Mexico - Solid Waste Management Pilot Project

Domm of The World Bank FOR OMCAuL USE ONLY / ,<j Q(cG 9_ xe-C R3"t N.. P-4247-ME REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN IN AN AMOUNT EQUIVALENT TO USS25 MILLION TO BANCO NACIONAL DE OBRAS Y SERVICIOS PUBLICOS, S.N.C., I.B.D. WITH THE GUARANTEE OF UNITED MEXICAN STATES FOR A SOLID WASTE MANAGEMENT PILOT PROJECT March 5, 1986 This document has a restricted distribution and may be used by recipients on!y in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  Currency Unit - Peso (Mex$) On February 24, 1986, the exchange rate in the controlled market was UeSl = Mex$431.80; the freemarket exchange rate stood at USS1 Mex$470.00. Fiscal Year January I - December 31 ABBREVIATIONS BANOBRAS - Banco Nacional de Obras y Servicios Publicos (National Bank for Public Works and Services) CUD - Convenio Unico de Desarrollo (Special Development Agreement) DGPCCA - Direccion General de Prevencion y Control de Contaminacion Ambiental (General Directorate for Prevention and Control of Environmental Contamination) EFF - Extended Fund Facility FIFAPA - Fondo de Inversiones Financieras para Agua Potable y Alcanta- rillado (Investments Fund for Water Supply and Sewerage Works) FORTAMUN - Programa de Fortalecimiento Municipal (Program for the Strengthening of Municipalities) GIRA - General Interest Rate Agreement GOM - Government of Mexico MDF - Municipal Development Fund MSP - Municipal Strengthening Project QRs - Quantitative Restrictions SEDUE - Secretaria de Desarrollo Urbano y Ecologia (Secretariat of Urban Development and Ecology) SG - Secretaria de Gobernacion (Secretariat of the Interior) SHCP - Secretaria de Hacienda y Credi_o Publico (Secretariat of Fi- nance and Public Credit) SPP - Secretaria de Programacion y Presupuesto (Secretariat of Pro- gramming and Budgeting)  FOR OFFICIAL USE ONLY MEXICO SOLID WASTE MANAGEMENT PILOT PROJECT Loan and Project Summary Borrower: Banco Nacional de Obras y Servicios Publicos, S.N.C.,I.B.D. (BANOBRAS). Guarantor: United Mexican States Beneficiaries: The Monterrey Metropolitan Area, eight medium-sized munici- palities, Secretariat of Urban Development and Ecology (SEDUE) and BANOBRAS. Amount: US$25.0 million equivalent. Terms: Repayment in 15 years, including three years of grace, with interest at the Bank's standard variable rate. Relending Terms: For the implementation of subprojects under the pilot component, the peso equivalent of the Loan would be made available to the beneficiaries with a 15-year repayment period including a grace period equal to the shorter of the construction period or four years, at interest rates specified in the General Interest Rate Agreement (GIRA). Funds for technical assistance and training to the municipalities would be provided as grants. For the national component, the proceeds of the Loan would be made available to SEDUE and BANOBRAS on a grant basis, to finance studies and technical assistance. Project Objectives and The objectives of the proposed project are: (a) to assist Description: the Government to more clearly define solid waste subsector objectives and policies and to develop national and local institutional capability to improve subsector management; (b) to Improve subsector services through pilot subprojects thereby reducing public health risks and environmental conditions in selected cities; (c) to test and evaluate alternatives for promoting cost savings, providing training and channelling funds in the solid waste subsector; (d) to help national and local governments fully understand solid waste management costs and to provide a basis for appropriate pricing and cost recovery; and (e) to provide a basis for preparing full-scale solid waste management improvement projects. Ih dowumt hb a mictd ditibutio and may be ued by recipients only in the pfornmace of dtr ofial dutba Its contets may not otherwie be dimlosed without Worl Bdank authotn .  - ii - The project designed to meet these objectives comprises two components. The pilot component would finance the develop- ment, testing and evaluation of replicable techniques for the delivery of services in about eight medium-sized municipalities and one metropolitan area. The national component, which would be executed at the federal level, would finance technical assistance, consulting services, studies, and equipment to: (i) define subsector policies and options for effective and efficient delivery of ser- vices and to reduce dependence on the Government's budget; (ii) strengthen institutions; (iii) develop plans to address subsector constraints; (iv) undertake plan prepara- tion and prefeasibility studies in 26 selected cities; and (v) prepare follow-up solid waste management projects. Risks: The main project risks are related to the need for close cooperation among several entities and the possible unwillingness of beneficiaries to borrow from the project's line of credit. The first risk has been minimized through institutional arrangements for project Implementation, technical assistance and consultants to assist SEDUE in project supervision, and reporting and monitoring provi- sions. The second risk has been reduced by requesting written commitments from beneficiaries showing their acceptance of subloan terms and conditiGns. Project Costs: Local Foreign Total U-SS thousand A. Pilot Component TA/Studies 3,841.2 805.9 4,647.1 Equipment and Spare Parts 4,201.5 3,788.1 7,989.6 Civil Works 13,063.5 2,739.2 15,802.7 Operations and Maintenance 2,697.8 - 2,697.8 Engineering/Administration 391.9 82.2 474.1 Subtotal 24,195.9 7,415.4 31,611.3 B. National Component Coordinating Unit (T.A., etc.) 1,766.3 1,305.6 3,071.9 Equipment 24.1 9.8 33.9 Generic Studies/Training 710.0 128.1 838.1 Plan Preparation/Prefeasibility Studies (26 cities) 1,967.5 668.0 2,635.5 Preparation of Future Follow-on Project(s) 826.0 159.0 985.0 Subtotal 5,293.9 2,270.5 7,564.4  - iii - Local Foreign Total US$ thousand Base Cost (12/85 prices): 29,489.8 9,685.9 39,175.7 Physical Contingencies 988.1 410.9 1,399.0 Price Contingencies (1/86-12/93) 7,069.0 2,356.3 9,425.3 Total Project Cost 37,546.9 12,453.1 50,000.0 Local costs include about US$0.8 million equivalent of indirect taxes on industrial products. Financing Plan: Local Foreign Total US$ thousand- Bank 12,546.9 12,453.1 25,000.0 GOM (SPP) 12,000.0 - 12,000.0 SEDUE 3,250.0 - 3,250.0 Beneficiary Municipalities 9,750.0 - 9,750.0 TOTAL 37,546.9 12,453.1 50,000.0 Estimated Disbursements: 1/ 1987 1988 1989 1990 1991 1992 1993 1994_ Bank Fiscal Year US$ milli Annual 6.00 6.00 4.00 2.30 2.62 1.78 1.29 1.01 Cumulative 6.00 12.00 16.00 18.30 20.92 22.70 23.99 25.00 Rate of Return: N.A. Staff Appraisal Report: Report No. 5952-ME dated March 5, 1986. 1/ Includes retroactive financing valued at US$2.5 million equivalent.  INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED WAN TO BANCO NACIONAL DE OBRAS Y SERVICIOS PUBLICOS, S.N.C.,I.B.D. WITH THE GUARANTEE OF UNITED MEXICAN STATES FOR A SOLID WASTE MANAGEMENT PILOT PROJECT 1. I submit the following report and recommendation on a proposed loan to Banco Nacional de Obras y Servicios Publicos, S.N.C., I.B.D. (BANOBRAS) with the Guarantee of United Mexican States for the equivalent of US$25 million to help finance a Solid Waste Management Pilot Project. The loan would be repaid over 15 years including 3 years of grace, at the standard variable interest rate. For the implementation of subprojects under the pilot component, the peso equivalent of the Loan would be made available to the beneficiaries with a 15-yehr repayment period including a grace period equal to the shorter of the construction period or four years, at interest rates specified in the General Interest Rate Agreement (GIRA). Funds for technical assistance and training to the municipalities would be provided as grants. For the national component, the proceeds of the Loan would be made available to SEDUE and BANOBRAS on a grant basis, to finance studies and technical assistance. PART I - THE ECONOMY 2. An Economic Report on Mexico (Mexico: Recent Economic Developments and Prospects, No. 4996-ME) was distributed to the Executive Directors on May 14, 1984. A new Country Economic Memorandum is scheduled to be issued by June, 1986. Recent economic developments and a provisional assessment of the consequences for Mexico of the recent sharp decline in oil prices are dis- cussed below. Country data are provided in Annex I. Background 3. Following an inward-looking growth strategy, Mexico experienced some three decades of high and stable growth from the 1940s to the 1960s. By 1970, however, Mexico had largely exhausted the early and efficient possi- bilities for import substitution. Against the expectation of rapidly rising petroleum earnings, the Government attempted to foster growth through expan- sion of public sector expenditures, rising subsidies, and the protection of high cost domestic production. Public sector expenditures as a percent of GDP increased by more than half between 1970 and 1976, from 20.9% to 31.9%. In 1976, Mexico experienced a serious financial and economic crisis. Al- though an increase in oil revenues led Mexico to a quick economic recovery in 1977, it also removed the urgency of policy reforms. Starting in 1980, rapidly rising public expenditures unmatched by revenue growth led to increasing public sector deficits. While inflation rose, no significant pressure was felt to adjust the exchange rate, thanks to the oil earnings and the relative ease of obtaining foreign finance.  4. The crisis came to a head in 1982. Public sector expenditures reached the unprecedented level of 40.1Z of GDP, while the deficit reached nearly 18 of GDP. In February, as capital flight intensified, the Bank of Mexico stopped supporting the peso, which then experienced a 401 devaluation in US dollar terms. A large wage adjustment and continuing slack in the oil market tended to undo the effects of the devaluation and kept the balance of payments under strain. Consumer price inflation nearly quadrupled from 29Z in 1981 to 99% in 1982. The international banking community declined to commit new funds to Mexico in the amounts required. These factors led to a second devaluation of 35% in August 1982 and the suspension of amortization payments on most of Mexico's external public debt. Capital flight continued as private sector confidence was shaken by the nationalization of the banks in September 1982 and by the mandatory conversion of US dollar deposits into pesos. Also introduced were exchange controls and quantitative restrictions covering all imports. 5. Beginning in late 1982, with the support of an Extended Fund Facility from the IMF, Mexico undertook a stabilization program based on drastic contraction of domestic demand, through fiscal, exchange rate, and monetary policy. The peso was depreciated to an unprecedented new I(w in real terms, and import controls were tightened. Public sector expenditure in relation to GDP declined over the period 1983-85, from the high of 40.1Z in 1982 to about 33% by 1985. Non-interest expenditure declined to about 22Z of GDP by 1985, a ten-year low. Public sector investment was cut from about OZ of GDP in the late 1970s to 6.6%, again a ten-year low, and non-interest current expenditure also declined, though more modestly, and remained still at the levels of the late 1970s. Real wages fell 20-25% between 1982 and 1984. Most public sector prices were raised in real terms. 6. The stabilization effort for 1983-84 was impressive. Imports fell 25%, non-oil exports (including border industries) rose 40%, and the trade balance showed unprecedented surpluses in 1983-84. Despite declining oil prices, net foreign reserves increased from a negative US$2.0 billion to $6.5 billion between the end of 1982 and the end of 1984. The 1983-84 performance was hailed by the international financial community as a model for other countries. A massive foreign debt restructuring was successfully nego- tiated. Total net foreign borrowing for the three-year period 1983-85 amounted to $4.5 billion, for an actual decline in the overall debt, in real terms, of about 4%. But the optimistic reaction to Mexico's success in 1983-84 overlooked the short-term focus of the stabilization program and the absence of long overdue structural reforms. Optimism turned to disenchant- ment a year later, when it became clear that stabilization in the absence of more fundamental structural reforms could not restore Mexico's creditworthi- ness, nor would sustainable economic growth be possible without such reforms. 7. Despite tight fiscal and monetary policies, inflation in both 1983 and 1984 turned out to be much higher than had been projected by the authori- ties, consumer prices rising by 80% and 59%, respectively. The fiscal defi- cit fell substantially in 1983, to 8.5Z of GDP, but then leveled off in 1984. GDP fell in both 1982 and 1983 (by 0.5% and 5.3%, respectively), and recovered only partially in 1984 (by about 3.5%X. GDP per capita by 1984 remained below the levels of 1980 and income per head lower still. By late  1984, as the Government prepared for the mid-term congressional elections of July 1985, fiscal policy began to ease, and public sector borrowing increased substantially. Monetary policy turned accommodating, the exchange rate appreciated further in real terms, and the fiscal deficit rose well above program targets. The demand-led growth spurt that resulted, accompanied by higher than projected inflation, was unsustainable and short lived. Recent Developments 8. Most program targets were missed in 1985. The fiscal deficit rose to 9.8X, inflation increased to 63.8%, non-oil exports declined by over 1O0 from their 1984 levels, and most components of the balance of payments deteriorated. Foreign reserves declined by nearly US$3.5 billion. While external public debt actually declined during 1985, the domestic debt of the public sector surged back up toward the level of 1982. As a result, crowding out of the private sector in the credit markets was severe, as the share of the public sector in total credit reached an unprecedented high in excess of 75% in 1985. The brief spurt of GDP growth between mid-1984 and mid-1985 came quickly to a halt in late 1985. 