Mexico - Zihuatanejo Tourism Project

RESTRICTED Report No. P-998 This report is for official use only by the Bank Group and specifically authorized organizations or persons. It may not be published, quoted or cited without Bank Group authorization. The Bank Group does not accept responsibility for the accuracy or completeness of the report. INTERNATIONAL BANK POR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO NACIONAL FINANCIERA, S. A. OF MEXICO FOR THE ZIHUATANEJO TOURISM PROJECT December 7, 1971  INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOPLiDEJATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO NACIONAL FINANCIERA, S.A. OF MiEXICO FOR THE ZIErUATANEJO TOURISM PROJECT I submit the following report and recommendation on a proposed loan to Nacional Financiera, S.A., with the guarantee of the United IMexican States for the equivalent of US$22.0 million, to help finance a project for the construction of' tourism infrastructure at Zihuatanejo on the Pacific coast of Mexico. T'he loan would have a term of 25 years, including five years of grace with interest at 7-14/% per anmum. PART I - INTROT.,UCTItON 2. Bank lending to Mexico tota'ls US$1,053 million net of cancel- lations, of which the Bank holds about U$831 million, including US$186 million not yet disbursed. A summary of loans as of October 31, 1971 is attached as Annex I. Over half of a'll lending to date has been for electric power, one-quarter for transport and the remainder for agricu'ture. The most recent loan, for livestock and agricultural deve'l- opment, was signed on June 9, 1971. During the current fiscal year I expect to be ready to present for your consideration a further power loan and other loans for industrial credit, railways and ports. The railway and port operations are a sequel to the study of the transport sector distributed to the Executive Directors on June 7, 1971 (R71-139). 3. Execution of Banlk-financed projects in Mexico has, on the whole, been satisfactory. Over a period of more than 20 years Bank iending has played an important role in strengthening the power sector and consoli- dating its management and finances. However, a financial problem current+' exists because of substantially higher 1970-71 construction expenditures than had been planned and excessive reliance on short- and medium-term debt for their financing. In addition, there has been a long delay in implementing the program for frequency unification in and around Mexico City. The necessary decrees are being issued and actual work of conver- sion is expected to proceed during 1972. Lags have been occurring in disbursements under Loans 528-ME (Third Road Project) and 695-ME (Fourth Road Project) because of delays in awarding contracts and in presenting loan applications to the Bank. A delay in construction and disburse- ments has also occurred on Loan 527-INE (Rio Colorado Irrigation Project) because of the time needed to work out an understanding with farmers relating to the recovery of a portion of project costs through water charges. The economic returns on one irrigation project in the north- east, financed under Loan 336-ME, are somewhat lower than expected as a result of the elimination of cotton production because of a price decline and problems of pest and disease control.  -2 - 4. IFC's total commitments to Mexico reached US$42.5 million by September 30, 1971, consIsting of US$20.0 million of operaticnal invest- ments and US$22.5 million of standby and underwriting commitments in nine enterprises. From these commitments, the Corporation held US$11.3 million on that date, consisting of US$10,0 million in loans and US$18 million in equity. IFC is considering several new projects in Mexico, including an investment in the production of newsprint from bagasse. PAOT II - TIC EOitOMY 5. An economic report entitled "Economic Situation and Prospects of Mexico" (CA.-14a) dated November 15, 1971, was distributed to the Executive Directors on November 26, 1971n A country data sheet is attached as Annex II. 6. As summarized in the latest economic report, the Mexican eco- nomy has demonstrated during the last 15 years its ability to combine an economic growth rate of 6-7 percent per year with relative price stabil- ity, institutional continuity and growth-oriented economic policies backed up by high savings and investment rates. A climate of confidence has been built up over the years both at home and abroad, reflected in a fully convertible and strong peso. However, export growth has slowed down in recent years and there have been signs of increasing social strains at home. A new administration headed by President Luis Echeverria Alvarez took charge in December 1970 for a six-year termT It has already taken a number of measures aimed at mobilizing additional public savings, strengthening the balance of payments, and improving efficiency in the public and private sectors. 