Document of The World Bank FOR OFFICIAL USE ONLY Report No. 23849-ME MEMORANDUM OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT AND THE INTERNATIONAL FINANCE CORPORATION TO THE EXECUTIVE DIRECTORS ONA COUNTRY ASSISTANCE STRATEGY OF THE WORLD BANK GROUP FOR THE UNITED MEXICAN STATES April 23, 2002 Colombia-Mexico-Venezuela Country Management Unit Latin America and the Caribbean Region 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. MEXICO-FISCAL YEAR January 1-December31 CURRENCY EOUIVALENTS (as of 18 April 2002) Currency Unit = Peso 9.16 Pesos = US$I WEIGHTS MND MEASURES Metric System ABBREVIATIONS AND ACRONYMS AIDS Acquired Immune Deficiency Syndrome IPAB Instituto de Protecci6n al Ahorro Bancario APL Adaptable Program Loan ISSSTE Instituto de Segurdad y Servicios Sociales de los ASERCA Apoyos y Servicios a la Comercializaci6n Trabajadores del Estado Agropecuaria LIL Learning and Innovationi Loan BANCOMEXT Banco Nacional de Comercio Exterior, S.N.C. NAFIN Nacional Financiera, S.N.C. BANOBRAS Banco Nacional de Obras y Servicios POblicos, NAFTA North Anierican Free Trade Agreement S.N.C. NGO Nongovemmental organization BANRUJRAL Banco Nacional de Credito Rural, S.N.C. OAS Organization of American States BANSEFI Banco del Ahono Nacional y Servicios OECD Organizafion for Economic Cooperation and Financieros Development CAS Country Assistance Strategy OED Operations Evaluation Department CCL Contingent Credit Line OD Operational Directive CAM Comisi6n Ambiental Metropolitana OP Operational Policy CNA Comisi6n Nacional de Agua PARE Programa para Abatir el Rezago Educativo CEM Country Economic Memorandum PAREIB Programa parm Abatir el Rezago en Educaci6n IniciaJ CFAA Country Financial and Accountability Assessment y Bisica COMPRANET Sistema Electr6nico de Contrataiones PCF Prototype Carbon Fund Gubemrnamentales PEMEX Petr6leos Mexicanos CONAFOR Comis%in Nacional Forestal PET Programa de Empleo Tenporal CONAPO Consejo Nacional de Poblaci6n POP Persistent Organic Pollutant CONASUPO Compadia Nacional de Subsistencias Populares PIDIREGAS Proyectos de knpacto Diferido en el Registro del CPAR Country Procurement Assessment Report Gasto CSO Civil Society Organization PROBECAT Programa de Becas de Capacitaci6n para DAL Decentralization Adjustment Loan Desempleados DIF Sistema Nactional para el Desarrollo Integral de la PROCAMPO Programa de Apoyos Directos al Camrpo Familia PROCEDE Programa de Certificaci6n de Derechos Ejidales y DRD Decentralization and Regional Development Titulaci6n de Solares Urbanos ECD Early Childhood Development PRODEI Programa para el Desarrollo de la Educaci6n inicial ENIGH Encuesta Nacional de Ingreso y Gasto de los PROGRESA Programa de Educaci6n, Salud y Alimentaci6n Hajores PRONAFIDE Programs Nacional de Financiamiento del Desarrollo ESMAP Energy Sector Management Assistance Program PSBR Public Sector Borrowing Requirements ESW Economic and Sector Work PSD Private Sector Development FARAC Fideicomiso de Apoyo al Rescate de Autopistas SAGAR Secretarla de Agricultura, Ganaderia y Desarrollo FOVI Fondo de Operaci6n y Financiamiento Bancario a Rural la Vivienda SAGARPA Secretar de Agricultura, Ganaderia, Desarrollo FOVISSSTE Fondo de la Vivienda del lnstituto de Seguridad y Rural, Pesca y Alimentaci6n Servicios Sociales de los Trabajadores del Estado SAL Structural Adjustmnent Loan FSAP Financial Sector Assessment Paper SAT Sistema de Administraci6n Tributaria GAIT General Agreement on Tariffs and Trade SECODAM Secretarfa de Contraloria y Desarrollo Admrinistrativo GDP Gross Domesfic Product SEDESOL Secretaria de Desarrollo Social GEF Global Environment Facility SEMARNAP Secretarla de Medio Ambiente y Recursos Naturales y GEF/MP Global Fnvironment Facility/Montreal Protocol Pesca GNP Gross National Product SEMARNAT Secretarfa de Medio Ambiente y Recursos Naturales IBRD Intemational Bank for Reconstruction and SIAFF Sistema Integral de Administraci6n Financiera Federal Development SixnSIP Simulations for Social Indicators and Poverty IDB Inter-American Development Bank SME Small- and medium-size enterprise IFC International Finance Corporation SSA Secretarla de Salud IMF International Monetary Fund TAL Technical Assistance Loan IMSS Instituto Mexicano del Seguro Social UNDP United Nations Development Programme IMSS-Solidaridad Instituto Mexicano del Seguro Social-Solidaridad UJNEP United Nations Environment Programme INFONAVIT Instituto del Fondo Nacional de la Vivienda para WBG World Bank Group los Trabajadores WHO World Health Organization INI Instituto Nacinala Indigenista WTO World Trade Organization IBRD IFC Vice President David de Ferranti Vice President, Investment Operations: Assaad Jabre Chief Economist: Guillermo Perry Director, LAC: Bernard Pasquier Country Director. Olivier Lafourcade Manager: Toshiya Masuoka Lead Economist/Manager: Marcelo Giugale Task Manager: Toshiya Masuoka Task Manager Marcelo Giugale Team Production Support: Michael Geller FOR OFFICIAL USE ONLY MEXICO COUNTRY ASSISTANCE STRATEGY TABLE OF CONTENTS I. SUMMARY AND MAIN MESSAGES ........................................................... 1 11. THE COUNTRY CONTEXT ........................................................... 3 (a) The Political Arena ........................................................... 3 (b) Recent Economic Developments ........................................................... 4 III. MEXICO'lS DEVELOPMENT CHALLENGE: PovERTY REDUCTION IN THE NEW ERA .......... ........ 5 (a) Consolidating Macroeconomic Gains ...........................................................8 (b) Accelerating Growth Through Enhanced Competitiveness ................................................. 9 (c) Human Capital Development ............................................................11 (d) Balancing Growth and Poverty Reduction with Protecting the Environment .......... ......... 14 (e) Building an Efficient, Accountable, and Transparent Government ................................... 15 IV. THE WORLD BANK GRouP's ASSISTANCE STRATEGY ........................................................... 17 (a) The Lessons from the Previous CAS ........................................................... 17 (b) The Lessons of IBRD's Portfolio ................ ........................................... 19 (c) The Lessons of IFC's Portfolio ........................................................... 21 (d) The Role of the WBG in Mexico's New Era ........................................................... 22 (e) The WBG Strategy, Program Selectivity, and Partnership Over the Next Three Years ........................................................... 24 (f) Sectoral Support Strategies and Tools to Deliver them ...................................................... 26 (g) Exposure Evolution Under the Proposed Strategy ........................................................... 35 V. THE RISKS IN THE PROPOSED CAS ........................................................... 37 VI. COORDINATION WITH OTHER PARTNERS AND PARTICIPATION N TmIs CAS ............. ............. 3 8 VII. CONCLUDING REMARKS .. 41 TEXT TABLES Table 1. Main Macroeconomic Indicators .. 5 Table 2. Share of the Population in Extreme Poverty and Poverty in Mexico .. 6 Table 3. Mexico and the Millennium Development Goals .. 7 Table 4. Inequality in Total Current Income (Gini Coefficient) .. 8 Table 5. Partnerships in Mexico's Development Framework .. 25 Table 6. Mexico-CAS Matrix FY03-05 .. 43-47 Table 7. Mexico-World Bank Group Financial Instruments-FY2003-2005 .. 49, 50 TExT BOXES Box 1. Country Assistance Evaluation ..................... 18 Box 2. Procurement and Financial Management in Mexico's Portfolio ...................................... 19 Box 3. What Went Well and No So Well in This CAS Cycle ................................................... 20 Box 4. Private Sector Strategy: Linkages in IBRD-IFC Assistance to Mexico ........................... 22 Box 5. Capacity and Learning Activities of the World Bank Institute (WBI) in Support of the CAS Objectives ................................................... 33 Box 6. IDB's Program ................................................. 39 Box 7. Mexico CAS Consultation with Civil Society ...................... ........................... 40 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. FIGURES Figure la. Mexico IBRD Exposure Scenarios, 1996-2015: Debt Outstanding .............................. 36 Figure lb Mexico IBRD Exposure Scenarios, 1996-2015: Disbursements, Repayments, and Undisbursed Balance ..... 37 ANNEXES BL. Mexico at a Glance ..... 51, 52 B2. Selected Indicators of Bank Portfolio Performance and Management ..... 53 B3. Bank Group Program Summary, FY2002-05 ..... 55 B3. IFC and MIGA Summary, FYl999-2001 ..... 56 B4. Summary of Nonlending Services ..... 57 B5. Poverty and Social Development Indicators ..... 59 B6. Key Economic Indicators ..... 61, 62, 63 B7. Mexico-Key Exposure Indicators ..... 65 B8. Status of Bank Group Operations in Mexico Operations Portfolio ..... 67 B9. Statement of IFC's Held and Disbursed Portfolio ..... 69 B1O. Mexico: Private Sector Strategy ..... 71-98 MEMORANDUM OF THE PRESIDENT OF TLE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT AND THE INTERNATIONAL FINANCE CORPORATION TO THE EXECUTIVE DIRECTORS ON A COUNTRY ASSISTANCE STRATEGY OF TIHE WORLD BANK GROUP FOR THE UNITED MEXICAN STATES I. SUMMARY AND MAIN MESSAGES 1. The World Bank Group's (WBG) previous Country Assistance Strategy (CAS) for Mexico was discussed by the Board of Executive Directors on May 13, 1999 (Report No. 19289- MX), and its Progress Report was considered on May 21, 2001 (Report No. 22147-ME). The central theme of that CAS was sustainability-economic and social-in the face of heightened uncertainty for the country and, consequently, for the WBG assistance program (notably, the end of the presidential sexenio, international financial volatility, the speed of the decentralization process, instability in the financial sector, and the nonadditionality of IBRD funding to the budgets of line agencies). Thus, the 1999 CAS called for flexibility in delivering assistance within a prudent overall financing envelope. 2. Over the CAS period, Mexico made remarkable progress along its development path, and is now entering a new era of opportunity for growth and poverty reduction. In the process surrounding the presidential election of July 2000, its political system showed a high degree of maturity and achieved a new level of openness, participation, and accountability. Its economic performance has also been strong. Seven years after a major macroeconomic crisis affected its banking system and sent millions of Mexicans into poverty, the country became one of the fastest-growing economies in Latin America, an investment-grade borrower, and has achieved considerable financial and commercial integration. While a succession of emerging economies stumbled (East Asia, Russia, Brazil, Argentina), Mexico continued growing. Even the 2001 recession in the United States was overcome-with a slowdown, but without crisis. As a result, Mexico's poverty headcount has sharply decreased, and is at present much lower than before the crisis. 3. The WBG has been a close partner of Mexico in its development progress. Using the program flexibility built into the last CAS, the WBG was able to deliver over the last three years assistance aimed at furthering the country's reform agenda at both the macro level (for example, fiscal, finance, decentralization) and at the sectoral level (for example, rural development, health, gender). Throughout, the primary focus has been poverty reduction, and the impact has been significant, especially in terms of intellectual contribution to policy design. The WBG's role in providing knowledge and advisory services is perhaps best shown by the role it played during the presidential transition-its collection of Policy Notes became an analytical bridge across administrations and, at the request of the incoming authorities, was published as a book.' In 1. Giugale, M., 0. Lafourcade, and V. Nguyen, eds., 2001, Mexico-A Comprehensive Development Agenda for the New Era, World Bank Publications, Washington, D.C. parallel, the WBG's financing flows toward Mexico remained strong and within the CAS envelope, the quality of its portfolio improved to highly satisfactory standards, and country exposure fell. None of the potential risks envisioned in the CAS materialized (the end-of- sexenio did not lead to a crisis; no externally or domestically generated macroeconomic shock took place; the financial sector stabilized and strengthened; and there was no reduction in projected counterpart funding). And new frontiers were reached in the relationship with the country-for the first time, the CAS Progress Report was made public, systematic CAS consultations with civil society were held, transition Policy Notes were published, an adjustment operation was implemented at the state level, a daylong summit between a Mexican President and the President of the WBG took place, and previously closed sectors/areas were open to analytical work (corruption, judicial, gender). 4. The combination of country development and success in delivering assistance has placed the relationship between Mexico and the WBG at an encouraging high point. Yet, for all the progress achieved, 45 million Mexicans are still poor, inequality remains massive (as do disparities across ethnic groups, genders, and business sizes), and the already vast development gap between north and south continues to widen. The WBG will therefore maintain its support over the next three years, and help the govermment seize the unique opportunity for poverty reduction that the new political era has brought about-an opportunity that may not last long or repeat itself. This call for continuing support has been voiced not only by the government, but also by civil society and private business sector representatives consulted during the preparation of this CAS. 5. Addressing the development challenges pending in Mexico will take formidable efforts on several policy fronts. Those efforts can, however, be organized around five strategic objectives: (a) consolidating the macroeconomic framework; (b) accelerating growth through competitiveness; (c) human capital development; (d) balancing growth and poverty reduction with environmental protection; and (e) building an efficient, transparent, and accountable government. These objectives, which underlie the federal authorities' National Development Plan, will also be the motivating pillars of this CAS. To deliver the WBG's assistance, IBRD will retain a rich program of analytical work and offer a three-year, US$5 billion lending envelope (half of which will be fast-disbursing) that preserves a US$1.5 billion "cushion," balances macro- and micro-oriented activities, and caters to the three levels of government (federal, state, and municipal). That five-pillar IBRD strategy will be integrative and mutually reinforcing of IFC's program of interventions-in turn, geared to provide a wider spectrum of private entreprises with a better and broader business environment in which to operate, including a more developed financial market, better means to compete internationally and, critically, support in accessing industries that may become open to private participation. (The WBG's Private Sector Strategy is presented in Annex B 10). 6. The strategy described above (five poverty-reducing pillars guiding IBRD's interventions, and IFC's support for broad-based private sector development) heeds the lessons learned during previous CAS cycles-the value of program flexibility, attention to portfolio quality, timely analytical work, interaction with subnational governments, balance between macro- and microeconomic interventions, and country ownership. These lessons give comfort that the risks embedded in this CAS are manageable-risks of large, negative macroeconomic shocks; Congressional paralysis; reform complacency; weak intra- and intergovernmental coordination; unsuccessful federalismo; or infrastructure crises. Finally, the strategy presented 2 here fits into, and exploits the synergies of, the array of comparative advantages across partner institutions operating in Mexico, especially the IDB and the IMF. II. THE COUNTRY CONTEXT (a) The Political Arena 7. The transformation of the Mexican political system toward a multiparty democracy acquired a new dimension with the election of President Vicente Fox in July 2000, thereby ending a period of one-party domination that had lasted for seven decades and, more profoundly, redefining the roles of the legislative, executive, and judicial branches and those of political parties and local governments. Breaking with a history of recurrent end-of-sexenio crises, the transition of power was remarkably smooth-due in good part to solid macroeconomic management. Greater political plurality has been a welcome factor both within Mexico and abroad, for it entails a search for consensus around pending reforms (and, indeed, around the kind of society Mexicans want), a tool for conflict resolution, and a mechanism to enhance transparency and accountability in the exercise of the government function. 8. Predictably, the election results raised unrealistic expectations for immediate change. And, predictably, after only a year and a half in office, the administration has made slower than hoped for progress in enacting its ambitious legislative and policy agenda. With none of the political parties having an absolute majority in Congress and with limited country experience in legislative pluralism, negotiations over the two major reforms so far proposed by the Executive (indigenous law and tax reform) were protracted and, eventually, passed with substantial modifications. Furthermore, the administration's legislative agenda over the next year will be conditioned by the mid-term Congressional elections of July 2003. Yet, the chances for reform are not negligible, because neither the administration nor the various political parties stand to benefit from legislative gridlock. To be sure, the agenda of pending reforms is a challenging one-it includes opening the power sector to private sector initiatives, a new labor code that can keep Mexican workers competitive as the country further integrates into the world economy, a new social security scheme for public sector employees that does not threaten fiscal sustainability or stiffen the labor market, the rationalization of water use, and an adjustment in the mandate of public development banks. 9. Those reforms, and the ensuing consensus-building efforts, will have to take into account another dimension of governing today's Mexico-the speed and depth of the decentralization process, or federalismo. Since the early 1990s, decisionmaking power has been gradually devolved to state and municipal governments. This process gathered momentum in 1997 when, after legislative elections, Congress was no longer dominated by a single party and political negotiations led to the transfer of responsibility for major budget lines (in the so-called Ramo 33) to subnational authorities. The results of the presidential elections of 2000 gave additional force to decentralization-federalismo being a priority for President Fox, himself a former state governor. As a result, policy decisions in key development areas (such as education, health, and the enviromnent) are quickly becoming the prerogative of states and municipalities. While local responsibility is in general welfare-enhancing (because it brings decisionmakers and decision- beneficiaries closer together), it requires a clear framework of "rules of the game" if it is not to become a destabilizing element countrywide. Those rules are much more than technical parameters, because they will determine whether the quality of government services Mexicans 3 receive and, ultimately, the standard of living they enjoy, differ substantially across regions. In other words, the party controlling the federal government will have to establish working partnerships with 31 states (and one large federal district) and some 2,400 municipalities of which it controls only one third and one tenth, respectively. (b) Recent Economic Developments 10. After an extended period of strong expansion, economic activity in Mexico experienced a sharp slowdown during 2001 as the downturn in the global economy, and in particular in the U.S. economy, spread across emerging markets. Growth of Mexican manufactured exports, nine tenths of which go to the United States, plummeted from an average annual growth rate of 20 percent to minus 3 percent last year. Such a pronounced drop in external demand and the related slump in manufacturing investment led to a contraction of real GDP growth during 2001, down to -0.3 percent, in contrast to the 5.6 percent average annual growth rate observed over the preceding five-year period. 11. Even during the contraction, the economy proved resilient in many ways-thanks in large part to sound macroeconomic management. Whereas during the rapid economic expansion of 2000 there was a relatively expansionary fiscal stance and a tight monetary policy, the new authorities during 2001 targeted a lower budget deficit (0.7 percent of GDP), and implemented budget rules automatically cutting expenditures when revenues turn out lower than budgeted. Monetary policy was eased, although cautiously, in the face of strong capital inflows, weakening of domestic demand, and lower inflation expectations. Cautious monetary management, the appreciation of the currency (due to the strength of capital inflows), and the slowdown in growth, all combined to keep inflation in check-the 2001 year-end inflation rate fell to 4.4 percent, well below the initial target of 6.5 percent. 12. The external accounts remained manageable. The balance of payments' current account deficit stayed practically unchanged from the previous year (at 2.8 percent of GDP), as lower manufacturing export revenues and lower oil prices were largely offset by a similar reduction in imported intermediate inputs and capital goods. Mexico has continued to enjoy favorable access to external financing and steady investment flows. This simultaneously allowed for the bulk of the current account's deficit to be financed through foreign direct investment, an accumulation of international reserves, a strengthening of the peso, a reduction in private investors' perception of country risk as measured by sovereign bond spreads, and a significant reduction of domestic interest rates. As of March 2002, Mexico's sovereign bonds have investnent-grade rating by all three major international rating agencies, making it possible for a broad range of foreign institutional investors to buy Mexican bonds. The economy thus seems well positioned for a strong recovery upon the rebound of economic activity in the United States, expected in the second half of 2002. 13. Fiscal discipline is a key priority for the administration. As part of that discipline, the government proceeded with the publication of a broadened fiscal deficit measure, known as the Public Sector Borrowing Requirements (PSBR),2 which is projected at 4 percent of GDP for 2. The PSBR includes some quasi-fiscal operations that are not or are only partially included under the traditional fiscal deficit measure, such as the total interest cost of liabilities related to bank and debtor support programs, the deferred cost of investment projects (PIDIREGAS) in the energy sector, the net financial intermediation by development banks, and the inflation component of indexed bonds. The PSBR excludes nonrecurrent revenues from privatization and unrealized capital gains. 4 2002 (in contrast to the budget deficit target in its traditional definition at 0.7 percent of GDP). The shift of the attention to the PBSR was part of the motivation behind new tax legislation enacted in December 2001 that is expected to increase tax revenue by 1.2 percent of GDP in 2002. This additional income has been allocated to offset low oil prices, and to finance priority social expenditures. In its recently published medium-term financing framework (PRONAFIDE), the government stated its intention to move gradually to fiscal balance (on a PSBR basis) by 2006, something that will require further fiscal consolidation in the near future. Mexico has no active IMF program and no outstanding obligations to the IMF (see Section VI). 14. Over the CAS implementation period, the Mexican economy is expected to recover from its current, shallow recession toward the economy's medium term potential annual rate of growth of about 4-5 percent. Even though the recovery of demand for Mexican manufactured exports will initially be the driver of the economic expansion, the strong rebound expected as of the second half of 2002 is projected to be broad-based, i.e., a simultaneous and balanced growth of consumption, investment and export demand. This growth pattern is expected to lead to an increase in the country's balance of payments' current account deficit from the current 2.8 percent of GDP to about 4 percent of GDP by 2004 and stabilizing at that level thereafter. Foreign direct investment flows will continue to finance the bulk of the country's external deficit. Further fiscal consolidation is projected to take place not only to make progress in attaining fiscal sustainability but also as a key instrument in aggregate demand management and price stability (Table 1); Section IIIa describes the instruments of fiscal consolidation in more detail. Table 1. Mexico-Main Macroeconomic Indicators Actual Estimated Projected Indicator 1999 2000 2001 2002 2003 2004 2005 Gross Domestic Product(% growth) 3.8 6.9 -0.3 1.5 4.1 4.5 5.0 Consumption 4.2 8.7 1.7 1.4 3.7 3.9 4.9 Investment 4.1 8.8 -9.2 4.0 6.6 6.6 5.0 Exports 12.4 16.0 -5.0 2.7 6.0 6.1 6.2 Imports 13.8 21.4 -6.0 4.0 6.5 5.9 5.9 Balance of Payments Current Account (US$ billion) -14.4 -17.7 -17.5 -22.7 -26.5 -29.0 -31.1 Current Account (as % ofGDP) -3.0 -3.1 -2.8 -3.5 -3.9 -4.0 -4.0 Foreign Direct Investment (US$ billion) 11.9 14.2 21.0 13.6 14.4 15.8 16.6 Fiscal Balance (as % of GDP) Traditional definition -1.2 -1.2 -0.7 -0.6 -0.3 -0.3 0.0 Broadened PSBR -6.3 -3.7 -3.8 -4.0 -3.1 -2.6 -2.1 Inflation (% year-end) 12.3 9.0 4.4 4.5 3.5 3.0 3.0 III. MEXICO'S DEVELOPMENT CHALLENGE: POVERTY REDUCTION IN THE NEW ERA 15. Through fast and sustained growth, Mexico has over the last six years made solid progress in combating poverty, and has left behind the devastating social effect of the 1994-95 crisis-which in a few months, fully undid the 10-percentage-point reduction in poverty levels painstakingly achieved over the preceding decade. From 1994 to 1996, the share of the 5 population in poverty (defined as having a level of per capita consumption below what is necessary to meet basic food and nonfood needs)3 drastically increased, from 51 to 62 percent at the national level. Since 1996, however, there has been an impressive turnaround, with the share of the population in poverty in 2000 having declined to 46 percent nationally. The share of the population in extreme poverty (defined as not being able to meet basic food needs)4 has also fallen dramatically. Poverty, and especially extreme poverty, remains much higher in rural than in urban areas, but in both urban and rural areas, poverty is now below the 1994 precrisis level (Table 2). Table 2. Share of the Population in Extreme Poverty and Poverty in Mexico Extreme Poverty 1989 1992 1994 1996 1998 2000 Urban 18.13 16.79 10.95 18.16 16.25 8.45 Rural 41.38 44.66 49.78 60.47 57.06 46.08 National 27.04 24.42 21.46 29.72 27.31 18.02 Extreme and Moderate Poverty 1989 1992 1994 1996 1998 2000 Urban 50.70 49.14 40.64 53.25 49.97 36.33 Rural 69.32 73.26 78.82 84.84 82.06 73.29 National 57.84 55.74 50.97 61.88 58.66 45.73 Source: World Bank staff estimates based on the ENIGH surveys. The poverty measures are based on a comparison of total per capita current consumption (not adjusted to the national accounts) with poverty lines representing the cost of basic needs and computed following the INEGI/CEPAL method. 16. The lesson from the 1990s is clear-while many factors certainly play a role (notably, efficient social expenditures), growth is the most important determinant of poverty in Mexico. This close link between growth and poverty was a central theme of the previous CAS and remains so in this document, not only because of the obvious improvement that growth brings to the income of the poor, but also because of the positive synergies that it brings to their nonmonetary welfare (such as infant mortality, life expectancy, school enrollment, and access to safe water). Growth in Mexico is "propoor," because the distribution of gains in nonmonetary indicators favors the poor (for example, when enrollment rates increase, the poor are more likely to benefit from the increase than the nonpoor because the nonpoor already send their children to school). This should help Mexico meet, in some cases ahead of the 2015 deadline, the Millennium Development Goals (especially the extreme poverty target) (see Table 3).5 WBG estimates suggest that, in Mexico, an annual average GDP growth rate of 5 percent would reduce infant and under-five mortality by almost half by 2015, life expectancy would increase by more than five years, and net primary enrollment would come close to 97 percent. More generally, such an overall rate of growth would bring the level of extreme poverty (defined on a US$1/day basis which differs from the poverty lines in Table 2) down to 5 percent of the population by 2015 (that is, less than a third of the level in 1989). 3. That level of consumption translates into a Mexican peso value of 970 and 776 per month per person in urban and rural areas, respectively, in 2000 prices. 4. A Mexican peso value of 485 and 443 in urban and rural areas, respectively, per month per person in 2000 prices. 5. Table 3 accounts for seven of the eight Millennium Development Goals; at present, there is no sufficient data to assess fulfillment of the eighth such goal-Global Partnership for Development. 6 Table 3. Mexico and the Millennium Development Goals Targets Position of the World Current Position of Mexico 1. Reduce the proportion of people 20 percent of the world population Using the US$1/day poverty line (which differs living in extreme poverty and live on less than US$1 a day from the poverty lines used in Table 1), an suffering from hunger by half (WBG estimate for 2000). estimated 13.2 percent of Mexico's population was between 1990 and 2015. living in extreme poverty in 2000, versus 16.2 percent in 1989. The prevalence of malnutrition among children under age five decreased from 14.4 percent in 1988 to 7.5 percent in 1999. 2. Achieve universal completion of 90 percent of the world's According to the 2000 population census, 91.3 primary education by 2015 for both elementary-school-age children percent of Mexico's elementary-school-age boys and girls. (6-14) are enrolled (WBG children (6-14) are enrolled. estimate for 1997). 3. Eliminate gender disparities in Worldwide, there is a gender gap There is only a 0.6 percentage point gender gap in primary and secondary education by of 7.6 percent in the primary elementary education enrollment (ages 6-14) in 2005, and for all levels by 2015. education Gross Enrollment Ratio Mexico (Population Census 2000). However, the (WBG estimate for 1996). gender gap increases at higher levels of schooling. 4. Reduce infant and child mortality Worldwide, the infant mortality According to WBG data, the under-five mortality rates by two thirds between 1990 and rate per 1,000 live births was 54.2 rate in Mexico was 35.8 per 1,000 in 2000, 2015. (WBG estimate for 1999). compared to 46.0 per 1,000 in 1990. 5. Reduce matemal mortality rate by Worldwide, there are 400 According to Mexico's Ministry of Health, the three quarters between 1990 and maternal deaths per 100,000 live matemal mortality rate has been reduced from 54 2015. births (estimates depend on per 100,000 in 1990 to 51 per 100,000 in 1999. method used; UNFPA 1995). 6. Halt and reverse by 2015 the In 1999, the worldwide In 1999, the prevalence rate of HIV/AIDS among spread of HIV/AIDS, malaria, and prevalence rate of HIV/AIDS adults aged 15-49 in Mexico was 0.3 percent. other diseases. among adults aged 15-49 was Among women aged 15-24, it was in the range of 1.07 percent (WHO data). 0.05-0.08 percent. Among men aged 15-24, it was in the range of 0.33-0.48 percent (WHO data). 7. Ensure environmental Worldwide, in 2000, In Mexico, access to an improved water source sustainability. One indicator is approximately 80 percent of the increased from 83 percent of the population in access to an improved water source. population had access to water. 1990 to 86 percent in 2000 (WBG data). 17. Mexico's achievements in poverty reduction and development are, however, overshadowed by four persistent characteristics of the country's social map: (a) although reduced, absolute poverty numbers remain unacceptably high (some 45 million Mexicans are still poor); (b) there is sharp inequality in the distribution of income, which seems immune to the growth process and so far resilient to policy interventions (by current Gini measurements, Mexico's is the one of the most unequal economies in Latin America; see Table 4); (c) the incidence of extreme poverty in rural areas is abnormally acute (in 2000, almost one in every two Mexicans living in rural areas was extremely poor); and (d) there is a widening development gap between the southern region and the rest of Mexico (southerners are far poorer, less educated, less likely to have running water, and more likely to die younger). These characteristics gather additional urgency when seen in the light of the available employment opportunities for the poor-while formal unemployment has remained low, some 1 million new jobs are needed each year just to accommodate new entrants into the labor force (at the peak of its recent growth performance, the Mexican economy managed to create only about 600,000 such jobs). 7 Table 4. Inequality in Total Current Income (Gini Coefficient) Year National Urban Rural 1984 0.473 0.442 0.448 1989 0.519 0.498 0.444 1992 0.529 0.498 0.434 1994 0.534 0.508 0.419 1996 0.519 0.493 0.452 1998 0.543 0.511 0.480 2000 0.539 0.505 0.470 18. Both the achievements and the remaining challenges in reducing poverty and inequality (and creating jobs), point to a new agenda for Mexico's development-one that combines the effect of a solid macroeconomic framework and sustained growth with micro interventions by sector and region in order to bring the benefits of growth to all Mexicans. This comprehensive agenda, and the macro-micro links that it implies, can be organized around five challenges that are embedded in the country's 2001-06 National Development Plan-{a) consolidating the macroeconomic gains of recent years; (b) accelerating growth through competitiveness; (c) developing the stock of human capital; (d) balancing growth and poverty reduction with environmental protection; and (e) building an efficient, accountable, and transparent government.6 (a) Consolidating Macroeconomic Gains 19. Since the financial crisis of 1994, Mexico's macro framework has had three pillars: (a) a tight and fairly independent monetary policy, (b) a flexible foreign exchange regime, and (c) a conservative fiscal stance. This arrangement not only took the economy out of its crisis, but delivered a respectable rate of growth, single-digit inflation, a viable external balance, a comfortable debt position, and three investment-grade sovereign credit ratings, all despite four major international crises that dampened economic prospects worldwide (East Asia in 1997, Russia in 1998, Brazil in 1999, and Argentina in 2001). It thus seems sensible, over the coming years, to stay the course in macroeconomic policy, with one exception: fiscal management needs further strengthening. 20. The challenge of strengthening Mexico's fiscal and, thus, macroeconomic framework, involves policy efforts in several areas: (a) completing the tax reform initiated in December 2001 (whereby some major loopholes in the tax code were closed) and, equally important, improving the quality of tax administration; (b) establishing budget rules to stabilize revenues, reduce oil dependency, and avoid pro-cyclical fiscal policies (the country's oil revenue stabilization fund provides a good platform from which to design those rules); (c) addressing the public sector's implicit and contingent liabilities accumulated during past banking and transport sector rescues (by IPAB and FARAC), and currently building up through the deficits of various public housing 6. Mexico's National Development Plan 2001-06 is a broad government agenda that covers areas that go beyond (although are not unrelated to) economic development. It presents three main objectives: (a) Social and Human Development (education, equity, collective initiative, harmony with the environment, confidence in public institutions); (b) Growth with Quality (macroeconomic management, competitiveness, inclusive development, regional development, sustainable development); and (c) Order and Respect (sovereignty, national security, democracy, federalism, population dynamics, corruption, public security, justice). See www.presidencia.pob.mx. 8 institutions and guarantees in infrastructure contracts (INFONAVIT, FOVISSSTE, PIDIREGAS), or latent in the actuarial imbalances of the federal and state public-employee pension systems (ISSSTE); and (d) ensuring, through hard-budget constraints, that Mexico's rapidly unfolding decentralization process remains fiscally sustainable, both for the federation and for the states (see below). (b) Accelerating Growth Through Enhanced Competitiveness 21. In the past, Mexican governments sought to foster growth by bolstering aggregate domestic demand, the result of which were short-lived growth spurts brought to a halt by balance-of-payment crises. Today, with the country already integrated in and enjoying the benefits of the global economy, particularly in NAFTA, long-term growth acceleration will be sustainable only if achieved through an economywide enhancement in competitiveness. This needs to encompass both export-oriented firms (which in Mexico tend to be large formal corporations) and those catering for the domestic markets (which are usually smaller or informal). A large array of factors contribute to a country's competitiveness. This section focuses on the four challenges which, at present, could most add to Mexico's competitiveness: (a) enhancing the quality of its physical infrastructure, (b) broadening the reform of its financial sector, (c) raising the productivity of its agriculture, and (d) integrating middle-market and micro- and small enterprises into the "new" Mexican economy. 