RESTRICTED. Report No. P-241 INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATIONS OF THE PRESIDENT TO THE

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1 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized This report was prepared for use within the Bank. It may not be published nor may it be quoted as representing the Bank's views. The Bank accepts no responsibility for the accuracy ar completeness of the contents of the report. INTERNATIONAL BANK FOR RECONSTRUCTION REPORT AND RECOMMENDATIONS OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO NACIONAL FINANCIERA, S. A. IN MEXICO RESTRICTED Report No. P-241 AND DEVELOPMENT January 6, 1961

2 INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOI14ENDATIONS OF THE PRESIDENT TO THE EXECUTIVE DIRECTCRS ON A PROPCSED LOAN TO NACIONAL FINANCIERA, S.A., MEXICO 1. I submit the following Report and Recommendations on a proposed Loan in an amount in various currencies equivalent to $15 million to Nacional Financiera, S.A. to help finance the foreign exchange cost of an irrigation project in Mexico. PART I - HISTORICAL 2. Preliminary discussions were held in Washington and Mexico City in the summer and fall of 1959 between representatives of the Mexican Government and the Bank regarding the possibility of Bank assistance in financing irrigation projects in Mexico. in March 1960 the Secretariat of Hydraulic Resources presented a program for the completion and rehabilitation of 22 Irrigation Districts and in May-June 1960 a Bank mission visited Mexico to examine the technical, financial and economic aspects of the first phase of this program. 3. Loan negotiations took place in Washington between December 13 and 20, Nacional Financiera was represented by Messrs. Raul Martinez Ostos, Deputy Director General, and Manuel S. Valladares, Washington Representative; and the Government, by Messrs. Alfredo Colin Varela, Under-Secretary of Hydraulic Resources, Luis Guzman Gardufno, Director of Irrigation Districts,and Jorge J. Pedrero, Luis Zierold Reyes and Miguel Brambila Rulfo, Engineers. 4. The proposed Loan would increase the Bank's lending to Mexico to $226.3 million (net of cancellations and refundings).

3 - 2 - The Bank has made the following loans to Mexico: Amount Year No. Borrower Purpose (eqiiv. in $ million) ME Nacional Financiera & CFE Electric Power Development ME Nacional Financiera & CFE Electric Power Development ME Nacional Financiera & CFE Electric Power Development ME Nacional Financiera & CFE Electric Power Development ME Mexlight Electric Power Development e6 ME Mexlight Electric Power Development ME Bank Consortium & Development of Small 10.0 Financiera Industrial Projects ME Ferrocarril del Pacifico Railway Rehabilitation ME Nacional Financiera Road Construction and 25.0 Improvement / Total Cancellations and refundings Of which has been repaid 24.6 Total now outstanding Amount sold $ 16.2 Of which has been repaid Net amount now held by Bank / $ lj Not yet declared effective. g/ Includes $42.3 million not yet disbursed.

4 PART II - DESCRIPTION OF THE PROPOSED LOAN 5. Purpose: Borrower: Guarantor: To finance the completion of the construction and of the rehabilitation of four irrigation systems in Northwestern Mexico, and the purchase of maintenance equipment for these systems. Nacional Financiera, S.A. The United Mexican States. Amount: The equivalent in various currencies of 415 million. Amortization: 34 semi-annual instalments from July 1, 1964 to January 1, Interest rate: Commitment charge: 5-3/4 % per annum, including commission. 3/4 of 1% per annum. Payment dates: January 1 and July 1. PART III - LEGAL INSTRUMENTS AND LEGAL AUTHORITY 6. Attached are a draft Loan Agreement between the Bank and Nacional Financiera (No. 1) and a draft Guarantee Agreement between the United Mexican States and the Bank (No. 2). Under Mexican law and practice, Nacional Financiera is the Agency through which the Government contracts for foreign credits and would therefore be the Borrower. However, since the Project is to be carried out by the Secretariat of Hydraulic Resources, which is a branch of the Government, and not by the Borrower, the provisions relating to the execution and the supervision of the Project, as well as the Description of the Project, are in the Guarantee Agreement rather than in the Loan Agreement. The Borrower undertakes in Section 5.01 of the Loan Agreement to make with the Guarantor arrangements satisfactory to the Bank for the transfer of the proceeds of the Loan from the Borrower to the Guarantor. Section 7.01 makes the completion of such arrangements a condition of effectiveness.

