Mexico - Water Supply and Sanitation Sector Project

Document of The World Bank FOR OFFICIAL USE ONLY R^eport No. 14611 PROJECT COMPLETION REPORT MEICO WATER SUPPLY AND SANITATION SECTOR PROJECT (LOAN 3271-ME) JUNE 22, 1995 Environment and Urban Development Division Country Department II Latin America and the Caribbean Region This document has a restricted distTibution and mav be used bv recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Banl; authorization.  MEXICO PROJECT COMPLETION REPORT WATER SUPPLY AND SANITATION SECTOR PROJECT (Loan 3271-ME) Currency Equivalent Currency Units= Nuevos Pesos= 100 cents Average Exchange Rate 1990 US$1 NPMex2 57 1991 US$1 NPMex2.85 1992 US$1 NPMex3.00 1993 US$1 NPMex3 05 FISCAL YEAR January 1 - December 31  FOR OFFICIAL USE ONLY MEXICO PROJECT COMPLETION REPORT WATER SUPPLY AND SANITATION SECTOR PROJECT (Loan 3271-ME) WEIGHTS AND MEASURES One Hectare (ha) =10,000 square meters Metric Ton (mt) =2,200 pounds Metric Ton (mt) =1,000 kg Kilometer (km) =0.6215 miles Kilometer (km) =1,000 meters Cubic Meter (m3) =1,000 liters Liter =1,000 milliliters ABBREVIATIONS AND ACRONYMS USED ANOAPA - National Association for Water Supply Operation Agencies Asociaci6n Nacional de Organismos Operadores de Agua Potable APAZU - Program of Water Supply and Sanitation for Urban Areas - Programa de Agua Potable y Alcantarillado de Zonas Urbanas BANOBRAS - National Bank of Public Works and Services - Banco Nacional de Obras y Servicios Publicos CETES - Government of Mexico Treasury Bills - Certificados de la Tesoreria de la Naci6n CNA - National Water Commission - Comisi6n Nacional del Agua CONAPO - National Population Commnittee - Comite Nacional de Poblaci6n COPLADES - State Development Planning Committee - Comite de Planeaci6n de Desarrollo Estatal EAS - Water Utilities Association - Asociacion de Empresas de Agua IDB - Inter-American Development Bank - Banco Interamericano de Desarrollo IMTA - Mexican Institute of Water Technology - Instituto Mexicano de Tecnologia del Agua NAFTA - North American Free Trade Agreement - Tratado de Libre Comercio de Norte America 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.  OAs - Operating Agencies - Agencias Operadoras SARH - Ministry of Agnrculture and Water Resources - Secretaria de Agricultura y Recursos Hidraulicos SAHOP - Ministry of Human Settlementsand Public Works - Secretaria de Asentamientos Humanos y Obras Publicas SEAPA - State Water Supply and Sanitation Subcommittee - Subcomite Especial de Agua y Alcantarillado SEDESOL - Ministry of Social Development - Secretaria de Desarrollo Social SHCP - Ministry of Finance and Public Credit - Secretaria de Hacienda y Credito Publico SICREF - Development Credit System - Sistemas de Credito de Fomento SIAPA - General Information System for the Water and Sanitation Sector - Sistema General de Informaci6n para Agua Potable y Alcantarillado SPP - Ministry of Planning and Budgeting - Secretaria de Programaci6n y Presupuesto SWA - State Water Agency - Agencia Estatal de Agua SWSS - State Water Supply and Sanitation Subcommnittee - Subcomite de Agua Potable y Saneamiento TA - Technical Assistance - Asistencia Tecnica WUs Autonomous Water Utilities and Operating Agencies Agencias Operadoras Aut6nomas de Agua Potable  FOR OFFICIAL USE ONLY THE WORLD BANK Washington, D.C. 20433 U.S.A. Office of Director-General Operations Evaluation June 22, 1995 MEMORANDUM TO THE EXECUTIVE DIRECTORS AND THE PRESIDENT SUBJECT: Project Completion Report on Mexico Water Supply and Sanitation Sector Project (Loan 3271-ME) Attached is the Project Completion Report (PCR) for the Mexico - Water Supply and Sanitation Sector project (Loan 3271-ME, approved in FY91) prepared by the Latin America and the Caribbean Regional Office (Parts I and 111). Part 11, prepared by the National Bank of Public Works and Services (BANOBRAS) on behalf of the Borrower, presents a divergent, overly positive view of project experience. The loan was closed on December 31, 1993, and the full amount of US$300 million was disbursed. The project supported by the sixth loan in the sector, focused on assisting the Government of Mexico (GOM) with a major Sector Reorganization Program to be carried out during the 1990-1994 period. The project was designed to reduce the subsidies to the sector, strengthen the institutional framework at the national level, promote the autonomy of companies which operate water and sanitation systems at sub- national levels, serve 3.2 million additional people by the end of 1994 with water supply and sanitation services, and improve the environment through a pilot water-pollution control program. Total project costs reached US$1,340 million equivalent, twice the appraisal estimates. The project's physical achievements were substantial, as 96 percent of the project resources were used for works construction in some 2,150 sub-projects. Because disbursement was faster than scheduled the project closed 18 months ahead of target; disbursement was 98 percent completed before Bank staff discovered that many sub-projects did not meet the agreed selection criteria on rate of return. Progress towards policy and institutional objectives was achieved at the national level and many states changed their law to grant more autonomy to local Operating Agencies. Yet little evidence was presented on the quality of their works and their financial and operational capabilities thus leaving project sustainability in question. With hindsight, a program of this size and type could have benefitted from disbursement in tranches, so that implementation in subsequent tranches would proceed only after compliance with subproject conditionalities had been demonstrated. The project outcome is rated as marginally unsatisfactory based on the PCR and the stated detailed objectives. Its institutional development impact is rated as modest. The sustainability of project benefits is rated as uncertain. The PCR is of satisfactory quality, and provides an adequate discussion of implementation experience and project achievements. The project may be audited. Attachment 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.   