Mexico - Water Supply and Sewerage Projects

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 11448 PROJECT COMPLETION REPORT MEXICO MEDIUM CITIES WATER SUPPLY AND SEWERAGE PROJECT (LOAN 1186-ME) SECOND MEDIUM-SIZE CITIES WATER SUPPLY AND SEWERAGE PROJECT (LOAN 1913-ME) AND THIRD MEDIUM-SIZE CITIES AND SINALOA STATE WATER PROJECT (LOAN 2281-ME) DECEMBER 21, 1992 Infrastructure Division Country Department II Latin America and the Caribbean Regional Office This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EOUIVALENTS Currency unit = Peso (Mex$) US$1.00 = $12.50 (1972) " = $25.60 (1980) " = $18.00 (1973-80) = $2,267.50 (1990) = $507.00 (1982-90) WEIGHTS AND MEASURES meter (m) = 3.28 feet kilometer (km) = 0.62 miles PRINCIPLE ACRONYMS USED BC - Beneficiary Cities Water Supply and Sewerage Companies BANOBRAS - National Bank of Public Works and Service. (Banco Nacional de Obras y Servicios Publicos, S.A.) CAVM - Valley of Mexico Water Commission (Comi.ifn de Agua del Valle de Mexico) CEAPAS - Sinaloa State Water Board (Comisi6n Estatal de Aqua Potable y Alcantarillado de Sinaloa) CNA - National Water Commission (Comisi6n Nacional de Agua) DIGESAPA - General Directorate of Water Supply and Sewerage Systems (Direcci6n General de Sistemas de Agua Potable y Alcantarillado) FIFAPA - Investment Fund for Water Supply and Sewerage Works (Fondo Fiduciario para Agua Potable y Alcantarillado) MCMA - Mexico City Metropolitan Area PIU - Project Implementation Unit RCs - Regional Companies to be integrated into CEAPAS SAHOP - Secretariat of Human Settlements and Public Works (Secretaria de Asentamientos Humanos y Obras Publicas) SARH - Secretariat of Agriculture and Hydraulic Resources (Secretaria de Agricultura y Recursos Hidr&ulicos) SEDUE - Secretariat of Urban Development and Ecology (Secretaria de Desarrollo Urbano y Ecologia) SRH - Secretariat for Hydraulic Resources (Secretaria de Recursos Hidraulicos) UNDP - United Nations Development Programme WSS - Water Supply and Sewerage  FOR OFFICIAL USE ONLY THE WORLD BANK Washington, D.C. 20433 U.S.A. Office of Director-General Operations Evaluation December 21, 1992 MEMORANDUM TO THE EXECUTIVE DIRECTORS AND THE PRESIDENT SUBJECT: Project Completion Report on Mexico Medium Cities Water Supply and Sewerage Project (Loan 1186-ME) Second Medium Cities Water Supply and Sewerage Project (Loan 1913-ME) Third Medium Cities Water Supply and Sewerage Proiect (Loan 2281-ME) Attached is a copy of the report entitled "Project Completion Report on Mexico - Medium Cities Water Supply and Sewerage Project (Loan 1186-ME), Second Medium Cities Water Supply and Sewerage Project (Loan 1913-ME) and Third Medium Cities Water Supply and Sewerage Project (Loan 2281-ME)" prepared by the Latin America and the Caribbean Regional Office with Part II contributed by the Borrower. The physical elements of the projects were successfully implemented, albeit with significant delays. Public health and environmental conditions improved in all project cities. On the other hand, the creation of an appropriate institutional context (including coherent sectoral norms) was undermined by frequent organizational changes and inadequate inter-agency coordination. Furthermore, the important objective of replacing government grant financing for urban water and sewerage projects by loan financing, coupled by systematic cost recovery, was not achieved. A number of cities withdrew from the projects given the availability of alternative (grant) funding. The first two projects are rated unsatisfactory. The third project, in an improved policy environment, is rated as marginally successful. Sustainability of all those projects is rated as uncertain. While much delayed, the Project Completion Report is of good quality. Part II, the borrower's comments, is refreshingly frank on the institutional problems of the sector. The three projects are being audited as a cluster. Attachment This document has a restricted distribution and may be used by recipients only in the performance of their officiaL dutles. Its contents my not otherwise be disclosed without WorLd Bank authorization.   FOR OFFICIAL USE ONLY MEXICO PROJECT COMPLETION REPORT lPCR) MEDIUM CITIES WATZR SUPPLY AND SEWERAGE PROJECT (LOAN 1186-MEI SECOND MEDIUM-SIZE CITIES WATER SUPPLY AND SEWERAGE PROJECT (LOAN 1913-ME} THIRD MEDIUM-SIZE CITIES AND SINALOA STATE WATER PROJECT (LOAN 2281-MEl Table of Contents Paae No. Preface ........................................................ 1 Evaluation Summary ............................................. iii PART I. PROJECT REVIEW FROM BANK'S PERSPECTIVE ............... 1 Identity ............................................. 1 Background ........................................... 1 Preparation .......................................... 5 Implementation ....................................... 18 Financial Performance ................................ 31 Project Results ...................................... 32 Sustainability ....................................... 35 Performance .......................................... 35 Project Relationships ................................ 38 Consulting Services .................................. 38 Documentation and Data ............................... 38 Lessons Learned ...................................... 