22. Despite major advances in creating an open and supportive environment for private businesses to operate in Mexico, the infrastructure sector has not fully benefited from the efficiency enhancing effect of private participation-an uncomfortable position for a country that is estimated to need additional infrastructure investments worth 2 percent of GDP per year over the next 10 years, and has limited public sector resources to pay for it. For example, the energy subsector (petroleum, natural gas, and electricity) still faces the challenges of structural reform, to unbundle activities, create strong and independent regulatory bodies, and establish a robust competition framework. The transport system is in a similar position. Although Mexico has enhanced the quality and efficiency of its airports and ports (mainly through private-sector-led competition), the quality of its road network is declining, reflecting years of inadequate maintenance and poorly designed private concessions.7 From highways to secondary and rural roads, the upcoming challenge is to find contractual arrangements with private partners for federal and local governments that ensure both financial and physical sustainability. To improve export competitiveness, more attention is needed to facilitating multimodal transport and associated logistical improvements. 23. Sustainability is an even more immediate issue for the water and sanitation subsector, which faces a crisis in the near term. Weak pricing policies, payment enforcement and property rights, and unclear definition of responsibilities and varying institutional capacities across levels of government contribute to the problem. While aggregate figures of service coverage compare favorably to most other Latin American countries, one out of eight Mexicans (mostly poor) lack access to clean water, and one out of five lack sanitation service. The government is aware of the health risks associated with these deficiencies and has declared them a matter of national 7. An attempt in the last decade to expand the highway network via an aggressive toll road concessions program ended up in a highway sector crisis as a result of unrealistic demand assessments and faulty financial design, with many private concessionaires eventually having to be bailed out by the federal government under a special FARAC program. 9 security. As with other parts of the country's infrastructure, a sustainable solution to the water problems will call for private-public partnerships. 24. Private participation has also been limited in another critical component of Mexico's infrastructure-housing. The country has an estimated housing deficit of about 4.6 million housing units, a gap that is rapidly expanding as some 700,000 new families are formed each year. Meeting that pent-up demand will involve bringing private financiers to a market that has always been dominated by public financial institutions dispensing subsidies which, in turn, have been financed through social security contributions and payroll taxes. The government recognized the magnitude of the necessary reform, especially in transforming dispersed subsidies into means-tested, up-front, demand-side contributions, restructuring major public institutions (notably INFONAVIT, FOVI, and FOVISSTE), facilitating the development of primary and secondary housing finance markets, opening a new role for microfinance institutions for housing and home improvements, and coordinating the related federal level agencies (SEDESOL, Housing Commission, etc.) with each other and with state and municipal authorities. In the urban context, that coordination will also be critical to provide the housing market with a viable physical context-that is, with an integrated, metropolitan-area-based approach that combines basic urban infrastructure and services with effective land planning and titling, affordable urban transportation, and environmental preservation. 25. The second task implicit in the challenge of enhancing Mexico's competitiveness is to build a broad-based and efficient financial sector. The country has overcome the traumatic banking crisis of 1995; it has succeeded in establishing an adequately capitalized, competitive banking industry that operates within solid supervisory and regulatory parameters, that has received abundant foreign direct investment, and that enjoys a more conducive legal framework for loan recovery. While the crisis-driven assumption of bad loans and resolution of unviable banks has created a large, long-term debt for the govermment, asset recovery and debt management is being handled effectively (through the so-called IPAB). These are hoped to set the stage for a long-awaited recovery of domestic credit that contracted during the past six years. However, several areas of the financial sector beyond banks remain in need of reform. First, the mandates (and, thus, practices) of the public development banks will have to be adjusted to the new realities of the markets in which they have been operating (for example, BANOBRAS in the current, more fiscally decentralized and more market-driven framework for subnational borrowing) and to ensure that they complement, rather than compete with, private initiative (for example, BANRURAL's role in giving access to credit to the rural, unbanked poor). 26. Nonbank credit institutions, especially those serving the poor and populations in the rural areas, will likely play a more prominent role, calling for matching supervisory arrangements (for example, implementing recently passed legislation governing microcredit, saving and loans, and financial cooperative institutions). Third, while major progress has been achieved in giving private-sector workers adequate mechanisms for long-term saving, the reform of the public- employee pension systems (both federal and state) has not begun and, in some cases, will require a revision of the cross-funding arrangement that those systems operate (for example, financing health insurance or mortgages). Finally, Mexican capital markets remain largely untapped as a source of finance, notably long-term finance. Improvements in information disclosure, protection of minority shareholder rights, corporate governance, and the like are still under implementation. Further private sector participation is needed to broaden the institutional investor base and strengthen still nascent capital market infrastructure. 10 27. With adequate physical infrastructure and a more effective financial sector, Mexico will be well placed to tackle the third constraint to its competitiveness-the low productivity of its agriculture and the integration of its rural sector into the rest of the economy. This sector has, arguably, had the most drastic structural reforms over the last decade (GATT- and NAFTA- driven trade liberalization, elimination of price interventions, constitutional reform of land tenure), but the results have been disappointing (stagnating growth, lack of external competitiveness, increased rural poverty) in spite of much public support (PROCAMPO, PROCEDE, Alianzapara el Campo, CONASUPO, ASERCA, among others). Past reforms have not resolved decades of structural limitations in the capacity of smallholders to access assets, to participate in better-functioning factor and goods markets (land, financial services, labor, warehousing, technology), and to add value in the marketing chain, all of which have severely constrained the contribution of the rural sector to the growth process. This presents a major policy challenge because the NAFTA agreement will put the sector in open competition with Canada and the United States as of 2008. The key will be to redesign and coordinate official support programs so that they promote diversification into higher-value crops or shifts into more productive on-farm and off-farm activities. The government is aware of these challenges and has already put in motion a number of initiatives: (a) it enacted a new Rural Development Law that provides the framework for future policy and institutional intervention in the sector; (b) it approved a Sector Development Plan that emphasizes competitiveness, on-farm and off-farm employment generation, promotion of rural enterprises, rural finance, and regional development; (c) it enacted the Capitalization Law that disconnects the PROCAMPO payments from planting and permits "cashing-out" the discounted value of the whole of those payments against viable investment projects; and (d) it is restructuring and decentralizing its support programs for enhanced integration and relevance. 28. Finally, the effort to enhance competitiveness will worsen income distribution if it leaves behind the mass of middle-market and micro- and small (mostly informal) enterprises that make up Mexico's "other economy" and that, by some estimates, may account for as much as three quarters of total employment. These homegrown enterprises represent a core of the Mexican private sector, and if left behind, could become an Achilles' heel for Mexico's long-term growth and poverty reduction. Improving investment climate for these enterprises is therefore critical. Indeed, proceeding with the comprehensive infrastructure and financial sector reforms described earlier, eliminating labor-related rigidities (see below) and, importantly, rationalizing and decentralizing the 200-odd federally funded, size-specific support programs are also essential to mitigate the tradeoff faced by the typical informal entrepreneur-to avoid regulatory costs by remaining small and informal ("under the regulator's radar") or to abide by the regulations in order to expand and reap economies of scale. The government has made a good start on this by launching an Enterprise Development and Competitiveness Plan for 2002-06-an overall strategy to foster the provision of microfinance including private sector initiatives, technological upgrading, and business development services. (c) Human Capital Development 29. Over recent decades, Mexican governments have implemented several nationwide programs to reduce poverty. The record of those programs, especially earlier ones, is mixed and their sustainability is unproven. Yet, past efforts provide a solid platform from which to tackle the poverty and the inequality problems on a more permanent basis, not through open-ended 11 transfers but, rather, through human capital development. This encompasses reform challenges in education, health, social protection, labor markets, and in the group-specific needs of indigenous peoples, women, and the rural poor. 30. Mexico's education system continues to be the focus of many quality-improvement and outreach programs (Carrera Magisterial, PRODEI, PARE, Escuelas Comunitarias, PAREIB, Telesecundaria, among others). Many of these programs are achieving their objectives. Access to primary education is universal, secondary enrollment is high and continues to increase, and per capita educational expenditure has been expanded. This provides a good stepping stone from which to address a broader challenge in Mexico's public education-to bring the system to the next level of quality, a level compatible with the demands of a modernizing economy. The current teacher-centered teaching model, which effectively emphasizes memorization to the detriment of comprehension and was designed for the average student, has to be abandoned in favor of cooperative, student-driven learning by investigation, where the teacher is not just the source of knowledge and the custodial controller of the students but, rather, the class facilitator. 31. That new teaching approach will require adjustment in the curriculum (which will have to put more weight on critical thinking and communication); in time-on-task (more time devoted to classroom teaching and less to classroom administration and mechanical repetitions-it is estimated that a Mexican primary school teacher spends less than half of the prescribed 810 classroom hours per year actually teaching); in the school environment (teachers will need to have more say about the type and amount of textbooks, material, and infrastructure that their individual classes get, and the government's near monopoly in textbook production will need to be eliminated to give room to creative competition); and, most critically, in the nature of the mechanisms for teacher and school accountability (supervisor and parent participation will have to focus less on process and more on actual results, as measured by published student scores in standardized national tests). In all these reforms, the teachers themselves (individually and collectively through their unions) and the states (which, as recipients of the education decentralization process, will need to be in charge of human resource management in the sector) will have to be included as partners. All this amounts to a change in the culture of Mexico's education system, a change that will take time but that can start during the current sexenio. 32. A change in culture is also the key to improving quality in the health sector. In the past, Mexico used centralized institutions and vertical programs to control infectious diseases and increase prevention and education. This brought about major first-generation successes-lower maternal and infant mortality, higher vaccination rates, and higher life expectancy. These and other factors have changed the country's epidemiological profile, and now chronic diseases and injuries are becoming the main causes of death and disability, new health threats are emerging (such as AIDS and pollution), and increasingly sophisticated consumers demand advanced- technology medicine. These second-generation issues call for a change in the government's role away from command-and-control and toward facilitating private provision, while ensuring universal access to an essential health package. 33. To fulfill its new role in the health sector, the government will need to put in place new institutional and financing arrangements and a different market structure for health services. The current public health institutions (SSA; IMSS; IMSS-Solidaridad; ISSSTE; the health services of PEMEX, the states, the Federal District, the police, the armed forces, and other parastatals) each finance and operate health systems with their own facilities and physicians. This raises costs and fails to pool risk. The fragmentation among public health institutions shelters them from private 12 competition and hampers efforts to set an adequate legal and regulatory framework for regulation of private health providers. It perpetuates the subsidization of supply rather than means-tested demand, and precludes the objective of universal coverage. Furthermore, the current industry structure makes it difficult to accommodate another institutional arrangement that is sweeping the provision of public health service-decentralization to state and municipal responsibility. 34. While education and health undoubtedly top Mexico's list of social investment needs, it remains a challenge to set up mechanisms able to protect that investment. The country's progress in social assistance and social insurance has been significant. Some of its social assistance programs are world models-notably OPORTUNIDADES (formerly known as PROGRESA), a direct income transfer arrangement for poor, rural women conditional on the use of selected education, health, and nutritional services by themselves and their children. The general direction in food-related programs (like Liconsa, Tortibono, Diconsa, and DIF Breakfast) has been the right one: means-testing has largely replaced universal subsidization, and program decentralization to the state and municipal level is proceeding. The same appears to be the case for income-generating interventions (PET, PROBECAT, Apoyos Productivos, among others). Yet, important gaps in social risk coverage still exist. The social security system covers only one in every five of the urban elderly population, and only 2 percent of the total poor. Critical social assistance tools (like preschool and ECD programs) have at best limited reach in rural, indigenous areas. And poor, urban, school-aged children too often drop out of both ends of the school system. In social insurance, the pension system and negative income tax regime have, by nature, benefited the formal, middle-class workers, and left out the informal, the poor, and the unemployed. 35. Even though building and protecting human capital is the key to reducing poverty, human capital does not by itself reduce poverty. The poor need to be able to earn income with that capital. The link between human capital formation and actual poverty reduction is provided by the labor market. It is therefore a serious concern that the legal and regulatory framework for Mexico's labor market is outdated (part of it dates back to 1917) and constitutes an impediment for workers, especially poor workers, in an increasingly globalized economy. The current system of severance payments; collective bargaining and industry-binding contracts (contratos- ley); obligatory union memberships (cldusula de exclusion); compulsory profit sharing; restrictions to temporary, fixed-term and apprenticeship contracts; requirements for seniority- based promotions; registration of firm-provided training programs; and liability for subcontractors' employees (patr6n indirecto) do not benefit the employees. As a result, roughly one in every two Mexican workers remains in the informal labor market, about half of them against their will. It is also not surprising that NAFTA investors resent Mexican labor regulations and pass the cost on to workers through lower wages-those regulations impose a "tax wedge" worth 31 percent of payroll, compared with 12 and 19 percent in Canada and the United States, respectively. 36. Finally, the challenge of human capital formation is particularly difficult for three, overlapping social groups-women, indigenous populations, and the rural poor. Socially ascribed gender roles have placed women at a clear disadvantage in terms of both health (especially reproductive health), education, labor, and personal safety. Similarly, about I in 10 Mexicans defines himself or herself as indigenous and holds, and may respond to, a different set of economic values, whereby assets (especially land) are nontradable sources of group identity, community benefit is held in higher regard than individual profit maximization, traditional social 13 governance bodies are trusted over those dictated by the country's laws, social organization is based on prestige and civic duty, and the language of preference (and frequently the only language) is not Spanish. The recently passed Indigenous Rights Bill is an attempt, although a contested one, to recognize those differences. Correlated with that ethnicity, the incidence of extreme poverty in rural areas, especially in the ejidos, is disproportionately high-and persistent. Past reforrns in the sector have not resolved decades of structural and cultural limitations on the capacity of poor farmers to access input and output markets. Nor have they addressed the heterogeneity of the rural sector and its regional variations. As a result the sector remains uncompetitive, segmented between farm and off-farm employment, and unable to capture the externalities of conglomeration between urban centers and rural areas. (d) Balancing Growth and Poverty Reduction with Protecting the Environment 37. Mexico's economic growth has been predicated, in great part, on the mining of natural resources and, in the absence of a coherent approach to environmental protection, has contributed significantly to polluting the environment. Water, forests, biodiversity, and air quality are being depleted in order to foster growth, which "green" national accounting shows has cost the country some 10 percent of GDP per year. Such degradation has now become a binding constraint to Mexico's external competitiveness, and to its ability to access new markets, attract foreign investments, and further develop its tourism industry. As a member of NAFTA, WTO, and the OECD, the country is compelled to enhance its environmental standards and compliance mechanisms. There is growing international awareness that exports based on polluting production carry negative global externalities and constitute an unfair competitive advantage. Moreover, the deterioration of the environment is already becoming a physical impediment to production. For example, the depletion of aquifers (100 of Mexico's 257 aquifers are being overexploited) is a direct impediment to industrial activity in the northern states, where most of Mexico's economic dynamism is located. In other words, at the current rate of environmental degradation, growth and, hence, poverty reduction, are no longer sustainable. 38. Yet, the relationship among poverty and environmental degradation presents the characteristic of a vicious circle-in many rural areas, depleting natural resources appears to be the only way for the poor to survive because they lack access to markets, public services, infrastructure, and, plainly, better alternatives. This calls for a revision of existing development programs and incentive structures, whereby pricing policies and subsidies (in water, energy, agriculture) that claim to assist the poor, actually convey perverse signals and induce overuse, misallocation, and waste of environmental assets. Thus, unless the implicit short-term tradeoffs between social protection and environmental protection are addressed, environmental programs are likely to fail. 39. Environmental management in Mexico also entails difficult institutional challenges. First, the definition of property rights over natural resources, both on individual and community bases, remains incomplete, as does the enforcement of those rights and the ensuing protection responsibilities (especially in a large country like Mexico, where enforcement must also rely on market-driven instruments, social communal control, public disclosure programs, and voluntary compliance). Second, decentralization of environmental management (a very desirable arrangement for a function so dependent on local knowledge) is now under way but faces uneven institutional capacities across states and municipalities and weak fiscal incentives for those subnationals to tax polluters and recover the cost of environmental usage (one clear example is 14 water management where further decentralization at the watershed level would be warranted). Finally, mainstreaming the environment through sector policies and programs has remained an elusive objective of the federal government; the Environmental Ministry has suffered in the past from its sectoral confinement but is now taking steps to obtain commitments from sectoral ministries (Agriculture, Energy, Infrastructure) toward the achievement of environmental objectives. (e) Building an Efficient, Accountable, and Transparent Government 40. The challenge of putting the Mexican economy on a sustainable, rapid, poverty-reducing, environmentally-balanced growth path will tax the government's capacities, and calls for their enhancement. Improving the quality of government (understood to be a more effective, more efficient, and more transparent body of providers of public goods) is, however, a multifaceted, multiyear task the full completion of which will likely span into the long-term. It will therefore be imperative to focus on four critical areas where the marginal returns in terms of quality improvement are highest-decentralization, the judicial system, anticorruption, and civil society organizations. 41. As mentioned, decentralization in Mexico is already under way and progressing rapidly. It has tremendous potential for improving the quality of government services by bringing policymakers and final beneficiaries closer together. It can rightly change the role of the federal government away from pursuing those results that the subnational governments can achieve on their own, and toward capturing nationwide externalities. But ill-conceived or poorly implemented decentralization also has the potential to be a destabilizing factor for service delivery and public finances at all levels and, ultimately, for the country's macroeconomic performance. The Mexican government has thus sought to avoid these dangers by imposing hard budget constraints on states and municipalities (through, among other things, renouncing its own powers to hand out discretionary transfers, establishing a regulatory link between credit access and credit ratings, and assisting those states that seek adjustment-for example, Estado de Mexico). However, in the medium term, subnational fiscal discipline will have to be supplemented with a framework more conducive to decentralization, something that entails reform in the tax-sharing system (or "Fiscal Pact"), a clearer assignment of expenditure responsibilities (and for policymaking around those expenditures), and better reporting and coordination among levels of government.8 42. The judicial system is the second governance front where the payoffs of reform will be particularly high for improving the overall quality of the government function (and simultaneously, of the business environment for private-sector-led growth). Although currently void of comprehensive and systematic evaluations, this is an area where consensus seems to exist on the broad diagnosis-the system provides services in insufficient quantity and of poor quality, is not free of corruption, and is not equally accessible to the nonaffluent. The cause of such 8. It is important to note that the devolution of taxes and the assignment of expenditure responsibilities are much more than technical matters, because they will defne the type of federal nation Mexico wants to be. For example, the amendment of the Fiscal Pact to devolve taxes will call for a parallel amendment of the transfer formulas which, in effect, currently carry resources from richer to poorer states and smooth development disparities across regions. Similarly, full decentralization of expenditure responsibilities may or may not be conditional on minimum standards of achievement (say, in education) meant to ensure a certain level of national homogeneity. 15 weak performance, and the reform challenge, is a combination of outdated substantive and procedural laws (including those that allow for recourse at higher levels of government or amparos), overlapping federal-state jurisdictions, inadequate administrative structures and processes, inadequate human resource management, and underfunding. Although Mexico is quickly advancing toward judicial and electoral independence from political powers (at the federal and state level), it will need further development of alternative dispute resolution mechanisms for efficiency and participation purposes. 43. Third, improvement in the quality of Mexico's government function will undoubtedly involve the strengthening of anticorruption mechanisms. While systematic diagnosis and documentation of the problem is recent and incomplete, available indications and surveys suggest that there is a pent-up demand for transparency. The federal government is responding with agency-based anticorruption strategies that often involve private sector support and client participation. Addressing the corruption problem will, however, be difficult and will take time. It will thus be critical to focus first on key incentive-setting institutions: (a) SECODAM and the Contaduria Mayor de Hacienda (the government's internal and external auditors, respectively), and core federal agencies to reduce corruption opportunities; (b) a career civil service must be established, where promotion and compensation are market competitive and performance based and where official information (records, accounts, decisions) is kept confidential only by specified exception; and (c) several societal institutions will require specific support, notably, the judicial system (addressed above), the police (to break the link between crime and corruption), and the media (the role of which in the new, more open Mexico is likely to expand, testing the strength of the legal protection framework for its operation). In addition to setting up a conducive framework, the implementation of the federal government's Integrated Financial Management System (SIAFF) remains incomplete (instituting legislation, inter-agency harmonization, and training are still required for the SIAFF to be fully operative). 44. Finally, civil society organizations (CSOs) will play a critical role in enhancing government quality, as partners in the design of development policy and as a means for public accountability during implementation. Mexico has a long and evolving tradition of social organization-from small, voluntary, and philanthropic foundations dealing with localized issues to professional, technically-competent entities influencing public policy in trade, democracy, human rights, anticorruption, environment, and women's rights. The new administration has taken positive steps to foster CSO participation. Alianza Ciudadana, a national office for public- private partnerships and reporting directly to the President, was inaugurated. CSOs have been regularly invited to debate specific issues of national relevance. Several line ministries have engaged CSOs around sectoral strategies and programs (notably, SEDESOL's Consejos de Consulta Ciudadana in social assistance, SAGARPA's Consejos Regionales de Desarrollo Sustentable in regional development, and INI's Fondos Regionales for indigenous peoples). And several respected civil-society leaders were appointed to new posts within the government. Yet, despite that significant progress, the environment in which CSOs operate remains a constraining one: the legal and fiscal framework does not facilitate their emergence; their institutional capacity to engage in policy debate and seize new opportunities to participate (for example, in public expenditure monitoring) is uneven; inter-CSO coordination is weak (especially, between highly-representative but often isolated community-based organizations and technical organizations with access to decisionmakers); and they face a persistent (although at present declining) culture of exclusion in parts of the public sector. 16 IV. THE WORLD BANK GROUP'S ASSISTANCE STRATEGY (a) The Lessons of the Previous CAS 45. The fiscal 1999-2002 CAS period was driven by the theme of "sustainability," both economic and social. The uncertainties of the then-upcoming presidential elections, and the preceding record of end-of-sexenio crises, called for flexibility in the design of the assistance program. There lies the first lesson of the now-closing CAS: when properly used and with clear selection criteria, flexibility works. The WBG was able to support macroeconomic and financial sector sustainability through adjustment operations for which political consensus around the necessary reforms existed (as in the decentralization and banking areas); to refrain from others where such consensus was lacking (as in fiscal reform, for which the WBG focused on diagnosis and analysis); and to seize opportunities for intervention in key development sectors as they presented themselves (as with the Gender LIL). These and similar efforts were carried out within a predefined financing envelope that respected cautious exposure limits. 46. The second lesson from the previous CAS is the high value of good analytical work, independent of the likelihood of immediate actual reforms. In Mexico, investment in country knowledge tends to have large returns but long "payback" periods. The "seed" value of ideas is particularly high. Thus, when the issue is important for development, the WBG must assist in understanding it, preparing suitable policy options, and help to foster consensus among stakeholders. This conceptual readiness positions the institution well to respond at short notice-for example, the WBG's support to the recently approved reforms in the fiscal code started a year earlier with the Fiscal Reform CEM. Similar advanced investments in knowledge will be made in the coming years-in areas like judicial systems, anticorruption mechanisms, labor legislation, and public development banks. 47. Third, tailoring assistance to the level of government effectively responsible for policies and programs pays off. Following the deepening of the political decentralization process in Mexico during this CAS period, the WBG put heavier strategic emphasis on working with municipal and state governments, both in investment (for example, DRD III) and adjustment (for example, Estado de Mexico SAL) operations, and in analytical work (for example, Public Expenditure Reviews in Guanajuato and Veracruz). This will help the WBG adapt its future assistance to the deepening federal nature of its Mexican client. 48. Fourth, for most Mexican counterparts, technical quality is what makes IBRD's assistance attractive, not its advantageous financial terms (although these terms remain attractive for the financial authorities). In Mexico, IBRD loans are not additional to the budgets of the implementing sectoral ministries (their individual allocations are determined in the federation's budget independently of how they are funded). In spite of this nonadditionality, which is very likely to remain in future operations with the federal government, the authorities still see IBRD participation as a catalyst for best practices in design, support in implementation and, critically, market credibility through the commitment of resources by an independent party. 49. Fifth, IBRD, through policy dialogue, knowledge management, and advisory services, has been acknowledged to have contributed to a smooth process of transition between presidential administrations. The production, discussion, and publication of the comprehensive collection of policy notes (some 30 sectoral notes, five thematic notes, and an overall strategy- setting synthesis) proved to be an instrumental input for the incoming government, because they distilled the sector-by-sector observations that the Bank accumulated during more than five 17 decades of relationship with the country, provided diagnostic analyses of the main issues, and put forward policy options to resolve them. 50. Sixth, effective assistance strategy requires a balance between interventions that foster growth within a sound macroeconomic framework and those that pursue microeconomic objectives necessary for sectoral efficiency. Over the CAS period that now closes, the IBRD support carried that balance, delivering both broad, rules-establishing operations (for example, the Decentralization Adjustment Loan) and investment projects that enhanced the quality of specific sectoral expenditures (for example, Education APL). This combination of mutually reinforcing, macro and micro priorities will remain in the upcoming CAS cycle. 51. Seventh, as with the previous CAS, recurrent evidence cautions against overreliance on quantitative, time-bound benchmarks when designing strategy. The large array of factors outside the WBG's (and, sometimes, the government's) control lessen the value of those benchmarks- some outcomes were obtained even without the predicted policy action taking place (for example, large foreign investment in the banking industry without reform of the judicial system), while others were missed even though that action took place (for example, slow growth in 2001 despite a sound macroeconomic policy mix). 52. Eighth, as for IFC, a major lesson of the past years in Mexico and other countries is that the Corporation is coming under increased pressure to balance its multiple objectives of profitability, efficiency, and outreach, as it seeks to serve smaller (and often riskier) companies and pioneer (often more complex) projects. In Mexico, IFC has so far been able to maintain a good balance with the combination of large, medium, and small clients, intervention through financial intermediaries, and targeted small projects with high probability of success. 