9. In response to the emerging new crisis, the Government adopted during the course of 1985 a series of important corrective measures, includ- ing removing import licensing requirements from an additional 40% of merchan- dise imports, thus increasing the share of imports not subject to QRs to 63% of total imports. The controlled exchange rate was devalued by almost 20% in real terms, and the system of preannounced fixed daily crawl was replaced by a more flexible managed float. Important economies were announced in the public sector, including the elimination of some 25,000 full-time pcsitions and plans to privatize over 230 small state-owned companies. The Government also started to rationalize parastatal operations. Further, aggressive adjustment of the controlled exchange rate and a consequent narrowing of the margin between the controlled and free rates, combined with tight domestic credit brought capital flight to a virtual halt in late October. 10. In spite of the reconstruction needs created by the September earthquakes (estimated at US$4 billion), the authorities prepared an austere budget for 1986. This budget signaled the commitment of the administration to renewed demand-management efforts to recover internal and external balance and move on to a sustainable growth path by the late 1980s. The budget aimed at halving the fiscal deficit to 4.9% of GDP, through sharp cuts in transfers and subsidies, smaller reductions in public investment, a surcharge on upper-income taxpayers, and large adjustments in official prices and tar- iffs. The 1986 program also stressed the importance of continuing policies to liberalize trade, and pushing ahead with other major reforms such as the restructuring/privatization of some parastatal companies and the easing of remaining restrictions to foreign investment. 11. The recent instability in the world oil markets has lowered the Government's revenue projections for 1986. The expectation of lower prices and volume of oil exports for this year, despite its negative fiscal and balance of payments implications, has not affected the Administration's resolve to continue with the stabilization cum structural reform policy. The  1986 budget that is now being revised will undoubtedly reflect a larger public sector deficit and larger external financing requirements. For the fiscal deficit, part of the loss from oil taxes will be offset by further trimming of subsidies and public expenditures. Similarly the increase in foreign borrowing requirements will be much smaller than the actual drop in oil export receipts, as a result of foreign interest rates, imports and build-up in reserves all expected to be lower than the original budget "assumptions. Hence, the picture for external financing needs, although some- what more difficult, should remain manageable barring further major declines in Mexico's oil export prospects. Medium-Term Prospects 12. Mexico's medium-term prospects for recovery and stable economic growth remain good, provided the Government is persistent in pursuing its current stabilization program accompanied by major structural adjustment policies (including trade liberalization cum non-oil export promotion, restructuring/privatization of parastatal companies), pr:vate sector confi- dence is restored, and the international environment remains reasonably favorable, including open markets for Mexico-s non-oil exports. Restoration of private sector confidence is crucial, since only a strong and dynamic private sector will be able to raise investment and production from the present depressed levels and supply the increasing non-oil export surplus required for the resumption of growth and the attainment of sound balance of payments prospects. As regards the external environment, the international financial community should be prepared to provide fi ancing in support of sound, growth-oriented economic policies. 13. Under moderately favorable external and domestic conditions, Mexico's economic growth could reach a sustainable 4-5Z a year toward the late 1980s. However, should a more outward-oriented growth pattern compris- ing fiscal discipline, improved domestic efficiency, and non-oil export development fail to materialize, Mexico could enter into a period of prolonged stagnation, characterized by insufficient labor absorption, domes- tic price distortions, and continued balance of payments difficulties. External Debt and Creditworthiness 14. Mexico's external public and private debt increased by about US$6 billion during 1983-84, and fell by US$1.5 billion in 1985 to US$92.8 bil- lion. With an international oil price of US$20/barrel, the net new borrowing requirements are expected to average eome US$2-3 billion per annum during the remainder of the decade, with the debt service ratio remaining a little over 50%. With an oil price of US$15/barrel, the net borrowing requirements would be an average of US$4-5 billion per annum during the same period, while the debt service ratio would be around an average of 55%. 15. At the end of 1985, the Bank's share in Mexico's public debt was 5.1%. The Bank's share in Mexico's total public external interest payments was 4.3%. The Bank's exposure in Mexico as of end-1985 amounted to 7.6% of its total. In view of the expectation that sound economic policies will be pursued in the future, Mexico is considered creditworthy for this loan.  - 5 - PART II - BANK GROUP OPERATIONS IN MEXICO Bank Operations 16. As of September 30, 1985, Mexico had received 91 loans from the Bank, amounting to US$7.72 billion, net of cancellations and terminations; of these, 59 loans totalling US$3.6 billion were fully disbursed. The Bank held US$6.1 billion, of which US$2.4 billion had not yet been disbursed. Some 40% of Bank lending has been for agriculture and rural development, 20% for industry, 9% for power, and 18% for transportation; the remaining 13Z has been for water supply, tourism, urban development, and vocational training. Annex II contains a summary statement of Bank loans as of September 30, 1985. 17. Of the US$7.72 billion total lending, about US$4.7 billion was for establishing or strengthening institutions for channelling credit to areas where credit supply was deficient or non-existent, and setting up in the com- mercial banking system the ability to carry out project-related appraisal of investments in agriculture, industry, and tourism. These credit programs have facilitated lending to low-income farmers and small- and medium-scale industrial and tourism enterprises. 