5 Other provisions of the Loan and Guarantee Agreements of special interest are: (a) Loan Agreement (i) Section 2.03 provides that the Borrower will be reimbursed for the estimated foreign exchange component of the public construction work included in the Project. (ii) The achievement of substantial progress toward the completion of arrangements required under Section 3.09 of the Guarantee Agreement (see b(iii) below) is made a condition of effectiveness. (b) Guarantee Agreement (i) In Section 3.01(c) the Guarantor undertakes to continue taking such action as shall be required to assure that the land included in the Project and the water made available therefor are to the maximum extent possible fully, effectively and promptly utilized. (ii) In Section 3.01(e) the Guarantor undertakes that charges will be levied on the water users at levels necessary to provide revenues sufficient to cover all operating and maintenance costs and to provide for reasonable reserves. (iii) Section 3.09 provides that the Guarantor shall make with the water users contractual arrangements, satisfactory to it and to the Bank, providing for the repayment, on reasonable terms and conditions, of the amount invested. by the Government in the Project.

6 Nacional Financiera is authorized by decree of the Mexican Congress of Doccr-ber 19, 1960 to contract the proposed Loan and, as the Government's representative, to guarantee the Loan on behalf of the Government. 9. The Report of the Committee provided for in Article III, Section 4(iii) of the Articles of Agreement of the Bank is attached (No. 3). PART IV - APPRAISAL OF THE PROPOSED LOAN Justification of the Project 10. The appraisal of the Project (TO 258b) is attached (No. 4). 11. The development of irrigation is essential in Mexico as production on naturally watered land cannot keep up with the needs of the fast rising population. Mexico has therefore undertaken an intensive program of construction of irrigation works as a result of which the area at present under irrigation by public projects is over 2.6 million hectares. Production on irrigated land represents more than one-third of the total value of agricultural production and contributes about one-third of total commodity exports. 12. Because of the urgency of bringing new lands under irrigation and the relative shortage of funds, new projects were undertaken before the completion of other alrs4y under construction. In the four systems (Culiacan, Fuerte, Mayo and Yaqui) which would be included in the proposed Project, the irrigation and drainage canals were not completed. As a result, a rising water table is causing salinity over an extensive area. About 14 per cent of the land in the Project area has already been put out of production. In another 28 per cent production has decreased considerably and, due to the break-down of the soil structure, cultivation costs have risen. The salinity which started first in the low-lying lands of the Project area is constantly spreading and unless the drainage canals are completed, it will continue spreading. The irrigation systems are also suffering from lack of adequate maintenance and it is necessary now to improve many of the existing canals, drains, structures and roads. 13. Under the Project to be financed with the proposed Loan, the irrigation and drainage works in the Project area would be rehabilitated and completed. The major result would be an improvement in drainage, and consequently a lowering of the water table,

7 - 6 - reduction of salinity in the affected areas and prevention of salinity in the areas not yet affected. In addition, water distribution would be improved and extended with the result that irrigation waters would be better controlled and some new land would be brought under production. Flood damage would also be reduced materially. 14. In order to help waters users to take full advantage of the Project, the Secretariat of Hydraulic Resources will prepareplans for the private on-farm works and the Government will make credit available on reasonable terms to meet the cost of their construction. The efficient operation and maintenance of the rehabilitated systems would be helped by the use of modr'n maintenance equipment which would be financed by the proposed Jloan. The Secretariat of Hydraulic Resources will reorganize its maintenance services and has undertaken to raise the present water charges and maintain them at levels adequate to meet the cost of operation and maintenance of the systems and to provide for reserves against floods and other hazards. 15. As a result of the desalting of lands in the Project area and of the efficient operation of the irrigation systems, the annual net value of production of the area after deduction of operation and maintenance costs, would increase by about 240 million pesos (qf19.2 million). This would represent an average return on the public and private investment required for the Project of almost 30 per cent per year. This very favorable return does not take into account the benefits which would result from preventing the expansion of salinity in the areas which are not affected at present. In addition, increases in the production of export crops on the rehabilitated lands would increase foreign exchange earnings by an amount estimated about ~16 million equivalent per year. Execution and methods of procurement 16. The Project will be carried out under the supervision of the Secretariat of Hydraulic Resources which was established in 1947 to develop and administer the water resources of Mexico. The Secretariat has a well-qualified and experienced technical staff, both in Mexico City and in its 64 Irrigation Districts, and maintains adequate hydraulics, soil mechanics and material testing laboratories. Its staff and its equipment are adequate for the execution and supervision of the Project. However, if any special problems appear in the preparation of the plans for the private drainage canals, the Secretariat would obtain the services of outside experts.