53. Finally, a 10-year retrospective Country Assistance Evaluation was completed in 2000, covering only partially the now-closing CAS period. It points to a varying degree of effectiveness and relevance over the different CAS cycles, and emphasizes the role of government ownership in guiding the WBG's assistance (see Box 1). Box 1. Country Assistance Evaluation The WBG assistance program to Mexico during fiscal 1989-2000 was reviewed by OED, and the report, Mexico- Country Assistance Evaluation, has been discussed at the CODE. The report found that the WBG's assistance program was adequately adapted to the country's rapidly changing developmental challenges and noted that the Mexico operations of the period received more favorable OED ex post evaluations for outcome, likely sustainability, and institutional development impact than other operations in the region and Bankwide. Still, the report concluded that the effectiveness of the program varied over time and should be, overall, considered as partially satisfactory. ESW was considered marginally effective, partly because Mexican officials under the previous governments did not want to accept outside intellectual influence, or at least did not acknowledge it. The CAE found that the Bank had positive impact in primary education and health services, the transport sector, and in reforms in contractual savings. It also found that there were significant lapses in the Bank's effective engagement in the financial sector during FY92-94 and on environmental issues in FY96-99. Also, the CAE stated that Bank lending had the most impact at times of crisis, when Mexico's access to capital markets was curtailed. The CAE stressed that the Bank's experience since FY89 showed that, due primarily to the quality of human capital available to the Government and changing nature of the country's development tasks, it was increasingly challenging for the Bank to have non-financial value added in Mexico. During the most recent period of evaluation, fiscal years 1997-2000, the report concluded that the WBG's assistance program was relevant but too ambitious, relative to which the results were partially satisfactory. The ambitiousness of the 1996 CAS program led the government to expect high levels of new commitments and disbursements that were not fully met due to lack of policy progress and a tighter-than-expected fiscal stance, creating a shortage of counterpart funding. For the most part, the program in the 1999 CAS was not yet at a stage to be considered in the report. 18 (b) The Lessons of IBRD's Portfolio 54. Mexico's portfolio performance remains satisfactory with only two projects rated unsatisfactory (3.7 percent of commitments), as of March 14, 2002. The Bank's portfolio in Mexico includes 28 active projects, including six GEF/MP projects, with about US$5.2 billion in net commitments and an undisbursed balance of around US$2.8 billion. The year-to-date disbursement ratio for investment loans was 10 percent. Proactivity and realism indexes for the portfolio are both at 100 percent. Financial management and procurement performance has been impeccable (see Box 2). Box 2. Procurement and Financial Management in Mexico's Portfolio The Country Procurement Assessment Review (April 2002) concluded that procurement in IBRD projects was satisfactory and free of major problems, because the agencies responsible for project implementation carry out procurement in accordance with WBG policies and procedures, using its standard bidding documents. Two procurement audits and 10 agency procurement capacity assessments carried out in the past two years found no major issues. In April 2002, the government, together with IBRD, OAS, and NGOs, sponsored an International Conference, Mexico Unido Frente a la Corrupci6n, at which the Plan of Actions put forward in the CPAR was discussed. The CPAR states that Mexico needs to: revise the current public Procurement Laws to differentiate procurement of goods and services from selection of consultants in order to obtain better designs and advice; standardize bidding documents among its 3,000 agencies to avoid arbitrary specifications or conditions; create a procurement career track to ensure availability of qualified staff; and fully implement the rule of calling for bids only when final designs are completed. The first Country Financial and Accountability Assessment (CFAA) will be completed within fiscal 2002, and on-demand subnational level assessments are scheduled as of fiscal 2003. For all IBRD projects, annual audit reports have been reviewed and considered acceptable. Most of them have been received on a timely basis. Misuse of funds has not occurred in any IBRD project in Mexico. The use of COMPRANET, the federal government's innovative system for electronic bidding, was successfully piloted in an IBRD project and will be expanded. The presence of a senior financial management and procurement team in IBRD's Mexico Office has proven instrumental in these achievements. Despite these satisfactory developments, the government's information systems do not yet have classifications that are sufficiently detailed and harmonized. IBRD continues to work on procurement and financial management with Mexico as part of the government's anticorruption strategy and promotion of access to information. All new investment projects are required to have a Financial Management Specialist as a member of the task team throughout the project cycle, to carry out a financial management assessment at entry, and to establish adequate mechanisms for constant monitoring. 55. Over the last CAS period that now concludes, a number of general observations can be made about those projects that performed less well than others (see Box 3). First, some operations have been affected by broad changes in the political and legislative environments. Implementation was slowed down by the transition of administrations both before and after the July 2000 presidential election, especially in terms of delayed project signing and effectiveness. Similarly, an accelerated devolution of budget and execution authority from the federal to state governments has necessitated a time-consuming reorientation of several operations that were originally designed for the federal level. 56. Second, the previously mentioned nonadditionality of IBRD funding has made sectoral ministries increasingly reluctant to give budget priority to implementing Bank-financed programs, which must compete with others while being characterized by stricter fiduciary and safeguard requirements (this is especially true of the infrastructure sectors). This underscores the 19 continuous need for superior quality in IBRD's technical inputs, both at the stage of project design and during implementation. 57. Third, in a handful of high-risk-high-reward cases, IBRD-financed operations have been buffeted by volatile policy debates (for example, housing finance). This riskiness, which sometimes was a delaying factor, is also a healthy feature of IBRD's portfolio, as the institution seeks to explore new avenues for civil participation that can give sustainability to the government's reform efforts. 58. Finally, as already noted in the May 1999 CAS, decentralization of IBRD's Country Department to the field, particularly in the fiduciary area, has resulted in faster response times and better results on the ground. Mexico-based staff are now taking on an expanding share of task management, enabling the Bank to respond to the client in a more timely manner and, in some sectors, to open up new lines of cooperation-for example, anticorruption programs with SECODAM and rapprochement with subnational governments. While there is no hard evidence of cost savings out of the Department's decentralization process, those costs have not increased either-while client service has improved. Box 3. What Went Well and Not So Well in This CAS Cycle IBRD-supported programs have had both successes and failures over the last four years. Here are some examples of both. The lack of progress in the transport sector, evidenced by a long delay in the signing and effectiveness of the Federal Highway Maintenance loan and the long gestation of the Highway Finance SECAL, is especially emblematic of the nonadditionality conundrum in Mexico. In those sectors where the Bank's technical contribution does not substantially outweigh the cost of its procedural, fiduciary, and safeguard requirements, assistance opportunities will remain limited. The decentralization agenda (that is, working with subnational governments) has generally had positive results, although advances have been uneven. A major achievement is the work done under the Estado de Mexico SAL in fiscal 2000, the first-ever adjustment operation with a Mexican state. The loan, and the multisectoral policy package it supported, helped the state redress its fiscal imbalances in the context of a comprehensive, cross- sectoral adjustment program-something that both became a model for other states and, critically, protected the national macroeconomic framework over the presidential transition. This followed the Decentralization Adjustment Loan (fiscal 1999) which had helped consolidate the federal framework for subnational fiscal autonomy and creditworthiness. The necessary complement of state-level or city-based poverty-focused investment programs, especially in infrastructure, is still in process for a number of reasons: (a) lingering political transition uncertainties at several levels of government, (b) lack of a solid financial intermediation channel (BANOBRAS has been undergoing internal structural changes over the last few years and is still redefining its mandate); (c) IBRD is only starting to develop knowledge about the institutional capacity of this new set of clients (PERs were completed recently for Guanajuato and Veracruz, and assessments of the fiduciary and safeguard systems in a few selected states are in their early stages); and (d) the modality of the Bank's financial relationship with the states had to undergo (and successfully underwent) a thorough legal review to give confidence that it meets Constitutional provisions. Those delaying factors were, in effect, startup investments, as they have now solidly set the stage for an expansion of IBRD support to subnational entities. Finally, the IBRD's engagement in the human development sectors continues to be successful. At the request of the government, the Bank's technical involvement and financing role in health and education were stepped up significantly during the CAS cycle that now concludes. More generally, IBRD's program has had great success in the unprecedented level of dialogue and cooperation surrounding its analytical work, where the Bank has come to be perceived as a trusted advisor. (A notable example has been the publication of Mexico-A Comprehensive Development Agenda for the New Era, the collection of transition notes whose dissemination included a large number of Mexican states, plus the United States and Europe.) 20 (c) The Lessons of IFC's Portfolio 59. As per the CAS Private Sector Strategy cycle that now closes, IFC's activity in Mexico has followed three priorities: (a) assisting the Mexican private sector in gaining greater and more evenly distributed access to external private financing; (b) improving the efficiency of domestic financial intermediation and mobilizing domestic resources; and (c) helping private firms grow and enhance their international competitiveness. These have translated into IFC's sectoral focus on financial sector development, support for middle-market firms, private infrastructure, and the social sectors. In addition, sustainable development, an area that had not been explicitly identified for IFC in the previous CAS, has received increased emphasis. More specifically, from fiscal 1999 to date, IFC approved operations totaling US$907 million, including syndications of US$301 million, for 27 projects, of which 10 were in general manufacturing and services (middle-market firms), 8 were in the financial sector, 5 in infrastructure, 2 in health and education, and 2 in environmental sustainability. IFC has also continued to expand into new, high-impact areas. This is reflected in project approvals in such areas as hospitals and primary schools (fiscal 2000), a private railway project in Chiapas (fiscal 2000), housing finance (fiscal 2001), microfinance (fiscal 2001), cleaner fuel (compressed natural gas) for automotives (fiscal 2001), and sustainable forestry products (fiscal 2002). 60. Mexico has IFC's third-largest exposure, representing 7.4 percent of IFC's total disbursed portfolio (net of specific reserves). As of February 28, 2002, IFC's disbursed and outstanding portfolio in Mexico consisted of investments in 47 companies, with total exposure of US$708 million for IFC's own account and US$422 million for participants. IFC's investments in Mexico cover a broad range of sectors. On a volume basis, the financial sector, infrastructure (utilities and transportation), chemicals, food and agribusiness, and general manufacturing and services are the sectors with the highest level of IFC investment. The financial sector (30 percent) and infrastructure (21 percent) have received the largest shares of investments, reflecting IFC's strategic priorities in these sectors. 61. Overall, IFC's portfolio in Mexico is of high quality and has managed to withstand economic cycles. As of February 28, 2002, only 0.6 percent of IFC's loan portfolio was in nonaccrual status, ranking among the best in the Corporation. This stellar perfornance was attributable to Mexico's flexible macroeconomic management and increased private sector resilience (honed through the liberalization process since the early 1990s), and to IFC's project selection, emphasis on due diligence, and early involvement in project structuring. IFC's strategic emphasis during the previous CAS period on frontier (or riskier) types of projects and sectors, such as the social sector, middle-market firms, subnational infrastructure, and microfinance, has not to date affected the aggregate quality of the Mexico portfolio. With the economic slowdown in 2001, declining capital flows to developing countries, and stress on IFC's global portfolio, maintaining the quality of new projects at entry, and of portfolios of Mexico's size, is expected to become increasingly important for IFC's strategy implementation and overall performance. (See Box 4 for a discussion of the linkages between the private sector strategy and IBRD-IFC assistance to Mexico.) 21 Box 4. Private Sector Strategy: Linkages in IBRD-IFC Assistance to Mexico Mexico, with three consecutive CASs with a private sector strategy, represents a primary example of an integrated WBG approach to PSD. Over the three CAS periods, the WBG's PSD strategy has become more coherent, with its activity progressively integrated between the IBRD and the IFC, as the following examples indicate (more details of the WBG's approach to PSD in Mexico are provided in the Private Sector Strategy presented in Annex B 10): * The financial sector. The IBRD's assistance in enhancing the regulatory and supervisory environment and the strengthening of the banking sector and the financial sector infrastructure would help set the stage for the IFC's increased involvement in direct and indirect assistance to viable Mexican financial intermediaries, including capital market institutions. The IBRD's assistance in urban development and housing would also be complemented with the IFC's assistance in developing housing finance institutions and mortgage markets. * Infrastructure. A number of subsectors where the IBRD's assistance helped improve the regulatory framework have provided increasing opportunities for the IFC's sequential involvement in helping structure and mobilize a financial package for pioneering private infrastructure projects. This synergy is expected to continue in the areas that could be further liberalized, such as water and energy. * SMEs. IBRD's nonlending services in SME development would benefit from the IFC's complementary experiences with impediments to private sector development generally, and with SMEs in particular. This IBRD activity would in turn support the IFC's increasing focus on assisting SMEs and middle- market companies through financial intermediaries. * Health and education. IBRD's assistance in reforming and improving the public services in this area would continue to be supplemented by the IFC's support for private service providers, helping enhance public-private complementarities. (d) The Role of the WBG in Mexico's New Era 62. As described earlier, Mexico faces formidable development challenges-consolidating its macroeconomic framework, enhancing its competitiveness, developing its human capital, protecting its environment, improving the quality of its government. The country is, however, in an enviable position from which to meet those challenges given that it is a middle-income nation with a relatively sophisticated institutional capacity, membership in the OECD and WTO, access to international financial markets, and a free-trade agreement with the largest economy in the world (NAFTA). Mexico is an investment-grade sovereign borrower, has an annual GNP per capita of US$5,080,9 already meets several of the Millennium development goals, and boasts several private conglomerates that are global leaders in their field. Its political system is stable and representative, and its most recent presidential election was an example of participatory democracy and smooth transition. 63. Against this background, it is natural to ask: What is the value added of the WBG for Mexico in the new era? Or, in other words, should the country "graduate"? Mexico should indeed seek graduation, but along a gradual path and as a long-term objective. Within the three years covered in this CAS, the WBG should maintain, and where necessary enhance, its engagement in Mexico, in both an intellectual and financial capacity. There are several reasons behind this view, which represents the expressed desire of the Mexican government and the broad message of the civil-society consultation process underpinning this CAS. 9. World Bank Atlas methodology. Datum is for the year 2000. 22 64. First, as mentioned, there are still some 45 million Mexicans living in poverty. And the country's average income indicators disguise deep disparities-between the 10 percent of the population that accrues more than 40 percent of the income and the rest of the Mexicans that do not, between urban and rural areas, north and south, large outward-looking corporations and small domestically-oriented entrepreneurs, indigenous and nonindigenous people, men and women. The WBG will respond to the authorities' request and employ its analytical and financial resources as a contribution to closing those development gaps. 65. Second, growth will be a necessary (although not sufficient) condition for poverty and inequality reduction. In turn, achieving higher, long-term growth in Mexico calls for the implementation of a large, pending reform agenda by the federal government in areas such as labor, energy, the financial sector, fiscal federalism, and water. It has been the lesson from past CASs in Mexico, and the recommendation of the recent Bankwide Task Force on Middle- Income Countries,'0 that the WBG's analytical and financial support, together, can prove instrumental for governments that are committed to such reforms and have the political will to see them through. On the one hand, the WBG technical assistance effectively transfers international best practices that enhance the quality of the reforms. On the other hand, by committing its own resources through investment or policy-based operations, the WBG lends critical market credibility to the reforms in question and facilitates further private sector financing. This is the essence of the "growth rationale" for WBG intervention: WBG funding is not necessarily linked to balance-of-payments or fiscal gaps; rather, it is a catalyst because it seeks to ensure that the growth process is credibly sustainable and, thus, the country is creditworthy, so private sources can fill those gaps. Recent examples of this in Mexico are the Banking Restructuring Facility Loans I and II, the Decentralization Adjustment Loan, the forthcoming Tax Rationalization and Environmental SALs, and IFC's intervention in private sector projects. 66. Third, the rapidly unfolding process of decentralization has changed the nature of the policymaker in Mexico. In most of the key development areas (education, health, business environment, natural resource management, just to namne a few), the federal government no longer decides policy unilaterally. State governments now have primary or shared responsibility for legal, regulatory, and institutional frameworks (and, certainly, for the implementation of programs). Increasingly, the federation has a subsidiary role-focusing on interventions with externalities at the national level. For those states taking on new tasks, the continuing presence of the WBG is particularly critical. Not only do they face a large agenda of first-generation reforms (like setting up effective payment enforcement mechanisms for public services), but they also generally have limied technical expertise and have access only to domestic financial markets. 1 " Moreover, the WBG often helps catalyze federal-state coordination. While the WBG has worked with Mexican states and municipalities for decades, it has since 1999 supported the 10. World Bank. 2001. Report of the Task Force on the World Bank Group and the Middle-Income Countries. Washington, D.C. 11. Mexican states are constitutionally forbidden from entering into debt contracts with foreign lenders or in foreign currency. To facilitate subnational financing, in 1939 the federation created a development bank (BANOBRAS) primarily to channel funding from the official multilateral and bilateral donors to states and municipalities. The WBG, and other donor agencies like IDB, have over the years funded subnationals through BANOBRAS with sector-specific investment operations and, more recently, with policy-based adjustment lending. 23 country's decentralization process with enhanced strategic emphasis on state-level analytical and financial interventions, with encouraging results (for example, the Estado de Mexico SAL).'2 67. Fourth, the presidential election of 2000 and the additional impetus it gave to the process of federalism has opened a unique window of opportunity to address long-awaited and much- needed reforms at the federal and state levels. The next three years will be crucial in seizing that opportunity. This makes it desirable to use the full capacity of the WBG's instruments. In terms of IBRD lending, this will mean respecting a prudent exposure "cushion" while deploying the feasible financing envelope as the implementation of the pending reform agenda allows.' 68. Finally, because of the size of its economy and its prominence among emerging-market borrowers, Mexico's development process carries regional and global externalities. These externalities can directly affect poverty counts elsewhere as the effect of the 1995 "Tequila Crisis" demonstrated-particularly in this era of heightened risk perception over, and reduced capital flows to, emerging markets in general. (e) The WBG Strategy, Program Selectivity, and Partnership Over the Next Three Years 69. Poverty reduction will remain the overarching and ultimate objective of the CAS . The lessons of the previous CASs and the critical role that the WBG can play in seizing the poverty- reduction opportunities available in today's Mexico suggest that the optimal strategic path over the next three years is one of continuing, close involvement, and where gross financial flows are used to support reforms that address the main development challenges the country faces. Those flows will fit within an overall IBRD lending envelope of US$5 billion over fiscal 2003-05 (half of which in fast-disbursing operations), evenly distributed across years. This strategy will place the country and the WBG in a flexible position from which to define a new assistance plan three years from now. 70. More specifically, the WBG's strategy will be based on five pillars: (a) macroeconomic stability; (b) competitiveness; (c) human capital development; (d) environmental sustainability; and (e) good governance. For each pillar, a program of sectoral interventions-analytical and financial-is proposed. In all cases, IBRD will heed the experiences of the previous CAS and, thus, will invest heavily in early analytical contributions, work with all levels of government 12. Given the relevance of the Estado de Mexico SAL as a source of not only demonstration effect for other Mexican states but also of lessons in subnational adjustment operations valid for other countries, the WBG will respond to a request by Estado de Mexico authorities and publish a book distilling that experience. 13. An argument can be made in favor of holding back new IBRD lending commitments in order to create even more "room to maneuver' in case Mexico runs into an external financing crisis. That argument should, however, be weighed against several factors. First, IBRD's yearly gross commitments amount to some US$1.7 billion, while Mexico's average gross annual financing needs exceed US$60 billion; in other words, even if IBRD refrained completely from lending to Mexico over the next five years, it would still not have enough lending room to effectively fund the country through a close-down of access to international financial markets. Second, with Mexico among emerging market borrowers with ample access to external financing (and one of the very few with sovereign investment grades), only an international financial crisis of massive proportions and long duration could close down that access; such a situation would likely call for a complete reconsideration of the country assistance strategy, rather than a relative small increase in lending. Finally, and more fundamentally, Mexico today faces a historic opportunity of reform, one that has not presented itself in the last 70 years. Letting that opportunity slip away could be the cost of holding back IBRD assistance and overcushioning IBRD exposure. 24 (federal, state and municipal), and preserve a balance between macro- and micro-oriented activities in its work program. 71. As explained in Section III, the five pillars which conceptually underpin Mexico's National Development Plan 2001-2006 are mutually reinforcing, and hence, equally essential for sustainable poverty reduction. The WBG fully supports the Government's comprehensive approach to development and stands ready to work in each of the priority areas defined by Government. However, within the Government's priorities, specific areas for WBG involvement have been selected in accordance with a number of strict criteria as follows. The overarching criterion is the likely poverty-reduction impact of a given WBG intervention, albeit recognizing that such impact is not always direct, quantifiable, or immediate. Nor are the impacts exogenous to each other-the poverty-reducing effect of, say, rural finance reform is much enhanced by the existence of an efficient judicial system. In this context and based on the country's circumstances, the CAS program contains interventions within each sector that will: (a) contribute most to the poverty reducing objectives of sectoral strategies; (b) have the most "spill- over" effects to other sectors of WBG involvement; (c) enjoy a high degree of "ownership" among relevant stakeholders; and (d) best exploit the WBG's comparative advantages, taking into account the planned activities of the full range of other domestic and international development partners (see Table 5). Table 5. Partnerships in Mexico's Development Framework Developmer acr Acoelerating growh through enhanoed Human Capital Emnronment Good govemanc Challenges ecDnornic Competitiveness Development Stability l_ Pa8 , : l E 8/i = CC ~, X 8 ' p mman l L E111111li i 0 ' 8 Y E E ~~ 0) LD CG 0L 4 VO Wol ank/ 1lllllllllliiiiiiiii 'Ellllliiil- (D U~~~w AFcb 8 iiiiillll E >iiiiiii l E Elo | ~~~~~~LiSJ Focu (DilSm ou giiatFcsHg ou co~ w= - Co D IMF ~ ~ ~ ~ ~ ~ ~ ~ ~ I 72. As the preceding suggests, the WB3G's assistance will be closely coordinated with that of other key external agencies supporting Mexico. For example, while the WBG will play an important role in supporting some aspects of macroeconomic management (like tax administration), it will only play an observer role in others (like monetary policy, to be primarily supported by the IMF). Similarly, the WBG will provide selected analytical support in the area 25 of social protection, while IDB will finance the authorities' flagship OPORTUNIDADES (PROGRESA) program. Finally, IBRD will follow IDB's lead in the financing of infrastructure investment under the Puebla-Panama Plan. [For more details on coordination with other partners, see Section VI]. 73. WBG support presumes that several conditions are in place, as follows: (i) that sound macroeconomic management, including a continuing, satisfactory dialogue with the IMF; (ii) that all targeted interventions are "owned" by the respective counterparts, defined to include stakeholders whose political support is instrumental in implementation; (iii) that intragovemment coordination remains conducive to reform dialogue and project implementation; and (iv) that the solid record of procurement and financial management of IBRD projects is maintained. Slippage in these areas will trigger a shift in the WBG program toward a "downside" scenario of reduced exposure. 74. As with all WBG operations, it should be noted that its support will depend on the conduciveness of legal and regulatory environments and, when necessary, on the political consensus for the required reforms (for example, in taxation, banking, labor, public pensions); lacking that consensus, lending will be correspondingly lower. Naturally, the speed at which reforms will be implemented cannot be predicted with precision and, therefore, the WBG assistance will be adjusted accordingly. However, an indicative program of financial and non- financial interventions is presented in Tables 6 and 7 (and Annexes B3 and B4) for each development pillar. 75. As an integral part of the overall WBG strategy described above, the IBRD and IFC will work closely together in the implementation of a Private Sector Strategy (see Annex B10) aligned along the five pillars, especially competitiveness and human capital development through private sector initiative. IFC's interventions will thus focus on giving private entrepreneurs a more developed financial sector (and more evenly distributed access to financing); better means to compete internationally; support to invest in areas newly opened to private participants (for example, the social sectors and infrastructure); and assistance in internalizing sustainable development and corporate governance practices. The volume and composition of IFC's activities will depend on market conditions, private sector's access to international financial markets, and reform progress-in general, IFC's role is stronger when and where access to international financial markets is limited, which has not been the case for top-class Mexican firms in recent years. IFC has thus remained relatively more active in other parts of the private sector, and in industries that have become open to private sector participation. (f) Sectoral Support Strategies and Tools To Deliver Them 76. The general strategy described above will be delivered through a set of sectoral strategies and corresponding analytical and financial products. These are listed in Table 6, alongside the primary development objectives they will serve, and the benchmarks for monitoring their progress.14 Their conceptual thrust is explained below for each sector.15 14. Further details are provided in Table 7 and Annex B3-Financial-and Annex B4-Nonfmancial. 15. In the previously mentioned day-long summit between President Fox (and his economic cabinet) and President Wolfensohn (and WBG senior management) on December 8, 2001, five areas of the proposed WBG strategy were identified as subjects for special emphasis: the "poorest among the poor" (especially those living in Mexico's southern region), education, health, judicial reform, and anticorruption mechanisms. 26 77. Poverty and Inequality Monitoring and Analysis. As mentioned, poverty reduction is the ultimate, overarching objective of this CAS, and the common theme of all its sectoral strategies. It is therefore crucial that the WBG maintains a thorough understanding of the determinants and trends in poverty and inequality. IBRD has completed two Poverty Assessments for Mexico, based on the 1996 and 2000 household surveys; it will complete a third assessment on the results of the 2002 survey. It will also analyze how business cycles affect the poor, what poverty programs can do to smooth negative impacts, and how OPORTUNIDADES (PROGRESA) has influenced the welfare of its beneficiaries. IBRD has also, in recent years, studied the causes of Mexico's deep disparities (for example, earning differentials; the way technology diffusion affects returns to education), and will now devote further efforts to assist the Government in the design of growth-friendly policy options to reduce inequality (Growth and Inequality, FY04). (i) Consolidating Macroeconomic Gains 78. Macroeconomic Framework. The analysis of poverty dynamics in Mexico shows that macroeconomic sustainability is a necessary, although by no means sufficient, condition for poverty reduction. This CAS will contribute to that sustainability through two main channels. Firstly, IBRD will support, with fast-disbursing lending, the design and implementation of critical macroeconomic reforms as they are put forward by the authorities. An example is the Tax Rationalization SAL and accompanying Technical Assistance Loan expected to be presented to the Board in fiscal 2002. In the event that the labor market reform is implemented, IBRD will support it through a Labor Reform SAL. Secondly, IBRD will devote ample analytical efforts to key macro issues like public expenditure management, fiscal responses to economic shocks, public debt management, international factor mobility, and labor markets convergence. A technical dialogue will be initiated on shifting public expenditure management (in particular, investment expenditures) toward a result-based approach, to lay the foundations for result-based management of the country's development process in the future. Finally, IBRD will continue its close monitoring of macroeconomic developments in the country, as a means to inform its policy dialogue with the authorities and adapt the implementation of its assistance strategy. This monitoring will cover short-term developments (for example, through short-term risk notes) and more fundamental, long-term structural trends (for example, through Country Economic Memorandums). (ii) Accelerating Growth Through Enhanced Competitiveness 79. Infrastructure. The change in administration has opened a new opportunity to bring reform, especially private participation, to core infrastructure facilities. Because of the analytical basis that the WBG has built over the years in this area, its strategy is now to support the implementation of that reform. For example, recently completed sector work on urban development and low-income housing will provide the conceptual basis for financial support to a nationwide urban upgrading initiative (National Urban Upgrading Loan FY03). The program will emphasize management of major metropolitan areas (logistically, financially, fiscally) in a way that carefully balances urban development with environmental sustainability, urban land management, institutional reforns, and rationalization of low-income housing subsidies. Similarly, the ongoing IBRD support to the design of a national program for the modernization of the water and sanitation systems throughout Mexico (with legal, regulatory, and institutional reform at the federal, state, and municipal levels, as a means to induce water conservation and 27 enhance private sector participation) will be expanded through a Water & Sanitation Investment Loan in fiscal 2003. Also building on recent sector work, a Highway Finance loan in fiscal 2004 will support the government in improving the design and financial engineering of private highway concessions, as required to ensure fiscal and physical sustainability, and synergy between the old and new parts of the national, state, and local road networks. 80. A Power Sector Reform operation (fiscal 2005) is envisioned to support the reform, if approved by Congress, in the petroleum, natural gas, and electricity sectors which is being contemplated by the government and will give larger participation to private agents. A GEF project and a parallel IBRD Technical Assistance operation (fiscal 2003) are being developed to complement and facilitate the mainstream power sector reforms with an off-grid rural electrification program. If successful, this could be extended to a full-fledged national effort. IBRD funding and advisory services will be offered to help the authorities design a strategy to increase the share of renewable energy sources (including sugar-cane based resources) as part of the ongoing ESMAP program, and to develop carbon trading under the Prototype Carbon Fund (PCF). To make sure that the various infrastructure reforms permeate to the subnational levels of government, IBRD will prepare two State Level Infrastructure Decentralization APL operations-a "wholesaling," financial-intermediary operation which would make funding available for fiscally sound states and municipalities that seek to consolidate that fiscal soundness, develop their institutions, and complete sector reforms and invest in water and sanitation, electricity, transport, and telecommunications. 