FOR OFFICIAL USE ONLY REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN

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1 Public Disclosure Authorized Document of The World Bank FOR OFFICIAL USE ONLY Report No. P-3799-HO Public Disclosure Authorized Public Disclosure Authorized REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN IN AN AMOUNT EQUIVALENT TO US$19.6 MILLION TO THE REPUBLIC OF HONDURAS FOR A WATER SUPPLY AND DRAINAGE PROJECT Public Disclosure Authorized May 1, 1984 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.

2 CURRENCY EQUIVALENTS Currency Unit = Lempira (L) US$1.0 = L2.0 L1.0 = US$0.5 WEIGHTS AND MEASURES Metric System PRINCIPAL ABBREVIATIONS AND ACRONYMS USED CABEI Central American Bank for Economic Integration CDC Commonwealth Development Corporation CONADI National Investment Corporation CONSUPLANE National Superior Council for Economic Planning DIMA Municipal Water Division of San Pedro Sula DREE French Directorate for External Economic Relations DSA Environment Sanitation Directorate ICB International Competitive Bidding IDB Inter-American Development Bank LCB Local Competitive Bidding MC San Pedro Sula Municipal Corporation MH Ministry of Health INA National Agrarian Institute PAHO Pan American Health Organization SANAA National Autonomous Water and Sewerage Service USAID U.S. Agency for International Development FISCAL YEAR January 1 to December 31

3 FOR OFFICIAL USE ONLY HONDURAS WATER SUPPLY AND DRAINAGE PROJECT Loan and Project Summary Borrower: Beneficiaries: Amount: Terms: Relending Terms: Go-Financiers: Project Description: Risks: Republic of Honduras San Pedro Sula Municipal Corporation (MC) National Autonomous Water and Sewerage Service (SANAA) US$19.6 million equivalent, including the capitalized front-end fee 20 years with 5 years of grace at standard variable rate Same as to Borrower. The foreign exchange risk would be borne by the MC and SANAA Commonwealth Development Corporation (CDC) and the Direction des Relations Economiques Extgrieures (DREE), of the French Ministry of Finance The proposed project would consist of two main components, the larger of which would provide improvements to the water supply and drainage systems in San Pedro Sula and technical assistance for institutional improvements for DIMA, the autonomous operational division of the MC responsible for providing water, sewerage, and drainage services. This component would benefit approximately 521,000 persons by The second component would provide technical assistance to SANAA for support in formulating sound financial policies at the national level in the water supply sector, for the development of an action plan to improve its operational and financial performance, and to improve planning at the national level. The San Pedro Sula component of the project would involve risk stemming from DIMA's planned assumption of expanded responsibilities and the consequent pressure on its financial resources; however, this risk has been lessened by the advanced stage of project preparation, the willingness of DIMA to use qualified consultants to assist with project impiementation, and the redefinition of DIMA's legal status, which will allow it to operate on an independent basis and 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.

4 ii obtain needed tariff increases on a timely basis. The main risk associated with the SANAA component involves the continued commitment to providing a suitable environment at the national level, in which the various water supply and sewerage companies can operate. Achievement of ultimate objectives will also depend on application of consultants' recommendations, where appropriate. These would be addressed through close supervision and dialogue with Government. Project Cost: V Item Local Foreign Total US$ Million----- San Pedro Sula Component National Component Base Cost Physical Contingencies Price Contingencies Total Project Cost Interest During Construction and Commitment Fees: - Bank Financed Other Front-end Fee on Bank Loan Total Financing Required 1/ Financing Plan: Bank Loan CDC Loan Norwegian Grant French Grant (DREE) DIMA SANAA Total Financing Disbursements: 2/ Bank Fiscal Year US$ Million Annual Cumulative Rate of Return: 14% Appraisal Report: No HO, dated April 30, / Total financing requirements distributed as follows: Local Foreign Total San Pedro Sula SANAA / Includes retroactive financing of contracts valued at about US$400,000.

5 INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE IBRD TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF HONDURAS FOR A WATER SUPPLY AND DRAINAGE PROJECT 1. I submit the following Report and Recommendation on a proposed loan of US$19.6 million to the Republic of Honduras for a Water Supply and Drainage Project. The loan would have a term of 20 years, including 5 years of grace, with interest at the World Bank's standard variable rate. US$19.0 million of the proceeds of the loan would be relent, on the same terms as the Bank loan, to the Municipal Corporation of San Pedro Sula (MC), and US$0.6 million would be relent on the same terms to the National Autonomous Water and Sewerage Service (SANAA). Of the amount lent to the MC, about US$13.0 million would be used for expansion and improvement of the water supply and technical assistance. About US$6.0 mill4on would be used to cover the Bank's capitalized financing charges, including the front-end fee of US$0.05 million, as well as interest during construction and commitment fees. The US$0.6 million to be relent to SANAA would cover consulting costs for technical assistance (US$0.4 million), and interest and commitment fees on the Bank loan (US$0.2 million). In addition to the proposed Bank loan, the MC would receive US$11.0 million from the Commonwealth Development Corporation (CDC) for the financing of the San Pedro Sula component. The CDC loan would have the same term and grace period as the Bank loan, but would be lent at 11 percent. The Borrower for the CDC Loan would also be the Government. CDC would also finance interest during construction and commitment fees; it does not charge a front-end fee. The French Government, through the Direction des Relations Economiques Extgrieures (DREE) of its Ministry of Finance, would provide a grant for about US$500,000 equivalent to finance part of the SANAA component. PART I - THE ECONOMY 2. A report entitled "Current Economic Memorandum on Honduras" (3312-HO) was distributed to the Executive Directors on July 29, Bank missions visited Honduras during July and November 1983 to review recent economic performance. The main findings of these missions are summarized below. Country data sheets are attached as Annex I. 3. Honduras' per capita GNP was about US$600 in 1981, making it one of the poorest countries in the Western Hemisphere- Malnutrition is severe; infant mortality is about 9 percent of live births; and the literacy rate is only 60 percent. About one-half of the population is without safe water and three-quarters of the households are without access to sanitary waste disposal and electricity.

6 -2-4. The population of about 3.8 million is growing rapidly, at about 3.4 percent a year, straining available resources. While two thirds of the economically active population is employed in agriculture, only one-quarter of the land area is arable. The Government is showing some awareness of population problems. Family planning information and services are provided at Government health clinics and by the Honduran Family Planning Association to anyone requesting them. External assistance to these and other smaller programs comes from the United Nations, private organizations, and USAID. 5. During , the real growth rate of the Honduran economy was 3.7 percent a year; per capita income grew by only about one percent a year. A number of factors contributed to this poor performance. A major reason was the continued dependence on banana exports, and deteriorating terms of trade. The risk of dependence on banana exports was illustrated dramatically during when extensive destruction of the plantations by one of the worst hurricanes in Honduras' history resulted in a sharp reduction in exports and GDP. 6. Subsequently, real GDP recovered remarkably during , growing by 7.7 percent a year. Real investment--public and private--and exports were the most significant growth factors. Inflation averaged seven percent a year. The favorable growth performance of the economy during was partly a result of more aggressive Government development policies in the 1970s. A land reform program distributed about 210,000 hectares to over 48,000 families, of which 36,000 remain on the land. Serious infrastructure deficiencies in transport and power were eased when a basic network of trunk highways and ports was built and power generating capacity expanded significantly. Public fixed investment increased from 3.3 percent of GDP in 1972 to 6.6 percent in 1974 and to over 9.0 percent in As a result, private sector activities expanded rapidly during , taking advantage of the externalities created by the public s ect or. Recent Developments 7. During , the economy stagnated as exports and investment lost their dynamism; real per capita GDP declined by about 14 percent. Private investment was adversely affected by political events in Central America and by tight credit. Real exports decreased 8 percent as exported quantities of bananas, beef, and manufactures declined; simultaneously, the terms of trade worsened by about 15 percent. As a result, the country's external financial position deteriorated. The current account deficit of the balance of payments averaged about US$261 million (9.7 percent of GDP) a year, and net official foreign exchange reserves declined substantially in spite of significant inflows of foreign official capital, partly because of a sharp decline in foreign commercial credits. The Central Bank rationed foreign exchange. Import permits were introduced in May 1982 to restrain the demand of non-essential imports; since then, a 100 percent guarantee deposit is required for all requests to open letters of credit for import payments. Imports in were on the average 25 percent