MEXICO PROJECT COMPLETION REPORT WATER SUPPLY AND SANITATION SECTOR PROJECT (Loan 3271-ME) Table of Contents Page No. Preface .......................................................... iv Evaluation Summary ..........................................................v PART I PROJECT REVIEW FROM BANK'S PERSPEC'rwVE . Project Identity .1 2. Background .1 Economic Overview .1 Sector Overview .2 Sector Organization and Legal Aspects .3 Sector Strategy .4 Bank lending to the Sector .4 3. Project Objectives and Descrption .5 4. Project Preparation, Design and Appraisal .7 5. Project Cost and Financing .11 6. Project Implementation .12 Contracting Staff and Consultants .12 Preparation Guidelines for Feasibility Studies .12 Government Counterpart Funding .12 Project Cost .13 Procurement .14 Disbursement .14 7. Project Results .14 Physical Results .15 Sub-projects .15 Studies .16 Training .16 Institutional Results .17 Audit Compliance .18  ii 8. Project Sustainability ...................................... 18 9. Bank Performance ...................................... 18 10. Borrower Performance ...................................... 21 11. Project Relationship ...................................... 23 12. Consultant Services ...................................... 23 13. Project Documentation and Data ...................................... 23 14. Lessons Learned ...................................... 24 PART II PROJECT REVIEW FROM THE BORROWER'S PERSPECTIVE .. 27-51 PART IH STATISTICAL INFORMATION ANNEXES 1. Related Bank Loans ...................................... 55 2. Project Timetable ...................................... 56 3. Cumulative Estimated and Actual Disbursements ...................................... 57 4. Project Cost and Financing ....................................... 58 (a) Project Cost and Financing ...................................... 58 (b) Project Financing ...................................... 59 (c) Loan Allocation by Category ...................................... 60 5. Procurement ...................................... 61 (a) Procurement of the Project ....................................... 61 (b) Procurement of the Loan ....................................... 62 6. Status of Covenants ...................................... 63 7. Use of Bank Resources ...................................... 64 (a) Staff Inputs ...................................... 64 (b Mission Data ...................................... 64 8. Project Results ...................................... 65 (a) Total of Sub-Projects ...................................... 65 (b) Studies ...................................... 66 (c) Training Activities ...................................... 67 (d) Cost of Training Activities ...................................... 68 (e) Total Sector Investment ....................................... 69 (f) Total Sector Investment by Source of Funds ....................................... 70  i.i (g) Water Supply and Sanitation Coverage .................................... 71 (h) Water Supply and Sanitation Connections .............. ...................... 72 9. Performance Indexes .................................... 73 10. Poverty Index .................................... 74 11. CNATotal Staff 1989-1993 .................................... 75 12. Total Operating Agencies (QAs) .................................... 76 CHARTS 1. BANOBRAS .77 2. CNA . 78   iv MEXICO PROJECT COMPLETION REPORT WATER SUPPLY AND SANITATION SECTOR PROJECT (Loan 3271-ME) PREFACE This is the Project Completion Report (PCR) for the Water Supply and Sanitation Project, financed under Loan 3271-ME for the amount of US$300 million to the National Bank for Public Works and Services (Banco Nacional de Obras y Servicios Publicos, BANOBRAS) with the guarantee of the United Mexican States. The loan was approved on November 29, 1990 and signed on January 18, 1991. The Bank declared its effectiveness on June 18, 1991. The loan was closed on December 31, 1993, approximately two years ahead of the appraisal estimate. The last disbursement was on March 1, 1994. The PCR was jointly prepared by the World Bank and the Government of Mexico between November, 1993 and November, 1994. The Environment and Urban Development Division, Country Department II, of the Latin America and Caribbean Regional Office prepared the Preface, the Evaluation Summary, and Parts I and Im. The Borrower prepared Part 11 of the report after reviewing Parts I and II. The report is based principally on the following sources: data obtained during a mission to Mexico in November 1993; the Staff Appraisal Report; the Loan and Guarantee Agreements; Project Supervision Reports; correspondence between the Bank and the Borrower; interviews with Bank staff and Mexican Govermment officials; and internal Bank memoranda.   v MEXICO PROJECT COMPLETION REPORT WATER SUPPLY AND SANITATION PROJECT (Loan 3271-ME) EVALUATION SUMMARY Objectives 1. Loan 3271-ME was the sixth loan to support the development of the water supply and sanitation sector in Mexico and to finance a high priority part of the Mexico's National Water Supply and Sanitation Investment Plan 1990-1993. The project was designed to improve the quality and quantity of water supply and sanitation services, promote sound pricing policy and improve environmental conditions in the country. Specific objectives were to: (a) reduce the amount of subsidies to the sector; (b) strengthen the institutional framework at the national level; (c) promote at state, regional and/or municipal levels the development of companies of sufficient scale to operate economically and maintain their water and sanitation systems efficiently and with financial autonomy; (d) provide by the end of 1994 water supply and sanitation services in Mexico to about 24 million additional people, most of whom belong to the poorer segment of the population; and (e) improve the environment by implementing a pilot water-pollution control program and requiring a comprehensive environmental assessment of each financed sub-project (para. 3. 01). Implementation Experience 2. The project was approved by the Board on November 29, 1990. The Loan was signed on January 18, 1991, but legal opinions on behalf of the Borrower were provided to the Bank with some delay, and thus the loan finally became effective on June 18, 1991. Although the project was originally scheduled to be completed by December 31, 1995, it was actually implemented in only three years, two years ahead of the appraisal estimate, and was closed on December 31, 1993 (paras. 