81. The overall program of IBRD support to the infrastructure sectors will be underpinned by related analytical products, notably an Energy Sector review (fiscal 2004), a report on Low- Income Housing (fiscal 2004), and a policy note on Urban Land Management issues and options (fiscal 2005). IBRD will also develop for federal and subnational authorities an urban poverty "tool kit" (fiscal 2003) that pulls together knowledge developed by various sector groups on urban poverty issues. 82. IBRD's efforts in infrastructure will be synergetic with an expanding IFC participation. The Corporation will seize the opportunity to facilitate private investments in power, water, sanitation, and hydrocarbons, as these sectors become open to private agents-a path-breaking event that, as mentioned, will greatly contribute to unleashing Mexico's growth potential. At the same time, IFC will continue to provide support for private sector projects in transport and logistics. 83. Financial Sector. In addition to continuing close monitoring, IBRD will seek to support the broadening of financial sector reforms beyond the commercial banking industry, in a three- pronged strategy. First, it will support policy and institutional reforms in rural finance (including the restructuring of BANRURAL) through a Rural Finance SECAL (fiscal 2003). Second, it will assist in the reorientation and restructuring of the other main public development banks (NAFIN, BANOBRAS, and BANCOMEXT) toward complementing, rather than competing with, private providers of financial services (Financial Sector SECAL I, fiscal 2004). Third, further strengthening of the legal and institutional infrastructure for capital markets transactions (like information disclosure practices, and collateral and credit registries) will be sought through a Financial Sector SECAL II (fiscal 2005), and through a comprehensive review of impediments to the development of the insurance sector (fiscal 2004). Finally, an operation to support reforms in state-level public-employee pension systems may also be considered in the outer year if the 28 states in question show their readiness to embark on such programs following the reforms implemented for the federal employees' pension regimes (see below IMSS and ISSTE). 84. Those IBRD activities will be mutually reinforcing with the IFC's activities which, in the financial sector, will focus on (a) reaching out to Mexican firms (including SMEs and microenterprises) that lack access to term-financing through local financial intermediaries, and (b) supporting transactions that help develop the domestic financial sector. The latter will include nonbank intermediaries, housing finance institutions, credit enhancement, and local currency facilities, and better corporate governance practices (for example, through private corporate and financial restructurings). 85. Agriculture and Rural Development. In spite of many reforms, Mexico's agricultural sector has not yet adjusted and prepared for the forthcoming competition under NAFTA. The WBG aims to help make that adjustment both efficient and, more important, socially sustainable. Thus, it will base its sectoral strategy on a more integrated rural development strategy that builds on on-farm and off-farm opportunities at the regional level while promoting agricultural productivity. First, it will support efforts to improve the living standards of the rural poor- especially the indigenous populations-through the expansion of the Rural Development in Marginal Areas APL project (fiscal 2004) and the related Carbon Sequestration in Coffee Areas project (fiscal 2003) with financing from the Prototype Carbon Fund, and a new phase of the Community Forestry project (fiscal 2004). Second, enhanced agricultural competitiveness will be sought through the consolidation of the transfer of the irrigation districts and their modernization (Irrigation and Drainage Modernization, fiscal 2003), and continued support to the restructured Alianza program (Agricultural Productivity II, fiscal 2004) with an emphasis on diversification and microenterprise development. Third, the improvement of key factor markets will be (re-) emphasized, notably; (i) rural financial markets (a Savings and Credit TA loan in fiscal 2002 and a Rural Finance SECAL in fiscal 2003 will support, respectively, the strengthening of savings and loan institutions through BANSEFI and SAGARPA, and the restructuring of public development banks like BANRURAL and FIRA); (ii) land markets (a Land Titling LIL for fiscal 2003 will be the vehicle for enhanced access and security, completion of the PROCEDE program, and the sharing of international experience); and (iii) warehousing and inventory financing through sector work (fiscal 2003). Finally, as in other sectors, the policy dialogue with state governments will be deepened, in this case as a means to foster municipal capacity and the provision of basic infrastructure services in rural areas (Municipal Development in Rural Areas fiscal 2003). This four-part strategy described above will be based on the continuing accumulation of analytical knowledge on the sector which, in the coming three years, will explore policy options for the repositioning of the coffee and sugar sectors (fiscal 2002), agricultural competitiveness under NAFTA (fiscal 2003), rural public pension schemes (fiscal 2003), indigenous peoples' access to assets and factor markets (fiscal 2004), warehousing schemes (fiscal 2003), and rural enterprise development (fiscal 2004). Improvements in the sector's policy framework will present opportunities for firms with enhanced competitiveness in agribusiness, an area in which IFC will continue to focus as a means to reach out to smaller farmers through larger actors. 86. Middle-Market, Micro-, and Small Enterprises. IFC will take the lead in direct financial assistance to the Mexican corporate sector, catalyzing access to investment financing for the broad spectrum of Mexican firms. IBRD will focus its support to microbusinesses and small and medium enterprises (MSMEs) on creating a market-friendly environment for their operation 29 (cost of doing business, technology-based development services, access to finance, and the like). The strategy, and its interventions will, however, be demand driven and decentralized-that is, it will allow private agents (firms, financial intermediaries, and other service providers) and subnational governments to decide what kind of assistance they need, with the federal government (and the WBG) assuring appropriate monitoring and evaluation. When required, this will translate into remittance investment schemes, whereby the savings of migrants residing abroad are channeled into (micro)business in their community of origin. The ongoing South- East Regional Development LIL, National Micro- and Small Business Development Project soon to be brought for Board consideration, and a forthcoming report (SME Development, fiscal 2003) will provide the operational framework for IBRD's assistance, and will be well complemented by IFC's funding for financial intermediaries catering for MSME (including microfmancing schemes in poor areas). (iii) Human Capital Development 87. Education. Mexico's education system needs better quality, more uniform access, market sensitivity, and local accountability. The WBG's education sector strategy, and a major part of its overall CAS, will be aligned to serve those needs-the richness of the existing sectoral dialogue and project pipeline provides an excellent platform from which to proceed. The ongoing IBRD efforts in basic education (the sustainability of which will be ensured by the Basic Education APL III in fiscal 2005) will be complemented by new interventions in Technological Training and Certification in fiscal 2003 (to put the opportunities of the new knowledge economy within the reach of Mexican workers competing in global markets), Science Education in fiscal 2004 (to foster critical thinking and group learning in the early stages of education), and Science and Technology II in fiscal 2005 (to continue bringing financing to those that merit higher education but cannot afford it). In parallel, two formal reports will study mechanisms to improve quality and access in secondary (fiscal 2004) and adult education (fiscal 2003) (especially for the poor and the indigenous), and an assessment of constraints to the expansion of the Knowledge Economy will be carried out in fiscal 2003. IBRD efforts will be complemented, on the supply side, by IFC's support for private providers of education, a growing area of activity for the Corporation in Mexico. 88. Health. The WBG will align its strategy in the health sector to the three objectives of the government's National Health Program 2001-06-equity, quality, and financial viability. This entails IBRD's support of interventions to deliver health services to people living in underserved rural and urban areas (and specifically the indigenous populations through the Indigenous Health project in fiscal 2005), and to continue developing sustainable institutional capacity at the central and local level (ongoing support for SSA; ISSSTE SECAL and TAL in fiscal 2003; and Health Systems Reform IMSS in fiscal 2004). The reform of these institutions will not be rapid or simple-the issues include separation of financing and delivery, agglomeration of all public financing under a single fund, definition of basic health packages, competition in delivery, accountability, and regulation and accreditation of providers. IBRD will continue to contribute to the design of those reforms through the above-mentioned projects but, equally important, through formal and informal analytical work. At the same time, technical assistance will be provided for the implementation of insurance mechanisms that could alleviate the formidable financial burden that catastrophic illnesses have on the poor (for example, the Indigenous Health report in fiscal 2004). Fundamentally, as IBRD-supported reforms take root, the health sector 30 will open to private investors, whose entry IFC will seek to facilitate through partnerships that build on the Corporation's experience with health provision in Mexico. 89. Social Protection. Mexico can show major recent achievements in its social protection network (for example, its OPORTUNIDADES program), and has allocated the necessary resources to build on them. The WBG will thus focus on contributing ideas to preserve and, where possible augment, the efficiency of that network as the process of enlarging coverage unfolds, especially onto urban areas. There, it will be difficult but important to minimize regressive targeting structures, avoid leakage to the nonpoor, evaluate impact, and coordinate the actions of the three levels of government. The WBG's analytical contribution to efficiency enhancement will also include the design of more adequate mechanisms for "graduation" from program eligibility, countercyclical triggers for social expenditure, closer links between planning and demographic dynamics, and early identification of new groups at risk. Two pieces of analytical work will channel that support (Urban Poverty report, fiscal 2003, and Safety Net Programs, fiscal 2004). 90. Indigenous Peoples. The WBG's strategy toward indigenous peoples in Mexico will continue to fulfill its responsibilities under OD 4.20 (currently under revision as OP 4.10); that is, to ensure that Bank-financed operations in Mexico do not cause adverse impacts upon indigenous peoples and that they provide such peoples with culturally appropriate benefits. But the strategy will go beyond safeguards-it will emphasize indigenous people's direct participation in WBG-financed operations, especially those meant to improve their access to basic health, education, and rural development services (for example, Indigenous Health, fiscal 2005). The WBG has supported, in collaboration with a number of Mexican governmental and academic institutions, the preparation of a series of state-level profiles of indigenous peoples, and a major investigation of the situation of indigenous peoples living in urban areas. This analytical work provides a framework for "development with identity," especially in projects located in indigenous regions that mean to protect the local environment (the ongoing Indigenous Community Biodiversity Conservation and Mesoamerican Biological Corridor GEF projects, the Regional Southeast Development LIL, and the forthcoming Community Forestry II in fiscal 2004). A new sector work on indigenous people access to assets and markets will be prepared in fiscal 2004. 91. Gender. Over the next three years, the WBG gender strategy for Mexico will continue to focus on bringing gender considerations across the whole of the development spectrum-that is, on "mainstreaming" gender. Priority areas of entry for this mainstreaming will be gender constraints in the labor, family, and domestic violence laws; gender differences in responses to workforce participation and self employment; and male gender issues such as violence (including domestic violence), risky behavior, and substance abuse. Three types of vehicles will deliver that strategy. First, the recently approved Gender Equity LIL will, among other things, support gender-specific financial services for female-headed microbusinesses, access to child care, and the resolution of gender stereotypes in childrearing (especially by fathers), pedagogical methods, and youth development. Second, analytical work will identify policy options for gender issues, notably through the dissemination of the book, Gender and the Mexican Economy, published in 2001, and the soon-to-be-completed "Gender Assessment of Mexico's Legal Framework." Third, a Portfolio Gender Assessment (fiscal 2004) will identify mechanisms to mainstream gender in the WBG's own operations. 31 (iv) Balancing Growth and Poverty Reduction with Protecting the Environment 92. Environmental Management. The government's five-year environmental action plan, with which the WBG will continue to align its strategy for the environment, involves two types of cross-cutting reforms-institutional (especially decentralization of responsibilities to the state and municipal levels and better enforcement), and policy (user charges, fees, taxes, and pricing in different sectors, notably water and energy). The WBG will support both types as it will prepare a programmatic, environmental adjustment operation to address regulatory and policy reforms in sectors like water, forestry, waste, energy, and tourism, that are critical for the protection of natural resources (Environmental Support SAL under discussion for fiscal 2002, and its programmed successor in fiscal 2005). The above financial interventions will be conceptually supported by a growing body of analytical work-Degradation and Poverty (fiscal 2003) and Environment and Growth (fiscal 2004). 93. Mainstreaming. In the context of a better policy and institutional framework, the WBG will continue to work with the line agencies leading environmental protection programs in each sector: (i) in water, with CNA, a modernization program will be supported for the consolidation of the irrigation sector (fiscal 2003), and for the strengthening of the water and sanitation sectors (fiscal 2003); (ii) in forestry, with CONAFOR, support will be continued for the expansion of the community-based approach developed under the on-going project for indigenous forest-based ejidos (fiscal 2004); and (iii) in air quality, with CAM, through the Mexico City's Transport and Air Quality II (fiscal 2004) in support of the Government's recent Air Quality Plan that sets the stage for a revision of the effectiveness of the transport system, the efficiency of vehicle technology, and the policy and regulatory framework for, air quality management. 94. Global Issues. The WBG will assist the government in taking advantage of the potential synergies among global, national, and local resource management through the GEF. The National Protected Areas system will be consolidated and expanded (fiscal 2003-04); and a new operation for the conservation of the Gulf of Cortez will be promoted (fiscal 2004). Moreover, support will be sought for testing Climate Friendly Air Quality measures (hybrid technology) in Mexico City (fiscal 2003), and efforts to control the use and environmental impact of Persistent Organic Pollutants (POPs) will be pursued. Through the Prototype Carbon Fund, a follow-up operation to the existing GEF carbon sequestration project in Oaxaca would be put in place. 95. While IBRD interventions focus on strengthening institutions and setting policies for environmental protection, IFC's support for business in sustainable development will help foster environmentally and socially sound practices among private participants-an increasingly important area for maintaining international competitiveness and growth, as mentioned earlier. (v) Building an Efficient, Accountable, and Transparent Government 96. Decentralization. As noted throughout the sectoral strategies,federalismo, understood as the devolution of decisionmaking power to states (and their municipalities), is changing the way policy is made in Mexico across all sectors-and the nature of IBRD's country client. The WBG has therefore accompanied, and will continue to accompany, this decentralization process closely with a four-pronged strategy. First, it will assist on insuring that the process is sustainable, both fiscally and programmatically. The first step in this direction was the FY99 Decentralization Adjustment Loan (DAL), of which the underlying package of federal "rules-of-the-game" has 32 become a model for other countries. Subsequent operations will help fine-tune those rules (for example, through analysis of options for the Reform of the Fiscal Pact in fiscal 2003). 97. Second, the WBG has begun to support individual states that request help in adjusting to the new responsibilities and to the structural reforms and fiscal discipline that those responsibilities imply-as it did with the Estado de Mexico SAL in fiscal 2000, and will do with a program of State-Level Adjustment loans and technical assistance that will place special emphasis on poorer states, a parallel implementation-focused Technical Assistance Window for subnationals in fiscal 2004, and a succession of state-level Public Expenditure Reviews and State Economic Memorandums as of fiscal 2003.116 Third, IBRD will also help states and large municipalities that have reached a sustainable fiscal and financial path, access infrastructure financing in sectors (like water, sanitation, and transport) where they still need know-how to complete legal and regulatory frameworks that are conducive to private participation (the channel for this assistance will be the State Infrastructure Decentralization APL I and II projects, in fiscal 2003 and fiscal 2005, respectively). Fourth, IBRD will continue its institutional development work with poor municipalities in rural areas through the Municipal Development in Rural Areas projects (fiscal 2002 and 2005). Finally, the World Bank Institute will maintain, and where possible expand, its successful, long-distance learning programs for subnational officials, with special emphasis on public sector management techniques (Box 5). Box 5. Capacity and Learning Activities of the World Bank Institute (WBI) in Support of the CAS Objectives. As the learning and capacity-building arm of the World Bank Group, WBI designs and delivers courses and seminars aimed at building the institutional and human capacity of its client governments to fight poverty. It facilitates networks and communities of development practitioners among its clients so they can access, share, and promote innovation and knowledge. In Mexico, WBI supports the CAS objectives by focussing on capacity building, with special-emphasis areas such as decentralization, finance, governance, sustainable development/environmental management, population and health, and social protection. In support of this strategy: * During 1999-2001, over 5,000 participants from Mexico took part in WBI activities, at both the national and regional levels and in worldwide events. * WBI has established a training partnership with the Instituto Tecnologico y de Estudios Superiors de Monterrey. This partnership, through which public sector management education was delivered to thousands of national and local government officials in Mexico and Latin America, pioneered the use of distance-learning technology in this field. * The federal government's internal auditing institution, SECODAM, participated in a WBI worldwide forum on anticorruption strategies, and in ensuing training on participatory government. In the coming three years, WBI will continue to align its knowledge and capacity-building program with the development priorities identified in this CAS-in particular, decentralization and public finance, governance, education, community empowerment and social protection, sustainable development and environmental management, rural poverty and development, and health and population. In all cases, WBI will continue to work closely with the Mexico Country Department and other relevant operational units to ensure that its interventions are client responsive, demand driven, and integrated in current and future projects. WBI will also seek to establish 16. The criteria to choose states for IBRD adjustment support will follow the government's own priorities as expressed in the letter of development for the Estado de Mexico SAL (Report No. P7400ME). These include: i) the state's poverty levels and incidence; ii) impact of the state's finance on the national macroeconomic framework; iii) degree of the state's commitment to a comprehensive reform program; and iv) potential demonstration effect on other states. 33 additional partnerships within the country to ensure long-tern sustainability and national-level "ownership" of the various training programs. Distance learning will remain the main communication tool, because it ensures access to wider audiences at all levels of governuent and throughout the Mexican territory. 98. Judicial System. In fiscal 2000, a diagnostic study of Juicios Ejecutivos Mercantiles was completed at the request of the Supreme Court of the Federal District. Since the presidential transition of 2000, the government has made judicial reform a priority, and has requested IBRD support. The key for the success of that support will be ownership by the judicial branch itself. Assuming such ownership materializes, the first step in that support, and the initial objective of the sector strategy, will be to design, in partnership with the judiciary, a comprehensive Judicial Reform Agenda in fiscal 2003. "Early wins" and lessons in implementing that agenda will be sought through an Access to Justice LIL, also in fiscal 2003. This will set a solid basis for a second phase of support, and for the deepening of related reforms, through a Judicial Reform Investment loan in fiscal 2005. Mexico is also participating in the WI31-sponsored training program on judicial reform in Latin America. 99. Anticorruption. As with judicial reform, the WBG had until the current presidential administration only a limited presence in the anticorruption area- although a successful one, for its support led to the establishment at SECODAM (the federal government's internal auditor) of a path-setting electronic system for public procurement (COMPRANET). Since the publication of the government's Anti-Corruption Program 2001-06 and the ensuing interministerial agreements, the WBG faces a heightened demand for support in the fight against corruption at the various levels and institutions of government. WBG will respond to that demand. First, it will provide on-demand technical assistance for the design of anticorruption strategies to individual federal ministries and their dependent agencies, starting with those the operations of which are most exposed to rent-seeking practices (the first will be Secretaria de Hacienda y Credito Pu2blico, and the Tax Administration Office [SAT] it oversees). Second, it will, also on demand, carry out State Financial and Accountability Assessments and State Procurement Assessment Reports each year through fiscal 2005. Third, an Anti-Corruption Investment Loan (fiscal 2004) will support the implementation of necessary institutional reforms, at both the federal and state levels. Fourth, IBRD will continue assisting SECODAM in making the federal government more transparent in areas like standardization of bidding documents, arbitration of procurement disputes, contracting of consulting services, and e-government. Finally, WBI will expand its training programs for federal and subnational employees, whose emphasis on corruption has recently proven instrumental for SECODAM's strategy-setting efforts; Mexico was also chosen as the site for a region-wide course on National Governance and Anti- Corruption (in which more than 2000 public officials have participated). 100. Civil Society. The WBG will continue to assist the opening of Mexico's development process to civil society participation. This CAS has been prepared in a consultative manner, with three regional events to gain feedback from a broad range of local actors (see below). Consultations with key civil society actors were held in 2001 to discuss the WBG's own policies for information disclosure and indigenous peoples. And IBRD continues to explore ways to involve local CSOs in its lending products. In a remarkable example, the Marginal Areas project has transferred decisionmaking on community development priorities, approval of subprojects, contracting of technical assistance, and project supervision to Regional Councils, with civil society and community involvement-mostly through indigenous organizations. Over the next three years, the WBG will expand its support for dialogue between government and civil society 34 on participatory approaches to the design, execution, and evaluation of WBG-financed projects and, more generally, to public policy formulation and accountability. It will also seek suitable mechanisms to help civil society engage in budget planning, execution, and evaluation, and will pilot an information disclosure initiative to bring better access to information for poor communities and their organizations. If requested, the WBG would provide technical assistance on enabling legal frameworks for CSOs. (g) Exposure Evolution Under the Proposed Strategy 101. As of February 28, 2002, IBRD exposure to Mexico was US$10.9 billion, its third-largest country portfolio, and 9.5 percent of the total IBRD portfolio. Under the scenario outlined in this CAS, with a lending envelope of US$5 billion during fiscal 2003-O5 (half of which through faster disbursing adjustment loans), Mexico's IBRD exposure is projected to increase to US$12.1 billion by end-fiscal 2005 and stabilize at that level thereafter. IBRD exposure to Mexico would thus remain well within the IBRD's single borrower exposure guideline of US$13.5 billion throughout the CAS period, leaving a US$1.5 billion "cushion" should additional lending be needed. 102. Exposure projections are sensitive to, among others things, the level of new lending, its rate of disbursement, disbursements from the existing pipeline of US$3 billion in loans already approved, possible cancellations of approved lending and, for longer-term projections, the repayment schedule selected. To ensure that the IBRD's single borrower exposure guideline is not breached in the outer years because of the level of lending committed during this CAS cycle, and that IBRD's assistance program is therefore not impaired in the future, exposure projections have been carried out for a 10-year period (see Figures la and lb). These projections show that keeping the IBRD annual commitments at US$1.6 billion in fiscal 2006 and thereafter-that is, a program similar in size to the one proposed in this CAS for fiscal 2003-05-would lead to a relative peak exposure of only US$12.3 billion in fiscal 2009, well below the guideline and leaving some headroom to assist in case of a crisis. 103. Alternative disbursement assumptions were also employed to test the sensitivity of the exposure projection to a faster disbursement profile of both adjustment and investment lending (see, again, Figures la and lb).'7 Whereas the normal disbursement scenario assumes a three- year disbursement profile for adjustment lending (with 65 percent of the loan disbursed within the first year) and an eight-year disbursement profile for investment loans (both based on the actual disbursement profile of IBRD lending to Mexico over the past decade), the fast disbursement scenario assumes an immediate, upon-approval, one-tranche disbursement of all future adjustment operations and a shortened, five-year disbursement profile for investment 17. In addition to the level of new lending and the disbursement profile (the latter inclusive of the split between faster disbursing adjustment and investment lending), exposure projection scenarios may include variations in future loan cancellations, repayment schedules, and the currency composition of IBRD debt. To err on the cautious side, the projections presented here do not include any future cancellations and take a standard repayment schedule for future lending applicable to Mexico with a five-year grace period and 15-year maturity. In the past CAS, both disbursement ratios and new commitments proved lower than orginally anticipated, which resulted in an exposure lower than expected (for example, the 1999 CAS projected a total IBRD TDO of US$13.3 billion for the year 2001, compared with an actual for that year of US$10.8 billion). The projections do not consider the exchange rate risk stemming from the currency composition as practically all of Mexico's IBRD debt outstanding is denominated in U.S. dollars, and all contracting of IBRD debt has taken place in this currency ever since the single currency loan was initiated in fiscal 1998. 35 lending. Such an accelerated disbursement would bring exposure to US$12.8 billion by end- fiscal 2005 and US$13.4 billion by end-fiscal 2009, still within-though exceptionally close to- the exposure limit. Although such a disbursement profile would constitute a major change from past performance (evident in the rapid drop of the undisbursed balance of approved loans), such a fast buildup of exposure could require a cutback in lending past fiscal 2006. Management will continuously monitor the implementation of the lending program, including the disbursements of approved lending and the implications thereof for country exposure. 104. Both the proposed IBRD lending program and its sensitivity analysis, assume that policy- based, adjustment lending will be disbursed as per regular practice. The Mexican authorities are aware of IBRD's new and forthcoming product lines (especially, Deferred Draw-Down Options and Guarantees) and may consider requesting them in the future if they suit the evolving economic and development conditions of the country. From the point of view of IBRD's Mexico exposure (as opposed to Mexico's debt outstanding and disbursed with IBRD), the choice of delivery tool does not change the time-series or conclusions from Figure la and lb-that is, the proposed program preserves a US$1.5 billion "cushion" vis-a-vis the absolute concentration limit. Figures la and lb. Mexico IBRD Exposure Scenarios, 1996-2015 (a) Debt Outstanding Actal I P iecte 145- 4.,,,,,,,_ , 140 13500 E osZ linit - - w . # t FastDisb. 1150 Disb. IIOOOD 1050D 36 (b) Disbursements, Repayments, and Undisbursed Balance 4400 4000 . . . ...... 3600 3200 O2800 Uni\u=e_ :S * ~~~~~~~~~~Fast Disb. Normal Di 2400 f_ _ae 1600 Nor Diab. Fast Disb' 12000, 800 so,. 00O O O O O ' - ,oO Os o e V. THE RISKS IN THE PROPOSED CAS 105. The assistance strategy put forward in this document faces a series of real but manageable risks. First, in the more integrated Mexico of today, the possibility of negative external developments unsettling the country's macroeconomic framework is not negligible-the rebound of the U.S. economy is by no means guaranteed, and contagion from another emerging market crisis cannot be assumed away. Also, the recent appreciation of the Mexican peso deserves close monitoring, even though much of the currency's strength reflects a significant improvement in market "fundamentals" (higher productivity, a floating exchange rate regime, enhanced independence of the monetary authority, fiscal credibility, a more comfortable public foreign debt position, three investment grades, falling inflation rates, a flight-to-quality by international investors seeking emerging market exposure in their portfolios, and so on). As mentioned earlier, fiscal consolidation remains a challenge. Oil price volatility presents an additional challenge. Mexico's recent macroeconomic record and policy mix (especially its fiscal discipline and flexible exchange rate regime) are solid, have proven resilient during the U.S. recession, and have "market differentiated" Mexico through successive international financial crises (East Asia in 1997, Russia in 1998, Brazil in 1999, and Argentina in 2001). 106. Second, with no single party holding a majority in Congress, and mid-term elections scheduled for 2003, the Mexican government may find it all but impossible to see through pending reforms (energy, labor, judicial, water, and so forth). While this type of political risk is difficult to mitigate, the government has learned the lessons from the recent attempt at fiscal reform (eventually passed but in a partial manner)-future legislative initiatives are likely to be accompanied by more up-front debate, systematic consensus building, and negotiation. 107. Third, as the U.S. economy rebounds, growth in Mexico will likely recover in full force and quickly reach the high rates of the late 1990s. This may put Mexican policymakers in a "comfort zone," that is, under the perception that further structural reforms are either not necessary or not worth the political cost. Growth sustainability could then be compromised. The 37 likelihood of this complacency is, however, not large, because the current administration continues to show a strong commitment to reform that is compatible with the mandate for change it received in the 2000 elections. 108. Fourth, many of the necessary reforms are cross-ministerial undertakings, fall under the purview of both federal and subnational governments, and are championed by presidential commissioners. Coordination among that many actors will be difficult, even before stakeholders outside the Executive (like Congress) enter the debate. Such coordination problems did occur in the early part of the administration, but a gradual and reassuring improvement is visibly underway (for example, in the design of water sector reform). 109. Fifth, as federalismo unfolds and long-entrenched structural problems in the states become immediately binding, the likelihood of a crisis, be it financial or social, at the subnational level will expand. For example, this could take the form of a state or large municipality being fiscally unable to deliver the basic social services for which they are increasingly responsible, or previously marginalized groups bringing their accumulated grievances and pent-up demands to bear all at once, overwhelming the capacity of local governments to respond. This risk is present countrywide, but especially in poorer southern states. It is in part mitigated by the federal government's recent efforts to establish market- driven rules for decentralization, by its ongoing support to states that proactively seek to reform themselves, and by the newly available mechanisms for subnational accountability. 110. Sixth, in the absence of sectoral reforms, Mexico may run into an "infrastructure crisis" during this sexenio-power generation might prove unable to keep up with faster growth, northern industrial states might run out of water, or transport-driven air pollution might bring large cities to a halt. This type of crisis, and the resultant political pressures for quick-fix solutions, could permanently damage the country's prospects for long-term growth. The federal government is aware of these dangers and is placing better infrastructure provision (notably, through increased private sector participation) at the forefront of its reform agenda. 