STAFF APPRAISAL REPORT MEXICO. April 15, 1982

Transcription

1 Public Disclosure Authorized Document of The World Bank FOR OFFICIAL USE ONLY Report No. 3756b-ME Public Disclosure Authorized STAFF APPRAISAL REPORT MEXICO Public Disclosure Authorized CAPITAL GOODS INDUSTRIES DEVELOPMENT PROJECT April 15, 1982 Public Disclosure Authorized Projects Department Latin America and the Caribbean Regional Office 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 = Peso (Mex$) The Mexican peso is adjusted on a floating basis. The Central Bank withdrew from the exchange market on February 18, Immediately prior to that date, the exchange rate was 26.9 pesos per US dollar. In recent weeks, the peso has traded around 45 pesos per dollar. GLOSSARY OF ABBREVIATIONS ACF tbnce CANACINTRA CEDIs CENAPRO CFE COCOFIN CONACYT CONALEP CONCAMIN FIDEIN FISOMEX FOGAIN FOMEX FOMIN FONEI FONEP GDP IMIT INFOTEC NAFINSA NIDP PAI PEMEX 'Program' SECOM SEPAFIN SHCP SMI SOMEX SPP STPS. Index of Average Cost of Funds to Multipurpose Banks Banco Nacional de Comercio Exterior Camara Nacional de la Industria de Transformacion Indirect tax rebate certificates provided to exporters Centro Nacional de Productividad (National Productivity Council) Comision Federal de Electricidad (National Electricity Comission) Comite Coordinador y de Evaluacion Financiera del Programa de Desarrollo a la Industria de Bienes de Capital (Coordinating Committee of the Proposed Program) Consejo Nacional de Ciencia y Tecnologia Colegio Nacional de Educacion Profesional y Tecnica Confederacion de Camaras Industriales Fideicomiso de Conjuntos, Parques, Ciudades Industriales y Centros Comerciales Fomento Industrial SOMEX Fondo de Garantia y Fomento a la Industria Mediana y Pequena Fondo para el Fomento de las Exportaciones de Productos Manufacturados Fondo Nacional de Fomento Industrial Fondo de Equipamiento Industrial Fondo Nacional de Estudios de Preinversion Gross Domestic Product Instituto Mexicano de Investigaciones Tecnologicas Servicio de Informacion Tecnologica Nacional Financiera, S.A. National Industrial Development Plan Programa de Apoyo Integral a la Industria Mediana y Pequena Petroleos Mexicanos Capital Goods Industries Development Program which would be supported by the proposed project Secretaria de Comercio (Ministry of Commerce) Secretaria de Patrimonio Nacional y Fomento Industrial (Ministry of National Patrimony and Industrial Development) Secretaria de Hacienda y Credito Publico (Ministry of Finance and Public Credit) Small and Medium Scale Industry Sociedad Mexicada de Credito Industrial Secretaria de Programacion y Presupuesto (Ministry of Programming and Budgeting) Secretaria de Trabajo y Prevision Social (Ministry of Labor and Social Security)

3 FOR OFFICIAL USE ONLY MEXICO CAPITAL GOODS INDUSTRIES DEVELOPMENT PROJECT STAFF APPRAISAL REPORT TABLE OF CONTENTS Page No. I. THE CAPITAL GOODS PRODUCING INDUSTRIES IN MEXICO A. Background... 1 Manufacturing Sector Performance Structure of Manufacturing The Capital Goods Industries Sub-sector... 3 Employment, Productivity, and Intersectoral Linkages... 4 Development Potential... 4 Development Constraints and the Proposed Capital Goods Industries Development Program... 5 B. Policy Framework.... d... 7 Policy Coordination Incentives System Protection Policy Public Sector Procurement The Overall Balance of Protection and Incentives C. Technical. Structural and Other Factors Affecting Subsectoral Development Technology Absorption and Development Excessive Vertical Integration Information Dissemination System Technical Standards Engineering Software Technical Manpower Training II. THE FINANCIAL SYSTEM AND CAPITAL GOODS INDUSTRIES FINANCING A. Institutional Structure The Banking System The Trust Funds The Securities Market B. Credit Availability and Interest Rate Policy C. Capital Goods Industries Financing Availability of Financing Financing of Domestic Sales Complementary External Financing D. Outlook 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 - Page No. TABLE OF CONTENTS (Continued) III. MAJOR PARTICIPATING INSTITUTIONS A. Nacional Financiera, S.A. (NAFINSA) Project Promotion Department Credit Department B. Organizacion SOMEX Industry Wing (FISOMEX) Banking Wing (Banco Mexicano SOMEX) C. Fondo de Equipamiento Industrial (FONEI) IV. THE PROJECT AND THE PROPOSED BANK LOAN A. The Project Financing of Production Sales Financing Complementary Measures.. 38 B. Project Financing and Implementation.39 Financing Limits, Onlending Terms and Conditions 40 Project Cost, Financing Plan and Cofinancing..40 Project Implementation and Program Coordination 43 Channeling Arrangements and Spreads to Implementing Agencies.. 44 Operating Regulations and Project Execution Paper 44 Annual Reviews C. The Proposed Bank Loan.45 Loan Features.. 45 Disbursement of Bank Funds.. 46 Procurement and Auditing. 47 Approval Limits.. 47 D. Project Benefits and Risks.47 V. RECOMMENDATIONS.. 49 This report is based on the findings of an appraisal mission which visited Mexico in May/June The mission comprised Messrs. Challa, Baskind, Voljc, Lopez-Lopez (LCP), Gonzalez (UNIDO/Bank Cooperative Program) and Figueiredo (Consultant) and Ms. Vergara (Consultant).

5 - iii - TABLE OF CONTENTS (Continued) ANNEXES Annex 1 Annex 2 Annex 3 Annex 4 Annex 5 Annex 6 Annex 7 Estimated Quarterly Schedule of Bank Loan Disbursements Capital Goods Product Categories as Defined Under the National Industrial Development Plan Summary of Principal Fiscal Incentives for Industrial Investment Under NIDP, 1979 Institutional Infrastructure for Technology Development by Industries Structure of the Mexican Technical Education and Training System for Industry Operating Regulations of the Industrial Equipment Fund (FONEI) Supplementary Tables T-1: Gross Domestic Product by Sector of Origin, T-2: Gross Value of Production and Value Added in Capital Goods Industries, T-3: Manufacturing Sector and Capital Goods Industries Subsector, T-4: Trends in and Structure of Gross Fixed Investment, T-5: Number of Enterprises in Capital Goods Industries Sub-Sector T-6: Employment in Manufacturing and Capital Goods Industries Sub-Sector T-7: Value Added and Fixed Assets per Worker in Manufacturing Industry (1975) T-8: Selected Capital Goods Exports and Imports, T-9: Financial Sector Summary Accounts T-10: Financial Agents' Share in Total Financial Intermediation in 1980 T-11: Resource Mobilization and Credit Availability Indicators T-12: Mexico's Largest Banks T-13: Liabilities of the Banking System by Instrument T-14: Institutional Structure of the Banking System T-15: Total Financing by Sector and by Type of Bank T-16: Banking System Credit by Sector, T-17: Geographical Distribution of Credit and Deposits T-18: Selected Interest Rates in Mexico, USA, and London Interbank Rates T-19: FOMEX's Financing for Capital Goods Industries T-20: Types and Characteristics of NAFINSA's Credit Operations T-21: NAFINSA's Domestic Currency Interest Rates to Final Borrowers in Effect Since May 1981 T-22: NAFINSA - Total Approvals by Sector T-23: NAFINSA's Approvals of Credits to Capital Goods Industries T-24: NAFINSA - Credit Approvals to Capital Goods Industries by Type of Activity, T-25: Banco Mexicano SOMEX--Approvals to Capital Goods Industries T-26: Analysis of Characteristics of FONEI's Loan Approvals, T-27: Pipeline of Subprojects Presented to FONEI for Financing as of June 30, 1981

6 - iv - TABLE OF CONTENTS (Continued) ANNEXES Annex 8 C-1: C-2: C-3: C-4: C-5: C-6: Annex 9 Annex 10 Supplementary Charts Organization Structure of NAFINSA Organization Structure of NAFINSA's Credit Department Organization Structure of Organizacion SOMEX Organization Structure of FISOMEX's Capital Goods Industries Department Organization Structure of Credit Sub-Directorate of Banco Mexicano SOMEX Organization Structure of FONEI Items to be Included in the Proposed Information Dissemination System and Training Program Selected Documents and Data Available in the Project File MAP

7 I. THE CAPITAL GOODS PRODUCING INDUSTRIES IN MEXICO A. Background Manufacturing Sector Performance 1.01 Manufacturing industry played a major role in the strong growth performance of the Mexican economy in the last three decades, when per capita GDP increased some 3% per annum despite population growth of over 3% per annum. Manufacturing grew at over 8% annually in this period; its share in GDP rose from 17% in 1950 to about 24% in / Since 1970, the growth rates of overall economic activity, and industrial output in particular, have experienced relatively sharp fluctuations. The 7% annual GDP growth rates at the beginning of the decade dropped to 2% in , but rose to 7-8% in Increases in manufacturing production similarly averaged almost 8% in the first four years, dropped to 2% through 1977 but then recovered, reaching some 9% in 1978 and Partly because of infrastructural and input constraints, the increment to industrial output in 1980 was only of the order of 6% (Annex 7, T-1 to T-3) The changes in industrial growth momentum experienced during the last decade reflected changes in the macro-economic environment as well as in the policies adopted by the different Mexican administrations. The difficulties in the mid-years of the decade resulted from the demand management and exchange rate policies followed earlier. The more recent period of strong growth ( ) is associated with increasing earnings from oil exports, more open trade policies involving reduced reliance on import licensing, and crawling peg exchange rate regime introduced by the administration which took office at the end of The emergence of a substantial hydrocarbon resource base should help to moderate the balance of payments constraints on future development policy Gross fixed capital formation has risen substantially to reach 25% of the GDP in 1979 and 1980, compared to 20% in the early 1970's (Annex 7, T-4). Both public and private investment have increased reflecting recovery from the relatively low investment levels earlier in the decade as well as more optimistic expectations for the future growth of the Mexican economy and of certain key subsectors, particularly petroleum, petrochemicals and electric power. In the first phase of this boom, a considerable proportion of increased demand for machinery and equipment was met from local production, through better utilization of existing capacity. In 1979 and 1980, however, the share of imports in total supply of equipment rose sharply, as a result of increases of 40% and 28% respectively in the volume of those purchases, making capital goods the largest category of imports (para. 1.08) While prospects for rapid economic and industrial growth are good for the medium and long-term, the macro-economic policies followed must be conducive to sustained expansion. During 1980 and 1981 overall demand continued 1/ Manufacturing industry under the Mexican definition excludes petroleum refining activities.

8 -2- to rise in the face of resources constraints on output and inflation remained in the 26-30% range. Although some measures were taken in the course of 1981 to restore balance, including an accelerated crawling peg, a reversal of the trend towards liberalization of imports and an attempt to cut back on government expenditures, the fiscal deficit reached 14% of GDP. Moreover, the current account deficit was equal to 9% of GDP in 1981 reflecting both an unprecedented surge in imports and an unexpected fall in petroleum exports. At the beginning of 1982, there were fears of a further setback in oil exports and of an acceleration of inflation, resulting in pressures in foreign exchange markets. On February 18, 1982, the authorities announced their withdrawal from support of the peso which subsequently depreciated vis-a-vis the US currency to a current level of around Mex$45 per dollar. The Government also announced a stabilization program including additional budget cuts, liberalization of certain basic imports (including capital goods), and price controls. 1/ Structure of Manufacturing 1.05 The recent period of growth of manufacturing activity has witnessed a substantial deepening of the sector. At the beginning of the 1960s, the traditional subsectors producing basic consumer goods (including food, clothing, shoes, pharmaceuticals and toiletries) accounted for almost two-thirds of industrial value added. By 1970 that share had dropped to about 55%, while metal-working and mechanical engineering industries grew rapidly, from a base in 1960 comprised mainly of repair installations and simple fabrication and assembly into more advanced manufactures, increasing their share from 13% in 1960 to 18% in This trend continued through the 1970s, as the share of the basic consumer goods industries in output dropped further to about 50% and that of the engineering industries rose to 22% by Table 1.1: STRUCTURE OF VALUE ADDED IN MANUFACTURING a/ (Percentages) Food processing, beverages, and tobacco Textiles, clothing, shoes and leather products Paper and wood products (publishing) Basic chemicals, petrochemicals and fertilizers Pharmaceuticals, toiletries, soaps and related products Non-metallic minerals and base metals Metal products, machinery, and equipment (of which autos and auto-parts) (2.2) (3.9) (5.7) Miscellaneous Total a/ Excluding petroleum refining. SOURCE: Banco de Mexico (unrevised series) 1/ For an earlier discussion of these matters, see also Mexico: Development Strategy - Prospects and Problems, Bank Report No ME, August 31, 1981.

9 - 3- The Capital Goods Industries Subsector 1.06 The capital goods industries subsector 1/ has been one of the more dynamic groups within manufacturing. Starting from a relatively low level, output has increased some 9% in real terms annually over the last two decades (Annex 7, T-3). The growth has been particularly pronounced recently (averaging annual 11% p.a. over ). The number of enterprises engaged in capital goods manufacture also increased more rapidly than the average for manufacturing sector as a whole, although suffering large fluctuations (Annex 7, T-5). Nevertheless, compared with other relatively large middle and low income countries such as Argentina, Brazil, India, and Korea, the Mexican capital goods industries subsector remains underdeveloped. It represents only 11% of total manufacturing sector output in Mexico in recent years, compared to about 20% for Argentina, and 15% for Brazil. 2/ Total requirements of capital goods, on the other hand, grew rapidly over the past three years (at a rate exceeding 20% per annum) with an increasing gap between requirements and domestic production. Over this period, Mexican domestic production of capital goods supplied about 50% of domestic demand, compared to 80% in Brazil About one-third of output in the subsector is made up of metal products (e.g., pipes, tubes and fabricated structures), particularly for petroleum distribution and refining and petrochemicals production and steelrolling-mill equipment (Annex 7, T-2). Non-electrical machinery accounts for more than 30% of the subsector total, and includes a wide variety of agricultural as well as industrial machinery and equipment (e.g., tractors, hand tools, pumps, compressors and machinery for production of glass, cement, sugar and flour), but production of general purpose metal-working machinery such as machine tools, forges and presses has been very limited. Electrical and electronic machinery also represents about 30% of value added in capital goods production with the principal product lines among power transmission and distribution equipment and small and medium sized generating equipment. Transport equipment accounts for the remaining 7% of output. 3/ 1/ The definition of the capital goods producing industries raises some conceptual and statistical problems. For the general purposes of this report, use is made of the definition given in the industrial incentive decree of March 5, 1979, and subsequent revisions (the latest is reproduced as Annex 2). However, the statistical tables appearing in Annex 7, T-1 to T-4), are based on the definition provided in the recently revised national accounts data, using a 72-sector model. Due to limitations of those data, some consumer goods and intermediate products are included among metal products while the bus and truck industries are excluded from the transportation equipment category. 2/ The problems mentioned in the previous footnote, as well as the differences in national coverage, make it even more difficult to undertake international comparisons of the subsector. The Mexican manufacturing data exclude, but the Argentine and Brazilian include, petroleum refining; adjusting for this exclusion would further reduce the share of capital goods in Mexican industrial output as compared to Argentina and Brazil. 3/ For reasons of data availability mentioned earlier, this figure covers only the production of ships and railway equipment.

10 - 4 - The fastest growing category over the past two decades has been nonelectrical machinery, in particular, equipment for agriculture, petroleum extraction and refining and petrochemical production. Total purchases of capital goods in Mexico were valued at about Mex$400 billion (about US$17 billion equivalent) for Capital goods currently represent Mexico's largest import category, accounting for almost one-third of merchandise imports, while capital goods exports represent less than 10% of the country's total merchandise exports. In 1979 imports of capital goods were about US$3.6 billion (compared to US$195 million of exports), and the preliminary estimate for 1980 exceeds US$5 billion (Annex 7, T-8). According to trade balance coefficient calculations, metal products and machinery are the main contributors to the foreign trade deficit in Mexico per unit of final demand. Employment, Productivity, and Intersectoral Linkages 1.09 Employment in capital goods manufacturing has shown a dynamic growth. Between 1960 and 1975, the average annual growth rate of employment in the capital goods industries (9.7%) was almost double that of manufacturing industry (5.0%), and by 1975 capital goods industries accounted for about 10% of the employment in the sector, compared to about 5% in 1960 (Annex 7, T-6). The average incremental employment per unit of incremental gross output is estimated to be somewhat higher for capital goods industries than for manufacturing industries as a whole, while the corresponding capital-output ratio estimate is about the same as that for total manufacturing industry. Comparison of direct labor and capital coefficients (Annex 7, T-7) indicates that all capital goods industries except transport equipment are moderately laborintensive, and can be considered as important sources of future employment opportunities in Mexico. 1/ Another important feature of capital goods industries is their strong forward and backward linkages in the economy, which have become even more prominent as a result of Mexico's recent rapid development. Capital goods industries would thus have substantial impact on the growth and employment in other industries. Development Potential 1.10 The large increases in investment in both public and private sectors anticipated in the 1979 National Industrial Development Plan indicated high annual rates of growth in domestic demand for capital goods in of 17-19% for electrical and non-electrical machinery and 12-14% for other capital goods. Using more recent and somewhat more conservative growth projections, the Ministry of National Patrimony and Industrial Development (SEPAFIN) estimated the total demand for at Mex$9,000 billion in 1980 prices (equivalent to approximately US$375 billion in 1980 prices), reflecting a projected annual growth of approximately 12%. Demand from the public sector is expected to account for over 50% of the total demand for capital goods, the bulk deriving from the state petroleum and electricity companies, Petroleos Mexicanos (PEMEX) and Comision Federal de Electricidad 1/ Analysis of a sample of recently implemented capital goods projects indicates an average fixed investment cost per incremental job of about $29,000 equivalent in 1980 US dollars.

11 (CFE). In the medium term, the major users of capital goods are expected to be the petroleum and petrochemical industries, electric power generation, steel making and non-ferrous metal industries, mining and mineral processing, sugar mills, and cement industries. Although the domestic market size in Mexico for many of these categories of equipment is large enough to permit an efficient scale of production of the respective capital goods, a large proportion of the equipment needs (40-50% in recent years) is currently being met through imports (Annex 7, T-4). Given the high capacity utilization rates currently prevailing in most industrial subsectors in Mexico, the gap between the domestic supply and domestic demand as regards capital goods, which is already high in relation to other countries in comparable stages of development, is projected to increase significantly over the coming years The relatively large size of the domestic market, together with the relative labor intensity of most capital goods industries (as compared with consumer or intermediate products industries of similar size), the prospects for continued strong growth of the domestic demand for fixed capital investment, and the low labor cost in Mexico, lend reason to believe that Mexican capital goods industries can operate efficiently and compete internationally in many product categories. Field interviews with private industrialists confirmed that there are many product lines, especially those involving batch production rather than highly automated continuous production, in which Mexico can compete effectively in international markets. Several enterprises in the metalworking field, including manufacturers of specialized machinery (e.g., equipment for glass making, food processing, and petrochemical industries), are already exporting significant proportions of their production. Development Constraints and the Proposed Capital Goods Industries Development Program 1.12 The development of capital goods industries has, however, lagged considerably behind the indicated potential. The subsector has been handicapped by low productivity, excessive fragmentation, limited specialization, inadequate technology absorption and development, unreliable supply and inadequate quality of parts and components, and high regional concentration. These factors have limited the subsector's potential economic impact and many capital goods categories in which Mexico possesses longer term comparative advantage are not being produced Three principal factors contributed to the above problems. First, in the past the development of capital goods industries took place in the absence of a unified policy framework. The subsector has been subject to varying and relatively low (compared to other industries) protection levels through most of the recent period. As a result of low tariffs combined with an overvalued exchange rate, some 'net' effective protection levels have been estimated to be negative (e.g., in the mid-1970s). Although prior licenses were used as a protection device for several capital goods categories, most licenses were in fact granted very liberally, particularly to the public sector entities which have been the source of a large proportion of the incremental capital goods demand. Moreover, until recently the public sector entities enjoyed an almost full exoneration of tariffs on capital goods imports. Also, export incentives provided to the subsector have been inadequate through much of the recent period. Second, the development of

12 - 6 - the subsector has been constrained by a number of technical, structural, and information deficiencies. Several of the existing symptoms of weakness are attributable to inadequate technology absorption and development, shortages of qualified technical manpower and skilled workers, deficiencies in standardization and abilities to provide 'engineering software,' a tendency towards excessive vertical integration, insufficient subcontracting, and important deficiencies in sectoral and technical information. These factors have led to inadequate project preparation, efficiency and productivity shortfalls, and a somewhat haphazard 'programming' of capital goods manufacturing projects by public and private sectors in the absence of reliable background information. Third, a scarcity of credit facilities to support domestic production and sales of capital goods and a lack of adequate expertise or coordination among the financial institutions in helping the preparation and promotion of sophisticated capital goods industries projects have weakened the competitive position of Mexican firms vis-a-vis foreign suppliers The government clearly considers the capital goods industries to be a strategic subsector whose development is critical to Mexico's immediate as well as long-term needs. This assessment appears justified in view of the large growth potential of the subsector, its substantial linkages with the other sectors of the economy, the employment potential, and perhaps most of all, its potential contribution to Mexico's long range development through the expected favorable impact on technology absorption and "technology mastery'" in Mexico. The government is mounting a major effort to develop the subsector with the participation of the local and foreign private sectors and assistance from bilateral and multilateral agencies. To this end, it has initiated a comprehensive program for the development of capital goods industries (hereinafter referred to as 'the Program') to address each of the three sets of factors identified above. The Program is designed to provide: (a) a well defined and comprehensive policy framework which gives appropriate incentives and support for the development of an efficient capital goods industries subsector; (b) several complementary measures to address the technical; structural and information deficiencies; and (c) an institutional framework to ensure an adequate mobilization of domestic and external resources, a well coordinated financing structure and consistent financing policies In response to the government's request for Bank assistance in formulating and implementing the Program along the above lines, Bank missions have worked closely with the Mexican authorities for the past 3 years. Several of the Program's elements have already been initiated or are about to be initiated by the government; other elements would be started during the Program's initial phase. The proposed Bank project, which is presented in Chapter IV of this report, is designed to support the first phase of the proposed Program, and would be implemented under the overall coordination of COCOFIN. The remaining two sections of this chapter explain the steps being taken or proposed to be taken on the policy framework and complementary measures (items (a) and (b) referred to above). Chapters II and III provide the details of the Mexican financial system and the principal participating institutions in the proposed project.