8 Substantially all the work for the completion of the construction and the rehabilitation of the irrigation systems included in the Project is to be carried out by contractors. For work totaling not less than 70 per cent of the total cost the contracts would be awarded on -the basis of international competitive bidding. The balance consists of small works for rehabilitation of existing canals and structures over a widely extended area, which are not suitable for submission to competitive bidding and would be carried out by the Secretariat directly or by local contractors through negotiated contracts. All the maintenance equipment to be financed by the proposed Loan would be obtained through international competitive bidding. F inancing 18. The total cost of the Project is estimated at about ;41 million equivalent. The proceeds of the Loan would cover the foreign exchange component. The domestic currency cost, about $26 million, would be financed from annual appropriations in the Federal Budget. Economic Position 19. As indicated in the Report "Current Economic Dosition and Prospects of Mexico" (WH-96b), distributed on August 1, 1960, the Mexican economy has experienced over the past two decades fast, sustained and well-balanced growth. In 1959 gross national product increased by 4.6 per cent with the price level remaining fairly stable. Exchange earnings reached an all-time peak of $1.5 billion. The proceeds from traditional exports (cotton, coffee, copper, lead and zinc) have fallen since 1957 because of declines in the prices of these commodities but this decline has been more than offset by the rise of earnings from other merchandise exports and tourism. No fundamental change in economic conditions or policies has occurred during The total external public debt of Mexico as of October 1960 amounted to $1,069 million. A substantial part of recent external borrowing was used to finance capital investment in the petroleum industry and expansion of electric power capacity. The servicing of the external public debt of Mexico is not excessive in terms of present or expected foreign exchange earnings. Service of the debt outstanding at present amounts to about 10 per cent of estimated current foreign exchange receipts in 1961 and falls rapidly thereafter.

9 - 8 - Prosoects of fulfillment of oblieations 21. The Project has been well prepared by the Secretariat of Hydraulic Resources, which is also well qualified to supervise its execution. The Guarantor has undertaken to make available promptly as needed all sums required for the execution of the Project, and to give technical and financial assistance to water users in the construction of drainage canals on their lands. 22. The Guarantor proposes immediately after the consummation of the proposed Loan, to make arrangements with the water users providing for payments for the water made available to them. Water users who hold 80. per cent of the Project land have already indicated their support of the rehabilitation program and their willingness to make payments which would assure the Government both repayment of and a return on its investment. A bill now pending in the Mexican Legislature will strengthen the Government's power to assure the conclusion of such arrangements and to enforce them. 23. The Project would result in substantial foreign exchange earnings far above the amounts needed for the servicing of the proposed Loan. 24. Mexico should be able to service the proposed Loan in addition to its existing debt. PART V - COMPLIANCE WITH ARTICLES OF AGREEMENT 25. I am satisfied that the proposed Loan would comply with the Articles of Agreement of the Bank. PART VI - RECOMMENDATIONS 26. I recommend that the Bank make a Loan to the Nacional Financiera, S.A. with the guarantee of the United Mexican States in an amount in various currencies equivalent to $15 million with interest (including commission) at 5-3/4 per cent per annum and on such other terms as are specified in the attached Loan and Guarantee Agreements tand that the Executive Directors adopt a Resolution to that effect in the form attached (No. 5). Washington, D.C. January 6, 1961 Eugene R. Black President