7 -3- below 1981 levels. A parallel market for foreign exchange has since developed. 8. Public finances also deteriorated, mainly at the Central Government level. Central Government current expenditures increased rapidly during , reflecting salary adjustments and large expenditure increases in the areas of education and health. Weak public finances during brought about a large increase in the use of domestic credit by the public sector. To correct the situation, the Government took significant tax measures during 1982 as part of a stand-by agreement with the IMF covering a 14-month period ending in December Nevertheless, actual revenues were insufficient in 1982 and 1983 to cover rising current expenditures--mostly for goods and services, and interest--in spite of a wage freeze which reduced the Central Government's wage bill from 8.5 percent to 7.5 percent of GDP. Tariffs of the port authority, power company, telecommunications company, and water authority were also increased significantly late in 1982 under the stand-by arrangement, resulting in higher operating surpluses. However, the overall deficit of the non-financial public sector remained high in 1983 (10.3 percent of GDP) because of lower than expected revenues, higher purchases of goods and services, and the large additional burden created by the refinancing of the National Investment Corporation (CONADI) obligations with foreign commercial banks arising out of its support to private sector projects with share capital, loans, and loan guarantees. Many of these projects are now bankrupt or in arrears on their debt obligations, and the Government has had to honor these debts. As a result of these developments, the Honduran Government was unable to meet all the performance criteria of the IMF stand-by arrangement and thus was not able to draw on the last tranche. Discussions are currently proceeding between the IMF and the Honduran Government with the objective of negotiating a new program. 9. Negotiations with foreign commercial banks to refinance the debts of CONADI and a few other public agencies are nearly complete. About 17 percent of existing external public debt at the end of 1982 (about US$225 million) is being refinanced; about US$120 million of amortization payments will be rescheduled. Prospects and Development Programs 10. Economic growth prospects during the next few years depend on a number of differing factors. The Government investment effort underway, together with the good prospects for increasing export volumes of lumber and wood products and some other non-traditional exports, as well as possible diversification efforts by the private sector, could result in significant growth by the late 1980s. Nevertheless, the immediate outlook is colored by the political climate in the region, low export prices, and reduced demand in the industrialized countries, all of which discourage private investment. In these circumstances, the needed task of strengthening public finances will present a serious challenge to the authorities. A new IMF Stand-by arrangement is expected to include a prudent financial program in the public sector, reasonable financial and

8 incentives policies, and appropriate overall demand management. These Government programs, together with an improved investment climate, could help revitalize the private sector so that it can make a greater contribution to the further growth of the economy and take advantage of the new opportunities thus presented. 11. The current account balance of payments will likely show moderately high deficits in the next few years. After an initial sharp increase owing to a rapid expansion of lumber exports due to the completion of a large sawmill and related port infrastructure in 1984, the quantum of exports would likely grow at a low rate for the next few years; low prices will also affect foreign exchange earnings from exports. Imports are expected to expand, reflecting some recovery of economic activity as well as the import requirements of the public investment program. However, the completion of the Cajon hydroelectric plant in 1985 will significantly reduce fuel imports. Imported oil costs reached US$170 million (23.0 percent of c.i.f. merchandise imports) in The public investment program for the next few years shows continued large expenditures on infrastructure projects, particularly for ongoing power and transport projects. Power investments will be the largest, averaging about 40 percent of public fixed investment, mostly because of the large, lumpy investment required for the El Cajon hydroelectric project, which the Bank Group is helping to finance (Loan 1805-HO and Credit 989-HO, approved in 1980). Transport investments include rural roads, a modest expansion of the trunk highway system and completion of a new port at Castilla for wood products and banana exports. Also likely are substantial expenditures for agricultural and rural development as well as for water supply. Agricultural investments will be focused on rural development projects for three major valleys (Aguan, Guayape and Comayagua) and the western area of the country. Water supply investments will be concentrated in Tegucigalpa, San Pedro Sula and provincial towns. Educational investments are mostly for rural primary schools, agricultural and vocational training institutions. Tight public finances will necessitate trimming the public investment program to include ongoing and new projects of highest priority only. External Financing 13. Honduras' disbursed public external debt repayable in foreign currency amounted to US$1.4 billion or 49 percent of GDP at the end of 1982; US$2.0 billion, if undisbursed commitments are included. In the past, Honduras has managed to keep its external debt-service ratio fairly low, because foreign loans to the non-financial public sector were almost all on concessionary terms. The debt-service ratio in 1981 was 14 percent. It increased to 18 percent in 1982 owing to a sharp increase in CONADI's obligations with foreign commercial banks, arising out of direct debts and guarantees to private investors (paragraph 8). The public debt service is expected to peak at about 24 percent in 1986.

9 At the end of 1982, the Bank Group held about 21.8 percent of the disbursed public debt outstanding and repayable in foreign currency; excluding IDA, the Bank's share is about 16.0 percent. These shares are not expected to increase significantly in the next few years. About one-fourth of the Inter-American Development Bank's (IDB) total loans disbursed and outstanding are repayable in local currency, so that IDB's share of the disbursed public debt repayable in foreign currency is only 12.9 percent. The Central American Bank for Economic Integration (CABEI) accounts for 9.1 percent of the total, the U.S. Government for 12.9 percent, Venezuela for 9.6 percent, privately held debt for about 27.6 percent and other debt for 6.1 percent. 15. During , the principal official lending agencies committed some US$1.9 billion at FY82 prices, of which the Bank Group provided 34 percent, IDB 32 percent, CABEI 22 percent, and the U.S. Agency for International Development (USAID) 12 percent. IDB has concentrated on manufacturing, agriculture, power, transport, water and sewerage, and education; CABE! on transport and power; and USAID on agriculture and education. 16. The current account deficit is expected to average US$214 million during , a reduction of about 20 percent from that of The bulk of the external financing requirements is expected to be met through public borrowing. Honduras will require an estimated gross capital inflow of about US$0.9 billion during , of which about 41 percent will be disbursed from commitments made through the end of The balance is expected to be obtained on concessionary terms from bilateral and multilateral agencies, which will minimize any increase in the total debt service. 17. Honduras is expected to improve its balance of payments in the near term as projects which will reduce fuel import requirements and expand lumber exports are completed. Export promotion policies which are in the process of being implemented will contribute to continued improvement in the longer term. Strengthening of the Government's finances remains a high priority in the adjustment program required to deal with the adverse external environment which the country has faced in the past few years. Efforts to achieve this are reflected in the sharp expenditure cuts in many areas contained in the Government's 1984 budget. Provided the Government makes further improvements in its adjustment program, including more effective incentives for exports, maintains a prudent external borrowing policy, and continues to avoid the conflicts which have occurred in some of its neighboring countries, the country is expected to resume economic growth in 1984 and sustain accelerated growth of GDP averaging 5 percent annually during the second half of the 1980s. Honduras' relatively low debt service ratio (18 percent at the end of 1982), the expected continuing official flows on concessionary terms, and the Government's continued efforts to implement an appropriate adjustment program make it creditworthy for Bank lending.

