Argentina - Third Buenos Aires Power Project

RESTRICTED FILE COPY. FILE CO Y XReport No. P-743 This report was prepared for use within the Bank and its affiliated organizations. They do not accept responsibility for its accuracy or completeness. The report may not be published nor ma-y ;t be quoted as representing their views. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO SERVICIOS ELECTRICOS DEL GRAN BUENOS AIRES, S. A. WITH THE GUARANTEE OF THE ARGENTINE REPUBLIC September 24, 1969  REPORT AND BECOMMNDATION CF THE PRESIDENT TO THE EXECUIVE DIRECTORS ON A PROFOSED LOAN TO SERVICIOS ELECTRICOS DEL GRAN BUENOS AIRES, S.A. WITH THE GUARANTEE OF THE ARGENTINE REPUBLIC 1. I submit the following report and recommendation on a proposed loan in an arount in varieus currencies equivalent to US$60 million to Servicios Electricos del Gran Buenes Aires, S.A. (SEGBA) for the third Buenos Aires power project. PART I - HISTORICAL 2. In August 1968, SEGBA indicated to the Bank that it would need a third loan to help finance the execution in 1970 of the final stage of its 1967 - 1970 expansion program. Subsequsntly, however, the launching of the El Chocon hydroelectric project, with the help of the Bankls loan of December 1968 to Hidronor, and the Government s decision to build a nuclear power plant at Atucha resulted in a change in SEGBAJs investment plans. A new program was prepared for 1970 - 1972, with the aim of connecting the transmission lines from El Chocon and Atucha with SEGBA's system and further expanding transmission and distri- bution in Greater Buenos Aires. This program was presented to the Bank in February 1969 as a basis for a third loan and a mission appraised it in Buenos Aires in April/May. Negotiations were held in Washington between August 12 and 28, 1969, with Ing. Gabriel A. Meoli, Executive Vice President, representing SEGBA and Dr. Daniel Fernandez, Financial Minister at the Argentine Embassy in Washington, representing the Government. 3. The two previous loans to SEGBA were made by the Bank in January 1962 and January 1968, in the amounts of $95 million and $55 million, respectively. The first enabled SEGBA to complete a 600 MW thermal plant and expand its transmission and distribution system. The work was carried out diligently and the loan account was closed in June 1965. The second loan is helping to finance investment in transmission and distribution under SEGBA]s 1967 - 1970 program. While the project is progressing satisfactorily, delays in delivery under several equipment contracts will make it impossible for SEGRA to claim full reimbursement under these contracts before December 31, 1969, the Closing Date of the loan. Consequently, SEGBA intends to ask the Bank to postpone the Closing Date to April 15, 1970; simultaneously, SEGBA intends to cancel an amount of up to $4.5 million which will not be used for the project, mainly because its cost proved lower than estimated.  h. The following is a summary statement of the previous Bank loans to Argentina as of August 31, 1969: Loan Number Year Borrower Purpose Amount Undisbursed - - (US$ Million) 288 1961 The Argentine Republic Roads 30.9 - 308 1962 Servicios Electricos del Gran Buenos Aires, S.A. (SEGBA) Power 93.4 - 505 1967 The Argentine Republic Livestock 15.3 15.2 525 1968 Servicios Electricos del Gran Buenos Aires, S.A. (SEGBA) Power 55.0 30.1 577 1968 Hidroelectrica Norpatagonica S.A. (HIDRONOR) Power 82.0 7h.7 619 1969 The Argentine Republic Roads 25.1/ 25.0 Total (less cancellations) 301.6 of which has been repaid to Bank and others 21.6 Total now outstanding 280.0 Amount sold 5.5 of which has been repaid .9 h.6 Total now held by Bank 275.4 Total now undisbursed 145.0 5. The program of credit to livestock producers, supported by the Bank's $15.3 million loan made in 1967, has been very slow to get under way mainly because of an apparent lack of demand for credit from the producers. The Bank intends to undertake a thorough reappraisal of this project if there is not soon a substantial increase in the rate of lending. 6. IFC has made commitments to seven companies in Argentina for a total of $23.7 million; through cancellations and terminations, this amount wias reduced to $18.0 million. IFC presently holds $8.3 million for its own account; of this, $4.2 million is undisbursed. 7. The proposed loan is likely to be the only Bank operation in Argentina in the current fiscal year. The rehabilitation of the Argentine railways, to which I referred in mr report of June 9, 1969 on the proposed loan for the second road project (P-722), is progressing. By the end of 1969, the railways expect to have formulated an investment program, which the Bank may decide to appraise for financing in the next fiscal year. Also, an additional road project may be ready for consideration next year. 1/ Not yet effective.  - 3 - PART II - DESCRIPTION OF THE PROPOSED LOAN 8. BORRCWER: Servicios Electricos del Gran Buenos Aires, S.A. (SEGBA) GUARA.NTOR: The Argentine Republic PURPOSE: To finance part of the foreign exchange costs of a program for expanding SEGBA's transmission and distribution system. AMOUNT: In various currencies equivalent to US$60 million. AMORTIZATION: In 20 years, including a. L-year period of grace, through semi-annual installments beginning November 15, 1973 and ending November 15, 1989. INTEREST RATE: 7% per annum. CCMMTMENT CHARGE: 3/4 of 1% per annum. PART III - THE PROJECT 9. A report entitled "lServicios Electricos del Gran Buenos Aires, S.A. (SEGBA) Appraisal of 1970-1972 Expansion Program"! (PU-19a) is attached. The Power Sector 10. The installed generating capacity of the electric power sector in Argentina is 4,100 ICJ; an additional 1,700 MW is represented by power plants olvmed by industry. The sector comprises one large system supplying the Buenos Aires-Litoral area, two medium-size systems serving, respectively, Southern Buenos Aires Province and the city of Cordoba, and five smaller systems, three of them in the north and two in the west of the country; in addition, there are some generating plants in small localities. 11. Public supply of electricity in the Buenos Aires-Litoral system is presently ensured by SEGBA, a Government-owned stock corporation, Compania Italo-Argentina de Electricidad, S.A. (CIAE), a Swiss-controlled private company, and Agua y Energia Electrica (AyEE), a federal agency which operates thermal plants on the Parana River above Buenos Aires. Four years from now, Hidronor's hydroelectric plant at El Chocon and the Atomic Energy Commission's nuclear plant at Atucha should be connected iith this system.  12. In Greater Buenos Aires, which includes the federal capital and 31 municipal districts southeast and northw6st of it along the River Plate, SEGBA and CIAE generate and distribute more than 50% of the total public supply of electricity in Argentina. Since the beginning of 1968, as a result of a coordination effort consistently supported by the Bank, all generating plants of the two companies have been controlled by a central dispatch office. The draft Loan and Guarantee Agreements commit SEGBA and the Argentine Government to coordinating the expansion of all electric power entities supplying Greater Buenos Aires and to achieving the most economic operation of their generating plants. The Company 13. Established in 1958 as a successor to the Belgian-oTned Compania Argentina de Electricidad (CADE) and reorganized at the time of the Bank's first loan, SEGBA is one of the largest power utilities in South America. In 1968, it sold 5.4 billion kwnh, supplied 2.1 million customers, employed 25,000 people and invested $54 million equivalent in new facilities. 1. SEGBA is managed by an Executive Committee, consisting of an Executive Vice President and four department heads. This Committee constitutes a competent and effective management team. Since the appoint- ment, three years ago, of the present Executive Vice President, substantial progress has been achieved towards improving the organization and increasing its efficiency. 15. The labor situation, once a thorny issue, has greatly improved since the Bank made its second loan to SEGBA. Between January 1, 1968 and June 30, 1969, there was a reduction of 1,140 persons on SEGBA's payroll. This reduction, combined with an annual increase of about 100,000 in the number of customers, demonstrates a significant rise in efficiency. In the next three years, SEGBA intends to continue reducing its operating personnel, mainly through retirement and transfer to construction lwork. Slow but consistent progress has also been made in revising the labor contract and restoring management authority in labor matters. In its dealings with the Light and Powler Union, SEGBA has had the Government's support. 16. SEGBAts concession which, according to the Loan Agreements Eith the Bank, cannot be changed without the Bank's prior consent, provides for a level of electricity rates necessary to produce revenues sufficient to cover operating expenses, including adequate maintenance and deprecia- tion, and to yield an 8% return on net assets. The present capitalization of the Company consists three-fourths of equity and one-fourth of debt, the Bank being by far the largest creditor. SEGBA's debt could be increased by amounts substantially larger than the proposed loan within the debt limitation written into the Loan Agreements with the Bank. SEGBA has undertaken (see Section 5.12 of the Loan Agreement) to use its best efforts to borrow in the private market in order to prepare itself to finance expansion without further substantial assistance from the  Bank. SEGBA also intends to start paying cash dividends, as its cash position allowJs, to conform with the Government's policy, expressed in the Guarantee Agreements with the Bank, of encouraging a market for SEGBA's shares, thereby opening a channel for attracting private equity investment in the expansion of electricity services. The Project 17. The project is SEGBA's expansion program for 1970-1972. Its main features are to build a 120 km. long