor: Republic of Colombia Amount: US$129.0 million equivalent Terms: 17 years, including 5 years grace (para. 40), at the standard variable interest rate. Project Description: The proposed project would continue the Bank's past efforts to provide essential water supply and sewerage infrastructure for Bogota. It would consist of (a) construction of a major water transmission tunnel and main; (b) primary water distribution system reinforcements; (c) water distribution System rehabilitation; (d) additions to water, sewage and drainage networks for low-income neighborhoods; (e) a reservoir for untreated raw water storage; (f) metered house connections; (g) tecbnical assistance for the institutional improvement of EAAB; and (h) implementation planning for a project to control flooding and pollution of the Bogota River. The project would enable EAAB to utilize in full existing water production capacity constructed under previous Bank financed projects. It is expected that approximately 2.1 million persons would benefit from the project by 1992, of which about 54Z would be the urbar; poor. Risks: To finance the proposed project, EAAB vill have to secure suppliers' credits, to contain its costs (especially personnel), and to raise its tariffs by 152 in real terms by the end of 1989. Because the availability of suppliers' credits can not be assured in advance of bidding for the equipment to be financed, there is some risk of delay in the implementation of the project. Delays in taking actions to control the costs and to rain.e the tariffs may adversely affect EAAB's financial position and the project financing. However, EAAB is atI experienced borrower, having successfully implemented a larger and  more complicated project than the preanat one under Bank loan No. 741-Co. Contingent Bank financing for bigh priority pipeas ha. also been provided for, particularly in view of cur=ent uncertalnties in mobilizing ezt -il resources, in tha avant that appropriate co-. nanclng cannot be obtained for this item. Estimated Cost: Local Foreign Total -- - - USS Million - - - - Primary water distribution 42.9 49.6 92.5 Distribution rehabilitation 8.1 6.9 15.0 Secondary netwrorks 13.6 22.6 36.2 Emrgency storage 17.7 22.3 40.0 Rio Bogota project i2plentat4an study 1.1 1.0 2.1 Imsticutional iaprovement oi zAAB 2.5 13.2 15.7 Engineering and administration 20.8 5.8 26.6 ase Cost 106.7 121.4 228.1 Physical continjencies 7.8 9.3 17.1 Price continbgncies 22.7 48.0 70.7 Total Project Cost 137.2 -178.7 315.9 Capitalized Interest - 37.6 37.6 Total Financing Required 137.2 216.3 353.5 Financing Plan: ZBRD loan - 129.0 1 29.0 Suppliers' credits - 42.5 42.5 Comercial bank loans - 7.5 7.5 EAAB's internal cash generation and customer contributions 117.2 37.3 154.5 Otherj/ 20.0 - 20.0 Total Financing 137.2 216.3 353.5 Disbursements: Bank Fiscal Year 1986 1987 1988 1989 1990 1991 1992 1993 --S- - -USS million Annual 22.5 20.1 22.6 22.7 20.7 13.8 5.9 0.7 Cumulative 22.5 42.6 65.2 87.9 108.6 122.4 128.3 129.0 Rate of Return: About 13S (for project components which account for about 922 of the total project coSt). ApPraisal Report: Report No. 5278-CO, datad February 28, 1985. / Including contrIbution by the Bogota Electric Company (SE3B) for construction of the ozmrpgncy wLter storap component (parm. 48).  INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO EMPRESA DE ACUEDUCTO Y ALCANTARILLADO DE BOGOTA WITH THE GUARANTEE OF THE REPUBLIC OF COLOMBIA FOR A FOURTH BOGOTA WATER SUPPLY AND SEWERAGE PROJECT 1. I submit the following report and reco_mendation on a proposed loan to Empresa de Acueducto y Alcantarillado de Bogota, with the guarantee of the Republic of Colombia, for the equivalent of US$129 million to help finance a Fourth Bogota Water Supply and Sewerage Project. The loan would have a term of 17 years, including 5 years of grace, with interest at the Bank's standard variable rate. PART I - THE ECONOMY 2. An economic mission visited Colombia in July 1982 and its report (4444-CO) was distributed to the Executive Directors in August 1983. A mission to review the external sector and agriculture visited Colombia during April/May 1983, and its report (4981-CO) was distributed to the Executive Directors in April 1984. Country data sheets are presented in Annex I. Background 3. The Colombian economy has made considerable progress since the early 1950s. From a largely rural and agricultural base, the economy has evolved into one that is more integrated with a greater urban-industrial and services orientation today. The growing economic activity, rapid rural-urban migration, together with the increased participation of women in the labor force and expanded public services, has been instrumental in reducing poverty and improving income distribution over time. Financial and capital markets have evolved pari-passu with the growing needs of the economy, and the v country has become an active participant in international capital markets. The state enterprises are few, follow adequate pricing policies, and many have some form of private sector participation. The country's energy balance has been changing in recent years and the country is expected to become a net petroleum exporter in 1986 and to increasingly become an exporter of thermal coal. 4. In the 1950s and early 1960s, development policy favored import substitution supported by high tariff protection. By the mid-1960s, the prospects for further import substitution were substantially reduced, and the country was confronted with great economic uncertainty, arising from the fact that economic activity and the balance of payments were heavily influenced by developments in the world coffee market. In order to ease this constraint, beginning in 1967 the authorities adopted an outward-looking development strategy, expanding and  -2- diversifying exports. Export promotion policies, in:luding fruquent small devaluationu, export tax rebates and other incentives were introduced and the authorities begau lowering tariffa somewhat and relaxing capital markets controls as a moans of raising efficiency and increasing the profitability and competitiveness of Colombian goods in external markets. These measures were highly successful in relieving the foreign exchange constraint and stimulating growth and employment. However, by 1974 the economy waS once again experiencing difficulties caused primarily by the world recession and by excessive Central Bank financing of the Central Government's deficit. A. Colombia's Economic Performance During the 1970'. 