18. The Government arranged adequate budget financing in the years 1978 to 1981, which significantly improved project implementation. Government and Bank officials met periodically to review project implementation, and greater attention was focused on project monitoring. As a result of these measures, most of the Bank-assisted projects were being implemented satisfactorily until mid-1982, and disbursements rose from US$91 million in FY78, to US$448 million in FY82. However, the 1982 financial crisis again caused delays in the provision of counterpart funds; consequently, disbursements in FY83 declined to US$389 million. A Special Action Program (SAP) was established in early 1983 to help the Government by alleviating the counterpart funding constraints on development projects, and 18 Bank-financed projects are receiving support under the Program. Partly as a result of the SAP, dis- bursements during FY84 improved significantly at US$528.87 million or 352 over disbursements in 1983. The FY85 disbursement figure is US$787.93 million, 49% over 1984 or 100% over projected. A reconstruction loan has been appraised to respond to the needs of the September 1985 earthquakes. The proposed loan will be multi-sectoral and will cover all aspects of the overall reconstruction program. In addition, ongoing loans have been adjusted to address reconstruction needs. IFC Operations 19. As of September 30, 1985, IFC had made investment commitments in 27 companies in Mexico, for a total of US$753.9 million, of which US$572.8 mil- lion had been sold, repaid or cancelled. A summary statement of IFC invest- ments is presented in Annex II. IFC has been working together with the Bank in preparing proposals to establish a facility for provision of foreign exchange financing to private sector companies, for the importation of machinery, equipment, and spare parts required for production of exportable products, for efficient import substitution, and for improvements in the  - 6 - utilization of their existing productive capacity. IFC approved a US$100 million facility (including funds mobilized from foreign commercial banks) in 1983, which is providing finance for fixed investments of a larger size than those assisted under the Bank loan for an Export Development Project. Bank Strategy 20. The Bank's major objectives in Mexico prior to the 1982 crisis were to: (a) support policies and programs leading to a wider distribution of the benefits of economic growth; (b) help finance projects that, directly or indirectly, contributed significantly to output and employment; (c) help reduce Mexico's urban/regional imbalances; and (d) help free bottlenecks which prevent rapid growth. These continue to be important objectives of Bank assistance to Mexico. However, following the 1982 economic crisis, and a reassessment of the Bank's role in Mexico, the Bank Management concluded that: (a) increased Bank lending, critical to Mexico's recovery, must be linked to central policy reforms; and (b) the Bank should play a central role in assisting Mexico's return to voluntary lending. To prepare itself for this new role, the Bank has intensified and broadened its economic and sector work. Specific policy reforms that are presently being pursued through a dialogue with the Mexican Government cover priority macro-economic and cross-sectoral issues, such as trade liberalization, rationalization of preferential credit systems, improvement in public sector pricing and investment and subsidy reduction. Traditional lending incorporating project- or sector-specific policy issues will be conducted in parallel with policy dialogue on cross-sectoral or macropolicy issues. 21. Because of the difficult structural problems of agriculture and the sector's crucial importance fcr the one-third of the nation's population living in rural areas, the Bank has made agriculture the leading sector for its lending. The Bank's agricultural lending program in Mexico aims at (a) a more efficient and rational use of natural resources to increase production; (b) productivity improvements of cultivated lands, with emphasis on the productivity of small farmers; and (c) promotion of employment generating investments in rural areas. To support these goals, infrastructure invest- ments in Bank-assisted projects have been complemented with support services, such as extension, marketing programs and credit. The Bank has made 10 loans in FYs8O-85 totalling US$1,566.0 million for irrigation, rural and agricul- tural investwent projects, and agro-industrial and livestock credit pro- grams. Projects for irrigation rehabilitation, extension and research, seed multiplication, forestry, agro-industries and agricultural credit are in various stages of preparation. Special emphasis has been placed in recent years on the development of rainfed areas. 22. Bank lending for industry aims at: (a) improving competitiveness and export growth; (b) decentralizing industrial activities away from the major, increasingly congested, urban areas; (c) promoting greater employment and skilled development; and (d) supporting the growth of enterprises and the financial sector. Between FYs8O-85, seven loans amounting to US$947.30 mil- lion were approved in the areas of small- and medium-scale industry, mining, vocational training, development of capital goods industries, and promotion of exports. In response to the current needs of the industrial sector, *1  -7- several projects to support non-oil export development, acquisition of modern technology, and financial restructuring of enterprises are in various stages of preparation. A Trade Development Policy Loan (DPL) is now being appraised aiming at supporting the trade liberalization process, assisting in the recovery of sustainabli oconomic growth and facilitating the mobilization of commercial bank funds to cover part of the external financing needs for 1986. 23. Bank lending for transport has focused on regional development, strengthening of institutions and rationalization of public investment out- lays and pricing policies. Between FYs80-85 six loans amounting to US$753.75 million were approved including two in each of the following three sub- sectors: highways, railways and ports. Additional projects to support the above goals were undertaken in the urban sector. During FYs8O-85 four loans were approved in the urban sector, totalling US$408.5 million in the fields of water supply and sewerage, and other urban investments. Additional projects are under consideration in the transport and urban sectors aiming at stre gthening the various institutions in the areas of planning, management, and finance. These upcoming projects would further support the Government's decentralization objectives. 24. The Economic Development Institute CEDI) is assisting Mexico through various courses/seminars dealing with policy alternatives and insti- tutional reforms. EDI training is specifically directed at courses/seminars on water supply and sanitation sector management, transport policy, agricul- tural policy, industrial development and finance, and macro-policy analysis. 