Mexico - Highway Rehabilitation and Traffic Safety Project

Documa t of The World Bank FOR OMCLAL USE ONLY MICROFICHE COPY Report No.:P- 6035 ME Type: (PM) Title: HIGHWAY REHABILITATION AND TRA Author: PINILLA. L. ReportNo. P-6035-ME Ext. :38767 Room:I 8100 Dept. :LA2IE MEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT T0 THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN IN AN AMOUNT EQUIVALENT TO US$480 MILLION TO BANCO NACIONAL DE OBRAS Y SERVICIOS PUBLICOS, S.N.C. (BANOBRAS) WITH THE GUARANTEE OF THE UNITED MEXICAN STATES FOR A IGHRAY REBABILITATION AND TRAFFIC SAFETY PROJECT NAY 18, 1993 This document has a restricted distribution and may be used by recipients only in the permtoance of their official dutics. Its contents may not otherwise be disclosed without World Bank authorization. CURRENCY EQUIVALENTS Currency Unit = Mexican Pesos (Mex$) US$1.00 = Mex$3,095 (February 23, 1993) ISCAL YEAR January I to December 31 UNITS OF WEIGHTS AND MEASURES Metric BritishlUS Equivalent 1 kilometer (km) = 0.62 mile (mi) 1 meter (m) = 3.28 feet (ft) 1 gram (g) = 0.0022 pound (b) 1 kilogram (kg) = 2.20 pounds (b) 1 ton = 2,205 pounds 1 liter (It) = 33.28 fluid once (f1. oz) ABBREVIATIONS BANOBRAS National Bank of Public Works and Services (Banco Nacional de Obras y Servicios Pdblicos) DGP General Corodination for Planning of SCT (Coordinaci6n General de Plhneaci6n) DGCCOP General Directorate for Maintenance of Public Works of SCT (Direcci6n General de Construcci6n y Conservaci6n de Obras Pdblicas) ERR Economic Rate of Return ICB International Competitive Bidding LCB Local Competitive Bidding SICP Secretariat for Finance and Public Credit (Secretarfa de Hacienda y Cr6dito Pdblico) SCT Secretariat for Communications and Transport (Secretarfa de Coianicaciones y Transportes) MEXICO FOR OFFICIAL USE ONLY IGMWAY REHABILITATION AND TRAFFIC SAFETY PROJECT LOANANDEPROJE Borrower: Banco Nacional de Obras y Servicios Pdblicos, S.N.C. (BANOBRAS) Guaantor: United Mexican States EBecuto Secretarfa de Comunicaciones y Transportes Agencs and (SCT), and the users of the federal highway system. Beneficiarie: US$480 million equivalent. Tena Repayment in 15 years, including 5 years of grace, with interest at the Bank's standard variable rate. OD " term Loan proceeds to be relent to Government (for SCT) on the same terms and conditions as the Bank loan, with the Government bearing the foreign exchange and interest rate risks. EhNancin Plan: LOCAL FOREISMN TO]AL (In Million of U.S. Dollars) Government of Mexico 922.71 157.17 1079.88 IBRD - - 480.00 480.00 Bilateral programs (Sweden, U.K. and France) -. 0.12 0.12 Total 922.71 637.29 1560.00 ECOnmic Rate of Retu: The ERR of most of the highway rehabilitation works, the main project component, will be in excess of 25%, except for a number of subprojects for which the accumulated total investment does not exceed 10% of the budget for the year in which such subprojects are being considered; such portion of subprojects would require an ERR of at least 12% each. Staff Awaraisal Renort: Report No. 11720-ME, dated May 18, 1993 Me: IBRD No. 23709 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. MEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO BANCO NACIONAL DE OBRAS Y SERVICIOS PUBLICOS, S.N.C. (BANOBRAS) WITH THE GUARANTEE OF THE UNITED MBXICAN STATES FOR A HIGHWAY REHABILITATION AND TRAFFIC SAFETY PROJECT I. I submit for your approval the following memorandum and recommendation on a proposed loan for an equivalent of US$480 million to Banco Nacional de Obras y Servicios Pdblicos, S N.C. (BANOBRAS), with the guarantee of the United Mexican States, to help finance the Government of Mexico's Highway Rehabilitation and Traffic Safety program. The proposed loan will be repaid over 15 years, including 5 years of grace. Part 1 of the -ocument contains a discussion of Mexico's economic policies and the Bank Group's assistance strategy. Part 2 describes the proposed loan. PART 1 COUNTRY POUCIES AND BANK GROUP ASSISTANCE STRATEGY A. HISTORICAL PERSPECHVE AND RECENT PERFORMANCE 2. Mexico, as it enters the mid-1990s, has both (i) considerable strengths to build on, due in part to the extensive reforms implemented since the mid-1980s, and (ii) some important challenges still to resolve, particularly relating to short term economic prospects. Historical Perspective 3. These strengths and challenges have emerged from events that unfolded in three distinct periods. 4. Pre-1982. From 1940 to 1980, the country enjoyed four decades of high growth and stability, with GDP rising a robust 6.2% per year on average. Gradually, though, the seeds of future difficulties took root. Steady deterioration in productivity (with total factor productivity growth falling to zero in the 1970s), large increases in public spending in the 1970s (taking the primary deficit to 8.0% of GDP by 1981), upsurges in inflation (climbing to 30% by 1981), overvaluation of the exchange rate, a boom in imports (which increased fourfold between 1975 and 1981), an explosion in public debt (rising from $7 billion in 1972 to $78 billion in 1981), and an ensuing burst of capital flight - all left the country highly vulnerable. 5. 1982-1988. In 1982, foreign creditors, concerned about these unsustainable policies in light of rising world interest rates and falling prices for oil (then Mexico's leading export), stopped extending new credit. By August, international reserves were exhausted and foreign debt service had to be suspended. A stabilization program and fragile recovery followed, but it soon became clear that addressing short term stabilization issues alone would not be enough: the underlying structural problems in the economy would also have to be dealt with. Two maor shocks - the Mexico City earthquake of September 1985 and the oil price collapse of 1936 - added to the difficulties. A new adjustment program, signalling an important change in direction, was initiated in 1986, emphasizing rigorous fiscal discipline and liberalization of trade. A further boost came in late 1987 when the Government, business, and labor reached agreement on the first of what became a series of accords (the Pactos) that enabled structural reforms and fiscal discipline to go forward in an environment of constrained wage and price increases. Looking back later, some observers have concluded that Mexico's successful recovery required all three of (i) stabilization, (ii) adjustment, and (i) the Pactos, and that any two of these would not have been enough. 2 .t.mate r 11 g; OR A"'.4,R, XX"% ,4.. . . .......4j%'. ....' . Real .rowth5Rates .. ..~ ....... Gross Jvestas (as(% of cant 0PG . 21.3 r' 21.6 Private Fixed Invebtmeit 1.1 17.1 17.1 Public Fwd iestot . .4. 3.9 . . 3.9 CbhaeStocks . . ..0) 0.5 ICOR (5-yr moving avera) 6.7 .3 5.4 21 Dowestio savip ("%.of meodA .0 .17.1 .. Cnent Accout.Qs %of n P 4.6 -4.9 -4.4% . Ilatio (ye4d. . . ..8 58 119 6.8 creditw6rd-Anes. I&rli DODMGDP 0 . 33;Z 35: 4., '0.5 TOW 6t io.024 Ottdn t I .10.0 IBRDionatry PtboDSiS1 k. . 21* $ ,20.2 WR 'WICjdu~p 4 . 32- ;Y ICOR ae dWe pei d, m Asad odditakesthee is on5etiner a 4nes. . 6. 1988-1992. In December 1988, President Carlos Salinas de Gortari took office and his administration immediately strengthened the reform process further. In the next four years, Mexico achieved a remarkable turnaround. GDP growth rebounded to 3.7% per year for 1989-91. Inflation plummeted as may be seen in Figure 1, Annex 7. (Figures 1 to 10 are contained in Annex 7). Fiscal discipline converted a large deficit (15.8% of GDP in 1987) to a srplus (0.4% in 1992) in the overall balance (excluding privatization receipts). This was reflected also in an improved primary fiscal balance (Figure 2). An aggressive privatization and closure program reduced the number of public enterprises from 1,115 in 1982 to 221 in 1992. Extensive trade liberalization transformed Mexico from a highly closed economy to one of the most open in the world - with more to come if the North American Free Trade Agreement (NAFTA) is ratified. Public sector debt shrunk from 62.4% of GDP in 1988 to 28.4% in 1992, which is less than half the corresponding figures for the U.S. and Japan. International reserves tripled between 1988 and 1992 (Figure 3). Sweeping tax reforms, deregulation, reduction of subsidies, and financial sector reforms underscored radical changes in the roles for the nublic and orivate sector and a strom commitment to nrivats ectnr led arnwth 3 Recent Performance 7. The strengths that Mexico now has as a result of these impressive accomplishments are substantial: a stabilized, liberalized, and privatized economy, with a fiscal swplus, ample international reserves, good access to international capital markets, diminished public debt, and low irJation. The principal objective of the Government!s macro program -has been to reduce inflation, so as to create a solid foundation for long-term growth, and in this the administrationhas been outstanding successful. Inflation fell from 159% in 1987 to just 12% in 1992, with less than 10% likely for 1993. 8. The challenges that remain are related to the fact that the economy has not yet responded vigorously to th5 reform measures. GDP growth, only 2.6% in 1992, is still weak. So is productivity growth: total factor productivity has been increasing at under 0.5% yearly, less than a fourth of what Chile and Indonesia have recently had. The current account deficit is large, at $22.8 billion, or 7.1% of GDP, in 1992 (Figure 4), largely as a consequence of declining private savings (Figures 5 and 8). Imports have grown strongly (22% in 1991 and 26% in 1992) while exports have risen more slowly (2.6% in 1991 and 3.5% in 1992). Interest rates are high: nominal short term Government borrowing rates were 17 to 18% In March 1993, up from 11% a year earlier; and real rates were close to 8%. Total investment has not grown as a share of GDP since 1989 (Figure 5). 9. The combined presence of these trends has been noted by international investors. If GDP and productivity were growing strongly as a consequence of higher investment, then a large current account deficit would be understandable: a developing econor3y would be investing in its future with the help of foreign capital. However, with weak GDP and productivity results, the high current account deficit has raised some concern among investors. 10. The large capital inflows that have financed the current account deficit have been sufficient to maintain a positive balance of payments and permit strong growth in international reserves, which are now over 6% of GDP ($18.5 billion at the end of 1992, and higher more recently). However, these inflows have changed in character recently. From the late 1980s, when they began, until the first half of 1992, they appear to have been a response largely to the improved climate for investment in Mexico, reflecting confidence in the reform program. More recently, they have been driven more by the large differential of Mexican over international interest rates (Figure 7). This differential rose sharply in 1992 when the Government further tightened monetary policy as it saw capital inflows starting to decelerate. Given the potential volatility of capital inflows, especially when they include considerable short term money attracted by interest rate differentials, developments affecting capital movements will need to be watched closely. 11. Exchange rate policy has since 1988 been one of small daily nominal devaluations, at a pace less than inflation, thus leading to appreciation in the real exchange rate. In October 1992, the Government moved to an explicit band system. The ceiling of the band is now raised by 0.04 new centavos per day (about 4.6% in a year), while the floor is kept fixed. Within the band, the actual spot exchange rate is set by market forces, and is determined in part by monetary policy through its impact on interest rates. With the widened band, the real exchange rate conceivably could stay about constant now (unless Mexican inflation were to be above 10%), instead of continuing to appreciate. 12. The decline in priate savings (Figure 8) has exceeded an increase in public savings, which have nearly tripled since 1988. The result has been a decrease in total savings, implying increased dependency on foreign finance for new investment. Consumption booms (savings declines) are not uncommon in countries coming out of economic crises and a stringent stabilization program, although Mexico's has been larger than most. 13. Primwte debt has been rising briskly, as Mexican banks and corporations have increased their borrowings from abroad in the face of high interest rates at home. Aware of the questions this trend might raise about increased 4 exchange rate exposure, the central bank instituted limits in April 1992 on banks' foreign borrowing. Meanwhile, public debt has continued its decreasing trend as a share of GDP (Figure 9). 14. The banking sector, while generally healthy, still needs extensive modernizing. Although none of the 19 commercial banks is reporting difficulties at present, it would not be unusual, given other countries' experiences, for a few to have problems sometime in the short to medium term. Non-performing assets, recently at 4.7% of their total portfolio, have been growing rapidly, although from a low base. Part of this increase is a result of the banks introducing stricter standards in the renewal of credit. 15. The high interest rates have impacted private sector development. While the largest and best-off firms, with their access to external markets, can often borrow at the currently low international rates, smaller or less profitable firms have only the local markets (where nominal rates can be 25% to 35% or more for some borrowers), at a time when they urgently need to invest to meet the stiff foreign competition unleashed by the removal of trade barriers. 