1. Finally, as with the previous CAS cycle, IBRD's assistance program to federal entities remains at budgetary risk-the nonadditionality of IBRD funds with respect to sector-ministry budgets will continue to dampen the demand for its participation. As in the past, the decisive factor will be the technical quality of IBRD's contribution. The presence of a particularly strong program of analytical work in the proposed CAS seeks to mitigate that risk. VI. COORDINATION WITH OTHER PARTNERS AND PARTICIPATION IN THIS CAS 112. The WBG continues to maintain a fluid and productive relationship with the community of Mexico's development partners. That relationship takes many forms, in accordance with the country's needs. In some areas, the WBG is the leading agency and acts as a catalyst for the intervention of others (for example, in GEF operations where UJNEP and UNDP take part). In other cases, the WBG has developed complementary partnerships (for example, with the IMF to help strengthen the macroeconomic framework) or joint products (for example, IDB's parallel financing of the Decentralization and Rural Development project series). Sometimes the government led institutional specialization. For example, in decentralization, the WBG has focused on setting conducive legal and regulatory frameworks and helping states adjust to them, 38 while IDB emphasized institutional capacity at the subnational level. And sometimes donor coordination has taken the form of knowledge sharing, like with the OECD. A comprehensive overview of how various stakeholders integrate into a comprehensive framework is shown in Table 5. Among partner activities, two of particular importance for this CAS are further described below-IMF and IDB. 113. Mexico maintains an excellent relationship with the IMF. Following the successful completion in 2000 of a 17-month SDR US$3.103 million Stand-by Arrangement, which the country eventually treated as precautionary and from which it did not withdraw the last installment, the Fund continues providing regular surveillance (Article 4 consultations) and technical assistance (for example, in monetary policy up to the year 2000, and tax administration matters). It also produced, together with IBRD, a Financial Sector Assessment Paper (FSAP) in 2001. In addition, the authorities may explore the possibility of an IMF Contingent Credit Line (CCL), which would be the first of its kind since the facility became available for countries which pursue strong macroeconomic and structural policies and show progress toward adherence to internationally accepted standards in the financial, fiscal, and statistical areas. Apart from the continued pursuance of sound economic policies, the CCL would be based on further progress toward compliance with international standards, including following up on the recommendations made in the FSAP. These IMF efforts are, of course, directly complementary to the first conceptual pillar of the proposed CAS-consolidating the macroeconomic gains of recent years. 114. IDB also has a sizable assistance program in Mexico (with new commitments worth some US$1.2 billion per year, and an accumulated debt of about US$6 billion). Its strategic focus is on social sector modernization and poverty reduction, fiscal decentralization, private sector competitiveness, and international economic integration. The ensuing interventions have reinforced, rather than substituted for, the WBG's assistance-IDB has put emphasis on institutional development (for example, in decentralization) and on supporting ongoing programs (for example, PROGRESA), while the WBG's analytical and financial assistance has favored the design and implementation of new reforms (for example, in state-level adjustment programs). The synergies have sometimes lead to joint or parallel-financing operations (for example, in rural municipality development, and in the proposed ISSSTE project). (For more details on IDB's program in Mexico see Box 6). Box 6. IDB's Program During 1999-2000 the IDB had 11 projects in Mexico-one general multisector loan, five in the power sector, and one each for bank restructuring, housing, labor market reform, strengthening subnational finances, and rural water and sanitation. Mexico's outstanding debt with the IDB was US$5.8 billion at the end of 2000, with net disbursements of approximately US$250 million in recent years, usually lower than the interest payments. IDB's program for the next five years has four main components: (a) social sector modernization and poverty reduction, (b) modernization and decentralization of the state, (c) improvement of private sector competitiveness, and (d) international economic integration. The base-case scenario includes operations in the amount of approximately US$1.2 billion per year on average during 2002-06. Approximately 40 percent of the value of the planned operations corresponds to support for poverty reduction; 35 percent is for improvements in private sector productivity, 20 percent is for modernization of the state, and 5 percent is for international integration. The high-case scenario includes lending of approximately US$1.5 billion per year, with the main difference being greater emphasis on fast-disbursing operations. To support modernization of the social sector and reduction of extreme poverty, the IDB will put forward operations in several areas: primary education, the labor market, and targeted support to poor groups, particularly 39 women, indigenous peoples, and probably also health. The biggest projects in this area would be for PROGRESA, primary education, labor market reform, restructuring social security for public sector workers (ISSSTE), and sustainable restructuring of small-scale rural producers. Improving competitiveness of the private sector by lowering barriers to enhanced productivity is the second major area of lending foreseen by the IDB. This includes support for modernization of the financial system; public and private investment in various sectors; improvement of regulatory schemes and incentive systems; and enhancing economic efficiency by helping the private sector play an active role in financing and implementing investments in electricity, water and sanitation, transportation, telecommunications, and education and health infrastructure construction projects. Modernization of the state, and subnational decentralization and development, while having a smaller volume of lending than the first two areas, is equally important for improving the social and economic climate in Mexico. The IDB would support improvements in government practices and in the regulatory framework, strengthening the civil service and public institutions in states and municipalities, and improving the justice and property rights systems. Since the integration of Mexico with the rest of North America through NAFTA is proceeding satisfactorily, IDB support in this area would be for the Puebla-Panama Plan, which seeks to expand integration to the south as a way to fight poverty in both Mexico and Central America. 115. The preparation of CASs in Mexico has followed an increasingly participatory approach. Until 1999, CAS documents were confidential and of limited distribution even within the government. In 1999, a consultation process was undertaken with a range of stakeholders (including NGOs, academics, think tanks, unions, businessmen, and politicians) and the final product was made widely available within the administration. The 2001 Progress Report (on the 1999 CAS) was published by the authorities-a first-ever event for Mexico. This gradual opening to civil society in the articulation of the WBG assistance took another step forward in this CAS-a countrywide process of consultation with the full array of stakeholders was put in motion through a series of public events organized in Mexico City, Monterrey, and Oaxaca during March 2002. (For a description of those consultations, see Box 7). Those events were complemented by a large number of individual meetings with leaders of civil organizations, whose feedback will also be sought on a continuing basis during CAS implementation, a practice that proved instrumental in the previous strategy cycle. Box 7. Mexico CAS Consultation with Civil Society In the process of preparing this CAS, WBG staff organized three full-day seminars with a broad and diverse selection of members of Mexican civil society, including representatives from trade unions, religious groups, academic institutions, charitable foundations, producer and community-based organizations, business chambers and other non-governmental organizations. The discussions that took place in March 2002 with more than 120 representatives of civil society organizations at three different locations throughout Mexico-Mexico City, Monterrey and Oaxaca-allowed for a better definition of the role that the WBG may have in assisting Mexican society to address the country's main development challenges, as well as an increasing stakeholders' awareness of the WBG's activities and assistance strategy. Despite, at times, different and divergent perspectives on development issues, the general constructive atmosphere in which the consultations took place contributed to an improved understanding of the key problems that Mexico faces and the identification of new issues for future support, such as: * The importance of evaluation and impact analysis of public policies and programs in order to improve the efficiency of public spending and the design of effective government interventions. Such evaluations should be made public and should be widely discussed, something that would not only improve the quality of future service provision but also give legitimacy to the taxation required to fund those services. * The need to conceive development as a broader and multifaceted process that, beyond economic growth 40 and poverty reduction, should aim at the improvement of overall human well-being. . The role that strengthening domestic-market-oriented suppliers (including through linkages with NAFTA- driven ones) and the enhancement of their competitiveness can play in economic growth, job creation and poverty reduction. . Developing closer relationships between civil society and government will enhance stakeholder participation and ownership of public policies and programs. In view of the political transition that Mexico is going through, the WBG can play a critical role as an independent analyst and catalyst for dialogue within society and between government and civil organizations. * The relevance of taking into account regional dimensions in the design and implementation of development policies and public investment programs, especially in a country of the size and with the sharp regional contrasts of Mexico. The continued, strong engagement of the WBG in Mexico received broad endorsement by Mexican civil society in view of the major development challenges the country faces and, in particular, the contribution the WBG can make in tackling the still-prevailing high levels of poverty and inequality in the country. Many participants expressed their appreciation for the WBG's initiative to reach out to civil society for views on its assistance strategies and strongly encouraged a continuation of such activities with the possibility to include the Mexican government in such discussions. A summary report and detailed minutes of the consultations have been distributed to participants and are available upon request. VII. CONCLUDING REMARKS 116. The objective of this WBG assistance strategy is to support the government's efforts to consolidate the macroeconomic framework, accelerate growth through enhanced competitiveness, develop the country's human capital, protect the enviromnent, and build an efficient, accountable and transparent government. That strategy is the result of extensive analytical work, lessons of operational experience, and country consultation. James D. Wolfensohn President By: Shengman Zhang Peter L. Woicke Washington, D.C., April 23, 2002 41 42 Table 6. Mexico-CAS Matrix FY03-05 COUNTRY WORLD BANK GRouP's SUPPORT INSTRUMENTS DEVELOPMENT GOVERNMENT FINANCIAL NON-FINANCIAL PROGRESS OBJECTIVES INSTRUMENTS BENCHMARKS Consolidating Strengthening federal fiscal anchor Tax Reform SAL FY02 Macro-monitoring (ongoing) For country: Continued sound fiscal macroeconomic by (a) continuing the tax reform, (b) Tax Reform TAL FY02 Public Expenditure Management and monetary policies including stability addressing implicit and contingent Labor Reform SAL FY04 (tbc) FY04 reduced dependency on oil-related liabilities, (c) maintaining Promoting Trade FY04 revenues, coupled with continuation subnational fiscal discipline; and (d) Intemational Factor Mobility FY04 of tax reform. Preserve satisfactory sub.ational fiscal discipline; and (d) Country Economic Memorandum standing with IMF. Maintain stabilizing oil revenues FY05 sustainable balance-of-payments Economic Shocks and Fiscal current account deficits. Responses FY05 For WBG performance: Enhanced Labor Market Convergence FY05 country awareness and debate around Public Debt Management FY05 key macro vulnerabilities, notably the need for completing tax reform as evidenced by relevant reform proposals by core interest groups Accelerating growti Ensuring the adequate provision of National Urban Upgrading Loan Energy Sector Dialogue FY03 For country: Improved financial through enhanced physical infrastructure FY03 Urban Poverty Toolkit FY03 performance and efficiency in Off-grid Rural Electrification Energy Sector Review FY04 highways, power, and water utilities; competitiveness Loan FY03 Low Income Housing FY04 improved access for the poor to basic States Infrastructure Urban Land Management FY05 infrastructure. Increased ownership Decentralization APL I FY03 and involvement of subnational Water & Sanit. Modernization governments in setting key FY03 infrastructure development and Highway Finance Loan FY04 fmancing strategies Power Sector Reform Loan For WBG performance: Enhanced FY05 catalyst role in progress toward States Infrastructure structural reform in key infrastructure Decentralization APL 11 FY05 subsectors, notably electricity, as IFC's Operations in Transport, evidenced by the quality of the sector Power, Water, Sanit. & dialogue and operations. Expanded Hydrocarbons support for state-level infrastructure reformn. ancrasin g efficiency in the financial Rural Finance SECAL FY03 Fin. Sector Monitoring (ongoing) For country: Strengthened financial sector (broadly defined). Financial Sector SECAL I FY04 Insurance Sector Report FY04 sector supervision, better performing Financial Sector SECAL n development banks, and improved FY05 financial infrastructure. IFC's Financial Sector For WBG performance: WBG Instruments FY03-05 technical assistance as a catalyst for reform in the overall incentive structure for the operation of the financial sector, especially in the area of legal and regulatory infrastructure. 43 Table 6. Mexico-CAS Matrix FY03-05 COUNTRY WORLD BANK GROUP'S SUPPORT INSTRUMENTS DEVELOPMENT GOVERNMENT FINANCIAL NON-FINANCIAL PROGRESS OBJECTIVES INSTRUMENTS BENCHMARKS Accelerating growth Raising productivity in the Savings & Loan Sector Coffee Sector Study FY02 For country: A consolidated non- through enhanced agricultural sector Development FY02 Sugar Sector Restructuring FY02 bank savings and loan sector, being competitiveness Irrigation Sector FY03 Ag. Competitiveness FY03 strengthened through capacity Land Titling LIL FY03 Muicipal Development in Rural Areas building and enhanced supervision. (continued) Rural Finance SECAL FY03 FY03 An improved framework for Ag. Productivity II FY04 Rural Pension Schemes FY03 agricultural productivity and Rural Develop. Marginal Areas Warehousing Schemes FY03 competitiveness and better access to APL III FY04 Rural Enterprise Development FY04 diversification opportunities and TA. IFC Operations in Agribusiness A restructured sugar sector in the FY03-05 process of privatizing the government expropriated mills. A revised incentive framework for the rehabilitation and repositioning of the coffee sectors. The operation of more effective warehousing schemes. For WBG performance: Contri- bution to the implementation of key programs as determinants to agricultural competitiveness and productivity, and enhanced understanding of the functioning of factor and goods markets in rural areas through the delivery of key sector work. Integrating Middle-Market and National MS Business SME development FY03 For country: Improved business Micro- and Small Enterprises in the Development Project FY02 environment for MSMEs, including a "new" Mexican economy. IFC Financial Intermediary reduction in the "cost of doing Operations for MSME FY03-05 business," and better access to IFC Direct Support for Middle- - development services and finances. Market Companies; Corporate For WBG performance: Governance Support FY03-05 Satisfactory implementation and completion of the ongoing Southeast Regional Development LIL and Urban Micro-Business Loan. 44 Table 6. Mexico-CAS Matrix FY03405 COUNTRY WORLD BANK GROUP'S SUPPORT INSTRUMENTS DEVELOPMENT GOVERNMENT FINANCIAL NON-FINANCIAL PROGRESS OBJECTIVES INSTRUMENTS BENCHMARKS Human Capital Enhancing the quality of public Tech. Training & Certification Knowledge-Economy Assessment For country: Improved quality of Development education FY03 FY03 education inputs (i.e., increased Science Education FY04 Adult Education Study FY03 number of primary education teachers Basic Ed. APL III FY05 Secondary Ed. Study FY04 retained in remote rural areas, Science and Techn. 11 FY05 increased number of primary IFC's Operations with Private education students with educational Education Providers FYO3-05 material in rural areas), and enhanced efficiency (i.e., intemal efficiency in primary education) For WBG performance: Delivery of technical assistance for effective education programs at all levels (basic, secondary, technical, and -------------- ------------------------------------- !~ighereducation). Increasing the quality of public ISSSTE SECAL FY03 Evaluation Basic Healthcare FY03 For country: Increased access to health services ISSSTE TAL FY03 Indigenous Health FY 04 basic healthcare for rural (particularly Health System Reform IMSS indigenous) and urban underserved FY04 populations, and strengthened Indigenous Health FY05 coordination among public health IFC's Operations with Private care institutions at the three levels of Health Providers FYO3-05 government. Arresting the growth of the implicit debt in the public- _Femployee pension system For WBG performance: Cons- olidating the delivery of a basic health care package for uncovered and underserved rural and peri-urban poor. Successfully assisting in the implementation of the public- employee pension reform. Closing gaps in social protection Urban Poverty FY03 For country: Improve coverage and Social Safety Net Evaluation FY04 minimize regressive targeting structures and leakages. For WBG performance: Deliver TA to help GOM design better SP programs. 45 Table 6. Mexico-CAS Matrix FY03-05 COUNTRY WORLD BANK GROUP'S SUPPORT INSTRUMENTS DEVELOPMENT GOVERNMENT FINANCIAL NON-FINANCIAL PROGRESS OBJECTIVES INSTRUMENTS BENCHMARKS Human Capital Understanding and attending to the Indigenous Health FY05 Gender Assessment of Legal For country: Improved access to Development (continued) specific needs of the poor and the Gender LIL (recent approval) Framework FY02 health services for the indigenous. disadvantaged. Dissemination of Gender and the Identify and begin to correct gender Mexican Economy FY03 biases in the country's legal Poverty Assessment FY03 framework, as well as in the WBG's Impact of PROGRESA FY03 own portfolio. Portfolio Gender Assessment FY04 For WBG performance: Improved Business Cycle and the Poor FY04 understanding of indigenous and Growth Poverty and Inequality FY04 gender issues, and related projects Indigenous Peoples Access to Assets being satisfactorily implemented. and Markets FY04 Expanded analytical work on poverty and inequality leads to better targeted _____ _____ ____ _____ _____ ____ operations. Balance growth and Establishing an adequate incentive Envirornental SAL FY02 Degradation and Poverty FY03 For country: Better and more poverty reduction with framework for environmental Air Quality 11 FY04 Environment and Growth FY04 decentralized management of water protecting the environment, protection and for the Community Forestry FY04 and forestry resources. Improvement decentralization of environmental Environmental SAL H FY05 of air guality in Mexico City. management. Breaking the vicious IFC's Operations in For WBG performance: Effective maa gement Break the vco Environmentally-sound contribution to environmental policy circle between degradation and Infrastructure FY03-05 reforms and to capacity building at survival. IFC's Operations in Sustainable the state level. Better understanding Development Business Practices of the incentive structure driving FY03-05 environmental degradation and its -. .-- -inka-es with poverty and growth Pursuing opportunities for GEF Protected Areas 11 and III For country: Expanded protected harnessing global benefits to the FY03/ FY04 areas system to new reserves. advantage of local development. GEF Climate Change-Hybrid Contribution to climate change Technology FY03 initiatives through better transport PCF - Carbon Sequestration in technology and carbon sequestration. Coffee Areas FY03 For WBG performance: Catalyst GEF - Persistent Organic role in Mexico's seizing opportunities Pollutants FY03 to contribute to global-level GEF - Gulf of Cortez FY04 biodiversity conservation and climate ___________________________ ~~~~~~~~~~~~~~~~~~~~~~~~~change mitigation. Building an efficient, Pursuing Decentralization Municipal Development in State-level CFAA FY03 For country: Decentralization is accountable and transparent (Federalismo) Along a Sustainable Rural Areas FY02 State-level CPAR FY03 proceeding apace, while fiscal government. Path EdoMex TAL FY02 Reform of the Fiscal Pact FY03 discipline at subnational levels is State Infrastructure State-level PER FY03 maintained. Improved institutional Decentralization APL FY03 State-level CEM FY03 capacity among states and State-level Adjustment FY03 State-level CFAA 11 FY04 municipalities. State-level CPAR 1I FY04 46 Table 6. Mexico-CAS Matrix FY03-05 COUNTRY WORLD BANK GROUP'S SUPPORT INSTRUMENTS DEVELOPMENT GOVERNMENT FINANCIAL NON-FINANCIAL PROGRESS OBJECTIVES INSTRUMENTS BENCHMARKS Building an efficient, Pursuing Decentralization State-level TAL Window FY04 State-level PER 11 FY04 For WBG performance: Catalyst accountable and transparent (Federalismo) Along a Sustainable State-level Adjustment II FY04 State-level CFAA III FY05 role in improving coordination across governrnent (continued) i Path (continued) Municipal Development in State-level CPAR III FY05 levels of government, strengthening government (continued) Rural Areas II FY05 State-level CEM II FY05 the sustainability of decentralization, State Infrastructure WBI Sub-national Training Programs and facilitating state adjustment. Decentralization APL II FY05 FY03-05 Effective contribution to institutional State-level Adjustment III FY05 capacity at the subnational level. Fostering a more efficient and more Access to Justice LIL FY03 Judicial Reform Agenda FY03 For country: Dispute resolution accessible judicial system Judicial Reform Loan FY05 mechanisms are faster, more efficient, and more accessible, at both national and subnational level. For WBG performance: Instru- mental contribution to putting in motion judicial reforn across all ---~~~~~~~~~~~~~~~~~~~~~~~~~~levels of government. Strengthening anticorruption Anticorruption Anticorruption TA Window FY03-05 For country: Mexico's international Mechanisms Mechanisms Loan FY04 State-level CFAA FY03-05 ranking of transparency is State-level CPAR FY03-05 significantly improved. WBI Transparency Training For WBG performance: Lending Programs FY03-05 and nonlending support to transparency enhancements prove effective and sustainable. Expanding the role of civil society Civil Society Organization Dialogue For country: CSOs participation in in government accountability and TA FY03-05 public policy formulation and accountability. Enhanced institutional capacity of CSOs. For WBG performance: Local CSOs participation in IBRD operations is deepened at all stages of the project cycle. Network of CSO dialogue is expanded. 47 48 Table 7. Mexico-World Bank Group Financial Instruments-FY2003-2005 FY03 FY04 FY05 Policy-based. Rural Finance SECAL ($200 million) Highway Finance Loan ($200 million) Power Sector Reform Hybrid Loan ($200 million) ISSSTE SECAL ($500 million) Financial Sector SECAL I ($200 million) Financial Sector SECAL II ($200 million) State-level Adjustment ($200 million) Health System Reform IMSS ($200 million) Environmental SAL II ($200 million) State-level Adjustment II ($200 million) State-level Adjustment III ($200 million) .______________________________________ _ : .Standard Investm ent Projects National Urban Upgrading Loan ($50 million) Ag. Productivity II ($300 million) Science and Techn. II ($150 million) Off-grid Rural Electrification Loan ($5 million) Science Education ($100 million) Indigenous Health ($50 million) Water & Sanit. Modernization ($200 million) Air Quality II ($100 million) Municipal Development in Rural Areas II ($200 million) Irrigation Sector ($220 million) Community Forestry ($100 million) Judicial Reform Loan ($30 million) Tech. Training & Certification ($150 million) State-level TAL Window ($50 million) ISSSTE TAL ($15 million) Anti-corruption Mechanisms Loan ($50 million) APLs (new and follow-ups) States Infrastructure Decentralization APL I ($250 million) Rural Develop. Marginal Areas APL III ($100 million) States Infrastructure Decentralization APL II ($200 million) l____________________________________j Basic Ed. APL III ($170 million) _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _L IL Access to Justice LIL ($5 million) Land Titling LIL ($5 million) continued 49 Table 7. Mexico-World Bank Group Financial Instruments-FY2003-2005 (continued) FY03 FY04 FY05 CEF/M*tP GEF Protected Areas 11 GEF Protected Areas IIl GEF Climate Change-Hybrid Technology GEF Gulf of Cortez GEF Persistent Organic Pollutants PCF - Carbon Sequestration in Coffee Areas IDF/Grants Municipal Development-Capacity Building [FC' IFCW s Operations in Transport Power. Waier. Sanil. & IFC's Operations in Transport. Power, Water. Sanit IFC's Operations in Transport, Po%%er, Water, Sanil. & Hydrocarbons & Hydrocarbons Hydrocarbons IFC's Financial Sector Projects IFC's Financial Sector Projects IFC's Financial Sector Projects IFC Financial Intermediary Operations for MSME IFC Financial Intermediary Operations for MSME IFC Financial Intermediary Operations for MSME IFC's Operations with Private Education Providers IFC's Operations with Private Education Providers IFC's Operations with Private Education Providers IFC's Operations with Private Health Providers IFC's Operations with Private Health Providers IFC's Operations with Private Health Providers IFC's Operations in Sustainable Development Business IFC's Operations in Sustainable Development IFC's Operations in Sustainable Development Business Practices FY03-05 Business Practices FY03-05 Practices FY03-05 IFC Operations in Agribusiness IFC Operations in Agribusiness IFC Operations in Agribusiness IFC Direct Support for Middle-Market Companies; Corporate IFC Direct Support for Middle-Market Companies; IFC Direct Support for Middle-Market Companies; Corporate Governance Support Corporate Governance Support Governance Support Note: 3IBRD overall projected lending commitment in FY03 IBRD overall projected lending commitment in IBRD overall projected lending commitment in FY05 is $1,800 million, of which $900 million in adjustment FY04 is $1,600 million, of which $800 million $1,600 million, of which $800 million in adjustment lending in adjustment lending lending a. All IEFC instruments are indicative, and subject to the Mexican private sector's demand for EFC assistance. 50 Annex B 1 Mexico at a glance Latin Upper- POVERTY and SOCIAL America middle- Mexico & Carib. income Development diamond' 2000 Population, mid-year (millions) 98.0 516 647 Life expectancy GNI per capita (Atlas method, US$) 5,080 3,680 4,620 GNI (Atlas method, US$ billions) 497.0 1,895 2,986 Average annual growth, 1994-00 Population (I%) 1.5 1.6 1.3 'N Labor force (I%) 2.5 2.3 2.0 GNI Gross Per pnmary Most recent estimate (latest year available, 1994-001 capita enroliment Poverty (% of population below national poverty line) Urban population (% of total population) 74 75 76 Life expectancy at birth (years) 72 70 69 Infant mortality (per 1,000 live births) 29 30 28 Child malnutrition (% of children under 5) 8 9 .. Access to improved water source Access to an improved water source (% of population) 86 85 87 Illiteracy (% of population age 15+) 9 12 10 _ Mexk Gross primary enrollment (% ofschool-age population) 114 113 107 Mexico Male 116 .. 108 ---Upper-middle-income group Female 113 .. 105 KEY ECONOMIC RATIOS and LONG-TERM TRENDS 1980 1990 1999 2000 Economic mtloe GDP (US$ billions) 223.5 262.7 479.4 579.9 Gross domestic investmenVGDP 27.2 23.1 23.5 23.1 Trade Exports of goods and services/GDP 10.7 18.6 30.9 31.1 Gross domestic savings/GDP 24.9 22.0 21.9 21.3 Gross national savings/GDP 22.4 20.3 20.5 20.1 Current account balance/GDP 4.7 -2.8 -3.0 -3.1 Dometc 1 Investment Interest payments/GDP 2.0 2.2 2.1 2 0 savIngst m ent Total debt/GDP 25.7 39.8 35.0 2814 savigs Total debt serviceJexports 45.4 20.9 25.8 34.0 Present value of debt/GDP .. .. 33.9 26.1 Present value of debt/exports .. .. 102.6 77.8 Indebtedness 1980-90 199040 1999 2000 2002-04 (average annual growth) GDP 1.1 3.1 3.8 6.9 3.3 Mexico GOP per capita -1.0 1.4 2.3 5.4 1.9 Upper-middleincome goup Exports of goods and services 7.0 14.6 12.4 16,0 4.9 STRUCTURE of the ECONOMY 1980 1990 1999 2000 Growth of Investment and GDP (%) (% of GDP) Agriculture 9.0 7.8 4.7 4.2 Industry 33.6 28.4 28.8 27.9 20 - Manufacturing 22.3 20.8 21.1 20.4 Services 57.4 63.7 66.5 67.8 -20 + 9D 7 Oa DD 00 Private consumption 65.1 69.6 67.1 67.5 .40 General government consumption 10.0 8.4 10.9 11.0 Got --"-GDP Imports of goods and services 13.0 19.7 32.4 32.8 1980-90 199040 1999 2000 Growth of exports and Imports ( (average annual growth) Agriculture 0.8 1.8 2.0 2.1 40 Industry 1.1 3.8 4.2 6.6 30 Manufacturing 1.5 4.4 4.2 7.1 20 Services 1.4 2.9 3. 7 4 10 Private consumption 1.4 2.4 4.3 9.5 -10 General govemment consumption 2.4 1.8 3.9 3.5 -20 Gross domestic investment -3.3 4.6 4.1 8.8 Exports -* Imports Imports of goods and services 1.0 12.3 13.8 21.4 Note: 2000 data are preliminary estimates. The diamonds show four key indicators in the country (in bold) compared with its income-group average. If data are missing, the diamond will be incomplete. 51 Annex B2 Mexico PRICES and GOVERNMENT FINANCE 1980 1990 1999 2000 Inflation (%) Domesti'c prices (% change) 40 Consumer prices .. 26.7 16.6 9.5 30 ImplicitGDPdeflator 33.4 28.1 14.9 12.1 20 Govemment flnance It (% of GDP, incudes current grants) o I , I Current revenue 27.4 25.3 20.9 21.8 95 96 97 g9 99 00 Current budget balance 4.1 0.9 1.5 2.0 -GDP deflator --OCPI Overall surplus/deficit -3.6 -2.6 -1.2 -1.2 TRADE (US$ millions) 1980 1990 1999 2000 Export and import levels (US$ mill.) Total exports (fob) 16,284 40,711 136,391 166,455 200,000 Oil 10,441 10,104 9,928 16,383 Agriculture 1,528 2,162 3,926 4,217 150.000 Manufactures 3,802 27,828 122,085 145,334 Total imports (cif) 19.342 41,593 141,975 174,458 100,0h* Food 2,448 5,099 12,175 16,691 50000 16* Fuel and energy 11,720 29,705 109,270 133,637 Capital goods 5,174 6,790 20,530 24,130 o 94 9s 99, 97 99 00 o Export price index (1995=100) 134 99 98 106 9 5 9 7 9 9 c Import price index (1995=100) 67 90 99 102 EExpoorts UInWorts Terms of trade (1995=100) 201 110 99 103 BALANCE of PAYMENTS (US$ millions) 1980 1990 1999 2000 Current account balance to GDP (%) Exports of goods and services 22,600 48,732 148,083 180,167 ° Imports of goods and services 27,430 51,535 155.465 190,494 -1 Resource balance -4,830 -2,803 -7,382 -10,326 .2 Net income -6,438 -8,626 -13,306 -14,747 3 Netcurrenttransfers 833 3,978 6,313 6,994 4 Current account balance -10,434 -7,451 -14,375 -18,079 5 Financing items (net) 11,453 10,999 14,969 20,901 Changes in net reserves -1,019 -3,548 -594 -2,822 . Memo: Reserves induding gold (USS millions) 3,052 9,909 31,829 33,595 Conversion rate (DEC, localWUS$) 2.00E-2 2.8 9.6 9.5 EXTERNAL DEBT and RESOURCE FLOWS 1980 1990 1999 2000 (US$ millions) Composition of 2000 debt (USS mill.) Total debt outstanding and disbursed 57,378 104.442 167.626 164,686 IBRD 2,063 11.030 11,353 11,444 IDA 0 0 0 0 24382 11444 | - > ~~~~~~~-13674 Total debtservice 10,958 11,311 39,760 63,497 4494 IBRD 255 1,552 2,155 2,220 IDA 0 0 0 0 Composition of net resource flows Official grants 14 54 .. Official creditors 795 4,168 -1,708 -525 Private creditors -524 -582 13,181 -5,059 Foreign direct investment 2,156 2,549 11,915 14,190 Portfolio equity 0 563 3,901 478 128061 World Bank program Commitments 625 2,562 1,671 1,130 A-IsRD E-Bilateral Disbursements 422 3,326 844 1,647 B-IDA D - Other multilateral F - Private Principal repayments 89 801 1,323 1,330 C- IMF G - Short4eerm Net flows 333 2,525 -479 318 1 9 Interest payments 166 751 832 890 Net transfers 167 1,774 -1,311 -573 Development Economics 52 Annex B2 CAS Annex B2 - Mexico Selected Indicators* of Bank Portfolio Performance and Management As of March 14,2002 Indicator 1999 2000 2001 2002a Portfolio Assessment Number of Projects Under Implementation a 24 26 28 28 Average Implementation Period (years) b 3.4 3.3 3.1 3.4 Percent of Problem Projects by Number a c 12.5 11.5 10.7 7.1 Percent of Problem Projects by Amount a. c 10.1 13.3 12.6 3.7 Percent of Projects at Risk by Number at d 12.5 11.5 10.7 7.1 Percent of Projects at Risk by Amount a d 10.1 13.3 12.6 3.7 Disbursement Ratio (%) ' 20.2 22.9 25.7 9.6 Portfolio Management CPPR during the year (yes/no) No No No -- Supervision Resources (total US$000) 1,866.6 2,386.6 2,144.5 -- Average Supervision (US$000/project) 77.8 91.8 76.6 -- Memorandum Item Since FY 80 Last Five FYs Proj Eval by OED by Number 118 22 Proj Eval by OED by Amt (US$ millions) 22,279.9 4,113.1 % of OED Projects Rated U or HU by Number 28.4 10.0 of OED Proiects Rated U or HU by Amt 0 0 a. As shown in the Annual Report on Portfolio Performance. For current FY data as of March 14, 2002. b. Average age of projects in the Bank's country portfolio. c. Percent of projects rated U or HU on development objectives (DO) and/or implementation progress (IP). d. As defined under the Portfolio Improvement Program. e. Ratio of disbursements during the year to the undisbursed balance of the Bank's portfolio at the beginning of the year: Investment projects only. * All indicators are for projects active in the Portfolio, with the exception of Disbursement Ratio, 53 54 Annex B3 Mexico-Country Assistance Strategy Annex B3. Bank Group Program Summary, FY2002-05 Proposed IBRD Lending Program, FY2002-05 FY Project Amount Strategic Implementation (US$ millions) Rewards Risks 2002 Tax Reform SAL 200 H* L Tax Administration TAL 30 H M Savings & Loan Sector Development 43 H M Environmental SAL 200 M M Municipal Development in Rural Areas 400 M M EdoMex TAL 27 H M Urban Microbusiness 8 M M Landing Titling LIL 5 M M Total FY02 905 2003 Rural Finance SECAL 200 M M ISSSTE SECAL 500 H H State-level Adjustment 200 H M National Urban Upgrading Loan 50 M M Off-grid Rural Electrification Loan 5 M L Water & Sanitation Modemization 200 M M Irrigation Sector 220 M L Technical Training & Certification 150 M L ISSSTE TAL 15 H M State Infrastructure Decent. APL 1 250 H H Access to Justice LIL 5 H H Land Titling LIL 5 M M GEF Protected Areas II M M GEF Climate Change-Hybrid Technology M M GEF Persistent Organic Pollutants M M PCF Carbon Sequestration in Coffee Areas M M Total FY03 1,800 2004 Highway Finance Loan 200 H M Finance Sector SECAL 200 H L Health System Reform IMSS 200 H M State-level Adjustment II 200 H M Agricultural Productivity II 300 M L Science Education 100 M L Air Quality 11 100 M L Community Forestry 100 M L State-level TAL Window 50 H M Anti-corruption Mechanisms Loan 50 H H Rural Develop. Marginal Areas APL III 100 M M GEF Protected Areas 111 M M GEF Gulf of Cortes M M Total FY04 1,600 2005 Power Sector Reform Hybrid Loan 200 M M Financial Sector SECAL 11 200 M L Environmental SAL II 200 M L State-level Adjustment III 200 H M Science and Technology II 150 M L Indigenous Health 50 M L Municipal Development in Rural Areas II 200 M L Judicial Reform Loan 30 H M States Infrastructure Decent. APL 11 200 H M Basic Education APL III 170 M L Total FY05 1,600 TOTAL 5,905 * H = High, M = Moderate, L = Low. 55 Annex B3 CAS Annex B3 (IFC & MIGA) - Mexico IFC and MIGA Program, FY 1999-2001 1999 2000 2001 IFC approvals (US$m)' 121 210 232 Sector (%)1 Agribusiness 0 0 3 Chemicals 0 21 4 Financial Services 44 1 92 Infrastructure 1 46 0 Manufacturing & Services 55 14 1 Social Services 0 17 0 Total 100 100 100 Investment instrument (%)' Loans 73 86 93 Equity 18 9 5 Quasi-Equity 9 0 1 Other 0 5 0 Total 100 100 100 N1GTA -uarancec- (USSin i 0 0 0 lApprovals for IFC's own account; approvals including syndications amounted to US$13 Im (1999), US$401m (2000), and US$332m (2001). 