13 - 7 - B. Policy Framework Policy Coordination 1.16 Reflecting the high priority attached by the government to the development of capital goods producing industries, the National Industrial Development Plan in March 1979 and numerous associated decrees have provided a broad spectrum of fiscal and other incentives for the subsector. 1/ Within the inter-ministerial National Commission for Industrial Development created to monitor progress under the Plan, the government established in December / a Sub-Commission for Capital Goods Industries Development composed of high fevel representatives of the key ministries and agencies concerned with the Subsector. These are the Secretariat of Patrimony and Industrial Development (SEPAFIN), the Secretariat for Finance and Public Credit (SHCP), the Secretariat of Programming and Budgeting (SPP), the Secretariat of Commerce (SECOM), the Secretariat for Labor and Social Security (STPS), the Secretariat for Agriculture and Hydraulic Resources (SARH), Nacional Financiera (NAFINSA), and Organizacion SOMEX. The Sub-Commission, which is chaired by the Minister for Industrial Development, has the responsibility for monitoring progress of the subsector and for proposing measures and necessary criteria to stimulate its rapid and efficient development Two other inter-ministerial bodies also play major roles in formulation and implementation of policies. A Committee for Coordination and Financial Evaluation of the Capital Goods Industries Development Program (COCOFIN) was set up in 1978 under the chairmanship of SHCP and with other representatives from Banco de Mexico (the Central Bank), NAFINSA, Banco Nacional de Comercio Exterior (BNCE), and Organizacion SOMEX. COCOFIN, which has been reviewing the general adequacy of financial resources available for the subsector, has been given the role of establishing the operating policies and supervising implementation of the comprehensive development program for the sub-sector to be supported by the proposed Bank loan. In addition, the Tariff Commission, comprising principally SECOM, SEPAFIN and SHCP, which has the responsibility for elaborating the government's overall commercial policy, has recently been giving considerable attention to the details of the import protection system for capital goods industries. Incentives System 1.18 Fiscal incentives for investment in capital goods producing industries are included in the general incentive decree 3/ issued by the government in 1/ The Plan and the original set of relevant presidential decrees which set out the incentive system established to achieve its objectives have been discussed in detail in the Staff Appraisal Reports for the Fourth Industrial Equipment Fund (FONEI) Project, Report No ME dated May 10, 1979, and for the Second Small and Medium Scale Industry Development Project, Report No. 2947a-ME dated May 30, / This body replaced an inter-ministerial commission which had been set up in / The main features of the March 1979 decree are summarized in Annex 3.

14 - 8 - March 1979 concurrently with the publication of the National Industrial Development Plan (NIDP). The system combines the various objectives of NIDP, which include regional decentralization, the promotion of small industry and the generation of additional employment opportunities, as well as the promotion of priority industries. The development of the capital goods manufacturing subsector is a key element of the strategy laid out in the NIDP, and the subsector is among the branches which have been accorded the highest priority (Priority Category 1) in the Plan and the incentives decree. For industries producing priority goods, the decree provides for tax credits of 20% of the investment costs plus an additional amount proportional to the number of incremental jobs from the investments creating or expanding productive capacity, except in case of plants located in the industrially congested areas of the Federal District (Zone IIIA) and designated contiguous municipalities in four states (Zone IIIB). 1/ Provision of such incentives is subject to the enterprises meeting certain production, price, exports and other targets to be specified for each industrial product line (para. 1.20). The qualifying enterprises receive certificates (CEPROFIs) for the values indicated which can then be used in payment for most federal taxes. As a further stimulus to the expansion of domestic output of these items, the decree entitles purchasers of locally produced capital goods from qualified suppliers to a 5% rebate (in the form of CEPROFIs) on the purchase price. 2/ 1.19 A June 1981 decree allows additional fiscal incentives of up to 10% on investment and employment in the case of enterprises which can operate in an "efficient and internationally competitive manner", and are willing to create sufficient production capacity to enable significant exports. The decree also allows an increase in the rebate for purchasers of domestically produced capital goods from 5% to 15%, if the producing enterprise fully satisfies the conditions of the development program registered with SEPAFIN. Moreover, subject to certain conditions to be specified in the development programs for individual capital goods categories (e.g., minimum percentages of domestic value added--para. 1.20), the decree extends the 15% rebate to locally produced parts and components purchased by those capital goods producers who subscribe to a development program; this latter measure is designed in part to stimulate subcontracting within the subsector and reverse the trend towards excessive vertical integration (para. 1.33). With a view to restrict this latter incentive to cases of genuine subcontracting (i.e., to exclude captive supplier companies created by a parent company only for legal and tax reasons), the decree authorizes the incentive only for parts and component producers who can demonstrate a significant diversification of their sales among different purchasers In September 1981 the government issued a further decree, entitled 'Program for the Development of the Capital Goods Industries', setting out the basic rationale for giving priority to capital goods industries, and summarizing the incentive-protection framework applicable to them as well as the 1/ However, expansions of existing plants in Zone IIIB are eligible to receive the tax incentives. 2/ In addition, industries creating or expanding facilities in the areas of highest priority (zone IA) are offered a 30% discount on energy prices (natural gas, fuel oil and electric power); a 30% discount on prices of basic petrochemical inputs is also offered for new facilities of petrochemicals industries, subject to an export commitment. The government is considering discontinuing these incentives, however.

15 - 9 - obligations to be fulfilled by enterprises which wish to obtain the benefits offered. On the matter of incentives, the new decree is essentially a restatement of the provisions discussed above which have appeared in previous decrees. In addition, the decree outlines the nature of the obligations and targets on levels of production, prices, domestic value added and exports, which would have to be fulfilled by enterprises in order to be eligible for the fiscal incentives. These objectives, together with the relevant incentives and protection, would be spelled out in the 'development programs' ('programas de fomento') to be authorized by SEPAFIN to individual product categories. Most importantly, as part of the strategy to enforce efficiency, the decree provides that eligible enterprises must commit themselves within their approved investment programs to achieve, in the medium term, domestic price levels which will not be more than 15% in excess of the comparable prices prevailing in the domestic markets of the countries of origin of the imported technologies. In addition, the obligations specified in the development programs are expected to include commitments by the individual enterprises to attain at least 50% domestic value added within five years, and reasonable export targets to be agreed with the enterprises for each product category. 1/ In a separate measure to discourage excessive importation of subquality used machinery and equipment and over invoicing of such imports in connection with equity contributions of foreign partners, for purposes of computing the tariff payable, the government requires used machinery and equipment to be valued at least at 70% of the corresponding new price. 2/ Protection Policy 1.21 The September 1981 decree also spells out the general criteria for setting the levels of import protection for capital goods. The criteria reflect the government's desire to have a rational protection policy for the subsector which would help it in its "take off" stage, while minimizing the burden of such protection on the rest of industry and fostering efficiency in the medium term. Emphasizing the need for selectivity in approach, the decree distinguishes between the types of protection offered for three different groups of capital goods products: (a) products unlikely to be produced in Mexico on a viable basis in the medium term, for which no prior license requirements and only 'low' import tariffs would apply; (b) product lines being produced in Mexico but whose production is still at an incipient stage, in which case some infant industry protection would be provided through 'moderate' levels of import tariffs combined with prior import license requirements applicable for periods of up to 5 years; and (c) products whose production has reached reasonable 1/ Substantial sanctions are contemplated against capital goods industries receiving fiscal incentives if they violate the export, price and other obligations to which they subscribed under the development programs, with the possibility of imposing penalties of up to four times the total amount of fiscal incentives granted for these industries. 2/ In case the importer requests partial or full exoneration of this import tariff, a special committee composed of SEPAFIN and SECOM representatives would evaluate the merits of such a request, after taking into account the fair market value and the adequacy of quality characteristics of the concerned machinery or equipment.

16 levels of maturity, but still need time to achieve the target efficiency levels, in which case the protection offered would be only through 'adequate' import tariffs. 1/ 1.22 Precise definitions of the nominal tariff levels which would be considered 'low', 'moderate' and 'adequate' were not provided in the decree. However, in connection with the proposed project, the government has provided the Bank the draft of a more detailed protection and incentives policy statement, spelling out, among other things, the specific tariff ranges proposed and the principles which would govern protection policy for capital goods industries. This draft statement indicates that tariff levels would be in the 5-10% range for industries in category (a), 10-25% for those falling in category (b) (i.e., infant industries), and 25-40% for those in category (c) ('mature' industries). It also states that, as an industry matures the tariff levels would be progressively scaled down (and any prior import license requirements removed) in order to achieve protection levels which are consistent with the 15% maximum price difference goal referred to earlier (para. 1.20). Protection would be applied on a selective basis to production of items in which Mexico is likely to achieve international levels of efficiency (including reasonable export prospects) in the medium run, rather than indiscriminately to encourage the domestic manufacture of all lines of capital goods. Within these guidelines, the Tariff Commission would determine the specific nominal tariffs or other protection applicable to each product category (including the required scaling down over time) on a case-by-case basis, as applications are received from individual industries for subscribing to the 'development programs' for the respective capital good category. The Mexican officials emphasized that the 15% maximum price difference criterion for the medium term would be applied strictly by the ministries concerned in evaluating all projects for capital goods manufacture submitted for authorization of fiscal incentives The above principles appear to provide a sound basis for promoting industries which are efficient and internationally competitive in the long run. They have been confirmed during loan negotiations and in a letter from the Mexican authorities to the Bank. However, the specific tariff ranges in the draft policy statement now need to be revised to take account of the recent major changes in the exchange rate (para. 1.04). The government is currently evaluating the necessary changes in tariff levels. Receipt by the Bank of a satisfactory revised policy statement for the subsector would be a condition of effectiveness of the proposed loan. Any subsequent change in the policy statement during the project's implementation period would have to be acceptable to the Bank. It is understood that the applicable protection policy would be reviewed and adjusted from time to time to reflect significant future changes in the real exchange rate, international trade developments, etc The Mexican authorities have taken several measures to provide a stimulus for exports, including provision of sales financing (through FOMEX) and risk insurance for exports at interest rates competitive with those 1/ "Mature" industries in this context include capital goods industries graduating from the initial infant industry protection, as well as those that have hitherto been operating inefficiently and need some protection over a limited period to adjust or rehabilitate themselves in order to achieve the target efficiency levels.

17 charged by export credit agencies in other capital goods exporting countries, rebates for indirect taxes and import tariffs on inputs (and components), and additional investment and employment incentives available for industries operating on an efficient and internationally competitive basis (para. 1.19). Public Sector Procurement 1.25 A closely related issue is the government policy with regard to procurement by public sector entities. It is the government's strategy to use public sector investment programs, particularly those of PEMEX and CFE, 1/ to stimulate the growth of the domestic capital goods industries. At the end of 1980, the government issued a decree, followed by implementing regulations, establishing standardized policies and procedures for all procurement by public sector agencies and enterprises. In relation to capital goods, the regulations provide that international competitive bidding would be permitted in those cases when it is demonstrated that equipment of suitable quality is not manufactured locally in sufficient quantites or is not likely to be available in a timely manner from local sources. It is also specified that international bidding would be permitted if the prices prevailing for locally produced items exceed the margin of domestic preference (15%) or the applicable tariff, whichever is higher. The external price used in this comparison would be that prevailing in the domestic market of the country of origin of the technology. Officials of various affected institutions have indicated their satisfaction with the procedures being used by SECOM in implementing the above policies, noting that the regulations are being applied judiciously without forcing the purchase of inappropriate or expensive locally made items. The Overall Balance of Protection and Incentives 1.26 The proposed policy framework contains a balance of moderate protection and incentives. The government believes that a period of infant industry protection is justifiable for the subsector because of its critical role in the economy and its special characteristics with a relatively long learning curve, numerous external economies and the current situation of intense competition at the international level (often involving 'dumping' according to Mexican industries and government officials). Recognition has been given to the need for ensuring a longer-term efficient production path and the need for selectivity and 'temporality' in providing protection, while ensuring adequate investor interest. A substantial portion of the initial costs will not be borne by the consumers, but by the national budget in the form of the investment, employment and purchase incentives. Mexican capital 1/ As noted earlier, these two institutions together are expected to account for major portion of the public sector purchases of capital goods.

18 goods manufacturers are aware that the government does not intend to provide permanently high levels of protection, and that the long-term viability of the investments will depend upon their international competitiveness. Given the experience of other countries which have undertaken programs to promote capital goods development and the conditions affecting their production, the average level of effective protection implied by the policy framework for the subsector does not appear to be excessive, and measures to avoid antiexport bias appear satisfactory. 1/ C. Technical, Structural and Other Factors Affecting Subsector Development 1.27 Mexican authorities have become increasingly conscious in recent years of the important contribution that capital goods producing industries can make to the development of a broader based and better integrated industrial sector. In order to explore the principal technical, marketing and other issues involved in fostering a deepening of the sector, a working group was established in the early 1970s composed of staff from NAFINSA and a team of international experts from the United Nations Industrial Development Organization (UNIDO). In 1977, the group published its main report 2/ which examined the past performance and possibilities for future growth of the subsector in the light of the experiences of other industrializing countries in this field, the production characteristics of capital goods, and the relationship with Mexico's other manufacturing activities. Subsequently, the joint working group undertook more detailed studies of the supply-demand characteristics affecting the main capital goods categories, and feasibility studies to identify viable projects which could serve as catalytic agents in the subsector's development. 3/ Based on the information from the NAFINSA-UNIDO I/ An inter-ministerial working group is currently undertaking a study on effective protection for all sectors of the economy, based on direct price comparisons for a relatively large sample of goods. Preliminary results using 1979 data indicated that the average level of effective protection for manufacturing activities as a whole was in the 12-15% range, with the two main groups of capital goods, non-electrical and electrical machinery, in the 17-19% range. The effective rate of protection for the economy as a whole was close to zero, given the negative protection rates for agriculture and petroleum. The working group is expected in the near future to recalculate the respective protection rate estimates using more recent data (for 1980 and 1981). Possible Bank collaboration in this effort is being discussed in the context of the Bank's economic and sector work program. 2/ Una Estrategia Para Desarrollar La Industria de Bienes de Capital (Mexico, 1977). 3/ Some of these studies have also been published as annexes to the main report.

19 studies, information available from other agencies and representatives of the Mexican private sector, and the analysis of the Bank missions, several technical, structural and other factors have been identified as sources of important constraining influences in the development of the capital goods manufacturing subsector in Mexico. Technology Absorption and Development 1.28 The effectiveness of technology absorption and technology development in capital goods manufacturing appears to have been quite varied, depending upon the nature of technical collaboration between the foreign and domestic partners, the participation of an aggressive local private sector partner, and the nature of the project itself. While Mexican companies have been able to absorb reasonably well the technology from their foreign partners, they have been less effective in adapting, innovating or developing new technology. The government's program for subsector development includes measures to correct this deficiency through strengthening of the institutional infrastructure for technology-related assistance, and provision of fiscal incentives for technology innovation and adaptation Mexico's institutional infrastructure to support technological research, development and adaptation activities is reasonably well developed. The main institutions of relevance to capital goods industries are: the Consejo Nacional de Ciencia y Tecnologia (CONACYT), which formulates the national science and technology policy and operates 12 technological research and development centers (specialized by subsector) at different locations in Mexico 1/; Servicio de Informacion Tecnologica (INFOTEC), a NAFINSA administered trust fund devoted to providing industry-oriented technological information, advice and other related services, which enjoys wide contacts and good reputation with private industry 2/; Instituto Mexicano de Investigaciones Tecnologicas (IMIT), a decentralized public institute which carries out project feasibility studies and technological research for industrial enterprises on a consulting basis; the Instituto de Investigaciones Electricas (IIE) and Instituto Mexicano del Petroleo (IMP), two highly reputed technological institutes specializing in activities related to electric generation/transmission/ distribution and petroleum and petrochemicals extraction/processing 3/; and several private sector consulting companies (some with foreign affiliations) which can provide a wide range of engineering and other services. The nature of the activities and capabilities of these institutions are discussed in greater detail in Annex While the above institutional infrastructure can provide valuable support, past research studies have indicated that the key advances in technology absorption, development and adaptation tend to be mainly a function of 1/ CONACYT is the recipient of a US$50 million loan in 1981 from the Inter- American Development Bank, mainly to help strengthen technological resarch and development centers, institutes and departments. 2/ INFOTEC is participating in the first and second small and medium scale industries development projects (Loans 1552-ME and 1881-ME approved in FY78 and FY80). 3/ IIE is affilated with CFE and IMP with PEMEX.

20 the enterprise's own initiative. Recognizing the need to stimulate such initiative by the industrial enterprises, the government issued a decree in November 1980 providing of broad range of incentives, including: (i) tax credit of 20% of the investment costs of fixed assets and exemption of reinvested profits from corporate income taxes, for institutions devoted exclusively to technological research and development, or technological assistance including the elaboration of basic engineering designs, provided that the facilities are located outside of the highly congested Mexico City area (Zone IIIA); (ii) 25% investment tax credit or exemption of duties on imported equipment for national institutions devoted to scientific and technological development; (iii) tax credit of up to 20% of investments for technological research, development and adaptation activities by productive enterprises (25% in case of small enterprises); and (iv) 10% tax credit on sales of the technology developed by industrial enterprises. In addition, enterprises which purchase services provided by eligible institutions or enterprises will receive tax credits equivalent to 10% of the value of the contract, 15% if the purchaser is a small enterprise. Finally, since 1976, the government has also permitted accelerated depreciation for tax purposes on capital equipment used for R&D purposes, and R&D expenditures can be deducted as current business expenses in computing taxable income Government regulations on acquisition of foreign technologies appear to be reasonable and do not constitute an undue administrative burden. All technology transfer contracts have to be authorized by SEPAFIN's Registry of Technology Transfer which checks for the suitability of royalty payments and other conditions of the contract, which frequently helps the entrepreneur to negotiate reasonable levels of payment. Subject to this, technology may be acquired freely from abroad by enterprises in priority sectors (including capital goods) but payments purely for trade marks are not permitted. In the case of capital goods, royalties have generally been in the range of 3-7% of sales As an additional measure to address the problem of insufficient industry-sponsored technological research, development and adaptation (RDA), FONEI and CONACYT have initiated programs for financing such activities on a risk-sharing basis. Under the FONEI scheme, costs incurred by industries for technology-oriented in-house RDA, as well as industry-sponsored RDA work contracted to technical consulting firms, are eligible for financing, whereas the CONACYT scheme contemplates support mainly through work undertaken by one of CONACYT's technological research and development centers at the request of the respective industry. The schemes of both FONEI and CONACYT involve a significant subsidy element, mainly in the form of financing at low interest rates, and absorption by the respective agency (FONEI or CONACYT) of up to 75% of the costs of the research program in the case it does not yield fruitful results. 1/ A recent IDB loan to Mexico for technology development includes US$2.5 million component to support CONACYT's risk sharing program for the 1/ The terms and conditions of financing differ somewhat under the two programs. The effective yield on the financing provided by FONEI in the case of successful projects is of the order of 6-8 percentage points below the ACF index (that is, currently about 24%); the corresponding yield on CONACYT's financing is considerably lower, but a provision is made for some possible royalties to CONACYT in case of successful research projects.

21 full range of industrial activities. The proposed Program would include a small component to support the technology RDA activities of capital goods manufacturing industries through the risk-sharing program of FONEI (para. 4.02). Given the innovative nature of the risk-sharing programs, FONEI (and CONACYT) has opted to offer financing conditions that may prove to be somewhat overgenerous in the long run. While this may be essential in the initial stages to generate sufficient industry interest in technology development, financing conditions for the technology financing component would be reviewed, as part of the annual review of the entire Program (para. 4.19), with a view to identify and make any needed adjustments (e.g., inclusion of additional conditions providing for royalty payments to FONEI in case of successful research). Other complementary support would also be provided under the proposed Program to help strengthen INFOTEC's technological information and other support services (para. 4.07). Also, financing would be included to help provide production-related technical assistance and on-the-job training oriented towards improving the efficiency of utilization of existing facilities ("X-efficiency") as well as ensuring efficiency in new investments (para. 4.02). Excessive Vertical Integration 1.33 As a result of difficulties in assuring adequate quality and a reliable supply of components and other inputs and the previous emphasis in the incentives decrees only on final products, a high degree of vertical integration is evident among many Mexican capital goods industries. 1/ The lack of specialization in component manufacture and the relatively small use of horizontal linkages and subcontracting have led to a fragmented market in the production of many capital goods components. In an effort to correct this trend, the government has initiated a system of subcontracting exchanges where small and medium enterprises can register their capabilities and make that known to larger enterprises. To date four such exchanges have been set up with the assistance of the Directorate General of Small and Medium Scale Industry (DGSMI) of SEPAFIN, at Guadalajara, Bajio, Puebla-Tlaxcala and Veracruz, and two more at Monterrey and Nuevo Leon are planned. DGSMI has carried out useful preparatory work and provided guidance in the establishment of the exchanges, but they are eventually to be taken over and operated by the local chambers of industry. While it is too early to judge the effectiveness and impact of these subcontracting exchanges, they represent a worthwhile initiative. The operation of the exchanges is expected to be closely coordinated with the technical assistance and extension activities under the national small and medium scale industry development program (the PAI program which receives support under Loans 1552-ME and 1881-ME). The recent extension of fiscal and other incentives to locally produced parts and components of capital goods (para. 1.19) is expected to provide a further stimulus towards increased use of subcontracting Nevertheless, there remain important obstacles to wider use of subcontracting systems particularly those involving smaller enterprises. The most important of these has been the disparity in technological absorption 1/ Another factor that encouraged high degrees of vertical integration appears to have been the availability of relatively cheap capital in the past (before 1977/78) which implied relatively low penalties for underutilization of equipment capacity.