39 PART II. BORROWER REVIEW OF THE PROJECT ....................... 41 Section I. BANOBRAS Comments on Draft PCR (6/22/92) ....... 41 Section II. Summary of Final Project Report Prepared by BANOBRAS and SEDUE ........................ 43 Background ........................................... 43 Analysis of the Project .............................. 44 Execution, Operation, and Project Costs .............. 45 Institutional Performance ............................ 47 PART III. STATISTICAL INFORMATION .............................. 49 1. Related Bank Loans ................................ 49 2. Project Timetable ................................. 50 3. Actual Cost & Source of Financing ................. 51 4. Actual & Forecast Disbursement Timetable .......... 54 5. Allocation of Proceeds: Appraisal, Revised, Actual 55 6. Project Implementation ..8........... S 7. Use of Bank Resources ............................. 65 8. Status of Covenants ............................... 70 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.   PROJECT COMPLETION REPORT MEXICO MEDIUM CITIES WATER SUPPLY AND SEWERAGE PROJECT (LOAN 1186-MEI SECOND MEDIUM-SIZE CITIES WATER SUPPLY AND SEWERAGE PROJECT (LOAN 1913-MEl THIRD MEDIUM-SIZE CITIES AND SINALOA STATE WATER PROJECT (LOAN 2281-Nil PREFACE This is the Project Completion Report (PCR) for three related projects aimed at Improving and extending water supply and sewerage services in medium-size cities in Mexico: - MEDIUM CITIES WATER SUPPLY AND SEWERAGE PROJECT for which Loan 1186-ME in the amount of US$40 million was approved on December 18, 1975. The Borrower was the National Bank of Public Works and Services (BANOBRAS)t the executing agency was the Secretariat of Hydraulic Resources (SRH), which was reorganized in 1976 as the Secretariat of Human Settlements and Public Works (SAHOP). Almost all of the loan (99.5%) was disbursed. The loan was closed on January 14, 1984, four years beyond the date estimated at appraisal, and the undisbursed balance of US$0.21 million was canceled. The last disbursement was on May 23, 1984. - SECOND MEDIUM-SIZE CITIES WATER SUPPLY AND SEWERAGE PROJECT for which Loan 1913-ME in the amount of US$125 million was approved on October 4, 1980. The Borrower was BANOBRAS; the executing agency was SAHOP, which was reorganized in 1982 as the Secrtarilat of Urban Development (SEDUE). About 60.6% of the proceeds of the Loan were disbursed. The loan was closed on November 30, 1986, about two years after the date estimated at appraisal, and the undisbursed balance of US$49.27 million was canceled. The last disbursement was on August 31, 1987. - THIRD MEDIUM-SIZE CITIES AND SINALOA STATE WATER PROJECT for which Loan 2281-ME in the amount of US$100.3 million was approved on May 17, 1983. The Borrower was BANOBRAS; the executing agency was SEDUE. About 95% of the Loan was disbursed. The loan was closed on April 30, 1991, four months beyond the date estimated at appraisal, and the undisburs-d balance of US$5.03 million was canceled. The last disbursement was on March 13, 1991. With respect to costs, implementation periods, etc., this PCR treats the three projects separately, not as a single project, as they were presented to the Board as individual projects. However, Bank and Mexican officials came to think of the separate projects as parts of a single OFIFAPA* operation -- "FIFAPA" being the acronym for a funding device comon to all three projects, the Investment Fund for Water Supply and Sewerage Works. Bank and Mexican officials referred to the projects as FIFAPA I, 1I, and III, and had no trouble distinguishing between the projects and the financing 'mechanism.  I  - ii - PROJECT COMPLETION REPORT MEXICO MEDIUM CITIES WATER SUPPLY AND SEWERAGE PROJECT (LOAN 1186-MEt SECOND MEDIUM-SIZE CITIES WATER SUPPLY AND SEWERAGE PROJECT (LOAN 1913-ME) THIRD MEDIUM-SIZE CITIES AND SINALOA STATE WATER PROJECT (LOAN 2281-MEl EVALUATION SUMMARY 1. Description. Between December 1975 and May-1983, the Bank approved three loans, amounting to US$265.3 million (1186-ME, 1913-ME, and 2281-ME), to help finance three water/sewerage projects, consisting of a heterogeneous collection of water supply and sewerage (WSS) works for medium size cities. The projects consisted of: water, construction, installation, rehabilitation, or improvement, as appropriate, of wells, storage tanks, treatment facilities, transmission and distribution pipe, house connections, and water metersl and sawerace, construction, rehabilitation, or improvement, as appropriate, of pumping stations, treatment facilities, lines, interceptors, and house connections. Also included in the projects were miscellaneous equipment, leak detection programs, and accounting programs (paras. 3.11, 3.27, and 3.40). 2. Because these three projects relied on the same financing facility, the Investment Fund for Water Supply and Sewerage Works (FIFAPA) established at the National Bank for Public Works (BANOBRAS), and because they closely followed (1975, 1980, 1983) and resembled each other, Bank and Mexican officials adopted the practice of referring to them as FIFAPA I, II, and III rather than using their longer, official titles. 3. Borrower. Imolementina Aaencyv and Beneficiaries. Not only did the projects resemble one another with respect to works, but also with respect to: (i) borrower, executing agency, and beneficiaries (paras. 