16. Perhaps the single most puzzling question is why GDP and productivity have not grown more. Their present growth rates are low by historical standards as well as in comparison with other countries with successful adjustment programs. Chile and Indonesia, for example, have had better than twice the GDP growth and four times the total factor productivity growth. Possible explanations that have been advanced for Mexico's case include: that more time is required for the positive effects of the reform program to take hold; that a substantial share of the existing capital stock has become economically obsolete, partly as a result of the reforms, and has to be replaced, which requires time; that the reforms have been piecemeal with some key sectors, in particular agriculture and financial services, left until later, and that therefore productivity in these sectors has yet to improve, thus weighing down the total; that important areas of reform, such as increasing flexibility in labor markets, have still to be addressed; that infrastructure growth has been inadequate; that the exchange rate appreciation has slowed the growth of the tradeable goods sectors; and that the continued tight macro policies (while necessary for the continued reduction in inflation) have restrained expansion. The Government has also explored sectoral constraints (Box 1). Bank economic and sector work and economic monitoring will focus on identifying and addressing the casues of low GDP and productivity growth. 17. As the Government addresses these challenges, the strengths it now has to draw on will be a powerful asset. Its strong fiscal position, plentiful reserves, and good external creditworthiness will give it space to manoeuver. Its successes in sharply cutting public debt, slashing inflation, shrinking the size of the public sector, tearing down trade barriers, and redirecting the role of Government to be more supportive of private sector initiative will mean it is free of many burdens that other countries are still struggling with. Its advances in implementing extensive sectoral reforms will provide a strong basis for greater efficiency and increases in productivity. The deepening of the reforms continues at an impressive rate, even in comparison to the high standard set in the mid and late-1980's. In the year and a half since mid-1991, the Government has: (1) enacted fundamentally reforms to the ejido system of land tenure; (2) re-privatized the commercial banking system; (3) legalized private generation of electricity; and (4) assigned an increasingly important role to the private sector in building and operating infrastructure. In short, the Government has put in place the fiudamentals for sustainable, private-sector-led development, and thus is strongly positioned to confront the challenges before it. B. THE EXTERNAL ENVIRONMENr 18. The main issues for Mexico now regarding external factors are: the North American Free Trade Agreement (NAFTA); the economic prospects of its trading partners, especially the U.S.; the terms of trade, including oil prices; and developments in international capital markets and their impact on private capital inflows into Mexico. 5 19. NAFTA. Implementation of NAFTA has been a paramout goal of . the Salinas administration, on a efforta to consolidate and accelerate the Tn economic modernition already In A process. By May 1993, the prospecta nMUa for approval by the U.S. Congress i#.aueMy the coto emping red--ction- tai dnon seemed less assured than earlier. A successful outcome is nonethees stil Matok 99 t co e cne raked by t laton possible, some observers feel, noting that . a all the key parties Involved have more ta anÉmpt p gain by going ahead than not, despite the no tough rhetoric and posturing to the contrary that would dominate the closing *n dpr n stages of the negotiations. Even the uye, critics - especially labor and M r environmentalists - would have an l.e - a opportuity to achieve major gains they d might not get otherwise, since the U.S. and Mexican negotiatora' eagerness to be responsive to the these concerns mght Canp not be the same if the NAFTA talks p te ds broke down. In addition, NAFTA's xemspewa d and th progresoc t n oo chieved to date (Box 1) could not be e o nt d Jgnored.-AT%ogenmaanaloatenertowt 20. If NAFTA la not implanentrd o the consequences for Mexico could be à t v substantial. The Immedate reaction n could Include sharp adverse effects on p ad capital flows, Invetment, and savings, as investor confidence ffr and the .ite tv, h Uo n db e credibilty of the Government'S policies . was questioned. Ihe implications of these developments, together with the political ~mpact of a major defeat on a prominent priority, could potentially lead to ahina in the views of the Government, and reconsideration of some policies. Abandonment of NAFTA would not, by itself, be destabilizing, given the economy's fundamental strenghas due to the achievemnts of the reform program; but if dropping NAFTA resulted in a weaning of cmmitment, or to policy reversals, problems could arise in the short term. While the Government would have the means at its disposal to cope with whatever challenge. that might ensue if NAFTA were defeated, there would be conflicting pressures, especially given that 1994 is a presidendal election year. 21. If, on the other hand, NAFTA is implementu Its Impacts on Mexico would be far-reaching. Besides the expected galna in growth, employment, wages, and trade, NAFTA would give greater permanency to the Salinas reforms, as growing integration of North American markets backed by legally binding international unde andings would make reversals by future administeations difficult and unlikely. 22. The effects on the g sector would unfold fastest. Sectors where Mexico has a cmparative advantage - such as textiles and apparel, glassware, food processing, beverages, and electroncs - would 6 expand, as Mexico's lower labor costs come to bear. Sectors and firms that do not restructure and improve productivity quickly enough would fall behind their northern competitors, or be absorbed in joint ventures. The banking, transport, and telecommunication sectors would face stiff new competition from US and Canadian firms, which would lead to lower costs and more efficient services for consumers. 23. Agriculture and related sectors would experience both gains and losses. The basic grains would be hit hard by competition from more efficient U.S. producers, especially maize, where maize currently accounts for over one-third of the total arable land and is grown by over two million producers. The removal of protection on maize (domestic prices are now 70% above international prices) would shaply affect output, rural wages, rural poverty, and migration to cities. Other farm products - principally fruits and vegetables, where Mexico's climate is an advantage - would gain, and become a source of increased growth, exports, and jobs. However, these benefits would accrue predomiantly to the irrigated and tropical wetland parts of the country, rather than the rainfed areas where the maize losses would mainly occur. To mitigate the adverse consequences for those negatively affected, and to safeguard the impoverished, the Government Is preparing special programs, with Bank support, to ease the transition to new sources of income and employment 24. Economte Prospectkfor Mexico's Tding Partnef . Demand for Mexican products abroad has been dampened in recent years by the slumping economies elsewhere, especially the U.S, which accounts for 75% of Mexico's exports and 71% of its imports. The next few years are projected to be moderately better. Growth in the industrial countries is expected to recover to around 2 percent per annum in the short term and then remain at a modest level in the medium term, due to slow productivity growth and poor savings performance in some major economies.1 The U.S. economy has been picking up steam recently, although the recovery remains patchy and uncertain. 25. World trade is projected to rise faster than industrial country growth, in part because of increased trade bitween developing countries and in part because of the impact of regional arrangements. The disappointing progress of the Uruguay Round of Multilateral Trade Negotiations, and general rise of protectionism worldwide, are of concern. However, Mexico's trade with the U.S. is likely to continue growing rapidly, all the more so if NAFTA is implemented. 26. Terms of Tade. Mexico's terms of trade are projected to be roughly constant in the short term, with some improvement toward the end of the decade due to higher oil prices. The Government maintains a highly disciplined approach to oil, still one of the country's largest export revenue earners (though smaller now than before - see Figure 10). Unexpected oil price declines are guarded against by hedging in futures markets. Windfall increases are deposited in a special account used only as insurance for the fiture or to reduce debt. Strictly isolating oil revenues from the general budget protects against the "Dutch disease" tendencies that upset fiscal policy in the years leading up to the 1982 crisis. 27. International Capital Markets. Mexico now has access to the major external capital markets, particularly in the U.S. and Europe, after having been excluded for most of the 1980s. Both the Government and major private companies are now able to issue bonds in these markets on good terms, with maturities of up to ten years and spreads as low as 200 basis points over equivalent U.S. Treasury issues. Continued improvement of terms is likely as long as investor confidence in the economic program holds, and will favorably affect financing possibilities for investment, including infrastructure improvements. 28. The large capital inflows Mexico is now receiving, like all such private flows elsewhere, could diminish if investors chose for any reason to put their money elsewhere. The external factors that have contributed to stimulating the inflows show signs of persisting for now, but conditions could always change, e.g., if there were 1. Tis& section draws on *Global Economic Prospects and the Developing Countries 1993', International Economics Department, February 25, 1993. 7 a delay in the implementation of NAfrA or the economy failed to improve. One such factor, already noted above, is that Mexican interest rates are significantly above U.S. rates, creating a very large interest differential. A significant increase in U.S. rates would erode this differential, though even the most extreme projections for U.S. rates for the next two years would still leave them far below current Mexican rates. In any event, Mexico would always have the option of using monetary policy to raise their rates too - and have shown in 1992 that they are ready to do so if necessary. C. THE BANK's COuNTRY ASSISrANCE STrATEGY 29. This section is struc'ured as follows. The main thrusts of (1) Mexico's development objectives and (2) the Bank's objectives are briefly summarized first. Then subsequent st ' tions, elaborating on both Mexico's and the Bank's priorities and programs, focus on (3) macroeconomic pohy, (4) poverty reduction, (5) human resources development, (6) the environment, (7) infrastructure, (8) agriculture, and (9) institutional strengthening. The areas of special emphasis for Mexico are covered partly in these discussions (e.g., poverty reduction) and p.rtly in a further subsection (10) concentrating on issues not already highlighted. 30. Finally, (11) the lending levels and composition of the Bank's program, (12) portfolio management, (13) IFC and MIGA, and (14) cooperation with other multilateral institutions are discussed. MWexico's Development Objectives 31. The Government remains strongly committed to the objectives and policies that have guided the reforms accomplished under President Salinas. The goal of completing within the decade the final steps that will lift the country once and for all into the ranks of the most developed nations is widely shared, and to many seems closer now than ever before. OECD membership and further trade with the U.S. are expected to come eventually and quicken the pace. Contination and further enhancement of current strategies are seen as vital, particularly on the core concerns of (1) the economy and (2) social issues, including poverty, human resource development, and environment. (The distribution of Government expenditure by sector is provided in Annex 2.) 32. On the economy, the principles used successfully to stabilize, liberalize, and privatize the economy in earlier years of the administration are still very dominant. A fundamental reshaping of the roles of the private and public sectors, a vigorous drive to lower trade barriers, a strict adherence to tight fiscal discipline, and a sharp reduction in regulatory and legal impediments to economic activity - with an overriding interest in creating a level playing field for all - are seen as crucial for promoting private sector led growth and accelerating long term development. 33. On social issues, President Salinas has breathed new life into long-standing goals, particularly with regard to reducing poverty, upgrading education, and attacking environmental problems. Details are discussed in the sections below. Overall, the aim is to energize social policies in ways that (1) sharply improve services that government should provide (and leave others to the private sector), (ii) bring real change for the better to the least advantaged, who in the past frequently got promises but little action, (iii) promote and draw on grass- roots organizing of local people, right down to the neighborhood level, and (iv) complement the rigorous market-oriented economic program with help for those it misses or affects adversely in the transition to faster growth, but without blunting the progress of economic reforms. The Bank's Objectives 34. The Bank's strategy, in support of promoting equitable, sustainable development, will focus on: (1) reducing poverty and improving human resources development; (2) protecting the environment; and (3) reviving growth and 8 favilitating private sector development through addressing constraints in physical infrastructure and Institutional development. This will involve assisting the Government in deepening ongoing sectoral reform programs that are succeeding, reorienting those that are not, and Identifying further Issues that, If not addressed, could develop into problems in future. The Bank will thus remain a strong supporter of the Government's program while also helping to bring about change where needed. 