FILE C JU' The World Bank

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1 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized n fnflv Document of FILE C JU' The World Bank FOR OFFICIAL USE ONLY Report No. P-2161a-PO REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF PORTUGAL FOR A LISBON REGION WATER SUPPLY PROJECT March 10, 1978 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 AND EQUIVALENTS Currency Unit = Escudo (Esc) $1 = Esc 38.5 Esc 1 = $0.026 Esc 1,000 = $26 Esc 1,000,000 = $26,000 (Floating exchange rate) FISCAL YEAR January 1 - December 31 GLOSSARY OF ABBREVIATIONS DGSB - General Directorate of Basic Sanitation of the Ministry of Public Works EC - European Communities EFTA - European Free Trade Association EIB - European Investment Bank EPAL - Lisbon Public Water Enterprise IMF - International Monetary Fund SERHSB - State Secretariat for Water Resources and Basic Sanitation in Ministry of Public Works USAID - United States Agency for International Development WHO - World Health Organization

3 FOR OFFICIAL USE ONLY PORTUGAL - LISBON REGION WATER SUPPLY PROJECT LOAN AND PROJECT SUMMARY Borrower: Beneficiary: Amount: Terms: Relendina Terms: Project Description: Republic of Portugal. Government and Lisbon Public Water Enterprise: Empresa Publica das Aguas de Lisboa (EPAL). $40 million equivalent. 15 years including 3 years of grace, with interest at 7.45 percent per annum. $37.8 million to be on-lent to EPAL on Bank terms. The project would increase the production of potable water and improve the water distribution system of the Lisbon region. It would also assist the Government in water sector reorganisation and in design and planning capability. It consists of: (a) construction of a pipeline from the Castelo de Bode reservoir to the Lisbon region and related pumping and treatment facilities; (b) expansion of the Lisbon region water distribution system and (c) studies for the regionalization of sanitary services in the Lisbon area and water supply and sewerage feasibility studies in the Porto and Algarve regions; and short period training abroad for DGSB and EPAL senior staff. The beneficiaries would be 2.6 million people in the Lisbon region, currently including some 300,000 urban poor. The project would face risks if EPAL is not able to achieve the tariff increases required for redressing its financial situation. In that case it could not generate funds for the financing of part of its investment program, nor could it operate as a financially viable enterprise. Construction might be curtailed or extended in time if Government or local banks cannot meet the financing requirements of EPAL. Measures to avoid these risks would be adopted by the Government and EPAL (paragraphs 51, 53 and 62); therefore risks should not affect project implementation. 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 - Project Cost: -- $ Millions ---- % of Item Local Foreign Total Total Transmission pipeline Water treatment plant Pumping stations Distribution system Administration & engineering Land Training of EPAL Staff Sub-total Physical contingencies Price contingencies Total Studies and Training Price contingencies Total Grand Total Financing Plan: EPAL's financing needs for the period (including the proposed project) amount to $180.6 million and would be financed as follows: Funds Sources $ Millions Internal Funds 90.9 Less: Debt Service (87.1) Net Internal Funds 3.8 IBRD Loan 37.8 /1 Caixa Geral de Depositos or Other Local Lenders 79.0 Government Equity 60.0 Total Sources /1 Of the $40 million proposed loan the Government will retain $2.2 million for studies and for management training.

5 - iii - Estimated Disbursements: $ Millions Bank FY Annual Cumulative Appraisal Report: No. 1733a-PO, dated March 1, 1978.

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7 INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE IBRD TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF PORTUGAL FOR A LISBON REGION WATER SUPPLY PROJECT 1. I submit the following report and recommendation on a proposed loan to the Republic of Portugal, for the equivalent of $40 million to help finance a Lisbon Region Water Supply Project. The loan would have a term of 15 years, including 3 years grace period, with interest at 7.45 percent per annum. The Government would relend $37.8 million of the loan proceeds to Empresa Publica das Aguas de Lisboa (EPAL) on Bank terms. PART I - THE ECONOMY 2. An economic report entitled "Portugal: An Economy in Transition" (No. 1408a-PO) was distributed to the Executive Directors on March 16, Country data sheets are attached as Annex I. Past Performance 3. The five years preceding the revolution of April 1974 were years of rapid economic growth for Portugal. GDP increased at an average rate of 7 percent per annum, with industry and construction growing at 10 percent and 12.5 percent, respectively. Investment levels were high--21 percent of GDP on average. The rapid growth in Western Europe contributed to an increase of 9 percent per annum in Portugal's exports (though nearly 20 percent of the total went to the colonies), while the balance of payments also benefited from large numbers of tourists and remittances from the huge migrant labor force (over one million, equivalent to about one-third of Portugal's labor force). As a result, the balance of payments showed substantial surpluses, with accumulated foreign exchange reserves reaching the high level of $1.65 billion at the end of 1973, in addition to a stock of gold of about 860 metric tons. 4. The rapid growth, however, concealed a number of fundamental weaknesses. Agricultural output in 1973 was 3.4 percent below the 1968 level, partly as a result of the emphasis given to industrialization and the exodus of the rural labor force. By 1973, the bottom 50 percent of households were receiving only 14 percent of total income, while the top 5 percent received 40 percent. The social services remained underdeveloped. Economic power was concentrated in the hands of a small number of powerful companies and individuals. The distribution of land ownership was characterized by large estates, especially in the south of the country. The low unemployment level (3 percent) was a consequence of massive emigration (about 550,000 during ) and a growing colonial army.

8 -2- Recent Developments 5. Between the revolution of April 1974 and September 1975, a substantial transformation of the institutional framework and ownership pattern of the Portuguese economy took place. The most important changes were (a) the nationalization of banking, insurance, power, transportation and major industrial groups; (b) comprehensive land reform legislation affecting most of the land in the central and southern parts of the country; and, (c) direct measures to redistribute income in favor of workers, through the establishment of a minimum wage (which has been increased several times), restraints on upper salary levels and price controls. The overall effect of these changes was to establish a new and different relationship between management and labor, which at first resulted in indiscipline, absenteeism and reduced productivity. 6. The social unrest and political uncertainties in Portugal resulted in a GDP decline of 4 percent in However, during the past two years, the economy has shown some sign of recovery (significant increase in industrial production and revival of construction activity) and GDP is estimated to have increased by 5.4 percent in 1976, and by an estimated 6 percent in One of the main sources of domestic demand expansion was the sharp increase in consumption. This reduced domestic savings to a negative level in 1975 and to an estimated 7 percent of GDP in In 1977, however, there was no increase in consumption, and domestic savings increased to an estimated 14 percent of GDP. Investment by the private sector stopped almost completely. However, after a sharp decline of 45 percent in 1975, investment in 1976 increased by 25 percent, due to a strong recovery in construction and to a largely speculative buildup of inventories of raw materials and intermediate goods. This recovery continued during 1977 and investment is estimated to have increased by about 44 percent. 7. During , there was also a deterioration of the fiscal situation as a result of the subsidies, price controls, higher salaries for civil servants, expenditure on returnees, increases in social security benefits and the attempt by the Government to take up some of the slack caused by the shortfall in private investment. The overall budget deficit rose from $400 million in 1974 to about $1.5 billion, or 9.5 percent of GDP, in The overall deficit in 1977 is estimated to be reduced to about $1.4 billion or 8.2 percent of GDP and the current account deficit of the public sector is expected to be two-thirds of the 1976 level because of an increase in taxes, a reduction in subsidies as a result of the increases in prices, and because the deficit of the social security system was reduced by increases in premiums. The rate of inflation also became a serious problem during this period--about 20 percent per annum in , and despite the moderating trend in wages in 1976 and 1977, an estimated percent in 1977, 8. Portugal's balance of payments has deteriorated sharply since 1974; the balance of payments current account dropped, as a result of the unstable situation in Portugal but also of recession in the EC and EFTA countries and of the loss of colonial markets, from a surplus of about $300 million in 1973 to deficits of about $800 million in 1975, $1.2 billion in 1976, and is again expected to be about $1.2 billion in Exports declined sharply. In constant escudo prices, exports declined by 4 percent in 1974, 16 percent