10 -6- PART II - BANK GROUP OPERATIONS 18. Beginning with a loan of US$4.2 million for roads in 1955, :onduras has to date received 29 Bank loans totalling US$483.5 million and 12 IDA credits totalling US$85.1 million, both net of cancellations. Bank Group lending to Honduras was unusually large during 1979 and 1980, both because of the Government's stepped-up investment program and because of the major investment in the El Cajon Power Project, for which a US$105.0 million loan and US$20.0 million credit were approved on March 11, As of March 31, 1984, a total of US$145.5 million remained to be disbursed on 13 Bank Group-assisted operations for electricity, roads, education, agricultural credit, industrial credit, ports, regional development, tourism, and petroleum exploration. Execution of projects financed by the Bank Group has, on balance, been satisfactory. 19. Speed of disbursements in Honduras has varied considerably by sector, with power projects generally accounting for the largest share. In FY83, disbursements reached a record high of US$54.6 million, of which nearly half was accounted for by El Cajon. Agricultural credit accounted for the second-largest share of the disbursed amount, US$9.2 million. Annex II contains a summary statement of Bank loans, IDA credits, and IFC investments as of March 31, In the past, Bank Group lending was heavily concentrated in transport and power, where inadequate facilities hampered the development of the country. However, the First Livestock Development Credit, approved in 1970, marked a first step towards the diversification of our lending. Since then, while lending for power and transport has continued, diversification of our lending has increased through operations for another livestock project, two education projects, three agricultural credit projects, a regional development project, two industrial credit projects, a tourism development project, a petroleum exploration promotion project, and now, a water supply project. 21. We hope to actively continue to support Honduras' development efforts, though the annual Bank Group lending level is currently constrained by the relatively large size of the El Cajon operation in our portfolio. An important factor which will be taken into account in determining the pace and size of future lending will be the Government's capacity to implement its large ongoing program and to absorb further operations (paragraph 12). In future lending to Honduras, we plan to support the Government's objectives to increase production, employment, and exports, and to raise living standards of the poor by emphasizing projects in the productive and social sectors. In order to promote and diversify both agricultural and industrial production, we would continue to provide credit to those sectors. The proposed project would be the first to the water supply/sewerage sector. We would, however, continue to complement the active programs of USAID and IDB in that sector and in the housing sector. The proposed project also supports the objective of limiting demands on the Central Government for counterpart funding--the majority of

11 -7- A local counterpart would be generated at the local level in San Pedro Sula. In addition to such projects aimed at improving living conditions for the urban poor, we would also continue to emphasize rural development to support the Government's agrarian reform efforts. New lending for infrastructure could be considered once the immediate obstacles to development are overcome and the Government's absorptive capacity has improved. In formulating our lending program we will continue to coordinate our efforts closely with other international and bilateral agenci s. 22. It is expected that the Bank's share of total external public debt disbursed and outstanding will increase slightly from its current level of 16 percent to about 17 percent during the late-1980s. Annual interest and amortization on Bank loans currently represents about 14 percent of total public external debt service. This proportion is projected to increase to about 16 percent by the late-1980s. 23. IFC's activities in Honduras include a 1964 loan and equity investment, of US$295,000 and US$55,000, respectively, in a tannery, Empresa de Curtidos Centroamericana, S.A. In 1966 an additional equity investment of US$27,500 was made in this company. In 1968 and 1970 equity investments totalling US$75,000 were made in a pilot company, Compania Pino Celulosa de Centro America, S.A. In 1978 IFC approved a loan of US$9.0 million and an equity investment of US$1.0 million in Textiles Rio Lindo, S.A. de C.V., a locally owned textile company, to help finance an expansion and diversification project. IFC continues to look for investment opportunities in Honduras. Proposals for cotton cultivation and dairy projects are currently under preliminary consideration. PART III - THE WATER SUPPLY SECTOR Background 24. During the decade, the population of urban areas grew rapidly, at rates averaging 5.5 percent per annum, compared with an overall population growth rate of 3.3 percent per annum. Assuming these rates continue, by the year 2000, total population would be nearly 7 million, with the proportion of urban population increasing from 36 to over 50 percent. During the same decade, San Pedro Sula experienced a particularly high growth rate--7.0 percent per annum. This rapid urbanization has placed ever increasing strains on urban infrastructure and the ability of major cities and towns to provide adequate services, including water supply and sewerage. This trend, combined with existing low service levels, which place Honduras sixteenth out of 21 countries in the region in terms of water supply services and fourteenth in terms of sewerage, underscores the importance of a continued and intensified government effort to improve access to modern safe water and sewerage facilities.

12 Inadequate water supply and sanitation also play a major role in lower life expectancy (currently estimated at 59 years), and higher infant mortality (86 per thousand live births in 1980). These indicators contrast with the average figures for middle-income Latin American and Caribbean countries: life expectancy, 63 years, and infant mortality rate, 67 per thousand live births. Though statistics on causes of mortality and morbidity are limited, available data suggest that diarrheal diseases, caused by poor water supply and sanitation, are the most important cause of death (20 percent of certified deaths). Water Resources and Existing Sector Service Levels 26. Honduras has a relative abundance of good surface water sources, and groundwater has therefore been tapped only rarely. Few exploitable sources of surface water remain, however, and greater use of groundwater will be required in the future. General studies of water quality carried out by SANAA indicate that both disinfection and standard treatment for turbidity during heavy rains would be required to produce acceptable potable water from most sources. Spreading deforestation has been identified as a contributing factor to deterioration in water quality and, unless arrested, could become a serious problem. 27. Total population served with water supply through house connections in 1982 was 51 percent in urban areas and 13 percent in rural areas. Quality of service is generally deficient, owing to inadequate supplies, poor system maintenance, and frequent equipment breakdowns. Sewerage service in 1982 for the total population reached 15 percent by waterborne systems and 19 percent by other systems. In urban areas, 49 percent of the population was served, and in rural areas 26 percent was served, principally by latrines. Institutional Framework 28. Water resource development is presently carried out under a 1927 National Water Law which requires Government approval for all water development activities and identifies priorities for different uses of water. Planning of new investments in the sector is done by the National Superior Council for Economic Planning (CONSUPLANE) under the Ministry of the Presidency. 29. SANAA, the most important institution in the sector, was established in 1961, with jurisdiction (subject to municipal consent) for water supply in all communities with more than 500 inhabitants and for sanitary sewerage in all towns with population over 20,000. By 1982, SANAA was operating the water, sewerage, and drainage systems in Tegucigalpa and 101 other urban and eligible rural communities, serving about 700,000 persons with piped water. However, SANAA's own institutional constraints have limited the fulfillment of its legal mandate, as well as its effectiveness in providing service (paragraph 32). In practice, therefore, many communities have preferred to operate their own systems, though with mixed success.

13 San Pedro Sula and about 600 other towns and villages operate their own water systems. Of these, 33 (including San Pedro Sula) also have sewerage systems. About 650,000 persons received piped water under such systems in In San Pedro Sula, water supply, sewerage, and drainage services are provided by the Municipal Water Division (DIMA) (paragraphs 46-47). 31. Responsibility for constructing water supply and sanitation facilities in communities under 500 inhabitants and "marginal areas" -- slums at the periphery of urban centers--rests with the Ministry of Health (ME), through its Directorate of Environmental Sanitation (DSA). Though some progress has been made in providing small communities with low-cost systems (partly with assistance from USAID), DSA has been able to benefit very few "marginal areas." 32. Most institutions in the sector, including SANAA, have generally low salary scales, and are unable to attract sufficient numbers of qualified professional staff, especially at top and middle management levels. This results in inefficiencies of all kinds, including poor operation and maintenance of systems and inadequate financial, physical, and operational records. Information systems in most cases fail to provide management with sufficient information to assess performance or promptly identify and solve problems. Generally low tariffs and inadequate collection procedures have necessitated dependence on subsidies from the Central Government. In an effort to improve SANAA's financial position and reduce its dependence on Central Government transfers, tariffs were raised substantially in Tegucigalpa in However, failure to improve meter coverage and collection procedures may result in a lower-than-expected increase in revenues, despite the higher tariffs. The development of an action plan for institutional strengthening of SANAA is included in the project (paragraph 40). Government Policy Framework and Objectives 33. Government policy in the sector consists largely of setting goals for levels of service, translated into investments necessary to achieve them. The Honduran authorit_(s, with technical assistance from the Pan American Health Organization (PAHO) and the German Society for Technical Cooperation, began work in 1982 on a national water supply and sanitation plan. A sector diagnostic completed under this plan in May 1982 recommended goals for piped water and sewerage coverage of 90 percent and 40 percent, respectively, by Total investment to meet these goals * was estimated at US$326 million (an average of US$47 million per year), programmed in constant January 1984 prices. To achieve this goal, annual expenditures would have to treble, an unrealistic target, given current budget constraints. Nevertheless, the results of the study underscore the need for investment in the sector to provide an adequate level of safe water to the population. 34. No cost recovery policies (and, therefore, no tariff policies) have been established for the sector. Although water authorities are expected to cover operating costs, they are rarely expected to contribute