7. The new administration introduced a substantial tax package early in its term, which is summarized in the economic report (paragraph 91). Sugar prices were also increased by nearly 50 percent to eliminate a heavy government-financed deficit and to provide funds for the modern- ization of the industry. It has also been strengthening the central control of public sector borroTwing, both external and domestic, and im- proving the debt profile. At the end of November 1971 the authorities presented to the Congress a package wihich can be e;pected to contribute to the further strengthening of Federal Government finances in 1972. An area of uncertainty, however, exists in the finances of the major decentra- lized agencies, especially in the electricity, railways and petroleum sectors. The Government in the last year has been preparing the invest- ment programs of the most directly productive sectors for the next five years; it is ex6pected that presidential review of these programs will give rise to the necessary rate adjustments in the three sectors mentioned, but actual measures are not likely before sometime in 1972. Further programs are also being prepared for the social sectors, including peasant agriculture, education and public health. Sectorial six-year plans are a major improvement over the past, when investment decisions were made on a year-to-year basis. In the agricultural sector a new agrarian code has been written favoring peasant agricultLre. On the export front an export subsidy averaging about 10 percent in the form of tariff and tax rebates has been introduced together with various other export promotion measures.  -3- 8. The measures taken so far have been in the right direction, but further action is needed, particularly in the field of public fi- nances, to provide a firm basis for continuing growrth and stabilit;y Growth has been deliberately slowed doam this year to protect the balanre of payments, and there has been a mild business recession. In the longer run, moreover, the Government will have to come to grip with fundamental structural problems such as the balance between key economic reoources and the demands of a rapidly rising population, severe unemployment, a backlog in education, and the uneven distribution of national income, which shows up most sharply in extensive rural poverty. iMe>dco is also faced with a potential scarcity of water and is now beginning a national water resource survey with the help of Bank staff to aid in attacking this problem. 9. Mexicots medium and long-term public external debt outsstanding as of December 31, 1970 amounted to US$3.8 billion including undisbursed, The debt service ratio (22.9 percent in 1970 and estimated at 19.4 percent in 1971) is high, but has remained in the lower 20 percent range for the past few years and is likely to remain at its present level or decline somewhat during the remaining five years of the present administration. This is partl;y the result of the Government's effort to tighten up its external borrowsing procedures and to keep external borrowing at the minimum possible while limiting external borrowing by decentralized public sector agencies oin commercial terms. As a result external borrowing already declined in 1970 and terms showfed some improve.nent. The i ture debt outlook is good if the Government continues to exercise the same degree of vigilance as this year, and if Mexico can continue to benefit from a rapid increase of foreign e=change earnings as in the past decade. PART L:II - T11 SECTOR AMD TIM PROJECT 10. The tourism sector has showm remarkable dynamism during the last decade and has become the most important source of foreign exchange for Mexico. Gross tourism earnings, excluding those included in border trade, have risen fromL US$160 million in the early 1960's to US$575 mil- lion in 1970, rising from 12 percent of current foreign exchange earnings in 1960 to 20 percent in 1970. This trend can be associated with growming U.S. affluence and a rapid expansion of tourist accommodation in Me:ico. In 1969 1Mexico attracted 1.6 million out of some 10 million U.S. resident;z who vacationed abroad (excluding border tourisn and overland travel to Canada), while Mexyicots two main conmpetitors, Europe and the Caribbean, attracted 3.6 and 2.2 million U.S. residents respectively. Up to now the bulI of tourists in Me.ico are U.S. residents going to Me,ico City and Acapulco. 11. The Mexican Government is putting particular emphasis on the continued rapid development of tourism, both to strengthen the balance of payments and to provide employment in depressed zones with high tourism potential. Tourism requires less capital investment to create job opportunities than most other productive sectors in MlIexico, a country which sufifers from widespread unemploayment and underemployment. Mloreover, many areas of tourism potential are located in the poorer regions of the country and their development could contribute subs tan- tially to alleviating regional income disparities.  - h - 12. In the effort to expand tourism, the Government -- through Infratur, a trust fund of the Bank of Mexico -- is investing a good d-al of resources in developing new projects in poor regions, outside exist- ing resort areas, to increase the tourism potential of the country and to diversify its beach-based tourism assets, consisting mainly of Acapulco. One of these projects, on the Yucatan coast at Cancun, is being financed by IDB; the other, on the Pacific coast at Zihuatanejo, would be financed by the proposed Bank loan. Its main features are summarized in Annex III. 13. The Zihuatanejo project is the first project for tourism in- frastructure to be financed bv the Bank. It would provide the infra- structure required for establishing a new tourist resort in the nearby site of Ixtapa and for the rehabilitation and expansion of the existing fishing village of Zihuatanejo, which is expected to grow to at least three times its present population during the first five years of tourism development at Ixtapa and at Zihuatanejo itself. It also includes an international airport to provide the area with direct communication with the tourism supply markets. In addition, about US$1 million is included in the loan for consultants services to help finance the preparation of future projects in new tourist zones, a plan for attacking current problems of water pollution and urban deterioration in Acapulco resulting from th2e rapid growth of slum areas, and a training program to provide the hotels of the Ixtapa area with a qualified labor force. 1h. The Bank was requested to consider financing the Zihuatanejo project in 1969. The preparation and the appraisal of a tourism project in the new and complicated field of integrated urban and area develop- ment has not been easy. In cooperation with many different agencies, Federal, State and Municipal, involved in the project, and with extensive help from the Bank staff, Infratur, assisted by Mexican consultants, has worked out a master plan and zoning regulations for Ixtapa and Zihuatanejo and a master plan for the airport. The authorities involved have already agreed to the designs for the various components of the project and their construction capacity is proven. Accordingly, pros- pects are favorable that the infrastructure will be completed as planrned and without serious delays. 15. The Secretariat of Public Works will be responsible for building the airport. Infratur, through a special project unit, will be in charge of constructing most of the works at Ixtapa, including boulevards and streets, the water distribution and sewerage collection network, telecommunications, electricity, beach works, the commercial center and the golf course. The Secretariat of Hydraulic Resources will be re- sponsible for all water supply and sewerage works at Zihuatanejo and bulk water supply and sewerage treatment facilities at Ixtapa. The National Bank for Public Works will be in charge of construction of most of the works in Zihuatanejo including main streets, electricity connections, distribution network and public lighting. Several other agencies will be responsible for operating and maintaining the various components of the project. The Government of the State of Guerrero and  - 5 - the Municipality of Z-huatanejo will also have important functions in relation to the project. Infratur will have the leadership at the working level in coordinating the execution of all the project compcn- ents. The Government will ensure the timely and effective participation of the various executing agencies acting through normal coordinating arrangements. 16. The project depends very much on when the hotels will be ready. Various hotel companies have expressed interest in sponsoring hotels but Infratur decided not to begin negotiations with them before loan approval. EHwever, the Mexican Government has given assurances that it will ensure that at least 750 hotel rooms will be built and operating by 1976 and will provide finance for this purpose if necessary. To avoid probleims with airline routes the Mexican Government will declare Zihuatanejo a co-terminal with Acapulco. The Government has agreed to prevent pollution in the tourist area. 17. The economic return on the-project will be very sensitive to the rate at which hotels are built and occupied. On varying assunmptions about occupancy levels and opening dates, and with shadow pricing .Qf unskilled labor, the internal rate of return is estirmated at between 15 percent and 21 percent, excluding benefits to the local population of improved infrastructure in Zihuatanejo. 