22 between the larger and smaller enterprises. To help overcome this constraint, subcontracting enterprises would be eligible under the Program to receive technical assistance loans at concessional interest rates (para. 4.02). In addition, to ensure adequate consideration to subcontracting possibilities in individual subprojects, all subproject evaluations accompanying requests for authorization of Bank financing would be required under the Program's operating regulations (para. 4.17) to include an assessment of the subcontracting possibilities. Information Dissemination System 1.35 There appears to be an insufficient dissemination of information regarding the supply-demand characteristics and current installed capacity of capital goods industries. Also, relatively little information is available on investments under consideration by the public and private sectors affecting the demand or supply of capital goods. This has been in part due to the previous lack of programming and projection of capital goods needs by the principal public sector purchasers, notably PEMEX and CFE, the reluctance of some elements of the private sector to give out relevant information, and lack of an institutional infrastructure to systematize and provide the relevant information to industries. The deficiencies in available information increase the uncertainties associated with investments in capital goods projects and hamper the private sector's ability to plan investments in capital goods industries on a rational basis. They also appear to be preventing the optimal grouping of capital goods products and intermediates in formulating manufacturing projects. For example, the appraisal mission noted several instances of large plants manufacturing equipment for electric generation and transmission, petroleum refining, petrochemicals production and sugar refining which have the ability and idle capacity (at least part of the time) for undertaking heavy fabrication, forging, pressing, machining, heat-treatment, etc. Such capacity could be used to produce equipment for a wide range of other activities, with suitable programming, minor adjustments and acquisition of the needed know-how One measure which has recently been taken to improve this situation is the publication by the principal public sector enterprises (particularly CFE and PEMEX) of their long term investment programs projecting their likely requirements of major equipment, say, over a 5-10 year period. Also, as part of the measures taken to standardize public sector procurement procedures, all entities within the public sector are required to submit to SECOM at the beginning of each year details of their planned expenditures for the year; these are later published by the government. Finally, in order to provide a forum for discussion of the public sector investment programs and procurement information, the government has started creating Mixed Commissions ('Comisiones Mixtas') comprised of representatives from the private sector capital goods producing industries and the major public sector purchasers of those goods (one Commission for each major public sector entity or association). Thus far such Mixed Commissions have been established for CFE, PEMEX, SIDERMEX (steel) and the association of nationalized sugar producers; these appear to be reasonably effective and a similar commission may be created in the future for FERTIMEX (fertilizers) Two additional initiatives would be taken by COCOFIN in collaboration with SEPAFIN, as part of the proposed Program, in order to fill the most critical information gaps and improve access to information on the capital

23 -17 - goods 8ubsector, namely, a comprehensive inventory of existing production capacities of relevance to the subsector, and implementation of a broad information dissemination system (paras and 4.08). The above measures would facilitate optimal grouping of products in formulating the investment projects, prevent duplication of projects and redundant productive capacity, provide a better basis for user industries to consider domestic procurement of capital goods, and help entrepreneurs plan capital goods investment projects on a rational basis. Technical Standards 1.38 Difficulties in having commonly accepted engineering standards for both products and inputs have also contributed to the slow growth in subcontracting and, more generally, have adversely affected the development of the subsector. Common technical standards are needed to ensure interchangeability of parts and reliability according to a predetermined level of performance. With growth in world trade, there has been a major effort at establishing international standards, or at least reconciling diverse national standards to provide compatible equivalents. The issue of choosing among different existing standards becomes particularly important for a developing country such as Mexico which depends upon technology derived from different developed countries, and whose products include parts and components used in a wide variety of final products elaborated in other countries. The related decisions could affect the size of the production runs and production costs of capital goods industries The Mexican authorities have initiated a comprehensive program to establish a national standards system, and working groups have begun to elaborate norms for various product lines, including some capital goods. The degree of acceptance of these standards by the domestic industries has been limited, as may be expected at an early stage of developing standards. Most enterprises including those in the public sector continue to rely on foreign/ international standards, apparently because a high proportion of their existing equipment is imported; moreover using internationally accepted standards could facilitate exports Given the relatively early stage of capital goods production in Mexico, it would be difficult to establish a consistent and streamlined system of standards quickly. It is likely that the most practical approach may be to focus on selected product lines considered to be of highest priority for establishment of national standards, striving to obtain strong participation of producers and consumers in the working groups for these items. For a majority of the products, however, acceptance of an internationally known standard may be the best solution, at least in the near term. To address the issue, COCOFIN would periodically review, together with other agencies concerned, the progress achieved and required additional measures towards streamlining and/or developing standards (para. 4.09). Engineering Software 1.41 Mexico seems to have made little advance thus far in the development of "engineering software", that is, putting together designs and engineering of complete plants as opposed to only pieces of hardware. In comparison with other developing countries such as India, Korea and Brazil, the contrast is notable. This would be a major area where potential for future growth and improvement lies, and should be emphasized in the future development strategy.

24 As the capability to put together complete plants and to manufacture sophisticated equipment develops, Mexican companies would also have to build a capability to provide their clients (both domestic and foreign) required maintenance services and technical assistance in the operation of the plants or equipment. Progress in the development of capacity in this area will be monitored during the course of the Program, and COCOFIN would provide a forum in which it will be possible to discuss and decide upon possible measures to assist this process of growth (para. 4.09). Technical Manpower and Training Needs 1.42 Shortage of qualified manpower, particularly technical manpower with the skills and experience required in capital goods manufacture is becoming a serious constraint. The deficiencies appear most critical at the skilled worker and technician levels, but are also evident at the professional and managerial levels. An adequate system of vocational training programs would be essential to address the various technical and structural issues discussed above. Suitable training programs, 'mini-courses' and seminars are also needed to bolster the capacity of the professional and managerial staff of the industries as well as the technical staff of the principal financing agencies under the proposed Program. Emphasis needs to be put on the treatment of the technology transfer process, technology transfer agreements and the design of complex financing packages involving foreign collaborators to formulate 'bankable' projects (para. 4.05) A large number of public, semi-public and private institutions provide technical training at various levels, including the Ministry of Education, Ministry of Labor and several autonomous and semi-autonomous agencies. The most important facilities relevant to capital goods industries are: the CONALEP system of training centers which is designed to offer terminal training to skilled workers and lower level technicians 1/; the CECATI system of centers for training semi-skilled and skilled workers; the CET and CECYT systems which serve the dual purposes of providing 'terminal' technical training for low to middle level technicians as well as preparing candidates for universities and higher level institutes; CENAPRO which has been involved in training technicians, professionals and middle level management personnel; ARMO, the UN-assisted system of brief but intensive vocational training programs under the auspices of CENAPRO; the system of regional technological institutes; universities and higher level technological institutes which offer industry-oriented programs from time to time; and programs custom-designed for the needs of individual enterprises either in-house or with assistance from 1/ The Bank has approved a US$90 million loan in FY81 to provide support to the CONALEP system (Loan 2042-ME). In addition to the general upper secondary level technical training courses in the metalworking field which are offered by several CONALEP centers, two specialized training and applied research programs in the metalworking field expected to be initiated during 1982/83 at CONALEP's Saltillo and Cuautitlan centers are of particular relevance to capital goods industries. The center at Saltillo which will start operating in 1982 will cover foundry, boilershop work, mechanical fabrication, installation and maintenance (with capacity to train 500 technicians and 250 workers each year), while the Cuautitlan program, expected to be initiated later, will cover metallurgy, foundry, machine tools, fabrication, installation and maintenance (with expected yearly output of 2,400 technicians and 500 skilled workers).

25 consulting companies or independent institutions. 1/ Annex 5 provides a schematic diagram and explanation of the various training sources Mission discussions with industry representatives indicated substantial deficiencies in their knowledge of the available training facilities from the various sources and the suitability to their own operations. The problem is compounded by the seeming or real overlap between the training functions among the different institutions, particularly with respect to the programs for skilled and semi-skilled workers and technicians. In order to overcome this deficiency, a comprehensive inventory of all available training courses relevant to capital goods industries would be carried out under the direction of COCOFIN, as part of the proposed Program (para. 4.06). II. THE FINANCIAL SYSTEM AND CAPITAL GOODS INDUSTRIES FINANCING A. Institutional Structure The Banking System 2.01 Mexico's banking system comprises Banco de Mexico (the Central Bank), 23 public banks and 64 institutions of private and mixed ownership. In 1980, private and mixed banks accounted for 61% of the banking system's liabilities, the public banks for 31%, and Banco de Mexico for 8% (Annex 7, T-9). Other financial intermediaries include insurance and guarantee companies, credit unions, deposit banks, and the securities market, which together account for about one quarter of the total financial intermediation (Annex 7, T-10). Mexico maintains an open financial system vis-a-vis external markets Although the financial system experienced a period of rapid deepening from 1967 to 1972, when the ratio of banking sector's non-monetary liabilities to GDP increased from 0.32 to 0.40, the economic uncertainties of the mid-1970s that ultimately led to the massive peso devaluation in 1976 caused a significant capital flight; based on a partial survey the ratio is now estimated at about 0.33 (Annex 7,T-ll). Banco de Mexico has since taken several measures to reverse this trend, the most important being a liberalization of interest rate ceilings on deposits and offering remuneration on reserve requirements of banks. Private sector deposits with private and mixed banks as a percentage of GDP, however, increased recently from their 1977 low of 23.2% to 26% in 1980; together with a growing share of banking system credit in GDP, this indicates a reversal, or at least a stemming, of the earlier unfavorable trend in financial intermediation. Although the largest 12 banking groups account for over 85% of the assets (Annex 7, T-12), indicating a fair degree of concentration, the system appears to be quite competitive, particularly in raising deposits. Administrative expenses of banks are relatively high (exceeding on the average 6% of deposits), mainly due to costs associated with their large branch networks. Due to the high liquidity preference of savers, liabilities of the banking system have been skewed towards short-term obligations (Annex 7, T-13). 1/ Since 1978, Mexican firms have been made legally responsible to ensure adequate training facilities for their employees; this regulation is still only in the initial stage of enforcement.

26 Traditionally, financial institutions in Mexico were specialized as deposit and savings banks, financieras or investment banks, and mortgage banks. The financial crisis, when the banking system experienced massive withdrawals of funds, convinced the Mexican authorities of the urgent need to introduce organizational reforms. In December 1978, a series of amendments and additions to the Banking Law were introduced to raise the efficiency and effectiveness of the banking system. The most important modifications involved measures to encourage grouping of specialized banks to form the multipurpose banks (multibanks), with a view to increase competition through the increased financing capacity of the smaller banks, lower administrative costs of the system through economies of scale, and improved access to the full range of financial services for clients outside the biggest cities. The capital requirements for banks were also changed, with the requirements now being linked to the risk classification of assets instead of liabilities. With a view to counteract a traditional over-emphasis on loan collaterals, the 133% minimum collateral was eliminated, and principles were established that loans should be granted taking into account the economic feasibility of the project being considered, and that repayment periods should be set on the basis of a project's expected cash flow. Overall exposure limits per client have also been set to avoid excessive concentration of portfolio risks of individual banking institutions Mexico's multibanks are now the dominant type of private sector and 'mixed' financial institutions. 1/ Multibanks can offer a full range of financial services through their branch offices and provide a fairly broad regional coverage of the country. As of March 31, 1981, there were 64 private and mixed banks (down from 198 as of September 30, 1977), of which 35 were multibanks (up from 14 as of September 30, 1977 and 26 at year-end 1978). The multibanks now account for more than 90% of the assets and 80% of all the branch offices of private and mixed banks. Despite the fact that the number of financial institutions was reduced to two-fifths in less than four years (from 220 in 1977 to 87 in 1981), the number of branch offices increased in the same period from 3,535 in September 1977 to 4,492 in March 1981 (Annex 7, T-14). Among the public sector banks, NAFINSA is by far the most important one supporting the industrial sector, and fulfills a combination of development banking, commercial banking and industrial promotion activities; it also administers several government trust funds (para. 2.05) and acts as an agent of the government in obtaining external borrowings. The most important 'mixed' bank involved in industrial financing is Organizacion SOMEX. Under the proposed capital goods development program, NAFINSA, Oroanizacion SOMEX, as well as the entire private banking system (through the trust fund mechanisms described below), would participate as financial intermediaries. The Trust Funds 2.05 In order to channel additional financial resources to sectors it considers a priority, the government has set up several trust funds. These funds derive their resources principally from the reserve requirements of the banking system, although several have also received loans from local and international sources, including the Bank. The most important trust funds providing financing to the industrial sector are among those managed by the Banco de Mexico and NAFINSA. The principal trust funds administered by 1/ 'Mixed' banks are entities with mixed public and private sector ownership which operate essentially as private sector banks.

27 Banco de Mexico are FONEI, which finances relatively large export and efficient import substitution projects in the industrial sector, and FOMEX, whose main activity is pre- and post-export financing. The main NAFINSAadministered trust funds supporting industrial activities are FOGAIN (credit to small and medium scale industry), FOMIN (equity and quasi-equity financing to small and medium scale industry), FIDEIN (promotion and development of industrial estates) and FONEP (financing of preinvestment and other studies in connection with project preparation). The trust funds financing credit operations (FONEI, FOMEX and FOGAIN) operate through the entire banking system by rediscounting loans made by individual banks During 1979, trust funds administered by Banco de Mexico and NAFINSA channeled Mex$66,400 million through the banking system, equivalent to about 6.5% of total banking sector credit. The amount for 1980 is estimated at Mex$88,400 million. The trusts' share in medium- and long-term financing is important due to the relatively short maturity of the resources mobilized by the banking system assets; in 1979, they accounted for 23% of the total mediumand long-term credit to industry and 38% to agriculture. Capital goods producing industries obtained Mex$16,950 or 19% of total trust financing in The Securities Market 2.07 Although it has grown rapidly following a series of reforms taken in the mid-1970s, Mexico's securities market is still relatively small and has not yet developed into a very important mechanism to finance industrial firms. In 1980, new issues of shares and fixed interest securities accounted for only 4.2% of the country's total financing through financial intermediaries. Comparatively few, mostly well-established and large, companies are listed in the organized securities market (centralized in 1976 into a single securities exchange). 1/ Total value of shares traded in the organized market increased from Mex$30,300 million in 1978 to Mex$93,800 million in 1979, but fell to Mex$74,900 in 1980; the volume of traded debt securities has been declining since 1976, reaching Mex$65,000 million in 1978, Mex$33,000 million in 1979, and Mex$25,700 million in Recognizing the limitations of the existing securities market, the government is providing equity and quasi-equity investments through direct investments undertaken by NAFINSA, FOMIN, and FISOMEX (holding company wing of Organizacion SOMEX). This type of financing has had an important impact on capital goods industries' equity financing, and would be supported under the proposed project. B. Credit Availability and Interest Rate Policy 2.08 As the economy recovered from the crisis, the financial sector grew rapidly. Total financing increased 5.1% in real terms in 1978, 11.4% in 1979, and 7.7% in Credit given by private and mixed banks expanded at an average annual rate of 16.1% in real terms in and accounted for 38.7% of total financing in 1980, compared to 30.3% in 1977 (Annex 7, T-15). Credit to the manufacturing sector, however, has had a less dynamic growth: 5.5% in real terms in 1978, 4.9% in 1979, and 2.1% in The manufacturing sector accounted for slightly over 20% of total banking system credit in 1980, compared with 25-26% in , reflecting in part the increase in the relative share of the energy sector (Annex 7,T-16). 1/ Responsibility for control and supervision of the securities exchange rests with the National Securities Commission.

28 It appears that the heavy concentration in Mexico City, typical for both industrial value added and industrial credit, has decreased significantly. As of December 31, 1980 the Federal District accounted for 47.7% of total credit to the manufacturing sector, compared to 57% in 1978 (Annex 7,T-17). Priority zones as designated by the National Industrial Development Plan registered some gains in their respective shares of credit, a trend which is expected to continue in the future and which would be encouraged under the proposed project Since 1974, financial institutions in Mexico have been adopting increasingly a variable interest rate system for term lending operations. By 1977 practically all term loans were made at floating interest rates, using as an index the average cost of deposit funds (ACF) to investment banking departments of private and mixed banks. In December 1979, following the transformation of the banking system from specialized banks to multipurpose institutions (para. 2.04), Banco de Mexico modified the ACF index calculation to base it on the average cost of all term resources (3 days to 2 years) of the Mexican (private and mixed) banks, making it broader and a better indicator of the cost of funds in the market. In line with Mexico's open financial system, domestic deposit and lending interest rates can be expected to maintain an approximate parity with interest rates in international markets and to reflect changes in the domestic inflation rate, although with same lags. The ACF index rose from about 18% in December 1979 to about 34% in March 1982 (Annex 7, T-18), reflecting the periodic adjustments of all deposit rate ceilings to maintain domestic financial savings and preserve party with foreign markets. During , the level of interest rates on loans as well as term deposits of banks not only exceeded the rate of inflation in Mexico (estimated at about 28% for 1981), but also made peso deposits competitive with those denominated in foreign currencies. This is reflected in a progressive decrease in the percentage of foreign currency-denominated credits from about 35% in 1977 to 28% by the end of The margins over the ACF charged by banks range from less than 2 points for prime clients with reciprocal business, to about 7 points for marginal clients, implying current lending rates of about 36% to 41%; the average effective lending rate currently charged by the private and mixed banks in Mexico City is estimated at 38-39% The widespread application of adjustable interest rates has caused a gradual shift of lending towards medium term loans, although banks are still constrained by the high liquidity of their liabilities. As of December 31, 1980, private and mixed banks had 46% of their loans at terms exceeding one year, compared to 39% in Long term loans (say of terms of more than 5 years) make up only a small proportion of these, reflecting continued difficulties in the access of industries to longer term financing which is needed for large investment projects or investments involving long gestation periods. This is mainly a result of the concerns of the banks with regard to borrowers' repayment capacity and uncertainties in domestic and international interest rates experienced in recent times. Banco de Mexico is continuing its efforts to improve the term structure of the banking system's liabilities, through several recent measures including elimination of the highly liquid investment and mortgage bonds, further liberalization of interest rates on certificates of deposits of 24-month maturities, offering higher remunerations on the reserve requirements for banks whose proportion of term deposits exceeds that for the banking system as a whole, and elimination of remunerations for reserve requirements on checking and savings deposits.

29 C. Capital Goods Industries Financing Availability of Financing 2.11 Because of the long gestation periods involved in implementing capital goods industry projects and in their achieving the required level of technology absorption and development, availability of adequate long-term financing is particularly important to the development of the capital goods subsector. Consequently the availability of term funds from the trust fund mechanisms (most importantly FONEI and FOMEX) and from the public and mixed banks has been a significant factor in facilitating the subsector's development. Funds available from these channels would be supplemented through additional resources under the proposed Program, including additional term funds for sales financing of capital goods (para. 2.13) The government is aware of the difficulties in capital goods financing and is monitoring the available support through COCOFIN (para. 1.17) whose membership represents several financial institutions (NAFINSA, Organizacion SOMEX, BNCE, FONEI, FOMEX, FOGAIN and FOMIN). During 1980 these institutions approved Mex$28,700 million in credit to capital goods industries, a substantial increase over Mex$17,700 million in 1979; about 37% of the credit in 1980 went for non-electrical machinery, 24% for transport equipment, 21% for electrical and electronic equipment, and 16% for metallic products. Among the above institutions, FOMEX was the largest source of funds, providing 37% of total credit in 1980, followed by BNCE (27%), NAFINSA (22%), FONEI (7%), Organizacion SOMEX (5%), and FOGAIN (2%). However, as mentioned above, a good deal of the financing is in the form of short-term working capital credit, over 80% in the case of FOMEX and BNCE (1980 data), about 70% in the case of NAFINSA ( average), and some 30% in the case of Organizacion SOMEX ( ). FONEI's credits, on the other hand, are of a longer term nature, with over 90% of the financing in the over 4 to 10 years category. Financing of Domestic Sales 2.13 At present the main source of financing specifically designed to finance sales of capital goods to local and foreign buyers is FOMEX, which rediscounts buyer or supplier loans made by Mexican banks (with maturities of up to 15 years) for this purpose (Annex 7, T-19). FOMEX's scheme for financing domestic sales of capital goods was originally started more than 10 years back, but became significant only in recent years when it started being used to provide short term sales financing to address specific problems related to the sales of capital goods to Mexican public enterprises (most notably PEMEX and CFE). In principle it is available for short, medium, as well as long term financing of all domestic sales of capital goods (with terms of up to I'1 years), for amounts for up to 85% of the invoice value net of the cost of imported inputs. To date the bulk of the sales financing provided under this scheme (over 80%) has, however, been only short term. Loans to finance the domestic sales are generally denominated in pesos and bear a floating interest rate equal to two percentage points above the ACF index (that is, equal to those under FONEI loans--see para. 3.22). In principle FOMEX may also rediscount sales financing loans denominated in foreign currencies using interest rates competitive with those offered by foreign suppliers in that particular currency, although the option of foreign currency denominated loans has rarely been used in the past in financing local sales. No exact data on the banking sector sales financing to capital goods producing industries

30 exist; estimates indicate, however, that the capital goods subsector's share of such financing in total manufacturing is about 12%, close to its share of the manufacturing value added, but is also almost entirely short term Shortages of sales financing and the perceived inferior competitive position of domestic capital goods producers vis-a-vis foreign suppliers with respect to the terms and conditions of sales financing are frequently cited by Mexican industrialists as major factors hindering the growth of the local capital goods industry. While shortages in sales financing actually experienced in the past have not been critical, there is little doubt that the needs for sales financing would increase very substantially in the future as the domestic capital goods industry develops. On the other hand, industrialists are not well informed about the features of financing available through FOMEX for domestic sales of capital goods, and banks not fully familiar with the markets and technical aspects of capital goods tend to be reluctant to provide the full amount of sales financing which can be rediscounted under FOMEX's scheme. Another potential problem is that capital goods producing industries cannot afford to use up the bulk of their borrowing capacity in arranging sales financing. To help address these problems, the proposed project would provide greater facilities to publicize information on available sales financing resources, terms and conditions. Consideration would also be given to the need for an increasing use of foreign currency denominated loans (to be offered as an option to the industries) in the financing of local capital goods sales to help domestic capital goods producers overcome any competitive disadvantage. In the longer run, consideration should also be given by COCOFIN and the concerned government agencies to the possibility of promoting private institutions specialized in financing of sales/purchases of capital goods, which might more readily accept loan exposure (e.g., as 'acceptance corporations' willing to assume full collection responsibility and credit risks of the buyers in return for a margin, through 'factoring' of sales), and developing a secondary market for acceptance type instruments for sales financing. Complementary External Financing 2.15 The larger industrial enterprises of Mexico have had reasonable success in recent years in obtaining short and medium term investment financing in the form of direct loans from foreign private banks, suppliers credits, equity participations by collaborating foreign partners. Based on an analysis of a representative sample of medium size capital goods manufacturing projects which have been financed recently, or are being considered for financing, total financing from external sources (excluding IBRD and other multilateral aid agencies) accounted for 10-15% of the total investment costs on the average. It is believed that with additional efforts to mobilize complementary external resources this percentage can be increased significantly. The 'cofinancing' proposed in connection with the proposed Capital Goods Development Program would be a step in this direction (para. 4.13). D. Outlook 2.16 Given the vigorous domestic demand, existing structural imbalances and possible needs to accelerate the rate of peso devaluation, the inflationary pressures in the economy can be expected to continue in the near future. On the other hand, the high level of public sector deficit, part of which is