6 01-6 02). The speed of implementation was due to higher demand for investments than had been expected, with a final total of 2,122 sub-projects financed (more than had been anticipated in the SAR). 3. The project began with some minor delays during the first year of implementation, because contracting staff in the executing agencies and CNA was slower than expected. BANOBRAS and CNA also experienced some similar lags in beginning their institutional development programs.  vi Additional delays occurred in updating the guidelines for the preparation of the feasibility studies and in acquiring the required hardware for the implementation of the General Information System for the Water and Sanitation Sector (SIAPA). The Government was slow in providing counterpart funding for the project in a timely manner, which made BANOBRAS the sole source of financing for the operating agencies (OAs) and caused delays. This situation improved over the course of the project, as counterpart funds became available (paa 6. 03). 4. By early 1993, project implementation had progressed faster than forecast in the original implementation schedule. The speed of disbursements, however, masked some serious problems. BANOBRAS could not supply the Bank with information necessary to monitor compliance with covenants in the Loan Agreement relating to specific sub-projects. The Bank could therefore determine neither whether each sub-project was following the agreed implementation plan, nor whether it had earned the agreed minimum rate of return (Section 4.02 (c) (iii) of the Loan Agreement). It became apparent that many sub-projects were out of compliance. By the time it discovered this situation 98% of the funds had been disbursed, and the Bank could not realistically stop project implementation. The Bank did, however, call the situation to the attention of the Mexican officials, at which point matters began to improve (pacra. 6.05). Inadequate coordination and rivalries between BANOBRAS and CNA in the earlier stages of the project also affected the project's implementation (paras. 6.01-6.03). 5. Procurement caused some delays, especially in the preparation of bid documentation. Both suppliers and contractors were concemed about lack of confidentiality in the bidding process. Both the Govemment of Mexico and the Bank agreed that this is an area where the agencies need much improvement. BANOBRAS prepared and sent a circular with precise instructions to all executing agencies handling procurement, which improved confidentiality conditions. Mexican staff considered the Bank's documentation requirements to be excessively burdensome (para. 6.06). Results 6. The project was very successful in expanding and improNing the quantity and quality of water supply and sanitation services. A total of about 4.5 million people received water and/or sanitation services compared to 3.2 million estimated at appraisal. A total cif 2,171 sub-projects (para 7.03) led to the construction of 43,342 water supply and 32,077 sewerage connections and supporting infrastructure. Final designs were completed for 147 cities under the PoLution Control Program and simultaneously the operating water treatment capacity was increased from 15m3/sec to 23m3/sec., and the inventory of 478 water treatment plants was completed (pa-a. 7.02). Total project cost reached US$1,340.0 million, more than twice the original appraisal estimale. Ninety six percent of this financed investments (para 7.03). Of the total, US$319.0 million (23.8%) was financed by the Bank (including  vii US$19.0 million from loan 2666-ME); US$544.7 million by the Federal Government; US$316.0 million by the State Governments; US$33.4 million by the Operating Agencies' cash generation; and US$126.9 million byBANOBRAS. 7. The project only partially achieved its objectives of supporting decentralization in the water supply and sanitation sector. Although the Government fundamentally changed its policy from one of centralized decision-making to one of promoting local ownership and operation, the project only partially achieved its objective of creating technically strong beneficiaries. Water losses (average 45%) are still high, despite several studies on ways to improve operations. Some of the works inanced were not the best solutions to local problems. This was largely because beneficiaries participated to a very limited degree in sub-project design and decision-making, and therefore did not develop a real sense of sub-project ownership. Powerful institutions such CNA and SEDESOL hindered full beneficiary participation by promoting certain types of sub-projects and even authorizing sub-projects that were not in compliance with the eligibility criteria and on-lending conditions. Insufficient Bank supervision and absence of field visits caused this lack of consultation to go undiscovered and allowed inappropriate projects to go ahead. 8. The project training results were satisfactory both in terms of quality and quantity. A total of 5,041 of the operating personnel received training during the three years of project implementation. The original target for the training of about 10,000 operating personnel of 300 state and local operating agencies had been estimated based on a six-year period of project implementation (Annex 8.C). The training component has been satisfactorily implemented by the water training institute, IMMA, under the guidance of CNA and in cooperation with the Association of Water Utilities (EAS). IMTA and CNA have designed a National Training Program, which will be implemented in 1994-1997. Sector training workshops were organized and materials were designed (pwa 7.06). 1MTA has periodically revised and evaluated all of the materials. More than 200 courses and seminars were conducted in the areas of (i) administration; (ii) commercial activities; (iii) pollution control; and (iv) unaccounted-for water. Additionally, there were several technical exchanges among water utilities (WUs) and foreign water utilities. Project experience shows that training is most successful when continuity is assured. In order to be consistent with the government's decentralization objectives, training should focus on staff of the WUs, and on CNA staff at the state and regional levels, wvho provide technical support to the WUs. Annex 8C shows the distnbution by agency and by type of seminars and workshop of participation in training courses (Dora 7.06). 