18. The proposed US$22 million loan would cover about half of the total cost of the project, which consists of a wide variety of works requiring many small contracts. If the Bank and Mexico shared in the financing of all the components of the project, the administration of the loan would be unduly complicated. Accordingly, a division has been worked out under which HIexico would finance 100 percent of a wide variety of items and the Bank would share in the financing of a selective group of major wiorks, particularly the airport, the water supply and sewerage systems at Ixtapa and Zihuatanejo, and various works at Lxtapa, as well as consultant services for the feasibility studies. The com- ponents of the project to which the proceeds of the Bark loan would be applied total about US$29 million including contingencies and the proposed loan would cover about 76 percent of the value of these items. Major civil works contracts and contracts for most equipment would be awarded after international competitive bidding. Water supply, sewerage and other contracts too small for foreign bidders amounting to $3.3 million would be let after local competition. In evaluating bids for equipment Mexican manufacturers would receive a preference of 15 percent or the actual import duties, whichever was less. Contracts totalling US$200,000 for electric and telecommunication lines for the airport would be awarded through direct negotiations with the companies providing these services. 19. The foreign exchange component of the project has been estimated at US$13.3 million; just over one-third of the loan will therefore be for local costs. Mexico has a diversified industrial structure capable of supplying a large proportion of its requirements for  - 6 - capital goods; yet its gross external borrowing requirements are very substantial, especially in the light of its high external debt service. Hence some local cost financing by external lending agencies is required to complement the intensified fiscal efforts now being made by the Government, as summarized in paragraph 7. Bank loans for power, high- ways and irrigation have traditionally been tied to the foreign exchange costs of projects; I consider some local currency financing in other sectors to be justified, particularly for high priority projects simultaneously yielding economic and social benefits, such as offered by the Zihuatanejo tourism project through increasing Mexico's foreign exchange earnings and providing substantial employment in an extremely poor zone. PART IV - LEGAL INSTRUMENTS AND AUTHORITY 20. The draft Loan Agreement between tha Bank and Nacional Financiera, S.A., the draft Guarantee Agreement between Mexico and the Bank, the draft Project Agreement between the Banco de Mexico, S.A. and the Bank, the Report of the Committee provided for in Article III, Section 4(iii) of the Articles of Agreement and the text of a resolution approving the proposed loan are being distributed to the Executive Directors separately. The draft agreements conform to the normal pattern for Bank loans to Mexico. 21. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank. PART V - RECOMMENDATION 22. I recommend that the Executive Directors approve the proposed loan. Robert S. McNamara President Attachments December 7, 1971 Washington, D.C.  Annex 1 Page 1 of 2 MEXICO: SUMMARY OF BANK LOANS AND IFC INVESTMENTS Bank Loans - at October 30, 1971 - Un- Loan Year Borrower Purpose Im ount disbumrsec- 19h9/ Loans fully disbursed (less 1965 cancellations) 592.6 336-ME 1963 Nacional Financiera, S.A. Irrigation 12.5 1.2 85o-ME 1966 Nacional Financiera, S.A. Irrigation 19.0 2.2 527-ME 1968 Nacional Firnanciera, S.A. Irrigaticn 25.0 18.8 528-NE 1968 Nacional Financiera, S.A. Roads 27.5 7.0 5h4-ME 1968 Comision Federal de Electricidad and NAFIN Power 90.0 2.1 659-ME 1970 Comision Federal de Electricidad and NAFIN Powier 125.0 54.9 695-4E 1970 Nacional Financiera, S.A. Roads 21.8 21.6 610-ME 1968 Nacional Financiera, S.A. Agriculture 65.0 3.5 747-PE 1971 Nacional Financiera, S.A. Agriculture 75.0 75.0 Total (less cancellations) 1,053.4 Of which has been repaid to Bank and others 217.6 Total now outstanding 835.8 Armount sold: 50.7 Of which has been repaid: 46.o 4m7 Total now held by Bank 831.2 Total undisbursed 186.3  Annex 1 Page 2 of 2 IFC Investments - at September 30, 1971 Original Uhn- Year Coany _ rpose Conmitznent disbur,e _ _# ~ ~ ~~~~~7Ti 1 miorns) 1958/ Inclastria. Perf'ect Circle, Industrial 1959 S * A 2r Equipment .8 1958 Bristol ds Mexico, S.A. * A/C Dngine Overhaul .5 1961 Acero Solar, S.A. * Twist Drills .3 1962/5/ Compania Fundidora Fierro y 6/8 Acero de Nionterrey, S.A. Steel 23.7 1963 TUbOs de Acero de Mexico, S.A. Seamless S-teel Pipes 1.0 1963 Qui.mica del Rey, S.A. * Sodium Sulphate .7 196C/6 Industria del Hierro, S.A. Const. Equip- ment 2.0 1970 hinera del Norte, S.A. Iron Ore M-ni.ng 1.5 1971 Celanese Mexicana, S.A. Textiles 12.0 2,