3.07, 3.24, and 3.36); and (Li) objectives, issues, and financing arrangements (paraz. 3.04-3.06; 3.16- 3.17; and 3.34-3.35). The loan for the first FIFAPA project (FIFAPA I) established the pattern followed by subsequent loans as to parties to the project ("institutional arrangements"). The borrower was BANOBRAS; the executing agency was the Secretariat for Hydraulic Resources (SRH)v the Federal water planning/ construction agency at the time when the loan was prepared; the beneficiaries were a shifting group of medium-size cities. The executing agency was restructured and renamed several times during project execution. In 1976, SRH was succeeded by the Secretariat of Human Settlements and Public Works (SAHOP); and in 1982, SAHOP was succeeded by the Secretariat of Urban Development and Ecology (SEDUE) (paraz. 2.07; and 2.10-2.13). 4. ibictives. Izszaes and Financina Arrancoments. FIFAPA I established the physical and other objectives followed by FIFAPA II and III (paras. 3.04- 3.06; 3.16-3.17; and 3.34-3.35). The physical objective of the FIFAPA projects was to extend and improve WSS services in medium-size cities. The other objectives of FIFAPA I -- financial, economic, and institutional -- includaed (a) introducing the concept of loan financing, as opposed to grant funds, to finance WSS works; (b) substituting "realistic tariffs" based on the concept of cost recovery for tariffs based on the concept of water as a "social" good; (c) establishing a suitable financial mechanism to channel and recuperate funds for works; (d) introducing the use of technical, economic and financial criteria in  - iii - the selection of WSS project.; and (e) improving the operational, adminiotrative and technical capacity of sector institutions at both the national and municipal levels. FIFAPA II, building on FIFAPA I, aimed at the organizational objective of decentralizing the sector by traneferring Federal responsibilitieo to state and municipalities. The objectives of FIFAPA III largely paralleled those of FIFAPA II. 5. FIFAPA I addressed very contentious issues for the state and municipal governments in a country used to "free" water that tariffs should cover costs and that interest-bearing loans should replace grants. For the Bank and the Government, the projects provided a unique opportunity for innovation. As such, the first project was responsible for creating the FIFAPA trust fund, a revolving fund that provided loan funds on the basis of cost-recovery and municipal commitment to the concept of financial self-reliance (para. 3.08). It also provided a basis for subsequent operations in the second and third projects. The third project included a pilot health education component which was intended to serve as a model for replication throughout the country. 6. Implementation Experience. FIFAPA I began in 1976 and ended in 1984, almost four and a half years behind schedule (para. 4.02). FIFAPA II began in 1981 and ended in 1986, two years late (para. 4.16). FIFAPA III began in 1984 and ended in 1990, about a year late (para. 4.24). To complete FIFAPA I without further extension of the closing date, the Bank agreed to shift remaining civil works under construction to FIFAPA II and procurement of materials (amounting to US$8.3 million) from FIFAPA II to FIAPAP I (para. 4.14). There was also a shift of works under FIFAPA II to FIFAPA III prior to the closing of Loan 1913-ME (para. 4.23). 7. The difficulties of FIFAPA I were somewhat redue d in the two subsequent projects, but not eliminated. Prior to 1979,the progress of FIFAPA I was hampered because of the considerable time required by the executing agency (SRH/SAHOP -- para. 3) to complete the evaluation of subprojects and because of the reluctance by locai authorities to adjust tariffs, and to accept least-cost alternatives (paras. 4.04). Implementation was also regularly hampered by jurisdictional disputes between the implementing agency and BANOBRAS and by staffing problems at the agencies. From 1979 to mid 1982, project progress was satisfactory due to personnel changes at SAHOP suggeoted by the Bank and due to the contracting of consultants by SAHOP to prepare appraisal reports based on least-cost principles. Due to sharp reductions in budgetary allocations for FIFAPA in 1982 and non-payments of contractors, the execution of FIFAPA I and II was effectively paralyzed for several months in 1982-3. After implementation was resumed in the second half of 1983, there were difficult discussions betw n BANOBRAS and the boneficiaries in connection with the renegotiation of subloan agreements. Renegotiation was required because of high inflation and frequent devaluations of the peso (para-. 4.18-4.19)1 hence, the subloans, which had been negotiated in a fixed amount of pesos, did not cover tho total subproject costs. Moreover, because the executing agency had carried out the contracting function without the participation of the beneficiaries, the beneficiaries were reluctant to increase their indebtedness, as they regarded the cost increases as overruns to a fixed-cost contracts rather than as legitimate price adjustments for inflation. 