9. Institutional achievements ranged from modest to disappointing aras. 7.08 ad 7.09). Achievements of the studies, seminars and workshops were also modest. The objectives of strengthening the institutional framework at the national level (developing CNA's capacity to provide technical support, strengthening BANOBRAS and reinforcing its project preparation capacity) were only partially achieved. The project also had very limited success strengthening CNA's capacity to  vii prepare projects based on least-cost principles. The situation improved toward the end of project implementation, based on Bank recommendations. However, inuch remains to be done to extend least-cost principles throughout the sector. 10. Certain project initiatives were successful. The project instituted unified financing mechanisms for all sub-borrowers, which improved efficiency of all investments financed by BANOBRAS. Integrated water and sanitation projects, supported by the project, were instrumental in the sector, particularly as a means of combating surface and ground water pollution from domestic waste water. During the course of the project a large number of states improved their laws, which will help the performance and management of Operating Agencies (OAs) in the future. The principal changes are related to: (a) easier tariff approval methods--tariffs will now be approved by the Municipal Councils, thus avoiding delays and political interference from State Congresses; (b) legal rights of the OAs to cut service due to lack of payment; and (c) more autonomy in setting investment priorities. Sustainability 11. Physical facilities and equipment that have been incorporated under the project are still functioning properly, and there is no evidence that they will not be sustainable during their full useful life. The agencies gained experience over the course of the project that helped to rationalize investments, promote water conservation and improve water quality. The limited institutional organizational changes and the reduction of the sector's dependence on the Government are both sustainable, but have not tackled the roots of the problems. The Government has taken a more effective role in the management of the water resources and accumulated much more information. The project increased awareness on the part of all sector officials of the need for institutional improvements, least cost solutions, and better information management systems, and so formed a strong basis for the follow-on Second Water Supply and Sanitation Sector Project. In the long run, the situation is exected to improve further, once the sector decentralization process that is currently underway achieves its fUlll effect. Lessons Learned 12. The following lessons emerge from the implementation of the project: (a) The project could have benefited from increased beneficiary participation and ownership. Sub-projects would have been better adapted to local needs had beneficiaries been involved in their design. Financing and revenue collection would have been more efficient had the beneficiawy been the primary organizer and investor in the project. The lack of beneficiary involvement in the project reflects the situation at the time of project design, when decision-making was almost exclusively concentrated at the Federal level. During the course of project implementation, however, the Bank  Lx did not make sufficient efforts to insist on the participation of beneficiaries in project development. This lesson fits with the Bank's worldwide experience, and should incorporated in the design of all future projects (paras. 4.05, 4.07. 6.02404 and 7.01). (b) BANOBRAS did not monitor or supervise the project adequately. It did not have a properly-designed Management Information System nor did it devote adequate resources to supervision. It therefore approved ineligible sub-projects, agreed to physically and financially unfeasible implementation plans, and continued to fund sub- projects that were not meeting agreed physical targets and not complying with financial and other sub-loan covenants. BANOBRAS's progress reports were inadequate both in terms of quality and regularity, and contained no data on the financial analysis of the operating agencies. BANOBRAS was not able to tell when projects were running seriously over-budget and therefore had to re-finance several sub-projects after they had been completed (paras. 6.02-6. 04, 6. 08, 9.05, 10.02 and 10.03). (c) Inadequate Bank supervision exacerbated both ol these problems. It should not have accepted fast disbursements as sufficient indication that the project was moving well. The Bank should have realized the inadequacy of BANOBRAS's supervision efforts and stepped up its own supervision. It would then have discovered that sub-projects were not in compliance with covenants at a stage when it could have taken action, by, for instance, suspending disbursements. The total lack of financial infornation tended to force Bank supervision missions into a role of basic fact-finding rather than of analysis of results.' Had these issues come to light earlier, the Bank could have insisted on remedial action. Bank supervision did not put sufficient emphasis on beneficiary participation. Increasing supervision focus on visits to the local level would have helped involve sub-borrowers, fostered a sense of ownership and forced BANOBRAS and CNA to address the issue in more detail. Projects with a large number of sub- projects typically require more intensive supervision and greater emphasis on field visits, especially when they involve politically sensitive changes, as in this case. The Bank should have acted upon this knowledge. (d) The Bank needs to track performance much more closely during project implementation to ensure that the Borrower complies with all project covenants. In this case, the Bank did not discover lack of compliance until 98% of project funds had been disbursed. The Bank should enforce compliance with covenants and must be able and willing to suspend disbursements in the case of major institutional problems. (paWas. 