31 financed through the financial system, lends reason to believe that monetary and credit policies will at best be moderately expansionary. It may reasonably be expected that interest rate policies will continue to be set taking into account international financial market trends, differences between Mexican and world inflation rates, and the need for a more adequate term structure of domestic savings. Under such circumstances, capital goods producing industries, whose output is expected to grow considerably faster than that of the rest of the manufacturing sector in the years to come, may be particularly affected by the high interest rates and a shortage of funds necessary for new investments, expansion and sales of their products. The proposed project would contribute to strengthening the financing system for capital goods industries together with improvements in other areas such as the policy framework, institutional structure and needed technical measures, as described in Chapter IV. III. MAJOR PARTICIPATING INSTITUTIONS 3.01 The investment financing under the proposed Program would be channeled mainly through three institutions--nafinsa, Organizacion SOMEX and FONEI (paras and 2.05). Sales financing would be provided mainly through FOMEX, whose activities have been discussed in para This chapter provides a brief institutional analysis of NAFINSA, Organizacion SOMEX and FONEI, the main agencies channeling Bank funds under the Program. A. Nacional Financiera, S.A. (NAFINSA) 3.02 NAFINSA is the government's most important development bank supporting the industrial sector. Through its own operations together with those of its affiliate 'Banco Internacional,' it also acts as a commercial bank, accepting deposits and offering a wide range of services, mostly to the industrial sector. It has a large holding company wing through which it holds equity participations in industrial companies of public and mixed ownership (162 companies including 20 majority interests at year-end 1980). NAFINSA also acts as the government's official agent in a variety of financial transactions, the most important of which involve raising external resources in capital markets and through bilateral and multilateral agencies. As of December 31, 1980, NAFINSA's total assets stood at about Mex$239 billion (close to US$10 billion equivalent), making it one of the world's largest development banks. NAFINSA has been the Borrower for the majority of Bank loans to Mexico, including all previous Bank loans for the Mexican industrial sector NAFINSA's board of directors (Administrative Council) is composed of top level government officials. Its chairman is the Minister of Finance and other members include the Ministers of Programming and Budgeting, of Industrial Development, and of Commerce, the Director General of Banco de Mexico, the Chairman of the Confederation of Industrial Chambers (CONCAMIN), and two other representatives of the private sector. NAFINSA's administrative head is its Director General, under whom there are three general sub-directorates, one for industrial promotion, one for finance and one for trust funds and affiliate industrial companies. The main departments of NAFINSA which would be directly

32 involved in the implementation of the proposed Program are the Project Promotion Department of the Industrial Promotion wing and the Credit Department of the Finance wing (see indicative organization chart of NAFINSA in Annex 8, C-1) In addition to acting as the Borrower of the proposed Bank loan on behalf of the government (para. 4.20), NAFINSA would have an important role in three project-specific aspects. First, using the results of the sector analysis which it has been carrying out with UNIDO cooperation (para. 1.27), NAFINSA has been active over the last several years in generating new project ideas, preparing project profiles and carrying out feasibility studies for potential product lines within the capital goods subsector which can be produced in Mexico on an economically viable basis. In line with its objective of identifying and helping to fill major gaps in the subsector, NAFINSA's project generation and promotion work tends to focus on relatively new or undeveloped product lines in Mexico which nevertheless have significant potential, or product lines which require investments too large to be undertaken solely with private sector initiative.nafinsa would typically be prepared to finance part of the projects promoted through suitable equity investments. The project ideas generated and other background work by NAFINSA could also provide useful inputs to other potential investors in the subsector. Second, NAFINSA's banking wing would also participate under the Program as a credit institution to channel term financing to existing or new capital goods producing enterprises for increases in productive capacity. 1/ Third, NAFINSA would provide the Technical Secretariat of the Coordinating Committee of the proposed Program, to assist in the operational and administrative aspects of channeling Bank resources, maintaining the 'Program Account' and other aspects of Program monitoring (para. 4.15); based on the considerable information and expertise which it has developed, NAFINSA is also expected to provide important inputs into the proposed information dissemination system for capital goods industries (para. 4.08). This last aspect of NAFINSA's role under the proposed Program is discussed in the next chapter, while the first two aspects are covered below. Project Promotion Department 3.05 The Project Promotion Department undertakes subsectoral studies, identifies project ideas, prepares feasibility studies, and, in the case of promising industrial projects, carries out the necessary promotion work to obtain the collaboration of domestic private sector partners and/or foreign investors. The department is functionally divided into four divisions, one of which specializes in capital goods industries. The Capital Goods Projects Division has a total professional staff of 25 of which 15 are directly involved in project identification, preparation and promotion, while the others provide technical support and administer a newly formed information center. Identification, preparation and promotion of individual capital goods projects is typically handled by a project team of 2 or 3 professionals with technical, marketing and financial skills. Additional technical expertise can be made available by one of the UNIDO experts collaborating with NAFINSA in studying the subsector (para. 1.27). 1/ In the case of projects promoted by its industrial promotion wing, NAFINSA's policy has been to preferably obtain credit from other banking institutions, rather than from its own banking wing.

33 NAFINSA's prefeasibility studies of proposed capital goods manufacturing investments cover the technical, market, financing and other relevant aspects. Upon completion of the study for a particular project, NAFINSA invites offers from potential technology partners. The offers received are compared with respect to competitiveness of prices, exports and net foreign exchange impact, financial return, technology absorption, etc., and the best offer is chosen. There have been very few cases to date in which a local private sector enterprise has been chosen at an early stage as a project partner and invited to participate jointly with NAFINSA in the prefeasibility study and technology selection process. This appears to have been the result of a perception within the private sector that NAFINSA is primarily a public sector oriented entity. The lack of a close participation of a local private sector partner with prior experience in capital goods manufacture has tended to prolong the gestation period of new projects and weakened NAFINSA's position in negotiations with foreign partners Negotiations are then initiated with the chosen partner(s) on the financing plan of the project, the relative share contributions of the partners, technology transfer agreements, marketing, procurement procedures, plant location, legal status of the enterprise to be formed, etc. If these are successfully completed, the project proposal together with the amount, terms and conditions of NAFINSA's proposed equity participation is submitted for the authorization of NAFINSA's Director General, and later for ratification by NAFINSA's Project Appraisal Committee which is chaired by the Under-Secretary of SEPAFIN. Subsequently, steps are taken to constitute a new enterprise (if applicable) and formalize the NAFINSA's equity participation Over the last four years, NAFINSA has prepared more than 20 prefeasibility studies, covering a wide spectrum of product lines, particularly in the areas of: metal products and metal working (e.g., heavy foundry-forge and fabrication, boilershop and large diameter pipes); process equipment (process pumps, valves and speed reducers); electrical and associated machinery (turbogenerators, hydraulic turbines and minicomputers); agricultural equipment (farm tractors); and other general and special purpose machinery and equipment (mineral crushers, earthmoving equipment, radial drilling machines, large chain saws, etc.). Despite an impressive effort in generating many project ideas and elaborating sectoral and prefeasibility studies, NAFINSA has had only a limited success in bringing capital goods manufacturing projects to a 'bankable' stage where outside entrepreneurs and financing agents show active interest in participation. 1/ A greater entrepreneurial orientation for the project promotion staff (for example, through orientation/training courses to help in dealing with technology transfer issues and in designing complex 1/ The most important projects developed to date have been those for heavy forge and foundry facilities (NKS), large pumps (KSB), large diameter pipes (PROMETUSA), and turbogenerators of 1 to 60 MW capacity (TURALMEX). All except one of these are still in the initial stages of implementation. NAFINSA expects to be able to finalize several more capital goods projects in the near future, including those for earthmoving eqipment, hydraulic turbines, textile machinery and valves for process industries.

34 financing packages), and a closer involvement of Mexican private sector partners from an early stage in project processing should help to address this shortcoming. This point has been conveyed to NAFINSA and would be addressed in part through the proposed training/orientation courses under the Program (para. 4.05). Credit Department 3.09 NAFINSA's Credit Department has total professional staff of about 95, organizationally divided into the Credit Analysis division, which is responsible for evaluation of credit requests received, and the Credit Operations division, which carries out formalization, administration and supervision of approved credit operations. An indicative organization chart is included in Annex 8, C-2. NAFINSA's internal regulations allow it to make fixed assets or working capital credits, provided that its participation is no more than 50% of the total project costs. Annex 7, T-20 provides a summary of the various types of financing operations carried out by NAFINSA. The Credit Department can also process endorsements ("avales") to foreign banks or suppliers. NAFINSA's evaluation of its credit applications covers the financial, economic, technical and marketing aspects of the firms, the financial viability of the firm being the single most important consideration. In line with the government's priorities, special attention is paid in credit evaluations to socio-economic aspects such as decentralization, employment generation and environmental impact. NAFINSA's analysis of the above aspects, while generally of good quality, is typically focussed on the firm as a whole, with little analysis of the incremental impact of the investment project. Under the proposed Program, NAFINSA would be required to include in all its financing requests for credits an incremental analysis and a ERR calculation following guidelines acceptable to the Bank (standard guidelines for DFCs involving use of border prices and similar to the guidelines being used by FONEI -- para. 3.21). All subproject appraisals under the Program would also have to include an adequate consideration of subcontracting possibilities, training needs and procurement issues (paras and 4.06). Credit supervision and portfolio control procedures employed by NAFINSA include periodic analysis of financial statements, routine plant visits and special control steps in case of arrears or other financial difficulties; these procedures appear satisfactory and the arrears in loan portfolio are within acceptable limits. The final authority for deciding on credit proposals rests with NAFINSA's Credit Committee which is appointed by its board; but the Committee has delegated approval authority for the smaller operations to the Director General or his appointees. 1/ 3.10 NAFINSA's onlending rates to final beneficiaries on loans made using own resources are in 1.75 to 5.5 percentage points above the ACF index (para. 2.09), depending on the economic activity (most importantly, the priority category specified by the government); geographic zone (in accordance with the National Industrial Development Plan), and type of borrower (private, public or mixed enterprise). Annex 7, T-21 shows the interest rates to industry as of mid / NAFINSA has 19 branch offices throughout the country, which undertake part of the credit appraisal and supervision responsibilities, particularly in the case of smaller operations; about 20 additional branches are planned to be opened over the next 2 years.

35 While the overall amount of credit granted by NAFINSA grew rapidly in real terms in recent years (Annex 7, T-22), the level of NAFINSA's financing of the capital goods industries has been varying; after a sharp drop in 1978, the credit to the capital goods sector more than doubled in nominal terms in 1979 and then fell again in 1980 (to about US$235 million equivalent). In the period, more than two-thirds of capital goods financing were shortterm operations (Annex 7, T-23). Non-electrical machinery and transport equipment accounted for 35% and 39% respectively of the total numbers of credit operations for capital goods industries. The amount of financing, however, shows a marked skewness in distribution: nearly 90% of the credit to capital goods industries was for manufacturers of heavy transport equipment (i.e., trucks, buses and tractors) (Annex 7, T-24). The skewness is explained in large part by a heavy lending program during to Diesel Nacional, S.A., which accounted for 56% of total lending to capital goods industries. The proposed Program is expected to help NAFINSA reverse this trend and develop a more diverse set of capital goods industries. B. Organizacion SOMEX 3.12 Organizacion SOMEX is a vigorous banking conglomerate with 'mixed' ownership 1/ which operates essentially as a private sector bank while striving to achieve the developmental objectives laid down by the Government. The banking wing of the group, Banco Mexicano SOMEX, provides short, mediumand long-term credit to industry. Through its holding company subsidiary called Fomento Industrial Somex S.A. (FISOMEX) the group also holds equity participations (usually controlling shares) in a diverse set of industries. Over the past 2-3 years FISOMEX has been moving increasingly into investments in capital goods manufacturing projects, with emphasis on rationalization of existing industries and with the stated aim of aggressively competing in the market to promote efficiency in the subsector Organizacion SOMEX emerged during the late 1970s through a sequential merger of the Sociedad Mexicana de Credito Industrial (SOMEX, an investment bank) with the Financiera Hipotecaria and Banco Mexicano. Its banking wing (Banco Mexicano SOMEX), a multipurpose bank, is now the fifth biggest among private and mixed banking institutions in Mexico. The holding company wing (FISOMEX) was created in 1979 to promote new industrial projects in the private sector and to control the industrial, real estate and tourism enterprises in which the group is a shareholder. In addition to the banking and industrial wings, Organizacion SOMEX also has a corporate services wing in charge of legal, fiduciary, administrative and overseas operations (see organization chart in Annex 8, C-3). Organization SOMEX's board (Administrative Council) is composed of high level representatives from SHCP, SPP, Banco de Mexico, NAFINSA, 1/ A 'mixed' institution is one with joint state and private sector ownership (generally with the state having a controlling share), but classified as a private sector bank for legal purposes. Organizacion SOMEX is the most prominent 'mixed' banking institution supporting Mexico's industrial sector. It has about 70% state ownership.

36 BANOBRAS (Banco Nacional de Obras Publicas), PEMEX and the private sector. The Council meets once a month to take decisions on financing requests, investment proposals and other policy matters. The Executive President of Organizacion SOMEX also chairs the Administrative Council. Each of the three main wings (banking, industry and services) is headed by an Executive Vice- President. Industry Wing (FISOMEX) 3.14 FISOMEX is organized into several 'Corporate Directorates' according to the type of industrial activity of its holdings. FISOMEX has recently created a capital goods industries department within its 'Corporate Directorate for Development' to supervise its expending acquisitions and holdings of capital goods manufacturing enterprises and to prepare and promote new or expansion projects in this field suitable for further equity participations by FISOMEX. The department is still at an early stage of organization, with less than 10 professional staff by mid-1981; a number of additional budgeted slots are expected to be filled in the near future. The department's indicative organization chart is presented in Annex 8, C-4. Investment operations and projects in the heavy transport equipment area (buses, truck parts, etc.), which would also qualify as capital goods under the proposed definition (Annex 2), are handled by FISOMEX's Corporate Directorate for Automobiles and Auto-parts FISOMEX started its acquisition program in the capital goods industries field a few years back. The focus of the acquisition program so far has been to consolidate and rationalize existing capital goods manufacturing operations, with a view to later expanding the productive capacity of such operations. In selecting projects under its acquisition and expansion programs, FISOMEX gives particular weight to the market analysis and international and domestic competitiveness. Thus far, FISOMEX has acquired four firms involved in manufacture of engineering equipment: Mecanica Falk, which manufactures speed reducers and transmission mechanisms; MECAMEX, which produces a diversified line of small machine tools; and the Fairbanks-Morse Manufacturing Company and its Central-American affiliate, which manufacture a variety of mechanical and electrical equipment including small machine tools (especially lathes and drilling machines), agricultural and municipal pumps, compressors, electrical transformers (monophasic and distribution transformers of capacities in the KVA) and A.C. motors. These product lines are expected to be further diversified and expanded over the the coming 2-3 years. In addition, FISOMEX expects to continue and expand its strong involvement in the manufacture of transportation equipment and parts, including the production of trolley buses (through holding in Mexicana de Autobuses, S.A.), trucks and trailers (through holdings in Traksomex, S.A. which has the collaboration of Mack Trucks, Inc. of the United States). FISOMEX also expects to expand its involvement in manufacturing crankshafts for VAM and Chrysler engines as well as a new line of crankshafts for Perkins diesel engines (through MACIMEX); diesel engines with collaboration from General Motors (Somex Diesel Allison); and tractors and other farm equipment (through a new operation to be established in 1981/82). FISOMEX has recently also started a new engineering company (Proyecta) with collaboration from Davy-McKee Corporation to facilitate the group's entry into the engineering software and 'product engineering' fields.

37 Final authority to approve equity investments of FISOMEX rests with the Administrative Council of Organizacion SOMEX. The Council has, however, delegated to the Executive President and his appointee(s) the authority to approve operations involving amounts below 5% of FISOMEX's capital subject to certain cumulative limits. As of December 31, 1980, FISOMEX had total equity holdings in subsidiaries and affiliates (including minority equity positions) totalling about US$37.5 million equivalent distributed among nearly 60 companies. The policy of the group is to hold a controlling equity participation in the associated companies, whenever feasible, in order to be able to actively affect the market and production strategy of the companies. Its stated strategy for future investments in the capital goods area is to focus on: (i) product lines which are currently fragmented so that a consolidation and specialization could yield potential profits and drive down product prices; (ii) products in whose production technology absorption is a major factor, which is considered by FISOMEX to be an area of its comparative advantage; and (iii) projects which involve development of capital goods industry 'infrastructure' (e.g., heavy fabrication), and product and process engineering ('engineering software'). FISOMEX's acquisitions and investments to date appear consistent with this strategy, and show good promise for success. Banking Wing (Banco Mexicano SOMEX) 3.17 The Credit Department of the banking wing is responsible for managing all credit operations. It is headed by a Corporate Director and organized into several sub-directorates. The Sub-directorate for Development Credit, which would handle the group's credit operations under the proposed Program, is comprised of five divisions, of which three carry out credit appraisal work (one each for the public sector, private sector and tourism), one handles the legal and administrative aspects of approved credits, and one deals with credit supervision. Currently the Sub-directorate has some 60 professionals, including 18 credit analysts (referred to as 'account managers') (Annex 8, C-5). To the extent feasible, the credit analysts specialize by line of productive activity. Organizacion SOMEX's board has delegated the authority to approve credits smaller than Mex$100 million to a Credit Committee appointed by the board, and in case of smaller amounts, to the President and his executive staff. The criteria, procedures and quality of credit evaluation and supervision are essentially similar to those of NAFINSA's Credit Department described earlier (para. 3.09). As in the case of NAFINSA, while most credit appraisal staff have the competence to carry out a full project analysis including ERR and FRR calculations, this is not always included in the credit appraisal process. Under the proposed Program, Banco Mexicano SOMEX would be required to include a full analysis of the incremental economic impact of projects submitted for Program financing, following guidelines similar to those applicable for NAFINSA and FONEI (paras and 3.21).

38 Although SOMEX is predominantly an industrial credit institution, the group's involvement in financing capital goods industry investments at a significant scale is of a more recent origin. Only two such projects totalling Mex$248 million were approved in 1978; the number grew to 10 credit operations in 1980 for a total amount exceeding Mex$1.5 billion. Over the period, more than two-fifths of the credit operations, amounting to over 50% of the total credit went for metallic products, followed by non-electrical machinery which accounted for one-third of the total number of capital goods industry operations and one-fourth of the total amount (Annex 7, T-25). Of the 18 credits approved in this period, 5 were for new plants, and the remaining for expansion or diversification of existing capacities, with Banco Mexicano SOMEX's financing representing some 35% of total project cost. About 70% of the financing was medium-to-long term credit for fixed assets and permanent working capital. The group's financing of capital goods industries is expected to be further extended and diversified under the proposed Program. C. Fondo de Equipamiento Industrial (FONEI) 3.19 FONEI was established in 1971, following extensive discussions between the Mexican authorities and the Bank, to help improve industrial efficiency, the structure of industrial financing, and the country's balance of payments position. FONEI was set up as a trust fund of Banco de Mexico, to provide supplemental term financing through the entire network of Mexican commercial and multipurpose banks for industrial projects which would have a positive impact on the balance of payments through higher exports or efficient import substitution. Additional operational objectives were emphasized as FONEI became a more mature institution, the most important being to strive towards an efficient allocation of resources through the financial system by inducing banks to make their lending decisions increasingly on the basis of comprehensive project appraisal, to promote industrial efficiency by encouraging enterprises to prepare detailed feasibility studies, and to encourage lending for new high priority activities such as pollution control and technology development. To help achieve these objectives, the Bank has made four loans to FONEI totalling US$360 million. 1/ A full institutional appraisal of FONEI is available in the Staff Appraisal Report prepared and circulated to the Executive Directors in connection with the latest FONEI loan (Report No. 2478b-ME of May 10, 1979). The following is a summary description of the main features and recent developments FONEI's Technical Committee (its highest decision-making body) is composed of high level government officials. Its chairman is the Director General of Public Credit of the Ministry of Finance, and other members include representatives of the Ministries of National Patrimony and Industrial Development, and of Commerce, Banco de Mexico, NAFINSA, IMIT (para. 1.29), and two representatives of the private sector nominated by the chambers of commerce and industry. The Committee meets once a month to decide on all proposals for FONEI financing above Mex$15 million. Decisions for credits below this amount are delegated to FONEI's Director. An organization chart of FONEI is included in Annex 8, C-6. 1/ Loans 824-ME of June 1972, 1205-ME of April 1976, 1560-ME of September 1978 and 1712-ME of July 1979.

39 The policies and procedures which govern FONEI's operations are set forth in its Operating Regulations (Annex 6), which may be modified by FONEI's Technical Committee in consultation with the Bank. They define the types of projects that may be financed by FONEI, terms and limits of subloans, interest rates, criteria for project selection, responsibilities of the intermediaries and final beneficiaries, and procedures for FONEI's authorization of financing. These Operating Regulations specify that in selecting projects for financing, FONEI should consider, inter alia, the following economic criteria: (i) the project's foreign exchange generation or savings; (ii) its economic rate of return; (iii) its utilization of labor and its value added; and (iv) industrial decentralization aspects. The maximum amount of financing FONEI can normally provide to a single investment project is Mex$200 million. However, to facilitate significant participation in relatively large projects considered of high priority by the government (e.g., capital goods and petrochemicals), FONEI can approve financing in excess of the above amount provided prior authorization of the Ministry of Finance is obtained. FONEI's subloans have maximum maturities of 13 years, including up to 3 years of grace. FONEI recently also initiated a risk-sharing program to provide a special stimulus to technology research, development and adaptation activities of industries, under which it may provide a partial grant and may waive the client's obligation to repay in case the research project becomes a non-success (para. 1.33) FONEI requires its resources to be complemented by funds from clients and financial intermediaries. To ensure adequate capitalization, final borrowers for investment projects are required to finance at least 25% of fixed asset costs of new investment projects and 20% of expansion projects. The intermediaries are required to finance at least 15% of FONEI's financing for new projects (which in turn is limited to 65% of project cost), and 11% in the case of expansion projects where FONEI could provide up to 72% of project cost. In addition, the intermediary is required by FONEI to ensure that projects have adequate working capital financing. In practice, FONEI finances about 40% of project costs on average for investment projects. Onlending interest rates on FONEI's loans for investment projects are set on a floating rate basis (adjustable every six months) at two percentage points above the ACF index (para. 2.09), including a spread of two percentage points for the intermediary bank, which assumes the full credit risk. Loans granted for pollution control and technology improvement are eligible for interest rates which are 2%-5% lower than its regular rates to help stimulate these activities FONEI's project appraisal and supervision capabilities have developed well over the years. It has been reasonably successful in its efforts to encourage the intermediary banks to take over the responsibility for carrying out full project appraisals before submitting the financing requests to FONEI and to undertake regular and systematic supervision of the projects. This was partly achieved by offering additional spreads of % to intermediary banks willing to assume project appraisal responsibility, and a further 0.25% if the bank also agrees to undertake full project supervision following FONEI's guidelines. FONEI is currently considering steps to further improve its project monitoring and supervision procedures.