9 in 1975, and increased by 4.3 percent in Despite the devaluation of the escudo in February 1977 and other measures to boost exports (see paragraph 13), an increase of only 4-5 percent is expected for This is mainly because the buoyancy in domestic demand diverted goods away from the export market, and capacity constraints of industries turned out to be far more important. On the other hand, imports in constant escudo prices increased by 8.4 percent in 1974 and, following a decline of about 26 percent in 1975, they increased by 13 percent in 1976 and are estimated to have increased by 10 percent in 1977, due to speculative imports and significant increases in inventories. In addition, the receipts from tourism declined at a rate of 15 percent per annum in nominal dollar terms during , and workers' remittances in 1976 were about 12 percent below the 1973 level. However, tourism and workers' remittances have recently shown signs of recovery; tourist earnings are estimated to have increased by 44 percent in 1977, and workers' remittances by 35 percent. 9. During this period, Portugal lost almost all of its liquid foreign exchange reserves. At the end of June 1977, the liquid reserves were down to $65 million (equivalent to less than one week's imports). However, there still remains a gold stock of about 768 metric tons valued at $4.4 billion at market prices ($160 per ounce in November 1977), serving as a safety net, which Portugal has used as collateral for short-term borrowing; so far, about one-half has been pledged for this purpose. 10. The most serious feature of the current economic situation is the high level of unemployment percent of the labor force at the end of 1976 (in total about 450,000 unemployed). High unemployment is a result of the influx of 500,000 returnees from Angola and Mozambique, a sharp reduction in emigration abroad, a slowdown in the economic activity in Portugal and Western Europe, and demobilization of the armed forces. The Government's intervention during to support many enterprises facing financial difficulties, together with trade union pressures and legislation against dismissals, prevented open unemployment from rising to even higher levels but created widespread underemployment. Such a high rate of unemployment presents problems to which there may be no quick solutions and which can be improved upon only in the medium to long-term. The Government's Response 11. There are no easy solutions to Portugal's economic problems--a perilous balance of payments position, large budgetary deficits, severe inflation, and high levels of unemployment. The Government is faced with a dilemma. Reducing the rate of unemployment will require rapid growth and a substantial increase in the level of investment but this, unless carefully planned, will lead to increased inflationary pressures and will worsen the balance of payments deficit. The Government has taken a number of austerity measures but so far these have not succeeded in putting the economy on the right course. Several austerity measures were introduced in late 1975 and early 1976, and the Soares Government, which came to power in July 1976, immediately committed itself to further measures. It announced a wide-range austerity program on February 26, 1977, which was reinforced by a new package on August 25, The new Government, which came to power in January 1978 is preparing a new austerity program.

10 The main thrust of the economic measures taken by the Government so far has been to reduce the balance of payments deficit by containing consumption and imports, and to stimulate investment and exports. The Government has tried to shift resources from consumption to investment by raising the controlled maximum prices, charging higher prices for public utilities, reducing subsidies, increasing indirect taxes and social security contributions, and by limiting payroll increases to 15 percent per annum in 1977, which, when compared to the estimated rate of inflation of percent in 1977, implies a substantial decline in real wages and, therefore, in the purchasing power of workers. A national council to develop a price and income policy was established in early On August 25, 1977, the Government announced a cut of percent in public expenditures and limitations on new credit, except for exports and export-oriented investments, housing, and agriculture. To stimulate private savings, interest rates on deposits in banks were raised to a maximum of about 17 percent. Government efforts to revive private housing construction will also induce more individual savings, and decontrolling prices should lead to higher business profits. Although private and public consumption has not increased in real terms in 1977, compared with an estimated 6 percent increase in GDP, the level of overall consumption is still high and the share of savings in GDP is low. The challenge now facing the Government is to reduce consumption especially where it competes with exports, to reduce budget deficits, and to control the rate of inflation (beyond the unavoidable and corrective impact of the increases in import prices, due to devaluation of the escudo, in indirect taxes and in utility rates, and of the adjustments in regulated prices). 13. The measures to contain consumption were an important element of the strategy to reduce the balance of payments deficit. The Government has also taken a number of direct measures. To cut imports, import tariffs were increased in May 1975, surcharges on imports were imposed which have since been increased, an advanced deposit requirement was introduced, quantitative restrictions on certain consumer goods were imposed, and credit for imports was restricted. The most important measure, however, was the depreciation of the escudo by about 20 percent between December 1975 and February 1977 and the 15 percent devaluation of February 26, As of August 25, 1977, the escudo was allowed to float against other currencies, with the Central Bank announcing periodic adjustments (about one percent downwards per month) in the exchange rate to reflect price changes in Portugal, and its main trading partners. This depreciation and the devaluation of the escudo were important steps in restoring some of the price competitiveness of Portuguese exports. A series of other measures have been taken recently to encourage exports. These include special credit facilities for exports at concessionary interest rates, various fiscal incentives to exporters, a modification in the export insurance scheme to make it more effective, and the creation of a National Council of Foreign Trade in April These measures, together with the Government's efforts to dampen domestic demand, the return of stable production conditions, the various measures to improve the financial position of enterprises, and the moderation in wage increases, should assist in the recovery of Portuguese exports by improving the competitive position of exporters. The Government has also negotiated some trade concessions for Portuguese exports with the EC and EFTA. For the longer term, the Portuguese Government formally applied on March 28, 1977, for membership in the European Economic Community.

11 14. From a policy point of view, reducing the rate of unemployment has been, and will remain, the most difficult of Portugal's objectives to achieve. Although the Government is still following selectively its earlier approach of stopping open unemployment from rising to higher levels through direct assistance in the form of subsidies, loans and guarantees to those enterprises which are in financial difficulties, but can recover, it is now focussing more on raising productivity and increasing the level of new investment. To further encourage investment from abroad, the Government, in August 1977, revised and improved the April 1976 Foreign Investment Code. A law defining the role of public and private sectors has also been passed. The Government has announced that no further nationalizations are envisaged. In August 1977, the legislation on compensation for nationalized assets was passed. Three important laws on labor relations, governing workers' committees, workers' dismissals and strikes were also enacted. Furthermore, to direct investment to the labor-intensive activities, rebates in interest rates for labor-intensive and export-oriented projects have been introduced. These measures to stimulate private investment are encouraging, and should help remove uncertainty and revive investor confidence. Strenuous efforts are also being undertaken to strengthen the institutional and managerial capability of the public sector and to prepare suitable investment programs. Major sources of employment creation in the immediate future, however, will be in housing, construction and services. Tasks Ahead 15. Although there are clear indications of economic recovery, Portugal's economy is still adjusting to the vast post-1974 turbulence. Despite a considerable medium- and long-term potential, the economic situation at the end of 1977 remains serious. The policy measures so far adopted have been in the right direction and often politically difficult to take, but taken together, they have not attained the desired reduction in the rate of inflation, the balance of payments deficit and unemployment, nor the hoped for increase in the level of savings and investment. More is therefore needed. 16. The revival of growth in the Portuguese economy is by no means an easy task. The process of reconstruction and reform will only be completed over a period of several years, and the prospects for the medium and longterm will largely hinge on the success of short-term stabilization measures. Achievement of these objectives would only be possible in the context of a substantial reduction in consumption and a substantial increase in savings and investment. The public sector budget deficit would have to be cut to reduce inflationary pressures and to free resources for private sector investment. Portugal's situation calls for a growth strategy based on labor-intensive, export-oriented investment, particularly in the manufacturing industry. Government policies must restore Portugal's competitive position to take advantage of the upswing in the world economy. Most of the growth in domestic output should be aimed at increasing exports, and domestic consumption needs to be restrained where it competes with exports for goods. Immediate measures are needed to get the "price signals" right for exports--a general reduction in export costs, elimination of the import substitution bias of the incentive system, consideration of additional export subsidies on a temporary basis,

12 - 6 - and raising interest rates which are deeply negative, even after the significant increases in August Progressive adjustments in interest rates to positive real levels would encourage industrial investment over the longer term and provide incentives for more efficient resource allocation and, in particular, employment-intensive production. Meanwhile, housing, construction and services will have to serve as a means of absorbing the unemployed. The attitude of the private sector toward new investment has so far generally been cautious due to poor financial results and uncertainties about Government policies and legislation affecting such critical areas as labor, compensation, the role of the private sector and foreign investment. Now that a number of laws have been enacted in these areas, the Government can favorably influence investment decisions by effective implementation and the maintenance of stable policies, particularly those affecting price incentives. Decisions on investment projects need to be based on calculations of economic profitability that involve more sophisticated methodologies than are presently employed. 17. The overall growth during 1978 and 1979 will largely be determined by the new Government's policies. With appropriate economic management and external assistance, Portugal should be capable of achieving a growth rate of percent per annum in these two years. If a significant growth in exports (8-10 percent) and fixed investment (15 percent) is achieved, and consumption and imports are reduced further, the economy would have weathered the worst and could look forward to some increase in per capita consumption in the following years. Over the longer period , Portugal should be able to achieve an income growth rate of about percent per annum. This projected GDP growth is realistic and would largely be achieved through exports of manufactured goods and the revitalization of the agricultural sector. Portugal, having achieved growth rates of 9 percent per annum during , is capable of reaching these targets and increasing its exports provided adequate policy measures are taken in time. 18. The new Government recognizes the urgency of the situation, and there are fair prospects of improvements in these directions because first, the Government seems committed to introduce the tough measures that are required, and, second, the country has shed the euphoric and unrealistic expectations which followed the revolution of April We propose to continue to monitor the economic situation closely and to pursue our discussions with the Government with a view to encouraging adequate action in various areas. The former Government, while focussing on the short-term economic management, also turned its attention to sectoral policies to lay the basis for longer-term development and the new Government can now build upon these efforts (paras ) External Assistance 19. Since the last economic report in March 1977, the Bank has continued to improve its understanding of the various sectors of the economy. It will continue to assist the Government in its efforts for restructuring the economy,

