FALL REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE INSTITUTO NACIONAL DE OBRAS SANITARIAS (INOS)

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1 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized FALL PY RESTRICTED Report No. P-474 This report was prepared for use within the Bank and its affiliated organizations. They do not accept responsibility for its accuracy or completeness. The report may not be published nor may it be quoted as representing their views. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE INSTITUTO NACIONAL DE OBRAS SANITARIAS (INOS) IN VENEZUELA April 5, 1966

2 INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT PRESIDENT'S REPORT AND RECOMMENDATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE INSTITUTO NACIONAL DE OBRAS SANITARIAS, VENEZUELA 1. I submit the following report and recommendation on a proposed loan in an amount in various currencies equivalent to US$21.3 million to the Instituto Nacional de Obras Sanitarias (INOS). PART I: HISTORICAL 2. Late in 1962, the Government of the Republic of Venezuela requested the Bank to consider a loan to assist in the financing of a project for the expansion of the water supply for the Caracas Metropolitan Area, which is comprised by the Municipalities of Caracas and Sucre. Bank staff members visited Venezuela in connection with the project in 1963 and in 1964, but it was not possible to appraise the project until April 1965, after the Bank received a comprehensive feasibility study prepared by a consulting firm. 3. Negotiations on the proposed loan began in Washington on October 4, 1965, but were interrupted to permit INOS to consult with the Municipal Councils of Caracas and Sucre, respectively, on the fixing of water and sewage rates. Discussions were subsequently held at the Bank with representatives of the Municipal Councils concerning these rates. Negotiations were resumed on January 24, 1966, and completed on January 28, All actions required to put into effect water and sewage rates satisfactory to the Bank have now been taken. INOS was represented in the negotiations by Mr. Julio Urbina, President of INOS, and staff members from his organization; the Municipalities by Mr. Fernando Monegui, President of the Municipal Council of Sucre, and Mr. Alberto Cuevas Picon, President of the Municipal Council of Caracas; the Government was represented by Mr. Carlos Perez de la Cova, Minister-Counselor of the Venezuelan Embassy in Washington. 4. The proposed loan to INOS of $21.3 million would bring the Bankts total lending to Venezuela to $232.3 million. The following is a summary statement of Bank loans to Venezuela as of February 28, 1966:

3 -2- Amount (US$ MIillion) Year Borrower Purpose Bank Undisbursed 1961 Republic of Venezuela Express Highways EDELCA Electric Power Republic of Venezuela Highways CADAFE Power Transmission CANTV Telecommunications Total (less cancellations) of which has been repaid M.8 Total now outstanding Amount sold: 12.2 of which has been repaid 0.8 1l.4 Total now held by Bank Total undisbursed Delays in disbursements have been experienced with the following loans: (i) Ioan 306-VE (Expressways): The undisbursed balance on February 25, 1965% was US$10.8 million. Construction of the project is proceeding satisfactorily, but some of the works are still under way and disbursements have been delayed by the Governmentts slow procedures in making withdrawal applications. The Bank has requested the Minister of Finance to take up this matter with appropriate Government agencies with a view to speeding up procedures so that disbursements from the Loan Account will more accurately reflect the progress in execution of the project. (ii) Loan 390-VE (Second Highway Loan): The undisbursed balance of February 28, 1966, was US$26.5 million. Over 20% of the project has been completed and construction is proceeding approximately on schedule. However, the firm which has been selected to supervise the project was unable until recently to certify payments documents because of the Government t s long delay in approving the consultant's