25. The Inter-American Development Bank (IDB) is the second largest source of multilateral aid to Mexico. The IDB has made loans to Mexico totalling US$3.4 billion as of September 30, 1985. Over 50Z of the total has gone to agricultural and rural development projects, and the balance to transportation, industry, water supply and sewerage, tourism infrastructure, education, municipal development and pre-investment. The IDB and the Bank have coordinated their assistance on several projects. Each has made loans for the national integrated rural development program (PIDER), agricultural and livestock credit, small- and medium-scale industries development, and hotel development projects. The International Fund for Agricultural Develop- ment (IFAD) has approved a loan of US$22 million for a rural development project in the State of Oaxaca, which was appraised by the Bank's staff and for which the Bank is acting as cooperating institution for administering the loan. PART III - THE SECTOR/SUBSECTOR 26. Mexico's outstanding spatial problems are the heavy concentration of economic activity, wealth and population in Mexico City, the lack of integration between urban and rural areas, and unbalanced inter-regional development. Population growth has declined from 3.2% p.a. in the early 1970s to 2.6% p.a. at present. Approximately 68% of the country's 75 million  -8- people live in urban centers of more than 2,500 inhabitants, while about 26% of the population live in the three main metropolitan areas: Mexico City, Guadalajara and Monterrey. 27. Between 1970 and 1983, Mexico made significant progress In expand- ing and improving its water supply and wastes services. During this period, the percentage of population with access to piped water increased from 49 to 66Z and the percentage with connection to sewerage systems or sanitation increased from 29 to 43%. However, it is estimated that about 50% of all systems need rehabilitation. The improvements in water and sewerage coverage have been offset by worsening water pollution and solid waste problems. 28. Collection, transfer and final disposal of solid waste are inadequate in virtually every city. Collection service, often erratic and inconsistent, is available only to 70Z of the urban population, and is generally provided with limited and/or aging facilities, deteriorating equip- ment and untrained personnel. Adequate final disposal techniques are applied to only 5% of the total volume of wastes collected, and open air dumps are used for final disposal in 90% of all Mexican cities. Solid waste services in the municipalities under the pilot component of the proposed project would be representative of the rest of the country. 29. Inadequate and erratic solid waste collection and disposal and lack of public education programs on proper waste management are resulting in the spread of debilitating diseases by insects and animals, and by direct human contact. Growing quantities of industrial and toxic wastes which are produced in unknown, but presumably large quantities and are stored, dumped or discarded in unknown locations, present yet another major problem. The proposed project would support studies on the quantities and characteristics of industrial and toxic wastes. Subsector Organization 30. The Secretariat of Urban Development and Ecology (SEDUE) is respon- sible for establishing and enforcing regulations and norms for the solid waste subsector and promoting proper planning and operation of services by providing technical and financial advice. lBecause of the increased apprecia- tion of the magnitude of the solid waste problem, SEDUE has been given the mandate to organize and develop the solid waste subsector. SEDUE has also provided funds from its regular budget to municipalities as seed capital to design and construct sanitary landfills (para. 35). Within SEDUE, the Directorate General for the Prevention and Control of Environmental Pollution (DGPCCA) comprising three departments (Standards and Enforcement, Studies and Technical Support) is responsible for solid waste management activities. An informal unit was established in DGPCCA to prepare this project. This unit, which reports directly to the Director General of DGPCCA, has been formalized and would be responsible for project management and execution of some sub- components of the project (para. 55).  31. BANOBRAS In a financial agent of the Government responsible for financing infrastructure (urban development, water supply, highway, etc.) investments. The federal government, through SHCP, controls BANOBRAS' pollles and directs its borrowings and lending activitles. BANOBRAS onlends funds to states and municipalities through various "windows" on varying terms and conditions. However, in view of the internal organization requiring coordination among four divisions (External Credit, Planning, Operations and Training), as well as complex bureaucratic procedures for loan application and processing, and lack of promotion, BANOBRAS has not been a major source of funding to municipalities. 32. The Government, as part of Its decentralization efforts, in February 1983, modifled Article 115 of the Constitution which governs municipal functions. This modification defined the legal responsibilities of municipalities to include the planning, financing, implementing, operating and maintaining of basic municipal services. Municipalities are, therefore, responsible for the collection and disposal of municipal solid wastes. Responsibility for collection, transport, storage, treatment and final disposal of toxic and industrial wastes rests with the generating industries, SEDUE and, In some cases, with the municipalities. 33. Various arrangements are employed to handle waste management at the municipal level. In many municipalities, one department is responsible for collection, transport, disposal and fleet maintenance and repair. Others have a separate department of transport to handle management, maintenance and repair of all municipal vehicles. In others, a municipal "empresas handles all aspects of waste management, including fleet maintenance. Contract and/or private collection is employed in some municipalities, usually to cover specific zones and institutions (hotels, hospitals, restaurants, etc.). Lack of information precludes a clear-cut assessment of the potential efficiency and effectiveness of private and/or contract service. This would be studied and defined under the proposed project (para. 46). Industrial and toxic waste management is not organized, except where municipalities have assumed the responsibility. There are virtually no inter-municipal cooperative arrangements or organizations to promote and manage shared facilities and equipment. Subsector Operational Performance 34. Solid waste services throughout Mexico are characterized by poor operational performance. Because of a lack of planning and funding, on average, about 25% of the most organized municipalities' operative fleets are out of service at any given moment. It is estimated that more than half of the inoperative vehicles could be repaired at a cost of 10% to 15 of their replacement cost. Although solid waste management is estimated to consume up to one-third of municipal