13 - 7 - and for bringing about the long overdue institutional reforms and the rationalization of sectors, which will be necessary preconditions to rapid and more balanced development in the future. 20. Multilateral and bilateral agencies have responded well to Portugal's need for external assistance, both for balance of payments support and longterm project loans. With gold as collateral, Portugal has obtained about $1 billion as of August 10, 1977, in short-term loans for balance of payments support from the Bank for International Settlement and European central banks (mainly the Deutsche Bundesbank). The IMF has so far extended about $290 million as gold tranches, oil facilities, compensatory financing, and the first credit tranche. The Bank has approved $110 million equivalent in loans to the power, transport and DFC sectors during FY76 and FY77. In addition, the EC, EIB, EFTA, as well as USAID and other bilateral agencies have committed significant funds to Portugal in emergency concessionary aid and for long-term projects. In total, therefore, aid commitments in 1975 equaled $400 million, and in 1976 over $1 billion. In early 1977 the Portuguese Government obtained from the US Government a short-term loan of $300 million. In addition, in the late spring of 1977, under the leadership of the United States, Portugal obtained a commitment of $750 million in the form of a multi-country aid package for medium-term financial assistance linked to the negotiations with the IMF on the second standby credit. Portugal will continue to require sizeable external capital inflows in the years ahead, and, therefore, the Bank's assistance can play a very important role, not only in providing the urgently-needed foreign exchange for important projects and the technical assistance needed for the restructuring of the economy, but also because it can act as a catalyst to help mobilize other sources of financing. Creditworthiness 21. It is estimated that public and publicly guaranteed medium- and long-term debt (outstanding and disbursed) was of the order of $1,120 million at the end of The debt service ratio for medium- and long-term debt was 6.8 percent in 1976, and is estimated to be about 8 percent in As has been mentioned before (para. 9), Portugal is using its gold stock as security for short-term borrowing purposes. Based on reasonable assumptions concerning export growth, a substantial scale of borrowing, and credit terms, Portugal's debt service ratio is not likely to go much beyond percent by the early 1980s. In the light of these facts, the efforts made by the Government, and the prospects for growth, and on the assumption that the new Government will continue financial stabilization policies, Portugal can be considered creditworthy for Bank lending. PART II - WORLD BANK OPERATIONS IN PORTUGAL 22. The first phase of Bank lending to Portugal was during the period and lending was concentrated in the power sector, in line with Government priorities which reflected the power needs of a rapidly developing industry. Five loans totaling $57.5 million helped finance three thermal and two hydropower projects, which were successfully completed to meet the country's increasing power requirements.

14 The turbulent events of the more recent past and the ensuing dislocation and exodus of managerial talent, high-level technicians and capital, have deprived Portugal's economy of some of its most vital elements. Moreover the transition into an open political system has revealed social and economic weaknesses which are unusual for a high-income developing country. The former Government has been aware of these weaknesses, and after some degree of social and political peace and stability was achieved, it addressed itself to restructuring the economy and the social services, and to carrying out the wide institutional reforms required for that purpose. The dual task of facing the inherited short-term problems and restructuring the country for economic integration within Europe will require far-reaching efforts from the Government and the people of Portugal. Meanwhile, to overcome pressing short-term economic problems and to eliminate the structural deficiencies without postponing developmental efforts, Portugal will continue to require sizeable external assistance, both financial and technical, in the years ahead. 24. The Bank has responded to Portugal's needs by supporting projects in rapid succession, and has been assisting the Government in economic and sector work. The proposed loan, which would be the first for water supply in Portugal, would finance the Bank's ninth project in that country, the fourth since the resumption of lending in At that time, demand for power had outstripped supply once again and a power project was selected as the Bank's first new operation in this familiar sector. A loan to finance a portion of Electricidade de Portugal's investment program for was approved on June 24, Two further operations followed: a loan for a highway project, involving maintenance and construction, preparation of a transport master plan, a railway rehabilitation plan and a road investment plan, and a loan to Banco de Fomento Nacional for industrial finance were approved on October 19, 1976 and May 24, 1977, respectively. Total Bank loans now amount to $167.5 million. Annex II contains a summary statement of Bank loans as of January 31, 1978 and notes on the execution of ongoing projects. 25. In an intensive parallel effort at the macroeconomic and sectoral levels, the Bank assisted the Government in reviewing policy and management issues. Reviews of the water supply (together with WHO) and the education sectors were carried out and were discussed with the Government in March Agriculture and manufacturing export industries were also studied, and were reviewed with the Government in November The report entitled "Manufacturing Export Industries in Portugal" (No a-PO) was distributed to the Executive Directors on January 13, In agriculture, there are major problems, but there is also considerable scope for stepping up growth, and the Government has placed a high priority on developing the sector. A revised Land Reform Law was passed in August 1977 and needs to be implemented quickly so as to remove uncertainties, and make a positive contribution to production. Improvement in the agrarian structure of the small-farm sector will require studying and adopting land consolidation measures to enable younger farmers to acquire land to expand presently unviable farms. To reverse the trend of a very low level of investment in agriculture, consolidation of Government credit agencies and of their functions is urgently needed, and the recent creation of the Financial Institute for Agriculture and Fisheries Development (IFADAP), to channel

15 - 9 - credit for agriculture, is a step in the right direction. Portugal, in the past, has followed a very complex system of agricultural price and subsidy policies, and this needs a complete overhaul to get the "price-signals" right and to correct distortions in resource allocation. Most importantly, the Government has begun to reorganize the Ministry of Agriculture and Fisheries. 27. Portugal's industrial structure, at present, is weak. Its traditional export industries, such as textiles and clothing, are of very small size, have poor management and low productivity. If these industries are to maintain their importance in Portugal's exports, they will have to go through a complete overhaul--closing down the many uneconomic enterprises, merging small firms to achieve economic-size plants, modernizing equipment, improving productivity, and strengthening the financial situation of enterprises. Furthermore, there is urgency in getting new investment underway. Portugal has applied for membership in the EC and, therefore, in addition to expanding its labor-intensive traditional exports, it will have to put its industrial base on a sound footing and modernize its industries. However, Portugal should develop only those industries in which it is cost competitive over the long-term vis-a-vis its European partners in order to survive under the free trade regime. Strengthening the project preparation capability of both the public and private sectors is also of very high priority at present. The Governent has sought, and has been provided, Bank technical assistance in reviewing its plans for an industrial complex in Sines, situated on the Atlantic coast south of Lisbon. 28. In education, a sector in which Portugal has lagged badly behind the rest of Europe, policies to reflect the new socio-political objectives, to eliminate skill shortages in certain categories of labor, to meet the manpower needs of the economy and to help to reduce unemployment are among the main preoccupations of the Government. Measures will need to be taken to reduce regional imbalances and to lessen disparities in the quality and range of educational opportunity available as between the rural and urban areas, and to remedy overcrowded facilities catering to the needs of the poorer sections in urban areas. 29. In the water supply and sewerage sector, Portugal is the most deficient of Western European countries, and the threat of cholera and other waterborne diseases is ever present (Part III). The proposed project would help to remedy this situation. 30. In the light of the sector discussions mentioned above (para. 25), we intend to direct FY78 lending to education and agriculture, in addition to the proposed water supply project. In education, our main objectives at this time are management and technician training to serve industry's future needs, and better teacher training to improve the quality of education. In agriculture, we intend to assist Government's efforts in revitalizing fisheries and to back its major thrust for stimulating on-farm and livestock development. In industry, where our next operation is scheduled for FY79, the focus will be on direct lending to selected industries that are expected to play a major role in Portugal's development programs, and to the extent possible, to small and medium-size enterprises, as they resurface after difficult years.

16 Employment creation, export promotion, and structural reform have been identified as key objectives of Bank assistance to the industrial sector. The Bank's involvement in these major sectors is intended to assist the Government in strengthening its project selection and evaluation techniques, and in linking sector policies closely with the overall economic objectives of the country. 31. Thus, essentially through its involvement in agriculture, industry, education, highways, and water supply, the Bank has mounted a substantial effort aimed at: (i) easing the immediate foreign exchange constraint; (ii) improving the longer-term balance of payments situation by supporting projects aimed at export expansion and selected import substitution; (iii) assisting public investment especially in previously neglected social areas; and (iv) supporting Government efforts toward institutional and policy reform needed to restructure the economy. 32. Sizeable and timely long-term external assistance is essential if Portugal is to be able to deal successfully with the many problems that confront its economy. It is the Bank's objective to contribute to this effort while providing advice on developing the new institutions and reforming old ones, an institutional effort which is indispensable if Portugal is to achieve its overall long-term economic objectives. PART III - WATER SUPPLY AND SEWERAGE IN PORTUGAL 33. Water supply and waste disposal have been badly neglected in the past, and the services and infrastructure available in urban and rural areas are very deficient by European standards. About 66 percent (5.9 million) of the population of mainland Portugal is connected to piped water supplies and 20 percent (1.8 million) to waterborne sewer systems but only about 40 percent (3.6 million) have good water supply, and only 2 percent (0.2 million), good sewerage service. The resulting poor sanitary conditions are a confirmed hazard for public health, in particular among the poor of the main urban concentration areas. These are mainly the Lisbon, and Porto regions which account for nearly 45 percent of the total population of mainland Portugal, and the touristic Algarve region. 34. A cholera epidemic which broke out in Algarve, in , spread to the slum areas of Lisbon and Porto before it could be controlled at high human and material cost; cholera may now have become endemic in Portugal, and this confirms that urgent measures must be taken to introduce modern sanitation systems. Other prevalent waterborne diseases are hepatitis and typhoid. At present, further outbreaks of waterborne epidemics are probably being