40 FONEI's lending operations and loan portfolio have grown rapidly over the past five years (with an almost 10-fold increase in portfolio since 1976), as a result of vigorous domestic demand as well as the promotional efforts and expanding contacts of FONEI with private sector industries and banks. New loan approvals in 1981 were about US$300 million equivalent, for about 110 projects (compared to about US$200 million equivalent in 1980 distributed among 80 projects) (Annex 7, T-26). 1/ Total loan portfolio of FONEI at year-end 1981 stood at about US$415 million equivalent. The income picture and overall financial condition are satisfactory, with a substantial growth in the net income from 1979 to 1980 and good prospects for continued growth In recent years, FONEI's financing for industries manufacturing capital goods and components amounted to 35-40% of its total financing, and covers all the main capital goods categories (Annex 2). A recent ex-post study carried out by FONEI on the basis of information from supervision reports submitted by participating banks for a sample of subprojects financed by FONEI during indicated that the average fixed investment cost per incremental job created by capital goods industries projects was about US$29,000 equivalent in 1980 dollars (which is lower than that estimated at the time of appraisal of these projects), indicating that these projects are fairly labor intensive. The net foreign exchange earnings of these projects during the first five years of their operation has been substantial, amounting to 2-5 times the corresponding fixed investment costs. Annex 7, T-26 shows that the geographical distribution of projects supported by FONEI has been bettered over the last two years, with as much as 45% of the financing going to the highest priority zone (Zone I). 2/ 3.26 FONEI expects continued high demand for its financing for capital goods industries projects through the private banking system. Given the increased fiscal stimulus and the government's special promotion efforts, the proportion of capital goods manufacturing projects in its operations is likely to be at least maintained. Annex 7, T-27 includes a representative list of investment projects of capital goods industries received for consideration by FONEI A Project Performance Audit Report (PPAR) of the First and Second Industrial Equipment Fund (FONEI) Projects (SecM of June 1979) acknowledged that FONEI financed sound investments, whose foreign exchange savings performance has been substantial. However, it commented on two important aspects of FONEI's early operations: 1/ FONEI had 44 budgeted professional slots in its organization structure in mid-1980, representing a significant increase from 19 in early Some further increase in staff may be needed to undertake the contemplated increases in its operational activity, including an active promotion of capital goods industries, pollution control and technology development projects. 2/ FONEI proposes to open three regional offices at Guadalajara, Monterrey and Mexicali in the near future to further facilitate project promotion in areas outside Mexico City.

41 (a) Given FONEI's attractive onlending interest rates, the relatively small spreads allowed for FONEI's participating intermediaries, and the prevailing conditions of credit rationing, the intermediary banks (which assume the full credit risks) tended to allocate loans preferentially to their 'prime' borrowers; this led to a disproportionately high concentration of FONEI's lending in large and well-established borrowers; and (b) FONEI made little progress towards achieving its objective, set under the Second Bank loan, of encouraging the participating intermediaries to use project appraisals as a major input to their lending decisions, rather than lend primarily on the basis of loan collaterals. The difficulties noted are in large part due to the fact that FONEI, in the period covered by the PPAR, was a new institution. Each of these difficulties has been addressed in the Third and Fourth projects which have subsequently been approved by the Bank. FONEI's onlending rates have since been increased and are now on a floating basis linked to the ACF index (para. 3.22). Interest rate spreads to participating banks have been increased to reasonable levels to provide them an incentive to assume greater lending risks in the utilization of FONEI rediscounts and to participate more actively in the appraisal and supervision of investment projects. Recent evidence indicates that these measures, together with changes in the banking law, have helped to reduce banks' collateral requirements and to increase appraisal-based lending. FONEI's lending is also becoming increasingly diversified, with a lower proportion of the subloans going to the larger clients. FONEI's loan portfolio at year-end 1981 was distributed among 270 companies, of which 86 companies borrowed for the first time from FONEI in IV. THE PROJECT AND THE PROPOSED BANK LOAN A. The Project 4.01 The proposed project would form the first phase of the Capital Goods Industries Development Program initiated by the government (para. 1.14), whose objective is to achieve a balanced and efficient development of the Mexican capital goods manufacturing subsector and thus help to improve productivity, employment, balance of payments and long range technology development in Mexico. To this end, the project would help to correct existing technical, structural and other deficiencies in the subsector and would provide the needed financial and technical assistance to individual capital goods manufacturing industries, in the context of a suitable policy framework. The focus of the production and sales financing components of the proposed project, which would cover the first 2-3 year period of the longer range Program, would be the development of medium size capital goods industries, while the proposed complementary measures are oriented to help the development of the entire subsector by providing needed technical assistance, training, information, and other facilities. The specific project elements are described below.

42 Financing of Production 4.02 The financing component to support production of capital goods would comprise assistance for medium size capital goods manufacturing projects through: (a) financing of medium- to long-term production credits for fixed asset financing for eligible projects involving the creation or expansion of productive capacity by capital goods producing industries; (b) financing of equity investments by the implementing agencies in capital goods producing firms in connection with eligible investment projects involving the creation or expansion of productive capacity; and (c) financing through the FONEI system for: (i) specialized technical and technological assistance provided by local or foreign consultants or institutes to enterprises involved in the manufacture of capital goods, including to enterprises supplying components or services to Mexican capital goods manufacturers on a subcontracting basis; 1/ and (ii) a risk-sharing scheme to stimulate research, development, and adaptation activities of capital goods industries (para. 1.32). Initially, the program of production credits would be administered by NAFINSA, Banco Mexicano SOMEX and FONEI, while NAFINSA and FISOMEX would be the agencies implementing the equity investments program. Participation of these agencies would provide a balanced mixture of capital goods development projects, since each of them has a somewhat different role with respect to the promotion of new or expansion projects. NAFINSA's industrial promotion efforts are likely to have a heavy emphasis on the creation of new enterprises and the development of new products, typically with some public sector involvement, while virtually all of the capital goods projects financed through the FONEI system are likely to be private sector projects, mainly involving expansion of existing production capacity or diversification into more sophisticated products within a product category that is already being produced. Investments undertaken by FISOMEX, on the other hand, are likely to focus on new or expanded productive capacity in the context of rationalizing existing production structures and consolidating existing production units to enable product specialization and increased operating efficiency. Other financing agencies may also participate in implementing the Program, as may be recommended 1/ Such assistance would be oriented towards achieving imaprovements in areas such as quality control, product design, production processes, production planning, market research, management systems, and related on-the-job or other training.

43 by the Coordinating Committee of the Program (COCOFIN) and agreed between the Borrower and the Bank. The most likely additional candidates for participation appear to be FOMIN and FOGAIN, the NAFINSA-administered trust funds responsible, respectively, for provision of risk capital and credit financing to small and medium scale industry. 1/ Sales Financing 4.03 The support for production of capital goods would be complemented by sales financing to be provided through FOMEX in the form of term credits to buyers and to suppliers of capital goods on adequate terms and conditions, in order to facilitate domestic sales of such goods. 2/ It would be ensured that the terms and conditions of such financing are competitive with those of foreign suppliers, paying due attention to the need for offering the option of foreign currency denominated loans in domestic sales financing (para. 2.14). Complementary measures 4.04 In order to ensure the success of the Program, a number of complementary measures would need to be implemented to help overcome existing technical, structural, and other problems facing the subsector. To initiate this process, the project would include several specific elements described below, which follow from the sector analysis presented in Chapter I. Bank financing would be made available to cover part of the foreign exchange cost involved in implementing these measures (para. 4.20), and local counterpart resources directly allocated to the Program would be available to meet the remaining costs. The Program's Coordinating Committee, COCOFIN (para. 1.17), would have the overall responsibility to monitor the implementation of the various complementary measures, but would seek the close collaboration of the principal implementing agencies as well as other concerned agencies (e.g., with SEPAFIN on information dissemination system, INFOTEC's technological information service, etc.) and industry associations. The details of implementation and coordination of the complementary measures have been included in a project execution paper prepared by the authorities in connection with the proposed Program (para. 4.18). 1/ These two trust funds are implementing agencies of the First and Second Small and Medium Scale Industry Development Projects being supported by the Bank through Loans 1552-ME and 1881-ME. They could provide useful links between capital goods manufacturers and SMI enterprises, although in the past the actual amount of financing by these trust funds to capital goods industries has been limited. 2/ The amounts, terms and conditions of FOMEX's existing mechanisms for financing exports of Mexican capital goods appear adequate, and would be continued during the Program period, but no specific Program support appears to be necessary to the export financing operations. I

44 Training. During implementation of the proposed project, two types of training programs would be carried out. Firstly, a formal training program would be undertaken to bolster the capability of the technical staffs of the principal implementing agencies for preparing, promoting, and/or evaluating capital goods development projects. The training program would focus on the areas of technology assessment, technology absorption possibilities, design of technology transfer agreements, and formulation of complex financing packages involving several parties and foreign companies (paras. 1.42). Secondly, more detailed seminars or 'mini-courses' for specialized technical and financial staff of industries and the principal financing agencies would be designed on specific topics relevant to the preparation and review of capital goods manufacturing projects. Annex 9 includes an indicative list of the topics to be covered To improve availability of information on training facilities (para. 1.44), and facilitate planning and implementation of human resource development programs by industries, a comprehensive survey of all available training courses relevant to capital goods industries would be carried out. The survey would cover vocational as well as more advanced technical training and management orientation courses, from all sources in Mexico, and would include information on the course content, frequency, type of participants, etc. for each course. The inventory would be made publicly available upon completion. In addition, an analysis of the technical manpower and training needs of capital goods industries over the next 5 years, disaggregated by type of industry and type and level of technicians/skilled workers, would be undertaken. 1/ Feasibility studies and subproject evaluations submitted by project sponsors and/or the participating intermediaries in support of financing requests would be required to include an assessment of the training needs under the subproject and plans to meet them Technological information and other support services would be expanded. INFOTEC would be assisted to increase the coverage and level of its services to the capital goods subsector, e.g., technological information service, assistance in selection of equipment and suppliers, comparative analysis of alternative technologies, technological audits, product and process selection, and industrial engineering. A 'technology gap and comparative advantage' study would be undertaken to evaluate the level of technology in Mexico in the manufacture of different capital goods product lines and the feasibility of producing these products in a competitive manner in Mexico. The study would take into account factors such as the technological complexity of the product, rate of technological obsolescence, the 'technology ceiling' (highest technology level attained in the world) and feasibility of attaining that level in Mexico, the role of economies of scale, structural problems, existing production capacities and markets. This analysis would then be used to identify the capital goods product lines in which the 'technology gap' can be most efficiently filled by Mexican enterprises. 1/ This work would draw on, and coordinate closely with, the work of the Joint Committee of the Ministries of Education and Labor on Human Resources Planning, which is currently preparing an aggregate longrange forecast of the human resource needs of capital goods industries.

45 Information Dissemination System. Two elements included in the proposed project would be designed to fill the information gaps identified in Chapter I (para. 1.37). First, an inventory of the effective installed capacities (together with relevant quality specifications) of major Mexican capital goods and components manufacturers, including installed capacities for 'job shop' work and other services relevant to capital goods manufacture, would be carried out to help promote closer linkages between component and final capital goods manufacturers, and facilitate better informed procurement decisions by producer and user industries. Second, a broad information dissemination system would be established and implemented to consolidate the available subsectoral information on current and projected installed capacities, available technologies, domestic and international markets for capital goods and their components, supply-demand characteristics, etc. Annex 9 includes an indicative list of items and sources of information for the system, which would be made available in an appropriate format to all interested producer and user industries. COCOFIN would rely on SEPAFIN for advice in formulating and implementing the system. 1/ To provide wide dissemination of the information, full advantage would be taken of the available information channels of the chambers of industry, INFOTEC and the financial institutions Other. COCOFIN would create a suitable mechanism to review other technical and structural issues affecting the subsector, such as the adequacy of technical standards (para. 1.40) and strengthening of capability to provide 'engineering software' (para. 1.41). It would also provide support to FOMEX in promoting sales financing, reviewing the adequacy of domestic sales financing conditions and terms, and strengthening after-sales service related to both exports and domestic sales (paras and 4.03). B. Project Financing and Implementation Financing Limits, Onlending Terms and Conditions 4.10 The project would focus on the development of medium size capital goods industries. Only projects with total investment costs below US$50 million equivalent would be financed. Most of the projects are expected to involve total investment costs in the US$5-40 million range. To avoid undue concentration of Bank funds, a maximum limit of US$10 million would be applicable for total Bank financing for any single subproject. Moreover, Bank financing to any given subproject would not exceed 25% of the total investment costs involved, which represents a ceiling equivalent to 50% of the estimated foreign exchange cost of the typical subproject. This limit is expected to result in the Bank financing of about 30% of the total foreign exchange cost involved in the investments supported by the Program (para. 4.13). Enterprises receiving loans under the Program would be required to provide at least 20% of 1/ Representatives of SEPAFIN expressed to the appraisal mission their keen interest in collaborating with COCOFIN and the Program in this respect.

46 the total investment costs of the subproject financed. In the case of equity investments, Bank financing for a single subproject would be limited to one half of the total equity contribution by the respective implementing agency in connection with the subproject, subject to a maximum of $2 million in Bank financing per subproject. Moreover, no Bank funds would be available for financing loans by implementing agencies to enterprises in which they hold a majority ownership. All subproject financing requests submitted for Bank financing would be required to include a full financing plan for the respective investments supported Subloans to the final beneficiaries for fixed assets financing would bear floating interest rates adjustable at least once every six months to equal the latest monthly ACF Index (para. 2.09) plus 2%. The ACF tends to move in parallel with inflation, so that these onlending rates can be expected to lead to positive real interest rates over the life of the loans (para. 2.09). 1/ FONEI's subloans for financing technical assistance would bear onlending interest rates of 5 percentage points below the rates on its regular subloans; financing for technology research, development and adaptation activities on a risk-sharing basis would be on terms and conditions consistent with FONEI's operating regulations (paras and 3.21). Maximum subloan amortization periods would be 13 years including up to 3 years of grace. FOMEX is expected to continue to use floating interest rates of ACF plus 2% on its peso-denominated credits for financing domestic sales; domestic sales financing credits denominated in foreign currencies would bear an appropriate onlending rate which is competitive with the financial market conditions for loans in the particular currency. Project Cost, Financing Plan and Cofinancing 4.12 Based on the project pipelines and demand projections of the principal implementing agencies, and assuming the size and financing limits, terms and conditions outlined in para above, it is estimated that total resources of the order of US$1,150 million equivalent would be required for the target capital goods manufacturing projects over the first 2-3 year period of the Program. This estimate includes about US$885 million equivalent for investments in fixed assets and permanent working capital, US$250 million for sales financing and US$12 million for technical assistance financing. Equity 1/ Spreads to intermediary banks under FONEI's loans would be the same as currently specified in its operating regulation--viz., 2% plus an additional spread of % depending on the loan size and the acceptance by the intermediary bank of project appraisal and supervision responsibility (paras and 3.23).

47 contributions from the local private sector participants in the projects and loans from local private banks using their own resources are together expected to cover some US$370 million equivalent of the investment and technical assistance financing needs. A direct allocation to the Program from budget resources would cover the counterpart resource requirements for implementing the proposed complementary measures under the Program. About $250 million of term financing is expected to be arranged for domestic sales of capital goods, primarily through FOMEX which would contribute US$200 million through rediscounting operations, with the remaining being provided by the intermediary banks concerned. The remaining resource gap of about US$520 million equivalent, roughly corresponds to the total estimated foreign exchange cost associated with the investments supported under the Program; this would be filled by the proposed US$150 million Bank loan and complementary external resources raised in connection with the proposed project, as described below. Tables 4.1 to 4.3 provide a full breakdown of the total costs among the different project components and financing sources The Bank loan would cover about 30% of the foreign exchange content of Program costs (para. 4.10) leaving substantial amounts of additional external resources, estimated at about US$370 million equivalent, to be raised from complementary sources. Of this, about US$150 million equivalent would be raised by the three principal implementing agencies (NAFINSA, Organizacion SOMEX and FONEI) in the external markets to provide amounts approximately matching those of Bank disbursements; 1/ these resources would be raised through direct financing from foreign private banks, bilateral export credit or other supplier credit mechanisms arranged by the principal implementing agencies. Each institution has had prior experience in borrowing from foreign private banks, and some of the necessary funds have been contracted. 2/ The balance of foreign exchange needs, estimated to total about US$220 million equivalent, would be raised in the form of equity contributions by foreign partners, loans from foreign private banks, and suppliers credits other than those arranged through one of the principal participating agencies (e.g., in connection with financing of required imported working capital). This implies a 1/ In the case of FONEI, external resources raised by FONEI together with those raised by the principal intermediary bank(s) financing the investment would have to match the resources being provided from the Bank loan. 2/ For example, NAFINSA currently has open 'global' lines of credit from official export credit agencies of 13 European, Asian, and American countries, which offer loans denominated in U.S. dollars and other foreign currencies at attractive interest rates, with maximum amortization periods ranging between 5 and 12 years. Banco Mexicano SOMEX and some of the private banks participating through FONEI also have access to open lines of credit offered by the official export credit agencies; efforts would be made during project implementation to increase such facilities to help provide the private sector an easier access and a greater choice among foreign supplier credits.

48 MEXICO - CAPITAL GOODS INDUSTRIES DEVELOPMENT PROJECT Table 4.1: Estimated Project Costs and Financing Plan (Million- US$ equivalent) Complementary External Resourcew Including Bilateral ExportrCredits Local Resources a/ Other External Resources */ TOTAL Sack & Suppliers Credits Raised Through Local Private Local Fin-ncial Foreign Foeign private Banks Subprogram Financing Principal Implementing Agencies Sector Sponsors Institutions b/ Collaborators & Other Sourcev Fixed Investment Credits Credits for Permanent Working Capital Equity Investments c/ Sales Financing d/ Technical Assistance & Complementary Measures e/ 12.0 Frontend loon fee TOTAL af Indicative estimates based on prior experience taking account of likely changes bf Figures include any local currency contributions by the principal implementing agencies as -ell as other intermediary banks. cf Local currency contributions by NAFINSA and FISOMEX. d/ Includes US$200.0 million equivalent financed through the FOMZX system and US$50.0 million provided by project sponsor. e/ T>ue 'n~tr 5 snfllios Af bsem dr,naaeaa allocated directly te the Progua far isplasstiag prepesed eelplsetry,senree Ad 115$2.5 million of local resources to be provided through FONEI for financing technical assistance eubloans and risk sharing program for technology devaelepent--ea Table 4.2 bela.. Table 4.2: Breadown of the Costa & Financing of Technical Assistance & Other Cnpliantary Measures (Millions us$ equivalent) Throngs COCOFIN and Project XFThoN Technical Assistance Agencies Sponsors Total (a) Strengthening of training facilities (b) Expanded technological information & other support services (including techonlogy gap study) (c) Strengthening of informatior dissemination system (d) Special surveys (Inventory of taining courses, disaggregated analys1s of manpower needs of industry & special inventory of installed capacities) (e) Financing technical assistance to industries (including subcontractors) (f) Risk-sharing program for technology development Subtotal Technical Assistance (Of which Bank financing) Table 4.3: Estimated Distrution of Bank Funds Organizacion SOYEX COCOFIN and Subprogram NAFINSA FONEI & Other Program Participants Technical Assistance Agencies Total Fined Investment Credits 42.5a/ Equity Investments 1 0 0a/ Technical Assistance and Complementary Measures TOTam a/ Includes possible financing of small and medium sized projects by FOMIN and FOGAIN.

49 considerable effort by the beneficiary enterprises to raise complementary external resources at the level of individual projects, which appears feasible. As one measure to help this, NAFINSA would encourage an increasingly active participation of the 'coinvestment funds' in providing equity funds to Mexican projects involving foreign collaborators. 1/ Specific co-financing packages incorporating the above elements would have to be arranged on a case-by-case basis for the individual subprojects, to suit the particular project needs and timing. Project Implementation and Program Coordination 4.14 COCOFIN (para. 1.17) would oversee the implementation of the Program. It would establish operating policies and guidelines, review the progress achieved by each of the implementing agencies in achieving Program objectives, ensure that subprojects submitted for financing are consistent with the national priorities for the subsector's development, and supervise the channeling of Program resources. In view of the institutional maturity of the implementing agencies, the Committee would not involve itself in detailed evaluation and supervision of subprojects, but would delegate those functions, to the respective implementing agency. In addition, COCOFIN would make or recommend allocations or reallocations of Bank and other Program resources among the implementing agencies, through approval of suitable annual budgets. Within the approved allocations, individual implementing agencies would be able to use Bank funds for financing eligible subproject expenditures (paras and 4.23); COCOFIN would review periodically the eligibility of the expenditures financed with the help of its Technical Secretariat on an ex-post basis. The arrangements would substantially preserve the autonomy of the individual implementing agencies in subproject evaluation and supervision and would not imply unduly cumbersome procedures. Finally, COCOFIN would pay particular attention to ensuring the implementation of the training, information dissemination, technical assistance and other complementary measures included as part of the Program (para. 4.04) and would provide a forum for reviewing the need for other related measures (para. 4.09). 1/ Under the program of 'coinvestment funds' initiated by NAFINSA several years back, collaborative agreements are drawn up between NAFINSA and a participating foreign bank, which together contribute resources to form a fund, usually 60% by NAFINSA and other Mexican agencies and 40% by the foreign banks; the proceeds are then used to make minority equity investments in suitable projects involving joint ventures between Mexican industries and collaborators in the respective foreign country. While the amounts of investments made by the coinvestment funds to-date have been small (totalling about US$18 million equivalent over the past five years), NAFINSA believes that it can make increasing use of this instrument in the future to play a catalytic role in attracting foreign direct investments together with required technological collaboration in capital goods manufacturing industries.

50 A Technical Secretariat within NAFINSA would assist COCOFIN in its day-to-day activities. The Technical Secretariat, which would be headed by a Subdirector General of NAFINSA, would be responsible for the operational and administrative aspects of channeling the Bank resources to the principal implementing agencies for approved subprojects, collection of respective repayments from the agencies, and maintenance of a separate "Program Account" to record major inflows and outflows and an information system to facilitate monitoring. It would prepare for COCOFIN's review proposals for allocation (or reallocation) of Bank and other Program resources, and would assist in monitoring the use of assigned budgets. Channeling Arrangements and Spreads to Implementing Agencies 4.16 Bank funds would be made available through the Program Account to the principal implementing agencies to finance part of the foreign exchange content of the fixed assets loans, equity investments and operations for financing technical assistance or risk-sharing programs to help technology development. Complementary external resources matching the Bank resources in amount would be raised by implementing agencies from commercial sources to cover the remaining part of these financing operations (para. 4.13). Sales financing would be channeled directly by FOMEX and its intermediary banks. Bank resources provided under the Program would be repaid by the implementing agencies into the Program Account, together with an interest equal to 4.0 percentage points below the onlending interest rate applicable on the respective subloans. 1/ The amortization schedule for the repayments by the implementing agencies would be identical to the amortization schedule agreed with the final borrower in the case of subloans; Bank resources provided to the implementing agencies for making equity investments would be repaid into the Program Account according to a fixed equal principal payment amortization schedule over 13 years including up to three years of grace. Operating Regulations and Project Execution Paper 4.17 The arrangements discussed above relating to the Program coordination, channeling and repayment of funds, maximum amounts, terms and conditions of financing, onlending interest rates, and criteria and responsibilities for subproject evaluation and supervision (paras. 3.09, 3.17 and 3.21) have been incorporated in the 'operating regulations' of the Program, which were discussed and agreed upon during loan negotiations. 2/ These operating regulations have since been formally approved and transmitted to the Bank by the Mexican Authorities. Any substantial change in the operating regulations during the project implementation period would have to be acceptable to the Bank. 1/ The interest rate payable by the implementing agencies on resources borrowed for the purpose of making equity investments would be equal to that payable in the case of resources for investment subloans. 2/ The operating regulations specifically require all subproject appraisals to include an economic rate of return (ERR) calculation.