5. In late 1974, the Government introduced a wide range of measures designed to correct the structural and policy weaknesses prevailing in the economy at that time. Before these reforms were fully offecdlve, the economy was subjected to strong inflationary pressures arising from a sharp increase in world coffee prices. The increased receipts from coffee exports., together with some official surrender of foreign exchange from illegal exports, caused a turnabout in the balance of payments. Incomes rose rapidly and stimulated aggregate demand; inflation accelerated. Economic growth also accelerated, and unemployment fell substantially, both in rural and urban areas. Largely as a consequence of increased coffee tax revenues, the public finances gene- rated overall surpluses averaging about 1Z of GDP during the 1976-78 period and, by the end of 1979, net official internat4onal reserves had risen to about US$4.1 billion, equivalent to about 1Z months imports of goods and non-factor services. 6. While beneficial in many respects, the foreign exchange boom had a somewhat negative impact on the evelucion of the economy. The rate of currency devaluation was slowed and the conversion of export receipts into pesos was delayed to moderate the growth of domestic demand, with adverse effects on export expansion and diversification. Also, the Government sought to control inflation by maintaining high reserve requirements and expand controls over credit thereby reducing, in real terms, the financing available to the private sector via the official capital market. 7. The 1977-79 economic program was partially successful in restraining aggregate demand growth, but relatively high inflation persisted. In response to the effects of the increasing restraint on aggregate demand and the troublesome financial market distortions, the authorities began in late 1979 to adjust the program. The rate of peso devaluation was advanced somewhat and in early 1980, credit restraints were relaxed. At the same time, interest rates on certificates of deposit-and on lending therefromr-were freed from controls. To offset the inflationary effects of these measures, the authorities further liberalized import payments and adopted the policy of.not expanding the subsidized selective credit operations of the Central Bank in excess of the resource captured from private savings for this purpose. The effects of the above measures were not immediately noticeable. Real GDP growth declined to 4Z in 1980 from an average of amost 6Y since 1960, unemployment started to creep up, and-inflationary pressures continued. B. Recent Economic Developments: the Early 1980s 8. In 1981 the economic situation took a turn for the worse and the problems continued through 1983. Real GDP growth which had decelerated to  -3- 2.5Z in 1981 fell to about 1Z on average in 1982 and 1983. Agricultural output was hard-hit as the production of cotton, oil seeds and other agricultural commodities dropped as a result of low international prices, reduced fertilizer use and adverse weather. Industrial activity deteriorated on account of depressed aggregate demand, and unutilized capacity continued to increase, particularly in manufacturing. As a result, unemployment reached almost 142 of the labor force at the end of the year, up from about 72 at the end of 1981. Inflation, however, slowed down in 1983 to a 20Z average for the year, down from 282 in 1981 and 252 in 1982. 9. After experiencing a surplus for six years, a deficit emerged in a the resource balance In 1981 of about USS1.5 billion, which increased on average to about US$2 billion in 1982-83. These deficits resulted mainly from a drop in exports by about 4Z annually in real terms: major reasons were the slowdown in world demand, a major devaluation and import restrictions in Venezuela-a major trading partner-in 1983, and the reduction in Colombia's coffee export quota in the International Coffee Agreement significantly below the 1981 coffee export level. Net foreign exchange reserves declined by about US$1.8 billion in 1983 to about US$3.1 billion, equivalent to about 6 months of imports of goods and non-factor services. On the fiscal side, a slowdown in revenue growth, together with increased current expenditures resulting from a system of automatic transfers and large infrastructure investments in energy and transport led to growing deficits: the overall Central Government cash deficit grew from 2.12 of GDP in 1980 to 3.7Z in 1983, while that of the consolidated public sector rose from 3.6Z to 6.5Z respectively. 