35. To these ends, the Bank will be paying particular attention to the areas elaborated in the subsections that follow. Macroeconomic Policy 36. The current administration has emrhasized that it Intends to remain firmly on courze with the macroeconomic policies that have served it well since 1988. The challenges It faces (see "Recent Performance" above) will be addressed with the aid of the strengths it has (also described above - i.e., its substantial budget surplus, drastically reduced public debt, plentiful reserves, sharply decreased inflation, strong external creditworthiness, and successfully completed restructuring of governments role). The next administration (with a new President, since the constitution prohibits reelection) will start its six year term in December 1994. The contenders presently considered the most likely possibilities all appear commited to continuity, although much may yet change before the future direction is clear. 37. Government leaders expect a gradual recovery leading to higher growth by mid-decade. The next year or two, they realistically project, will be sluggish. The main risks are that the economy does not improve fast enough, or worsens before it gets better. In that event, a slower - and less smooth - path to revived growth would result. Even in that scenario, though, Mexico would remain creditworthy and in a manageable debt posture. 38. The experience of other countries pursuing similar stabilization/reform programs suggests that Mexico's current challenges are not unique or insurmountable. As the Government has emphasized, exchange rate management is difficult in the face of strong foreign capital inflows; an increase in consumption is not surprising once an economy begins to recover from such a recession as Mexico went through, as well as when pervasive import controls are lifted; and time is required between when reforms are announced and their effects on efficiency and production will be seen. 39. For these reasons, we share the Governments view that the medium-term prospects for Mexico are good. Still, short-term challenges do exist and will need to be managed. The goal now is to reverse and recover from short term slowdown while also working toward long term development. While demanding, this dual agenda is well within reach. The outlook for the next few years remains positive, though with more risk than anticipated a year ago. Even with the recent uncertainties, Mexico's situation is far better than at any other time in it recent history, and more secure than that of many other countries. Poverty Reduction 40. The Governments strategy for attacking poverty involves action on several aspects of the problem simultaneously. The Bank's assessment concurs with the Government's on what is needed now. The Bank will assist in each of the areas listed below.' 41. First, economic growth is vital. The economic policies now in place, if continued and extended, offer the best route to restoring sustainable growth. The importance of growth for poverty reduction has been demonstrated 2. Poverty information (Box 3) is available in (1) the last CEM ("Mexico in Transition: Toward a New Role for the Public Sector', May 1991) and related papers and (2) "Poverty and Income Distribution in Latin America: The S'ay of the 1980sO, December 1992. 9 clearly by international evidence, ai was shown by the World Development Report for 1990. Even the poorest 10 percent of a population benefits when an economy is growing, and Sox 2. overty In, Ivdco the losses to the poor when growth Is lacking can dramatically exceed what they can gain from special poverty Abot 20 p t of the populadon assistance programs. Furthermore, the poor benefit more nbaists an less than US$350 a person a year and than proportionately from growth when other initiatives such an even geater number, though above this as those described below are also undertaken. extremely low levol, livean vey meager Incomes. The gap between tich and poor is large, reflecting 42. Second, social services need to be adequately a distribution of Income. that, as in many Latin supported and sharply improved. The Salinas administration Ameie couNeei t is bhyt skewed. The has taken bold action in this area. Previously, public poorest 10 petnt -fthe population survive on expenditures on social services heavily favored the better-off one evn tht luaea level of the richest 10 states, and spending cuts in the 1980s undermined efforts to percant, ac cin to-dos o Avera per capita expenditume, ShM.JW 1940pverty. is believed to reach the poor. Real per capita expenditure on social hav:f it declined th. In the economically services declined throughout the 1980s, especially in the Wubled 19s woireneb. T .13% drp in per health sector. Since 1989 there has been a sharp capita incume in 1A tbd0 affcted the poor at improvement, with education's share of the total budget lh possibly more s. rising from 4.9% to 12% by 1992, and with health's share increasing from 0.7% to 1.7%. President Salinas has made a highly visible effort to correct these imbalances and to ensure adequate provision of social services and basic infrastructure to disadvantaged areas (Box 3). 43. Third, and a critical part of social services upgrading, emphasis on human resources development is needed to assure that the poor are healthy enough and educated enough to take advantage of new opportunities arising from growth. Here, too, new steps are in process (see next section). Removing barriers that impede the poor is especially important for women (see section on areas of special emphasis). 44. Fourth, these efforts must include assuring that the new Income-earning opportunities generated by growth are not wasted because the poor lack the necessary job skills or cannot overcome other barriers to access in labor markets. The most important - and frequently the only - asset the poor have is their own labor. Skills training can help them use that asset better, and is being actively promoted by new Government programs. Currently, the Government is providing retraining to about 60,000 unemployed workers per year. Comparison with those not receiving such retraining demonstrates increased earnings of upwards of 30%. In addition, the best training is stwi often work itself, as experience and on-the-job training lead to new competencies. Government policies are effectively supporting that concept as well, through facilitating private-sector-led growth that will result in increased demand for labor. The maquiladora industries in the north hav 'iown vividly how untrained, poorly educated farm laborer can transform themselves into efficient factory v, .ers. A flourishing of informal sector development, which for many of the poor can be a first step toward better jobs later, is also essential. Small and micro enterprises account for 48% of employment in the food industry, 68% in the textile industry, and 90% in retailing. Old regulations impeding informal sector development have been lessened some, but further progress is required. Other barriers the poor face in labor markets include geographic isolation for those living in many rural areas, and hiring practices that in the past have resulted in some groups faring better than others (e.g., men compared to women). Rectifying these problems has only just begun and will be a lengthy process. 45. Fifth, the special problems of the rural poor must be confronted. Of the approximately 21 million people (25% of the total population) who live in rural areas, 12 million are extremely poor (subsisting on less than $350 per person per year), and many of the rest are at levels not much higher. Over 70% of Mexico's extreme poor are in rural areas. The poorest of the rural poor have higher dependency ratios, more children, and higher proportions of female headed households. The prospects for the rural poor will depend in part on 10 the effects of the recent trade liberalization B 3. -b h measures, most notably the gradual decontrol of maize prices. While some rural groups (e.g., Solidridad fforts tory in M o a growers of fruits and vegetables) will gain, the e S th Naio poorest - who depend a maize now and live in solidaity Pr , initiated by P et areas where few other crops are profitable - will Salinas.in December 1988. Responsible ft lose. To offset this effect, the Government is tageting health, educationW Ntrition, actively developing programs that will employment, infratnuctu, nd other compensate losers and provide a rural safety net proutv rjcst h or oiaia for those impacted most. ha grown insz ad coverag. ts budget 46. Sixth, wrban poverty must also be tnS. bilin 99 Whii ed ~.. tackled. Of the 64 million urban dwellers, 5 beneicirie a "Mec irgd to . patiiat7 million are among the extreme poor and up to 40 epon efo. uts and. dependin ot million others are moderately poor. Conditions ,are en for most of these households are difficult, . lad i e lha ln more particularly for those living in squatter resoutetothe poor neighborhoods where basic services - such as water, sanitation, electricity - are deficient or World Bn W B s a r ta fa nonexistent. Urban growth continues at a rapid 1 o o to . ec .s por Unde ....h. pace, and would accelerate further if NAFTA is ma*nXllafthP and in ratified; but most growing cities lack an urban eoma e iagdevelopment strategy. New efforts are being the World Bank hasc.dinte d packge. made to help them develop strategies, and a "100 Mb.X poect *treted t ChiSa : cities" program is focussing attention on the most o .[ glaring problems, such as water supply and is being o e fr sanitation. Efforts to expand the provision of knft=tue primy .educaion, and housing are also imperative, given that there is a heaWth OM. In addtton, othr Bak pretw - housing deficit of 6 million units. Significant - a.g., on *atr supply and eoitation, and on reforms in the housing sector have been initiated housing - mve addressed the problems of the that should enhance the targeting and efficiency poor. of public subsidies to ensure they reach the needy. 47. Seventh, the changes set in motion by the economic and sectoral reforms (and accelerated by NAFTA, if ratified) will have transitional effects that could adversely impact some of the poor not just in agriculture but in other spheres as well. Restructuring of industries and conversion to new technologies, some of them more capital intensive than the old ones, will lead to job losses, and although the overall effect on employment is likely to be eventually quite positive, the transition process could be dif icult for some, especially the unskilled. The Government hopes that its growth-reviving policies and other measures, including the Solidaridad program, will minimize this problem. In addition, it is stepping up efforts to ease access to credit for medium, small, and micro enterprises. 48. The Bank's support for the Government's program in these seven areas will be contained in lending operations with objectives as outlined in Annex 1. Human Resources Development 49. The Government and Bank share a common view that strengthened human resources development will have multiple benefits: poverty reduction; economic growth; and improved welfare generally, through the direct effect that better education, health, etc. have on the public wellbeing. 11 50. Education. Deep-rooted deficiencies in the education system (Box 4) Box 4k The Education Challenge are being aggressively addressed by the new Government initiatives, with Bank support. Salleas adnistrion took a clt look t the A Primary Education project in the four education system, they quickly concluded that a compte overbaul poorest states (Oaxaca, Chiapas, Guerrero, was needed. the problems are basic, running from omplete and Hidalgo) and an Initial Education project eces0(especlly n the poorest states) ad high drop-out rates to (for children ages 0-4) in ten of the poorest Moorquyadlowr Msurce utiAlonfficiey. petitiontates states are now under way. Both projects are aroundZO% iationally, up to 30% in the poorest states, and can emphasize institutional strengthening, ra upto 50% inrsural areas in he early priary grades. An educational quality and efficiency e 0 childrenabandon prary ashooleach year,umout improvement, and targeting of disadvantaged befwe pleting third grade ol50% ofstudents terin first regions and population groups. Bank grd complt the six year Of .he primarycyh o t ilin groups. adnlts are illitert adults, ad onlyr half of the adult populationas assistance is also improving the supply of c education, Educational mate4als are in abost textbooks and audio-visual materials to the sply,andi are oten unable to take rural poor. In the future, the Bank will aete f assist the Government strategy to expand these efforts to other states, targeting the A new Wvtalizatloa program Is _aow.n neediest first. Urgent needs for improving s gffe.tiveledership. Theeuctnbudget,longstarvead has teaching will be addressed through a national been increased from -% to 4.2% eDP our thelst.4 years, teacher training project in FY94. Once these despitet tight fisual po thatandinto issues are adequately dealt with, the Bank iad prescl educatioR have beco deciated ational will support expansion of basic education to p Ad classes have expaded rapidly to6% the lower secondary education level and c rW h ag o v toprou and ening of preschool (ages 5 and 6) and _ _ _m hot o h b tedmicallvocational education. Mfor stp ivill folw statesvaywflinter aclabiy 51. Skls Trubdg. Mexico has well- t...... .td developed and sensible policies in e l e.r a employment and in labor markets, with a relatively strong involvement of the private sector. More needs to be done, though, to fully implement these policies and thereby optimize the gains expected if NAFTA is implemented. Priority areas for further improvement include the efficiency of resource allocation in technical training (through greater emphasis on shorter courses linked with the needs of the private sector), improved targeting of training for the unemployed (through giving priority to those with prior work experience), innovative training programs for under-educated rural migrants (initially on a pilot basis in Guanajuato, Queretaro, and Mexico City), and capacity-building for small entrepreneurs. Bank support has led to a new Labor Markets and Training project, with possible further steps in future. 