14 to their investments or to service their debts. Shortfalls are made up chiefly by Central Government transfers. 35. Although SANAA's legal mandate gives it the authority to set its tariffs as necessary, in practice, tariffs are changed only with approval of the President of the Republic. Tariffs charged by independent municipal water authorities must be approved by the Ministry of Government and Justice as part of the municipal budget approval process. Tariffs for use of rural water systems constructed by the MH are set by community boards. Efforts have begun to develop a consistent tariff policy which would take account of the need to reflect through tariff levels the economic cost of water use, while providing some subsidy to the poorest segments of the population. Sector Financing 36. In the past, about 45 percent of total investment in the sector has been financed with external assistance, principally from IDB and USAID, with the remaining 55 percent financed mainly by the Central Government and, in some cases, by municipalities. Continued substantial external support can be expected in the future, but increasing Central Government financial constraints are forcing a reduction in Government subsidies and support for most sectors, including water supply. Such decreases in government transfers are now requiring both SANAA and municipal governments to confront the necessity of establishing and implementing adequate cost recovery policies in order to generate internally more of the funds necessary to carry out investments planned to improve--or even sustain--the level of service provided. Bank Strategy 37. These changing circumstances have made apparent the need, not only for additional external funding, but for technical assistance to help agencies which provide services in the sector to achieve financial self-sufficiency. This is an area on which other agencies with active programs in the sector have not and do not plan to concentrate significant effort. The Bank's strategy, therefore, is to assist institutions in the sector to achieve this goal of financial viability, while they continue to improve the level of service which they provide. Though the Bank has not previously lent for water supply in Honduras, such lending has been discussed periodically since 1978, and extensive dialogue has been conducted in the course of sector work and project preparation. The proposed loan would represent the first step in implementing Bank strategy by providing both financial and technical assistance for expansion of the water supply system of San Pedro Sula, while also providing technical assistance for the strengthening of DIMA's financial and operational performance, for a study to determine the specific actions necessary to achieve similar goals in SANAA, and to carry out certain actions which have already been identified. This work with SANAA would lay the foundation, through formulation of a national policy framework, for possible future operations at the national level. Such operations would provide a vehicle

15 for assistance to SANAA in implementing measures recommended as a result of the work to be carried out under the proposed project, which could possibly include revision of tariff structures and overall cost recovery policies, as well as improvements in operational efficiency. PART IV - THE PROJECT Project Origin 38. The proposed Project was developed in two parts: the first was prepared between by the Municipal Water Division of San Pedro Sula (DIMA), with the assistance of two foreign consulting firms and in consultation with the Bank; the second was prepared during 1983 by SANAA, in consultation with the Bank. The Project was appraised in May 1983, with a post-appraisal mission in September A report entitled "Staff Appraisal Report - Honduras, Water Supply and Drainage Project" (Report No HO), is being distributed separately. Negotiations were held in Washington, D.C. from March 5 to March 12, The Government delegation was led by Ms. Maria Antonieta Dominguez, Director General of Public Credit, Ministry of Finance. Supplementary data are contained in Annex III. Objectives and Description 39. At the municipal level, the proposed project aims at (a) making DIMA technically sound and financially independent by strengthening its management, operations, and finances; (b) eliminating water shortages affecting a majority of the population (especially the urban poor) of San Pedro Sula, the country's second largest city (1982 population 293,000), through expansion of the water supply system; (c) providing water service to the growing population of the metropolitan area, estimated to reach 625,000 by 1994, through expansion of the distribution system; (d) providing water supply and sewerage service to poor residents through installation of service connections in low-income neighborhoods; and (e) reducing flooding (which mainly affects poor neighborhoods) through expansion of the stormwater drainage system. At the national level, the project includes a small technical assistance component to help SANAA to develop an action plan to meet its statutory and operational objectives, while reducing its reliance on Central Government subsidies. 40. The proposed project incorporates the following components: A. San Pedro Sula Component (1) Water supply improvements, through construction of about 18 wells and 3 chlorination stations and rehabilitation of about 7 wells, and including technical assistance to evaluate aquifer capacity and design deep wells;

16 (2) Water transmission, distribution, and storage improvements, through rehabilitation of 2 water intakes and respective water mains, construction of about 46 km of primary water distribution mains, 2 booster pump stations; and construction of 2 distribution storage reservoirs with a combined capacity of about 30,000 cubic meters; (3) Construction of about 15 km of secondary water distribution mains and about 10 km of secondary sewerage collectors; repair or replacement of defective secondary water distribution mains; installation of about 25 standpipes, about 5,000 water service connections, and about 4,000 sewerage service connections; and installation of about 24,000 water meters and about 6 water master meters; M (4) construction of about 3 km of stormwater drainage interceptor; (5) acquisition of equipment for leak detection and provision of technical assistance to prepare water distribution maps, set up a leak detection program, and train DIMA staff in leak detection; (6) provision of technical assistance to implement measures for the institutional improvement of DIMA and acquisition of equipment for operation and maintenance of the water supply and drainage systems, including spare parts, materials, vehicles, and a micro-computer; (7) provision of technical assistance to prepare a study on the health hazards associated with continued use of polluted Rio Sauce water for sugarcane irrigation. B. SANAA Component Provision of technical assistance to support SANAA in achieving financial self-sufficiency through (a) formulation of financial policies for the water supply and wastewater sector; (b) preparation of an action plan to improve SANAA's management, engineering, accounting, and commercial systems; (c) assessment of sectoral investment needs and assignment of priorities to projects identified to address those needs; (d) evaluation and implementation of SANAA's training program; (e) preparation and implementation of a program to reduce water loss in Tegucigalpa; and (f) preparation of a project designed to address the needs identified by the assessment carried out under (c), above.

17 Project Cost and Financing 41. Total project cost is estimated at about US$33.4 mniiliorn (including contingencies), of which about 64 percent, or US$21.5 million, represents the estimated foreign exchange cost. Baseline costs are updated to January 1984 price levels, from cost estimates prepared in fall There are no identifiable taxes or duties, since both the MC and SANAA are tax-exempt. Physical contingencies represent 10 percent of baseline costs. Price contingencies were calculated based on forecast inflation rates (local equal to international) of 7.5 percent in 1984, 7.0 percent in 1985, and 6.0 percent thereafter. Financing charges on foreign loans, including interest during construction, would add US$8.9 million, bringing total financing requirements to US$42.3 million, 72 percent of which (US$30.4 million) represents the foreign cost component. 42. The financing plan provides for a Bank loan of US$19.6 million, including the capitalized front-end fee of about US$0.05 million, and interest during construction and commitment fees of about US$6.1 million. The financing of interest is designed to help alleviate the heavy impact which the project would have on DIMA's finances (the project would represent a 200 percent increase in DIMA's fixed assets) concurrently with its efforts to attain financial viability (paragraphs 60-61, below). The Bank loan would provide 48 percent of the financing requirements of the San Pedro Sula component and 51 percent of the financing requirements of the SANAA component and represents entirely foreign cost in both components. An US$11.0 million CDC loan would finance 26 percent of the San Pedro Sula component. The Norwegian Government has provided a grant of US$300,000 toward project preparation in San Pedro Sula. About US$10.8 million, equal to about 26 percent of total financing requirements of the San Pedro Sula component, will be provided by DIMA's internal cash generation. The French Government would provide a grant of about US$500,000 equivalent to finance part of the technical assistance to SANAA (paragraph 40.B.(d), (e), and (f)). SANAA would finance an estimated 7.0 percent of total requirements of the SANAA component (12 percent of the Bank-financed parts). The contributions of both DIMA and SANAA consist entirely of local cost. Tables showing project costs and the financing plan are contained in the Loan and Project Summary at the beginning of this report. 43. Consultants would be hired to assist DIMA in carrying out the San Pedro Sula component (paragraph 48), and to provide technical assistance for execution of the SANAA component. About 734 man-months are estimated to be required for the various tasks under the San Pedro Sula component and about 81 man-months for the SANAA component. About 344 man-months of work would be provided by expatriate consultants, and the balance would be supplied by local professionals and assistants. 44. The CDC loan is expected to have a term of 20 years, including 5 years grace, at 11.0 percent fixed interest. There is no front-end fee; CDC would also finance interest on its loan during construction. Execution and delivery of the CDC loan contract and the French grant agreement and satisfaction of the conditions of effectiveness of those contracts would be