8. Inadequate information also hampered project implementation. Information to assome the financial performance of the sub-borrowers was  - iv - unreliable and incomplete, mainly due to three recurrent problems among the beneficiaries: (a) poor institutional capabilities which the project aimed at improving; (b) a lack of experience in reporting to federal agencies and; (c) lack of a sense of ownership of the project, which itself stood in the way of reporting to a central agency, either state or federal (paras. 3.24 and 3.36). 9. The timing of the loans also led to implementation difficulties. The first and third loans were declared effective shortly before new administrations took office in Mexico. While the Bank had explicitly noted the risks involved with proceeding with these operations at a time of change in government, it was decided that establishing the concept of cost-recovery and strengthening the institutional capacity of the beneficiaries were sufficiently important to sector development to justify the assumption of these risks. Moreover, the Bank also concluded that, instead of interrupting or postponing lending operations to accommodate administrative modifications and delays, these issues could adequately be tackled during project implementation. 10. In 1982, SEDUE succeeded SAHOP as the executing agency, and as a result of this development, there were major organizational and personnel changes in the executing agency. In 1983 and 1984, there was some project progress, but in 1985, the Project Implementation Unit (PIU) was abolished and its responsibilities were transferred to other units in SEDUE, causing serious problems of coordination between SEDUE and BANOBRAS. Meaningful supervision of beneficiaries and satisfactory reporting offectively were non-existent for about a year after the abolition of the PIU. (Because of the economic difficulties and natural disasters experienced by Mexico, the Bank deferred taking remedial action in the expectation that project implementation would improve. When this did not materialize, the Bank closed Loan 1913-ME in November 1986 and canceled the undisbursed balance of US$49.28 million. This action stimulated improved implementation of FIFAPA III.) To help overcome this recurring spat- of difficulties, the Bank worked out a "Plan of Action" with SEDUE and BANOBRAS, but compliance with its timetable was unsatisfactory and it was not sufficient to correct the difficulties, mainly due to lack of coordination and communication between the SEDUE and BANOBRAS (paras. 4.23 and 4.29). 11. During implementation of all three projects, Mexico continued to employ grant financing as well as loans at different rates and conditions through BANOBRAS and other lending institutions to finance investments in the sector. During appraisal of FIFAPA II and III, it had been expected that the budgetary problems of the Government would lead to reduced grant funding; but these expectations did not take into account municipal and state resistance to much reductions. These different financing windows resulted in an arbitrary structure of fund schemes and hidden subsidies through subsidized credits, which tended to mask system inefficiencies. Furthermore, these hidden subsidies stood in the way of efforts to implement least-cost solutions in the sector (para. 4.30). RUulta 12. Many physical targets were surpassed. The projects helped to finance 226,590 water and 130,300 sewerage connections, respectively, and served an incremental population of 1,870,300. Despite these achievements, the target p.rcentages for population served could not be met due to rapid population growth.  13. Concerning financial, economic, sectoral and institutional objective., results were mixed. The first objective, substituting at the national lovel loan financing for grants for the development of the sector, was accomplished only for FIFAPA operations, which only funded 8% of total sector investment (para. 6.08a). The second objective, the establishment of a sustainable financial mechanism to fund works for the sector was also only partially achieved. That in, the FIFAPA revolving fund was established in BANOBRAS, but, because relending rates were too low compared to domestic inflation, it became doecapitalized (6.08b). The third and fourth objectives were decentralizing the sector and substituting the concept of tariffs based on cost recovery for tariffs based on traditional concepts, i.e., water as a social good. Results have been mixed. The Government established the legal framework for transferring responsibilities to states and municipalities, but the local operators remained, for the most part, weak in terms of management, operations, and finances, *specially tariff levels (paras. 6.08c). The objectives of improving BANOBRAS and the executing agencies have not been met. (para 6.08d). Least-cost planning was established for all the works financed under FIFAPA, but not for all works carried out by the executing agency (para. 6.08e). 