51 To facilitate coordination and a close monitoring of the progress achieved, a 'project execution paper' has been prepared and submitted to the Bank by the Mexican authorities. The paper, whose text was agreed upon during loan negotiations, includes a description of the Program, division of responsibilities among the implementing agencies, and a full description and steps for implementation of the training, technical assistance and other required complementary measures. The expected time schedules for implementing the various complementary measures have been transmitted to the Bank through a separate letter of the Borrower acting as the Technical Secretariat of COCOFIN. Any material changes in the project execution paper would have to be acceptable to the Bank. Annual Reviews 4.19 In view of the complexity of the Program, COCOFIN and the implementing agencies would, with Bank participation, carry out at least once every year (before December 31 of each year starting in 1983) a full review of the progress achieved in implementing each of the project elements. The review would cover the adequacy of the policy framework relevant to capital goods industries, including any need to revise tariff levels and other elements of the protection policy, and progress on the utilization of the financing components and implementation of the complementary measures, with a view to identify any needed adjustments in the Program's design, financing conditions, project selection criteria, free-limits and implementation procedures. Adjustments mutually agreed among the Bank, the Borrower and COCOFIN as a result of the review would be incorporated in the project. Loan Features C. The Proposed Bank Loan 4.20 The proposed US$152.3 million Bank loan would finance about 13% of the total costs involved in implementing the first phase of the Program as outlined above (about 30% of the foreign exchange costs -- see paragraph 4.13), in addition to the capitalized US$2.3 million front-end fee on the loan. The Borrower of the loan would be NAFINSA, acting as the agent of the government. It is expected that the loan would finance investment subloans, equity investments, technical assistance financing operations, and several (say 5-10) individual operations to finance technology research, development and adaptation activites on a risk-sharing basis. In addition, funds from the proposed Bank loan would be available to finance the foreign exchange expenditures related to the implementation of the various complementary measures envisaged under the Program (para. 4.04). Sales financing would not be provided using resources of the Bank loan, but would be supported through local resources (para. 4.16). The eligibility conditions and financing limits explained in para would be applicable for Bank financing. About 60% of the Bank loan would initially be allocated among the agencies, with US$35 million each for NAFINSA and FONEI, US$10 million for Banco Mexicano SOMEX, US$5 million for FISOMEX and US$2 million for implementation of complementary measures. The Bank would allocate the remaining part of the loan resources, and make appropriate reallocations from time to time,

52 depending on the progress of the different project components, and taking into account the recommendations of COCOFIN (para. 4.14). The Government (with NAFINSA acting as its agent), rather than the individual implementing agencies, would assume the responsibility for servicing the Bank loan, including the associated foreign exchange risk. Repayments received from the implementing agencies into the Program Account (para. 4.16) would be used as seed capital for the Program and would have to be relent for purposes similar to those of the proposed project. In view of these arrangements, and the relatively long amortization periods expected for subloans, 1/ the proposed Bank loan would be repaid according to an equal principal payment amortization schedule with 15 years term including 3 years of grace. Disbursement of Bank Funds 4.21 Subject to the limits specified in para. 4.10, disbursements under the proposed Bank loan would be made for up to the following percentages of costs of individual items financed by COCOFIN or the principal implementing agencies through fixed investment subloans, technical assistance subloans, equity investments, risk-sharing program for technology development, and proposed complementary measures under the Program: (a) 100% of foreign expenditures for directly imported equipment, services contracted for implementing the technical assistance activities and other complementary measures under the Program; (b) 70% of total expenditures for imported equipment purchased off-the-shelf in Mexico; and (c) 45% of the ex-factory cost of domestically manufactured equipment. Full documentation to evidence the above expenditures would be required for authorization of Bank disbursements. Only expenditures made no more than 180 days prior to the date of receipt by the Bank of the corresponding financing requests would be eligible for reimbursement under the proposed loan. The proposed extension of the Bank's normal 90-day limit under DFC projects represents a continuation of the practice under the ongoing loans to FONEI, and would be justified in view of the complex institutional arrangements involving several institutions and a multi-stage review process. Annex 1 includes the estimated disbursement schedule for the proposed loan. The estimated disbursement schedule is based on the average disbursement profile for IDF projects in LCP during , modified in the later years to reflect the experience on recent FONEI operations, which provides the most directly comparable subloan disbursement experience. 1/ Typically 7-12 years, reflecting the nature of capital goods manufacturing projects as well as the need to complement substantial amounts of shorter term co-financing resources.

53 Procurement and Auditing 4.22 Procurement procedures for goods and services financed under the proposed loan would follow the procedures customary to Bank DFC-type projects, with the principal implementing agencies having the responsibility for ensuring the competitiveness, in price and quality, of items procured and their suitability for the purpose intended. In the case of all individual procurement packages exceeding US$1.0 million in value, the agencies would require the beneficiary enterprises to provide specific evidence of adequate international tendering, with the participation of at least three international suppliers. 1/ Subloan contracts signed by them with the client enterprises or participating banks (in case of FONEI) would contain provisions to ensure satisfactory procurement procedures along these lines. These provisions would be reflected in the Program's operating regulations (para. 4.17). The accounts of NAFINSA, FONEI, Banco Mexicano SOMEX and FISOMEX, including those kept for the purpose of the project, and the 'Program Account' (para. 4.15), would be audited annually by reputable auditors following accounting principles satisfactory to the Bank. Approval Limits 4.23 Prior Bank approval would be required for: (i) the first three fixed asset subloans submitted by each implementing agency; (ii) all fixed assets subloans involving more than US$2.0 million in Bank financing; 2/ (iii) all equity investments requiring Bank financing of more than US$1.0 million; (iv) all equity investments by participating agencies in enterprises in which they already hold or are expected to hold a majority ownership; and (v) all subloans for technical assistance financing or financing of risk-sharing contracts which involve Bank financing of US$200,000 equivalent or more. These limits are expected to provide for prior Bank review of about one-third of the subloans and investments financed, accounting for about 60% of the loan amount. D. Project Benefits and Risks 4.24 The proposed project is expected to help the efficient development of the capital goods manufacturing subsector in Mexico through the financial assistance, policy actions and other complementary measures. Some investment projects involving investment costs of about US$885 million equivalent are 1/ For projects involving new technologies or technology transfer agreements, the competitiveness of available alternatives would be assessed taking into account the price, terms, and conditions of the technology transfer package, any associated equity participation by the potential technology partner, the price and quality of the equipment to be procured, and the related financing arrangements. 2/ This limit is equal to FONEI's free-limit established in 1979 for the ongoing Bank project for general industrial financing (Loan 1712-ME).

54 expected to be supported; in addition operations to finance technical assistance and technology research, development and adaptation would be assisted. Most subprojects are expected to have real economic rates of return (ERR) in the 15-35% range. ERRs would be calculated for all investment subprojects to ensure the utilization of loan resources only for efficient projects. Between 20,000 and 24,000 incremental jobs are expected to be generated by the investments supported at an average investment cost of US$38,000 to 42,000 equivalent per job. In addition, in view of the strong forward and backward linkages of capital goods industries with other parts of the economy, substantial indirect employment impact can be expected. A significant regional development impact is also expected as a result of the existing fiscal incentives and other measures to encourage industrial decentralization away from the big cities: about 60% of the investment projects supported can be expected to be located in the highest priority zone identified by the National Industrial Development Plan (Zone I), and less than one-tenth of the investments are likely to be in areas in the immediate vicinity of Mexico City. Total foreign exchange earnings or savings of US$ billion are expected during the first five years of operation of the subprojects supported; exports generated by the projects are likely to account for at least US$ million equivalent of this amount. The streamlining and coordination of the financing structure, policies and complementary technical support, which the proposed Program would help to achieve, would provide long-range benefits by facilitating a rational subsector development. Perhaps the most important long term gain would be the technology absorption, development and mastery which is likely to be gained in the process of preparing and implementing capital goods manufacturing projects and the complementary measures under the Program, which could have very substantial effects on future Mexican productivity, employment and balance of payments The project involves two kinds of risks. First, at the policy level, the government could hesitate to make the appropriate adjustments in exchange rate and protection policies in the light of future macro-economic changes, which would create the risk of encouraging inefficiency in the capital goods manufacturing subsector. The understandings reached on this issue and the proposed annual reviews as well as the government's own interest in ensuring efficiency and developing exports, suggest that this risk is not large. Moreover, PEMEX and CFE, which account for substantial capital goods purchases in the country, have expressed their keen interest in maintaining competitiveness in their domestic purchases, with prices within the stated margin of 15% vis-a-vis comparable international purchases. Second, the Program involves complex institutional and coordination arrangements. In particular, the coordination of financing and a satisfactory execution and monitoring of the complementary measures require effective management and coordination on the part of COCOFIN, including delegation of the operational tasks to specialized agencies. The Bank would closely follow developments in this regard, paying particular attention to them during the project's annual reviews. This and the provisions of the project execution paper should help limit the institutional risk involved. On the whole, the project presents a moderate degree of risk.

55 V. RECOMMENDATIONS 5.01 During loan negotiations, agreements and/or understandings were reached: (i) with the Mexican Government, NAFINSA (in its capacity as the Borrower) and COCOFIN on: (a) the loan amount and the project financing plan (para. 4.12); (b) availability of required counterpart resources to provide sales financing in adequate amounts, terms and conditions (paras and 2.14), and to implement the various complementary measures (para. 4.12); (c) arrangements for channeling the proceeds of the Bank loan and for repayment of the Bank loan (paras and 4.20); (d) institutional and coordination arrangements (paras and 4.15); (e) operating regulations of the Program (para. 4.17); and (f) policy statement on incentives and protection applicable to the capital goods subsector (para 1.23). (ii) with NAFINSA (in its capacity as the Borrower), COCOFIN and the principal implementing agencies (NAFINSA, FONEI and Organizacion SOMEX) on: (a) projects eligible for support, financing limits, terms and conditions (para. 4.10); (b) plans for implementing the technical assistance components and other complementary measures (paras. 4.04, 4.08 and 4.09), and the text of the project execution paper (para. 4.18); (c) allocation of the Bank loan resources among the different implementing agencies and project components and procedures for their review and reallocation (paras and 4.20); (d) complementary external resources to be raised by the principal implementing agencies (para. 4.13); (e) onlending interest rates (para. 4.11); (f) annual reviews of the progress in the project's implementation (para. 4.19);

56 -50- (g) criteria and procedures for evaluation of subprojects (including ERR calculations) by the implementing agencies (paras. 3.09, 3.17 and 3.21); (h) procedures for disbursements of the Bank loan (para. 4.21); (i) free-limits (para. 4.23); and (j) procurement and auditing arrangements (para. 4.22) Receipt by the Bank of a satisfactory revised statement of policy on protection applicable to capital goods industries (para. 1.23) would be a special condition of loan effectiveness.

57 ANNEX I MEXICO - CAPITAL GOODS INDUSTRIES DEVELOPMENT PROJECT Estimated Quarterly Schedule of Bank Loan Disbursements a/ (US$ million) IBRD Fiscal Year Disbursements in Cumulative and Quarter Quarter Disbursements December 31, March 31, June 30, September 30, December 31, March 31, June 30, '85 September 30, December 31, March 31, June 30, September 30, December 31, 1985 b/ March 31, O June 30, September 30, December 31, 1986 c/ 1.0, a/ The estimated disbursement schedule is based on the average disbursement profile for DFC projects in LCP during , modified in the later years on the-basis of the experience on the most recent FONEI loans to Mexico, which represent the subloan disbursement experience most directly comparable to that under the proposed project. b/ Last date for submission of subprojects for Bank financing. c/ Closing date.

58 MEXICO - CAPITAL GOODS INDUSTRIAL DEVELOPMENT CREDIT PROJECT Capital Goods Product Categories as Defined Under the National Industrial Development Plan 1/ Industries involved in the manufacture of the following goods are considered as capital goods industries (included in the industries categorized as Priority I) under the National Industrial Development Plan. Canital Goods fall under Section 1.2 of the Plan's classification Machinery and Equipment for Production of Food and Food Products Machinery and equipment for industrialization of food products Tractors, harvesters and farm machinery Airplanes for crop dusting Machinery and Equipment for the Petroleum and Petrochemicals Industries Machinery and equipment for on-shore and off-shore exploration and drilling Valves, axles, shafts, couplings and pumps Motors, pumps, compressors, turbo-compressors and blowers Tubing for drilling, process and support Tubular heaters and heat exchangers Machinery and Equipment for Electrical Industry Machinery and equipment for generation, transmission and distribution of high voltage electricity Hydraulic turbines, gas turbines and related generators of electricity Injection pumps, boilers and large piping Equipment for measurement and control. 1/ As amended by the decree published on October 7, 1981.

59 53 ANNEX 2 Pag Machinery and Equipment for Mining and Metallurgical Industry Machinery and equipment for extraction, concentration and benefaction of minerals Machinery and equipment for coking, peletization and smelting of ferrous minerals Machinery and equipment for smelting, refining, molding and lamination of metals Machinery and equipment for manufacture of metallic products involving sheets, wires and rods Machinery and Equipment for Construction Machinery and equipment for construction industry Earthmoving and soil conditioning machinery and equipment Transport Equipment Tractor-trucks, heavy and semi-heavy trucks and trolley buses and integrated buses Boats for non-sport activities and their parts and components Railway locomotives, railing cars, heavy railway equipment and installation and their parts and components Machinery and Equipment for Diverse Industries Machine tools Carbon and alloy steel tubing Pumps, compressors, valves, couplings and conveyor belts for process industries Measurement, control and laboratory equipment for industrial use Direct or alternating current motors greater than 1 HP and their controls Machinery and equipment for cement industry Machinery and equipment for paper and cellulose industry.

60 ANNEX 2 Page Foundry, forging and molding of parts for machinery and equipment made of iron, steel and their alloys Heavy fabrication, machining and welding Industrial boilers and heat exchangers Machinery and equipment for-textile, garment and leather industries Machinery and equipment for plastics and glass industries Industrial refrigeration machinery and equipment Machinery and equipment for materials handling Machinery and equipment for packaging and bottling Diesel motors for general use and their components Machinery for preventing environmental pollution Machinery and equipment for water wells Velocity reducers for industrial use Metal molds, dies and matrices Industrial Electronics Equipment and Components Electronic telephone equipment Industrial and communications electronic equipment and components Electronic computers and components Integrated circuits and electronic components of general use Manufacture of electronic equipment for measurement and control. Vl

61 MEXICO: CAPITAL GOODS INDUSTRIES DEVELOPMENT PROJECT Summary of Principal Fiscal Incentives for Industrial Investment Offered Under the 1979 Decrees Issued with NIDP Priority Sectors All Industrial Activities Geographic Location Other Purchase of Employment Generated of Investment Small Enterprises b/ Activity Category 1 c/ Activity Category 2 d/ Industries Local Equipment!y Additional Shifts Zone I Preferential 25% Investment 20% Investment 15% Investment - 5% 20% Additional 20% Employrment 20% Employment - Employment Zone II State Priorities 25% Investment 20% Investment 10% Investment % Additional> 20% Employment 20% Employment - Employment Reat of the Country 25% Investment e/ 20% Investment 10% Investment e/ - 5% 20% Additional -n 20% Employment 20% Employnent e/ Employment Zone III A. Controlled growth B. Consolidated growth 25% Investment e/ 20% Investment e/ 10% Investment e/ - 5% 20% Additional 20% Employment e/ 20% Employment e/ - Employment a/ Geographic zones are defined in the decree published in Diario Oficial. February 2, Fiscal credits can be used for the payment of any federal tax which is not im,lased for a specific use. The percentages shown in the table for investment are applied to the total value of construction and installations and the purchase of new machinery and equipment directly related to the production process; it is granted at the time of undertaking of the expenditure. In the case of employment, the percentage is applied for a period of two years on the new employment valued at the annual mininmum wage. b/ Enterprises with fixed assets not exceeding 200 times the annual minimum salary in the Federal District. c/ includes agroindustries, capital goods producing industries and strategic inputs for the industrial sector (e.g. steel, cement) d/ Includes non-durable consumer goods, durable consumer goods and intermediate products specified in decree published in Diario Oficial, March 9, ei/ pplied only to expansions of productive capacity in the same industrial activity. Source: Secretaria de Patrimonio y Fosento Industrial, Plan Nacional de Desarrollo Industrial, (Mexico, 1979) p W

62 ANNEX 4 Page 1 MEXICO Institutional Infrastructure for Technology Development By Industries 1. Industry in Mexico has now reached a relatively high degree of sophistication and there exists a substantial pool of important engineering and technical skills. If Mexican industry is to further increase local value added and compete efficiently in world markets, there is a need to focus increasingly on the technology factor in industrial development and develop indigenous capabilities for technological acquisition, adaptation and innovation. This would help the development of new or improved products, more efficient production methods, and new processes to use available raw materials. The capital goods industries subsector has a key role in this respect because capital goods often act as the carriers of technology development and the capability to design and manufacture them is a good indicator of the degree of technological mastery'. Recognizing the importance of technology issues, Mexican authorities have created a relatively large institutional infrastructure to support technological development in industry. 2. The Instituto Mexicano de Investigaciones Tecnologicas (IMIT) was one of the pioneer institutions established in the area of industrial research and development, having been established in the fifties with the help of the Armour Research Foundation. IMIT is partly funded by the Mexican Government, through Banco de Mexico, and partly by revenues from industrial and banking clients for project preparation and evaluation. IMIT also conducts technological research for enterprises for a fee. The main focus of IMIT's research activities has been in the food and processing technologies rather than in capital goods subsector per se. 3. More recently, in 1970 the government created the Consejo Nacional de Ciencia y Tecnologia (CONACYT) to formulate and implement national policies aimed at strengthening the links between research organizations and industrial enterprises. Its activities were focussed initially only on science and the related support to human resource development. Since 1978, CONACYT has moved increasingly into technological development field. CONACYT has been instrumental in the creation of 12 technological research and development centers to date, and the provision of technical services to medium and small-scale industry. In general, the centers which deal with the metalworking industry are not as developed as those related to processing industries. The most relevant to capital goods industries are two relatively new and small centers: Instituto Mexicano de Investigaciones en Manufacturas Metal Mecanicas, A.C. (IMEC) located in San Luis Potosi, which provides simple designs for equipment and tools and assistance in production engineering to small-scale metalworking industries in the region (25 professionals); and Centro de Investigacion y Asistencia Tecnologica del Estado de Queretaro,

63 ANNEX 4 Page 2 A.C. (CIATEQ), established in 1978 in Queretaro, which is oriented towards the provision of services to small-scale metalworking industries on metal cutting, thermal treatment and forging processes. (15 professionals). CONACYT has been the recipient of a US$50.0 million loan approved earlier this year (1981) by the Inter-American Development Bank mainly for strengthening the science and technology research centers, institutes and departments functioning under its auspices. 4. Although it lies outside CONACYT's institutional system, mention should also be made of the Institute of Electrical Investigations (IIE) at Cuernavaca, which has achieved a higher level of performance than the aforementioned centers. It has a staff of over 400 professionals. While legally an independent institute, it depends heavily on CFE, which contributes a large share of its budget (38%) and provides the bulk of its work. The Instituto Mexicano del Petroleo (IMP), which is a research institute set up by PEMEX, is a well established research and development institute enjoying worldwide reputation for basic as well as applied research in the petroleum and petrochemicals field. Part of IMP's research activities are concerned with the design and development of equipment for petroleum extraction and refining and petrochemicals processing, a field in which IMPs contributions have been significant. 4. The Servicio de Informacion Tecnologica (INFOTEC), a spin-off of CONACYT, is a trust fund administered by NAFINSA, and provides technical information, technological advice and related support services to Mexican firms of varying size and industrial sophistication. It was designed after the Danish and Canadian technological information services. Since its establishment in 1972, INFOTEC has shown an impressive growth performance and an ability to generate the interest of private Mexican firms in its services. At present it has about 140 employees, of which approximately one half are professionals. The services offered include: technology information search, using the resources of its own library and periodicals subscriptions and through a network of relationships with other information centers, R&D centers and consultants; industrial liaison service under which INFOTEC seeks to identify, through plant visits, the technological information needs, problems and business opportunities of the industrial firms; an 'enquiry service to answer specific technical questions received in written form or by telephone; publication of a technical news bulletin; technical document acquisition service (e.g., acquisition of copies of patents, standards, etc.); and specialized technical assistance services to cater to specific requests from firms, e.g., for assistance in feasibility or market studies, plant layout, process optimization, analysis of alternative suppliers of technology, etc. Approximately one half of INFOTEC's budget needs are covered by fees paid by client enterprises.l/ 1/ INFOTEC has been the most active among the specialized technical assistance agencies participating in the first and second small and medium scale industries development projects (Loans 1552-ME and 1881-ME).

64 INFOTEC-s board is comprised of representatives from SPP (Secretariat of Programming and Budget), SEPAFIN, SHCP, Banco de Mexico, NAFINSA, Banco Mexicano-SONEX, Banco Internacional and the National Federation of Chambers of Industry (CONCAMIN). Its organization currently includes a separate department concentrating on capital goods industries (with 15 professionals). INFOTEC expressed strong interest in expanding its services oriented specifically towards capital goods industries. 6. Finally, Mexico also has a large number of competent private sector consulting companies which can provide a wide range of engineering, project preparation or other services. Some of the consulting companies have foreign associations and hence have easy access to technological information from foreign services. A few of the universities are also initiating programs oriented towards technology development and provision of services to industry, e.g., a new center for mechanical design is expected to be established in the engineering faculty of the Universidad Nacional Autonoma de Mexico (UNAM).

65 -59-. ANNEX 5 LEVELS: MEXICO: CAPITAL GOODS INDUSTRIES DEVELOPMENT PROJECT Structure of the Mexican Technical Education and Training System for Industry LOWER UPPER HIGHER PRIMARY SECONDARY SECONDARY LEVEL ARMO - Adiestramiento Rapido de Mano de Obra--a U.N. assisted program established in 1966 for brief but intensive vocational training in several specializations (with course durations ranging UNIVERSITIES from a few months to more than one year) as well PRIMARY CECYT AND HIGHER as training courses for first line shop l l TECHNOLOGICAL supervisors and trainers; at present it has ] TECHNICAL 1 INSTITUTES normal capacity of 40,000 to 50,000 trainee SECONDARY hours. CECYT- Centros de Estudios Cientificos y Tecnologicos (Centers for Scientific and Technological Studies), similar to CET referred to below. 'l ICECATI - Centros de Capacitaci6n para el Trabajo '.1 CECATI (Industrial Training Centers)--for terminal technical training of smi-skilled and skilled workers through courses of up to 40 weeks; CET nrimary school attendance is not a prerequisite CONALEP CENAPRO for entry into the CECATI system CERETI ENAMACTI CET - Centros de Estudios Tecnologicos (Centers for Technological Studies--which provides terminal technical training as well as training in ARMO custoii DESIGNED TRG PROGRAMS ITR ARMO l preparation to university. CENAPRO- Centro National de Productividad (National Productivity Center) - offers training programs (including on-the-job training) for shop foremen and middle level technical and managerial staff; its courses can be designed for individuals or specifically for an individual enterprise upon request. I/ CERETI - Centros Regionales de Enseefanza Tecnica (Regional Technical Teacher Training Centers). CONALEP - Colegio Nacional de Educacion Profesional y Tecnica (the National System of Professional & Technical Education),a semi-autonomous agency of the Ministry of Education, which provides terminal programs for skilled workers and lower and technicians through a national system of training centers. ENAMACTI - Escuela lacional de Maestros de Caoacitaci5n. pare el Trabajo Industrial. (National School for Industrial Technical Trainers). Custom -Designed Programs - ITR - Institutos Tecnologicos Regionales (Regional Technological Institutes). Training programs undertaken by individual industrial firms to suit the specific needs of their technicians and skilled workers; they are typically designed and administered with the assistance of a consulting company or a technical institute (e.g., the Monterrey Technological Institute has designed training programs for capital goods manufacturing units of the Alfa group). 1/ Up to now CENAPRO was located exclusively in Mexico City, but in 1981/82 two centers will be opened in Torreon and Merida, another one is in construction in Irapuato and others are planned in the states of Tabasco, Baja California and Tamaulipas.