52. Health. Like education, the health system has much unfinished business to attend to (Box 5), which the Government is now turning to in force, with the Bank assisting. A Basic Health Care project (PASSPA) is tackling the most pressing priorities, namely through extending basic health care to 13 million uninsured people in the states of Oaxaca, Chiapas, Guerrero, Hidalgo, and the shanty towns of Mexico City, improving medical supplies and upgrading health sector staff skills. Significant further reforms are required in public health care delivery and financing systems to improve the coverage, quality, and cost-effectiveness of services. The Bank is supporting Governments search for solutions through several studies, and will provide major investment support through future projects. 53. Nutdton. About 14% of children under 5 suffer from moderate or severe malnutrition. Studies have found that low income, unemployment, seasonal variations of food supply, intra-family differences in food consumption, and nutrient losses due to parasites and other diseases are among the primary contributors to 12 nutritional problems. Measured undernutrition is nearly four times higher in the rural southern states than in the north. In the southern states of 9 9 M Chiapas and Oaxaca, about 70% of preschool-age pIn children suffer from some degree of malnutrition. the 1980s, hov p ress& in gblie health. servl.e The Government Is working, with Bank stnatd. Mexia end ut$per pt or4%of assistance, on developing a food and nutrition 3DP?, on pubilc and vate health care,'which is below iter strategy to reduce the incidence of malnutrition coudethcra bevef vopm . ent through the use of food coupons, milk years, the ine~uliy i hoth con1ditlon betWa agtonsa.* distribution, and pilot health and nutrition mose gUp#aIfm r tIMé0 ay O fI7 ex'pecay W projects. These pilot projeets are being evaluated and the results will serve as a basis for defining 5 e an p op t a mo e food/nutrition policies and action plans, which would serve as a basis for further Bank support. Foymliet edaifp1pål ia javea 54. The Government is now taking firn heahh~. carsuraneö Man ohaan~ tonbaffo.measurve measures to address environmental issues and provideradepend~ eè i i b t4 s~e# o'ome reverse past neglect. On both environmentai and ratal co~mtMa t~, Eb piis se a ~wa <o.economic grounds, there is no time to lose. Failure to act soon would result not only in amitous further environmental degradation but also in retarded economic development, both through derailing NAFTA (since Mexico is mmutl under NAFTA to significant environmental progress) and through the longer term constraints to growth that environmental damage causes. 55. The problems are large, with major issues in water pollutlon, air pollution (especially in Mexico City and Monterrey), solid and toxic waste disposal, aquifer depletion, and devastation of ecosystems and biodiversity of exceptional worldwide Importance. The steps the Government has taken thus far have been substantial, but much more needs to be done. For ex~mple, the cross-cutting and cross-sectoral issues that lie at the root of many environmental problems need to be tackled more comprehensively. Efforts on air pollution, for instance, need to do more about the urban transport and Industrial emissions issues that are the source of the problem. 56. The Government is now moving toward a more comprehensive approach with Bank support, especially since high level discussions between the Government and the Bank in March 1993 (Box 6). 57. The Bank will support the development and implementation of the strategy through expansions of its analytical work policy dialogue, and lending. Since April 1992, two major operations (the Mexico Environment Project with $50 million of Bank support and $30 million of Global Environmental Facility funding; and the Mexico City Transport Air Quality Project with $220 million of Bank assistance) have been approved. Further operations are planned that will deal with water and sanitation, solid waste, toxic waste, natural resources management, problems on the border with the U.S., and institutional development. 58. In addition, a new environmental section is being created in the Country Department to provide added staff, expertise, and leadership for this purpose. The section is being structured so as to preserve and augment, rather than replace, the active involvement in environmental work of the sector divisions dealing with agriculture, infrastructure, and human resources - so that intrinsic synergies across sectoral lines are not thwarted. 13 59. A decade of > underinvestmeent in inftastructure Aq eioo t sk arn4tffon, Ité brodeing ht stratagyto bas resulted in a heavy backlog *eepa* tw itr infagse otiattv: of unmet needs in almost all subsectors. Road conditions A-oo patt¢ur nsin ta * d ntdm¢wor4 approach. Priorities throughout the country are poor, and with almost 60% of the TA bCA..e ~ Wiougnl edst etiscm itmnandor the Border network in poor shape there is need for expensive rehabilitation. h y.d i ofMxcolargest and The allocation of resources to ru 4a ra undertake rehabilitation and i e g potrochemical maintenance has been limited by induy ia major Pnuter. restrictive flscal policy. Access - Meico City. Though. mgajor efot have begn, more wi» be needed, to many services also e to on i u t be improved, only 70% of the .Acdonon tularucton, framabroadmUWreIOnaEprupective. Especially: population have access to piped water and 50% to sewerage, and there are only about 6 telephone .. - ·oso wast lines per 100 Inhabitants. To - tairesean e(e iue address these problems, the - k r*WpoIia#otrol (ualuding the oU noter) Government's strategy is to significantly expand the role of G.t« im .of- ~aootlve, ada *bter balanceb in tives and the private sector in the.-- provision of infrastructure b py- ed a 4bn ment Get fam good intentons on services and to improve cost hn t pu.yJJrdrd g recovery by the utilities. Whilegood Accomplishments in this regard Kas anårn d" oot:io Shreulatrijtrumnts (and norm and are alroady very impressive: the telephone company, TELMEX, tho nraewor Effortabwg nt the central has been privatized and is 0 ~ to Improving service, federal road construction is almost fully relying on the private sector Eeaal:al !egione andl sooou wil be coverd, sMp by step, over what which, through toll road - y ned to be ten you pwwn concessions, has already been awarded concessions for 3,250 ma bth dlfiaSone uegi ad sectöral -. are mecesary and will kms of new roads, and important 0WpSCOSÉ ehother. Thöfoner have advatages in asauring that OgAffi baangean e fo-accoant.dequualy,that thd special features of privatization programs are «W addaed, and tha underway in the ports, railways, åili sat tbeyandsat Ul. c~ura levet and down to concrete and electricity generation .hsa. kitg a an- lo.. e ia Ta ise avantage in asauring sectors. Although the privat iu sclyn offIs'a* wo veloped fi"t nadaawWdeperspctive downward. sector has an expanding role in financing and providing infrastructure services, some public sector financing of infrastructure will continue. The Bank will support these efforts with the Highway Rehabilitation, Raiway Restructuring, and Port Rehabilitation projects. At the state and municipal level, thee are more rocent initiatives to enlist privat. participation in water supply, water t and solid waste management. Both water and olectricity ratos have been increased significantly in the past four years - by more than 100% and 32% rspetively. As a result, the power sector has ceased to be 14 a drain on public sector finances, and the water sector, though still short of financial self-sufficiency, is starting to increase coverage and improve quality. 60. The agenda for the future includes some difficult issues. Capital market constraints limit private access to financing on terms suited for infrastructure projects, which typically have very long payback periods; indeed there are already some concerns about market saturation for medium-term paper for financing road projects. The development of sound regulatory frameworks and establishment of regulatory bodies is only incipient. Finally, some sectors may remain unsuited for private investment, as is the case of rural infrastructure which holds low private rates of return, and the needs for investment in the maintenance and rehabilitation of the highway network which remains in the public domain are still huge. These issues are the more pressing because of NAFTA, which would result in increased trade flows (with consequent need for investment In transport infrastructure) and in industry relocations, which also require supporting infrastructure. In addition, the increased focus, heightened by NAFTA, on Mexico's environmental problems has a direct bearing on the investment priorities for some subsectors, such as electricity generation and water and sewerage services, including water treatment. 61. The Government is aware of the limitations that the issue of capital market constraints could mean for its efforts to promote private-sector-led development of infrastructure. It has thus asked the Bank to explore the issue, both from a broad analytical standpoint and in terms of what the Bank could do to help. A Bank assessment is now under way (the main mission was in the field in May 1993), looking at the underlying issues and possible options. The conclusions from this work will determine what additional steps the Bank would undertake. The IFC would be an important part of any further help the Bank Group could provide In this area. (MIGA as well, except that Mexico has so far declined to join MIGA). If the assessment now underway concludes that an expanded role for IBRD support would make sense in this period, the lending program would be modified accordingly. Whatever actions would be proposed would of course need to support, and not undermine, the evolution of capital markets. Agriculture 62. The Mexican government intervened heavily in its agricultural sector for nearly forty years beginning after World War II. Policy objectives were to promote sector growth, to relieve rural poverty, and to restrain the prices of basic foods. Government agencies set output prices, restricted imports and exports through quotas, tariffs, and licenses, subsidized key inputs such as fertilizer, electricity, water and credit, and did much to determine the pattern of production, the domestic marketing system, the foreign trade balance and the distribution of agricultural income. By the mid-1980s policy distortions had become very severe, public expenditures for subsidies were high, and, as a result, growth in the sector fell to almost nothing. 63. Since the mid-1980s, major reforms have been under way. The public sector's role in production and marketing has been reduced, some trade protection has been cut, many input subsidies have been eliminated, 17 parastatals involved in marketing and production have been dismantled, 64 sugar mills have been privatized, and public employment in agriculture has been slashed by more than 50,000. Some credit subsidies have been lowered and the crop insurance system has been privatized, resulting in savings of more than US$300 million since 1989. Beginning in 1991, the government ended the historical land redistribution program and modified the constitution to allow the development of a rural land market; the resulting strengthening of private land rights will help promote more investment in rural areas. 64. While the impact of these reforms on production has been low so far, the government has a clear policy to move toward a free-market system in agriculture and the steps taken have established the basis for future growth. NAFTA would further strengthen the agricultural reform process. 15 65. Bank strategy has extensively supported the reform process. Two sectoral adjustment loans (AGSAL I and AGSAL II) assisted Mexico in moving toward a market-based system of agricultural pricing. AGSAL II assisted with a targeted system of food subsidies designed to increase the access of poor people to food. In connection with AGSAL II, discussions are currently underway between the Bank and the Government with respect to the second tranche release on the pace of price liberalization of rice, soybeans, and sorghum. Existing lending supports appropriate public investments in the irrigation and drainage sector, research and extension, a major public anti-poverty program, and rural development in the underexploited tropics of the country, all of which are designed to raise the efficiency of public investment and to target it to poorer areas. 66. The Bank is now preparing a series of operations to facilitate the adjustment to NATA, including loans for small scale irrigation, rainfed agricultural development and a second rural anti-poverty operation. An agricultural sector memorandum (ASM), to be presented to the next administration in 1994, will analyze policy issues affecting the efficienzy of public investment and the private sector's ability to compete under NAFTA. These include remaining price and trade reforms, transitional income support to producers affected by NAFTA, rural poverty, food and nutrition, research and extension, irrigation and drainage, the rural financial sub-sector, and intellectual property questions. Insatuional si 67. The changing role of the state, from provider of infrastructure services and owner/operator of significant industries, to policy-maker, regulator and major player in the social and environmental areas, is and will continue to be a severe strain and a difficult challenge to a public administration that has undergone many lean years and, as a result, has lost many qualified staff and has salary scales that are not competitive with those in the private sector. While recently the Government has addressed some of its most conspicuous pay problems, a fully satisfactory solution to pay scale issues will remain difficult given the fiscal austerity and continuing need to downsize staffing. This makes the task ahead difficult and raises the priority of comprehensive institutional strengthening efforts. Three areas merit special attention: regulation (of privatized infrastructure services), environment, and education. While much has been done in these three fields by the present administration, they will be even more important in the next one. 68. Also crucial will be continued emphasis on decentralization efforts, which, to be successful, require capacity building at the state and local level. This is an even more challenging task than at the national level, since the quality of civil service below that level is often much weaker. Although much of what needs to be done is conceptually simple (e.g., improving tax administration, reducing red tape, and developing civil service career paths), successful implementation is not easy. One complication at the municipal level is that mayors are only elected for three year terms (and cannot be reelected). Often a new mayor brings a new management team, so all efforts tend to have a short time horizon, and long term issues fail to be addressed adequately. There is also need to strengthen the national institutions through which the central government provides financial support and technical guidance to the state and local agencies, in such matters as water, urban transport, solid waste management and tax administration. 