10.03 and 9.02). '.Bank Experience in Project Supervision. Repon No. 10606, Apil 30, 1992. OED.  x (e) The objectives of the institutional reforms designed to increase financial autonomy at the municipal and regional levels were too broad and insufficiently defined. Municipalities, OAs, and WUs usually require a well-defined and carefully phased set of objectives, so that they can properly organize their activities, monitor project performance and make the necessary changes in the case of shortfalls. Continued reform of sector policies and institutions is a complex undertaking, subject to changes in the political climate, and one that the Bank should not expect to complete in the duration of just one project. (f) The inability of the Bank to finance the private sector directly in this project without a Govemment guarantee precluded private sector investment in sub-projects, despite strong interest. Given the potential efficiency and financial gains that the private sector can bring about, its participation should be encouraged to the maximum extent. Service contracts or management concessions are most suitable for current conditions in Mexico and the project should have done more to encourage arrangements of this type (paras. 7. 03 and 9.01). (g) Project design should pay particular consideration to the definition of specific institutional arrangements. One agency should have primary responsibility, and this should be clear to all agencies involved, in order to avoid rivalries (para.. 6. 05). In this project, institutional rivalries and lack of coordination between BANOBRAS and CNA during project implementation resulted in frequent discussions to determine their respective responsibilities for implementing the project, and caused delays and neglect of many important activities (para. JO.05).  MEXICO PROJECT COMPLETION REPORT WATER SUPPLY AND SANITATION SECTOR PROJECT (Loan 3271-ME) PART I: PROJECT REVIEW FROM THUE BANK PERSPECTIVE 1. Project Identity Project Name: Water Supply and Sanitation Sector Project LoanNo.: 3271-ME Amount: US$300 million equivalent Year of Approval: 1990 Borrower: BANOBRAS RVP Unit: LA2IE Country: Mexico Sector: Infrastructure Subsector: Water Supply and Sanitation 2. Background. 2.01 Economic Overview. Mexico's economy has been characterized by unusual turbulence over the past two decades. Until 1970, the economy grew rather rapidly on a sustained basis, but then it began to slow, with major recessions in 1976 and 1982. After the economic crisis of 1982, the Government gradually instituted an ambitious economic stabilization and restructuring program, which has brought inflation under control and laid a sound foundation for future growth. Economic growth resumed in the late 1980s, albeit of at a slow rate. In 1983, the constitution was amended to make municipalities responsible for infrastructure services, and thus rieduced their previous almost complete dependence on Federal Government funding. Implementation of this policy has been slow, and subsidies remain high, although they are now based on more rational and transparent eligibility criteria. 2.02 The Government's direct role in the economy has been reduced through sweeping public sector restructuring and a privatization program, which have generated proceeds in excess of  2 US$21 billion and led to a major streamlining of government institutions. Inflation has dropped sharply to 6.5% in 1993, down from an average of 90% per annum during 1982-88. Inflation for 1994 is expected to be around 9%. Through a combination of expenditure cuts and increases in revenues, the overall fiscal balance went from a deficit of 15.6% of GDP in 1982, to a surplus of about 1% of GDP in 1992, excluding proceeds from privatization. Finally, the implementation of the North American Free Trade Agreement (NAFTA) will further strengthen the foundations of the transformation of the Mexican economy. 2.03 Sector Overview. Provision of adequate water supply in Mexico is difficult and expensive. The country's water resources are very unevenly distributed. It has an area of 762,605 square miles and a population of 82.5 million (1990 data), which is growing at 2.6% per year (although the Government intends to reduce this rate to 1% by the year 2000). Some 75% of the total population lives in the urban areas, concentrated in just four cities: Mexico, Guadalajara, Monterrey and Puebla. Some 25% of the total population lives in the Mexico City Metropolitan Area. Average rainfall ranges from 100mn/year in the dry zones of the North to 5,000mm/year in the tropical lowlands of the South. About 85% of surface water resources are at an elevation of 500 meters or below, while fully 75% of the population and 80% of the industrial production are located above that elevation. These conditions have forced Mexico to develop a sophisticated and costly system of water resource management, which requires accumulation of increasing knowledge and information. To integrate this information and knowledge, a National Program for Water and Sewerage (APAZU) was formulated, taking into account water problems and demand-oriented solutions. Eighty eight percent of water is used by agriculture, whereas municipal water supply accounts for about 5% of total demand, and industry only about 6%. Estimated coverage (the percentage of people with access to water supply or wastewater disposal services) is known only approximately and is rather low compared with countries at a similar stage of development in LAC.2 Coverage increased annually by more than the population growth until about 1980. From that point until the end of 1992, coverage more or less matched population growth, because of budgetary constraints and insufficient attention to the sector. By the end of 1992, progress has been restored. The government expects water and sanitation coverage to reach a significantly larger percentages of the population by the mid- 1990s (Annex 8G). 2.04 Not only is coverage low, but water is also of poor quality. The systems currently provides water at a quality that is inconsistent with Mexico's level of economic development. Inadequate water and sanitation systems have created unhealthy environmental conditions. Disinfection is generally inadequate, especially for small systems. Deterioration of ground water quality is an increasingly important problem due to arsenic poisoriing in the northern area and leaching from dumps in the valley of Mexico and other urban areas. Pollution from agrochemicals is a problem in the agricultural areas. Unsafe water and the lack of sanitation are among the principal causes of 2 Other LAC countries have the following coverage for 1990: Argentina (67%), Brazil(96%), Colombia (89%) and Costa Rica (92%). Sewerage coverage including septic tank connections are: Argentina (89%), Brazil (79%), Colombia (97%) and Costa Rica (96Y%). PAHO "Health Conditions in the Americas".  