56 Annex B4 Mexico-CAS FY03-05 Annex B4. Summary of Nonlending Services Consolidating Macroeconomic Stability Cost (US$000) Cost (US$000 Macro-monitoring (ongoing) 158 Evaluation Basic Healthcare FY03 Reform of the Fiscal Pact FY03 41 Adult Education Study FY03 81 Public Expenditure Management FY04 81 Secondary Education Study FY04 41 Promoting Trade FY04 81 Indigenous Health FY 04 81 International Factor Mobility FY04 158 Urban Poverty FY03 81 Country Economic Memorandum FY05 158 Social Safety Net Evaluation FY04 81 Economic Shocks and Fiscal Responses FY05 81 Portfolio Gender Assessment FY04 41 Labor Market Convergence FY05 158 Business Cycle and the Poor FY04 81 Public Debt Management FY05 41 Growth Poverty and Inequality FY04 81 Indigenous People Access to Assets and Markets FY04 Accelerating Growth Through Enhanced Competitiveness Financial Sector Monitoring (ongoing) 81 Balance Growth and Poverty Reduction with Protecting the Coffee Sector Study FY02 81 Environment Sugar Sector Restructuring FY02 81 Degradation and Poverty FY03 81 Agricultural Competitiveness FY03 158 Environment and Growth FY04 81 Municipal Development in Rural Areas FY03 100 Rural Pension Schemes FY03 41 Building an Efficient, Accountable, and Transparent Warehousing Schemes FY03 41 Government Energy Sector Dialogue FY03 41 State-level CFAA FY03 90 SME Development FY03 81 State-level CPAR FY03 90 Energy Sector Review FY04 41 State-level PER FY03 81 Insurance Sector Report FY04 41 State-level CEM FY03 81 Low-Income Housing FY04 81 Judicial Reform Agenda FY03 81 Rural Enterprise Development FY04 81 State-level CFAA FY04 90 Urban Land Management FY05 State-level CPAR FY04 90 State-level PER FY04 81 Human Capital Development Anticorruption TA Window FY03-05 158 Gender Assessment of Legal Framework FY02 41 State-level CEM FY05 81 Dissemination of Gender & the Mexicon Econ. FY03 10 State-level CFAA FY005 90 Poverty Assessment 03 158 State-level CPAR FY05 90 Impact of PROGRESA FY03 41 WBI Transparency Training Programs FY03-05 Knowledge-Economy Assessment FY03 Civil Society Organization Dialogue and TA FY03-05 158 57 58 Annex B5 CAS Annex B5 - Mexico Poverty and Social Development Indicators Latest single year Same regionrincome group Latin America & Upper-middle 1995-2000 Caribbean Income POPULATION Total population, mid-year (millions) 97.4 508.2 571.5 Growth rate (% annual average for period) 1.3 1.6 1.4 Urban population (% of population) 74.7 74.9 75.4 Total fertility rate (births per woman) 2.4 2.6 2.4 POVERTY (unadjusted figure-all poor) (%6 ofpopulation) National headcount index 45.73 Urban headcount index 36.33 Rural headcount index 73.29 INCOME GNI per capita (US$) 5,080 3,800 4,870 Consumerpriceindex(1995= 100) 219 140 131 Food price index (1995=100) 227 INCOME/CONSUMPTION DISTRIBUTION Share of income or consumption Gini index 51.9 Lowest decile 4.0 Highest decile 56.7 SOCIAL INDICATORS Public expenditure Health (percent of GDP) 2.3 3.3 3.3 Education (percent ofGDP) 4.9 3.6 5.0 Social Security (percent of GDP) 2.9 7.4 7.9 Net primary school enrollment rate (7l of age group) Total 101 91 94 Male 101 Female 102 Access to an improved water source (%l ofpopulation) Total 86 85 87 Urban 63 93 94 Rural 94 62 68 Immunization rate (%6 under 12 months) Measles 96 90 90 DPT 96 87 88 BCG 99 Child malnutrition (percent under 5years) 8 9 Life expectancy at birth (years) Total 75 70 69 Male 73 67 66 Female 78 73 73 Mortality Infant (per thousand live births) 29 30 27 Under 5 (per thousand live births) 36 38 34 Adult (ages 15-59) Male (per 1,000 population) 166 207 233 Female (per 1,000 population) 104 122 143 Maternal (per 100,000 live births) 51 Births attended by skilled health staff (%) 92 Source: 2000 Census INEGI, and 2001 World Development Indicators. 59 60 Annex B6 CAS Annex B6 - Mexico Key Economic Indicators Actual Esiima(ed Projected lindiceawir 1997 1998 1999 2000 2001 2002 2003 2004 National accounts (as % GDP at current market prices) Gross Domestic Product 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Agriculturea 5.5 5.2 4.7 4.2 4.4 4.5 4.5 4.4 IndustlYa 28.6 28.6 28.8 27.9 27.0 27.7 28.0 28.2 Servicesa 65.9 66.2 66.5 67.8 68.6 67.8 67.5 67.3 Total Consumption 74.2 77.8 78.1 78.7 81.3 81.5 81.1 80.6 Gross Domestic Investment 25.9 24.3 23.5 23.1 20.9 21.4 21.9 22.4 Government Investment 3.1 2.8 2.9 2.9 2.9 3.7 4.0 4.2 Private Investment 22.8 21.5 20.6 20.2 18.0 17.7 18.0 18.2 (includes increase in stocks) Exports (GNFS)b 30.4 30.7 30.9 31.1 27.8 27.8 28.4 28.9 Imports (GNFS)b 30.4 32.8 32.4 32.8 30.0 30.7 31.4 31.8 Gross Domestic Savings 25.8 22.2 21.9 21.3 18.7 18.5 18.9 19.4 Gross National Savingsc 23.9 20.5 20.5 20.0 18.0 17.9 18.0 18.4 Memorandum items Gross Domestic Product 400,868 421,010 479,448 579,925 615,855 641,345 683,663 730,146 (US$ million at current prices) Gross National Product per 3,710 4,000 4,440 5,080 5,520 5,940 6,330 6,660 Capita (US$, Atlas method) Real Annual Growth Rates (%, calculated from 1993 prices) GDP at market prices 6.8 5.0 3.8 6.9 -0.3 1.5 4.1 4.5 Gross Domestic Income 7.7 4.2 4.6 8.3 -1.3 1.1 4.2 4.6 Real Annual per Capita Growth Rates (%, calculated from 1993 prices) GDP at market prices 5.2 3.6 2.3 5.4 -2.4 0.1 2.7 3.1 Total Consumption 4.4 3.5 2.8 7.2 -0.4 0.0 2.3 2.4 Private Consumption 4.9 4.0 2.8 7.9 -0.6 -0.7 2.2 2.3 61 Annex B6 CAS Annex B6 - Mexico Key Economic Indicators (continued) Actual Estimated Projected Indicator 1997 1998 1999 2000 2001 2002 2003 2111)4 Balance of Payments (US$ m) Exports (GNFS)b 121,701 128,982 148,083 180,167 171,207 178,342 193,965 210,732 Merchandise FOB 110,431 117,460 136,391 166,455 158,547 164,946 179,699 195,423 Imports (GNFS)b 121,608 137,801 155,465 190,494 184,494 196,789 214,652 232,327 Merchandise FOB 109,808 125,373 141,975 174,458 168,276 179,898 196,647 213,097 Resource balance 94 -8,818 -7,382 -10,326 -13,287 -18,447 -20,688 -21,595 Net current transfers 5,247 6,012 6,313 6,994 9,338 10,009 10,727 11,499 (including official current transfers) Current account balance -7,448 -16,090 -14,375 -17,737 -17,457 -22,701 -26,544 -29,037 (after official capital grants) Net private foreign direct investment 12,830 11,602 11,915 14,190 21,022 13,600 14,400 15,800 Portfolio investment 3,800 -451 3,901 401 1,092 1,146 1,204 1,264 Long-term loans (net) 356 12,420 11,479 4,416 113 9,353 11,889 11,301 Official -4,567 -805 -1,703 -524 2 760 526 262 Private 4,922 13,225 13,182 4,940 112 8,592 11,363 11,039 Other capital (net, including 4,395 -4,281 -8,643 5,850 2,645 61 74 87 errors and omissions) Net use of IMF resources -3,439 -1,063 -3,682 -4,299 0 0 0 0 Change in gross reserves -10,494 -2,137 -594 -2,822 -7,330 -1,459 -1,023 585 Memorandum items Resource balance (% of 0.0 -2.1 -1.5 -1.8 -2.2 -2.9 -3.0 -3.C GDP at current market prices) Current account balance -1.9 -3.8 -3.0 -3.1 -2.8 -3.5 -3.9 -4.0 (% of GDP at current market prices) Annual growth rates (%) Merchandise exports 15.0 6.4 16.1 22.0 -4.8 4.0 8.9 8.8 Merchandise imports 22.7 14.2 13.2 22.9 -3.5 6.9 9.3 8.4 (Continued) 62 Annex B6 CAS Annex B6 - Mexico Key Economic Indicators (continued) Actual Estimated Projecled lndiicaor 1997 1998 1999 2000 2001 2002 2003 2004 Public finance (as % of GDP at current market prices)d Current revenues 23.1 20.4 20.9 21.6 22.0 22.6 22.8 22.9 Current expenditures 19.9 18.3 19.3 21.1 21.0 21.1 21.0 20.9 Current account surplus (+) 3.1 2.1 1.5 0.5 1.0 1.4 1.9 2.0 or deficit (-) Capital expenditure 3.7 3.3 2.7 1.7 1.7 2.1 2.2 2.3 Overall Balance -0.6 -1.2 -1.2 -1.2 -0.7 -0.6 -0.3 -0.3 Monetary Indicators M2/GDP (at current market prices) 28.3 27.9 26.2 20.9 Growth of M2 (%) 33.9 19.7 11.8 -4.5 Private sector credit growth/ total credit growth (%) Price indices (1993=100) Merchandise export price index 114.8 108.0 112.1 120.6 120.7 122.4 125.6 128.6 Merchandise import price index 109.2 108.4 107.5 110.6 113.9 116.9 119.7 122.3 Merchandise terms of trade index 105.1 99.6 104.2 109.0 105.9 104.7 104.9 105.1 Real exchange rate (LCU/US$)0 101.6 97.9 100.2 88.3 85.4 85.4 85.4 85.4 Consumer price index 20.6 15.9 16.6 9.5 5.5 4.5 4.0 3.5 (% growth rate, period average) Consumer price index 15.7 18.6 12.3 9.0 4.4 4.5 3.5 3.0 (% growth rate, end of period) GDP deflator 17.7 15.4 14.9 12.1 5.4 4.5 4.0 3.5 (% growth of rate) a. GDP components estimated at factor cost, as a % of GDP at factor cost. b. "GNFS" denotes "goods and nonfactor services". c. Includes net unrequited transfers excluding official capital. d. Consolidated non-financial public sector e. "LCU" denotes "local currency units". A decrease in LCU/US$ denotes appreciation. 63 64 Annex B7 CAS Ans1ex B7 - Mexico EPey Exposure Indicators Actual Estimated Projected Indicator I"' 7 1998 1999 2000 2001 2002 2003 2004 Total debt outstanding and 148,697 161,404 167,626 164,686 165,099 174,513 186,476 197,865 disbursed (TDO) (US$m)a Net disbursements (US$m)r -3,083 11,357 7,797 117 413 9,413 11,961 11,387 Total debt service (TDS) 43,480 27,990 39,760 63,497 42,410 42,062 51,062 61,214 (US$m)a Debt and debt service indicators (%) TDO/XGSb 111.5 119.9 108.9 88.2 91.7 92.9 91.3 89.2 TDO/GDP 37.1 38.3 35.0 28.4 26.8 27.2 27.3 27.1 TDS/XGSb 34.4 20.8 25.8 34.0 23.5 22.4 25.0 27.6 IBRD exposure indicators (%) IBRDDS/publicDS 6.5 iO.6 10.1 7.4 15.8 17.4 16.5 13.2 Preferred creditor/ 20.8 22.2 38.6 29.3 21.2 24.1 23.8 19.2 public DS (%)C IBRD DS/XGSb 1.7 1.5 1.4 1.2 1.3 1.3 1.1 1.0 IBRDTDO(US$m)d 11,906 12,108 11,353 11,444 10,883 11,709 11,723 11,973 Present value 550 595 326 0 0 0 0 0 of guarantees (US$m) Share of IBRD portfolio (%) 11.0 10.2 9.3 9.4 9.0 9.2 9.3 9.6 IFC (US$m)' Loans 402 263 366 455 519 ... ... ... Equity and quasi-equity, 165 154 170 209 214 ... ... a. Includes public and publicly guaranteed debt, private nonguaranteed, use of IMF credits and net short-term capital. b. "XGS" denotes exports of goods and services, including workers' remittances. c. Preferred creditors are defined as IBRD, IDA, the regional multilateral development banks, the IMF, and the Bank of International Settlements. d. Includes present value of guarantees. e. IFC's own account exposure (excluding guarantees and risk management products). f. Includes equity and quasi-equity types of both loan and equity instruments. 65 66 Annex B8 CAS Annex B8 - Mexico Status of Bank Group Operations in Mexico Operations Portfolio As of March 14, 2002 OngiWal Amount in USS MillionS Diference between expected Last PSR and actual disbursements a/ Supervision Rating hi Project ID Fiscal Year Borrower Pwpose IBRD IDA Cancel. Undisb. Orig Fru Revd Dev Ob_ Imp Prog Number of Closed Projects: 157 Active Proiects MX-PE-7648 1993 BANOBRAS MEDIUM CITIES TRANSP 200.0 0.0 63.0 55.8 118.8 95.8 S S MX-PE-7710 1994 BANOBRAS N. BORDER I ENVIRONM 368.0 0.0 313.4 23.6 337.0 62.3 S S MX-PE-7701 1994 NAFIN ON-FARM&MINORIRRI 200.0 0.0 30.0 11.9 41.9 11.9 S S MX-PE-34490 1995 NAFIN TECHNICAL EDUC1ntAINING 265.0 0.0 69.7 51.3 120.9 90.9 S U MX-PE-7689 1996 NAFIN BASIC HEALTH B 310.0 0.0 0.0 29.6 29.6 29.6 HS HS MX-PE-7713 1996 NAFIN WATERRESOURCESMANA 186.5 0.0 0.0 120.4 101.2 41.9 S S MX-PE-7700 1997 NAFIN COMMUNITY FORESTRY 15.0 0.0 0.0 6.1 5.1 0.0 S S MX-PE-44531 1998 NAFIN KNOWLEDGE & INNOV. 300.0 0.0 0.0 195.4 67.0 0.0 S S MX-PE-7720 1998 BANOBRAS HEALTH SYSTEM REFORM - SAL 700.0 0.0 0.0 150.0 150.0 0.0 5 S MX-PE-55061 1998 BANOBRAS HEALTH SYSTEM REFORM TA 25.0 0.0 0.0 1.3 1.3 0.0 S HS MX-PE-49895 1998 BANOBRAS HIGHER ED. FINANCING 180.2 0.0 0.0 144.3 72.1 0.0 S S MX-PE-7711 1998 NAFIN RURAL DEV. MARG.AREA 47.0 0.0 0.0 30.2 22.5 0.0 S S MX-PE-48505 1999 NAFIN AGRICULTURAL PRODUCT 444.5 0.0 0.0 155.6 52.5 -28.1 S S MX-PE-7610 1999 BANOBRAS FOVI RESTRUCTURING 505.1 0.0 0.0 312.0 308.7 0.0 S S MX-PE-66938 2000 NAFIN GENDER (LIL) 3.1 0.0 0.0 3.1 1.4 0.0 U U MX-PE-57530 2000 NAFIN RURAL DEV.MARG.AR 11 55.0 0.0 0.0 42.7 5.4 0.0 S S MX-PE-64887 2001 BANOBRAS DISASTER MANAGEMENT 404.1 0.0 0.0 395.7 45.0 0.0 S S MX-PE-65779 2001 BANOBRAS FEDERALHIGHWAYMAINTENANCEPROJ 218.0 0.0 0.0 206.9 -11.1 0.0 S S MX-PE-70479 2001 BANOBRAS EDO DE MEXICO SAL 505.1 0.0 0.0 200.0 .304.6 0.0 S S MX-PE-71323 2001 NAFIN BANK RESTRUCTURING FACILITY II 505.1 0.0 0.0 350.0 -51.7 0.0 S S MX-PE-66321 2001 NAFIN BASIC HEALTH CARE PROJ. Hi 350.0 0.0 0.0 350.0 0.0 0.0 S S MX-PE-60577 2002 NAFIN SOUTHEAST REGIONAL DEVELOPMENIT 5.0 0.0 0.0 5.0 0.0 0.0 S S Total 5,791.4 0.0 476.1 2,840.8 1,113.0 304.3 Activc Proiects osed Proiects Iotal Total Disbursed (IBRD and IDA): 2,474.6 24,541.7 27,016.3 of which has been repaid: 84.4 18,435.3 18,519.7 TotalnowheldbylBRD andIDA: 5,230.9 6,121.9 11,352.9 Amount sold 0.0 92.3 92.3 of which has been repaid: 0.0 92.3 92.3 Total Undisbursed : 2,840.7 15.5 2,856.3 a. Intended disbursements to date mninus actual disbursements to date as projected at appraisal. b. Following the FY94 Annual Review of Portfolio performance (ARPP), a letter based system was introduced (HS = highly satisfactory, S = satisfactory, U = unsatisfactory, HU = highly unsatisfactory): s4 pToposed Improvements in Project and Portfolio Perfonnance Rating Methodology (SecM94-901), August 23,1994. 67 68 CAS Annex B9 (IFC) - Mexico Annex B9 Statement of IFC's Held and Disbursed Portfolio As of February 28, 2002 (In US Dollars Millions) Held Disbursed FY Approval Company Loan Equity Quasi Partic Loan Equity Quasi Partic 1998 CIMA Mexico 0.00 4.80 0.00 0.00 0.00 4.80 0.00 0.00 1998 C]MA Puebla 6.75 0.00 0.00 0.00 3.25 0.00 0.00 0.00 1994/01 CTAPV 2.88 0.00 1.69 0.00 2.88 0.00 1.69 0.00 2000 Cbiapas-Propalma 0.00 0.82 0.00 0.00 0.00 0.82 0.00 0.00 1997 Comercializadora 2.41 0.00 1.72 4.38 2.41 0.00 1.72 4.38 2001 Compartamos 1.00 0.66 0.00 0.00 1.00 0.66 0.00 0.00 1999 Corsa 11.14 3.00 0.00 0.00 11.14 3.00 0.00 0.00 2001 Ecomex 5.00 0.00 1.50 0.00 3.00 0.00 1.50 0.00 2000 Educacion 6.50 0.00 0.00 0.00 4.90 0.00 0.00 0.00 1997/01 Fondo Chiapas 0.00 4.18 0.00 0.00 0.00 0.54 0.00 0.00 1998 Foja Monterrey 12.07 3.00 0.00 12.07 12.07 3.00 0.00 12.07 1991/96 GIBSA 16.23 0.00 10.00 54.57 16.23 0.00 10.00 54.57 1993 GIDESA 2.50 0.00 0.00 0.00 2.50 0.00 0.00 0.00 1994/96/00 GIRSA 57.00 0.00 5.71 70.00 57.00 0.00 5.71 70.00 1993 GOTM 0.33 0.00 0.00 0.00 0.33 0.00 0.00 000 1997/98 Gen. Hipotecaria 0.00 3.29 0.00 0.00 0.00 3.29 0.00 0.00 2001 Grupo BBVA 0.00 2.67 0.00 0.00 0.00 2.67 0.00 0.00 1998 Grnpo Calidra 10.00 6.00 0.00 7.50 10.00 6.00 0.00 7.50 1989 Gnupo FEMSA 0.00 5.26 0.00 0.00 0.00 5.26 0.00 0.00 1997 GrupoMinsa 12.00 10.00 0.00 18.00 12.00 10.00 0.00 18.00 1992/93/95/96/99 Grupo Posadas 34.65 5.00 15.00 5.00 34.65 5.00 15.00 5.00 1998 Grupo Sanfandila 8.09 0.00 0.00 3.61 6.76 0.00 0.00 2.95 1994/96/98/00 HellerFinancial 0.00 3.12 0.00 0.00 0.00 3.12 0.00 0.00 2000 Hospital ABC 30.00 0.00 0.00 14.00 1.76 0.00 0.00 1.24 2000 ITR 14.00 0.00 0.00 4.00 14.00 0.00 0.00 4.00 2000 Innopack 0.00 15.00 0.00 0.00 0.00 15.00 0.00 0.00 1994 Interceramic 5.00 0.00 4.00 0.00 5.00 0.00 4.00 0.00 2000/01 InverCap 0.00 1.07 0.00 0.00 0.00 1.06 0.00 0.00 1998 Merida IH 29.59 0.00 0.00 72.15 29.59 0.00 0.00 72.15 1995/96/99 Mexplus Puertos 0.00 4.46 0.00 0.00 0.00 4.46 0.00 0.00 1996/99/00/01 NEMAK 0.00 0.00 9.04 0.00 0.00 0.00 9.03 0.00 2000/01 Pan American 0.00 9.00 0.00 0.00 0.00 9.00 0.00 0.00 2002 Puertas Finas 13.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 2000 Rio Bravo 50.00 0.00 0.00 59.50 50.00 0.00 0.00 59.50 2000 Saltillo S.A. 35.00 0.00 0.00 43.00 35.00 0.00 0.00 43.00 2000 Servicios 10.50 1.90 0.00 10.00 10.50 1.90 0.00 10.00 2001 Su Casita 0.00 10.62 0.00 0.00 0.00 10.62 0.00 0.00 1999 Sudainerica 0.00 15.00 0.00 0.00 0.00 15.00 0.00 0.00 1997 TMA 2.58 0.00 2.60 8.95 2.58 0.00 2.60 8.95 1992 Toluca Toll Road 4.83 0.00 0.00 0.00 4.83 0.00 0.00 0.00 1991/92 Vitro 0.00 10.17 0.00 0.00 0.00 10.17 0.00 0.00 1998 ZN Mxc Eqty Fund 0.00 15.30 0.00 0.00 0.00 14.77 0.00 0.00 2002 ZN Mexico H 0.00 10.00 0.00 0.00 0.00 0.90 0.00 0.00 1988/91/92/93/95 Apasco 10.80 0.00 0.00 43.20 10.80 0.00 0.00 43.20 1998 Ayvi 8.57 0.00 0.00 0.00 8.57 0.00 0.00 0.00 1990/92/96/99 BANAMEX 75.71 0.00 0.00 5.49 75.71 0.00 0.00 5.49 2001 BBVA-Bancomer 86.47 0.00 0.00 0.00 86.47 0.00 0.00 0.00 1995/99 Baring MexFnd 0.00 11.82 0.00 0.00 0.00 11.24 0.00 0.00 Total Portfolio: 564.60 156.14 51.26 435.42 514.93 142.28 51.25 422.00 Approvals Pending Commitment Loan Equity Quasi Partic 1998 Cima Hermosillc 7.00 0.00 0.00 0.00 1999 BANAMEX LRF nI 50.00 0.00 0.00 0.00 2002 Coppel 30.00 0.00 0.00 0.00 2000 Educacion 3.20 0.00 0.00 0.00 2001 BBVA-Bancomer CL 100.00 0.00 0.00 0.00 2001 SuCasita 0.00 0.00 2.40 0.00 2001 GFNorte-CL 100.00 0.00 0.00 100.00 2001 La Colorada 4.30 0.00 6.00 18.30 2001 Greenmanor 7.00 0.00 0.00 0.00 2001 PanAme-La Colora 0.00 1.20 0.00 0.00 Total Pending Commitmnent: 301.50 1.20 8.40 118.30 69 70 Annex BIO Mexico: Private Sector Strategy I. Context for Private Sector Strategy 1. Private sector development-a key cross-cutting theme for the Mexico CAS. This Private Sector Strategy (PSS) forms an integral part of the World Bank Group's (WBG's) approach to Mexico's development and poverty reduction. As noted in the CAS, growth is an essential (but not sufficient) condition for poverty reduction in Mexico. The costs of lagged or negative growth could be substantial to the poor, as we have learned through the crises in Mexico, Asia, and more recently, Argentina. The private sector is clearly the engine of growth in Mexico, and has also played a growing role in public service delivery. The first priority for Mexico, therefore, is the continuation of macroeconomic stability, which is essential for the private sector to continue its contributions to growth. However, there is also a large array of issues to be addressed, to enhance Mexico's competitiveness necessary for long-term growth, and to distribute more evenly the benefits of growth. These issues encompass a number of critical areas and require a coherent approach by the WBG. This PSS expands on the summary discussion presented in the main text of the CAS, and presents an overview of the WBG's multisectoral approach to private sector development (PSD) in Mexico. 2. Mexico PSS in the context of the WBG's corporate PSD strategy. This Mexico PSS draws substantially on the framework of the recently discussed corporate strategy for PSD. Mexico is one of the first countries where the WBG has sought to integrate a private sector strategy in the CAS, and is the first to have a third-generation private sector strategy. Drawing on the corporate strategic framnework now in place and on rich past experiences, this PSS solidifies the WBG's approach to private sedtor development in Mexico. The key threads of the WBG's private sector strategy in Mexico follow the overall corporate strategic thrust, which is summarized in the following: Private sector development is critical for poverty reduction in two major ways. First, private markets are the engine ofproductivity growth and thus create more productive jobs and higher incomes. Second, complementary to government roles in regulation, funding and provision, private initiatives can help provide basic services that empower the poor by improving infrastructure, health and education-the conditions for sustainable improvements of livelihoods. In Mexico these broad PSD themes have bearing on a set of CAS core threads: (a) consolidating macroeconomic gains, (b) accelerating growth through enhanced competitiveness, and (c) reducing poverty through human capital development. This PSS particularly addresses the second and the third threads, with the identification of more detailed development issues in Mexico, as follows: 1. Access to financing-more evenly distributed access to investment financing 2. The financial sector-broader, more efficient financial intermediation for growth 1. Private Sector Development Strategy: Directions for the World Bank Group, January 25, 2002 (SecM2002- 0047). 71 Annex B IO 3. Infrastructure for enhancing competitiveness and tapping private initiatives for public service delivery 4. The corporate sector-enabling an environment for enhanced competitiveness and broad-based development 5. Facilitating human capital development-private participation in the social sector. 3. This PSS is organized as follows. Section II provides a general overview of the Mexican private sector and a diagnosis of the principal private sector development issues. Section III details the WBG's strategy in responding to these issues, and a proposed division of labor between IBRD and IFC.2 II. Private Sector Development Priorities The Mexican Economy-the Past Six Years 4. Increased private sector role. The Mexican economy has gone through a dynamic transformation since the Tequila Crisis (1995), with the private sector playing an increasing role. Growth continued apace since then until the last year. This growth was accompanied by significant increases in the share of private investment in GDP, while public investment remained at a low and declining level. As shown in Table 1, the increases in industrial production played a major role in this growth, reflecting the private sector's role as the engine of growth. Unemployment rates in the meantime declined from a high of 6.3 percent in 1995 to 2.2 percent in 2000. Table 1. Mexico: Growth (per year) and Investments as a Share of GDP 1995 1996 1997 1998 1999 2000 Real GDP Growth % (1993 prices in pesos) -6.2 5.2 6.8 4.9 3.8 6.9 Industrial Production % Change -7.5 10.7 8.4 6.2 3.7 6.6 Public Investment as a % of GDP 3.7 3.0 3.1 2.8 2.9 2.9 Private Investment as a % of GDP 16.1 20.1 22.8 21.5 20.6 20.2 5. Exports and maquiladora sector expanded. A steady expansion of exports, and a strong performance of the maquiladora sector,3 characterized Mexico's growth during this period under the NAFTA (Table 2). The value of exports grew at an average nominal rate of 15.9 percent per year, with its shares in GDP growing from 14 percent of GDP in 1994 to 29 percent in 2000. The export expansion was helped by the strong performance of the U.S. economy, and the progressive economic integration under the NAFTA. The share of exports to the U.S. in the total exports increased in tandem, indicating an increased reliance on the U.S. economy. 2. Mexico is not a member of the Multilateral Investment Guarantee Agency (MIGA). 3. Maquiladora refers to Mexico's in-bond industry under the Maquiladora Program. A Maquiladora Program is granted to a legal entity that is formed in Mexico with the purpose of manufacturing, assembling, repairing, or other processing of goods that are destined mainly for the export market. 72 Annex B 10 Table 2. Mexico: Growth in Exports 1995 1996 1997 1998 1999 2000 Merchandise Exports ($ bn) 79.5 96.0 110.4 117.5 136.4 166.4 Exports % Change 30.6 20.7 15.0 6.4 16.1 22.0 Merchandise Exports % GDP 27.7 28.8 27.5 27.9 28.4 29.0 Merchandise Export: U.S. % Total 83.3 83.9 85.4 87.8 88.3 88.7 6. The role that the maquiladora sector played in this process was significant. First, exports by the sector maintained a significant and growing weight in the total exports (Table 3). Second, the maquiladora sector's net contributions to the overall trade balance were substantial. Third, the number of workers employed by the sector grew apace during the period. Fourth, many observe a growing role of the sector in technology transfer and human capital improvements, with corporate strategies in maquiladora shifting toward increasing the scope and technological complexity of the production process and the linkages with local producers and educational institutions.4 Table 3. Mexico: Maguiladora Sector 1995 1996 1997 1998 1999 2000 Maquila Exports ($ bn) 31.1 36.9 45.2 53.1 63.9 79.5 Total Merchandise Exports ($ bn) 79.5 96.0 110.4 117.5 136.4 166.5 Exports: Maquila / Total (%/6) 39.1 38.5 40.9 45.2 46.8 47.7 Employment by Maquiladoras (thousand) 681.3 799.3 936.8 1,043.5 1,195.4 1,308.0 Maquila Trade Balance (S bn) 4.9 6.4 8.8 10.5 13.4 17.8 Total Merchandise Trade Balance ($ bn) 7.1 6.5 0.6 -7.9 -5.6 -8.0 Source: INEGI. 7. Domestic finance played a minimal role in growth. The domestic financial sector did not play a major role in financing this growth and export expansion during the period. Credit to the private sector actually contracted from 34 percent of GDP in 1995 to around 10 percent in 2000. Steady flows of foreign direct investment (FDI) in effect represented the major source of financing for growth during the period.S External private debt flows were volatile, providing a major share of financing in 1998 (3.1 percent of GDP) and turned into a net outflow in 2000 (- 0.1 percent) (Table 4). With the increased risk aversion away from the emerging markets, private debt flows are expected to remain at a low level. With the weakened U.S. economy, FDI flows also face the risk of slowdown. This pattern of financing chiefly supported the expansion of the firms that had access to external fmancing-top-tier companies. The rest of the corporate sector benefited little from the external financing, and was at a disadvantage due to the domestic credit contraction. 4. See, for example, "Maquila, Economic Reform and Corporate Strategies," Buitelaar and Perez (World Development Vol. 28, No. 9, 2000). 5. The reliance on FDI flows from the United States also increased. The share of FDI originated from the United States in the total FDI to Mexico increased from 46 percent in 1994 to 71 percent in 1998. 73 Annex B 10 Table 4. Mexico: Domestic Credit to the Private Sector and Private Capital Flows (% GDP) 1995 1996 1997 1998 1999 2000 Credit to Private Sector 34.0 20.7 16.1 14.4 11.7 10.0 FDI 3.3 2.8 3.2 2.8 2.5 2.4 Equity Portfolio Investment 0.2 0.8 0.8 -0.2 0.8 0.1 Debt -5.2 0.5 0.7 3.1 1.7 -0.1 Sources: Institute of International Finance and Bank of Mexico. 8. Slowdown in 2001 points to future PSD agenda. The slowdown in the U.S. economy, particularly since September 11, 2001, has hit Mexico. The economic slowdown has been amplified in Mexico, with GDP contracting by 0.3 percent in 2001. Merchandise exports declined by 4.8 percent. Unemployment has edged up to 2.5 percent.6 Unlike the contraction after the Tequila Crisis, the current economic contraction was not caused by macroeconomic imbalances, and has highlighted the importance for Mexico to address the long-standing private sector development agenda to foster home-grown, broad-based growth. Private sector develoDment agenda (1) Limited and uneven access to financing 9. Top-tier firms maintained limited access. The current difficult international market conditions, coupled with the still low domestic financial intermediation, favor top-quality credits. Although Mexico has become an investment-grade country, sovereign borrowers, along with the largest and creditworthy firms, remain the primary beneficiaries of the limited access to external private financing. During 2000-01, for example, there were 25 bond issues for a total of $17.9 billion in the external markets, of which 18 issues totaling $14.9 billion were by the United Mexican States, PEMEX, and its affiliates. The rest (seven issues totaling $3.0 billion) were limited for a handful of blue-chip firms, such as Telmex, Cemex, Grupo Elektra, and Grupo Televisa. Top-tier firms have also maintained access to domestic credit. However, due to the contracted and still nascent domestic intermediation, even for large firms the tenor of such borrowing (except from foreign banks or with facilities backed by funding from multilateral institution) has been typically limited to revolving credit for up to three years. 10. Less than top-tier firms and SMEs. The rest of the Mexican firms (99 percent in numbers) have very limited access to investment financing, although the conditions are expected to improve over time, particularly for large firms, with the country's investment grade. As Table 5 shows, access to domestic and foreign banks significantly declines as the size of firms becomes smaller. The majority of bank credit is used for working capital needs, and loans for investment purposes are limited. The lack of bank credit, particularly for SMEs, is substituted by supplier and customer credit, and loans from other companies (40 to 65 percent of firms' outside financing sources). Such "substitute" financing is generally of a short-term, working capital nature (40 to 50 days)-an inadequate tenor for investment financing. The majority of those firms reported that they did not use bank credit even for such short-term financing because of high interest rates and the difficulties in accessing bank loans. Continued perceptions of uncertainty and high costs over collateral enforcement and bankruptcy processes further add risk 6. Employment in the maquiladora sector declined by 13.7 percent. 74 Annex B 10 premium, and significantly raise potential financing costs especially for smaller-sized companies.7 Because of the lack of alternative financing, those firms often have to consider prohibitively expensive nonbank financing as the only source for their investment fumding, with an interest rate 6 to 7 percent higher for a limited tenor than their larger counterparts. This differential access to, and cost of, financing makes broad-based development of the Mexican private sector difficult, and hampers an equitable sharing of the benefits of growth. A critical element in addressing this uneven access to financing is the development of the domestic financial sector, as noted below. Table 5 Mexico: Credit Market Survey* (3rd Quarter, 2001) (Percent of answers) By Firm Size** Small Medium Large AAA Sources of Financing Suppliers 62.3 52.9 44.1 32.5 Commercial banks 14.6 23.5 21.7 30.0 Foreign banks 2.4 3.7 9.9 15.0 Firms that Used Bank Credit For: Working capital 70.4 66.3 53.8 63.6 Investment purposes 14.8 11.2 15.4 9.1 Firms that Did Not Use Bank Credit Because of: High interest rates 24.5 32.0 23.1 14.3 Difficulty in access 42.9 37.0 40.4 35.7 Firms that Grant Some Tvpe of Financing To: Clients 84.3 76.9 77.1 50.0 Suppliers 11.6 12.0 7.6 13.6 Average maturity of the financing granted (days) 41.1 44.5 50.6 81.4 * Nationwide sample with responses from at least 500 firms. The reply to this survey is voluntary and confidential. ** Based on firms sales in 1997, Small = I to 100 million pesos, Medium = 101 to 500 million pesos, Large 501 to 5,000 million pesos, and AAA = over 5,000 million pesos. Source: Bank of Mexico. (2) The fnancial sector-broader, more efficient intermediation for growth 11. A well-functioning domestic financial sector is an essential element for broad-based and sustained growth of the private sector.8 In this regard there is much to be done in Mexico, because domestic financial intermediation through both the banking sector and the capital markets are still at a low level. The following presents a snapshot of the Mexican financial sector, and the areas for improvements. 12. Banking sector. The most notable feature of the Mexican banking sector in the past years is credit contraction. There are also three other notable features in this period: (a) consolidation, (b) foreign participation, and (c) improvements in capital adequacy toward international standards. The consolidation process started after the Tequila Crisis, and the 7. The recent legal reforms are in the early stages of implementation. 8. This section is a synthesis of the WBG's findings and analysis, drawing heavily on IBRD's financial sector work and IFC's experiences. 75 Annex B 10 number of traditional Mexican banks has come down significantly. Of the present 35 banks, only two have not gone through changes of control or been intervened. The Mexican banking system has become among the most concentrated in the world, with 80 percent of the banking assets held by the five largest groups. This consolidation has been accompanied by a remarkable increase in foreign participation. Prior to 1998, foreigners controlled only 24 percent of bank assets. In 2001, foreigners had effective control over three-quarters of the total banking assets. While there has been an improvement in capital adequacy, studies by rating agencies and investment banks suggest that capital adequacy still falls short of international standards in certain areas of the system. The foreign capital infusions and improvements in profitability are expected to further improve capital adequacy; however, the continued strengthening of the regulatory and supervisory functions will be important for maintaining sound development of the sector. 13. Potential impact of consolidation and foreign participation on local firms. The consolidation and foreign participation may amplify the lack of access to credit for homegrown middle-market firms and small- and medium-sized enterprises (SMEs). Some recent studies show that these processes may lead to less access to bank credit for those firms, as bigger (and foreign) banks tend to follow large (or foreign) clients. This is probably because large banks perceive lending to smaller (or local) firms as riskier, in view of the quality of information, collateral values, and lending experiences (or lack thereof). Three measures could be envisioned to mitigate this potential problem: * Legal and regulatory improvements in secured lending and corporate bankruptcy procedures (under implementation by the government) * Helping improve infornation transparency, accounting practices, corporate governance, and management through regulatory measures and business development and other services * Transferring methodologies and credit culture that foster profitable SME lending, through credit lines and risk sharing facility from international institutions. 14. Capital markets. Both equity and bond markets are still small in Mexico. The equity market, with a capitalization of US$126 billion, is one of the larger among emerging markets. However, relative to the size of the Mexican economy, it is small (see Figure 1), and is not sufficiently developed to alleviate the scarcity of debt capital. There were only four equity issues in 2000 totaling $1.3 billion, of which $1.2 billion was for Telmex.9 In 2001, there was only one issue, which was related to Citibank's acquisition of BANAMEX. Again, top-tier firms addressed this limitation through their access to external capital-raising capital primarily in ADRs in the United States-and partially contributed to the stagnation of the domestic equity market. The bond markets are also small at around 30 percent of GDP. Furthermore, the government securities dominate new and outstanding issues, with a share of some 90 percent in the total outstanding debt securities. 9. Telnex accounted for about one quarter of the total market capitalization. 76 Annex B 10 Figure 1. Equity Market Capitalization to GDP, 2000 200 189 1 8 0 - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - 1 6 0 - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - 0 - 14 0 - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - o ~~~~116 c] 140 - -- - -- --- -- - 8--- - -- 8Y6 -- -- i ------------------_-_-_-_-_-_-_-_ _ 120 _ X - -88-- ---- Y8 0 _ - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -_ __ __ __ __ __ __ __ 37.9 40 - -- -- - - - 22 --- - 19 - - -- - 0 UK US Spain Chile Japan Brazil Mexico Peru Colombia (London) (NYSE) 15. There are two major reasons for this low level of domestic capital market activity. First, ownership is very concentrated and entangled in Mexico. In large companies, which dominate the market,'0 the controlling group holds 40 percent of their shares. Smaller companies are often closely held. Cross-lending and extensive cross-holdings by related parties reduce attractiveness in investing in Mexican listed securities, and corporate governance in Mexico has also been perceived as unattractive for outside investors (see paragraphs 34 and 35). Second, the investor base is still nascent and small." Domestic institutional investors, such as pension funds, mutual funds, and insurance companies, are still at an early stage of development, and hold a tiny fraction of shares and securities issued by the local private sector. 2 The current regulatory guidelines are very restrictive on investing in equities and securities issued by the private sector. Further reform, in particular, prudent liberalization of the investment regime to increase investment choices, is important for growth of this sector. Particularly important among these institutions are the private pension funds-AFOREs'3 (pension fund managers) and SIEFOREs'4 (pension funds themselves)-that have recently grown rapidly, and are expected to reach over $160 billion in 15 years. 10. Six companies account for over 60 percent of the Mexican stock market index. 11 This small investor base in turn tends to exacerbate the concentration of ownership in the market. 12. For example, only 7 percent of the total SIEFOREs' assets are in private sector securities. The rest are mostly in government securities. 13. Administradoras de Fondos para el Retiro. 14. Sociedades de Jnversi6n Especializada de Fondos para el Retiro. 77 Annex BIO Figure 2. Mexico: Private Pension System-Assets Under Management of AFOREs (US$ billion) $30 $25 - ----------------------- . $20--. - - $15 ---------------------- .... $10 . .. .... $5 . - ....- ..- $0 1997 1998 1999 2000 2001* * As of November 2001. Source: Asociaci6n Mexicana de Administradoras de Fondos para el Retiro, A.C. 16. SOFOLs. The expansion of the SOFOLs15 sector has partially filled the financing gap created by the contraction of bank credit and the low intermediation through the capital markets. Created in 1993, these non-deposit-taking, limited-scope lending institutions have substantially increased their credit; together, they increased credit from $31 million in 1994 to over $8 billion in 2001 (Figure 3). As of November 2001, there were 34 SOFOLs, of which 18 are specialized in housing finance; the others are dedicated to consumer financing, microfinance, and so forth. The housing finance SOFOLs play a major role in the sector, with $4.2 billion in outstanding loans, and are responsible for the origination and administration of 98 percent of the mortgages placed by FOVI, 6 a governmental institution acting as a second-tier bank for low-income housing finance. There are two main issues currently facing the SOFOLs. First, SOFOLs are highly dependent on funding from FOVI. In the medium to long term, SOFOLs need to find additional funding sources to reduce this dependence. Second, as a non-deposit-taking institution, SOFOLs have no formal regulatory body.'7 However, they are closely monitored by FOVI, their main creditor, and by the Bank of Mexico and the National Banking Commission (CNVB). There is a need to clarify and strengthen the regulatory and supervisory roles over SOFOLs. 15. Sociedades Financieras de Objeto Limitado. 