transmission ring around Buenos Aires, connect the transmission lines from El Chocon and Atucha, and further extend and strengthen the distribution network in Greater Buenos Aires. Investment in generating capacity will be relatively small. The project thus marks SEGBAMs transformation from a utility supplying primarily self-generated electricity to a distributor of large amounts of energy generated by others outside the metropolitan area. The cost of the project is estimated at the equivalent of $*12h7 million. The proposed loan will provide $60 million, and the balance wjill be covered largely out of retained earnings (supplemented by bond issues and suppliers' credits). The incremental financial. rate of return on the project is estimated to be in excess of 18%. 18. The proposed loan w,ould cover (a.) the cost of certain equip- ment and material purchased abroad and 60% (being the estimated foreign content) of the cost of certain equipment and materials purchased in Argentina., (b) the estimated foreign exchange content (17%) of the cost of civil works and equipment erection, (c) the foreign cost of consulting services, (d) interest during construction and (e) contingencies. Procurement 19. Procurement for public projects of equipment which can be manufactured in Argentina is normally reserved for local manufacturers, through a "Buy Argentine" act, and through heavy tariff protection. Prices paid to local manufacturers under these protective measures have sometimes been twice the c.i.f. prices of equivalent imports. With this ba.ckgromd, the Government was under strong pressure to require SEGBA to reserve part of the procurement for Argentine manufacturers without limitation as to price, and informed the Bank that it could not permit SEGBA to subject all purchases to international competition with a preference to Argentine manufacturers of only 15%. 20. In these circumstances, attempt was made in the negotiations to arrange procurement in such a way that local manufacturers iere induced to bring their prices down. It was eventually agreed that bidding for two-thirds of the equipment and materials of each category To1ld be invited on an international basis, wTith Argentine bidders receiving only a 15% margin of preference. If an Argentine bidder Tere successful for this two-thirds, he would be invited to supply  - 6 - the other one-third at the same price. If a foreign bidder vere awJarded the contract for the tno-thirds, separate bids from Argentine suppliers for one-third would be opened and nould be awarded to the lowest bidder if his price were belowr 138% of the c.i.f. price of the successful foreign bidder for the two-thirds. However, any domestic procurement undertaken on this basis would not be eligible for financing out of the loan. If the Argentine supplier's price were above 138% and he was unwilling to reduce to that level, the successful foreign bidder for the two-thirds would be invited also to supply the one-third at the same unit price. This limit of 138% was suggested by SEGBA in order to give Argentine industry opportunity to supply some equipment under the project without unduly increasing its cost. 21. Civil wporks, except for some works carried out by SEGBA itself, would be put to international competitive bidding. Small amounts of generation equipment, not included in the proposed loan, would be financed with supplier credits. PART IV - LEGAL INISTRUMENTS AND AUTHORITY 22. The draft Loan Agreement between the Bank and SEGBA, the draft Guarantee Agreement between The Argentine Republic and the Bank, the Report of the Committee provided for in Article III, Section 4 (III) of the Articles of Agreement and a draft Resolution are being distri- buted to the Executive Directors separately. 23. The provisions of the Loan and Guarantee Agreements generally conform to the pattern of Bank power loans and of the two previous loans to SEGBA. It should be noted that Section 6.oh of the draft Loan Agree- ment and Section 5.01 of the draft Guarantee Agreement provide that certain clauses of the agreements for the first and second SEGBA loans will be amended to read as in the new agreements provided. The new clauses include those dealing with consultation on the appointment of the Executive Vice President (Section 5.04 (e) of draft Loan Agree- ment, the encouragement of private investment in SEGBA (Section 5.12 of draft Loan Agreement and Section 3.06 of draft Guarantee Agreement), power rates (Section 5.13 of draft Loan Agreement and Section 3.07 of the Guarantee Agreement) and the covenant regarding registration of pledge not to mortgage SEGBA's assets (Section 5.15 of the draft Loan Agreement). Also, Section 5.10 of the draft Loan Agreement provides for consultation with the Bank instead of Bank consent as in the previous agreements, should SEGBA propose, during the construction of the Project, to undertake any major expansion. Section 3.09 of the Guarantee Agree- ment provides that Government will promptly issue any licenses or author- izations necessary for the acquisition or importation of goods and services required for the project.  - 7 - PART V - THE ECONOEY 24. The report 'Recent Economic Developments and Prospects of Argentina" (W.H-19la) w-ras distributed to the Executive Directors on June 3, 1969. The report concluded that in the light of the relatively favorable longer-term grow..Tth and balance of payments prospects and the Government's remarkable success in carrying out its program of economic stabilization and reactivation of the economy, Argentina should be creditw.worthy for the substantial volume of additional lending it requires. Economic developments since that time do not call for a modification of this conclusion. 25. The student and labor unrest last May, and the ensuing Cabinet changes, have not had significant effects on the execution of the Government's 1969 economic program. During the first six months of the year the gross domestic product grew at an annual rate of more than 7 percent as a result of a sharp rise in private investment, a marked improvement in agricultural output and exports and a. sustained increase in industrial production. The rising economic activity was accompanied by a sha.rp increase in imports - from $537 million in the first seven months of 1968 to $833 million during the comparable period of 1969. NTevertheless, while the political events of May and June resulted in some outflow of capital, gross official gold and foreign exchange reserves of $797 million at the end of August, were only $8 million less than at the end of 1968 and constituted the equivalent of about 7 months, imports. 26. The favorable growth and export performance of the economy has gone hand in hand mrith satisfactory price developments. The season- ally adjusted cost of living index for the first 8 months of 1969 rose by only 3.6% compared with 5.3, during the comparable period of 1968. While wholesale prices have increased by 7% up to the end of July, a. substantially more rapid rate than during the first seven months of 1968, this has primarily reflected a relative improvement of agricul- tural and livestock prices and a marked rise in import prices, wvhile domestic non-agricultural prices have shown only a small increase. 27. During the first 8 months of the year tax receipts exceeded amounts collected during the corresponding period of 1968 by over 15% and came close to budget estimates, 4hile the nrse in current expenditure has been limited to less than 10%. The financial performance of most state enterprises has continued to improve and - following decisions taken in early 1969 - public investment has been held about 15% below the originally budgeted levels. In early September, the Government enacted a.new railroad enterprise law, giving the railwiays increased autonomy and setting the stage for a far-rea.ching rationalization and reequipment program. Public sector savings are apparently financing a larger proportion of public investment than in 1968 and the budget deficit has been less than envisaged at the beginning of the year. The monetary situation has become somewrifhat tighter than had been foreseen  - 8 - at the beginning of the year since foreign exchange reserves have not increased, as had been expected. Interest ra.tes in the non-bank market have hardened and the Government has had to increase the effective interest rates on domestic Government bonds. The originally scheduled placement of Government bonds abroad has had to be partially postponed because of the stringency of international capital markets. Some of the borrowing carried out thus far - e.g., the 50 million dollars obtained from a consortium of U.S. banks - has been for a shorter term (5 years) than the Government had hoped, given its policy of seeking to lengthen the average maturity of the external debt. 28. It thus appears that, although some of the original targets of the stabilization program have had to be modified, the program as a whole is being continued successfully. Its next test will be the implementation of 1969 - 1970 incomes policy. As announced at the end of 1968, the Government set the stage at the beginning of September for a return to collective wage bargaining. While not relying on explicit wage and price guidelines, the Government will condition its approval of wage agreements on their conforming to a set of rules designed to permit significant wage adjustments within a frameoTork of relative price stability. The Government expects iages for 1970 to rise by 8 - 10% on the average and has announced that it intends to use its full powers (including its ability to expose industries to import competition by reducing import duties) to prevent the emergence of a new cost-price spiral. PART VI - COMPLIANCE WITH ARTICLES OF AGREEIENT 29. I am satisfied that the proposed loan would comply woith the Articles of Agreement of the Bank. PART VII - RECORENDATION 30. I recommend that the Executive Directors approve the proposed loan. Robert S. McNamara Attachments. President Washington, D.C. September 24, 1969