14. Sustainabilitv. The lingering problms besetting the FIFAPA operation clearly cast doubt on the *ustainability of the non-physical objectives of the projects. FIFAPA funded about 8% of sector investments. Yet, their influence extended beyond that small share by promoting cost-recovery and the uae of least- cost alternatives which were replicated in a numbor of cases throughout the country. The FIFAPA operation also served to establish a good dialogue with sector authorities and the three projects under review laid the foundation for the Water Supply and Sanitation Project, which was supported by Bank loan 3271-ME (1990; US$300 million). This project built upon sector work that focused on the institutional and financial problems of the sector and addresses the most important issues not covered by FIFAPA. It has both national and local components, and aims at: (i) furthering the institutional development of BANOBRAS, the National Water Commission (CNA), and the Mexican Institute of Water Technology (IMTA); and (ii) the rehabilitation and expansion of WSS systems in the poorer areas of subproject cities on a sound technical and financial basis. While it is till too early to assess fully the success of this ongoing project, it is valid to state that significant progress has been achieved. performance. 15. Bank performance was mixed. It was strong in reinforcing Bank credibility in Mexico by demonstrating support for Mexico at crucial moments (1983) and by combining the right combination of incentive and censure to correct institutional weakness at BANOBRAS and executing agency (1986); but poor in failing to address some important issues. At appraisal of all throe projects, the Bank did not recognize the potential for poor coordination between BANOBRAS and the executing agency or the need to provide for beneficiary participation in the project-preparation process. Thfse shortcomings in project design becam obvious during execution, especially with respect to the inadequate attention paid to the beneficiaries (paraa. 8.01-8.12). 16. SRH/SAHOP/SEDUE, the executing agency, which had a more important role ,to play than the borrower, performed in disappointing fashion while the efficient operation of FIFAPA by BANOBRAS counterbalanced its weak financial supervision of the beneficiaries. Both SRH/SAHOP/SEDUE and BANOBRAS failed to cooperate  -vi- effectively or carry out their respective functions promptly, but the executing agency, especially in the years 1985-1986, was particularly remiss with respect to preparing suitable subproject feasibility studies and supervising the projects (para. 8.12). Most important in assessing their performance was the availability of grant financing (85% of total sector financing) between 1981 and 1986, which undermined the central objectives of the FIFAPA operation. Findings and Lessons Learned 17. As experience .with this project demonstrates, the generation of support and understanding of project objectives at the local level are pre-, requisites for smooth and effective implementation. The Bank should have sought to develop such an understanding, through more intensive sector work and a more thorough analysis of institutional issues (para. 12.01 a). 18. In instances where the lead role for implementation can shift between the executing agency and the Borrower, the Bank must insist on a very clear definition of institutional arrangements and responsibilities. While some conflict was inevitable between the two Mexican institutions sharing responsibility for project execution, clearer delineation of roles and obligations during preparation would have likely mitigated some of these problems. The same judgment applies to the PIU (para. 12.01 b). 19. Projects that include a large number of subprojects also require more intensive supervision and field visits on the part of the Bank to assure smoother operation and implementation of procedures that are perceived as politically unpopular or too costly in the short run and to ensure a sense of ownership by beneficiaries by providing them a more significant role in project design. Had the Bank devoted more resources to supervision and local field visits, the spate of problems arising from a perception of lack of ownership by the beneficiaries would have been more adequately taken into account in the design of FIFAPA II and III (para 12.01 c). 20. A firm Bank stance can result in long-term gains. An example in point was the suspension of disbursements under Loan 1983-ME until the PIU's new staff stood in compliance with Bank Procurement Guidelines and Procedures. Another lesson is the utility of having agreed, country-wide bidding documents (para 12.01 d). 21. The FIFAPA operation illustrates the value of taking the long view. The projects were only one part of a larger effort to overhaul policy at the macro and sector levels. Notwithstanding the mixed results of these projects, the dialogue between the Government and the Bank continues and in connection with Loan 3227-ME there has been success in resolving issues posed by grant financing and settling jurisdictional conflicts. These achievements draw on the dialogue and experience under the FIFAPA projects; and hence appropriate credit should be given (12.01 e).  I  PROJECT COMPLETION REPORT MEXICO MEDIUM CITIES WATER SUPPLY AND SEWERAGE PROJECT (LOAN 1186-ME) SECOND MEDIUM-SIZE CrTIES WATER SUPPLY AND SEWERAGE PROJECT (LOAN 1913-MEl THIRD MEDIUM-SIZE CITIES AND SINALOA STATE WATER PROJECT (LOAN 2281-ME PART I. PROJECT REVIEW FROM BANK'S PERSPECTIVE 1. Identity Project Names: MEDIUM CITIES WATER SUPPLY AND SEWERAGE PROJECT, SECOND MEDIUM-SIZE CITIES WATER SUPPLY AND SEWERAGE PROJECT THIRD MEDIUM-SIZE CITIES AND SINALOA STATE WATER PROJECT Loan Numbers: 1186-MB (US$40 million; Approved, 12/75; Closed, 01/84), 1913-ME (US$125 million; Approved, 11/80; Closed, 11/86) 2281-ME (US$100.3 million; Approved, 05/83; Closed, 12/90) Borrower: National Bank of Public Works and Service. (BANOBRAS) RVP Unit: Latin America and the Caribbean Country: Mexico Sector: Water Supply and Sewerage (WSS) 2. ackaround. 