18 a condition of effectiveness for the Bank loan (draft Loan Agreement, Section 6.01(d) and (e)). Relending Terms and Repayment 45. The proceeds of the Bank loan would be relent to the MC and SANAA, on the same terms and conditions as the Bank loan, as spelled out in subsidiary loan agreements to be drawn up between the Government and the MC and SANAA, respectively. These subsidiary agreements would also specify, inter alia, the specific mechanisms to be established for the channeling of Bank disbursements to SANAA and DIMA and for repayment of the Bank loan, and that SANAA and the MC would bear the foreign exchange risk. Execution of the two subsidiary agreements, in a manner satisfactory to the Bank, would be a condition of effectiveness (draft Loan Agreement, Section 6.01(c)). Project Implementation 46. San Pedro Sula Component. The MC, through DIMA, would be responsible for project implementation in San Pedro Sula. In order to carry out its responsibilities under the project and to form the basis for development of financial self-sufficiency, DIMA has been legally redefined as an autonomous operating division of the MC.1/ To accomplish this redefinition, a law was approved by the National Congress to permit the establishment of autonomous operating divisions for the provision of public services. Within this framework, the MC has issued an Act (Acuerdo Municipal), approved by the Departmental Council, which defines the authority and guidelines for DIMA's operation as such a division. The Acuerdo Municipal provides, inter alia, for DIMA's authority to establish its own hiring and firing policies and salary scales, make employment decisions, formulate investment plans, and implement tariff increases. The Acuerdo also provides for settlement of accounts between DIMA and the MC. The MC has agreed to formulate a plan of action for payment of outstanding bills to DIMA by no later than September 30, 1984, and to ensure installation of meters and commencement of billing of MC water consumption by no later than December 31, 1984 (draft MC Project Agreement, Section 2.18). The MC would implement all other provisions of the Acuerdo as provided therein (draft MC Project Agreement, Section 3.01). 47. Under its present organization, DIMA is capable of starting project implementation as scheduled in To improve the efficiency of its planning, management, and operating systems, however, DIMA would be reorganized as part of an action plan for improvement of its operations (draft MC Project Agreement, Section 2.17). The reorganization of DIMA, which would be completed by September 30, 1984, would be aimed at a clear definition of functional and managerial responsibility and reduction of the 1/ Though operationally and financially independent, DIMA has no separate legal personality under its new status as operating division; for this reason, the Project Agreement for the San Pedro Sula component of the proposed project would be with the MC.

19 ratio of employees per connection. Other measures included in DIMA's action plan include: (a) employment, by no later than September 30, 1984 of (i) a consultant to serve as manager for finance, accounting and commercial operations and a consultant as manager for engineering and operations (draft MC Project Agreement, Section 2.02(b)); and (ii) a human resources manager (draft MC Project Agreement, Section 2.16(f)); (b) employment by no later than December 31, 1984 of qualifed data processing staff (draft MC Project Agreement, Section 2.16(e); (c) preparation, by March 31, 1985 of a study of DIMA's manpower requirements and training needs, preparation of a training program, and establishment, by September 30, 1985, of a training unit (draft Project Agreement, Section 2.16(c) and (d)); (d) establishment, by June 30, 1986, of a deferred payment program, satisfactory to the Bank, to recover costs of construction of service connections and secondary water and sewerage networks in low-income neighborhoods (draft MC Project Agreement, Section 2.15); and (d) evaluation, by December 31, 1985, of DIMA's insurance needs, and implementation of a program to address those needs by June 30, 1986 (draft MC Project Agreement, Section 4.08). 48. DIMA's Chief Engineer would serve as Project Manager. The Project Manager would be responsible for coordinating and supervising work under all parts of the project in San Pedro Sula, including groundwater investigations, construction supervision, implementation of the action plan, the leak-detection program, and the irrigation study. Consultants would be hired to support him in all these areas (paragraph 47, above). 49. SANAA Component. A Project Manager, to be appointed from SANAA's staff, would carry out all administrative functions related to the proposed technical assistance program for SANAA. The technical assistance itself would be provided by consultants acceptable to the Bank under terms of reference satisfactory to the Bank. A steering committee consisting of SANAA's General Manager and representatives of the Ministries of Finance, of Health, of Government and Justice, and of Natural Resources, would be responsible for reviewing the work of the consultants and for making policy decisions. SANAA would appoint a Project Manager and establish, together with the Ministries concerned, the steering committee, by no later than September 30, 1984 (draft SANAA Project Agreement, Sections 2.07 and 2.08). 50. The Bank would supervise all project components, including those parts of the project to be financed by disbursements from the CDC loan and the DREE grant. A Co-financing Agreement with CDC and a Memorandum of Understanding with DREE would include arrangements for the exchange of information and reports, and would specify responsibility for supervision. Procurement 51. Civil works contracts larger than US$500,000 (totalling US$5.5 million) and materials and equipment in packages larger than US$50,000 (totalling US$1.3 million) would be procured through international competitive bidding (ICB) in accordance with Bank guidelines. Other goods and civil works totalling US$0.5 million and US$1.0 million, respectively, would be procured under local competitive bidding procedures satisfactory

20 to the Bank. Consulting services totalling US$5.1 million would be procured in accordance with Bank guidelines for consultant selection. Consulting services totalling about US$0.5 million, financed with grant funds would be procured in accordance with guidelines of the French Government. No works under force account are anticipated. All bidding packages for civil works estimated to cost over US$1.0 million, and bidding packages for materials and equipment over US$100,000 would be subject to the Bank's prior review of procurement documentation. This would result in Bank review of about 90 percent of the total estimated value of civil works contracts and about 70 percent of materials and equipment contracts. The balance of contracts would be subject to random post review by the Bank after contract award. Procurement of civil works and goods financed by CDC (US$8.7 million) would be in accordance with CDC's procurement guidelines, which are similar to the Bank's. 52. All equipment supply contracts are expected to be awarded to foreign manufacturers. The three largest civil works contracts are expected to be awarded to foreign contractors. The other four civil works contracts are within the capacity of the local construction industry, and could go to either local or foreign contractors. All the consulting contracts are expected to be awarded to foreign firms in joint venture with local firms. Disbursements 53. The Bank loan is expected to be fully disbursed in seven years. All disbursements would be supported by standard documentation. A total of US$13.0 million would be allocated for project costs of the San Pedro Sula component, and US$0.4 million for the SANAA component. Loan proceeds would not be transferable from San Pedro Sula to SANAA, and vice versa. The Bank would disburse for the foreign cost of materials, equipment, and civil works for all parts of the project except those costs related to water transmission, primary distribution, and storage systems (cf. paragraphs 40A.(2) and 54). About US$6.2 million would be allocated for the Bank's financing charges during construction. 54. CDC would disburse for materials, equipment, and civil works for improvements to the water transmission, primary distribution, and storage systems. DREE would disburse for consulting services under the SANAA component. No contracts or project components would be jointly financed by the Bank and CDC or by the Bank and DREE. 55. Bank disbursements would include retroactive financing for contracts valued at about US$400,000 to cover costs incurred since May 1983 for beginning construction of three project wells and for related consulting services incurred after May 1983 (draft Loan Agreement, Schedule 1, paragraph 4). The wells will allow prompt increase in the Municipality's water supply, which would help to justify the 1983 tariff increase (paragraph 59, below) and facilitate implementation of further tariff increases planned for the early years of the project implementation period. Bank disbursements would be permitted against statements of expenditure for contracts valued at US$20,000 or less. q