16. Fondo de Operacion y Financiamiento Bancario a la Vivienda. 17. Under Mexican law, credit granting alone is not considered an activity subject to regulation by the financial authorities. If credit granting is done with resources funded by the public through deposit taking, then it is considered financial intermediation subject to regulation. In contrast, credits granted by nondepository financial institutions supported by funds raised other than from the securities markets are considered commercial transactions regulated by the Commercial Code. Moreover, transactions related to real estate (including mortgages) are regulated by the Civil Code of each state. 78 Annex B1O Figure 3. Mexico: SOFOLs-Total Loan Outstanding (US$ billion) 0 Other types * Housing Finance 9. 8---------------------------------- 6------- --- 5------- ------ ---- 4- --------------------- -. 3- -------------------------- ....---- -- 2-- ----- - 1- ------------------------------- o- ... I . n 1 I9 1994 1995 1996 1997 1998 1999 2000 2001* * As of November 2001. Source: La Asociaci6n Mexicana de Sociedades Financieras de Objeto Limitado A.C. 17. Housing finance. Mexico's housing finance sector relies heavily on the public sector's role, and has not been able to respond to growing housing shortages. Allowing a larger role of the private sector is critical for the development of both primary and secondary markets. Mexico's housing shortage is severe-estimated at 4.6 million units-due to the high rate of population growth in the past 20 years and the decreased availability of housing finance since the Tequila Crisis. The housing sector is primarily divided along the lines of annual income.18 There are largely two groups: (a) the social interest sector in which families earn between 2.5 and 15 minimum wages, and (b) the open market sector with borrowers earning more than 15 minimum wages.19 The social interest sector is currently addressed by public sector institutions, such as FOVI, INFONAVIT, and FOVISSSTE.21 The open market sector is currently served in a minimal way by a small portion of SOFOL lending and through cautious reentry of commercial banks to the market. Mortgage debt outstanding is only US$18 billion, or 3.1 percent of GDP. There is a large potential for increased participation of the private sector. The potential of the open market sector is estimated at about US$580 billion, and of the social interest sector at about $280 billion. 18. Primary Mortgage Market. The Tequila Crisis caused banks to withdraw from the mortgage market. As noted earlier, FOVI lends mortgage funds through the SOFOLs, while government-controlled pension funds such as INFONAVIT and FOVISSSTE engage in direct mortgage lending. Together, these three public sector institutions account for over 80 percent of mortgage credit to the social interest sector, and are the major sources of funds available for mortgage loans in Mexico. The private sector's role is limited primarily to SOFOLs. However, 18. Defined in terms of minimum wage; one minimum wage is about US$1,500 per year. 19. There also is a "minimum" sector for those with incomes below 2.5 minimum wages, and it comprises the informal economy where borrowers have no banking relationships, and housing is self-built and financed by discretionary cash or through microcredit facilities. 20. FOVI (Fondo de Operaci6n y Financiamiento Bancario a la Vivienda), INFONAVIT (Instituto del Fondo Nacional para la Vivienda para los Trabajodores), and FOVISSSTE (a pension/housing fund similar to Infonavit for government workers and teachers). 79 Annex B 10 SOFOLs are heavily dependent on FOVI for their funding. This funding limitation constrains them from entering into the open market sector. 19. Secondary Mortgage Market. The development of a secondary mortgage market is an important step for growth of the housing finance sector. There has not been a mortgage-backed securitization (MBS) market in Mexico.21 So far, Su Casita (an IFC client) has been the only institution to successfully place an MBS-type security with a reasonable size. The government has begun setting the foundations for the creation of a secondary mortgage market to serve the social interest sector. There is a large development potential in this area, with private sector participation and support from institutions such as the WBG. 20. Microfinance. Most of the microenterprises in Mexico lack access to formal financial services. This is critical, because many microenterprises reside in the poorer segments of urban areas and in rural areas, and their development is important for equitable growth. There are about 3.5 million microenterprises, which play a significant role in the Mexican economy: over 90 percent of Mexican enterprises are microenterprises, accounting for over 40 percent of the workforce. Microfinance is not well developed in Mexico. Studies show that less than 1 percent of the Mexican poor have access to some type of formal financial services. This creates a large potential market for commercial microfinance institutions (MFIs). There are only a few specialized, commercially oriented MFIs with a wide client base. With 82,000 clients, Compartamos (an IFC client) leads Mexico's MFIs. It reaches remote rural communities, which lack access to financial services. Serious limiting factors have inhibited the growth of Mexico's microfinance sector in the past, namely inflation and the collapse of many financial institutions (including numerous credit cooperatives) following the Tequila Crisis, and rigid and incomplete regulations. 21. The regulatory environment for MFIs is made of three main overlapping institutions: the Ministry of Finance, the Central Bank, and the CNVB. The Ministry of Finance, in cooperation with the other agencies, is implementing the April 2001 law (La Ley de Ahorro y Credito Popular) that would facilitate the provision of microfinance services by private financial institutions. The law proposes to consolidate and create a supervision context for savings and loan societies, credit unions, cooperatives, and private lending corporations. 22. Other financial intermediaries. There are also other important financial intermediaries that could help support broad-based growth. Leasing and factoring typically play a particularly important role in providing funds to smaller companies, which have not established a formal banking relationship due to banks' perceptions of high risks and other factors. In Mexico these industries are still underdeveloped. Leasing is a costly means of finance for firms in Mexico, due in part to perceived high risks associated with the processes of bankruptcy and collateral repossession. Factoring is also underdeveloped, due to costly regulatory filings and poor judicial efficiency. Financial institutions specializing in distressed assets (Non-Performing Loans, NPLs) have a particular relevance in Mexico, which still carries a large number of NPLs-the legacy of the Tequila Crisis. These institutions purchase packages of NPLs at a discount through auctions conducted by IPAB,22 and either liquidate, resell, or restructure NPLs and repackage them for issuing new securities backed by restructured cash flows. Liabilities held by IPAB are 21. An MBS issue was placed several years ago, but it was very small and illiquid. 22. Instituto de Protecci6n al Ahorro Bancario, the Mexican Deposit Protection Agency. 80 Annex B 10 estimated at US$75 billion, and IPAB plans to raise $2.2 billion annually for its own funding through auctioning of loan portfolios. 23. Credit annnmnt. As discussed earlier, firms in emerging markets, except for the largest known names, are faced with the difficulty in accessing the international market or even domestic debt markets. On the other hand, there is a large universe of creditworthy companies in Mexico, which are only moderately leveraged. These firms could be introduced to financial markets if an adequate Level of credit enhancement is provided with their debt issues. Multilateral institutions may have a potentially important role in this area as providers of such credit enhancement. in the case of domestic debt issues, this would in turn help develop the domestic markets by introducing additional securities and providing a potential benchmark for corporate issues. (3) ' L:, Ij. l, .g' i, and tapping private initiatives 24. bug beneven pirogress. Mexico has made significant, although uneven, progress in reforming the infrastructure sector.23 The role of the private sector in infrastructure has become increasingly important. Private investment in infrastructure during the last decade increased from 18 percent of GDP to 23 percent, while public investment declined from 5 percent to less than 3 percent. Starting in the late 1980s, the government opened various subsectors to private participation: first, telecommunications, and then toll roads and ports, and more recently railroads and airports. The results vary across these subsectors. Energy, and water and sarntation have largely remained in the public domain. Mexico's infrastructure agenda going forward includes (a) fiirtler improving the quality and efficiency of infrastructure services, thereby enhancing competitiveness of Mexican enterprises, and (b) promoting private participation where possible, thereby reducing large fiscal burdens associated with public sector management. 25. AK:. L-4Sv cmc e8veness. Mexico faces challenges in enhancing competitiveness through better infrastruct ue services in the context of globalization on one hand and decentralization on the o2ier. Mexican enterprises will require higher quality infrastructure services in telecommunications, transport, and power, in order to compete in free trade, especially within NAFTA. The need for infrastructure investment is very high. For example, in highway transport alone, the government has identified over 2,300 kilometers of priority projects and an additional 400 kilometers of bypasses for construction in the next 10 years.24 Analysts estimate that the energy sector would require expenditures of over US$100 billion over the next decade. Demand for higher quality and more efficiency point to the importance of promoting private financing of infrastructure where possible, further fostering competition in the liberalized subsectors, and capacity building among regulatory institutions at both the national and subnational levels. 26. L.^-IIraI2I;' sttructure and processes. To attract private investment, investor perception of risk needs to be lowered through the institutional and regulatory framework. Mexico's experience to date with autonomous and credible regulation has been limited. In many sectors a 23. This section draws heavily on the IBRD-IFC private participation in infrastructure country framework study (April 2001). 24. At the same time, the government is in the process of restructuring the debt that it took on of the federal highway system. 81 Annex B IO single agency has been responsible for policy formulation, actual operation and investment, and monitoring and regulation. The resulting environment of complex roles and incentives has led to the perception of high risk for private entrants, uneven regulation, and mixed sector performance. Regulatory agencies need political and financial autonomy, accountability, and transparent and open processes. Also, there is still a lack of capacity to plan, design, and execute complex transactions like infrastructure concessions, particularly at the subnational level. 27. Telecommunications. Mexican telecommunications performance made good strides during the 1990s, but it still lags that of other Latin American countries.. The state-owned monopoly carrier, Telmex, was privatized as an integrated firm. Under private operation, penetration and usage of phone service increased. However, performance indicators still lag behind those of other countries in the region.25 Competitive entrants to the market still have had limited success in Mexico, and regulatory limitations need to be addressed to promote competition. 28. Transport. An important challenge for the transport sector in Mexico is the need for more integrated transport systems that support efficient supply chains. Mexico has been very successful in attracting private sector interest and investment in ports and railroads, and in roads, though with mixed results. It has also made a good start in private participation through concessioning and privatizing airports. Progress in the railways privatization program has generated significant interest in multimodal logistics and improved intermodal coordination (including linkages with the U.S. systems). However, rail and road access to port facilities and distribution centers still needs improvement. The gains achieved through port reform are significantly reduced by long waiting times for truckers and trains in cargo reception areas in the interior. Also, the level of containerization of Mexican freight, a critical requirement for integration of the transport network, is low, at 36 percent. Mexico's inventory levels of raw materials and finished goods are higher on average by 58 percent and 46 percent, respectively, than those in the United States, indicating the potential for more efficient supply chains. A major obstacle is the lack of intermodal facilities, particularly with respect to international traffic. In highways country risk is perceived to be high, primarily due to the government's constraints and consequent inability to deliver on guarantees and contractually obligated adjustments. This continues to casts a shadow over toll roads, and devising mechanisms to finance the operations and maintenance expenditures remains a priority. 29. Broadening private participation-the energy sector. The energy sector continues to be an important sector for Mexico's economic development, given the country's substantial reserves of oil and gas, and the sector's potential to generate growth and employment. The sector has been recognized as a strategic sector for Mexico, and has been mostly in the public sector domain. Two state-owned companies-PEMEX (Petr6leos Mexicanos) and CFE (Comisi6n Federal de Electricidad)-dominate the sector. Substantial investments will be required for the sector to meet the demand for energy supplies. It is estimated that the sector will require investments of $100 billion to $130 billion to keep up with economic growth over the next decade. These investment requirements will represent 10 to 15 percent of annual federal 25. In 1998, Colombia, Costa Rica, and Uruguay had not yet privatized their wire-line telephone companies, yet all had better performance indicators than Mexico. Of the large Latin American countries, only Peru has lower telephone penetration, with GDP per capita some US$1,000 below Mexico's. International long-distance tariffs in Mexico are estimated to be the highest among large Latin American countries, except for Uruguay and Venezuela. 82 Annex B IO expenditures, and 50 to 60 percent of the federal investment budget. Thus, reducing the need for public sector funding, through promoting private sector participation, would be a critical element for the sector policy. Mexico has large reserves of both oil and gas. Oil reserves account for 29 billion barrels (about the same as in the United States); gas reserves account for 30 trillion cubic feet (slightly higher than United Kingdom's reserves). On the other hand, production rates per given reserves lag behind those of countries such as Canada, Norway, the United Kingdom, and the United States. Reform in the sector, along with that in petrochemicals, would attract much- needed financing for growth and efficiency, and present significant opportunities for the private sector. 30. Economic growth since the mid-1990s has highlighted the need for increased electricity supply. Mexico has at present 35,000 megawatts of capacity. Future demand is forecast to grow at 5.8 percent per year until 2010. This would require additional capacity of 27,000 megawatts. The cost of meeting this demand, including additional transmission and distribution capacity, would amount to $23 billion until 2010. Much of the expansion in generation capacity over the past six years is attributable to private investment under the IPP (Independent Power Producers) program, and is expected to follow this trend in the near future. There have been discussions on gradually allowing further private sector participation in this sector. A regulatory structure that provides sufficient incentives for investment is important, as the recent energy shortages in California and Brazil suggested. 31. Water and sanitation. Since the early 1990s, federal sector policy has promoted private participation as a tool for improving the efficiency and quality of urban water supply and sanitation services. However, in practice very few municipalities have had success so far in attracting long-term private funds. In spite of large investment needs (US$6 billion), the sector as a whole faces parallel trends of declining investment, low revenue mobilization, and limited cost recovery. The reasons for this relate to pricing, commercial and technical inefficiency, and continuing dependence on federal transfers. Water and sanitation tariffs charged by the majority of Mexico's urban water companies are quite low (US$0.3 per cubic meter) compared with tariffs in other countries in Latin America and the OECD ($0.9 to $2.5 per cubic meter), and barely cover operational costs. Subsidy policies and the tariff structure need to be reexamined in order to increase the private sector's contributions to the sector. Also, a credible regulatory environment is necessary for reducing investor uncertainty. Very few states have put in place regulations governing private sector participation. In addition, multilateral financial institutions could play a constructive role in supporting the new federal-subnational "master trust" arrangement that enhances private participation in subnational infrastructure and public services. (4) Corporate sector-enabling environment for enhanced competitiveness and broad- based development 32. The corporate sector plays the key role in Mexico's private-sector-led growth and job creation. In Mexico, large companies and maquiladoras have played a significant role in the recent export-led economic expansion, with important, although limited, "trickle-down" effects. However, micro, small, and medium firms continue to play a significant role in employment, providing 72 percent of the total employment in Mexico (Table 6). 83 Annex B IO Table 6. Mexico: Corporate Sector by Size (1999) Micro* Small Medium Large** Total Number of Companies (thousand) 2,690 88 26 8 2,811 Number of Employees (million) 5.9 1.8 2.3 3.9 13,9 * Possibly underestimates the number of informal micro firms; IFC's interviews with microfinance institutions indicate that the number could be over 3.5 million firms. ** Under the INEGI classification by the number of employees, firms with more than 500 employees in manufacturing and more than 100 employees in commerce and services are lumped as "large" firms. Source: INEGI Economic Census 1999. 33. The Mexican corporate sector is faced with a number of constraints to achieving broad- based private sector development. An underdeveloped financial sector and infrastructure deficiencies put the sector at a disadvantage in competitiveness. There are also issues that pose added challenges to the Mexican private sector-issues of laws and regulations that affect Mexico's business environment, such as corporate governance, bankruptcy and secured transactions laws, and the judiciary. 34. Corporate governance. Improving corporate governance practices is critical in developing the domestic capital markets and the corporate sector. Investors have become increasingly concerned with corporate governance issues in Latin America. McKinsey, in cooperation with the World Bank, surveyed 90 institutional investors in mid-1999 on their view on the issue of corporate governance and priorities for reform.26 Over 80 percent of respondents stated that, relative to financial considerations, they viewed corporate governance issues as important in their investment decisions. The most cited issues for Lain America, including Mexico, were shareholder rights, disclosure, and the boards of directors.27 The survey also asked investors whether they would be willing to pay more for investing in companies with international standards of corporate governance. For Mexico, 90 percent of respondents stated that they would pay an average premium of 21.5 percent. This indicates that the gains from improved corporate governance are considerable at the individual firm level in terms of cost of capital. 35. The government is making efforts in this area, and enacted a new Capital Markets Law in June 2001, which would allow Mexico to make a good stride in the right direction in corporate governance standards. Under the new law, the protection of minority shareholder rights is enhanced, and the CNBV is explicitly granted the power to regulate tender offers in order to prevent the exclusion of minority shareholders from the benefits of these transactions. Table 7 shows Mexico's improved corporate governance standards (as of January 2002), compared to other major countries in the region. The new law represents a marked improvement in Mexico's corporate governance framework, although there remain certain areas for further improvements (for example, oppressed minority remedy). Actual improvements in practice remain to be seen. There is a role for multilateral institutions to help improve corporate governance practices in Mexico. 26. Respondents represented 90 institutional investors with global asset holdings of US$1.65 trillion. 27. Observers note that Mexican corporate governance has been characterized by serious shortcomings in protection of shareholder rights, control of conflicts of interest, and responsibility and professionalism of boards of directors. Mexico historically scored poorly on corporate governance. Well-publicized cases, often involving the use of the company's assets to support the interests of the controlling shareholder, have damaged investor confidence and related securities markets development. 84 Annex B IO Table 7. Shareholders' Rights and Corporate Governance Practices Share Cumulative Mandatory Not Voting Share Share- Tender One Blocked Prop. To Pre- Oppressed holders Offer Bids Independent Committee Share/One Before Represen- Call emptive Minority Rights in Change Directors Practices Vote Meeting tation ESM Rights Remedy Indec? of Control New Required under Special committee Legislation new legislation; to review audits Chile Yes Yes Yes 0.10 Yes Yes 5 requires bids shnsion and conflicts- beginning im fund have long prone transactions 2003 directors required under new legislation Argent Required Required under 27% of boards ana No No Yes 0.05 Yes Yes 4 under new new legislation havestanding committees; legislation required under new legislation New Required legislation under new Brazil encourages Yes No 0.05 No Yes 3 legislation No 17.6% of boards reduction of only for have standing committees nonvoting voting shares to 50% shares New legislation CNBV 25% required Mexico m2o5e slitly No No 0.10 Yes No I empowered to by new Required under new legislation on nonvoting set rules legislation shares a. La Porta and others 1997 index (0 low to 5 high). This index was calculated prior to recent reforms, but still serves as an indicator of past practices and market perceptions. Sources: La Porta and others, in "Beyond the Washington Consensus; Institutions Matter," World Bank 1998, updated with World Bank/1IFC Corporate Governance Assessments for Chile, Brazil and Mexico; and Spenser Stuart Business Indexes: Brazil, 1999 and Argentina, 1998. As of January 2001. 36. Laws and judicial system. Legal and regulatory improvements, and reform in the judicial system, are seen as critical for a better business environment in Mexico. Improvements in secured lending and corporate bankruptcy procedures improve access to credit particularly for smaller firms, by reducing creditors' perceived risk. The government has made significant progress in this area. In May 2000, amendments to the Credit and Banking Laws and the Commercial Code became effective, and the new Commercial Insolvency Law was introduced. These substantially changed the framework for secured lending28 and bankruptcy procedures.29 The success and effectiveness of the new laws need to be tested over time. Improvements in laws will not be effective if they are not supported by an improved judicial system. It is well known that in Mexico citizens distrust the judicial system. An inefficient and unreliable judicial process presents a heavy cost to doing business. Judicial inefficiencies pose significant hidden costs to business; for example, in intermediation costs (because banks need to cover risks of 28. The amendments introduced the pledge without transfer of possession, and included provisions for the enforcement and foreclosure of security interests. This is expected to improve borrowers' access to credit with a pledge of a portion of their current assets, such as inventories and accounts receivable. Prior to the amendments, a pledge on movable assets could be perfected only under very limited circumstances. However, the amended provisions still have room to be improved. The new provision requires, in every pledge without transfer of possession, the introduction of a clause that provides that in the event the collateral is sold and the proceeds are not sufficient to cover the secured obligation, the uncovered portion is deemed to be extinguished and discharged. With this provision, banks may be reluctant to use the new pledge device, or ask for additional overcollateralization. 29. The new law provides for a single insolvency process-a conciliatory phase of mediation and bankruptcy filing-compared to the old system that had two processes-suspension of payments and bankruptcy, which significantly compromised creditors' position. 85 Annex B 10 judicial uncertainty in enforcing contracts within loan spreads), and in contracted prices (because business has to add a risk premium for the eventual unenforceability of commercial contracts). It is important that the government continue its current efforts to improve the judicial system. 37. Sustainable development. Another area of importance which has been gaining awareness in the Mexican corporate sector is sustainable development and good corporate citizenship. The increased awareness arises not only from the recognition of corporate responsibilities for preserving public goods, but also from its importance for maintaining Mexico's competitiveness and growth. Environmental and social practices that do not meet international standards, and actual depletion of environmental resources, are now becoming a competitive disadvantage for Mexican firms, and a constraint to their ability to access new markets and attract foreign investments (for example, in tourism). Substandard practices are increasingly seen as constituting unfair competition in external markets at the expense of global public goods, particularly with NAFTA, WTO, and the OECD, of which Mexico is a member. Recognizing this, a growing number of Mexican firms are turning to the concept of sustainable development, which enhances firms' competitiveness and thus the value of these firms. For example, wood products that use raw materials produced by sustainable forestry management may provide access to export markets in OECD countries. Sustainable environmental and social business practices may also attract and retain a motivated, high-skilled, quality workforce-an increasingly important ingredient in keeping up with competition in the globalization and attracting foreign capital. Such sustainable business practices will in turn complement the public sector's efforts in delivering environmental and social public goods, such as cleaner air and water, and community developments. (5) Facilitating human capital development-private participation in the social sector 38. The growing population, improving average income, changing demography, and stronger demand for a highly skilled workforce to sustain competitiveness will continue to put pressures on Mexico's health care and education systems. Mexico has made steady progress, particularly in improving access to basic services. The tight fiscal conditions will continue to constrain public spending, and it will therefore be necessary to rationalize and optimize the allocations of public resources and use private sector resources. The issue is not a matter of private versus public efficiency or quality of services, but how to optimize complementary roles of the public and private sectors, and maximize the results. 39. Health sector. Mexican health care has significantly improved over the past decades.30 However, demand for healthcare services still exceeds provision, as the population continues to increase and age, and a growing segment of the population has higher expectations in terms of quality of care. The private sector accounts for around 50 percent of healthcare expenditures,31 30. Between 1970 and 2000, life expectancy at birth increased from 61.0 years to an estimated 75.3 years, while the infant mortality rate fell from 72 per 1,000 live births to 16 per 1,000. 31. As for the public sector, the Instituto Mexicano de Seguro Social (IMSS) and the Instituto de Seguridad y Servicios Sociales de los Trabajadores del Estado (ISSSTE) are the two main public providers of health care (they account for nearly 75 percent of the government's healthcare spending). In 1999, they officially covered 45 million people and 10 million people, respectively (out of a total population around 100 million). In addition, some healthcare services are provided by the Defense and Navy Ministries, the state oil company (PEMEX), state organizations such as the Institute for Indigenous Peoples (INI), and the national system for Integrated Family Development (DIF) and, fnally, by private institutions. 86 Annex B 10 indicating its already significant role. An important element in sector reform going forward is the changing role of government, from one of directly providing all healthcare services to ensuring a coherent framework for the system that can be accessed by the population in a cost- effective manner. 40. The efficiency of the private health care sector in Mexico needs to be greatly improved. The number of people covered by private insurance has grown rapidly (some 60 percent over the past five years), but is still small. Only 4 percent of the population have private medical insurance, with a much larger group paying directly out-of-pocket. It is estimated that the private sector has around 2,500 hospitals and that it performs a third of all medical activities in the country. Private hospitals are typically small in size (the large majority have less than 15 beds), and have a limited range of medical equipment. Private investment could potentially greatly improve the efficiency and quality of services. However, it appears that the private sector thinks that the government should provide clearer direction in the reform and about the role of the private sector in the system. 41. Education. Mexico has made significant progress in the provision of education, particularly in universal access. Mexico's agenda in the education sector is therefore shifting toward the quality of services. This is a critical area for Mexico, as its labor demands shift to higher skills to keep pace with accelerating technological progress and global competition. The private sector has potential for a larger role, particularly in higher education, vocational training, introduction of information technology for education, and distance learning. 42. In addition to companies directly involved in education, the corporate sector has been playing an indirect role in education and human capital development. While comprehensive data are not available, observers note that a large number of Mexican firms offer in-house training courses. Many large firms also maintain formal agreements with educational institutions for the purpose of accessing experts for training courses, accepting internships of students, and occasionally employees teaching at one of the institutions. Workers' skills are also upgraded through on-the-job training, particularly in industries that require technological complexity and sophistication. As the Mexican corporate sector moves higher in the value chain in its products and services, such internal education, and partnership with educational institutions, will become increasingly important. III. The World Bank Group's Private Sector Strategy Toward higher, more equitable growth through enhanced competitiveness and human capital development 43. The WBG's Private Sector Strategy (PSS) for Mexico is based on the diagnosis and vision outlined above. The WBG's principal objective in private sector development in Mexico is to help the country move toward higher, more equitable growth through enhanced competitiveness and human capital development. This cuts across three of the five main threads of the CAS: (a) consolidating macroeconomic gains, (b) accelerating growth through enhanced competitiveness, and (c) reducing poverty through human capital development. Together, the PSS supports the WBG's overarching objective of poverty reduction in Mexico. 87 Annex B 10 44. Comparative advantages of IBRD and IFC. IBRD and IFC will follow a division of labor that is practical, and according to each institution's comparative advantages. In general, IBRD's comparative advantages lie in its assistance on macroeconomic stability, knowledge building and transfer, sectoral policy advice, and capacity building. IBRD has also been effective in advancing policy dialogue with the Mexican authorities and facilitating open and constructive policy discussions in Mexico. IFC's advantages lie primarily in specific transactions, catalyzing financing where IFC's presence adds value. IFC's strength is derived from its practical knowledge of the financial and corporate sectors, dialogue with international and local private investors, hands-on experiences in local constraints to private investment, and accumulated international knowledge and expertise. 45. In Mexico, as in other middle-income countries, demand for IFC services fluctuates with the extent of its comparative advantages vis-a-vis other sources of financing and know-how available for the private sector. As noted earlier, top firms have gained access to external financing, and with the country's investment-grade credit ratings, access is expected to further improve for large firms. IFC's role in providing financing for these firms is becoming limited. Investment financing for the rest of the corporate sector is expected to remain scarce, and IFC maintains a unique role in providing long-term financing suitable for their investments. The limited tenor of financing provided by domestic commercial sources, due to their funding constraints and market conditions, is a critical issue for sustained growth of the Mexican corporate sector. This is also true for private external financing, which offers at best medium- term financing (three to five years) that could subsequently pose refinancing risks, as the financial market to emerging economies opens and closes capriciously. In addition to the ability to provide long-terrn financing, IFC's role is becoming stronger with the private sector's growing awareness of the need for know-how in order to improve competitiveness. In particular, the growing acknowledgement of IFC's leadership position on sustainability issues, corporate governance, corporate strengthening through restructuring, and local supplier linkages, is expected to increase the demand for IFC in these areas. This aspect of IFC's knowledge sharing is expected to become more important in Mexico, particularly for relatively large and medium- sized firms that seek to enhance their competitive position. 46. IBRD/IFC Collaboration. In Mexico, the collaboration between IBRD and IFC has progressed over time. The two institutions have long worked together, particularly in the financial sector, infrastructure, SMEs, and the social sector. IBRD's assistance in enhancing the regulatory and supervisory environment and the strengthening of the banking sector and financial sector infrastructure are helping set the stage for IFC's increased involvement in direct and indirect assistance to viable Mexican financial intermediaries, including capital market institutions. IBRD's assistance in urban development and housing is also complemented with IFC's assistance in developing housing finance institutions and mortgage markets. In infrastructure, a number of subsectors where IBRD's assistance has helped improve the regulatory framework have provided increasing opportunities for IFC's sequential involvement in helping structure and mobilize a financial package for pioneering private infrastructure projects. IBRD's nonlending services in SME development benefits from IFC's complementary experiences with impediments to private sector development generally, and with SMEs. This IBRD activity would in turn support IFC's increasing focus on assisting SMEs and middle- market companies through financial intermediaries. IBRD's assistance in reforms in the social sector continues to be supplemented by the IFC's support for private service providers, helping enhance public-private complementarities. 