10. In response to the deteriorating economic conditions, in 1983 the Government introduced policies to stimulate aggregate demand, expand and diversify non-coffee exports, and resume economic growth. The rate of peso devaluation was accelerated; the housing construction industry was provided with incentives to mobilize an increasing amount of resources; and selective credit operations to the productive se:tors were expanded. Temporary import restrictions were introduced to arrest the falling foreign exchange reserves, with a view to being lifted once the real exchange rate improved and exports responded to this incentive. The Government also adopted a series of measures to reduce the fiscal deficit and ease distortions and restrictions in the financial system. While the thrust of these measures was in the right direction, they were clearly insufficient to reverse the deteriorating trends. At the same time, the country began to be affected by the tight international capital market. Colombia, unlike other Latin American countries, has not had a debt problem because of the high share of concessional debt in total debt outstanding and the term structure of such debt. Nevertheless, a sharp reduction, over a very short period, in the credit lines available to Colombia, and reluctance to provide medium-term loans to complete ongoing projects, resulting from the overall debt problem of Latin America, has contributed to further declines in foreign exchange reserves and to strains in the financial system. 11. As a result of the Government's policy initiatives, a reversal of the deteriorating trends began to take place in 1984 with a resumption of growth in manufacturing and non-coffee agriculture and an expansion in exports. At the same time government policy focused on demand management and emphasized the approval of additional revenue and expenditure measures to contain the fiscal deficit and tighten monetary expansion. In parallel to these actiops, the Government accelerated the exchange rate devaluations further and  -4- increased incentives to exports, it also moved to improve the profitability of the commrcial banking system's operations and resolve the external debt problems of the private sector The policy reforms began co taka hold during the second half of 1984. As a result, real GDP growth Increased to 3.1X, the unemployeunt rate fell to 132 of the labor force at year's and while inflation was brought down to 16.4X on average. Export performance improved, with total merchandise exports growing at over 16Z in nominal terms compared to 1983; the current account deficit in the balance of payments was reduced by about US$1 billion to 5X of GDP. The losses in foreign exchange reserves, which had accelerated during the first half of 1984, were reduced during the second half of 1984 and reserves remained at about USS1.8 billion, equivalent to about 4 months of imports of goods and non-factor services. Additional fiscal measures were introduced towards the end of the year while the overall public sector deficit stabilized at an estimated 6.7X of GDP, still a high level. Current Development Strategy 12. The Government's strategy for accomplishlng its development objectives is set forth in the 1983-86 National Development Plan. This strategy emphasizes growth with equity with the purpose of expanding the benefits of development to Colombia's population. The strategy also places high priority on the resumption of growth while- maintaining price stability-- Thus the Government is reorienting its trade policies toward an outward-looking growth to take advantage of medium-term trade prospects. In addition, efficient programming of the public sector investments and rational pricing policies are to serve as instruments to support sound medium-term development. In the meantime short term stabilization requirements and continued medium-term adjusts nts have become necessary in view of the abovementioned aacroeconomic problems. A stabilization cum adjustment program has been initiated. Aspects of the program that have become explicit especially for 1985-86 are spelt out below. 13. Fiscal Policy. In addition to those in effect during 1984, the 1985-86 program includes new measures which were approved by Congress in December 1984 and which will be effective in 1985. These comprise additional measures to eliminate deductions in the income tax, a broader base for the value-added tax, an increase in stamp taxes and an additional temporary 8% import cax, which together should result in addicional ColS55.5 billion in revenues during 1985. Additional measures totalling ColS17 billion in revenue collections have been presented for Congress' approval. As regards to expenditures, in public sector salaries approved for 1985 mean a reduction by about 102 on average in real terms. Publlc sector subsidies in transport have been reduced and a scaling down of the investment program has begun. Additional expenditure measures, expected to be approved by Congress in April 1985 concern a significant slowing down in the rate of increase of Central Government transfers to local governments, streamlining of decentralized agencies and expenditure controls. The combijned effect of the revenue and expenditure policies is projected to significantly lower the overall cash deficit to ColS85 billion (less than 2Z of GDP) in 1985 and ColS8. billion (1.5Z of GDP) in 1986 from an estimated Col$139 billion (3.8Z of GDP) in 1984. The improvement in the Central Government's fiscal performance combined with the scaling down of the public investment program and real increases in revenues of public enterprises (in part as a result of tariff policy) is projected to lower the overall public sector deficic from an estimated 6.7% of GDP in 1984 to 4.2% in 1985 and 2.3% in 1986.  -5- 14. Investment Program. The scaling down of the investment program includes the postponement or cancellation of all new large scale power generation and a number of large transport projects. The revised program, which implies containing public sector investment to about 9.2X of GDP during 1985-86 compared to 10.52 during 1983-84, largely consists of projects which already are in execution or for which loans have been contracted. The investment program is dominated by the mining and power sectors. The mining investments of nearly US$ 2 billion include ECOPETROL's petroleum production and development program in association with foreign partners and CARBOCOL's engoing El Cerrejon Coal project; a joint venture with EXXON. Both would contribute to a significant increase in export earnings from 1987 onwards. The power sector investment program essentially comprises ongoing generation projects, msay of which are in an advanced stage of completion, and some new transmission and distribution schemes to utilize the additional capacity and reduce losses, and thus, to contribute to an improvement in the final performance of the power sector. 15. Monetary Policy. A case deficit of about Col$83 billion on average during 1985-86 will allow for a dramatic reduction in monetary financing to the public sector from the high 1984 level of about Col$150 billion. Central Bank financing of the deficit will be kept to about Col$35 billion during 1985-86 annually, rising modestly in nominal terms thereafter. This would permit the growth in total domestic credit from the Central Bank to be kept in line with the growth in nominal GDP during the period. Such an outcome would also be a critical element of the program during a time period when no major fall in reserves can be sustained, because it would reduce the pressure on the growth of the monetary base and thus of monetary expansion. With year-end levels of reserves at about US$1,800 million during 1985-86, a fiscal policy as discussed above and a moderate expansion of credit to the private sector, the growth in the monetary base can be kept to about 232 annually. With no significant changes in the money multiplier, the growth in money supply would also be of this magnitude, or in line with the expected growth of nominal GDP. 16. Exchange Rate Policy. After years of steady appreciation, the Colombian peso depreciated (i.e. improved) in real terms against the US dollar by a large margin during 1983-84. Given the rapid appreciation of the US dollar against other major currencies, however, the peso depreciation against a basket of relevant currencies was much more modest. Nevertheless, a trade weighted index indicates a gain of about 10Z in 1984 on average raising the index to about 83.5 compared to a mid-1970s base and further improvements are expected in 1985. 17. Import Policy. The persistence of external resource gaps during 1983-84 forced the Government to rely on quantitative restrictions. Mindful of the resource misallocation effects of quantitative restrictions, however, the Government intends to undertake their phased elimination, beginning with the removal of all import controls on inputs and intermediate goods for exports. In addition, average nominal tariff rates which were fairly stable during 1979-81, increased in 1983, and again substantially in 1984 including an increase in the dispersion. Though temporary, these developments will entail policy actions for a reduction of dispersion and levels in tariffs. 18. Foreign Borrowing Strategy. A critical assumption underpinning the foreign exchange reserve scenario concerns the stabilization of reserve levels. Major support for tradeables is expected to be obtained from exchange rate adjustments in 1985: medium term export and import projections indicate a steady decline in the current account deficit. A significant reversal in capital inflows  ia also required: even with the reduction in the current account deficit, p,tonn disburse.ents from newly committed and already *i8ned commercial bank financing of about US$580 million (a 1180235 million increase or leos than a 42 increase in net exposure for the co _m rial banks) for project financing will be needed to stabilize reserves in 1985. 19. The projected pattern of gross disbursements indicates an increasing dependence in relative terms on official sources of finance (multilateral institutions, bilateral development agencies and export credic agencies) in recognition of the country exposure constraints with external comercial bank.. More than half of the new commitments and disbursements during 1985-86, inelWding the additional commercial bank resources requested, would be for the productive sectors. In order to support the expansion of the trade sector, it is also estimated that the country will require mainte- nance of its short-term credit lines available from its major external bank creditors to levels prevailing at the end of 1984, roughly US$1.5 billion. This should be possible within the authorized levels of exposure of external commercial banks in Colombia. Growth and Balance of Payments Prospects 20. Given the country's successful implementation of the medium-term adjustirnt program during 1985-86, Colombia's growth prospects for the rest of the decade are reasonably good. Because of the significant stabilization and structural adjustment meaures being undertaken to restore the country's international compstitiveness, the current account deficit of the balance of payments is projected to average US$1.3 billion per year during 1985-06, equivalent to about 3.62 of GDP. The deficit is projected to be financed by increasing disburae..nts of existing and projected public and publicly guaranteed and private sector loans and by direct foreign investment. By rhe end of this period, net official international reserves would have been maintained at a level of about four months of imports of goods and non-factor services (a level which is adequate for Colombia). This should be suFi