66 ANNEX 6 Page 1 OPERATING REGULATIONS OF THE INDUSTRIAL EQUIPMENT FUND (FONEI) I. OBJECTIVES 1. Objectives. The objectives of the Industrial Equipment Fund (FONEI) are: (a) to promote the efficient production of industrial goods and services; (b) to ensure that the auxiliary lending institutions and organizations (financial intermediaries) of the country take the viability of investment projects into account in their lending decisions. II. GENERAL PROVISIONS 2. Operations. FONEI may undertake the following operations: (a) to provide funds to the financial intermediaries for loans that they grant for: (1) the acquisition of fixed assets; (ii) the preparation of preinvestment studies, and (iii) the adaptation, production, integration and development of technology; (b) to carry out financing operations related to those mentioned in (a) above; (c) to provide guarantees to protect the financial intermediaries against the risks of default; (d) to make grants to enterprises to assist technological development. 3. Currency. The lending operations of FONEI shall be denominated in Mexican currency. 4. Credit Limits. The maximum amount of financing granted by FONEI for each project or program shall be Mex$200 million. The Committee may make larger loans for high-priority projects subject to ratification by the entity establishing the trust.

67 Maximum loan period. FONEI shall establish the loan period and other conditions of financing according to the nature of each project. The maximum period shall be thirteen years, including a grace period of not more than three years. 6. Interest rate. The annual net interest rate used in the various FONEI programs shall be charged on unpaid balances and based on the average percentage cost (CPP) of interest rate charges and if applicable, surcharges, on borrowing operations in Mexican currency by the whole range of private and mixed banking institutions, including loans by enterprises and individuals term deposits (except savings accounts), and also, where applicable, bank gonds, based on monthly estimates prepared by the Banco de Mexico. The CPP shall be rounded off to the nearest one-tenth of one percent. The initial rate applied shall be that in effect for the month immediately preceding that of the contracting of the loan between the institution and its borrower and shall be modified every quarter if necessary, even though the amortization payments may be monthly or quarterly, as stipulated in the prececing paragraph. 7. Discount differential. The discount in favor of the intermediary institutions shall in all cases be 2% on unpaid balances. However, FONEI may increase this differential in the following casest (a) up to 0.5% when the intermediaries undertake the appraisal of the projects, if the total assets before the project investment in an existing enterprise, or estimated assets in a new enterprise, are less than Mex$100 million, and by up to 0.25% when the assets exceed this amount' (b) by up to 0.25% annually after presentation to FONEI of the supervision report or reports. In both cases the intermediaries may carry out these tasks with their own technical staff or through outside consultants, with FONEI's prior agreement and in accordance with the terms of reference established by it. 8. Guidelines for the intermediaries. The lending institutions acting as financial intermediary in loans made by FONEI shall be subject to the following basic requirements: (a) in programs where FONEI finances only the acquisition of fixed assets, they must ensure that the borrowing enterprise will have sufficient resources to meet its working capital needs; (b) the costs of appraising and supervising the project shall not be passed on to the borrower; (c) except for any subordinate portion of the discount, the intermediary shall be obliged to service its debt punctually and in full, regardless of whether it has received payment from its borrower. In addition it shall immediately pay to FONEI any sums received as advance repayment of principal.

68 ANNEX 6 Page 3 9. Complementary financing. In the financing of projects supported by FONEI, other lending institutions, equipment suppliers, and in general any other sources of funds, may participate in addition to the financial intermediary. 10. Borrower's contributions. The contribution of the final borrower shall be made in the form of increases in capital stock, or through internal generation of funds during the execution phase of the project in the case of established enterprises. 11. Commitment charge. FONEI shall charge the financial intermediaries a commitment fee of 1% per annum on the undisbursed balances in accordance with the disbursement schedule approved by FONEI. The financial intermediaries may in turn pass this charge on to the final borrowers. 12. Rights of FONEI. The contracts signed by FONEI with the financial intermediaries, and those signed by the latter with the final borrowers, shall stipulate that FONEI is at all times entitled, without prejudice to those assisting the intermediaries, to obtain the information it considers necessary regarding the execution of projects or programs, to inspect and supervise their implementation and operation, and to require the final borrowers to submit financial statements certified by external auditors. 13. Coordination agreements. FONEI may enter into coordination agreements with other trust funds or entities in order to assist enterprises, under the terms of its Operating Regulations. 14. Portfolio limit. FONEI shall limit its loans to any one enterprise to 5% of its total assets. 15. Alternative sources. FONEI shall not make loans for projects or programs for which adequate alternative sources of financing are available. III. EQUIPMENT FINANCING PROGRAM 16. Objectives. FONEI may finance: (a) the equipping of new industrial plants or the expansion, modernization or relocation of existing plants which effectively promote national objectives for industrial development, or whose products have reasonable prospects of competing in foreign markets; (b) the equipping, extension or modernization of enterprises whose purpose is to provide services that generate or save foreign exchange efficiently. 'Efficiency" is understood to mean that production costs enable the products or services to compete now or in the foreseeable future, in terms of quality and price, with identical or similar products from overseas. 17. Use of resources. FONEI resources in this program musr be used only for the acquisition of machinery, equipment and installations, their assembly

69 ANNEX 6 Page 4 and conditioning, the construction of premises to contain them, and preoperating costs. 18. General guidelines. In selecting projects for FONEI financing under this program, the following factors among others shall be taken into account: the priority of the activity, the generation or saving of foreign exchange, industrial decentralization, regional development, employment creation, value added, and the economic and financial rates of return. 19. Credit shares. With a minimum of Mex$4.5 million, FONEI shall finance the acquisition of fixed assets in the following proportions: (a) for projects whose purpose is the establishment of new enterprises, up to 65% of fixed assets. The financial intermediary shall provide funds equal to at least 15.4% of the FONEI loan from its own resources and the final borrower shall contribute at least 25% of the value of said assets; (b) in the case of projects for expansion, modernization or relocation of existing plants, FONEI may finance up to 72% of the fixed assets under the project. The financial intermediary shall provide funds equal to at least 11.1% of the FONEI loan from its own resources, and the final borrower shall contribute at least 20% of the value of said assets. (c) within the framework of its participation, FONEI may subordinate its loan in relation to the financial intermediary in a percentage not exceeding that of the final borrower, in cases of high-priority projects for enterprises with total assets not greater than Mex$100 million. 20. Interest rate. The net interest rate charged to the final borrower shall be 2% above the CPP referred to in paragraph 6, except for the subordinated part of the loan, where it shall be 2.5%. However, these rates may be reduced by up to 0.25% in the light of the costs of the preinvestment studies incurred by the enterprise for the contracting of external consultants acceptable to FONEI. IV. POLLUTION CONTROL PROGRAM 21. Purpose of the program. Through this program FONEI may provide preferential loans to enterprises, especially those established in areas of high industrial or population density, for the acquisition of pollution control equipment, taking into account as far as possible the views of the competent authorities.

70 ANNEX 6 Page Amount of assistance. FONEI will finance up to 90% of the cost of fixed assets and technical advice. The enterprise must contribute not less than 10% of the investment. 23. Interest rates. The net interest rate charged by the financial intermediaries to the final borrowers shall be the CPP indicated in paragraph 6. V. TECHNOLOGICAL DEVELOPMENT PROGRAM 24. Purposes of the program. Through this program FONEI intends to support research into and the development and adaptation of methods and procedures for the efficient manufacturing of industrial products, and the design, construction and testing of capital goods, including prototypes and pilot plants. 25. Use of funds. The resources in this program will be used for such purposes as: purchase of basic data and process engineering, salaries, materials, equipment and services, training costs, etc., all-relating to technological projects. 26. Forms of assistance. FONEI may give its support in the form of loans and grants, separately or together, in such a way that the sum of both does not exceed 80% of the enterprise;s annual program costs. 27. Credit shares. FONEI's support may account for up to 80% of the entrepreneur's approved annual budget; the firm must in all cases provide a minimum of 20% of said budget. 28. Interest rate. The net interest rate charged to the final borrower shall be three percentage points less than that indicated in paragraph Loan guarantee. The guarantee for the loans granted by FONEI to the financial intermediaries under this program shll not be greater than 90% of the amount of each loan, including capital and regular interest. The financial intermediary or, as the case may be, the entrepreneur or party requesting the guarantee, shall pay to the trustee, in one single payment, the equivalent of 0.5% of the principal of the loan on the date on which the guarantee contract is signed. 30. Exemption from loan repayment. In the light of the features of each case, the Technical Committee may exempt an enterprise from repayment of part of or all of the loan if the results arenot positive, in which case it shall decide the destination of the remaining assets and rights. 31. Grant limit. FONEI's contribution in the form of a grant shall not exceed 30% of the entrepreneur's approved annual budget, within the allocation approved annually by the Technical Committee for this section of the program. 32. Criteria for grants. In making any grants, FONEI shall take into account principally the degree of risk involved, the degree of innovation, participation by a Mexican research institute or engineering firm, and the relative size and economic capacity of the enterprise.

71 ANNEX 6 Page 6 V. PREINVESTMENT STUDIES 33. Purpose of the program. To assist entrepreneurs in improving the bases for their investment decisions and loan requests, FONEI may grant loans for carrying out preinvestment studies when these relate to projects that are potential candidates for financing by the Fund. 34. Credit limits. FONEI's financing can cover up to 80% of the cost of the studies. The entrepreneur or promoter must contribute a minimum of 20% of said costs. 35. Consolidation. If the preinvestment study leads to implementation of a specific project, the loan shall be consolidated with that which FONEI may decide to grant to the project. 36. Loan guarantees. FONEI may provide its guarantee to the financial intermediaries under this program on the terms stated in paragraph Interest rate. The net interest rate charged by the financial intermediaries on loans for preinvestment studies shall be 3% below that referred to in paragraph 6. /s/ Banco de Mexico, S.A. Trustee of the Federal Government for the Industrial Equipment Fund

72 MEXICO: CAPITAL GOODS INDUSTRIES DEVELOPMENT PROJECT Table 1: Gross Domestic Product by Sector of Origin, 1965, 1970, (in current and constant 1972 prices) Shares Values in Current Prices (billion pesos) Agriculture, Forestry, Fishing t na Mining n.a Petroleum n.a ttanufacturing n.a Construction n.a Electricity n.a Commerce n.a Transport & Communication n.a Government n.a Other Services n.a Gross Domestic Product , , , ,767.0 n.e Non-Oil GDP , , , ,634.6 n.a Average Annual Growth Rates Values in 1972 Prices (billion pesos) Agriculture, Forestry, Fishing T 2.4 Mining Petroleum Manufacturing Construction Electricity Commerce Transport & Communication ,5 Government Other Services Gross Domestic Product Non-Oil GDP Source: Bank of Mexico and World Bank staff estimates. _

73 MEXICO: CAPITAL GOODS INDUSTRIES DEVELOPMENT PROJECT Table 2: Gross Value of Production and Value Added in Capital Goods Industries, (Revised Series) (Million Mex$ in Current Prices and Percentages) Gross Value of Production (Millions Mex$, curreilt prices) Total Manufacturing 274, , , , , , , ,096, ,363,023.6 Metal products 8, , , , , , , , ,046.1 Non-electrical machinery 5, , , , , , , , ,505.8 Electric and electronic machinery 6, , , , , , , , ,000.3 Transport equipment (ships & railway) a/ 1, , , , , , , , ,934.3 Sub-total 22, , , , , ,066.1 /1, , ,486.5 Share of capital goods in total manufacturing (%) Share in sub-sector total (%) Metal products Non-electric machinery Electric and electronic machinery Transport equipment (ships & railway) a/ Automotive industries (including buses & trucks) 14, , , , , , , , ,143.9 Value Added (Millions Mex$ in current prices) Total Manufacturing 105, , , , , , , , ,571.9 Metal products 4, , , , , , , , ,108.9 Non-electric machinery 2, , , , , , , , ,975.1 Electric and electronic machinery 3, , , , , , , , ,861.6 Transport equipment (ships & railway) a/ , , , , , ,062.2 Sub-total 10, , , , , , , , ,007.8 Share of capital goods in total manufacturing (%) Share in sub-sector total (7.) Metal products Non-electric machinery Electric and electronic machinery Transport equipment (ships & railway) a/ Automotive industries 4, , , , , , , , ,693.6 a/ Excludes buses and trucks. Source: Secretaria de Programacion y Presupuesto and Banco de Mexico, Sistema de Cuentas Nacionales de Mexico (Mexico, D.F.),January 1981.

74 MEXICO: CAPITAL GOODS INDUSTRIES DEVELOPMENT PROJECT Table 3: Manufacturing Sector and Capital Goods Industries Subsector, (Millions of 1970 Mex$) Average Annual Growth Rates Total Manufacturing 44, , , , , , , , , Metal products 1, , , , , , , , Non-electric-machioe,y , , , , , ,390.0 ) 15, Electric. & electric machinery , , , , , , , Transport equipment (ships & railway) a/ ,' ,078.6 ) Total capital goods 3, , , , , , , , Index (1970=100) Total manufacturing Capital goods a/ Excluding buses and trucks. Source: based on revised national accounts prepared by Secretaria de Programacion y Prssupuesto and Banco de Mexico, Sistema de Cuentas Nacionales de Mexico, (Mexico, D.F.), January estimated on the basis of data from previous national accounts; 1979 and 1980 estimated on the basis of partial data trom production indices. M l

75 MEXICO: CAPITAL GOODS INDUSTRIES DEVELOPMENT PROJECT Table 4: Trends in and Structure of Gross Fixed Investment 1965, 1970, 1972, l In Current Mexican Pesos (billions) Construction Domestically produced capital goods Imported capital goods Other Total l Share in GDP in percentages Composition in percent of total Construction Domestically-produced capital goods Imported capital goods other Total In 1972 Mexican Pesos (billions) Construction Domestically produced capital goods Imported capital goods Other Total Average annual growth rates (1972 prices) a/ Construction Domestically produced capital goods Imported capital goods Other _ Total a/ annual average for period ; annual aperage for period ; annual average for period Source: Banco de Mexico and Bank staff, see Report No ME, Mexico: Development Strategy - Prospects & Problems, August 31, 1981, Statistical Appendix Tables

76 MEXICO: CAPITAL GOODS INDUSTRIES DEVELOPMFNT PROJECT Table5: Number of Enterprises of Capital Goods Sub-Sector Annual Rates of Growth Number % Number % Number % Number % Total Manufacturing Ind. 100, , , , Total Capital Goods 3, , , , getal Products , Industrial Machinery 2, , , , Electrical Machinery Transport Equipment Share of Capital Goods Enterprises in Total Manufacturing Enterprises (X) SOURCE: Elaborated from the 1960, 1965, 1970, and 1975 Industrial Census Data. LCPI2 October 1980 A I

77 MEXICO: CAPITAL COODS INTUSTRT1S T)FVET.OPMENT PROJECT Table 6: Employment in Manufacturing and Capital Goods Industries Subsector Annual Rates of Growth 1960 % 1965 % 1970 % 1975 % Number Number Number Number 1. Total Manufacturing Ind. 791,440 1,323,274 1,520,817 1,654, Total Capital Goods 39, , , , Metal Products 14, , , , Industrial Machinery 12, , , , Electrical Machinery 6, , , , Transport Equipment 6, , , , Share of Capital Goods Industries in Total Manufacturing Industries Employment (x) SOURCE: Elaborated from the 1960, 1965, 1970, and Industrial Census Data. LCPI2 October 1980

78 -72- ANNEX MEXICO- CAPITAL GOODS INDUSTRIES DEVELOPM frl 'FOJECT T-7 Tablo 7: Value Added and Fixed Assets per Worker in Manufacturing Industry in 1975 (Thousands of 1975 Mex$) Direct Labor Value Fixed Coefficients Added Assets (Workers per Direct Capital-Output Coefficients per per Million 1975 Fixed Working Total Worker Worker Mex$ Value Capital Capital Capital Added) Food Beverages Tobacco Textiles Wearing Apparel Footwear Wood and Cork Products Wood Furniture Paper Products Printing Chemicals Petrochemicals Rubber Products Non-Metallic Minerals Basic Metal Industries Various Manufacturing Capital Goods: Metal Products Industrial Machinery Electrical Machinery Transport Equipment Average Capital Goods Average Total Manufacturing Industries SOURCE: Elaborated from the 1975 Census Data. LCPI2 October 1980

79 MEXICO: CAPITAL GOODS INDUSTRIES DEVELOPMENT PROJECT Table 8: Selected Capital Goods Exports and Imports, (millions of US$) Exports Imports a/ a/ Total Merchandise Trade 6, , , , , ,572,2 Total Capital Goods , , ,118.6 Of which Agricultural Equipment Railroad Equipment Other transport Equipment Planes and parts Trucks Boats and parts Industrial Equipment , ,938.7 Pumps Hand-tools Typewriters Textile machinery Rubber industry Temperature regulating equipment Metal-working equipment Data processing equipment Loading and underloading equipment Machinery for paper & carbon ind Soil perforation equipment Industrial tractors Turbines Presses & crushing equipment Scientific Equipment Electric & Electronic Equipment Generators, transformers & motors Electronic communications machinery and apparatus a/ Preliminary estimates. Source: Banco de Mexico ;

80 -74- ANNEX 7 T-9 MEXICO: CAPITAL GOODS INDUSTRIES DEVELOPI{INT PROJECT Table 9 Finantcial Sector Summary Accounts (Mex$ billion) I. BANCO DE MEXICO A. Total Assets Foreign Reserves Credit (Total) To financial institutions To public sector To private sector B. Total Liabilities Cufrency Reserves II- PUBLIC SECTOR BANKS A. Total Assets Net Credit to Financial Institutions Gross Credit Liabilities Credit to Public Sector Credit to Private Sector B. Total Liabilities Private Sector Net Foreign Liabilities Capital & Other III. PRIVATE AND MIXED BANKS A. Total Assets Net Credit to Financial Institutions Gross Credit Liabilities Credit to Public Sector Credit to Private Sector B. Total Liabilities , Private Sector Monetary Assets Net Foreign Liabilities Capital & Other SOURCE: Banco de Mexico, Indicadores Economicos. LCPI2 July 1981

81 -75- ANNEX 7 T-10 MEXICO: CAPITAL GOODS INDUSTRIES DFN7ELnPtKPMT'7KOJECT Table 1o: Financial Agents' Share in Total_Financial Intermediation in 1980 Volume Agent (Mex$ billion) % As % of GDP 1/ Banking System - 1, Private and Mixed Banks 2/ 1, National Banks Insurance and Guarantee Companies -/ Insurance Guarantee Auxilary Credit Organizations ± Credit Unions Deposit Houses Securities Market Variable Return Securities (shares) Non-government Fixed Return Securities Treasury Certificates & government bonds (includes P'etrobonos) TOTAL 2, / Total Assets 2/ Excludes foreign assets and includes interbank operations. Source: Banco de Mexico, Annual peport and Bank estimates LCPI2 July, 1981

82 -76- ANNEX 7 T-11 MEXICO: CAPITAL GOODS INDUSTRIES DFVF.L(YPM1NT PP RJCT Table 11: Resource Mobilization and Credit Availability Indicators (As Percentage of GDP) Total banking system liabilities Non-monetary liabilities of the banking system Non-monetary peso liabilities of the banking system 1/ Private sector's deposits 2/ Total banking system credit outstanding Banking system credit to private sector / All liabilities in local currency, except checking accounts and other demand deposits. 2/ In private and mixed banks. Source: Banco de Mexico, Annual Reports. LCPI2 July 1981.

83 MEXICO; CAPITAL GOODS INDUSTRIES DEVELOPMENT PROJECT Table 1: Mexicors Largest Banks (Outstanding Balances as of December 31, 1980) Assets Demand Deposits Savings Deposits (Mex$ Million) % (Mex$ Million) % (Mex$ Million) % Bancomer 338, , , Banco Nacional de Mexico 303, , , Banca Serfin 124, , , Multibanco Comermex 119, , , Banca Somex 88, , , Banco Internacional 43, , Banco del Atlantico 29, , , Banpais 27, , Banco BCH 25,947, , Multibanco Mercantil de Mexico 17, , Banca Confia 15, , Banpacifico 9, , Other 155, , , TOTAL 1,299, , , SOURCE: Comisitbn Nacional Bancaria y de Seguros, Negocios y Bancos and mission estimates. LCPI2 July 1981 _._T

84 MEXICO: CAPITAL GOODS INDUSTRIES DEVELOPMENT PROJECT Table 13: Liabilities of the Banking System By Instrument !! LIABILITIES Mex$ billion % Mex$ billion x Mex$ billion x Monetary Non-Monetary , , Savings Instruments Liquid Non-Liquid Up to 1 Year Maturity Year More Than 1 Year Other Liabilities Public Sector Private Sector Foreign Sector Other CAPITAL Liabilities in Domestic Currency , Liabilities in Fgreign Currency Total Liabilities 1, , , / Preliminary Source: Banco de Mexico, Annual Reports LCPI2 July _,

85 MEXICO: CAPITAL GOODS INDUSTRIES DEVELOPMENT PROJECT Table 14: Institutional Structure of the Banking System September 30, 1977 December 31, 1978 MaYrch 31, 1981 No. of No. of No. of No. of No. of No. of Institutions Offices Institutions Offices Institutions Offices Public Banks Private and Mixed Banks 198 2, , ,802 - Multipurpose Banks 14 1, , ,602 - Deposit Banks 93 1, Financieras Mortgage Banks Other Private Banks ' TOTAL 220 3, , ,492 1/ Does not include Banco de Mexico, S.A. Source: Comisi6n Nacional Bancaria y de Seguros. LCPI2 July, 1981.