17 prevented by, among other measures, heavy emergency chlorination of water. Though unsatisfactory, because it involves health hazards of its own, this is the best that can be done in the prevailing circumstances. 35. The Government is preoccupied with the dangers inherent in this backward sector and is preparing a massive sanitation program to improve water supply, sewerage and solid waste disposal throughout the country. It will also introduce long-term regional planning. Highest priority within this program has been given to the Lisbon region, because it contains almost 30 percent of mainland Portugal's population and, as the focus of internal migration, the largest number of urban poor. Priority has also been given to Porto and Algarve regions because of their large growth rates and especially deficient sanitary conditions. A rapid improvement of the sanitary conditions in these regions, including availability of treated water for the urban poor, is a pressing issue in view of the latent health hazards. It is also very important for the ongoing recovery of the tourism industry, a major foreign exchange earner. 36. The main constraints to the successful implementation of the Government's proposed program are poor sector management due to fragmentation of responsibility, lack of organizational and financial know-how, and shortage of qualified sanitary engineers. Another problem is the financial weakness of sector institutions which places a heavy demand on Government resources. Tariffs 37. Water tariffs are usually related to water consumption and are highly progressive for domestic consumers. Traditionally, commercial consumers have paid less for their water than domestic consumers and industrial consumers have enjoyed even lower rates. The January 1977 tariff increase (100 percent) eliminated the preferential industrial rates, placing industry and commerce at the lowest domestic tariff step. It is expected that there will be further increases for industrial and commercial consumers. 38. In constant 1970 terms, the price of water decreased steadily throughout the 1970s but in January 1977 tariffs were raised sufficiently to compensate for inflation. However, operating costs, especially salaries and energy, had climbed faster than the general rate of inflation during the period (21 percent p.a.), so that tariffs have remained inadequate. 39. Sewerage service is charged through property taxes and only in a few cases is it based on water consumption. Sewer charges are inadequate but increases are presently under study in many areas. Financial Requirements 40. The erosion of water tariffs and the inadequacy of sewer charges have created serious cash deficits which have been covered through Government subsidies. Present Government policy is to allow further tariff increases to cover not only operating expenses, but also to generate part of the funds required for new investment. Discussions with the Government during the sector

18 review and during the preparation of the proposed project have culminated in the understanding that substantial tariff increases would be required if sector institutions were to become financially viable entities. The large tariff increase of 1977 would be followed with another sizeable increase in 1978 and additional increases in future years. Studies included under the proposed project, at Government request, would examine the tariff structures and recommend measures to help sector institutions acquire sound financial positions. 41. Design and construction of water supply and sewerage projects have been financed through Government grants and low interest loans. Until 1975 Government investment was modest--which accounts for the backwardness of the sector--but is now gathering considerable momentum as a result of the initial phase of the Government's sanitation program. Substantial funds for this program are expected to be obtained through internal cash generation and commercial loans, with a decreasing reliance on Government grants. During the early years of the program, however, Government contributions will need to be significant because the water supply and sewerage organizations are financially weak, and commercial loans are made on terms relatively short for this type of investment. Indeed, Government grants represented over 80 percent of the $67 million invested in the sector in 1976, and are expected to exceed 65 percent of the total sector investment of $112 million estimated for Institutional Framework 42. Traditionally, local water supply and sewerage services have been the responsibility of the municipalities, which in some cases have created autonomous entities to operate these services. There is now consensus that some regionalization of services is necessary in large urban areas, particularly Lisbon and Porto. The Government has directed the Lisbon Public Water Enterprise (EPAL), the main water supplier in the Lisbon region, to proceed with studies for the regionalization of sanitary services (water supply, sewerage and solid wastes) in the area. Overall supervision of the sector is the responsibility of the State Secretariat for Water Resources and Basic Sanitation (SERHSB), a branch of the Ministry of Public Works. Its technical arm is the General Directorate of Basic Sanitation (DGSB) which has regional offices throughout Portugal and, at present employs about 300 people including 78 engineers. Both SERHSB and DGSB are weak institutions and many of their functions have been gradually absorbed by other central Government agencies created or assigned to attend to specific sectoral problems. Today, at least five ministries hold some responsibilities in the sector and, as indicated by the WHO/World Bank sector mission, this fragmentation is an important cause of the present disorganization of the sector. Recognizing the deficiencies in the institutional framework of the sector, the Government has recently announced its intention to strengthen DGSB and to give it all the central supervision responsibility. The Government has also made known its intention to seek, in the light of appropriate studies, regional concentration of responsibility in single regional entities in certain large urban areas (EPAL is an example). Consequently the Government faces the dual task of reinforcing DGSB and of establishing sound regional entities with no precedent to build upon. To accomplish these tasks, the Government has asked the Bank to provide training and technical assistance under the proposed loan to help the Ministry

19 of Public Works achieve its targets. The transfer of know-how from abroad through staff training and studies has therefore been included in the proposed assistance package. Some of the important points thus covered are: (i) Preparation of timetables and recommendations for the conversion of EPAL into a regional water supply authority and for the gradual regionalization of sewerage and solids waste services; (ii) Review of the organization, staffing and operation of the existing water supply and sewerage agencies in Porto and Algarve and preparation of specific recommendations on institution building and training programs; (iii) Determination of the level of water and sewer tariffs required to cover operation and maintenance costs, debt service and to provide a surplus to contribute to the normal expansion of the systems. 43. Water supply and sewerage projects are usually designed by private consultants and constructed by contractors. Design criteria for water distribution and wastewater collection are often outdated and there is little local expertise in wastewater treatment and disposal. Projects are not subject to financial feasibility or economic analysis, and are usually over-designed. Construction is supervised by the municipalities or by central Government agencies involved in the sector, and is generally of good quality. Seminars are being organized in Portugal by USAID and WHO to assist in improving the quality of project preparation. The Lisbon Region 44. Greater Lisbon extends on both shores of the Tagus (Tejo) River estuary and covers an area of about 600 km2, spread over many municipalities. The Lisbon region includes greater Lisbon plus rural municipalities situated on the periphery of the urban area or along the route of the water transmission pipelines (see map). The population of the region is estimated at 2.6 million and is projected to reach 3.6 million by The Tagus River is used by EPAL as the main source of water supply for the Lisbon region. It is the longest river (900 km) in the Iberian peninsula; it originates in Spain and crosses Portugal from east to west. The Tagus has been an important element in the development of both Spain and Portugal. However, intensive agricultural and industrial development in the river basin has caused rapid deterioration in the quality of river waters, forcing EPAL, which uses the river as its main water source, to upgrade its treatment facilities. This deterioration has also made further use of the river, for additional water, unsafe. The Government is taking steps towards eliminating the most dangerous sources of pollution. One of these sources, the city of Santarem, directly affects water quality at the main water intake of EPAL, contributing to the need for special water treatment arrangements at high cost. To control this pollution source the Government will start

20 construction of an adequate sewerage system before July 1979 (Section 3.06 of the Loan Agreement). The Castelo do Bode reservoir, to be developed under the proposed project, will provide an alternative unpolluted water source for the Lisbon region. 46. EPAL presently operates the water supply system in the Lisbon municipality and also sells water wholesale to municipalities of the Lisbon region located north of the Tagus estuary. In total, EPAL provides water to about 1.6 million people. The municipalities south of the Tagus estuary have their own water supply systems, based on the aquifer underlying the Setubal Peninsula. New well fields are being developed in that peninsula but decreases in the yields of existing fields and lowering of the water table indicate that the aquifer might already be overdrawn. Consequently EPAL will provide additional water to these municipalities in the coming years. Feeder lines, trunk mains and network storage facilities are generally inadequate, so that service on the periphery of the distribution systems is usually intermittent. These deficiencies, coupled with the continuous water shortages, have prevented the normal expansion of the secondary networks and the elimination of temporary supplies. Indeed, there are still many people served by standpipes even though they could afford house connections. PART IV - THE PROJECT 47. The Government of Portugal has requested Bank assistance for financing the investment program of the Lisbon Public Water Enterprise (EPAL), which is designed to increase water supply in the Lisbon region, to meet demand up to Through the expansion of the distribution network in low income areas this would also permit provision of safe drinking water to 300,000 urban poor. It has also asked for assistance in reorganizing the sector and strengthening urban and rural planning and project design capability in the country. The proposed project responds to these needs and would create over 20,000 manyears of employment at a time Portugal faces a serious unemployment problem. It was identified in January 1977 following the WHO/World Bank sector review, and appraised in May/June 1977; negotiations took place in Washington, January 9 to 13, The Portuguese delegation was led by Dr. Antonio dos Santos Labisa, Advisor, Bank of Portugal, and included representatives of the Ministry of Finance and EPAL. A report entitled "Portugal - Lisbon Region Water Supply Project" (No. 1733a-PO), dated March 1, 1978 is being circulated separately to the Executive Directors. The main features of the Loan and project are listed in the Loan and Project Summary and in Annex III. Project Description 48. The project comprises the major part of EPAL's investment program for the 1978 to 1982 period, namely, developing the Castelo do Bode Reservoir (see map) to supply the Lisbon region, and involves:

21 (i) Construction of the Castelo do Bode aqueduct with an initial capacity of 385,000 m3/day, including the installation of an 89 km long transmission pipeline between the existing Castelo do Bode Reservoir and Lisbon, and the construction of a water treatment plant and two pumping stations. (ii) Expansion and upgrading of the existing distribution system, including installation of nine inter-municipal trunk mains, with a combined length of about 73 km, construction of three pumping stations and seven network reservoirs with a combined capacity of 130,000 m3, and expansion of the distribution networks to areas currently served by temporary supplies and standpipes. (iii) Studies for regionalization of sanitary services in the Lisbon area, and feasibility studies for water supply and sewerage systems in the Porto and Algarve regions. (iv) Provision for the training of senior staff of General Directorate of Basic Sanitation (DGSB) and EPAL through short visits to water supply and sewerage organizations and systems abroad. 49. The project is technically and economically sound. The Castelo do Bode scheme is, under present conditions, the least-cost solution for increasing the water supply of the Lisbon region, and the studies and training will contribute toward better management of the sector. Project Cost and Financing 50. The total project cost is estimated at $153.2 million, net of taxes, with a foreign exchange component of $40.0 million or 26 percent. Construction costs, including transmission pipeline, water treatment plant, pumping stations and distribution system, would amount to $148.7 million, including physical and price contingencies. The studies and training component would cost about $4.5 million, including price contingencies. Prices for foreign equipment are assumed to increase by 7.5 percent in 1978 and 1979, and by 7 percent thereafter, and prices for construction by 15 percent in 1978, 10 percent in 1979 and 1980 and 8 percent thereafter. 51. The project would be financed by the proposed $40 million Bank loan, covering the foreign exchange cost, a $60 million equivalent Government equity contribution and by local bank loans, the main provider of which is expected to be the Caixa Geral de Depositos. The Government would retain $2.2 million of the Bank loan to finance the studies and training, and would onlend $37.8 million to EPAL towards construction costs. The local bank loans and Government equity contributions for the proposed project constitute part of the funding of EPAL's financing requirements up to EPAL's requirements and sources of financing would be as follows:

22 Amount ($ millions) Percent Funds Requirements Construction: Project Other construction Acquisition of meters and mechanical plant Total capital expenditure Increase in working capital Total Requirements Funds Sources Internal funds Less: Debt service (87.1) (48.2) Net internal funds IBRD loan Caixa Geral de Depositos or other lenders Government equity Total Sources The Government and the Caixa Geral de Depositos have indicated in letters of intent their willingness to provide in equity and in loans respectively, the funds required for EPAL's investment program. EPAL's entering into a financing agreement or agreements with the Caixa or other lenders is a condition of effectiveness of the proposed loan. For timely execution of financing arrangements, EPAL will submit annual investment programs in advance to the Government and other financing sources to indicate its lending requirements in the period ahead. Project Implementation 52. The project will be implemented by EPAL except for the feasibility studies for water supply and sewerage in Porto and Algarve regions and training of senior staff for the General Directorate of Basic Sanitation which will be executed by the Government. EPAL is a financially autonomous public company created in It is the largest supplier of water to the Lisbon region and can set tariffs, subject to Government approval, to cover all costs. It functions under a management board; EPAL's three top executives (general manager, and executive directors for financial and technical services) are the chairman and members of this board. The company has just over 1,500 employees, including about 1,000 technical and manual workers. EPAL is well managed and it is carrying out its responsibilities effectively. However, it still has to overcome a number of problems, mainly involving finance, labor relations and planning. The proposed project will help EPAL deal with these problems through staff training and institution building measures. EPAL has agreed

23 to establish and to pursue yearly staffing, training, system operation and financial targets in consultation with the Bank (Section 3.02 of the Project Agreement). It has also agreed to set up a planning department which will examine and propose improvements in EPAL's organizational arrangements and productivity (Section 3.03 of the Project Agreement). 53. EPAL took over from the former concessionnaire at the peak of the cholera epidemic and in the wake of the revolution, with a clear mandate to improve water supply services quickly and without sparing expenses. It received badly maintained facilities, which were insufficient to satisfy the water demand. It had to launch a large program of studies, repairs and expansions. The financial effects of this program have been compounded by severe inflation, large salary increases despite low labor productivity, and increased energy costs. Loan financing has added to EPAL's difficulties because of high interest rates and rplatively short amortization periods. Until the January 1977 doubling of tariffs, EPAL was not allowed to put up tariffs to cover costs. In 1974 and 1975 it incurred large net losses and, in 1976, it was assisted by a $12.0 million equivalent Government grant as compensation for deferred tariff increases. The doubling of average tariffs in 1977 helped EPAL to redress its finances to a significant degree, enabling it both to service higher interest charges in 1977 (on loans for financing its investment program) and to reduce its net loss after interest by about 75 percent compared with the potential loss of the previous year. The proposed project would help EPAL to substantially and progressively improve its financial situation so that already as of 1978 EPAL would break even despite further large increases in interest payments. EPAL is expected to make steadily increasing net profits starting in 1981 with an important acceleration in 1983, following project completion. This improvement would be achieved by an average tariff increase of 30 percent and a small repayable Government contribution in 1978, and by subsequent yearly tariff adjustments. The Government has authorized the 1978 tariff increase. Implementation of these higher tariffs would be a condition of effectiveness of the proposed loan. Agreement has been reached that in the future EPAL will set and maintain tariffs to cover all expenses (other than depreciation) and debt service and, beginning 1983, contribute towards the cost of its future investment program (Section 4.04(a) of the Project Agreement, Section 3.01 of the Loan Agreement). It is EPAL's confirmed policy to charge incremental costs of service to consumers who can afford it and to keep earnings at such levels as to provide a reasonable return on capital investment. EPAL has agreed to take effective action to achieve these objectives after the completion of the regionalization study but no later than the end of 1980 (Section 4.04(b) of the Project Agreement). 54. Currently EPAL's net cash earnings do not adequately cover debt service. EPAL would therefore not raise further loans without the consent of the Bank, unless its net cash earnings before depreciation and all interest exceed 1.5 times its expected debt service in any future year (Section 4.05 of the Project Agreement). From 1983 onwards, EPAL is expected to achieve a debt service coverage which will satisfy this ratio. Intimately bound to the financial prospects of EPAL are those of the municipalities to which EPAL supplies bulk water. I4unicipal services are financed through taxes on property

24 rental income, collected by the Government and remitted to mun:icipalities for their exclusive use; since 1974, remittances have been erratic., Municipalities have been in financial difficulty and they have not been paying EPAL their water bills; at the end of 1977 arrears amounted to $6.4 million equivalent and some pending bills dated as far back as This problem has received Government attention and is now settled. The Government has agreed to ensure that future billings to municipalities will be paid within three months of EPAL's billing date (Section 4.02 of the Loan Agreement). Procurement 55. Materials and equipment contracts estimated to cost more than US$100,000 per contract will be procured after international competitive bidding in accordance with the World Bank guidelines. Other materials and equipment contracts, estimated to have a combined cost of less than US$500,000 would be awarded on the basis of local competitive bidding in accordance with EPAL's procedures, which are acceptable. In determining the award of materials and equipment contracts, it is proposed that qualified domestic manufacturers will be given a margin of preference of 15 percent or customs duties whichever is lower. Most of these contracts are, however, expected to be awarded to foreign suppliers. Civil works contracts expected to cost more than US$500,000 will be awarded after international competitive bidding in accordance with the World Bank guidelines. Other civil works contracts, estimated to have a combined cost of less than US$16.0 million, would be awarded on the basis of local competitive bidding in accordance with EPAL's procedures, which are acceptable. Minor works, such as replacement of secondary networks estimated to cost no more than $50,000 in any particular case may be carried out by EPAL through force account, under arrangements acceptable to the Bank, up to a total value of US$1.0 million. The construction contracts for the Castelo do Bode Aqueduct (transmission pipe line, water treatment plant and main pumping stations) will include related material and equipment and are expected to be awarded to joint ventures of foreign and Portuguese contractors. The civil works contracts for the expansion of the distribution systems are expected to be won by Portuguese firms. The supplementary studies will require about 400 man-months of technical staff and 350 man-months of supporting personnel. The average foreign exchange cost for technical staff would amount to about $5,000 per man-month including the overhead and profit of the consulting firms. Advance contracting is envisaged for some of this work to permit an early start of implementatioln. Therefore, retroactive financing of up to $50,000 is recommended for expenditures incurred on these studies after September 30, Disbursements 56. The proposed loan would be disbursed over a five-year period as follows: 30 percent of total expenditures required for the construction of the Castelo do Bode Aqueduct, which represents the estimated foreign exchange component of these works; 15 percent of total expenditures on civil works contracts, and 100 percent of foreign expenditures (if locally manufactured, 100 percent ex-factory) on material and equipment contracts requiired for the