2.01 Context Between 1974 and 1990, Bank and Mexican officials collaborated to prepare and execute the three water/sewerage projects covered by this project completion report (PCR). The Bank supported these project. with Loans 1186-ME, 1913-ME, and 2281-ME, amounting to US$265.3 million. 2.02 To evaluate the results of these projects, it is important to understand the context in which they were planned and executed. During this period, there were four Administrations -- those of Presidents Luis Echeverria (1970-1976), Lopez Portillo (1976-1982), Miguel de la Madrid (1982-1988), and Carlos Salinas (1988 to the present) -- during which there were extensive changes with respect to policy, personnel, and Government commitment to the objectives of the projects. Also during this period, there were major economic developments, especially in 1982, when the oil-related boom collapsed, thereby requiring a fundamental re-thinking of the national development strategy and the subsequent implementation of stringent measures to stabilize and restructure the economy. Besides changing Administrations and economic developments, the context included elements ranging from other water sector Bank loans to the evolution of water resource poliey and sector organization. Set forth below is the first of these elements; the other elements arm discussed in later chapters. 2.03 Bank Landina. Since 1973, the Bank has made six loans (US$675.3 million) to support water supply and sewerage (WSS) projects in Mexico (Part III, Table 1). Supported by Loan 909-MB (US$90 million; 1973), the first project was completed in 1981, five years late. The project .accomplished its objective of inereased water production capacity, but with  -2- respect to institutional objectives for the beneficiary, Comision de Aguas del Valle de Mexico, accomplishments ranged from poor to fair.'' 2.04 Supported by Loans 1186-ME, 1913-ME, and 2281-ME (para. 2.01), the projects covered by this PCR achieved their physical objectives of extending and improving water and sewerage systems (referred to hereafter as "local operators") and increasing service levels, but they fell short of their objectives of establishing an appropriate institutional framework and sound cost-recovery policies. 2.05 The remaining two loans are 3101-ME (US$20 million, 1989) and 3271-ME (US$300 million, 1990). In 1991, at Government request, the Bank canceled Loan 3101-ME (from which no proceeds were disbursed). Underlying this request was a change in the Government approach to alleviating poverty which made loan funds unattractive for the beneficiary states.r The project supported by Loan 3271-ME is proceeding on schedule and is expected to be completed in 1995. 2.06 Physical Characteristics. About three-fourths of Mexico is arid or semi-arid and its water resources are unevenly distributed. Areas of heavy rainfall are thinly populated, while dry areas contain the bulk of the urban population. Because the mismatch of water resources and population is particularly severe in the Mexico City Metropolitan Area (MCMA), the Government is encouraging the relocation of people and industry to other locations. About 80% of the surface water resources are found below 500 meters of elevation, while 75% of the population and 80% of industrial output are located above that level. Consequently, water in many areas is scarce and costly, accentuating competing demands on agricultural users, domestic users and hydroelectricity generation. 2.07 Current Sector Organization. Because of the competition among users, Federal agencies establish water resource policy and standards to assure allocation of this scarce resource in line with national development priorities. Federal agencies are also responsible for the planning and construction of major new works. For example, the Secretariat of Agriculture and Hydraulic Resources (SAHR) sets water policy; it also constructs and operates bulk-water supply systems to municipalities. The National Water Commission (CNA), established in 1990 as an autarkic agency under SAHR, provides technical support in water supply and irrigation to local operators. The National Bank of Public Works and Services (BANOBRAS) is a main source of financing outside the Federal budget. The Secretariat of Urban Development and Ecology (SEDUE) sets standards for water pollution control and protection of the environment. 2.08 Local operators provide WSS services under a spectrum of organizational arrangements -- departments of municipal governments such as public works; semi-autonomous municipal companies; or state companies operat- ing municipal systems. Some local systems are operated by a Federal agency, but since 1975, the number of such systems has been slowly declining. With 1. World Bank: Proiect Performance Audit Report: Mexico City Water Supply Proiect (Loan 909-ME), 'Highlighta", pp. iv-v, Report No. 4623, dated June 30, 1993. Z Idem., Proiect Completion Memorandum, dated June 21, 1991, pp. 3-6.  