3 morbidity and infant mortality3. The use of untreated water for irrigation also causes a health problem in the country4. 2.05 Sector Organization and Legal Aspects. In an effort to improve its effectiveness, the sector has undergone many reorganizations during the past two decades. Overall, the results have been moderate, due to inherent institutional inefficiencies, or to lack of a adequately trained staff In 1980, in a first attempt at decentralization, more responsibility for the sector was given to state agencies, under the overall direction of the Ministry of Human Settlements and Public Works (SAHOP). In 1982, sector responsibilities were transferred to the Ministry of Urban Development and Ecology (SEDUE), which became the executing agency for external loans to the sector. In 1990, the National Water Commission (CNA) was created as an autonomous organization within the Ministry of Agriculture and Water Resources (SARI). In 1992, SEDUE's functions regarding water supply and sanitation and environmental protection were assumed by the Ministry of Social Development (SEDESOL). Amendments to the Mexican Constitution, made in 1983, have assigned to municipalities the responsibility for the provision of water supply and sanitation services. In practice, these services have been provided with heavy assistance from the state and federal governments. 2.06 Functions of the state-level water agencies vary widely from state to state. Some state agencies concentrate on assisting municipalities in the design and construction of water and sewerage systems, while making the municipalities responsible for the operation and maintenance of their systems. Other state agencies provide all water and sewerage services to urban and rural communities, from planning and construction to operation, billing and collection. At the Federal level, some institutional arrangements have changed, particularly those of SARH. There are five major players in the urban water supply and sanitation services, as described below. 2.07 The SARH is responsible for water administration through its agency the National Water Comrnmission (CNA). CNA is the technical sector support agency both in water supply and sanitation, as well as irrigation. For water supply, it has sector-wide responsibilities for planning, setting and enforcing technical standards, assisting operating agencies to develop their institutional development programs, monitoring the perfornance of the operating agencies, and helping them to prepare annual action plans to improve their performance. CNA is responsible for the definition of priorities of the sector, planning of development, and protection and administration of water resources. In addition, CNA is responsible for technical support, and in coordination with the National Bank for Public Works (BANOBRAS) and the Ministry of Finance and Public Credit (SHCP), reviews the sector annual investment plan, and coordinates design and implementation of the National Training Program with the Mexican Institute of Water Technology (IMTA) and the National Association of 3.In 1990, intestinal diseases was the number one cause of death in Mexico, with a rate of 32.8 per 100,000 people. SAR Second Water and Sanitation Sector Project, February 8, 1994. 4.It is estimated that about 240,000 hectares are being irrigated with untreated wastewater. As part of the cholera prevention campaign, the use of wastewater for irrigating vegetables has been banned.  4 Water Supply Operating Agencies (AMOAPA). SEDESOL is responsible for funding sector investments and issuing official water standards and environmental impact assessments, and together with the Ministry of Planning and Budgeting (SPP) within the Ministry of Finance and Public Credit (SHCP) participates in preparing and approving the annual investment program for the sector. To help coordinate and standardize state needs with the Federal and State plans, State Water Supply and Sanitation Subcommittees (SWSS) were created in all states. The main responsibilities of SWSSs are to: (a) coordinate sector activities; (b) set sector priorities for water use; (c) select communities where water and sanitation services will be implemented; (d) propose annual sector investment plans; (e) assign state financial resources with credit resources coming from BANOBRAS; (f) propose to the State Congress the tariff level and structure; and (g) promote private sector participation. CNA acts as the technical secretariat of each SWSS. In rural areas, the Programa Nacional de Solidaridad (SOLIDARIDAD) works with communities to promote economic development, including the provision of potable water and sanitation services facilities, and acts as a channel for government funds. The Federal Government is aware of the organizational problems at both the State and Municipal level and the Government continues implementing organizational changes to improve the provision of services nationwide (Charts 1-2). 2.08 Sector Strategy. In line with its overall strategy of decentralization, the Government is committed to support the delegation of water supply and sewerage services to municipalities and to promote sustainable development of water resources with emphasis on rational and efficient resource use. In addition, the Government is encouraging the preservation of water quality and the environment by taking the river basin as the basic unit for water management. The challenge to the Government is to help the municipalities carry out this responsibility efficiently. 2.09 To meet this challenge and as part of the APAZU, the Government (through CNA) prepared the National Program for Water Quality Improvement in 1991, which aims at: (a) monitoring water quality and its assessment; (b) developing effluent standards and discharge permits; (c) strengthening the finance system; (d) developing sanitation and treatment infrastructure; (e) improving management of river basin pollution; and (f) reinforcing the sector's institutional capacity. 