4 - 3 - contract. The contract has recently been approved and signed, and withdrawals from the Loan Account are proceeding. 6. The Venezuelan Government has also requested a loan of about $50 million for a third road project. A Bank mission visited Venezuela in February of this year to appraise the project and its report is in preparation. PART II: DESCRIPTION OF THE PROPOSED LOAN 7. BORROWER: Instituto Nacional de Obras Sanitarias (INOS). GUARANTOR: AMOUNT: PURPOSE: AMORTIZATION: INTEREST RATE: COMMITMENT CHARGE: Republic of Venezuela. The equivalent in various currencies of US$21.3 million. To help finance the cost of construction of improved and expanded facilities for the purpose of increasing the supply of water to the Municipalities of Caracas and Sucre. 17-½2 years (including 3 years of grace); 30 semi-annual repayments beginning on April 15, 1969, and ending October 15, percent per annum. 3/8 of 1 percent per annum. PART III: THE PROJECT 8. A report entitled "Appraisal of the Caracas Metropolitan Water Supply Project" (No. TO-493b) is attached. The project consists of: A. Additional intake and pre-treatment works on the Tuy River; transmission-main facilities consisting of a pipeline about 34 kilometers long; pumping stations and tunnels; the La Pereza storage reservoir; a water treatment plant; an electricity transmission line; and additional main supply lines and secondary distribution mains.

5 B. The study of an additional source of water for the Metropolitan Zone System. C. Services for the purpose of improving the operations of the Metropolitan Zone System. 9. There is an insufficient water supply for the Municipalities of Caracas and Sucre, and much of the area is served only a few hours daily. The water deficit would increase rapidly in the absence of the project. The Municipalities of Caracas and Sucre have developed into a complex urban metropolis with a standard of living comparable to many modern capital cities of the world. Although water-borne diseases are not as prevalent as in less developed communities, they continue to be significant in the areas served by the proposed project and are undoubtedly a principal cause of morbidity and mortality in the slum areas. 10. The project would be executed by the Instituto Nacional de Obras Sanitarias (INOS), which was created as an autonomous institute in 19h3 and, except for towms with a population below 5,000, has responsibility for the study, construction, improvement and expansion of the water supply and sewerage systems of the country. The works would be operated eventually by the Metropolitan Zone Department,which was created within INOS to operate the water supply and sewerage systems in the Metropolitan Area. The Metropolitan Zone Department's Director is the key official charged with operation of the project. INOS has agreed to consult with the Bank in the future before it appoints a new Director. 11. A competent consulting firm assisted in the preparation of the project. Consultants have assisted in the study and installation of improved operating procedures for the Metropolitan Zone System and fqr INOS as a whole and have recommended a new organizational structure for the Metropolitan Zone System, which is being implemented. Additional consultants will be used for coordination of the design and of the technical aspects of construction of the project; to assist in construction programming and supervision; to assist in the revaluation of assets; and to prepare a feasibility study with appropriate recommendations on the development of a new water source for the next stage of the development of water supply for the Caracas Metropolitan Area. 12. The estimated total cost of the project is the equivalent of US$57.7 million, including interest during construction, engineering, and contingencies. The Bank loan of US$21.3 million would cover the foreign exchange costs of the project except for the equivalent of US$3.4 million (which is being financed by a supplier's credit), plus the equivalent of US$1.2 million allocated for part of the local currency expenditures on Venezuelan consultants. The balance would be financed largely through domestic bond issues and internal cash generation, which becomes increasingly important as the construction program progresses.

6 13. With the exception of consulting services and such minor items as are usually procured directly from suppliers for reasons of economy or efficiency, goods and services required for the project would be procured on the basis of international competition. 14. Water and sewage rates in the Caracas Metropolitan Area have remained unchanged since 1943, resulting in cash deficits which were covered by Government subsidies. An initial increase in the average rate from Bs to Bs per cubic meter went in effect on April 1, 1966, and INOS has agreed to review the rates with the Bank in September 1966, and annually thereafter, in order to comply with the rate covenant requiring the financial rate of return of the Metropolitan Zone System to increase from 5 percent in 1968 to 8 percent in In order to promote adequate water and sewage rates and to ensure effective operation of the proposed project, the contracts under which INOS operates the water and sewerage systems on behalf of the Municipalities of Caracas and Sucre, have been appropriately modified. PART IV: LEGAL INSTRUIENTS AND AUTHORITY 16. The Draft Loan Agreement between the Bank and INOS, the Draft Guarantee Agreement between the Republic of Venezuela and the Bank 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. 17. These Draft Agreements are in the usual form. The following provisions are of special interest: Loan Agreement (a) In order to ensure that the Metropolitan Zone System will function on a sound financial basis, the Borrower covenants, under sections 5.14 and 5.15, that the Metropolitan Zone System will carry on its operations independently from the outlying water supply systems. (b) Under Section 5.16, the Borrower covenants that its program for recovery of its own capital investments in the Metropolitan Zone System will be on terms and conditions satisfactory to the Bank. It has been agreed that no interest will be charged through 1969, and that amortization will take place after 1969 in 40 years at 3 percent annual interest. (c) Section 6.02 (a) makes it an event of default if a substantial amendment is made of the regulations under which INOS operates which adversely affects INOS's powers and responsibilities. (d) As the Municipal Councils of Caracas and Sucre are not parties to the Loan Agreement, Section 6.02 (b) makes it a specific event of default if they do not take action necessary for INOS to comply with its obligations under the Loan Agreement.