budgets, there are no systems to record and compile the costs of solid waste operations. When maintenance and repairs are performed by a general municipal workshop, costs for labor, parts, supplies, and administration are not disaggregated by service. Without proper cost data, cost-efficiency is not an issue of concern, much less a goal to be achieved. Few, if any, cleaning agencies attempt to minimize exposed raw refuse or provide separate areas for hazardous wastes. Route planning for  - 10 - activities such as waste collection, disposal and proper vehicle operation, are particularly weak. Public education campaigns focussing on the social and health aspects of wastes have only recently begun. Disincentives for littering, illegal dumping and burning have yet to be developed. Finally, operational performance has been adversely affected by lack of trained professional and supervisory staff at the municlpal level. Subsector Investments and Financing 35. Municipal budgets have generally financed solid waste services management. However, as in the past, most municipal revenues were provided as Federal and State transfers, the majority of subsector investments as well as operation and maintenance costs were financed on a grant basis. BANOBRAS has lent some funds to the subsector, mainly for truck purchases, as part of larger urban development schemes (para. 31). Between 1983-85, SEDUE provided about US$6 million (1985 prices) to support the design, construction or operation of sanitary landfills in selected cities. Because of the rudimen- tary nature of the municipalities' accounting systems (para. 34), however, the level of subsector investments is unknown. Evidence gathered from a representative sample of cities indicates that investments made and planned are far bilow the estimated minimum required to upgrade services and provide a minimum acceptable level of solid waste collection and disposal. The modification to Article 115 of the Constitution (para. 32) provides the legal instruments for substantial increases in municipal own-source reve- nues. Municipalities, which previously received 15% of property taxes col- lected by states, are now responsible for collecting property taxes and retaining 80% of collections. Furthermore, municipalities (or their agen- cies) now collect and retain all user charges for water, sewerage and drain- ing systems, solid waste services, markets and slaughterhouses, among other basic services. Municipalities have adopted conservative fiscal policies and have, therefore, considerable potential for borrowing. Subsector Objectives and Constraints 36. At the end of 1983, the Government established broad, medium-term (1984-88) objectives for improvement of municipal and industrial solid waste management. The objective in mnicipal solid waste is to increase collection service coverage from 70% to 90% of the population in all cities with more than 100,000 inhabitants, and to increase appropriate final disposal from 5% to 90% of collected wastes through A program of sanitary landfill construc- tion. The initial objectives in industrial and toxic wastes are to: (a) identify the characteristics of wastes in 20 industrial zones; (b) draw up regulations for industrial waste management; (c) promote financing for the waste-generating industries to develop adequate collection systems and construct suitable dumps; and (d) construct industrial waste disposal sites (cemeteries) in the municipalities that have undertaken the management of industrial wastes. Total financial requirements to meet the above objectives are estimated at a minimum of US$500 million (USS125 million per year) in 1985 prices. 37. Achievement of the above subsectoral objectives is constrained by the following: (a) the country's public investment programs are being  - 11 - sharply curtailed, and financing from private sources is not available; (b) a national solid waste plan, including site-specific programs, has not been prepared; (c) SEDUE's capacity to provide technical assistance to municipali- ties and private companies on a wide scale is limited; (d) the municipali- ties' capacity to effectively absorb the investments leaves much to be desired; (e) options Involving the private sector have not been explored; (f) methods of promoting financing for waste generating industries have not been defined; (g) measures to increase efficiency and reduce costs are not being taken or planned; and (h) constraints on sanitary landfill operating capacity have not been considered, despite ongoing construction. In addition, key constraints such as lack of technical and administrative knowledge, weak planning, limited and/or aging equipment and facilities, untrained personnel, poor operation and maintenance of equipment and facilities, unclear and some- times inadequate pricing policies and cost recovery levels, and lack of experience in dealing with various types of wastes are not being addressed. As discussed in Part IV of this report, the proposed project has been designed to assist the Government in establishing an appropriate framework and basis to achieve subsectoral objectives by addressing the above constraints. Bank Sector/Subsector Strategy and Rationale for Bank Involvement 38. The Bank's strategy in the water supply and wastes sector comprises two elements: (a) to assist the water supply and sewerage subsector with continued emphasis on medium-sized cities and increased attention to the problems of small cities; and (b) to act as a catalyst in bringing about a rational development of the solid waste management and pollution control subsectors. In water supply and sewerage, in addition to stimulating improved management, developing appropriate financial policies and promoting training, the Bank is paying particular attention to the development of regional entities to manage the cost-effective provision of services. 39. The proposed project, the first direct Bank loan to the solid waste subsector, would help the federal, state and municipal governments initiate the process of rational development of the solid waste management subsector through nationwide studies, technical assistance and pilot works. These activities would provide a sound basis for establishing a cohesive policy with an appropriate framework and establish pilot examples with nationwide relevance. They would provide the grounding for future investments under a larger scale follow-up operation. Complementing the Municipal Strengthening Project (MSP) for which a parallel Bank loan is being processed, the project would: (i) help improve overall public sector management at the federal, state and municipal levels, and consolidate the Government's decentralization program; (ii) through actions at the subsectorial and technical level, improve the institutional and financial management of municipalities by gradually rationalizing the system of grant transfers, and strengthening municipal finances through application of a systematic methodology which would lead to appropriate pricing and cost recovery policies; and (iii) reduce federal subsidies to states and municipalities by improving access to credit for a ke-- municipal service and improving local finance mobilization. The proposed project would help meet basic needs of the population and establish a sound basis for developing a critical subsector.  - 12 - 40. Coordination with the Municipal Strengthening Project. Future Bank lending in both the Urban and Water Supply sectors will necessarily incorpo- rate the revised institutional framework required as a result of the Govern- ment's decentralization policy. The HSP would support the Government's objectives to improve the utilization of human and financial resources and strengthen institutions, particularly at the municipal level, to increase the delivery of affordable and efficient urban services. The proposed project would to the extent feasible, operate within the framework being established under the MSP, while developing, at the federal level, the technical sub- sector expertise and relevant institutional coordination required to provide municipalities with financial and technical assistance and training to adequately discharge their responsibilities in the solid waste subsector. Because of the pressing need to expand knowledge of the subsector and develop expertise at the federal level, SEDUE would assume a major role in implemen- tation of the proposed project, in order to be able to adequately discharge its assigned functions (para. 30). 41. The proposed project would be within the Government's Program for the Strengthening of Municipalities (FORTAMUN) which would be formally estab- lished under a mandate from SHCP to BANOBRAS, on terms acceptable to the Bank, as a condition of effectiveness of the MSP and of the proposed pro- ject. The mandate agreement authorizes BANOBRAS to control funding and establishes the basic structure of the program, including: (a) the estab- lishment of a high level interministerial Steering Comittee (Comite Directivo); (b) the establishment of a Technical Secretariat for coordinating various agencies involved in municipal strengthening and the program as a whole; (c) the establishment of a Training Support Unit; and (d) the formal- ization of Operating Guidelines which detail the basis for the operation of FORTAMUN. All subprojects under the proposed project would be subject to the financial appraisal criteria established in the Operating Guidelines and respective subloans would be reviewed and approved by the Comite Directivo. The Operating Guidelines would be approved by BANOBRAS and the Guarantor as a condition of effectiveness, on terms acceptable to the Bank. BANOBRAS would agree to follow policies and procedures as outlined in the Operating Guide- lines, which were reviewed during negotiations and would not make any changes in the manual which would materially and adversely affect the carrying out of the project. PART IV - THE PROJECT Project Origin, Background and Concept 42. In February 1984, the Government requested Bank assistance to develop the solid waste subsector and to help prepare a first project. Aa April 1984 mission concluded that a modest operation which would provide substantial technical assistance and a pilot program to test applications would be advisable. Such a project would review options and define policies, strengthen institutions, demonstrate the efficient delivery of subsector services and gain experience before tndertaking a larger lending operation.  - 13 - The resulting project was appraised in July-August, 1985. A Staff Appraisal Report (No. 5952-HE) dated March 5, 1986 is being distributed separately. Negotiations were held in Washington on February 18 through 25, 1986. The Mexican delegation was led by Mr. German Sandoval of BANOBRAS. Project Objectives 43. The objectives of the proposed project are to: (a) assist the Government to more clearly define solid waste subsector objectives and policies and to develop national and local institutional capability to improve subsector management; (b) improve subsector services through pilot subprojects thereby reducing public health risks and environmental conditions in selected cities; (c) test and evaluate alternatives for promoting cost savings, providing training and channelling funds in the solid waste subsector; (d) help national and local governments fully understand solid waste management costs and provide a basis for appropriate pricing and cost recovery; and (e) provide a basis for preparing full-scale solid waste management improvement projects. Project Description 44. The pilot component would consist of pilot subprojects, each designed to improve operations and environmental protection, reduce costs, and increase efficiency. Each subproject would be documented by audio-visual and written materials to be used for sector-wide training and to facilitate replication. Various combinations of subprojects would be undertaken in the following urban areas: the Monterrey Metropolitan Area, Puebla, Merida, Tlalnepantla, Acapulco, Ecatepec, Cuernavaca, and the Orizaba/Cordoba twin cities. The subprojects would finance civil works, equipment and materials, training and technical assistance for: (a) improved repair and maintenance facilities and systems; (b) low-cost collection systems for markets; (c) low-cost collection systems for marginal zones; (d) composting facilities designed to operate in direct response to market demand for their products; (e) construction of a regional sanitary landfill; (f) industrial waste disposal sites/cemeteries; (g) improvement of institutional, financial and organizational arrangements, including office improvements; (h) development of public education programs; and (i) three regional transfer stations and a sanitary landfill for establishment of a metropolitan waste management enter- prise and studies on the economic and technical viability of employing composting, mass burning and/or refuse-derived fuel systems of resource recovery. 45. The national component would finance: (a) technical assistance and equipment to strengthen SEDUE; (b) generic studies to define options and solutions to solve the fundamental problems, issues and needs of the solid waste management subsector; (c) development of plans and preparation of prefeasibility studies in 26 cities; and (d) preparation of a f*iture project. Draft terms of reference for technical assistance, studies and preparation of the follow-on projects, as summarized below, were agreed with the Government during negotiations.  - 14 - 46. The following generic studies would be carried out: (a) an examination of institutional aspects of solid waste management including legal, regulatory, enforcement, and definition of institutional/organiza- tional options for effective delivery of services (e.g. contract, concession, lease options, etc.) and assistance, where necessary, to the beneficiaries to implement applicable recommendations; (b) an examination of financial and accounting aspects of solid waste management comprising options for financing municipal solid waste service from municipal and other resources, financing industrial waste management, and accounting, including cost control; (c) development and implementation of an industrial waste data base manage- ment system and provision of training on its use; (d) design of a sampling and analysis program to fill gaps in the data base on municipal solid waste characteristics; (e) an evaluation of environmental impacts and costs associated with open dumping of municipal and industrial wastes in order to provide a basis for assessing the costs and benefits of other disposal options; (f) development of a data base of costing factors and a simplified computer system to enable ready comparison and analysis of collection, trans- port and transfer options; (g) assessment of the existing and potential markets for recycled materials and recovered resources; (h) assessment of constraints and incentives to recycling and resource recovery and definition of policy options and plans of action which could enhance recycling and resource recovery. 47. Plan Preparation and Prefeasibility Studies would include the development of comprehensive plans of action for improving solid waste management in 26 cities including, in each case, recommended options for improvements. 48. The development and preparation of future follow-on projects would comprise the: (a) comparison of issues and proposed approaches among cities; Cb) selection of cities based on sound selection criteria; (c) preparation of full feasibility studies, taking into consideration information contained in the generic studies and experience with implementation of pilot subprojects. 49. An important feature of the project is the special technical assistance to be provided to a number of the beneficiaries to implement recommendations developed above. This effort would concentrate on institu- tional and organizational options for effective and efficient service provision, accounting and cost control, administrative procedures and systems for analyzing collection, transport and transfer options. As specified in the Operating Guidelines, beneficiaries would be required, under subloan agreements (para. 60), to implement recommendations relating to cost recovery. Project Cost and Financing 50. The total project cost, excluding interest during construction, is estimated at US$50.0 million equivalent (US$40.09 million allocated to the pilot component and US$9.91 million, to the national component with an estimated foreign exchange cost of US$12.45 million). Costs have been based on December 1985 prices and include physical contingencies of 4%. Price contingencies have been estimated according to an eight-year disbursement profile, on US dollar based values at 7.5Z in 1986 and 8% thereafter. The  - 15 - local component includes about US$0.8 million equivalent of indirect taxes on Industrial products. Technical assistance and consultant costs have been based on those of similar internationally and locally recruited experts in Mexico and other countries in the region. The costs include about 1600 man- months of consultants' services, and 598 man-months of counterpart staff at the national level. Construction costs have been based on bills of quanti- ties of subprojects with advanced engineering designs, and on unit prices developed by SEDUE or found in recent bids for similar civil works, materials and equipment. 51. The Bank Loan of US$25.0 million (50% of total project cost) would finance total foreign costs and 33.5% of local costs. This is in line with recent Bank participation in social sector projects in Mexico, and is justified by the extensive expenditure in local currency (mainly for consult- ing services), the technical assistance and the pilot nature of the project. BANOBRAS would, as a condition of effectiveness, enter into contractual arrangements, satisfactory to the Bank, with the Government providing for the transfer of loan funds to the Government for the purposes of carrying out FORTAMUN and repayment of the loan by the Government. The amount allocated to the pilot component would provide initial capital to a Municipal Develop- ment Fund (MDF) under FORTAMUN to provide subloans for the implementation of pilot subprojects and grants for technical assistance and training to munici- palities on terms and conditions satisfactory to the Bank (para. 60). Prin- cipal and interest payments on subloans would be deposited in the MDF and further onlent to municipalities for the purposes of expanding FORTAMUN. Funds for technical assistance and training under pilot subprojects would be provided as grants (para. 62). Funds for the national component would be provided by the Government to SEDUE and BANOBRAS on a grant basis. Assur- ances were obtained during negotiations on the timely availability of counterpart funds and that the US$12.0 million of GOM counterpart funds would be channelled through the project's account under FORTAMUN. Beneficiaries' contributions of US$9.75 million, would be in the form of project-related services, assets and land. SEDUE would allocate US$3.25 million of counter- part funds from future budgets. Procurement and Disbursement 52. Procurement would be carried out following Bank guidelines. All contracts for equipment, spare parts and materials exceeding a total of US$300,000 and in excess of US$3 million for civil works would be awarded on the basis of international competitive bidding (ICB). Equipment, spare parts and materials for each subproject would, to the extent practicable, be grouped into packages in excess of US$300,000. Subject to an aggregate limit of US$12 million, contracts for civil works of less than US$3 million but over US$300,000, or less than US$300,000 but over US$100,000 for equipment, spare parts and materials, would be procured on the basis of local competi- tive bidding (LCB) procedures satisfactory to the Bank. Contracts of less than US$300,000 for civil works and less than US$100,000 for equipment, subject to a maximum aggregate of US$6 million, would be procured directly on the basis of a minimum of three quotations or force account. Goods manufac- tured locally and procured under ICB would be allowed a preference over foreign goods of 15% of the CIF price or the level of import duty, whichever is lower. Technical assistance and consultants' services would be procured  - 16 - in accordance with Bank Guidelines for Use of Consultants. Prior Bank review of feasibility studies, final designs, specifications and prequalifications, bidding documents, awards, and contracts procured under ICB would be required. BANOBRAS/SEDUE would retain all relevant documentation for local procurement of goods and services for review by Bank missions. The benefi- ciaries would maintain adequate documentation to support expenditures made for force account works. 53. The Bank would disburse as follows: for the pilot component: (i) 67% for consulting services and training; (ii) 100% of foreign expenditures for d