86 MEXICO: CAPITAL GOODS INDUSTRIES DEVELOPMENT PROJECT Table 15 : Total Financing by Sector and by Type of Bank 1/ Financing by Institution Amount % Am Amount Banco de Mexico To Public Sector To Private Sector 2/ To Credit Institutions National Banks To Public Sector To Private Sector 2/ To Credit Institutions Private and Mixed Banks To Public Sector t To Private Sector 2/ x To Credit Institutions Total Consolidated Financing 3/ , , , To Public Sector , To Private Sector / Balances outstanding as of December 31. 2/ Including foreign private sector. 3/ Total by institutions does not equal the consolidated total because in the latter interbank operations are excluded. Source: Banco de Mexico, Moneda y Banca. LCPI2 July, 1981.

87 ANNEX 7 T_lt6 MEXICQ: CAPITAL GOODS INDUSTRTFq, nm.tlnvw n' J1"" Table 16; Banking System Credit By Sector, (Outstanding Balances as of December 31) / 1980 Mex$ Million % Mex$ Million % Mex$ Million % Mex$ Million % 1. Primary 69, , , , Agriculture 63, , , , Mining 3, , , , Other 2, , , , Industry 195, , , , Energy: 19, , , , Petroleum 2, , , , Electricity 16, , , , Manufacturing Industry: 136, , , , Manufacturing 92, , , , Non-metallic Minerals 4, , , , Steel and Other Metallic Products 32, , , , Machinery and Equipment 7, , , , Construction 38, , , , Housing 18, , , , Services 84, , , Transport 28, , , , Communications , Banking 33, , , , Other 22, , , , Commerce 68, , , , Government 95, , , , TOTAL 532, }00.0 2fi1.Ai PC.. 1/ Due to changes in definitions of sectors, introduced in June 1979, the 1979 figures are not consistent with those of the previous two years, Indicadores Economicos. SOURCE: Banco de Mexico, LCPI2 July 1981

88 MEXICO: CAPITAL GOODS INDUSTRIES DEVELOPMENT PROJECT Table 17: Geographical Distribution of Credit and Deposits (Outstanding Balances as of December 31, 1980) Total Banking Private and Mixed Banks System Credit National Bank Credit Credit Deposits State Mex$ Billion % Mex$ Billion % Mex$ Billion % Mex$ Billion % Distrito Federal Nuevo Leon Jalisco Sinaloa Mexico Sonora Veracruz Michoacan m Coahuila Chihuahua Tamaulipas Guanajuato Other States TOTAL 1, , SOURCE: Banco de Mexico, Annual Report and Indicadores Economicos- LCPI2 July

89 MEXICO CAPITA7. GOODS INDUSTRIES DEVELOPMENT PROJECT Tablie18:i Slected Interest Rates in Mezico. USA, and London Interbank Rates Gross Net Gross Net Gross Net Groas Net Gross Net Gross Net Gross Net Gross Net Gross Net Gross Net MEXICO Time Deposits a/ 1 day a week day a month Certificates of Deposits 2 months ' months months or more CETES-/ Average Active Interest Rate Do _stic currency Foreign currency , Average cost of funds (ACF) USA Certificates of Deposits- 3 months months LONDON Eurodollar Deposits "Call Money" Months months months Annual Inflation ate (CPi increases for 12-month periods ending in thb respective cuarter) d!/ a/ Withdrawable on specific days. b/ Mexican Treaury Certificat". c/ US$ Minimum d/ Computed as ratio of the average CPT index for the thrbepionths coveted by the resystive qu&wter*. 9'i

90 -84- ANNEX 7 T- 9 MEXICO - CAPITAL GOODS INDUSTRIES DEVELOPMENT PROJECT Table 19: FOMEX's Financing for Capital Goods Industries (Mrex8 million) Amount Amount x Amount % EXPORTS 1, , , Pre-exports , Sales 1, , IMPORT SUBSTITUTION , , Sale-Purchase , PEMEX, CFE Invoice Receipts , Other , Total 2, , = L = ~ Source: FOMEX Annual Reports. LCPI2 July 1981

91 MEXICO: CAPITAL GOODS INWSTRIES DEVELOPMENT PROJECT Table 20: Types and Characteristics of NAFINSA'S Credit QperatiQnr aname of the Credit Concept Purpose Subiect of Credit Requirements Short-term Credits 1. "Descuento" A credit operation providing the tender Working capital Industrial enternrises Establishment of a credit the ownership of accepted credit titles, financing requirements. (complementary short-term line (revolving or nonoriginating from sales/purchase of merchandise, financing to ongoing long-term revolving). operations.) 2. "Quirografario" Short-term credit operation guaranteed IT ediate liquidity Complementary working capital Signoture of a promisory by the signature of the debtor only, financing to cover un- financing to ongoing operations note and/or an indoreeor with a required collateral, expected expenditures, of well known clients. ment; in case of collateral, a "provisional credit." a formalization letter specifying that 80X of the credit recovery will be used for c-pital repayment, the remaining 20 for interest 3. "Prendario" A credit operation documented by a Working capital financing. Well known clients from the repyment promisory note (for which pawn exists). agricultural, industrial and Signature or a promisory commercial sectors. n.te and/or sn indoreement. 4. "Directo" Short-term credit upto 180 days, Working capital financing. Federal government decentralized Personal guarantee andf renewable one time, agencies, parastatal enterprises, or real collateral. federal trust funds, etc. X 5. "Credito en Cuenta Corriente" Working capital financing. Federal government decentralized Personal guarantee or and/ agencies, parastatal enterprises, or real collateral. federal trust fund, etc. Medium- and Long-Term Credits 6. "Habilitacion o Avio" Medium-term operation initiated by Purchase of newumateriala, Industrial sector clients. R19 materials and other an opening credit contract, specifying intermediate goods, pay- purchased goods serve as the conditions of approval. ment of wages and salaries, collateral and have to be etc. insured against possible risks. 7. "Simple" Long-term operations; all other See 4 or 5 See 4 or 5- See 4 or 5. characteristics similar to those of "Credito Directo" or "Credito en Quenta Corriente." 8. "Refaccionario" Long-term operations for fixed assets Purchase of land, purchase Industrial sector clients. Lots, construction, financing, accompanied by a contract and installation of machi- buildings, machinery and specifying its objectives, duration of nery and civil works, output of the production credit, goods included in the guarantee, etc. covering of export costs, process serve as a collateral expansion and adaptation and have to be insured against of industrial plants, etc. various kinds of possible risks. 9. "hedocumentacion" The operation of extension of any kind of medium- and long-term credit. Source: NAFINSA's Operational Manual. LCPI2, June 1981.

92 -86 - ANNEX MEXICO: CAPITAL GOODS INDUSTRIES DEVF.T.nPMFNT PRn.TFCT T-21 T-21: NAFINSA's Domestic Currency Interest Rates to Final Borrowers-in Effect Since May 1981 Sector Interest Rate A. General (Manufar-turing) - Public Sector (Federal Government, ACF plus 2.5 Ministries, State Governments, Trust Funds, Decentralized Organisms, Enterprises with majority state participation), - Enterprises with minority state participation ACF plus Private Sector Priority activity Zone I ACF plus 3.5 Zone II ACF plus 3.5 Zone III and rest of the country ACF plus 4.25 Non-priority Activity Zone I ACF plus 4.25 Zone II ACF plus 4.75 Zone III and rest of the country ACF plus 5.5 B. Mexican Food System (SAM) - Public sector ACF plus Enterprises with minority state participation ACF plus Private sector ACF plus 3.0 C. Tourism - Public sector ACF plus Enterprises with minority state participation ACF plus Private sector Priority "A" ACF plus 3.5 Priority "B" ACF plus 4.25 Source: Nacional Financiera, S.A. LCPI2, June 1981 d9

93 ANNEX T-22 MEXICQ; CAPITAL GOODS INDUSTRIES DEVELOPMENT PIjE, Table 22: NAFINSA - Total Credit Approvals by Sector (Mex$ million) Amount % Amount X Amount % Infrastructure 7, , , Industry 17, , , Basic Industries 11, , , Other Manufacturing 6, , , (Capital Goods 1/ 2, , , Other Activities 11, , , Total 36, , , / Numbers in parentheses refer to credit for capital goods industries approved by NAFINSA's head office. SOURCE: Nacional Financiera, S.A. LCPI2 July 1981

94 MEXICO: CAPITAL GOODS INDUSTRIES DEVELOPMENT PROJECT Table 23: NAFINSA's Approvals of Credits to Capital Goods Industries, by Type of Credit 1/ (Mex$ million Total No. of No. of No. of No. of No. of Credits Amount Credits Amount Credits Amount Credits Amount Credits % Amount X Short-term Credits 2/ 1. Directo 6 1, , , , Aval (guarantees) 9 1, , , , , Descuento Other Sub-total 23 2, , , , , x Medium- and Long-term Credits 2/ 5. Habilitacion o Avio (for workiig , , Simple capital) , , Refaccionario (for fixed) _ Sub-total 5 1, , , , TOTAL , , , / Includes only credits approved by NAPINSA's head office. 2/ See Annex 7, T-20 for definitions of the different types of NAFINSA's credits, Source: Nacional Financiera, S.A. LCP12 June 1981

95 =EXICO: CAPITAL GOODS IIDUSTRIES DEVELOP.MENT PROJECT Table 24: NAFINSA - Credit Approvals to Capital Goods Industries by Type of AcLivity, I/ (Mex$ million) Subsector No. of No. of No. of No. of No. of Credits Amount Credits Amount Credits Amount Credits Amount Credits % Amount % Metallic products Non-electrical machinery , Electrical and electronic equipment Transport equipment 21 3, , , , , Measurement equipment Total 28 3, , , , , cod 1/ Includes only credits approved by NAFINSA's head office. SOURCE: Nacional Financiera, S.A. LCPI2 July !

96 MEXICO - CAPITAL GOODS INDUSTRIES DEVELOPMENT PROJECT Table 25: Banco Mexicano SOMEX -- Credit Approvals to Capital Goods Industries (Mex$ million) / No. of No. of No. of No. of No. of Credits Amount Credits Amount Credits Amount Credits Amount Credits % Amount Z Metallic Products , Non-electrical Machinery Electric and Electric Equipment Transport Equipment TOTAL , , / Projects approved as of mid-june, Source: Banco Mexicano SOMEX and Bank estimates. LCPI2 July 1981.

97 - 91- ANNEX 7 MEXICO: CAPITAL GOODS INDUSTRIES DEVELOPMENT PROJECT Table 26; Analysis of Chagacteriatics Qf FONE)Ts LQan Approvals 197d-80 (a) By Program I No. of Millions No. of Millions Fa. or' Ilillions - Projecta o Proiects of pesos I Projects of pesos General Equipment T 3T z 'I 3T T7 (a) \;ew projects (b) Expansion , Pollutiotn control I Technology'developeent Preinv.stment studies _ Total 61 2, SO 4, leorcns troll's 197i, 1980 Anual lports. (b) By Term No. of Millions No. of Millions No. of millions Projects of peso. I Projects of pesos 2 Projects of pesos S Up to 4 years Over 4 to 7,ycers 31 1, , , Over 7 to 10 years , Here than 10 y.aro I Total 61, Sowen. POMZU's Anual Resports. (c) By Category 197il 19*9 M o 1- -'Ro. 1. nilsi.one Nu, of Millions No. of X!Aliome Pro;ects of pesos 7 Pro;ecta of nos I Projects og e 2 so_. rndustrfal Prlortitfe il ~ Prioriy - I Agroindustry 'TT I Capital gooda , Stratesic inputs Priority , , S Noo-durablth con-eoro Dursbl,h consuo.er gooes e ILtero.Oiate goods o , Prontiar De,elopLeot S Other Ca tea-niea. - 4 _ t: Total 61 2, , o bserne POIU'a- 1979, 1980 Annual Reports. (d) By Zone _ ITo. of Millions No. of lillions _ Pro1ects of oesos 7. Projects of pesos I Zone , A. Industzial Ports B. Urban Industrial Centers 19 1, , Zone II State Priorities zone Ill 21 8t0), t A. Areas of Controlled Growth B. Areas of Consolidation a Reet of Country 18 9C Total , SoulCre FON3I's 1979, 1980 Annuel Reports.

98 -92- ANNEX 7 T-27 MEXICO: CAPITAL GOODS INDUSTRIES DEVELOPMENT PROJECT Table 27: Pipeline-of Subprojects Presented to FONEI for Financing as of June 30, 1981 (Mex$ million) Fjnterm. M C. W. a.h.*7ma. 3 C.a,la C.-P.) Its.6 U.r 7~S.40 MTLC : ^.34-z 1,II.a 2_ J * J 3. ear 0...*- ZSWJUMZAL. S.. I0R0. S. *a.4 _. eal. OVA S.7 0tt1. S_I lb. - _nte.pe - 433* &- ett... l...gtl MA LI 0.A D.4t410 b 1-witbty u -- la es.4.- *W111 S "OM-~L ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~b CUM Up Lt s. r30 * ? ".1 _ S. A. me C. V. r*t - *$1~.m *teit *t.el 4.1..'.., 4... * a. * MA aU.L lb. tso btltty S. * UI e. Siag _ t WF Ya a.p a 4_a HJW4 &C U1 *ri2tt.n vltolac * 00. I.M. 0 0 I K tt.* C I uni3c4.l..t,.-i U.1.i.u_4. _re. *.5 *?.8 fn3 I Is "S. C3. A.. p1d.t &.-I.4.. Wb. 1g rlu -- I UA _ ts*sr*r_ f 3.3 3i. C. W. 8eC eil *-3tub. I Na * swj P 3 LAN CLAM *tf4 _f'wt GMSrS?IU 30 4 an, b.7.. f * 1.4 *S LI 4' i * tba 211 I USTb.S. s _e, _ * I.8 *4 mxuwnil _,L. S. A. ' -M- * S.Ai u0ena 81 _.da _r SA ]PA" -- I P. E. 2. * l.l.. W * 8.A pite1 Ya *w Ni 8* a *aina. 8. A. -= VWl..31 A.1 L.z _e l u' -%

99 MEXICO: CAPITAL GOODS INDUSTRIES DEVELOPMENT PROJECT Chart 1: Organization Structure of NAFINSA DIRECTOR GENERAL LIC. JORGE ESP INOSA DE LOS REYES SUB-DIRECTOR GENERAL SUB-DIRECTOR FOR SUB-DIRECTOR GENERAL FINANCE INDUSTRIAL PROOMTION AFFILIATE ENTERPRISES LIC. ALFONSO GARCIA MACIAS LIC. CRISTOBAL LARA, BFAUTILL AND TRUST FUNDS r ', LIC. JORGE TAMAYO, _ PROGRAMMING PROJECT PROMOTION ENTERPRISE CONTROL DEPARTMENT TRANSACTIONS ASCURITIES DEPT. DEPARTMENT DEPARTMENT DEPARTMENT TRUST FUNDS DEPARTMENT DIECTOR: DIRECTOR : DIRECTOR: DIRECTOR: ADMINISTRATION DIRCTOR; DBEPCTOR: LIC. O LIC. HECTOR LIC. RAMON LIC. BENITO REYTI.CRO IECO:LC GAI ARAIGUA HICT0RAES CARLC. TORRESLIC.BINITORILLA DE C. K. FRANCISCO ALCALA DE LEON ARANGUA MDRALFS CARLOS GARZA SUAREZ DAVILA TORRES l ROMAY, ~~~~~~LA

100 MEXICO: CAPtTAL GOODS INDUSTRIES DEVELOPMENT PROJECT Chart 2; Organization Structure of NAFINSA's Credit Department IDIRECTOR: S LIC. CARIOS SORILLA DE IA GARZA CDIVISIS CHIEF: ING. GUSTAVO LCKBERA CRKOIT ANALYSIS ~~~~~~~~~~~~~~CREDIT OPERATIONS CENUAL DtVISION C. PG FUSTAVO R TUBIO INORTIOOERTIEF C s EAN OPERATIONS S O AND B ANDINC. JULIO RDIVISION SAWC OIF: SUDIS. SUB-DIVISION Sen CHIEFa 2 Seno T I Senior Analys1t Senior D A Analyst FORMLLIZATION, LIC. ECZTN PUB~~~~~~~~AD LICE SECTO SPRIVCEAIT.USTAVO 5 Analyoto ADMJOIYSATE- MNDPIAT 5 Analysts HERNANDEZ T A 10 Technical T Asats ALCPI2,ts JupAn1STATAL F9E8AL CDEVELOP9T FUNDS9S AND DRECTRALIZED AND STATE SSClaTARIATS AND MAJORITY STATE- OWNED, PRIVATII ORGANISMS SUB-DIV. SUB-DIVISION M'NED) ENTERPRISES SNTIRPRISUS, B CHIUEF: CBIUF SUB-DIVISION SPECIAL OPlRTv-IONS ORANDO CANO MN. JULIO SAM CHIEF: SUB-DIVISION 2 Senior Technicians* 2 Senior Technicians -.P WONIO BIDL LIC. UXRUCZgA, 13 Technical Aust.. 13 Technical Aunts. 2 Senior Tachnician 14 Techn1c&l Assat Z Senior Technicians LCPI2, June 1981

101 MEXICO - CAPITAL GOODS INDUSTRIES DEVELOPMENT PROJECT Chart 3: Organization Structure of Organizaci6n SOMEX BOARD Presidentl Dr. Mario Ramon Beteta Executive Vice-President Executive Vice-President Executive Vice-President of Banking Wing of Industry Wing of Services Wing (Banca SOMEX) Lic. Luis Chico Pardo (FISOMEX) Lic. Donaciano Tames Corporate Staff npnvrtments (Finance & Administration) Legal Trust Administrative International Other Corporate Directorates Corporate Director, Corporate Director, (Tourism, Chemicals, Consumer -& AoAutomobiles Auto Parts Development - Durables, Construction, etc.). Petrocemicals Capital GGOd co

102 IO-CAPITAL - GOODS IMDUSTIIES DVVi,OPTENT PROJECT Ch-rt 4: Organtoaion Structure of FIS70EX'. Capitl Goods Ind-1 trise DepOrtnnnt LCRCARDO GONZALEZ MECHNICA IIMNS O N MANIIFAC'TURING EDVIIH CIISO N MARIEF ALANNING HICA- RESOURCES DIVISION CHIEF: ING. ALVAREZ CANTU VCN I Coordinzter Assist-to DIVISI MARIO APERDINI CHIEF:~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~UIDIIIc4St-DVSII ~~~~2 UB F RATIONS -CTS SIN/ICD PLNNIG PLANNING SUB-DIV. T IIGHNICAL SUB-DIV RIHN S REs -S PULI RELATION SUB-DIV. ~~~~~~~~~AUDITOR SU--I.O SDB-DIVISIONN I CoordFltoI 7 Alyt 6 Ansly.t. 2 Analy.t. 2 SpIrloliote 1 Market Speci-list (Inventory & Control). VACANT LCPI2 July 1981

103 MEXICO: CAPITAL GOODS INDUSTRIES DEVELOPMENT PROJECT Chart 5: Organization St7uctore of Credit Sub-Directorate of BEnco Mexicano-SOMEX SUB -DISECTOR CROAECEIT.] LIC. JAINE RUIZ IGOVERNETSCO TOURISM SECTOR PIAESCO - CRDTPERATION T IT ANALYSIS OWNED ENORTE STAE CHIEF DIR. CESAR CHIEF CHIVISIO SUPERVISION DIVISION DIVIEF ANOIOLRE JOSE CARMON C'dIEF: VACANT 5 Accour.t l'.-ager3 lmil l 4 Account M.angers SUB-DIVISR SUE-DIVSION CREDT OPERATION CREDIT RECOVERY aon A ManAgeD CEI NLSS CEI (TO AGMINISTRATION c SUB-DVISION SIR-DITVANAUY LD-IVs Accou rs t M anag 5 A count M nagerspu B-DIVsional 13 P rofessionals 8 C redit A nalysts 8 C redit Supervisor s. LCPI2 July, 1981

104 MEXICO: CAPITAL GOODS INDUSTRIES DEVELOPMENT PROJECT Chart 6: Organization Structure of FONEI Technical Committee Director romot ons Technical Spca Operations Subdirector Subdirector r Projects Subdirector Promoters Regional Chief of Chief of Chief of Chief of Promoters Representatives Appraisal Supervision Operations Accounting Pro,~ects CSupervision Financial ortfolio Contracts Credit Information & Officers Control l C ontfiroflc Officers Officer Officer Analysis Officer Officer Appraisal 1 r = t Assistant Administrator Records Recrd World Bank fe'

105 _ 99 - ANNEX 9 MEXICO: CAPITAL GOODS INDUSTRIES DEVELOPMENT PROJECT Indicative Listing of Items to be Included in the Proposed Information Dissemination System and Training Programs A. Information Dissemination System The proposed, information dissemination system would consolidate the available subsectoral information on current and projected installed capacities, available technologies, domestic and international markets for capital Roods and their components, supply-demand characteristics. etc. Possible items and sources of information for the system include the proposed special survey of installed capacities (para. 4.08); SEPAFIN's registry which contains information provided by capital goods producing industries on planned new investments in connection with applications for authorization of fiscal incentives and subscription to a 'development program' (including information on existing and planned capacities, characteristics of the technologies, production characteristics and plant locations); demand information available from the public sector entities and the 'Comisiones Mixtas' (para. 1.36); information available with the chambers of industry on supply and demand characteristics; special sectoral studies such as those carried out by COCOFIN (e.g., information from survey of training facilities, para. 4.06), NAFINSA, and INFOTEC (e.g., the 'technology gap' study referred to in para. 4.07); information from the principal financing institutions (NAFINSA, FONEI, FOMEX, FOGAIN, Organizacion SOMEX, etc.) on capital goods projects by them. The relevant information from each of the above sources would be gathered, validated, systematized and made available in an appropriate format to all interested producer and user industries. B. Training Programs Two types of training programs are expected to be formulated and implemented. Firstly, a formal training program could be undertaken to bolster the capacity of the technical staff of the principal implementing agencies for preparing, promoting; and/or evaluating capital goods development projects. The training program would focus on the areas of technology assessment, technology absorption possibilities, design of technology transfer agreements, and formulation of complex financing packages involving several parties and foreign companies (para. 1.42). Secondly, more detailed seminars or 'mini-courses' for specialized technical and financial staff of industries and financial staff of industries and the principal financing agencies would be designed and offered on specific topics of relevance to capital goods industries, such as (i) identification of capital goods product categories which match the technical capabilities and comparative advantage of Mexico; (ii) factors affecting achievement of good technology absorption and technology mastery; (iii) criteria and intricacies of evaluating technology transfer/partnership agreements; (iv) importance of ensuring adequate quality control and reliable delivery schedules in supplying components to capital goods industries and ways to help subcontractors achieve them; (v) relevance of standardization and precision of machine tools in assuring adequate quality of capital goods and their components; (vi) ways to make best use of horizontal linkages and specialization among capital goods manufacturing enterprises; and (vii) methods of assessing the economic value of used vs. new machinery taking into account the long run implications to the production process, cost and quality.