88 Annex B IO 47. The following section outlines the focus of each WBG institution. IBRD 48. Summary. IBRD's role in supporting broad-based, private-sector-led growth is aligned with the preceding diagnosis. Foremost, IBRD's strategy focuses on supporting the government's efforts to consolidate the recent macroeconomic gains. It is aimed at supporting the efforts to deepen fiscal and other reforms that are associated with the continuation of prudent macroeconomic management. At the same time, IBRD focuses on enhancing Mexico's competitiveness and supporting human capital development. IBRD's activities in this latter category are expected to be primarily in the financial sector, housing, infrastructure, and the social sector. The Bank's intervention is expected to encompass both the federal and state levels, in support of decentralization in Mexico. 49. Financial sector. In the financial sector, IBRD will continue to focus on close monitoring of the financial system, and addressing the remaining weak areas that are likely to hinder further financial sector deepening and limit its efficiency. The continuation of financial sector monitoring will be provided through AAA services. IBRD's activity in the remaining issues of the sector would focus on regulatory improvements, market efficiency and development, and sector reforms, particularly at the state level and for underserved rural areas. First, IBRD will focus on further strengthening of the bank supervisory framework, and of the financial sector infrastructure that supports financial and capital markets transactions. The latter includes improvements in information disclosure practices on such transactions and the strengthening of property, collateral, and credit registries. Second, IBRD expects to assist in reorientation, reform and/or restructuring of major public development banks (NAFIN, BANOBRAS, and BANCOMEXT32) where new legislation is likely to be proposed to more sharply delineate the essential functions of these banks and ensure that they complement and support the activities of the financial system. The third area will aim at supporting required policy and institutional reforms in rural finance, including reform and restructuring of BANRURAL33 and putting in place an appropriate regulatory and supervisory framework to oversee rural finance institutions. An operation to support reforms in the state level pension systems to adjust their design parameters and practices and thereby help achieve financial sustainability will also be considered in the outer year of the CAS period if the states show the readiness to embark on such programs following the reforms implemented in the national level pension systems. 50. Housing/housing finance. Building on sector work on urban development and low- income housing issues, which has recently been completed, IBRD expects to continue to focus on support for a major national urban housing upgrading initiative. The program will take into account the key issues identified in both these pieces of sector work, including those related to management of major metropolitan areas in a way that carefully balances urban development with environmental sustainability, urban land management, and institutional reforms and rationalization of low-income housing subsidies. The Bank's assistance in this area, in tandem with IFC's activity in housing finance, is expected to have important linkages with further 32. NAFIN-Nacional Financiera, S.N.C.; BANOBRAS-Banco Nacional de Obras y Servicios Nblicos, S.N.C.; BANCOMEXT- Banco de Comercio Exterior. 33. BANRURAL-Banco Nacional de Credito Rural, S.N.C. 89 Annex B 10 development of housing finance markets through increasing access to housing, demand for financing, and improvements in the housing finance market structure. 51. Infrastructure and energy. IBRD's priority in infrastructure and energy focuses on enhancing Mexico's competitiveness and improving access to, and quality of, infrastructure services. An active dialogue with the government is already in progress on a major national program aimed at the modernization of water and sanitation systems throughout Mexico. The activity in this area is expected to address required institutional reforms; improvements in the regulatory frameworks at the national, state, and local levels of government; measures to induce water conservation; and enhanced private sector participation in water and sanitation development. In transport, IBRD will aim to support the government's program of rationalizing the highway finance system. This is a critical area for the development of Mexico's transport system, which has received increased private sector participation, but lags in the area of highways due to the past difficulties. IBRD's assistance is expected to help improve the design and financial engineering of private highway concessions, as required to ensure the financial and physical sustainability of the highway system. A related objective would be to achieve the maximum synergy between the old and new parts of the national, state, and local road networks. In the energy sector the Bank will support the expected major reform actions in the petroleum, natural gas, and electricity sectors being contemplated by the government. Such an operation is expected to be supported by an AAA service for energy sector review. In addition, a complementary GEF project, together with a parallel Bank technical assistance operation, is being developed to supplement the mainstream power sector reforms with support to an off-grid rural electrification program, and technical and advisory assistance to the government is envisioned in developing strategy for increasing the participation of renewable energy sources in the sector. 52. To ensure that the diverse infrastructure development initiatives and associated sector policy and institutional reforms perneate effectively to the state and local levels of government, the Bank is developing, in close collaboration with concerned government entities, a State Level Decentralization APL operation. The Bank would focus on support for the design and implementation of infrastructure development and related reform programs at the state and municipality levels across a broad range of sectors, covering water and sanitation, electricity, transport, telecomnmunications, and so forth. Eligibility of the states and sectors will be determined on the basis of an assessment of the quality of the sector strategy proposed to be undertaken by the state or local government and of the overall fiscal management at the decentralized level as reflected by objective indicators and financial market ratings of the state's or municipality's credit. Strategy documents prepared by the state or local government would elaborate on proposed sector priorities, policy, institutional, and regulatory reforms, actions to improve access to the poorer segments of the population in the particular state, and means to foster private sector participation. 53. IBRD's services in support of private sector development are also envisioned to include analytical work for the development of small and medium enterprises, a review of trade and competitiveness issues, and a diagnosis of private sector development issues in the southern states, through southern states development strategy and policy notes. In addition, the Bank will support a National micro- and small business development program, with a special focus on addressing the constraints faced by smaller enterprises in achieving their full economic potential and helping create employment. The program will include business development and advisory 90 Annex B 10 services, including via improved access to IT and e-government services, youth employment initiatives to reduce administrative obstacles in small enterprise operations ("red tape") and complementary financing. 54. Health and education. IBRD will continue to offer a range of lending and nonlending services to assist Mexico in the execution of social sector reforms. IBRD will continue to address major issues with respect to private sector development in the context of its overall assistance for these sectors, and focus primarily on helping develop an environment conducive to further private participation and stronger public-private partnership. In both health and education, improvement in quality of services continues to be a major focus. IFC 55. IFC will play a key role in the implementation of the WBG's Private Sector Strategy. IFC's strategy is closely aligned with that of the Bank, and is centered around the following four themes: (a) Fostering financial sector development and more evenly distributed access to financing (b) Enhancing international competitiveness of the private sector (c) Promoting investments in areas newly opened for private sector participation (d) Promoting sustainable development and good corporate governance. Each of the four objectives is mutually reinforcing, and individual IFC projects may pursue more than one objective. For example, IFC's support for providing SMEs with access to financing through a financial intermediary could entail capacity building in the financial sector for catering to underserved segments of the private sector and at the same time support export-oriented SMEs investments for modernization. Helping an IFC client improve sustainable development or corporate governance practices may lead to companies gaining access to new export markets or new sources of financing, thereby enhancing their competitiveness. 56. Strategy implementation under the last CAS. IFC's activity in Mexico over the previous CAS period has been consistent with the strategy set out in the previous CAS. IFC's activity followed three priority themes: (a) helping the Mexican private sector gain greater and more evenly distributed access to external private financing, (b) helping improve the efficiency of domestic financial intermediation and helping mobilize domestic resources, and (c) helping private firms grow and improve their international competitiveness. These translated into IFC's sectoral focus on financial sector development, support for middle-market firms, private infrastructure, and the social sectors. In addition, sustainable development, an area that has not been explicitly identified by the previous CAS, has received increased emphasis. During fiscal 1999 to date, IFC approved operations totaling US$907 million, including syndications of US$301 million, for 27 projects, of which 10 were in general manufacturing and services (middle-market firms), 8 were in the financial sector, 5 in infrastructure, 2 in health and education, and 2 in the area of environmental sustainability. During the period, IFC has continued to expand into new areas. This is reflected in more recent project approvals, in such areas as hospitals and primary schools (fiscal 2000), a private railway project in Chiapas (fiscal 2000), housing finance (fiscal 2001), microfinance (fiscal 2001), and environmental sustainability, such as projects for cleaner fuel (compressed natural gas) for automotives (fiscal 2001), and sustainable forestry products (fiscal 2002). 91 Annex B1O 57. As of February 28, 2002, IFC's disbursed portfolio in Mexico stood at US$708 million for its own account, representing 7.4 percent of the total portfolio, and US$301 million for participant banks. Overall, IFC's portfolio in Mexico is of high quality and has managed to withstand the economic cycles over the past years. As of February 28, 2002, only 0.6 percent of IFC's loan portfolio in Mexico was in nonaccrual status, ranking among the top in the quality of country portfolio of this size. This performance was attributable to Mexico's flexible macroeconomic management and increased private sector resilience, and to IFC's project selection, due diligence, and early involvement in project structuring. IFC's strategic emphasis during the previous CAS period on "frontier" (or "riskier") types of projects and sectors in general has not to date affected the overall quality of the Mexico portfolio. However, IFC's experience shows that identifying viable and profitable investments in the poorer south is more difficult than initially expected. IFC's coinvestment facility with an equity fund in Chiapas has not been successful, and there have been few good opportunities for direct investments in the area. The fund has had difficulty in finding feasible investment opportunities with an adequate risk return profile. The main reasons for the fund's lack of investment included a generally difficult business environment, frequent changes in both State administration and policies, and the fund's small size that could not easily attract strong fumd management. 58. Balancing portfolio quality, profitability, and outreach. With the combination of declining capital flows to developing countries, stress on IFC's own portfolio, and the recent economic slowdown, maintaining the quality of both the existing portfolio and projects at entry is expected to become increasingly important for the implementation of IFC strategy. IFC's profitability continues to be an important signal to private markets that there is gcod business to be done in developing countries. IFC's overall profitability at the corporate level has been coming under pressure due to adverse overall portfolio developments. Maintaining the existing strong performance of portfolios of Mexico's size will be increasingly important for IFC's overall performance and profitability. An essential element of maintaining good portfolio quality is to continue to book good quality assets, while older quality assets mature and exit. Operational efficiency-transaction costs per booked volume-also affects profitability. As IFC seeks to extend its reach to a broader base of the private sector, in particular smaller (and often riskier) companies and pioneering (and often complex) projects, IFC is increasingly faced with the need to balance its multiple objectives. In Mexico, IFC expects to address this issue with the combination of several types of activities: (a) reaching smaller firms through financial intermediaries; (b) direct financing of larger clients, where IFC's role is essential with its otherwise unavailable long-term financing and best practice expertise (for example, corporate governance and sustainability); and (c) targeted direct intervention with smaller projects in high impact areas (for example, microfinance), which have high probability of success. 59. The overall volume and composition of IFC's activities during the CAS period will depend largely on market conditions, the level of the Mexican private sector's access to international financial markets, and progress in reform. Experiences show that the availability of alternative financing fluctuates substantially over a CAS period, and IEC will respond to such changes, doing less or more, depending on market demand and IFC's additionality (Table 8). In general, IFC's role in Mexico is stronger when and where access to international financial markets is limited. The role that IFC can play for financing blue-chip firms that have attained access to external long-term financing has become limited over the past several years. IFC's role has remained strong for the rest of the private sector, and new areas that may become open for private sector participation. 92 Annex B 10 Table 8. Mexico: IFC Approvals and Private Debt Flows (US$ millions) 1996 1997 1998 1999 2000 2001 IFC Gross Approvals in Mexico 607 259 245 131 401 332 Net Private Debt Flows to Mexico 1,627 2,954 13,243 8,111 -629 807 Note: All years are fiscal years for IFC, and calendar years for debt flows. There is a six month lag between the two. 60. Operationally, the four main themes of IFC strategy in Mexico will be translated into more detailed sectoral focus, as outlined below. (1) Fostering financial sector development and more evenly distributed access to financing 61. Financial sector. Limited access for the private sector to investmnent capital, and low domestic financial intermediation, is a core issue in Mexico's private sector development. IFC's approach under this theme is twofold: (a) reach out to enterprises that lack access to term- financing through local financial intermediaries, and (b) support transactions that help develop the domestic financial sector. In its first approach to the financial sector strategy, IFC will continue to provide investment financing for the corporate sector through intermediaries in the form of credit lines and risk sharing facility. These credit facilities are expected to address SMEs, local enterprises that develop supply linkages to exporting firms, industrial infrastructure, housing, and financial and corporate restructuring of second-tier and mid-sized firms that need to strengthen their balance sheet under the economic slowdown. IFC will also look to large companies for intermediating its funds to their SME suppliers. 62. The second thread of IFC's financial sector strategy involves direct assistance to financial intermediaries that are important for the development of local markets. The increased foreign participation will likely limit IFC's role in the banking sector to inducing these banks to engage in high-impact, underserved areas. Credit lines and capital strengthening of local banks (for example, tier-two capital financing) are expected to remain an area for IFC assistance in enhancing local bank capacity. Credit lines assist in bank development through transfer of credit methods, culture, and IFC best practices and experiences, and the capital strengthening is still needed for part of the banking sector to meet international standards of capital adequacy. 63. IFC's focus will continue to be on the development of nonbankfinancial intermediaries and domestic securities markets. IFC's approach in this area is to help develop the originators of securities, institutional investors in these securities, and liquid markets. In this regard, housing finance is a particularly important area (see below), as are pension funds, mutual funds, and insurance companies. Credit enhancement and local currency facilities are also important. The current market conditions that substantially differentiate risk classes would likely lead to demand for guarantees and other credit enhancement products that could help (creditworthy but not well known) borrowers gain access, by helping issue securities with higher risk ratings. Debt issues denominated in local currency would help develop local markets by providing scarce corporate securities. With the recent improvements in the legal framework for secured lending, bankruptcy, and corporate governance standards, IFC will also look for opportunities in leasing, factoring, private equity funds, venture capital, and other capital market institutions, which would support growth of middle-market firms and SMEs. In addition, support for the development of local capital markets is expected to be provided through institution building of local financial infrastructure, such as brokerage firms, rating and valuation agencies, and so forth. 93 Annex B 10 64. Housing finance. IFC focuses on developing both primary and secondary mortgage markets. Support for SOFOLs and other banks reentering the primary mortgage market is an important element of IFC's approach in housing finance, since they foster the origination of quality mortgages, particularly on the open market. Helping SOFOLs diversify their funding sources is also important in this regard, and for the development of the social market, and IFC will continue to support this effort, as with its financing of Su Casita (see Box 1). In this context, IFC will also look at premortgage (or bridge) funding facilities, which are needed in Mexico. IFC will also explore opportunities to develop a secondary mortgage market. With its experiences in helping develop a secondary mortgage market company in several other countries, IFC is well positioned to extend its assistance in this area to other countries, including Mexico. IFC involvement in this area may also involve technical assistance in identifying an appropriate market structure and addressing other structural issues. In addition, IFC will explore opportunities to support intermediaries that are specialized in restructuring and scrutinizing distressed assets, for example, nonperforming mortgage portfolios of IPAB. Box 1. Supporting the Housing Finance Sector: Su Casita Hipotecaria Su Casita, established in 1994, is Mexico's second-largest SOFOL. Su Casita's primaiy business is the origination and servicing of FOVI mortgages. Su Casita was the first SOFOL to originate and service FOVI mortgages, which limit the price of the homes SOFOL can finance to a maximum of US$45,000. Over the past six years, Su Casita has experienced an annually compounded growth rate of over 100 percent, and Su Casita's profitability has also remained very high. In fiscal 2001, IFC invested approximately US$10 million to acquire a 14.4 percent share of Su Casita. The IFC funds were used to help expand Su Casita's mortgage operation. Su Casita now originates and services loans in 23 states with a network of more than 80 branches, with 46,000 loans serviced. EFC is also investing approximately US$2 million in a mezzanine tranche of a Su Casita bond issue, the first major mortgage-backed bond issue in Mexico. The bonds will be backed with mortgages issued by Su Casita directed to lower-middle- income households. The total bond offering was approximately US$20 million-equivalent with a 10-year maturity. Su Casita is positioning itself to be a key leader in the industry, particularly for the low-income housing market. IFC's investment in Su Casita is supporting the development of the housing finance sector in Mexico. It is also sending a signal to the market of its confidence in the Su Casita bond issue, and has attracted additional investors. Like Su Casita, other SOFOLs in housing finance are still heavily dependent on FOVI. Su Casita is one of the SOFOLs that has approached IFC for alternative market-based financing. IFC continues to look to extend its support to others in the sector. 65. Microfinance. Commercially oriented microfinance institutions (MFIs) are also important financial intermediaries in private sector development in Mexico. They are particularly important in terms of employment generation, their reach to the urban and rural poor, and their substantial developmental impact for a relatively small amount of investment for international financial institutions. IFC has invested in Mexico's leading MFI, Compartamos, and the initial results are very encouraging (Box 2). IFC will continue to support microenterprises through this investment and possible new opportunities in the microfinance sector. It will also look to projects that reach out to lower-income groups through other means, as it has done with Coppel (fiscal 2002 approval), a medium-sized retail chain that also provides consumer finance for its low-income customers. 94 Annex B1O Box 2. Financiera Compartamos Financiera Compartamos is a regulated, for-profit entity, incorporated in December 2000 to take over the microlending operations and portfolio of a Mexican non-governmental organization (NGO). In April 2001, IFC made a US$660,000 equity investment for 10 percent of the shares of Compartamos, and a five-year, US$1 million loan to the company. By September 2001, Compartamos grew to having over 82,000 clients and a loan portfolio of US$19 million equivalent. The average loan to the borrowers is currently US$240, underscoring Compartamos' penetration of the low-income strata of Mexico's population. Compartamos operates 34 branches in 11 Mexican states, including the underprivileged states of Oaxaca and Chiapas, and 3 branches in metropolitan Mexico City. Compartamos' shareholders include Compartamos AC, an investment vehicle of the original NGO; individual Mexican investors; Accion; Profund; and IFC. USAID and CGAP have provided funding and technical assistance to Compartamos. Through its seat on the nine-member board of directors, IFC is expanding its knowledge of the field and sharing best financial and corporate practices. IFC is also helping establish a new environmental management system for microfinance. (2) Enhancing international competitiveness of the private sector 66. This covers a broad range of IFC activity: (a) Backing companies that strengthen Mexico's international competitiveness and generate growth and employment (b) Agribusiness, to foster rural development (c) Investing in physical infrastructure that improves competitiveness. 67. Backing companies that strengthen competitiveness. IFC continues to support firms that lack access to long-term financing, are likely to create employment, and are investing to improve international competitiveness. IFC will consider direct financing support for these second-tier and middle-sized firms, which are important contributors to growth. Mexico has a large pool of these firms that are fundamentally creditworthy, but lack access to investment financing. Under the current economic slowdown, these firms are focusing on a limited scope of new investment. IFC will support such investments, and as the economy recovers during the CAS period, support expansion and modernization programs of these firms. IFC's support will also be provided for strengthening their corporate and financial structure. There are a number of firms that are fundamentally good business, but are under the current credit conditions resorting to short-term borrowing, which is not suitable for long-term investment programs. IFC will explore ways to strengthen these firms through long-term financing, restructuring advice, and guidance for corporate governance and management practices. 68. Agribusiness. The development of the agribusiness sector is important for Mexico's broad-based private sector development. Many agricultural activities take place in the rural areas, and are important for poverty reduction in Mexico. There could be many opportunities in this sector in Mexico, in particular activities that could gain competitiveness through reform. IFC will look for opportunities to support the sector by strengthening basic services necessary to its development. It will specifically focus on (a) investments in agricultural logistics (for example, silos, warehouses, cold storages, port facilities); (b) competitive agribusiness enterprises, particularly those with strong linkages to smaller firms and fanners; (c) the promotion of schemes to improve farmer access to pre- and postharvest financing (for example, 95 Annex B 10 warehouse receipts); and (d) the promotion of novel insurance instruments to reduce farmer vulnerability to price and weather risks. 69. Transport and telecommunications. IFC's support will continue to be directed toward the development of a transport system and telecommunications. These infrastructure subsectors play a critical role in enhancing Mexico's competitiveness by providing more efficient services with higher quality. IFC has invested in ports, railways, and roads, and will continue to look for opportunities to support further improvements in transport, in particular, logistics, intermodal facilities, airports, and other modes of private transportation. In telecommunications, including information technology, IFC will pursue projects which would increase competition in the sector, and for which IFC's additionality would be significant. (3) Promoting investments in areas newly opened for private sector participation 70. IFC's activity under this theme will depend on the pace of reform in energy (power, oil, and gas), petrochemicals, water and sanitation, and health and education. There is a large potential for private sector participation in all of these sectors, and adequate reform could present large demand for IFC services. As noted in the diagnosis, the energy sector's investment and financing needs are large, and the sector is likely to benefit substantially from private participation. IFC has already invested in several power generation projects under Mexico's Independent Power Producer (IPP) program, and is expected to provide continued support in this area. Further involvement in the rest of electricity sector will depend on a reform with an adequate incentive framework for private sector participation. The oil, gas, and petrochemicals sectors await further opening for private sector participation. As in the power sector, the potential for private investrnent is very high. IFC will focus on pioneering projects for demonstration effects, as the sector broadens private participation in both production and distribution (including gas distribution, and oil and gas service contracts). In water and sanitation, the extent of private participation will be determined by reform in the tariff structure, and the development of regulations governing private sector participation, particularly at the subnational level. The development of financing mechanisms suitable for this sector is also important, particularly because revenues are denominated in the local currency, and private financing in this sector involves subnational risks. Multilateral institutions, including IFC, have a potential role in providing local currency funding facilities and credit enhancement mechanisms that help subnational governments attract private sector financing. 71. Social sector. IFC expects to continue to expand its activities in this area in Mexico. The development of the social sector is critical for enhancing Mexico's competitiveness and a broad sharing of the benefits of growth. IFC has already provided financing for two projects in this sector-one in education and the other in health care (Box 3). IFC will focus on a wide range of activities in this area, including higher education, vocational schools, distance learning, and private hospitals, medical equipment leasing, medical supplies, and laboratories. 96 Annex B 10 Box 3. IFC Projects in the Social Sector: Hospital ABC and Education Hospital ABC. The American British Cowdray Hospital (Hospital ABC) is a not-for-profit tertiary hospital, with a strong reputation for ethics. The Hospital also provides extensive charity services to the poor in a dedicated clinic and a wide range of in-house training and research programs. In fiscal 2000, IFC provided a US$34 million loan, including a syndication of US$14 million for a project to build a new facility in a growing area of Mexico City (Santa Fe), which focuses primarily on upgrading emergency services and complementing existing operations. The new facility will include a specialized ambulatory care center, 24-hour emergency services, 60 beds for hospitalization, a preventive medicine center, and a welfare clinic. The project is helping Hospital ABC provide quality services to a larger share of a growing population, while containing cost escalation. The project is also supporting an expansion and upgrading of Hospital ABC's welfare clinic that provides healthcare services to poor people (earning less than US$500 per month) who live within a three-mile radius of the Hospital and do not have access to any medical facilities. In 2000, the Hospital performed over 18,000 consultations, 330 surgeries, and 265 hospitalizations under their charity program. Proyecto Educaci6n. This US$27.7 million project involves the first and second stages of a four-stage plan to construct and operate five private schools in the interior of Mexico. IFC investment includes two loans totaling US$9.7 million for the first two stages of the Project. The first stage, to build facilities from preschool through fourth grade at the five schools, will cost an estimnated US$18.6 million. The second stage, to accommodate growth into fifth and sixth grades, is expected to cost an additional US$9.1 million. These two stages are expected to create capacity for 5,200 students from preschool through primary school. The entire four-stage construction plan will provide education through high school for up to 9,000 students. The schools will provide quality bilingual education in five smaller cities of the country, where access to similar affordable education is either scarce or nonexistent. In doing so, it will help alleviate some of the burden on the public system. It is also expected to create employment for approximately 170 teachers, as well as directors and staff. At least 5 percent of the poorest students who enroll in Project schools will receive full scholarships. (4) Promoting sustainable development and good corporate governance 72. In Mexico, IFC will increase its focus on sustainable development and corporate governance. IFC has recently been developing expertise in sustainable development and corporate governance, and is now seen as an international leader in this area. IFC is experiencing greater demand in Mexico, and has already supported two projects in sustainable development (Box 4). These projects have presented opportunities for IFC to demonstrate that sustainable business practices also make a good business case and add value to firms pursuing such practices. IFC expects to continue supporting projects in this area in Mexico. In both environmental sustainability and corporate governance, IFC activity could involve relatively large companies, with which IFC could introduce visible demonstration impact on the Mexican corporate sector. In corporate governance, IFC, along with IBRD, will continue to collaborate with the OECD (for example, corporate governance roundtables) and in other activities that increase awareness of this issue. 97 Annex B IO Box 4. Environmental Sustainability Projects: Ecomex and Puertas Finas Ecomex. Ecomex was founded in 1997 to operate in the Compressed Natural Gas (CNG) conversion and dispensing businesses in the metropolitan area of Mexico City. The company currently runs two CNG dispensing stations and a workshop that offers services for the conversion of vehicles from gasoline to CNG. Ecomex has converted more than 800 microbuses, and its long-term strategy is to expand and further develop its target market to include taxis, buses, and official vehicles. IFC's investment (in fiscal 2001) consisted of a US$8.5 million loan and a US$1.5 million equity investment in 7.5 percent of Ecomex. The project supported by IFC involves the construction of five CNG dispensing stations and the provision of working capital to finance the conversion of microbuses. Due to the high cost of engine conversion and the limited means of most microbus owners, Ecomex fnances the entire cost of conversion and then recovers it by requiring microbus owners to commit to a take-or-pay contract for the purchase of specified quantities of CNG on a monthly basis. The Ecomex project represents a notable example of IFC's efforts to support private sector initiatives with strong sustainable development impact and a good business case. The project provides significant environmental benefits to reduce local air pollution in Mexico City. Ecomex's pioneering work is expected to result in the creation of sustained demand for CNG, and is in line with the Mexican authorities' program for better air quality in the region. Additionally, the innovative financing scheme associated with microbus conversions provides for savings by vehicle owners, which will then be used to replace Mexico City's fleet of old microbuses with a new fleet of more efficient CNG-run buses. Puertas Finas. With a US$13 million loan, IFC is helping Puertas Finas, a local group of companies that produce wood products. The objective of the project is to increase the production capacities of the company's existing door plants and add new plants and retail stores in various locations, restructure some short-term bridge loans, and upgrade environmental facilities at the plants. Puertas Finas has requested certification from the Forest Stewardship Council (FSC) to obtain a Chain of Custody Certification for its operations. Puertas Finas has already obtained more than 70 percent certification from the FSC. Such certification identifies part of Puertas Finas' production as using only woods derived from environmentally sustainable methods. With this certification, the company would be able to access European markets, and to continue supplying to the U.S. and Canadian markets, which are changing their buying policies to purchasing only certified products. IFC is also working with Puertas Finas to strengthen its relationship with the local communities from which the company buys its woods on a long- term basis. Puertas Finas is a traditional family-owned business, and thus IFC is also assisting Puertas Finas in improving governance and management practices. 98 ,,, , Ooo X IBRD 2354 M E X I C O * .2;; . - . - -, - U * . ,, 4 .- 1' x: - - - !-I; I: z 1 -~~~- ~~~ *~~ ~~~ I 1 11x_ A - s \ 0'O *_ d0 * pA 4 -- ~~~~~~~~~~~~~~~~~~~ , ~~~~A N Li I I AP I ~ ~ ~ i: _ . .a .'IOodE _ _ _ 7 ^ 1 \ _ ___- * r r , L, I i r; rl1~~~~~~~~~~~~~~~~ - o' . ] ri':;.o *t S- - --' - "II, , = - ;= - ; -I. , . , r.;|;rz:z i ,. - *~~~~~~~~~~44 ~~~~~~'A CAT CAS 00- ',-,,,- .k -'; 04, _ 0 -- . ;, ,-_ ;, , .04-,~ ~ ~ ~ ~ ~~~~~~~~- , I -.' -" ' - , .tz&if8 -~~ A , I ,;' . ..; ; - - ;A~- ~~~~~~~~~~ ;- ,.,,, i ;^S|-, _- t '" ' .444 r irf ED a-.oF° 1 U/S~~~~~~~~~~~~~~~~~~~~~~~~~~~~1A I7 -4 -.2- ' , .. ' - <,ls. _Q1 -. .. _~ ^~~~~~~~~~~~~~~~~~~~~~~~~.L:.0 1. ,'. 1. *: ' - .01 . ,,., -- - .. ,. tUArEMALAM- . 4 -- . .O . .04._ -K. .... ' . J *~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ I. I :tlir *- FEHONDURAS FEBRUARY 1992