21 Financial Analysis and Covenants 56. During appraisal, a detailed financial analysis of DIMA was carried out in order to determine (a) its capacity for meeting its project financing requirements and debt servicing obligations and (b) the additional action required by DIMA and the MC to ensure DIMA's financial viability over the longer term and minimize the risk to the Government in taking responsibility as Borrower for the Bank loan. To assure that the MC would remain in a position to ensure DIMA's execution of the project and repayment of the proposed loan to the Government, agreement has been reached with the MC that it would, for each year after 1984, produce sufficient revenues to cover the sum of its total expenses, debt-service requirements, and capital expenditures not financed by medium- to long-term debt. To this end, the MC would prepare semi-annual reports, to be reviewed with the Bank, each showing annual forecasts, covering a period of five years, of its current and planned investments, expenses, revenues, and borrowings related to all operations except DIMA. If any review showed that the Municipality's total sources of income would not cover its total obligations, the MC would promptly take all necessary measures in order to achieve such balance (draft MC Project Agreement, Section 4.04). Formulation of an initial financing plan, satisfactory to the Bank, would be a condition of effectiveness (draft Loan Agreement, Section 6.01 (f)). 57. DIMA's Current Position. DIMA's financial performance in 1981 and 1982 was unsatisfactory; it had operating losses in both years. This was largely the result of low sales due to production constraints, and to inadequate tariffs. However, DIMA was able to cover all of its debt-service requirements from internal cash generation, though cash reserves had to be drawn down to cover part of its investment costs, thus reducing them to L 0.35 million at year-end Expansion Program and Financial Prospects. DIMA's investment program for totals US$50.4 million, including the proposed project (US$41.1 million) and ongoing projects totalling about US$9.3 million. External financing under the proposed project (US$30.3 million) would provide 60 percent of total requirements, and another US$1.6 million of external financing for ongoing projects would provide an additional 3 percent. Customer contributions (e.g., direct payment for certain investments, such as secondary networks and connections) are estimated at about US$6.5 million, about 13 percent of total requirements during the period. DIMA's internal cash generation would have to provide the remainder, about US$12.0 million, or about 24 percent of the cost of its total investment program. 59. The investment program described above represents a substantial increase over the level of investments made by DIMA in recent years and would require a substantial increase in DIMA's contribution from internal cash generation. DIMA's estimated financial position for 1983 would not allow it to contribute immediately the level of resources required from internal cash generation which the program implies. However, some increased contribution would be possible as the project gets underway,

22 because two steps have already been taken to increase DIMA's revenues: in 1983, DIMA began a program to achieve 100 percent metering by year-end 1985, installing 9,000 new meters in the first year, and implemented a revised tariff structure (May 1983) which distributes the tariff burden more equitably among consumers. The change raised tariffs by an average of 20 percent. Together, the expanded metering and new tariff structure are estimated to increase revenues by 19 percent in 1983 and 38 percent in After 1984, DIMA's financial position is projected to show considerable improvement, provided that DIMA: (i) continues its metering program as planned (paragraph 59); (ii) increases tariffs substantially on a regular basis during project implementation; and (iii) improves its collection performance. The MC and DIMA appreciate the need for the prescribed measures, and have therefore agreed that DIMA would: (a) implement planned real tariff increases averaging 9 percent per annum, as required to achieve a rate of return on net revalued fixed assets of not lower than 1.6 percent in 1984, 4.0 percent in 1985 and 1986, and 7.0 percent thereafter and would make further tariff adjustments if indicated by an annual review of its financial position, to be carried out in consultation with the Bank (draft MC Project Agreement, Section 4.03; (b) annually adjust its level of revalued fixed assets to reflect additions to its asset base and inflation (draft MC Project Agreement, Section 4.07). (c) by December 31, 1984, revise its tariff policy toward unmetered water consumption (draft MC Project Agreement, Section 2.13); (d) update its records for private wells and strengthen its registration-fee collection procedures by no later than June 30, 1985 (draft MC Project Agreement, Section 2.10); (e) complete, by September 30, 1984, a cost recovery mechanism, satisfactory to the Bank, which would generate revenues adequate to cover the operating, maintenance, and investment costs of providing drainage services and would implement the mechanism by no later than June 30, 1985 (draft MC Project greement, Section 2.11); and (f) reduce its accounts receivable from 4.0 to 3.0 months of billings by no later than December 31, 1986 (draft MC Project Agreement, Section 2.12). DIMA's new operational autonomy allows it to establish tariff increases and carry out all actions necessary to improve its overall performance (paragraphs 46-47). A second factor which improves DIMA's prospects for

23 meeting all of its obligations, including its contribution to its investment program, is the spreading of project implementation over a seven-year period, which makes it possible to defer the main burden of DIMA's contribution until three years into the project implementation period, thereby giving DIMA's management time to improve the company's position before having to increase significantly its contribution to its investment program. 61. DIMA's debt-service ratio, projected to be 3.9 in 1984, would increase to a high of 9.6 in 1988, drop to 3.6 in 1989, and again to 1.8 in The drastic reduction in the ratio reflects the first semi-annual amortization payments on both the Bank and CDC loans in In order to avoid increasing this burden and to ensure adequate liquidity both during implementation and during the amortization period, the MC would obtain the Bank's consent before incurring any debt for DIMA's operations, or investments not related to the proposed project, if the debt would cause DIMA's debt service during any subsequent twelve-month period to be covered less than 1.5 times by its net revenues during the previous twelve months (draft MC Project Agreement, Section 4.05) and before undertaking any investment whose annual cost would exceed US$1.0 million (draft MC Project Agreement, Section 4.06). DIMA's operating ratio is projected to be 91 percent in 1984 and to drop to 66 percent by The operating ratio together with the goals for the metering program (paragraph 59) are among an agreed set of monitoring indicators by which DIMA would measure its performance. Economic Analysis 62. During preparation of the San Pedro Sula component, several alternatives for increasing water supplies were analyzed. The San Pedro Sula water supply component, as now proposed, was considered the least-cost solution to meet the city's expected water requirements through The economic rate of return (ERR) was calculated for the San Pedro Sula water improvements (supply, distribution, storage, and rehabilitation-- representing 90 percent of total project base cost), using expected revenues as a proxy for economic benefits. Shadow prices were estimated for foreign exchange and labor; conversion factors used were 1.02 and 0.83, respectively. The ERR calculated using these assumptions is 14 percent, which is satisfactory given the fact that revenues from water service do not fully reflect economic and social benefits. These would include improvements in health, nutrition, and labor productivity, and the indirect benefit to San Pedro Sula's industry and commerce, whose development depends on a reliable water supply, and benefits deriving from institutional technical assistance. Benefits 63. It is estimated that 23 percent (about 108,000) of the 521,000 persons to whom direct project benefits would accrue by 1994 would be urban poor. Of the total, about 9,000 would receive piped water for the first time, through installation of standpipes in low-income neighborhoods; and about 44,000 would benefit from improved water service. Of the latter,

24 about 20,000 would also enjoy relief from periodic flooding of their homes. The remainder (55,000) is the estimated increase in urban poor population who would benefit from at least one aspect of the project by The poor would also benefit through DIMA's revised progressive tariff structure. DIMA's tariff structure provides for the waiving of the fixed monthly fee for families below a specified income level. Estimated average tariff for families at this low income level at project completion is L 5.0 per month, including sewerage charges, which compares favorably with the affordability indicator of L 9.0 per month. 2 / Technical assistance under the project both for DIMA and SANAA is aimed at achieving equitable distribution of costs and benefits of water consumption. Tariff structures would encourage water conservation. 64. Technical assistance under the project would directly benefit both DIMA and SANAA. At the same time, measures to strengthen operational and financial performance would not only contribute to developing the viability of those institutions, but also reduce their dependence on fiscal subsidy. The progress which DIMA has already made in responding to Bank and consultant recommendations during project preparation offers promise that it could serve as a model of a financially self-sufficient, viable water supply "company," whose experience, if proved successful, could be replicated in other municipalities in Honduras. Environmental Impact 65. Increased water supply to the metropolitan area of San Pedro Sula is expected to increase sewage flows and consequently the pollution of the Rio Sauce, which is used for sugarcane irrigation downstream of the city. Without the project, however, it could be expected that an increasing number of poor immigrants to the city would resort to drawing water from the river for home use. Nevertheless, to identify the health hazards associated with the use of river water for irrigation, and to explore alternative solutions to the problem, a study would be financed under the project. The study would be completed and submitted to the Bank by December 31, 1987, and the MC would agree with the Bank by no later than June 30, 1988, on a plan of action and a timetable for its implementation based on the recommendations of the study (draft MC Project Agreement, Section 2.14). Risks 66. The project is subject to several types of risk, and a number of the agreed measures are aimed at reducing this risk. The risks associated with physical execution of the San Pedro Sula Component are minimized by the straightforward nature of the works, which are considered well within the capacity of DIMA's personnel. Cost estimates were prepared by experienced estimators from final designs, thereby lessening the risk of 2/ Based on an assumed admissible limit of 3% of family income for water charges, per capita relative poverty level of US$300 p.a., and average family size of 6.0 persons.