2.10 Bank Lending to the Sector. The Bank has been active in the water supply and sanitation sector in Mexico for about twenty years. Throughout this period, the Bank has supported the Government's priorities to make progress in proposing, planning, executing and financing key activities in the sector. Altogether, there have been five loans to Mexico for a total to US$ 375.3 million, as follows: loans 909-ME (US$90 million in 1973), 1186-ME (US$40 rmillion in 1975); 1913- ME (US$125 million in 1980); 2281-ME (US$100.3 million in 1983); and 3101-ME (US$20 million in 1989). Bank involvement began in 1973 with the first water supply loan, which was to build bulk water supply facilities for Mexico City (Annex 1). The next three financed physical improvements in various medium-sized cities. The fifth loan, to support water and sanitation facilities and productive opportunities for women, was allowed to lapse and never became effective. This was because the  5 Government created the SOLIDARIDAD program5 that provided grants rather than loans for the same activities. While the above projects successfully achieved their physical objectives (extending and improving water and sewerage systems and increasing service levels), they did not meet their institutional objectives (establishing an appropriate institutional framework and sound cost-recovery policies)6. This was due mainly to the limited ability of the national agency to provide technical assistance to local institutions and to the lack of adequate commitment to the objective of cost- recovery. The main lessons learned from these projects were the importance of developing self- sufficient water agencies, community support, and designs that reflect local needs and willingness to pay. 3. Project Objectives and Description. 3.01 The main objectives of the project were to support the implementation of the Sector Reorganization Program, which was designed to increase coverage of water supply and sanitation services, improve their quality, promote sound pricing policies, progressively reduce the need for government funding, and improve environmental conditions in Mexico. Specific project objectives were to: (a) reduce the amount of subsidies to the sector; (b) strengthen the institutional framework at the national level; (c) promote at state, regional andlor municipal levels the development of companies of sufficient scale to operate economically and maintain their water and sanitation systems efficiently and with financial autonomy; (d) provide by the end of 1994, water supply and sanitation services in Mexico to about 24 million additional people, most of whom belong to the poorer segment of the population; and (e) improve the environment by implementing a pilot water-pollution control program and requiring a comprehensive environmental assessment of each financed sub-project. 3.02 The loan consisted of the following two components that the Bank felt were equally important: A. The National Level. 3.03 This US$61.4 million component was to be executed by CNA and included: (a) assistance to CNA and training for its staff in: (i) sub-project preparation and evaluation under the new national policies; (ii) review and updating of existing technical norms and parameters for the design, construction, and maintenance of the water supply and sanitation systems; (iii) design and implementation of a sector monitoring 5.This program is designed to improve standard of living of the poor, and finance, on a grant basis, water and sanitation works in rural and in some urban areas. . World Bank: Project Performance Audit Report: Mexico City Water Supply Project (Loan 909-ME); Medium Cities Water Supply and Sewerage Project (Loan 1185-ME); Second Medium-Size Cities Water Supply and Sewerage Project (Loan 1913-ME); and Third Medium-Size Cities Water Supply and Sewerage Project (Loan 2281-ME). OED Report No. M93-779, July 23, 1993.  6 system; (iv) assistance to operating agencies for their institutional development programs; (v) strengthening environmental assessment capability; (vi) specialized studies to provide or update the basic information needed to define medium and long- term water pollution control policies; (vii) a pilot environmental project in the Lerma- Chapala Basin, which would also provide the opportunity to test the institutional, legal, technical, and financial schemes that were under consideration; (viii) financing for the physical infrastructure needed for the National Water Quality Monitoiing Program and the implementation and operation of the Water Quality Information System, which included equipment for five regional and 22 state laboratories and for field sampling and analysis; (ix) review of existing legislation and carry out the private sector participation study; (x) financing for the preparation of a follow-up project; (b) strengthening of IMTA's National Training Center through: (i) upgrading training facilities in Cuemavaca; (ii) purchasing training materials and equipment; (iii) development and organization of a management and technical training program for sector personnel, including the execution of a training program for sector managers and staff, (c) strengthening BANOBRAS in the following areas: (i) project preparation and evaluation; (ii) procurement; and (iii) monitoring and evaluation systems; and (d) technical assistance to undertake a study, prepare model contracting documents, and implement promotion programs and develop a strategy to encourage private sector participation in provision of water supply and sanitation services. B. The State and Local Levels. 3.04 This was to be the main project component, with a total estimated cost of US$589.5 million. It would provide a line of credit to municipal and/or state water and sanitation agencies and to private providers of water supply and sanitation services to be administered by BANOBRAS in full compliance with agreed sector policies. It would also fund investments to be made under the 1990- 1994 Investment Plan. Sub-projects would become eligible for Bank financing by complying with agreed-upon criteria--BANOBRAS would only sign sub-loans with established independent water and sanitation agencies after August 31, 1991. Eligible sub-projects would involve the rehabilitation and expansion of water supply and sanitation systems, including sewage treatment plants, work supervision, and institutional strengthening of sub-project executing agencies.  7 4. Project Preparation, Design and Appraisal. 