25 expansion of the distribution system; 50 percent of total expenditures for the consulting services required to carry out the supplementary studies, which correspond to the estimated foreign exchange component for this work; and 100 percent of foreign expenditures for training of staff. Environmental Impact 57. The studies to be financed under the proposed loan should provide adequate solutions to the immediate water supply and sewerage problems of Lisbon, Porto and Algarve regions. Both the studies and the training component should improve local expertise on sanitary and environmental engineering for the successful implementation of the proposed countrywide sanitation program. Negative environmental effects of construction under the project should be negligible. Justification 58. Permanent water shortages and inadequate distribution networks today characterize the water supply systems of the Lisbon region. These deficiencies have led to the extensive use of inadequately treated waters. Furthermore, the inability of the water authorities to maintain constant supplies at adequate pressure has resulted in intermittent service, severe summer water rationing, and contamination of waters in the peripheral distribution networks. The inevitable consequence has been the highest incidence of waterborne diseases in any large European city. By providing sufficient water, and by integrating the various municipal distribution systems, the project should greatly improve sanitary conditions in the Lisbon region and would make safe water available to all inhabitants. Among them are about 300,000 urban poor at present inadequately supplied, including slum dwellers who now receive water from contaminated sources, treated only by emergency chlorination. About 135,000 people at present supplied with potable water from standpipes, will have access to house connections. 59. The project is expected to have a major institution-building impact, since it would be the largest, best planned and most comprehensive Portuguese undertaking in water supply. The project's implementation should reinforce EPAL's position as the foremost water supply agency in Portugal and should provide valuable lessons for planning, designing, financing and constructing water supply systems in other parts of the country. Under the project, EPAL would set up a planning office with organization and methods capability to better organize its operations and future expansion. The regionalization studies will analyze the advantages of separate and combined water supply and sewerage agencies, and will examine the domestic and industrial tariffs for water and sewer services. They should greatly assist the Government in implementing its sanitation program. 60. Savings in public health expenditures (i.e., curative medical costs), because of the project's preventive contribution to public health, constitute economic and financial benefits of the project which, however, are difficult to quantify. The development of the Castelo do Bode source is the

26 least-cost solution for increasing water supply to the Lisbon region. A further benefit of the project would be the creation of about 1,500 permanent and 22,000 man-years of temporary skilled and non-skilled jobs, at a time when Portugal faces a severe unemployment problem. 61. Revenues derived by EPAL from present retail tariffs in the Lisbon region would give an internal financial return on the total investment program of about 2 percent, which confirms the evidence of the financial forecasts that tariffs are too low. An increase of about 70 percent (in constant prices) would be necessary to match average incremental costs and the attainment of this level by the end of project construction would yield an internal financial return of about 10 percent. Risks and Safeguards 62. In view of the heavy demands upon Government financial resources (and those of the Caixa Geral de Depositos) caused by the overall construction program to be implemented at a time of exceptional economic strain for Portugal, there is a risk that construction might be curtailed or phased in time. However, the high priority accorded by the Government to the project, coupled with the fear of another cholera outbreak with its immediate consequences on tourism revenues, is expected to provide adequate motivation for the timely provision of funds. Agreement was reached on appropriate administrative procedures to ensure availability of the necessary funds (Schedule 2, paragraph III of the Loan Agreement). The proposed Government contribution towards the project and towards related works by the municipalities (which together will serve about 30 percent of Portugal's population) is estimated to average about $18 million annually during In view of the very difficult economic conditions prevailing in the country, in particular the high inflation, uncertainties exist regarding the timely implementation of tariff increases. However, the program of gradual increases (paragraph 53) is consistent with Government policy and should help to mitigate this problem. PART V - LEGAL INSTRUMENTS AND AUTHORITY 63. The draft Loan Agreement between the Republic of Portugal and the Bank, the draft Project Agreement between the Bank and Empresa Publica das Aguas de Lisboa, and the Report of the Committee provided for in Article III, Section 4 (iii) of the Articles of Agreement, are being distributed to the Executive Directors separately. 64. Special conditions of the project are listed in Section III of Annex III. Execution on behalf of the Government and EPAL of a subsidiary loan agreement, an increase in EPAL's tariffs, financing agreements with appropriate lenders providing at least $80 million for EPAL's investment program, and appointment of financial and commercial directors by EPAL are special conditions of effectiveness.

27 I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank. PART VI - RECOMMENDATION 66. I recommend that the Executive Directors approve the proposed loan. Robert S. McNamara President Attachments March 10, 1978 Washington, D.C.

28

29 PORTUGAL ANIZX I TABLE 3A Pa4-1 of 4 - SOCIAL INDICATORS DATA SHEET LAND AREA (THOU KM2) PORTUGAL REFERENCE COUNTRIES (1970) TOTAL 92.1 MOST RECENT AGRIC ESTIMATE GREECE ITALY SPAIN *0* GNP PER CAPITA (USS) * La * * POPULATION AND VITAL STATISTICS POPULATION (MID-YR. MILLION) / POPULATION DENSITY PER SQUARE KM La PER S). KM1. AGRICULTURAL LAND j VITAL STATISTICS CRUDE BIRTH RATE (/THOU, AV) CRUDE DEATH RATE (/THOU.AV) INFANT MORTALITY RATE (/THOU) LIFE EXPECTANCY AT BIRTH (YRS) GROSS REPRODUCTION RATE POPULATION GROWTH RATE (%) TOTAL 0.7** O.S URBAN URBAN POPULATION (% OF TOTAL) AGE STRUCTURE (PERCENT) 0 TO 14 YEARS TO 64 YEARS , YEARS AND OVER AGE DEPENDENCY RATIO ECONOMIC DEPENDENCY RATIO 1.0 /a 1.1 j 1.0 b L 1.1 La FAMILY PLANNING ACCEPTORS (CUMULATIVE. THOU) USERS (% OF MARRIED WOMEN) EMPLOYMENT TOTAL LABOR FORCE (THOUSAND) ,0 ** LABOR FORCE IN AGRICULTURE (X) L 23.4 c UNEMPLOYED (% OF LABOR FORCE) j INCOME DISTRIBUTION % OF PRIVATE INCOME REC D BY- HIGHEST 5% OF HOUSEHOLDS HIGHEST 20% OF HOUSEHOLDS LOWEST 20% OF HOUSEHOLDS LOWEST 40% OF HOUSEHOLDS DISTRIBUTION OF LAND OWNERSHIP % OWNED BY TOP 10% OF OWNERS % OWNED BY SMALLEST 10% OWNERS HEALTH AND NUTRITION POPULATION PER PHYSICIAN /b,C /C /d /b POPULATION PER NURSING PERSON. /bd L POPULATION PER HOSPITAL BED Z PER CAPITA SUPPLY OF - CALORIES (% OF REQUIREMENTS) L.fI PROTEIN (GRAMS PER DAY) /j OF WHICH ANIMAL AND PULSE /a DEATH RATE (/THOU) AGES /e EDUCATION ADJUSTED ENROLLMENT RATIO PRIMARY SCHOOL SECONDARY SCHOOL o L o.o 57.0 YEARS OF SCHOOLING PROVIDED (FIRST AND SECOND LEVEL) VOCATIONAL ENROLLMENT (% OF SECONDARY) ADULT LITERACY RATE (%) HOUSING PERSONS PER ROOM (URBAN) 1.0 O.B.... OCCUPIED DWELLINGS WITHOUT PIPED WATER (X) 71.0 I ACCESS TO ELECTRICITY (% OF ALL DWELLINGS) RURAL DWELLINGS CONNECTED TO ELECTRICITY (X) CONSUMPTION RADIO RECEIVERS (PER THOU POP) 95.0 i45.o 174, PASSENGER CARS (PER THOU POP) ELECTRICITY (KWH/YR PER CAP) NEWSPRINT (KG/YR PER CAP) _ _ - _ SEE NOTES AND DEFINITIONS ON REVERSE