69. The Government, with Bank assistance, is beginning to confront these issues more systematically. Institutional strengthening components have been included in operations in virtually the all sectors the Bank is assisting, and some projects - such as the Decentralization and Regional Development Project aiding the four poorest states - are concerned mainly with these issues. Recently completed sector work on decentralization and urban management dealt with municipal level problems, and a series of workshops sponsored by the Bank is helping sectoral authorities explore possible solutions. In addition, special attention is being given to strengthening BANOBRAS, one of the national development banks. Two recent loans include technical assistance to BANOBRAS, and joint Bank/BANOBRAS missions are reviewing its organization and procedures. This will be a continuing effort over the coming years. 16 Areas of Special Emphasis 70. Preceding sections have already covered many of the priorities for special emphasis in Mexico - for example, poveny, human resources development, environment, and institadonal stengthening. These areas are core elements of the Bank's Mexico strategy. Two other priorities, implicit in the foregoing discussions but meriting further highlighting here, are private sector development and improvement of the situation of women. (Additional detail on the areas of special emphasis in the FY1992 and FY1993 lending program, by project, is provided in Annex 3.) 71. PrAWte sector development. Mexico's accomplishments in reorienting a state-dominated to a private- sector-led economy have rightly been recognized as a paradigm for other developing countries to follow in promoting private sector development, and Government leaders now find themselves besieged with requests to share their experience worldwide. With economic policies now firmly oriented toward creating a better enabling environment for the private sector, and with the privatization or closure of nearly 900 parastatals completed, the Government is now concentrating on further steps, including eliminating constraints that impede entrepreneurial activity. This involves correcting infrastructure deficiencies and dismantling excessive regulatory requirements. 72. The Bank has strongly supported measures to enhance private sector development and will continue doing so in the years ahead. Projects in infrastructure, agriculture, industry, and finance have focussed mainly on this issue (see Annex tables). A Private Sector Assessment is being completed now that focusses on the remaining actions necessary to complete and consolidate the reform program and on some of the key constraints to further productivity growth. In addition, the analysis now under way on private financing of improvements in infrastructure (paras. 60 and 61), undertaken at the Governments request, is addressing a major issue relating to constraints on future private sector growth. 73. Women. The situation of women in Mexico has changed markedly in recent decades. The economically active female population increased from 14% in 1950 to 29% in 1985, and is believed to be still rising today. In the industrial work force, women have gone from 12% to over 28%. A 1990 study found that although access to primary and lower secondary education and equality in educational opportunities for women are good, illiteracy is still higher among females (20.1%, compared to 13.8% for males, according to 1980 data), and school attendance rates are lower for girls than boys. Every new administration since 1980 has introduced new programs to improve opportunities for women, the latest being linked to the Solidaridad program and thus concentrating, sensibly, on women in poverty. Overall, Mexico is more advanced than some countries in coming to grips with gender issues, but much more remains to be done. The Bank's assistance supports Government efforts in diverse sectors, especially in the human resources area. A project on labor markets and training issues is helping women get job training and find jobs. A project on early childhood care is aiding women in learning better home-based child rearing practices and preparing children from ages 0 - 4 for timely school entry. A project on health care is training 23,000 community health workers and mid-wives to provide services for pregnant women. Lending Levels and COmpositlon 74. Past Lan dfag. The Bank vigorously supported Mexico's economic adjustment program in the FY86-90 period with loans totaling almost US$9.5 billion, more than half of which were quickly disbursing sector adjustment and interest support loans. During the FY86-89 period adjustment loans were made for trade policy liberalization, industrial restructuring and deregulation, privatization and public sector reform, and agricultural and financial sector reforms. The thrust of Bank lending in FY90 was directed at supporting Mexico's debt reduction program. In FY90, peaks were reached in loan commi.nents and disbursements of US$2.6 billion and US$3.6 billion, respectively. FY91 was a transitional year in Bank lending. Adjustment lending fell to 25 percent of the $1.8 billion of total now loan commitments and three of the eight operations approved were 17 targeted at poverty alleviation. By FY92, adjustment lending had fallen to zero (where it has Figur 11 remained since), new commitments had settled to $1.5 billion, and half of the six operations were in nill n 1ingMMlmft to VMei the areas of poverty and environment. (Further 1 is details on the levels and composition of Bank 51 lending by sector since 1982 are provided in so s0 Annexes 5-8.) s as 70 .t 75. FWw Lending. Our strategy for the 60 Bank's role for FY94-96 is primarily a continuation o50 ins K - 35% of the course charted a year ago. The decisions 40 made then, signalling a major shift from prior years, so 61 mtml noted that while the period requiring adjustment lending was over, the task of achieving and 20 35% maintaining sustainable, equitable growth for a to modernized Mexico still had very far to go. o FY198840O FT1894-98 76. The lending program will continue to focus on: revival of private-sector-led growth (through improving infrastructure, agriculture and urban development); poverty reduction and human resources development; and the environment. As shown below, a slight shift in the balance among these categories is planned, though, stressing the environment more': Iteiva ofgroth houh iptuing50% 3 andsran vlopent ta, 100% 100 77. On revival of growth (through improving infrastructure, agriculture, and urban development), operations are planned that will correct deficient policies and eliminate bottlenecks and inefficiencies in: road maintenance; medium cities urban transport; railways; electric power; agricultural development for rainfed areas; and on-farm and small-scale irrigation. As growth recovers and the country is better able to meet its infrastructure requirements on its own without assistance, our lending in this area will decrease, as shown in the table above. 3. Percentages shown have been rounded and are based on numbers of projects. Distributions by dollars lont sbow a similar shift from last year's to this year's plan. The data from last year's plan have been recalculated to include all human resources projects in the second category, so that deflnitions are consistent. 18 78. On poverty reduction and human resources development, operations will concentrate on: initial (early childhood), primary, and secondary education; training programs for the unemployed and for workers on the job; basic health and nutrition services; and regional development linked to the Solidaridad program. 79. On the environmental, operations will address Issues in: air pollution; institutional strengthening; water supply and sanitation; toxic waste management; solid waste disposal; natural resources development; and priority regional Initiatives, including the U.S./Mexico Border Plan. 80. Our strategy will continue the approach adopted last year of emphasizing the use of project instruments that maximize the development impact of Bank lending. Thus, we will be stressing sector policy lending, time- slice financing, and innovation in project design - all oriented toward specific policy goals. (Further details on the policy goals, by sector, are provided in Annex 1). 81. The total amount of annual lending will depend on how rapidly and effectively the executing agencies identify, prepare, and implement projects and the sectoral policy changes needed to supnort them. Unexpected delays in sectoral reforms or major setbacks in economic progress could slow the pace at which projects are presented to the Board, stretching out the lending program and causing each year's total to be smaller than it would be otherwise. Capacity constraints in executing agencies could limit how much can be accomplished in particular sectors, operations and time periods. Assuming no serious difficulties, total lending is expected to remain in about the same range it has been recently - and thus be under $1.5 billion per year. 82. A lending program of up to $1.5 billion annually would continue the gradual downward trend since the period of adjustment lending ended. Over the past six years, Bank lending first increased due to adjustment lending (from $1.7 billion in FY87, to $2.0 billion in FY88, $2.2 billion in FY89, and $2.6 billion in FY90), and then decreased in the transition to the post-adjustment era (from $1.9 billion in FY91, to $1.5 billion in FY92). After declining temporarily to $1.2 billion in FY93, lending is expected to be close to $1.5 billion in FY94. In the unlikely event of significant reversals in economic policy, the Bank would shift to a smaller core program aimed at preserving existing infrastructure and addressing poverty and environmental problems. Within sectors, failure to make key policy changes would trigger a reduction or cessation of new lending. 83. The strategy outlined here would lead to a gradual reduction in the Bank's exposure in Mexico. One of the Bank's largest single borrowers, Mexico accounts for 12% of the Bank's total loan portfolio (see exposure indicators in Table on p. 2). While this is above the 10% guideline, a country's track record in meeting payments is obviously important, and Mexico's has been impeccable. It has never halted payments to the Bretton Woods institutions, even during the severe debt crisis of the 1980s. With the lending program proposed here (assuming $1.5 billion yearly), the 12% exposure would fall below the 10% guideline by 1997. The smaller lending program compared with previous years would create more space for responding to future needs in the event of any unforeseen setbacks. The large reserves the central bank is accumulating (over 6% of GDP, $18.5 billion at the end of 1992, and higher more recently) provide added security. 19 Portfolio Manageent 7, P 0oriföli4 Man neet 84. Forty four projects with a total loan amount of $20.14 billion nt of öosin 0 ffectIv potfolio management will tnclude: cancellations are now under to have timöly and well focused country strategy implementation. Regarding the status of evw w the Govement twice a year, and the portfolio, 39 of the 44 projects theere leslona ag wesly to béng to light and resolve (89%) are rated "1" or "2" - no serious pobham problems - according to project g portfolio, by supervision ratings . The remaining five p g lose attet thefprojectproparation and are rated "3" (there are problens but to UR sataa of existing projects .th pacessing of ad they are remediabMe); none is rated worse b psd ayInewpIjets , than "3". The average rating for the entire portfolio is 1.7, and has remained Mvljug qcdtif cation andppaation at that level for three straight years. (A list of all Bank projects with an uIoth #l ntse P >th undisbursed balance is provided in x guR a d enreviewsusingobjecuve- Annex 4, along with the project . o ddt, t vi aenforcement performance ratings.) .. :Khlk 85. Among the projects experiencing p r difficulties, an urban transport project n ofeffetive portfolo has had delays in some components, n c9ye approach, centered on two states, Nuevo Leon and n O1 Misues early, active the state of Mexico; other components of Inte.st this w . m m e and the project have been implemented ntk* of thOPpe n on, at satisfactorially. A plan of action has now been agreed to resolve the Inaddition, otherm~s,r will mobehp outstanding issues. A water supply and M i iu Mdimal staff sanitatlon project has suffered from and ctme r spJ y fo pr management. weaknesses within two executing agencies. Recent frank discussions with - ne econoio and ector work program has been restmetured to both, and a change of leadership in one mo o dv* aå mor. u~ to ans, anw mmss thm la~on of projedt ~ mmrlnc more tepy. of them, have improved the prospects for progress. A forestry development - coordnaion~ wth other agencies wi inclide coser cooperation project has been stalled by inadequate an f~ ~8, Jokt misum wfth"nm C t noon wth%era cofim budget allocations and insufficient .d wlthe IFC conmitment by the primary excuting agency. With some parts of the work - Contfnn M pe, n« just fthrougb the Country now completed, the possiblity of . a ~ im b= amo cne, e cancelling the rest is now being -tud to ptin und work out problem. explored. Two agriculture projects have . . been adversely affected by changing -. Adjustmenof th ds mi withinthe Country Departent will -2alm buid up more lmplemeutätion , mirroring tho views within Government about basic b=nsation juto posadjustmt lnvetment . policy issues concerning agricultural pricing and how best to allow for the ~ spnded training of uaff will be a priorty. effects of NAFrA. Discussions are still in progress on these issues. 