25 cost overruns. The advanced stage of designs, together with a realistic construction period, reduces the likelihood of delays in project completion. Further, the fact that the MC would hire qualified consultants for construction supervision would lessen all of the above risks. It is crucial that JIMA improve its institutional performance in order to assume expanded responsibilities under the project and achieve its goals of financial self-sufficiency. The technical assistance for DIMA included in the project has been designed to improve DIMA's chances of achieving its institutional goals. DIMA's financial prospects are considerably improved by the substantial progress already made towards achievement of full metering and its ability to adjust tariffs as necessary. The financial covenants included in the MC Project Agreement (paragraphs 60-61) are designed to ensure the other elements necessary to DIMA's satisfactory financial performance. 67. At national level, the success of the project depends on the implementation of feasible recommendations to strengthen SANAA so that it can provide a suitable environment in which the water supply and sewerage companies can effectively operate. As this component would provide the greatest potential for a significant Bank contribution to the sector, and would determine future Bank participation in the sector, it is vital that the work of the consultants be monitored through close supervision and a close dialogue be maintained with officials in SANAA and the related ministries. This dialogue would be conducted both at the project and economic policy levels. PART V - LEGAL INSTRUMENTS AND AUTHORITY 68. The draft Loan Agreement between the Republic of Honduras and the Bank, the draft Project Agreements between the Bank and the Municipal Corporation of San Pedro Sula, and between the Bank and SANAA, and the Report of the Committees provided for in Article III, Section 4(iii) of the Articles of Agreement of the Bank are being distributed to the Executive Directors separately. The draft agreements conform to the normal pattern of loans for water supply projects, and their more important features and special conditions have been included in Part IV and summarized in Section III of Annex III to this report. There are three special conditions of effectiveness of the Loan Agreement: (i) that the subsidiary loan agreements between the Government and the MC and SANAA, respectively, have been duly executed; and (ii) that all conditions of effectiveness of the loan agreement between CDC and the Borrower and of the grant agreement between the French Government and the Borrower have been fulfilled; and (iii) that a financing plan, satisfactory to the Bank, for the MC's operations excluding DIMA has been formulated. 69. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank.

26 PART VI - RECOMMENDATIONS 70. I recommend that the Executive Directors approve the proposed loan. A. W. Clausen President By Ernest Stern W Attachments May 1, 1984 Washington, D.C.

27 -23- ANNEX I T A B L E 3A Page 1 of 5 HONDURAS - SOCIAL INDICATORS DATA SHEET HONDURAS REFERENCE GROUPS (WEICHTED AVERAGES) ia MOST (MOST RECENT ESTIMATE) /b lbregent MIDDLE INCOME MEIDDLE I-NcCME 1960/ ESTIMATE- LAT. AMERICA & CARIB EUROPE AREA ( THOUSAND 90. RN) TOTAL AGRICULTURAL GNP PER CAPITA (US$) ENERGY CONSUNPrTION PER CAPITA (KILOGRAMS OF COAL EQUIVALENT) n POPULATION AND VITAL STATISTICS POPULATION,MID-YEAR (THOUSANDS) URBAN POPULATION (% OF TOTAL) POPULATION PROJECTIONS POPULATION IN YEAR 2000 (MILL) 6.8 STATIONARY POPULATION (MILL) 17.0 YEAR STATIONARY POP. REACHED 2090 POPULATION DENSITY PER SQ. EM PER SQ. KM. AGRI. LAND POPULATION AGE STRUCTURE (X) 0-14 YRS YRS AND ABOVE POPULATION GROWTH RATE (X) TOTAL URBAN CRUDE BIRTH RATE (PER THOUS) CRUDE DEATH RATE (PER THOUS) GROSS REPRODUCTION RATE FAMILY PLANNING ACCEPTORS, ANNUAL (THOUS) USERS (X OF MARRIED WOMEN) /c FOOD AND NUTRITION INDEX OF FOOD PROD. PER CAPITA ( ) PER CAPITA SUPPLY OF CALORIES (X OF REQUIREMENTS) PROTEINS (GRAMS PER DAY) OF WHICH ANIMAL AND PULSE CHILD (AGES 1-4) DEATH RATE IRALTE LIFE EXPECT. AT BIRTH (YEARS) INFANT MORT. RATE (PER THOUS) ACCESS TO SAFE WATER (XPOP) TOTAL /e 64.8 URBAN T 77.8 RURAL /c 44.3 ACCESS TO EXCRETA DISPOSAL (X OF POPULATION) TOTAL /e 54.6 URBAN Th 69.8 RURAL o7; 29.8 POPULATION PER PHYSICIAN /f POP. PER NURSING PERSON POP. PER HOSPITAL BED TOTAL /d URBAN RURAL ADMISSIONS PER HOSPITAL RED /d HOUSING AVERAGE SIZE OF HOUSEHOLD TOTAL URBAN RURAL AVERAGE NO. OF PERSONS/ROOM TOTAL URBAN RURAL ACCESS TO ELECT. (X OF DWELLINGS) TOTAL /* URBAN RURAL / _ _ -_ _ _ _ - -_ -_ -_ -_ - _- -_ - -_ - -_ - -_ _-_- -_- -_-_ -_-_-_- _-_- _-_- -_- -_- -_-_ -_-_ -_-

28 -24- ANNEX I TA 3 L E 3A Page 2 of 5 HONDURAS - SOCIAL INDICATORS DATA SHEET HiONDURAS REFERENCE GROUPS (WEIGHTED AVERAGES) /a MOST (MOST RECENT ESTIMATE) /b RECENT MfIDDLE INCOME \DDLE INCOME 1960,b 1970=- ESTIMATE-/h LAT. AMERICA & CARIS EUROPE EDDCATION ADJL'STED ENROLLMENT RATIOS PRIMARY: TOTAL MALE FEIALE SECONDARY: TOTAL MALE FEMALE VOCATIONAL (Z OF SECONDARY) /h p PUPIL-TEACHER RATIO PRIMARY SECONDARY /h ADULT LITERACY RATE (.) /h CONSuMPrIOR PASSENGER CARS/THOUSAND POP /c RADIO RECEIVERS/THOUSAND POP TV RECEIVERS/THOUSAND POP NEWSPAPER ('DAILY GENERAL INTEREST") CIRCUILATION PER THOUSAND POPULATION 19.2/i CINEMA ANNUAL ATTENDANCE/CAPITA LABOR FORCE TOTAL LABOR FORCE (THOUS) FEMALE (PERCENT) AGRICULTURE (PERCENT) INDUSTRY (PERCENT) PARTICIPATION RATE (PERCENT) TOTAL MALE FEMALE ECONOMIC DEPENDENCY RATIO INCOME DISTRIBOrION PERCENT OF PRIVATE INCOME RECEIVED BY HIGHEST 5S OF HOUREHOLDS... HIGHEST 20% OF HOUSEHOLDS /. LOWEST 20Z OF HOUSEHOLDS.. 2 LOWEST 40% OF HOUSEHOLDS POVERTY TARGET GROUPS ESTIMATED ABSOLUTE POVERTY INCOME LEVEL (USS PER CAPITA) URBAN /h RURAL i ESTIMATED RELATIVE POVERTY INCOME LEVEL (US$ PER CAPITA) URBAN /h RURAL h ESTIMATED POP. BELOW ABSOLUTE POVERTY INCOME LEVEL (7) URBAN /h RURAL NOT AVAILABLE NOT APPLICABLE N o T E S /a The group averages for each indicator are population-weighted arithmetic means. Coverage of countries among the indicators depends on availability of data and is not uniform. /b Unless otherwise noted, 'Data for 1960' refer to any year between 1959 and 1961; "Data for 1970" between 1969 and 1971; and data for 'Most Recent Estimate" between 1979 and /c 1976; /d 1977; /e 1975; /f Registered, not all practicing in the country; /g 1974; /h 1978; /i 1962; /L May 1983