30 ANNEX I Page 2 of 4 unlec oher,!rnot d, dta for 1960 refet to,any year batwaan 1959.nd 1961, for 1970 b.tvea 1968 and 1970, and for Moat Ra...t E.tia,ate between 1973 n GNP per oapita dat. are based oo tha Wolod Bank Atlas methodology ( basia). Doe to onig-ti-o pop.lation growth rate.to Iar than rate of natural inerease.. Sp.ir b.. beco -vi-ted asoan objective country because of its topology and it eseaa likely that, shoul.d Protuga1 manage to attain the level per -apl.ica ucoc of Spain, th.atruoootra of the Portuguese.-oud Ia ahow aiilaritisa with that of Spain. PORTUGAL, 1960 I Ratio of population under 15 and 65 and over to total labor force; /b 1962; /c Regisetred, including physiciane p-taing dentistry; /d Including assistant nurses; /a 1965; 7Lf Inside on~ly. of 1970 / Ratio of population under 13 and 65 and over to total labor force; lb E.cludlng unenployed; I Regiutered, Including phyalci..a practicing dantietry; /d Including assistant nurseso; -7e Total, urban and rural. m.ostrecent ESTOMATt,: Ia 1976; /b Ratio of population undet 15 and 65 and ove r to total labor force; cfe..l.ding unemployed, /dt Inclu_ding phyaicians practicing dentiatry; L!e Hospital perecunne1, i~dding of nid.ivee and aaeiatant nursees; /f average; /A Diarupted enrollment due to political unreat. GREECE? 1970 Ia1967. ITALY 1970 I Ratio of population under 15 and 65 and over to total labor force; lb Hospital peraonnel. SPAIN 1970 /a pt,opoy,et office -aticeate; /b Rogiatcrd, eot all practioing in the country, Rll, January OgyDIIrIOIU OP SOCIAL INDICATORS Land Area (thou ka 2 ) Population par nursing, person - Populatiost dividod by n,obor Total of practicing -Total -uf.ce atu -prising land area and inland wat.rs, ale and f-walgraduata nus,trained" ar `certified` Mgi.-Oost reteot nurs., estimate and of agricultural area used temporarily or patia- a,eiliary Paraonnel With training or eaperiance. nently for crope, patur-a, earkac & kitchen gardeao or to Itis fallow. Pap,latien per hos bialbd - Papulation divided by n,mber of hospital hada aalbein public n private gan.r. an.d apcialieed hospital and GNP? per.apita (us$) - GNP per tapica.ati-etea at current -aket pricta, rehbilitation esntsr;.calculatd aciod.as n.rsig by a-m baosea -- veain and eatabliaboo.nt. method ae World for Bank Atlee ( basis); custodial and preventive care. 1960; 1970 and 1975 data. Per capita supply of sglaries (% of r*eouir esnt:) -tcepot.,d equivalent fro or energy nat toad.uppilaa a_ailaba in counry par cpita par day: Ppoplation and vital ettiatic. available supplies emepris. dossatic production, Population beporta lasa (mid-ya e.port., milo) and A. of July fi-at: if not avilabie. average changes in atock; aftw ndyuretiates oat supplies eatld. 16,190ad animal feed, 95 seeda, aa quantities used in faod proceaaing and louses in distribution; rsquiromeets wera eatimarcad by FAO ba..ed on phyeiolgioai ns.do for mernl activity and health Population d...aity nonid- - par suoare kou - MId-year population. par aquare kilestar acing nviroamonta1 temperature, body weights, age and see distributiona of (110 hectaree of total rer. 1ponlation dams ity - par population, ouar..w end of aari.. allowing land 10% - for waste Conputed at aa household babve for leve... Pet capita supply of prtotei fars per day) - Protein onteet o af Iiclorl ad per omly. capita nettsupply of fand par day; net supply of food is defined aa above; rqi -etafor all countries eatabliab.d by USDA Economic Rceseatch Servicee Vital atatistios. Provide for a minimuan alaneof 60 gross of total protein Crode per birth day, rate and Prt thousn, ad er"t" - Annual live birtho par thousand of 20 grosa of animal and pule. protein, mid-your of which population; 10 groea ta-year should be animal arithmetic sysrages ending in 1960 and 1970, protein; thea. atandards are losr than thus. of 71 ores and of five-year total protein vavrago -ding in 1975 for mast re...centstinate, and 23 groma of animal protein as an avaraga for the world, Crude propoaed death by rate FA0 par thousand, average - Annual deaths per thoueaand of odid-year in the Third World Food Survey. population; tan-year arithastic averagee ending in 1960 and 1970 and five- Per capita protein supply fre animal and pulse - Prtotin supply of yer fond average anding in 1975 for moat recent ea1timt. derived fr- animals and pulses in graies per day..otect untlt ae(tol-annual deaths of infants under one year of age Death rate (Ithmu) esee Annual deaths par thouasnd in ags group 1-4 per thousn lie iths. Life.noactranoYlat bilrth yeara, fyrs) to children - Average in thia n,ecr as. group; of years suggested of lif. as emaining an indicator at of malutition. birth;.auaily five-year avrags. ending in 1960, 1970 and 1975 for developing cntise. Educ.mtion GtOso reproduti.n rate - Average onmber of live daughtera a woean Will bear inhe Adiusted enrolletyratio.ora roprodtctive -Ermryshal.gro11ast period if she aexperiences present age-specific of all ages as par- prmay Petgao cholag pauac ;incue hlrn d61 er fertility rataa; ugually five-year aeyrages ending in 1960, 1970 and 1975 but adjuated for different lengtha of primary education; for develping for coutrisa countries. with univara1 education, enoletmy aecead,poplation1growth 100% since am ratse7. pupils total are below - Conpood annual growth rate" of eid-year or above the official school age. popuatio for195060, ad Adjustad anlmtratioe ecn at Population scool - Computed rowth rate6 aa above; (i)-6 secondary orhn Clspu.ted like growth rate of total education rquire atlet four years of approved primary population; Instruction; diffsrent definitiosa of urban aree. may affect C-sparability of providas general, vo.ctional or teacher training inetroutiona for pupila daeaogcountries, Olrba of 12 ta ouain( 17 years of fttl age; correpondeno ai fubnt -- taa 6se are population; gene.rally different... lid.d. Years of schooling definitiono proided of ifiret orb-o an eedlses ar.s my affect otlyaso conparabil1ity of data soang oputrims. schoolig; at seon.dary level, vacetional Instruction may be partially or aompletely aeladed. esrcue(1percent) - C"hildr.n (0-14 years), -Okies-ais (15-64 yerar), V9ocqatinal serelmaet %af "reeayl - Rotational imatitutian include andretred( ere. and over) aa porceotages of mid-year population, tehia,industrial or other programs which operate independently Age dp-mdeoty or rai a ai fpplation under 15 and 65 and ovr to thea. deparutneots of secondary inetituti.na. o.f agee 15 through 64. Adul.t!lite1racy rate (%) - Literate adults (able to read and ic write) ri dependecy ae per- ratio - Rlatfo of population under 15 and 65 and over to a oa Istg adult population aged 15 the years labor and fror ovar. in age group of yeare. Family Elsncinu-a.c.p-ot ic-nl.ttva. thou) - CuoIltive neber of acce Ptora jjnjg.gr of bir th- control dovi-e rodor a.. picas of ntoa fanily pl.miog program Pareon par rae furban) - a Average or oocpcion ntshr of person par rom in occupied conventional. dwelling in urban or...a; dwellings eaclude tiiy lning on-paes - a..nt users Cl of married anen - Pertentgags af maried ws,sa of structurea and unonoupied parts. child-hearing age (15-44, ys..r.) who us birth-control devios, to all maried Occupied d luello without piped water i - Ocupid wone tonn covntoa age group. dwellings in uban ad rurali areas without inaide or outsidea pi~ped wa1ter fanilitisa ~~~~~~~~~~~~~~~~~~~~~~Atcasto electricity (7ofa'ldl deel=ine - Conventional dwelling. With tmplov,oett Total labor force (thousand) - Eoonmeic11y active persons, including armd elec tricity in living quarters fornes as pertent and unoployd of total hut dwellinp eacludieg ha u.e.ivee, in urban and students, etc.; definitions rural areas. in.. ari..a eounrtetarer not ceparable. mural dwelling. cenord to electricity Labor Ml force - Computed inagriculture as above (%) for - rural Agricultural labor force (in faming, foreatry, dwellings only. hooting and fiahig) aa erntage of total labor farce. t)sonplayed (I ofibor force)r f- splaysd.are usly.defined as preoa" who Coapeoption are able,and Willing to tekn job, out ofa job on given day, reained out gadie receivers (per thou pool - All type of receivera for radio broadcas.ts of a J b ad aeeking work for a epecified minimum period sot exceeding one to general public per thousand of populetje; exclude. uninaneed seeb; may remeivera not he reparable between coutries due to different definitions in countria and in years when regietrati.n,of radio sets of unployed -ae in ffsct; and sourte of data, e.g., amploymat office statistics, sample data for recent yere may not b he survey., -.rparbe compulsory since mast.motrise uneaploymt abolished I auranc... licensing. Passeneroars I par thou imp) - Passenge.r cara comprise mstecarc.se aeting Inc=s dis.tribu.tion - Parceocatge of privateisteeo (both in cash end kind)la tn recive eight P-reosa; by rich-a enclude. 5%, ssbul.amase richest 20%, hearses pooret and 20%, military and poorest 40Y% of house- vehicles. holds. Electricity (khb/yr per cap) - emual oowa"tie, of imdustriel, cril Die tribotion public of -ad Privaet load electricity -.rerhip - Parc...toea in kilowatt of beur lend per ownd capit.,' by neal wealthtest 10%Z baed en preduetien data, and poorest without 10% allowanc of loand for oenera. Iwo"s in grida but allow ins for Imparts end exports of electricity. Newsprint(h/yr per cap) - per capita annual eanaprie in kilogres P,lk an.h,,d ut,r.1itio eaitdfr populatin doeestie oa preductiw ehy.liia plus net - Popu Importe lation of divided neweprint. by n,ber of practicing physirians qualified fin a me-dical school at university level.