respect to management, operations, efficiency, information systems, and financial records, the level of performance by local operators varies widely. Thin organizational pattern for Federal agencies and local operators has prevailed throughout the period covered by this report (1974-75 to 1990). 2.09 Since 1983, Federal water policy and legislation have aimed at maintaining the policy-making and normative functions of Federal agencies, reducing their financing and operating roles, and expanding and developing the roles of local operators with the objective of reinforcing their autonomy and financial viability. These objectives represent a substantial change from the situation prevailing when Mexican and Bank officials began preparing (1974-75) the first project, known as FIFAPA I.F However, progress has been slow for a variety of financial, technical, and institutional reasons. 2.10 Former Sector Organization. In 1972, the Water Law assigned wide policy-making and operational powers to a Federal agency, the Secretariat of Hydraulic Resources (SRH), including responsibility for: (1) planning, constructing, and operating urban WSS works which relied on Federal funding; and (2) approving the schemes of other entities, even if no Federal funding was involved. SRH controlled about 200 systems directly and another 600 systems through Federal Water Board (Juntas Federals. de Agua).4 Federally- managed systems served about 20% of the total population. State and municipal entities managed the remaining systems. State governments set tariffs. As a consequence of its fractured structure, the activities of the sector were not coordinated. 2.11 The 1976 Administration Reform Act assigned the duties of SRH (para. 2.10) to SARH, its successor (para. 2.07); however, the same law also assigned to the Secretariat of Human Settlements and Public Works (SAHOP) the task of constructing and operating WSS systems outside Mexico City. Accordingly, SARH delegated actual construction and operation of specific schemes to SAHOP. 2.12 To operate at the local level, SAHOP established "Centroo SAHOP", or state offices; and operated some 1,200 systems. The operational performance of these systems was poor -- inefficient management, unclear financial policies, insufficient cash generation, lengthy delays due to centralized decision making at the national headquarters. This experience underlaid the decision (1980) of the Federal Government to begin transferring to the states the systems operated by SAHOP. Reinforcing this decision were amendments (1983) to Article 115 of the Constitution, assigning to cities and municipalities the responsibility for providing WSS services. In practice the local operators often required the help of the state and Federal governments (para. 2.07). _/ In connection with the fint project, BANOBRAS created a funding device with the acronym FIFAPA - Investment Fund for Water Supply and Sewerage Workh. Bank and Mexican officials adopted the pracice of referring to the various projects as FIFAPA 1, FIFAPA U, and FIFAPA m. The roman numerals permitted them to distinguish between the different projects (FIFAPA 1, n, and II) and the funding device (FIFAPA). Because the projecs tended to resemble each other and because the financing of subprojects was trnsferred between the Loans 1 186ME and 1913-ME and between 1913-ME and 2I81-ME as needed, Bank and Mexican officials came to think of the separate projects u part of single 'FIFAPA opeation. Part n makes plain the Mexican point of view. The approach of this PCR is to treat the project parately. I/ World Bank: 'Issues Paper", datod January 27, 1975, p. 2, footnote 2.  2.13 The 1982 Public Administrative Law created SEDUE (para. 2.07), which had powers and responsibilities similar to those of SAHOP, which was abolished. SEDUE was responsible for: (i) WSS policy and planning outside Mexico City; (ii) coordinating all state and municipal actions affecting the sector; (iii) providing technical assistance to the states; and (iv) supervising the construction of all subprojects. In 1990, CNA took over the technical assistance responsibilities of SEDUE. In 1992, SEDUE became SEDESOL (Secretaria de Desarrollo Social) and, as regards the water sector, its future role will be limited to setting environmental norms. Hence CNA's role has been further strengthened. 2.14 Current Obiectives. Unlike the situation prevailing during preparation of FIFAPA I (1974-75), the Government has established clear technical, organizational and institutional objectives for the sector. By the year 2,000, the Government is aiming at supplying piped water and sewerage services to 94% and 82% of the population, respe ctively. As for organiza- tional objectives, the Government is committed to: (i) retaining its policy- making and normative roles; (ii) reducing its financing role; and (iii) delegating the provision of WSS services to states and municipalities. The institutional challenge to the Government is to help the local operators to upgrade their performance. The Government is also committed to seeking private-sector participation through concessional schemes. Concerning finance, the Government aims at increasing the internal cash generation of the local operators