20 86. There have been no problems of high cost overruns recently The only significant case of not meeting covenants occurred in a railways project, and this Is being addressed by reforms that the national railways company is taking to improve its operations in the context of the preparation of a follow up project. 87. Gross disbursements in FY92 were $1.51 billion, slightly more than new commitments. The portfolio had a total undisbursed balance of $3.5 billion as of February 28, 1993, which is 17% of the total loan amount. The disbursement ratio (disbursements in a fiscal year as a percentage of the undisbursed balance at the beginning of the year) was 39% last year (FY92). Disbursement ratios have been generally been high in comparison with other countries receiving Bank support, and lately have been increasing further - from 25% in FY91. 88. The Bank and the Government have been working closely together to improve project implementation. The importance of effective portfolio management has now been further heightened by: the return to investment lending, the high policy content of the new proj,ts, the challenges of new subjects (in poverty and environment, e.g.), the continuing need to search for innovative solutions, and the limitations of the sectoral ministries. Stepped up efforts and new initiatives to strengthen portfolio management (Box 7) are helping, not just on Bank projects but on other Government implementation activities as well. UC and MIGA 89. IFC. As a result of Mexico's economic reform and the resulting increased confidence in the country, private sector investment in Mexico, by both Mexican and international investors, has increased. This has increased the demand for IFC financing. IFC has concluded over 25 transactions over the last three fiscal years, with a gross investment of US$862 million. 90. IFC's operational strategy has been to support the Mexican private sector in adapting to the opening of the economy and to assist it in its re-entry to the international financial markets. The Corporation's investments have thus far been primarily directed at larger Mexican companies and have included a mix of activities which have encompassed corporate restructurings, capacity expansions, modernizations, efficiency enhancements, and greenfield operations. Mexico's capital markets, tourism, food processing, and manufacturing have benefitted most from IFC's past investments. Operations in mining, petrochemicals, and agribusiness have remained modest due to the slower progress achieved by the Government in opening these sectors to private foreign capital or in implementing the reforms needed to stimulate private investments in these economic activities. 91. With the ongoing economic liberalization program and despite increasing competitive pressures, prospects for a continuously active role for IFC in Mexico remain favorable. However, in defining the scope and characteristics of its future Mexican activities, IFC will have to take into account the fact that the pace of its recent investments has brought its portfolio close to the maximum country exposure limits. More specifically, as of December 31, 1992 Mexico was IFC's highest exposure country. Its outstanding Mexican investments - which involved loans of US$583 million and equity participations of US$80 million - accounted for 12.3 percent and 10.6 percent of total investments disbursed and held by the Corporation on that date. 92. For FY93, the exposure constraint has required the Corporation to adopt an investment strategy that emphasizes greater resource mobilization and a more selective approach to portfolio composition. As in the past, the mix of IFC activities in Mexico will remain highly diversified with equity and quasi-equity investments expected to account for about 20 percent of approvals. A greater concentration of resources is being devoted to assisting "second tier" industrial enterprises of the manufacturing sector, promoting infrastructure and agribusiness investments, and helping Mexico address its environmental problems. IFC's capital market activities have focused on the commercial banking system where it has helped establish credit and agency lines in support of small- and medium-size (SME's) borrowers. IFC is broadening its efforts to finance SME's by supporting the establishment of venture capital funds. Emphasis is also being placed on providing risk 21 management instruments, asset securitization, liquidity backup facilities for underwriting and assistance to financial institutions in raising funds in foreign markets. Efforts will continue to be made to improve the access of large non-financial companies to the international financial markets. To ensure greater IFC diversification, operations will be focused on those cases where the concerned enterprise will either initiate its entry to the international capital markets, need IFC's support to successfully place equity or debt offerings among foreign investors, or require innovative financial engineering to firm up project financing or hedge financial risks. In line with this country strategy, IFC's Mexican activities are expected to consist of 8 investments and an IFC net of US$118.0 million in FY93 as compared to 10 investments and US$141 million in FY92. 93. MIGA. Mexico is not a member of MIGA. The Bank has encouraged the Government to join MIGA, and will continue to do so in future. Cooperation ith Other Multilateral Institutions 94. Bank/IMF collaboration has been close over the years, especially since 1982, when the Fund began to assist the Government in addressing the underlying causes of the economic crisis. Since that time, the Government has benefitted from an extended arrangement for SDRs 3.4 billion, a special emergency drawing for 5DRs 291 million after the 1985 earthquake, a stand-by for SDRs 1.4 billion in 1986 and, in 1989, from an SDRs 2.8 billion extended arrangement through 1993 and a drawing of SDRs 453 million under the compensatory facility. Consultations between Fund and Bank staff concerning Mexico's current economic situation and prospects have led to a mutual understanding about the measures needed to bring the stabilization program to a successful conclusion, strengthen the balance of payments, and restore sustainable growth. 95. The Inter-American Development Bank increased its annual lending from about US$160 million in the 1987 to 1989 period to the US$1 billion level beginning in 1990. It has been able to do this, in part, by cofinancing some of its operations over the last two years with the Bank. The cofinanced operations have required a close coordination between the Bank and IDB on project appraisal and maintenance of policy conditionality. These efforts have been successful and have significantly added to Mexico's external resource availability. The Bank has played a similar but smaller role with Japan, where Bank lending has been responsible for official financing for projects that are being financed in coordination with the Bank in the energy and environmental sectors. D. SummARY ASSESSMENT 96. O.-reant Situadon and Issue. Mexico has been highly successful since the mid-1980s in stabilizing, liberalizing, and privatizing its economy and resolving its debt problem. The main challenge now is that the economy has yet to respond strongly to the reform measures: GDP and productivity growth are still weak, and the current account deficit is very large (7.1% of GDP). At the same time, some sectoral reforms have moved slowly. The Governments objectives remain firmly directed toward accelerating sustainable private-sector-led development while also aggressively addressing poverty and environment problems. The pace of progress toward these goals could be affected by (1) whether the North American Free Trade Agreement (NAFTA) is ratified and implemented, and (2) who will be the next President (whose six year term will begin in December 1994). Also important will be: decisions about monetary and exchange rate policy; efforts to eliminate remaining obstacles to growdt, especially infrastructure bottlenecks; and advances in deepening the reforms, within sectors (e.g., agriculture), across sectors (e.g., liberalization of labor regulations), and downward within the public sector (state and local government). 97. Prospect. Well aware of these issues, the Government is strongly committed to continuing the reform process and maintaining strict discipline in macro policies. With its substantial budget surplu, greatly reduced 22 public debt, plentiful reserves, drastically lowered inflation, good external creitworthiness, much trimmed- down public sector, and supportive orientation toward private sector development, Mexico has strengths to draw on if problems arise. Still, the weakness of recent economic performance has increased the level of risk since a year ago. Government leaders expect a gradual economic recovery leading, In a few years, to growth of 4% or more annually. The main risks are that recovery remains elusive or policy reversals occur, if, for example, the implementation of NAFTA is deleayed or the new President changes course. In that case, a longer period of slow growth could ensue, or (less likely) a substantial setback before an upturn. Even in a low base scenario, Mexico would be expected to remain creditworthy. Since its first Bank loan in 1949, it has never missed a payment to the Bretton Woods institutions. 98. Lending Strategy. The lending program recommended here - somewhat smaller than previous years' and more focussed on poverty, human resources, environment, and private sector development - would be consistent with Bank and Government priorities. It would be linked to performance: in the event of policy backtracking, lending would be reduced - in the worst case to a small core program aimed at protecting key priorities, e.g., human resources and environment. The Government has indicated it wants to maintain a full Bank program, less now to obtain financial resources than to ensure that vital sectoral reforms are well designed and implemented. The proposed program would be responsive to this request, would contain no adjustment lending, and would result in a gradual reduction in the Bank's exposure in Mexico . The principal constraining factors will likely be the absorptive capacity of implementing agencies and the tight budget restrictions they face (as continued tight fiscal discipline limits their resources, including provision of counterpart funds). PART II PROPOSED LOAN 99. Background. As explained in Part 1, Mexico has gone a long way in restructuring its economy and, by opening it to foreign competition and expanding the role of market forces in resource allocation, is laying the basis for sustained economic growth. However, a decade of underinvestment in infrastructure, resulting from restrictive fiscal policy, has resulted in a heavy backlog of unmet needs in almost all subsectors. In the highway sector, the Government, with Bank assistance, has enacted measures to deregulate road transport services, privatize highway construction through concessions, and contract out highway maintenance activities to the private sector. The 1989-94 National Program for Transport Modernization reflects these Government strategies. The economic crisis that began in 1982 has had a severe effect on the sector, and annual investments - including funding for highway rehabilitation, resurfacing and maintenance (HRRM) - declined from aboit US$800 million in 1982 to US$400 million in 1989 (of which only about US$120 million was spent on maintenance and rehabilitation). Since then there has been an effort to increase the HRRM budget. HRRM expenditures have increased through support from the ongoing Highway Maintenance Project (Loan 2875-ME), from US$120 million in 1989 to US$320 million budgeted for 1993. Despite these efforts, 60% of the network is in poor condition and there is a serious HRRM backlog on the federal highways, 90% of which were paved before 1980. Traffic safety is also a growing concern in light of the high number of traffic fatalities (an estimated 15,000 per year). 100. For greater transport sector efficiency, planning at the multimodal and modal levels needs to be improved, especially for highway maintenance, to ensure informed and cost-effective decision making based on sound management, economics and engineering principles. To decentralize administrative responsibility for rural roads, institutional strengthening is needed at the state level. Some support is being provided under the Bank-financed Decentralization and Regional Development Project (Loan 3310-ME) to strengthen the implementation capacity of state road agencies. 23 101. Objectives. The project aims to: (a) protect and enhance past Investments in the federal highway network through investments in rehabilitation and resurfacing of paved highways; (b) improve HRRM planning by strengthening the institutional capacity of SCTs highway maintenance directorate, DGCCOP; (c) support measures to improve funding for HRRM; (d) reduce transport costs through improvements in traffic safety and more efficient traffic flow on the federal highways; and (e) support further policy improvements through (i) studies and action plans on road financing; (1) development and implementation of a computerized data base for the transport sector; (il) preparation of project planning and evaluation manuals; and (iv) improved consideration of environmental factors in highway maintenance. 102. Description. The project objectives would be achieved through the implementation of: (a) an institutional strengthening component for improving transport sector planning and policies (US$7.27 million); (b) a comprehensive, four-year HRRM program for the federal highway system (US$1,532.48 million); and (c) a road traffic safety program (US$20.25 million). 103. The insdtuional strengthening component would include specific measures and actions to improve: (a) sector planning and coordination, especially for HRRM; (b) HRRM funding and budget preparation; (c) sustainability, through development of a coherent framework for road sector financing; (d) control of truck overloading, through the issuance of revised vehicle weight and size regulations and a program for their implementation; (e) specifications for HRRM works, to include quarry management and pollution control of construction equipment; (f) the system for truck driver education, tesAng and licensing; and (g) training of sector staff. 