31 ANNEX I COUNTRY DATA - PORTUGAL Page 3 of 4 AREA POPULATION DENSITY 2 92,072 km million (mid 1976) 105 per km Rate of growth: 0.9% ( ) GNP PER CAPITA (1976) $1690 POPULATION CHARACTERISTICS (between 1973 and 1975) HEALTH (1974) Crude birth rate (per 1000): 19.2 Population per physician: 900 Crude death rate (per 1000): 10.5 Population per hospital bed: 170 Infant Mortality (per 1000 live births): 37.9 NUTRITION (between 1973 and 1975) EDUCATION (1973) Per capita caloric intake as % of requirements: 118 Adult literacy rate %: 70 Per capita protein intake (grams per day): 85 Primary school enrollment %: 116 LAND OWNERSHIP (1968) (in % of total) Up to 4 ha 4 to 50 ha Over 50 ha Number of farms: Area: GROSS DOMESTIC PRODUCT IN 1977 /e (current prices and current exchange rate) ANNUAL RATES OF GROWTH (% constant prices) $ million % /e 1977 /e GDP at market prices 16, Private and public consumption 14, Gross domestic savings 2, Gross domestic investment 4, Current account deficit 1, Exports of goods and NFS 2, Imports of goods and NFS 5, GDP at factor cost 15, of which: Agricu].ture 2, Industry 6, Services 6, LABOR FORCE AND PRODUCTIVITY IN 1976 Labor Force V.A. Per Worker /e 1000 % $ % Agriculture , Industry 1, , Services 1, , Total/Average 3, , GOVERNMENT FINANCE (billion escudos) Revised % of budget GDP Current receipts (14.4) Current expenditures (18.5) Current surplus/deficit (-) (-4.1) of the state Balance of autonomous funds and (0.7) services and local administration Balance of social security system (-2.1) Current surplus/deficit (-) of (-5.5) public sector Capital expenditures (4.3) Overall deficit (-9.5)

32 ANNEX I Page 4 of 4 COUNTRY DATA - PORTUGAL (continued) Billion Esc. End End Annual Percentage Increase MONEY, CREDIT, WAGES AND PRICES /e /e Money and quasi-money of which: currency sight deposits time deposits nil 34.8 Bank credit of which: private sector public sector nil Wages (Lisbon and Oporto) Consumer prices (Lisbon and Oporto) BALANCE OF PAYMENTS /e MERCHANDISE EXPORTS, 1976 /e (current prices, $ million) $ million % Exports, fob 1, , , , ,938 Imports, fob 2, , , , ,372 Agriculture of which: oil (154.7) (531.3) (572.5) (662.5) (incl. wine) Trade deficit , , , ,434 Textiles and footwear Tourism, receipts Machinery and Other NFS, net equipment Factor income, net 1, , , ,030 Chemical 33 2 Wood, cork and Current balance , ,152 furniture Others Direct foreign , investment EXTERNAL DEBT END-1977 /e Public MlT loans (outstanding and disbursed) Disbursements Amortization $ million % Subtotal Public debt 1,437 ST capital and errors *- Debt service 155 and omissions payments Capital grants *- Debt service 8 ratio Other capital (nei) IBRD LENDING, December 31, 1977 Changes in reserves (- = increase) $ million Official reserves, 2, , , ,302.0 gross end of year /b Outstanding and 32.3 of which: Gold 1, , , , disbursed Foreign 1, , *- Undisbursed exchange Outstanding, including RATES OF EXCHANGE undisbursed 1973 $1.00 = Esc (February) $1.00 = Esc $1.00 = Esc (August) $1.00 = Esc $1.00 = Esc (December) $1.00 = Esc $1.00 = Esc (January) $1.00 = Esc /e estimated /p provisional /n includes claims on non-monetary financial institutions /b IFS. Gold is valued at official prices. February 17, 1978 Not available EMENA Region Not applicable

33 ANNEX II Page 1 of 2 STATEMENT OF BANK GROUP OPERATIONS IN PORTUGAL A. STATEMENT OF BANK LOANS (As of January 31, 1978) Amount (less cancellation) Loan No. Year Borrower Purpose Bank Undisbursed Five loans for power development fully disbursed Electricidade de Portugal Power Republic of Portugal Highways Banco de Fomento Nacional /a DFC TOTAL of which has been repaid 25.4 TOTAL now outstanding Amount sold 2.2 of which has been repaid TOTAL now held by Bank /b TOTAL undisbursed B. STATEMENT OF IFC INVESTMENTS (As of January 31, 1978) None. /a Not effective. /b Prior to exchange adjustment.

34 ANNEX II Page 2 of 2 C. PROJECTS IN EXECUTION I/ Loan No Sixth Power Project; $36.0 Million Loan of September 24, 1976; Effectiveness Date: December 23, 1976; Closing Date: June 30, The Project is likely to be delayed one year because of organizational changes in the Power Authority (EDP) and revisions in the Project scope. The Project cost is presently estimated at $786 million equivalent, a decrease of about 30 percent over the appraisal estimates due mainly to the postponement of the nuclear program and devaluation of the Escudo. Owing to the Government's decision to restrict bidding for the turbo-generator for the Setubal thermal plant to local manufacturers, mainly to protect the local industry, a possibility foreseen during negotiations, and to changes in the design of the Crestuma hydropower Project, about $15 million of the loan proceeds are being reallocated among the other categories. All these factors have delayed procurement under the loan, and the start of significant disbursements. The Power Authority is being reorganized with emphasis on decentralizing management and merging municipal and small private electricity undertakings with the Power Authority. After a poor year in 1976 owing to the bad hydrological conditions, the Power Authority's earnings in 1977 were satisfactory, with a self-financing level of 20 percent, because of better conditions and an average tariff increase of 25 percent effective February 1, Loan No Highways I; $24.0 Million Loan of March 3, 1977; Effectiveness Date: July 8, 1977; Closing Date: July 31, While road rehabilitation is on schedule, other projects items are some 10 months behind schedule. The Government's decision to postpone bidding until the effectiveness of the loan resulted in a 9-month delay in purchasing highway maintenance and workshop equipment. Delays in land acquisition may cause a 10-month delay in the construction of the Covilha bypass road. The rehabilitation plan for railways will also be 9 months behind schedule due to delays in selection of consultants. Loan No Development Finance Company Project; $50.0 Million Loan of December 19, 1977; Effectiveness Date: (expected March 28, 1978); Closing Date: December 31, 1980 While loan signing was delayed due to legal problems raised by the Attorney General's office and the Loan is not yet effective, project implementation is expected to catch up with appraisal estimates. The Borrower, National Development Bank (BFN), has submitted an initial list of six appraised projects which could require up to $2.0 million in IBRD sub-loans. 1/ These notes are designed to inform the Executive Directors regarding the progress of projects in execution, and in particular to report any problems which are being encountered, and the action being taken to remedy them. They should be read in this sense, and with the understanding that they do not purport to present a balanced evaluation of strengths and weaknesses in project execution.

35 ANNEX III Page 1 of 2 PORTUGAL - WATER SUPPLY FOR THE LISBON REGION SUPPLEMENTARY PROJECT DATA SHEET Section I: Timetable of Key Events (a) Time taken by the country to prepare the project: 2 years (b) The agency which has prepared the project: Lisbon Public Water Enterprise (EPAL) with the help of Portuguese consultants Hidroprojecto (c) Date of first presentation to the Bank December 26, 1976 and and date of first Bank Mission to con- January 19, 1977 sider the project: (d) Date of departure of Appraisal Mission: May 23, 1977 (e) Date of completion of Negotiations: January 13, 1978 (f) Planned date of effectiveness: June 30, 1978 Section II: Special Bank Implementation Action No special action necessary. Section III: Special Conditions 1. Conditions of effectiveness are: (a) Execution of a subsidiary Loan Agreement between the Government and EPAL (paragraph 64). (Section 6.01(a) of the Loan Agreement.) (b) Increase in tariffs to raise gross revenues from water sales (paragraphs 53 and 64). (c) Securing of funds from Caixa Geral de Depositos or other lenders for EPAL's investment program (paragraphs 51 and 64). (d) Appointment of EPAL's financial and commercial directors (paragraph 64). 2. Measures to be taken by EPAL include: (a) Establishing a suitable planning department and incorporating an organization and methods capability within this department by December 31, 1978 (paragraph 52).

36 ANNEX III Page 2 of 2 (b) Setting and maintaining tariffs to achieve adequate earnings (paragraph 53). (c) Raising new loans only with the Bank's consent unless net cash earnings before depreciation and interest exceeds 1.5 times expected debt service (paragraph 54). 3. Measures to be taken by the Government include: (a) Ensuring that all future billings for bulk water sold by EPAL will be settled by the municipalities not later than three months after receiving the bills (paragraph 54). (b) Taking the steps necessary to enable EPAL to set its tariffs to meet appropriate debt service and cash generation criteria (paragraph 53). (c) Ensuring that the construction of the Santarem sewerage project is started before July 1, 1979 and that it includes adequate disposal facilities (paragraph 45).

37 Q IBRD 13032R A F R A,4sV7bL iw ( A S ) a,(s M X P r ~~~ OMADRIDL v X > \/, \, SPA _~~~~CI RAL._~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~iT~A~A 6S INTX RASZBNTRM <vta S;utAtdl <U B A LA N~~~~~~~~~~~~~~~~~~~~~~~~~~ P A 0I NTJ' l\a ttu ADA~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~9 U97 JANUAY ( \ >EA) \ t s ::s:--vi. APRUP31 Are l)ras AL seryed eotiv s0 o by b f < 7 L t ~~~~~~~~~~~~~~~~~~~~~~- - MuOciCp3I Botindarles JNAY?7