29 -25- ANFEX I Page 3 of5 DEFPINITIONS Or SOCIAL ISICtMSle Notas Al thbnah.the d el e drw onsui esgaitalylogd hesoteuho. tteerhtetbt. o cci-aw etoedthtthy arnt e- wentec.t coeeraisbecus cith lcof _txader eii toeax,oxet ted by di! tcaccatri- n olec ld ti dta ti aeae toeteas, etlt orxc oti eoitde. roifteoend co. hrcett o i fernce coun clx.. tt -. desrib eti iexle... toarefdereoc e eusr lltorscc-o acrohebctoctxd IfI _c...r..tacoattgeaeaeoctathcetrgayeb sujet (xcpttc tghinos' outr iltaorar' rop tccettdde nccefert at ceen -hdl -tet isb. c sen.. hecaee o strtga eei-xaitteeoi t ropdt aede pplto eite ctnei an o ahinddo"o Oa ny iesjnayfteaeara. efllis. ntertrec i r got teas dat fo htidccc lc i oeaec cre.nthheld ctcedpnd x 1ratle I icy of. det.ea is tt o.itas., ctrten h - Ttaleotaorare coprieitd lend arcedn.d iniend eae 9;f60, piscan uilte twa edicl 1,e t ateric e"l 1970 aud 1981 data. Pouainprneigfpo uoatxiedadb es tpdeu 1970 and f9t0 data. Ppltu e erclc1-ttt ubnadrrl-pplce er nor pee OlPtnA (Int - ceprcpteaiasatccnte,.cpce,rablinulic n ent eee EitOiioihyiiionersnte-hod ae bond tank bela.. t1lf-ti hls;rhatcaocoes. -spcdkt d tspdtels -ratbli.h-eta =dhepicl.1 pse_eetly aed steld 1960, it70i..ad 1991 data. b tlct npylias. ftebliehaxerottgptptd catl tttit trunttipfil PE CaPITa -Attolapaetnnsato o nrcc eis cextera not peraaotyh stffed by phdycictaa fb. by c sait_ andtwbrralelctrciy)in, fcetqiaetyt xiaipctd ate efe dtora of sdta faci-tide. Fo.ctatactal POPU(dLATIO AND V1TAL STATISTiSecardhuptlae Inlddoxfaartal Todlpoultin.Mid-Year (tcostel-hao icy; 1960, 1970, and 1981 dtstn e ftop.altd-toa uhe fadlsxa oa iairs data.ifr hospital._dtntded by th n-ber of teds. d.ba fofttnirerrene of totall -- tanl nyf ra- toptali,,i poeltito;us Pnpuianlou frofectioxe -A hocaebcld cnit Ifagapo rllaia~ hr t gqnr w a el.0 ore o eilddi Ptuatoi Of -CretIplto rjwlt n ds nlfcadteo rlde a o a Thcacaa deacs. -clrtyctarti icrcetx teohe.it_e leads foocuirdface es Ifg eln I etliycor1gc its en n ps ell cest lcrllc(-fcn o ulilai-tta.ara.ad ae planigprtestie. Eac tatyisie espna of theenn onn,oa ullld theeeiiyl lnn exaa one ar.r S1toebtoxtta fecaiyaffri dir tre,frrnwto otw.nfttl ea.an ua u_l apciay nnaioar a tot 'ttlato-laaetloar te brttcrat isen-itc eaniirt. ppuatonchertano9ra- sod alo he cxae icoe st Tctryeitnaan hsi ciedol tr etllyes dotdtrletttn d_itrtchreianac henic cctoecdctot-cftxatrcpiefcho-oa.aiadeeltrnna,.seetaa eaidotc o-fae rpae ial ecl. h ttoer no_ n o l a a h tiet ee s etcsa e esci poeaitea e siaa not ei ftepoetd arte- oxn colaeppltos orxl eidseids gd41 far elx. he. ' Mi-ya pultion per total das. a20r00ilosce are ifto. 1101i an lcre Iof phnfsgnrl ectoa r ech tenn neris s popit usuall Ii t of sgecorrsspndeme If of If reas cersea Far! so Ia dlatnlln upcda ica o tlotrlln enai ldd laoeiut itsr far lybi, b:.-0 ed90f. epnin ee poplaios 0cr 1570-ti, d , ad pafanap tte adul poplaio aged ys t I sd aer Crue Der frt eerthusadl -anul ie d ri par thocau_o of.00y-t I g;. fear 0opi 1970t inbd 1970, ad.. Id1dt.Cdiefo bad ateipo Deth cbaa tdf-foe. atspctoao ri-erpaetc as(e thodan peais-on - asngecraopa ae fetlt aes sa- ie-enasae ending in, ,end drtcetcttr- lph oprtesx fepttte sldsa prograc. dtv -aecs%8. - teer (pa ca -ex pauoit Taenr arbxdatt f-in6lnoc - Ip 9sro,,so earned, nose. - fahoanteg of orixd teea pti tuadpa.puistino dsr sot tusa aieed7 ase 0 :19 o un ruo1ot* Cyca(99-I alo -- d9 (de ofper60 19ohldodI it Ic (P-cfptxr ifh tfectaiadgnea Ief t aoaiee tdeca. 100l F1t0 Pe coc-sop t aore -crcn ufretreettl-, Cupcdtu otl(ottre hced cuotoalene - paso, b c, da ea angyyunxso e arfod uplessntlbt tcunrfyer aic fr ore end tealoe ho-dd.tgbonna eoat,ec,c re da. ntibt ufilscufis dss icfodoin, aure-ee upoacrn f.l.ee..-..icxn nerru o.ces Tae e xpodxte, td IOearNlt hne aaot.dcaflc xld nalne,aca 190 YitO FW Ann, ltvi Odfi_ riontcln n on ued frcectn, cd naea In dltiolo.ptlsp-rrt d _eai,ao ocsa aretg f oe ab_trs Pe4a. asptyo7rcic(rt a day) - frotaiccuttec61 t65 of70per ca8l to 970enb191 dta re orl ffodprdy tfn t aixa bot aeie enepl attlaio y-c aa eie.adfel-fraxacee e-nndard dt.v CIl d ar IortaI fod hu f7 fn o oa rti fddowa_tfl_ciot ge-se Bc."cre oftxpplto,ea ta irted Thid tddfun Suet; 161tI,197 ed 110laI.toof di-pondeco ttd - -boiot oatoudr1 -- andt n tenth Percrit rroeioo byrtr I.tlel-d phyisa-,- _o,ioolntcdteoaieorc deolnd hfro enhe-e ed pttitg parday; l_i-bi, 197 end 197 freed id_cottert cii..l7..iob-f ot1, ftrton _" Iae d-ldo tte(a haedi-analdoh dd e huodi I ondeu rlaoluoxibt ncs o eenlb ihs fl~aecaoyt orifto pansoyn Ilfoi-blticaeetterrcearadonfp at 1900,tOO bitc; d.did - r -ot otuc an P901 dhcidh itlyeal-oearreaotoraolleraitt deo rtinl a (u Infunfcraleytac (arthoaadt-p he.ca rtsc if.toin n elae ptc.e...trioe nefroaat cul(i raienut e cet)-ohe a ae fec ertotof tog Ir 90,ifOad 91 OOry ht eelblu aetla tch; ae.oenoo oseiuc t rtee ttr Occese of mate JSafn - ( o _t poultin of -f _oa.1p-pbati and 23otal- tcfotnly dqaede pleseatlaf to-rad reure tent n uslncraoeisoeecor fodt -foabr'i fxop-lr toe,obct nceratclfliolodsetaucedaffareethara1d orotrpeat.d bctttatdseternrcucee,e(iwoat1ahuee nhers of th hodehit do otfen tobl 196. Mnd detruridnte a ar o rurl- ahr o y lyt.total urbn, b- fel seined Ifyoton--e J andtiolt ncaltttne ny d8