104. The four-year federal HRRM program would include about 27,000 km of highway rehabilitation and resurfacing (of which 11,000 km would be financed by the Bank), improvement and rehabilitation of bridges and maintenance depots and replacementtrehabilitation of equipment, as well as consultancy services. To promote sound financing practices for the sector, routine maintenance would be excluded from Bank fknancing. Also, to build gradually expenditures for rehabilitation and resurfacing works into the Governments budget financing for future years, Bank loan disbursements for road civil works would be on a declining percentage basis. 105. The road tra47c sqfty program, would seek to increase public road safety awareness and to improve driver behavior. It would include improvement of some 350 hazardous road locations (mostly intersections and sharp curves). The works would be undertaken under the proposed project either as part of the main highway rehabilitation works or under separate contracts as appropriate. This program would also finance the purchase of equipment for a new licensing and vehicle inspection system and to strengthen the preventive medical unit (including equipment for drug and alcohol detection), as well as road safety studies and information campaigns, a vehicle standards study and an international traffic safety seminar. 106. Total Cost and Financing. The proposed loan would finance a portion of SCT's 1993-1996 HRRM Program, the traffic safety and institutional components, and technical assistance, studies and training. The total project cost is estimated at about US$1,560 million equivalent with a foreign exchange component of US$637 million. The proposed loan of US$480 million would finance 31% of project costs. The road safety seminar, which vould cost about US$120,000, would be financed with aid from Sweden, UK, France and the Mexican private sector. The Government would finance the remaining US$1,079.88 million. Retroactive financing up to US$30 million equivalent is proposed for expenditures incurred after November 1, 1992. It will be used to finance the initial cost of the first batch of works initiated during the construction season as well as some consultant services required to start up the project. The breakdown of estimated costs and the proposed financing plan are provided in Schedule A. The amounts and methods of procurement and the proposed allocation of loan proceeds are provided in Schedule B. A timetable of key processing events and the status of Bank Group operations in Mexico are presented in Schedules C and D. Also attached is the SAR No. 11720-ME dated May 18, 1993. 24 107. Implementation. BANOBRAS would be the Borrower and would transfer the loan proceeds to the Guarantor (the United Mexican States), who would carry out the project through SCT. SCT has implemented ten federal highway projects with the Bank and would be responsible for project execution through its various general directorates. For project implementation, SCT would continue to use its Office of Coordination of External Financing, which would coordinate the project activities with BANOBRAS. BANOBRAS would also prepare and submit to the Bank the loan disbursement applications. Annual consultations on SCT's HRRM Program and the budget would enable the Bank to review the progress of program implementation with SCT and other Government agencies, notably SHCP. All subprojects would be evaluated and selected following a methodology satisfactory to the Bank, which would include an environmental assessment in all cases warranted. An improved specification for highway maintenance works under the responsibility of contractors, including the coverage of cultural patrimony, quarry management and pollution control of construction equipment, has also been agreed. 108. Sustainabiity. The project design stresses institutional strengthening and appropriate funding of HRRM. To ensure institutional sustainability, the Government Is reorganizing SCT's Highway Maintenance Directorate following recommendations from studies carried out by external consultants and, also with the assistance of consultants, has developed highway maintenance strategies that underpin the proposed project. The reorganization seeks to separate strategic and operational work by gradually transferring present operational activities to SCT's regional centers and by contracting out some activities to the private sector. The study on highway maintenance strategies offers a planning tool to prepare budgets and HRRM programs. Intense participation by Government officials in these studies has increased Government commitment to implementing their recommendations. 109. The Government has taken a number of steps in recent years to increase recovery of road costs from users. Besides raising gasoline prices beyond international levels, and diesel fuel close to such levels, it has increased tolls on the federal toll network substantially in real terms since 1988 with higher real increases levied on heavy vehicles. A "voluntary" user fee that SCT negotiated with the trucking industry at the end of 1992 should contribute additional modest resources to the funding of maintenance. Furthermore, to alleviate the budget constraint, the Government has been seeking significant private sector financing and began in 1989 to grant concessions to the private sector for the construction, maintenance and operation of highways and bridges. By 1994, the Government expects to have a total of 4,000 km under private concession contracts, for which private sector financing of about US$7.5 billion is expected. (To date 3,250 km are under concession of which some 1,400 km are in operation and the private sector has disbursed about US$3.5 billion). Increased reliance on the privately financed and operated network is intended in part to enhance recovery of costs associated with major new highways. However, high tolls on this system have led to lower than expected traffic. A recent review of road user charges indicates that, in the aggregate, HRRM costs are being fully recovered, but, despite the measures taken to date, heavy vehicles still do not contribute at levels commensurate with the damage they cause to the network. Given the structural changes which the sector has undergone, it was agreed at appraisal that a comprehensive review of highway financing strategies, and an assessment of resource mobilization options, would be carried out. The project would provide for a symposium to support dialogue on these issues between the public and private sectors and, based on a comprehensive study, the possible development and implementation of a related action plan. The study would include an initial definition of ways of measuring and recovering indirect costs, such as those associated with accidents and the environment. An interagency technical group (the cost recovery group), headed by SHCP, was established during preparation to take the lead on these issues, and will serve as the locus for the work to be carried out under the project. 110. Lemons from previous Bank involvement. The Bank has been heavily involved in Mexico's highway sector since 1960. During the macroeconomic crisis of 1980-88, there were slippages in institutional strengthening, sector planning, investment optimization and prioritization, and highway maintenance. The experience with the three sector investment loans shows that institutional measures take a long time to implement and that up-front actions on important matters and intense participation of Government officials during project 25 preparation are effective in speeding up the process. The proposed project design draws upon this experience by involving Government officials more in project preparation and by seeking key Government decisions before project appraisal. It continues efforts started in the Highway Maintenance and Road Transport and Telecommunications Sector Adjustment Projects (Loans 2875-ME and 3207-ME) to improve the size and distribution of budget allocations to maintenance. I11. Rationale for Bank involvement. The Bank lending strategy supports private-sector-led growth, aims to strengthen Government institutions and policies in a climate of comprehensive reform, and caphasizes environmental policies. The Bank's strategy for the transport sector seeks in particular to: (a) consolidate highway maintenance objectives and help catch up on delayed maintenance and rehabilitation of existing assets, which has higher economic returns than new Investments; (b) strengthen Investment selection and prioritization to ensure that they are mainly based on economic criteria; (c) support institutional and policy reforms and the use of sound economic analysis to ensure efficient traffic allocation between modes; (d) encourage decentralization and private sector participation where appropriate; and (e) promote thorough assessment of the environmental implications of transport investments and ensure that, when required, appropriate mitigation measures are taken. The Bank's sector lending program through FY95 would include the proposed Highway Rehabilitation and Traffic Safety Project and a Railway Restructuring Project. These will be supported by ongoing work to identify and address sectoral issues raised by the anticipated ratification of a Free Trade Agreement between Mexico, the United States and Canada, and to improve coordination between the various transport modes. 112. Agreed Actions. The Governments project implementation letter includes the 1993-96 HRRM Program, reflected in physical and financial terms. The program was prepared on the basis of a maintenance strategy developed by SCT with consultant assistance. The strategy is compatible with financial constraints, preserves the highway network and maximizes Its economic return. The most significant sector issue is the insufficient level of HRRM budget allocations. Efforts to allocate more funds to HRRM are constrained by macroeconomic policy. Although the US$320 million allocation for 1993 represents 82% of the proposed total budget for highway sector and a 33% increase over the 1991 HRRM budget amount, and shows the Governments commitment to fund HRRM in a period of macroeconomic constraints, it falls far short of the about US$700 million needed annually to eliminate the HRRM backlog by the year 2001. Due to the high pavement deterioration rate, this amount would be enough to prevent further deterioration of the network but not enough to achieve any significant improvements. The Governments Highway Maintenance policy letter presented in support of the proposed project spells out the Governments intentions for greater allocations of resources to HRRM beyond 1993, and its commitment to assigning priority to maintenance in future budget allocations. In addition, the annual review mechanism would Include a follow up of experience with past maintenance allocations and consideration of increases in future allocations. 113. The project design has stressed up-front actions, and during project preparation several studies were carried out regarding key institutional issues and decisions. As a result, SCT's Maintenance Directorate was reorganized, a cost recovery group was established, and a Planning Coordination Office (CGP) was created. During negotiations agreement or confirmation was reached on the following: (a) the Government to carry out, by contract, at least 70% of the rehabilitation works; (b) the timetable and implementation targets for action programs to (i) formally establish COP before December 31, 1993, and to strengthen its capabilities, (ii) implement the reorganization of DGCCOP, (ill) develop and implement the highway maintenance management system, (iv) continue the work of the cost recovery group, (v) enact and implement the vehicle size and weight regulations, (vi) implement the training program, (vii) implement the HRRM program, and (viii) implement the Traffic Safety Component; (c) the scope and content of the Highway Maintenance policy letter; (d) the preparation of the annual HRRM program to be systematized and have adequate balance between rehabilitation, resurfacing and routine maintenance; (e) review with the Bank, by October 31 of each year, the budget proposal for the following year, and by January of each year the HRRM budget for that fiscal year. The Bank would not consider financing new subprojects under the loan, for any given year, until it had been demonstrated that 26 the budgetary allocations for highway maintenance and rehabilitation are, for the year in question, reasonably within the levels set forth in the 1993-96 HRRM Program and cover the completion of Bank approved subprojects commenced in a prior fiscal year; (f) the Government to continue to pursue its policy of ensuring adequate road user charges, and submit to the Bank an annual report on the status of highway cost recovery; (g) prepare by December 31, 1994 a study on the road financing strategies and resource mobilization options, and if the Bank and the Government agree on the suitability of the study recommendations, submit by June 30, 1995 a satisfactory action plan of strategies and measures to be adopted, and implement the plan thereafter; (h) the Government to enact before December 31, 1993 the vehicle size and weight regulations; (i) the preparation of an annual report on the road safety situation; (j) the proposed 1993-1996 HRRM Program; (k) SCT to prepare and furnish to the Bank, by December 31 of each year, a summary report assessing progress made in implementing the HRRM Program; (1) SCT to furnish to the Bank, by January 31 of each year, the estimated monthly cash flow of HRRM expenditures for that year, confirming that the majority of the budgetary funds would be available to SCr during the first semester of the fiscal year, and that an authorization (Oficio de Secas) to allow for start of works has been issued by SHCP; (m) SCT to contract independent consultants to assist DOCCOP in the coordination of the program and to provide technical assistance to work supervision teams; (n) subprojects related to highway rehabilitation should be evaluated and selected following a methodology satisfactory to the Bank. Such subprojects should: (i) have an ERR calculated in accordance with a method satisfactory to the Bank of at least 25% each, except for a portion of subprojects for which the accumulated total investment does not exceed 10% of the budget for the year in which such subprojects are being considered - subprojects in this category would require an ERR greater than 12% each; (ii) not require changes in the road alignment or involve negative environmental implications for which ameliorative measures have not been identified through a satisfactory environmental assessment; (iii) have a structural design life of at least 15 years in the case of highway rehabilitation subprojects; and (iv) have a detailed economic analysis, for those subprojects on which traffic may be influenced by the construction of a toll road. Such economic analysis should consider the toll roads and the proposed roads as one system; (o) the procurement arrangements; (p) the arrangements for project monitoring, scope and timing of the annual and mid-term reviews, and scope and frequency of progress reports; (q) the accounts and auditing requirements; and (r) the disbursement arrangements. 