and reducing reliance on Federal contributions. The Government is also seeking to develop the institutional capability of local operators -- state, municipal and Federal -- to address water pollution and environmental issues. Through the ongoing Water Supply and Sanitation Sector Project which is partially financed with Loan 3271-ME (para. 2.05), the Bank supports the objectives of the Government, especially the development of local operators that are technically efficient, financially independent, and institutionally strong. The Bank also supports: (i) reforms which deal with water supply in an integral manner, from its source to its disposal; (ii) unification of Federal and state financial assistance to the operating agencies under standardized criteria and conditions; and (iii) protection of the environment and improvement of water quality. 2.15 Macroeconomic Developments. During the Administrations of Presidents Echeverria (1970-1976) and Portillo (1976-1982), the Government continued to adhere to the inward-looking, state-contered national development strategy which had prevailed since about 1940. Consisting of massive Government investment in infrastructure, subsidies to favored sectors, protection for industry, etc., this development model had helped transform Mexico from an agricultural to an industrial/service economy. However, by the end of the Administration of President Echeverria, the limitations of this strategy were beginning to appear, especially as increased Government spending had not been accompanied by corresponding and appropriate increases in fiscal resources. These limitations took the form of a stagnating economy, high levels of inflation, and serious public-sector deficits and balance-of-pay- ments shortfalls. To stabilize the economy, the Portillo Administration initially had to undertake a macroeconomic program based largely on devaluation and fiscal restraint. However, following the discovery of major oil reserves in 1977 and the prospect of large oil-related revenues and fQreign borrowings to finance Government programs, the Portillo Administration abandoned its stabilization program and resumed a high level of public sector  -5- expenditures. Over the next three years, the strong growth of the economy masked serious structural flaws, including the stagnation of non-oil exports. 2.16 In 1981, supply conditions and prices in world oil markets began to ease. This development implied reduced oil revenues for Mexico and threatened to undermine the foundation of the national development strategy. By the end of the year, the financial and economic conditions of the country had begun to resemble those prevailing in 1976 with the added complication of massive capital flight. In 1982, the Portillo Administration, facing a full- blown financial crisiu, nationalized the banking system, which led to further loss of public confidence in the capacity of the Government to address the problems of the country. 2.17 The Administration of President de la Madrid (1982-1988), which took office in December 1982, introduced a stringent stabilization program. Further, based on a major re-thinking of the national development strategy, it began to introduce over the next six years important structural reforms to integrate Mexico into the world economy: dismantling trade barriers, joining GATT, reforming taxes to stimulate investment and non-oil exports, liberalizing financial markets, and privatizing public enterprises. As a result of these comprehensive policy measures, which have been continued and extended by the Salinas Administration (1988 to the present), Mexico has become one of the most open economies in the world and has started on the hard road to recovery. Growth rates again have turned positive. 3. Prepartion 3.01 FIFAPA I: Issues. In addition to the evolution of development policy, changes in Administrations, and changes in sector organization, the context surrounding these projects also included numerous other issues -- water-resource/population policy, finances, economic, institutional, etc. As shown later, some issues first identified in connection with FIFAPA I reappeared with some change or refinement in connection with FIFAPA II and FIFAPA III. 3.02 Bank and Mexican officials planned FIFAPA I in 1974-1975, during the last years of the Echevarria Administration (para. 2.15). The Staff Appraisal Report (SAR) for FIFAPA I states that except for setting target service levels for 1980 and except for the organizational responsibilities of SRH mandated by the Water Law (para. 2.10), there was no "overall sector policy" F At that time (1975), the Government was considering the recomendations of a draft sector study and a draft National Hydraulic Plan (PNH), both of which the Bank had helped to prepare. The PNH "...was designed to formulate a water development program consisting of specific projects ...and facilitate adoption of policy decisions concerning water use and development"J The sector study identified sector .I Ld., Araisal of the Medium Cities Water SupolV and Saweraae Proicet. Mexico, Report No. 8SSa-ME, dated November 26, 1975, p. 3. Hereafier referd to aSAR, LfIEPA 1. Also, the Staff Appraisal Reports for FIFAPA n and FIFAPA ml will be refcrred to in like manner - that is, SFIAPA n, and SAR. PIFAPA In.