7 - 6 - (e) Section 7.01 provides, as an additional condition of effectiveness, that the Agreements between the TIOS and the Municipal Councils of Caracas and Sucre are fully effective. (f) As in the case of the previous loans to Venezuela, it is impossible under Venezuelan law to make, in the negative pledge clause of the Guarantee Agreement (3.01), specific reference to the Central Bank of Venezuela. Therefore, in order to protect the Bank's interest, the same formula used in the previous loans to Venezuela has been employed: Section 6.02 (c) of the Loan Agreement makes it an event of default to change the Guarantor's contract with the Central Bank which forbids the Central Bank from creating liens on gold or foreign exchange assets, except liens arising in the ordinary course of business and securing obligations of less than one year. PART V: THE ECONOMY 18. On March 29, 1965, a report on "Recent Economic Developments in Venezuela" (R65-49), and on August 23, 1965, a report entitled "An Appraisal of the Development Program of Venezuela" (R65-132), were distributed to the Executive Directors. Since the latter report was prepared, the generally favorable economic situation has continued and none of the key economic indicators suggests modification of the major conclusions of those reports. In 1965, the gross domestic product increased by an estimated 7 percent, in real terms, despite only a modest 2.4 percent increase in petroleum output (4.5 percent in 196h), and the level of foreign exchange reserves remained stable at over $820 million at the end of the year. 19. The Bank mission which prepared the second of the reports mentioned above concluded that the Venezuelan Government's proposed development program for , with some adjustments in size and timing, was well-designed to achieve a satisfactory rate of growth, a significant expansion of public welfare, and a gradual strengthening of the non-petroleum sectors of the economy. The recommended program contemplated capital expenditures of Bs billion (US$4.4 billion) which the Bank mission felt could be financed through the adoption of tax and other measures and by the utilization of new internal and external credits in addition to those already contracted. The Venezuelan Government is currently completing the formulation of the specific tax measures for presentation to the Congress. 20. Even with the increased external borrowing recommended by the Bank mission, the debt service ratio would remain below 4 percent of estimated exchange earnings at the end of the program period. Thus the Bank mission's evaluationreinforces the earlier report entitled "trecent Economic Developments in Venezuela," which concluded that Venezuela was creditworthy for a substantial amount of additional long-term external credits for high priority projects.

8 -7- PART VI: COMPLIANCE WITH THE ARTICLES OF AGREEHENT 21. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank. PART VII: RECOMMENDATION 22. I recommend that the Executive Directors adopt the following resolution: RESOLVED: RESOLUTION NO. Approval of Loan to Instituto Nacional de Obras Sanitarias in the amount of the equivalent of US$21,300,000 to be guaranteed by the Republic of Venezuela. THAT the Bank shall grant a loan to Instituto Nacional de Obras Sanitarias, to be guaranteed by the Republic of Venezuela, in an amount in various currencies equivalent to twenty-one million three hundred thousand United States dollars (US$21,300,000), to mature on and prior to October 15, 1983, to bear interest at the rate of six percent (6%) per annum, and to be upon such other terms and conditions as shall be substantially in accordance with the terms and conditions set forth in the form of Loan Agreement (Metropolitan Water Supply Project) between the Bank and Instituto Nacional de Obras Sanitarias and the form of Guarantee Agreement (Metropolitan Wvater Supply Project) between the Republic of Venezuela and the Bank, which have been presented to this meeting. George D. Wloods President Attachments Washington, D. C. April 5, 1966