114. It will be a condMon of loan qecvmnss that the Borrower and the Guarantor enter into contractual arrangements satisfactory to the Bank for the transfer of loan funds. Any substantial change in the internal organization of DGCCOP that materially and adversely affects its ability to carry out subprojects would be an event of defauW. 115. Environental aspects. The project is not expected to have a significant environmental impact, and has been assigned to Category C. The HRRM program consists of works along existing facilities and no road realignments are included. Earth works would be limited to occasional minor widening of road shoulders and no displacement of people is involved. The project will improve highway maintenance, which in tur enhances vehicle performance. The traffic safety program would help improve road-user behavior, and reduce the number and seriousness of accidents, with resulting social, economic, and environmental benefits. Furthermore, SCT has revised its highway maintenance work specifications to control pollution from construction equipment and to improve quarry management and, as part of project preparation, has established an Environmental Affairs Unit. 116. Benefits. The project's main direct benefit would be to reduce road transport costs by protecting the condition of the federal highways and by reducing the rehabilitation backlog on the most trafficked highways. Given that about 60% of the highway network is in poor condition, rendering road transport expensive, the project would yield substantial returns (the ERR of most of the highway rehabilitation subprojects in the program will be in excess of 25%). Indirect benefits, not easily quantifiable, include improved highway safety 27 and better institutional performance. The strengthening of DGCCOP would ensure better management of limited public funds. 117. Risks. The main risks are of inadequate budget allocations and/or of resource misallocations in future years. To mitigate these risks, satisfactory funding agreements for 1993 were obtained before appraisal. The proposed annual reviews would give the Bank an opportunity to verify if the future annual budgets are within the levels set forth in the highway maintenance program. The successful implementation of the highway maintenance strategy, of the pavement and bridge management systems, and of the proposed annual review of SCT's road investments would enable better-substantiated decisions, and SCT technical staff would have the tools to argue their case with decision makers regarding budget allocations. In addition, the expected improved macro-environment and fiscal situation would mitigate the above risks. There Is also a risk of delays and changes in the institutional strengthening program in view of the change of administration in 1994 and the inherent difficulties in getting an established institution such as SCT's Maintenance Directorate to adopt a planning and strategic role and to delegate the operational work to SCT's regional centers. To ensure commitment to objectives and minimize these risks, project preparation was accomplished with active participation of government officials and, to the extent possible, up-front actions. 118. Recommendation. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank and recommend that the Executive Directors approve it. Lewis T. Preston President Attachments Washington, D.C. May 18, 1993 28 Schedule A MEXICO Page 1 of 1 Highway Rehabilitation and Traffic Safety Project Project Cost Summary and Financing Plan Local Foreign Total PROJECT COST SUMMARY USS Millions Highway Rehabilitation, Resurfacing and Malatenance 1. Highway Rehabilitation 349.31 263.52 612.83 2. Pavement Resurfacing 175.67 132.53 308.20 3. Routine Maintenance 153.80 51.27 205.07 4. Bridge Rehabilitationt Improvement 47.29 35.68 82.97 S. Depots Rehabilitation/Improvement 1.89 1.26 3.15 6. Miscellaneous 8,7. _f J100,4 Subtotal Civil Works 813.73 548.94 1362.67 7. Equipment Acquisition and Parts LE 2. 295 Subtotal Goods 8.87 20.69 29.56 8. Supervision and Design Services aQ 14.00 40. Subtotal Services 26.00 14.00 40.00 Traffic Safety 9. Improvement of Hazardous Road Locations 8.28 .2 13.8 Subtotal Civil Works 8.28 5.52 13.80 10. Equipment for Licensing 0.48 1.13 1.61 11. Equipment for Vehicle Inspection 0.48 1.13 1.61 12. Equipment for Preventive Medicine Q.4 o 1.38 Subtotal Goods 1.38 3.22 4.60 13. Vehicle Standards Study 0.08 0.04 0.12 14. Road Safety Seminar 0.01 0.11 0.12 15. Information Campaigns 0.08 0.04 0.12 16. Road Safety Research iAS a0 QA Subtotal Services 0.24 0.23 0.48 Institutional Strengthening 17. Office and Audiovisual Equipment 0.05 0.07 0.12 18. Course Material Support 0.15 0.23 0.39 Subtotal Goods 0.20 0.30 0.51 19. Instructors Fee 1.08 0.58 1.67 20. Attendance at Outside Training 0.12 0.50 0.62 21. Consultants for Sector Planning ZA J.6Q 4.00 Subtotal Services 3.61 2.68 6.28 Total Base Costs 862.31 595.58 1457.89 Price Contingencies *60.40 41.71 10.11 Total Project Costs 922.71 637.29 1560.00 Local Foreign Total FINANCING PLAN USS Millions Government of Mexico 922.71 157.17 1079.88 IBRD - 480.00 480.00 Bilateral Programs (Sweden, UK, France) -, 2 0.12 Total 922.71 637.29 1560.00 * Due to the time-slice nature of the project physical contingencies are imbedded in the base cost estimates 29 sch~ni B MEXICO Page 1 of 3 IGEWAY RERABILITATION AND TRAFFIC såFET PROJECT (In MRn of U.S. Doars) ICB LCB 0THER N.B.F. 2l TOTAL - Highway Rebabilitation Reurfacing 151.42 489.54 359.35 1000.31 ad Hazardous ocations Improvemmnt (83.78) (270.84) 054.62) - Bridge Rubabiliation and eprovement 37.09 50.00 1.69 88.78 (0.52) (27.66) (48.18) - MaintMan Depots Rebablitation and 3.37 3.37 Improvement (1.87) (1.87) - Routin Maintmnance 219.43 219.43 -Micedan.ou 160.99 160.99 Subotal Civil Work 151.42 530.00 50.00 k 741.46 1472.88 (83.78) (293.23) (27.66) - (404.67) - Highway Matn Einant 27.39 3.78 0.46 31.63 Acq~iition and Part (24.10) (2.46) (0.30) (26.86) - Equipment fr Licensing, Vel 3.70 1.22 4.92 Inspection and Preventiv Medicin. (3.26) (0.79) (4.05) TrEiningqu Mat~rini 0.54 0.54 (0.50) (0.50) Subtotel Goods 31.09 5.00 1.00 kl 37.09 (27.36) (3.25) (0.80) (31.41) service - Conmu~tants for Highways 47.08 f 47.08 (41.44) (41.44) - Safety Studies, Campuign, Research 0.38 0.13 0.51 and Road Saety Sminar (0.33) (0.33) - Instmtor Fe. and Outuide 2.44 2.44 T~ining (2.15) (2.15) Subtotal Service : 49.90 0.13 50.03 (43.92) (43.92) TOTAL 182.51 535.00 100.90 741.59 1560.00 (111.14) (96.48) (7238) - (480.00) g/ Not Bank finmne hf Local b ing by Invitation of et l dst three biurs, ~ Inludes about US$3 mimlion for morinning the tbcnni amistani services of thr.e consultmnt adra (~ some selection). . Etla: uF~ in paraanen ar. amn~ts toh. flanoed by the proposed Loan. 30 ScheduleB Page 2 of 3 MEXICO HIGHWAY REHABMITATION AND TRAFFIC SAFETY PROJECT Initial Allocation of Loan Proceeds Amount of Loan Percentage of Expenditures Category allocated (US$) to be financed 1. Civil works for highway 330,000,000 - 61% until US$70,000,000 rehabilitation, pavement has been disbursed; then resurfacing and hazardous road locations - 58% until a cumulative of US$156,000,000 has been disbursed; then - 55% until a cumulative of US$236,000,000 has been disbursed; then - 51% until a cumulative of US$295,000,000 has been disbursed; then - 48% thereafter. 2. Civil works for bridge and maintenance depots rebabilitationt 47,000,000 55% improvement 3. Acquisition of highway maintenance 25,000,000 100% of foreign exp. equipment and spare parts 100% of local exp. (ex-factory cost) 65% local exp. 4. Goods & equipment for driver 3,800,000 100% of foreign exp. licensing, vehicle inspection, 65% local exp. and preventive medicine 5. Training program, including goods 2,500,000 100% Al and equipment, instructors, outside visits 6. Consulting services 39,000,000 100% 2l 7. Unallocated 32,700,000 a/ Excluding taxes. JnklXi~ - i~zgammaa (to MON= of U.&. Began) AnnuW 78 h/66 77 39 76 77 67 Cumulative 78 144 221 260 336 413 480 Jk/ A special account would be opened in dhe Cuad Bank, with an initial deposit of up to US$25 million equivalent. 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А. ь}н,�а.: : ^-�;ц.К:х �У}'г - }.v,::л•. +' {л}л:-и: .:.',`4г.ii •{$л.+..т..-.цг % : '.дУ:}С •+ г '}+ ,�-W� � {гг:Н-' - -- ,. а;:.:г-. .:+ ..+ ..., л,. y� ,.r..,-�.г}:.'.?}:5i:::<•}::r:т+.:'ч,. :�r?`i:•:.....}. : .:.:й::ю.. и.л -у. .?4. ..u�i.....x::a-}ч�`�л-i�>{> }}-•• ::• :. ,.... . г.. �п. �' ':�,5•ч �.г .. :}3?:}'у�•ar к г •,г'�,.' .i.t'.н�. . ..ц ц.w:.Дгч?С -:"f.?:i: �:: �:. лг':}•.а.}+:`:ч'J.:;:::: и: .tv.{г::-'.�i:}:^i:дiй:-:Б::;::::::�:Q+-г}4� :л: -i i'г\4.w..:.t:...v:y . ii +}�г':}Л i г •гfгг:ьW,й},чл'-:г..�3С?}}`:йС::•:}+К1.l:г.- 37 Am= 2 PUBLIC EXPEN121TURE -CateL.ry Percentage Rural Development 7.6% Fisheries 0.4% Education 4.6% Health and Labor 5.9% Solidarity Program / Regional Development 10.3% Urban Development and Environment 13.9% Communications and Transport 10.9% Commerce and Goods Distribution 1.2% Tourism 0.5% Industrial Sector 2.6% Energy (non-petroleum) 18.3% PEMEX 19.3% Administration 4.5% Total 100.0% Source: Cuarto Informs do Goblemo. 38 Annex 3 Recent Project Lending: Special Areas.of Emphasis Povesty Eaviro- Private Community bad"iitional WOmu in ment ~iwtor Partcipa- Develop- Develop- Develop- tion and mnt ment meatt NGOa Primary Bducato l Irrigatios & Draiage Baviroment & Natural Rere Agricutrual Technology Science & Technology Infrastrutre HousingMarket 9./ Development Iniiall uatia//.9. Labor Market& 9.. 9 Productivity Buamant Tauport Air Poltion Medum Cties Transport ighway Rehabilitation and Maintanaee ./ indicates dat projet contau a compoent wbch addrs the stated spcial area of ømphasis. Proct planned for FY93. И N в� И N р И Pt N р р N ОУ1 в� ir в� N р вв в� А И1 РО г �V А N Р1 �у r Н в� И N е+ !r в� � w б! О, Z 7L �. • К Д � аааа�ааа���а��ааааааа�вда$��аа�$�а888���ж8$ ��� � _ в «вяв�в��авsа���ввд��-�в�в��па�в�вsдвввва�вsвв �� д d.3d.iw�.-о�од �3 .-ед дрд^ �д^д,:д'r3ddd д�дд � вв .�. � �� � в:��ffi:�р��°���:�R°�й:�§��� ~g�д�ад� � ^�$$��'а' вдв � ei w а ��i4 е"v"����.�� o.�ow д д� � � � r � ��• �� � � � $ �3 $ $$ .� • гti �ас�т$�����йд�д�д��а�а��дсi����� а�� ���.�{�5 вq� А $ Q Д •• •• •• ..R�....й� �«R ��13 � м � .°.� � � �+ � � � �� � в iSвв8вв8в8в88 8&88в8: 88в 8888 в8вв8вв888 � о � �.о � ����ss���я������в�3���$3����������������� u�i� �� " •• � о .� t,� а � � � � � � • � � � ������ ����������������� �(q���МΡ �d�e+ �дΡ � � �� � � � � Р МА w�АвVв4����в1аb�К�в��� . � � п � е � �е � � �Я ��е �� � � . � � � Я � � � л. � � .g � � � ,� q '4��' � ю�♦' � � � � � �>� � � +� $ �� . � � �� � �� � � �� � �� ��� в� �. � � � �� �� �� �� � � � � �� � � � ���������� � � � �� ���� ����� _ �3�� � � �� �����w� �� Ф 40 (P~t¥c Distri~) Ell 1 .12 Pamat of T~ Adju~~ L~ 21 4 %buo En~ Reform 6 14 T«d Adj. U~ 53 kw~mt La~ Re~ Of a~ 34 64 29 kfiamru~ 20 43 16 2 21 13 b~ ad TMØ 12 P~ a gam~ 10 26 34 3 26 16 1 10 4 8 Eavirom~ 3 10 37 T~ Iw*o~ lradIm 47 100 100 T~ Lø~ M 100 iw 4a Amal Av~ 41 Annex 6 ThreeYea Commitmnsbweco~Y29 (US$ Mi~lon) A4juutmait LIading Idsy ade 500 1,800 25 Iastatructu~r. 380 l~bli. EtquisReom 500 Aauture 300 400 Iterest Supor 1,260 Total Ajuats~nt Lending 00 4,240 425 tvdstLading Rv~val of Orowth 1,931 2,74 2,548 2,15 • 1,200 nfaatructure 286 1,037 1,767 1,130 d50 Agdmulr- 908 799 146 550 550 b~~..e,y/ns 757 738 61s 475 lveaty & Om~ naees 90 81 80 1,375 1.$ 90 81 80 845 700 EealMod .adio 180 450 leVerty 350 350 Environmet 100 25 20 570 1,600 Total avstmnt Lmnding 2,122 2,680 2,628 4,100 4,300 TOal 2,122 3,180 6,868 4,525 4,00 Dbsburmnt~tatioV .28 .22 .24 - o. ofOpraio 14 19 21 18 18 11 Leading plea dependent on availability of quulity luograms and piojects. g fla0 of averg.aanwal dinsbumaa to ie avergeeah bain of unibussed balances at the boginadg of e4e yar(<nt of a4usnt operadeas). Exoudw 1993 disbugrmmoota. 42 Page I of 3 liigue1 Filgure 2 Fmm Budget D~it to Surpw 160 10 5 100 40 -3 120 t00 70 74 78 82 8 002 -0 N 0 2 i 80Bal8283 84e8887a8eg90 91 92 F~ur 3 mai.4 20 8 18 7 0 leur 3 iur 2 01- 1987 1988 1989 1990 1991 1992 1989 1900 1991 1992 43 由糅劉J h妒2 Of3 卹 訕 44 A籷口釀里 P鯧。3 of3 麵 45 Annex 8 Annual Cred1twordilum Indicators 4mvent) radmAted Prqjecjed 1"1 1"2 1993 19% 1"s 2000 DOD/GDP 36.0 33.2 33.3 38.2 34.2 DODMWrts GNFS 2S4.3 245.5 239.5 227.3 206.6 140.3 Total Debt ServiwMWft GM 35.1 35.5 32.4 29.2 26.2 20.5 Total hftmWGDP 2.8 2.1 2.2 2.5 2.8 2.6 Country Expomue/MRD Total Owsftft Portfolio 12.5 121 12.2 11.8 11.1 7.8 11BRD/Counhy Public Debt 16.1 1 .2 17.2 16.7 15.7 13.6 1BRD/Country Public Service 21.5 A.4 19.4 19.7 21.S 20.2 WD Deft Sm4m%Wft GM 4.5 4.4 4.0 3.7 3.7 2.4 Prdenvd Ckeditor/Public Debt Service 47.1 37.4 37.2 36.5 36.1 32.1 Source: Bank of Mexico; World Bank esdusatm. IBRD 23709 UNITED STATES OF AMERICA Nogal«i '-.3 CA4LIFORNIA $ 00 $ O NOR A4 10A ciå~\MEXICO L. PNa"N~l capita state capitals c 0 A n u 1 94 Principal cities or t n B A IA OI, -aN==s Divided highways CALIfORNIA Å--M QQd supn P,r- Roi~oj Rien S O4 Princpe airpors r ---Sfotb~ndwiffi iwn~im bundaries / Torr96 S [Ttill Trang A¢AAC f.ý~ HON DvrRnAS MAY& MozQ 1-SAN 0U1$ Por si eAtis ai tmr ( é ( AGUAN r RA zia T MAUSCO h É$AQUINIANAJ C ROO j- ACAMPECHE_4 ZihuteneChipancnoBEUIZE Bä* GUA EMAILA T:a HGONDURAS