4.01 A Bank mission identified the project in November 1988 and its main components were prepared by BANOBRAS through the middle of 1990. The Bank helped project preparation with several missions. At the same time, IDB prepared a companion project (US$350 million), with identical conditionality. The project was appraised in June 1990. The loan was approved by the Board in November 1990 and signed in January 1991. The Borrower provided the Bank with legal opinions with some delay, and thus the loan became effective only in June 199 1. 4.02 Project Design. The project was fairly well prepared. Project design was in general satisfactory and in line with the Government of Mexico's main objective of supporting decentralization and delegation of water supply and sewerage services to the municipalities. It was also in line with the Bank's strategy aimed at providing water and sanitation services to low-income populations, promoting more efficient sector management and supporting Government efforts to strengthen the sector. The project was also timely as it played an important role in shaping Mexico's investment program in the first stage of the Government's water supply and sanitation development plan. The preparation of the project grew out of an intensive dialogue between the Government and the Bank during preparation of the underpinning sector report7, which lead to the formulation of a Water and Sanitation Sector Reorganization Program, in CNA document called Lineamientos. 4.03 Sector Reorganization. The Government of Mexico has for the last three decades been closely investigating means of meeting demand for water and sanitation services. Several organizational changes have been made during the past two decades to improve sector performance (para. 2.06). Mexico made rapid progress in improving its citizens' access to water and sewerage services during the 1970s, but progress had subsequently slowed. The Government has been working hard to establish a coordinated legal policy and institutional framework for managing the country's scarce water resources. The Bank analyzed the need to improve water supply and sanitation coverage and standards during project preparation, with particular emphasis on improving services to neglected lower-income groups. 4.04 Sector Strengthening. The project was designed to strengthen the planning capacity of the sector, particularly at the State and Municipal levels. As is standard in Bank water and sanitation projects, the project used least-cost analysis for design of the investment prograrn. The absence of least-cost analysis in the sector had led to poor investment decisions in previous Bank loans8. The absence of such analysis in sector investments was traced to the system of grant financing and the absence of cost recovery, where little incentive existed to plan effectively and conserve resources. The project was to provide access to water and sewerage connections to about 3.2 million people (of 24 million benefiting from the National Water Supply and Sanitation Investment Plan), and mostly to low- 7. Urban Water Supply and Sewerage Sector Study --Institutional and Financial Constraints--7109-ME, June 1988. SAR Water Supply and Sanitation Sector Project. Report No. 8973-ME. November 8, 1990.  8 income groups. In the case of rural communities, improvements would have an important impact on the welfare of women, as local customs often call for women to walk long distances to fetch water in buckets. The project investment would also contribute significantly to improve both public health and the standard of living among the population receiving the services under the project. To qualify for a sub-loan, water supply sub-projects should yield a minimum Rate of Return (RR) of 12%, higher than the opportunity cost of capital in Mexico. The acceptable RR for water-pollution control sub-projects would be only 10%, since reducing pollution generates positive extemalities that are not easy to quantify. To help sub-project implementation, sub-project evaluation guidelines were prepared, which were consistent with the policies and priorities established by the Government to strengthen the sector. 4.05 Financial Measures. During appraisal, the Bank was concerned that water tariffs were not sufficiently high to cover operating and investment costs. Before appraisal, rates averaged about US$0.07 per cubic meter, which was considered very low, compared to an average incremental cost of services of US$0.30 to US$0.50 per cubic meter. Furthermore, many cities did not charge explicitly for sewerage services. Most water and sewerage agencies did not meter water services or establish sound accounting and internal control systems. To enhance cost recovery, the design of the project required: (a) that as condition for sub-lending for a sub-project, every sub-borrower should have tariffs in place to at least cover its operating and maintenance expenses (excluding depreciation); (b) a commitment, under the conditions of the sub-loan, from every sub-borrower to increase water and sewerage rates in accordance with a satisfactory initial timetable; and (c) a commitment from each sub-borrower to implement conmmercial accounting and internal auditing, and to carry an institutional development program. 4.06 The Bank was also concerned about the potential for conflict between project financing criteria and those of the newly created SOLIDARIDAD9 program. The Government agreed in August 1990 to avoid this by limniting SOLIDARIDAD's target group to the poorest populations, and confirmed during negotiations that SOLIDARIDAD funding for the water and sanitation sector in the poorest municipalities would have the same criteria and norms as the Bank project'. 4.07 Environmental Assessment. Lack of control of municipal and industrial water discharges was another major concern for the Bank at appraisal. Most industries connected to municipal sewers discharge their effluent without any pre-treatment. The project design therefore emphasized strengthening the institutional capacity of Operating Agencies (OAs), to operate, maintain, control and monitor waste-treatment facilities. It was agreed that all sub-projects would require an environmental impact assessment, to be carried out by CNA, as an eligibility condition. Failure to 9.This program was designed to improve the standard of living of the poor, and to finance on a grant basis, water and sanitation works in rural and in some urban areas. SAR Report No. 8973-ME, November 8,1990.