FILE Copy Document of The World Bank FOR OFFICIAL USE ONLY Report No. P-2101-ME REPORT AND RECOMMENDATION OF THE OESIDNTH RETURN To PRESIDENT | REPORTS DESK TO THE WITHIN EXECUTIVE DIRECTORS ONE WEEK ON A PROPOSED LOAN TO NACIONAL FINANCIERA, S.A. WITH THE GUARANTEE OF UNITED MEXICAN STATES FOR AN INTEGRATED RURAL DEVELOPMENT PROJECT PIDER II May 31, 1977 This document has a restricted disribtlm nd may be used by recipients only in the performance of their official duties. Its contents may don erwise be disclosed without World Bank authorization. I jr 7' _ Currency Unit - Peso (Mex$) The Mexican peso is free to float against other currencies; in recent weeks the rate of exchange has fluctuated in the range of Mex$22 to Mex$23 per US dollar. On May 27, 1977 the peso traded at 22.83 per US dollar. GLOSSARY OF ABBREVIATIONS CFE = Federal Electricity Commission CIDER = Research Center for Rural Development CONASUPO National Company for Popular Subsistence FIRA = Agricultural Trust Funds of the Bank of Mexico PEMEX = Petroleos Mexicanos PIDER = Investment Program for Rural Development PRONDAAT National Program for Extension in Rainfed Areas SARE Secretariat: of Agriculture and Water Resources SPP Secretariat of Programming and Budgeting SRA = Secretariat of Agrarian Reform FOR OFFICIAL USE ONLY MEXICO LOAN AND PROJECT SUMMARY Borrower: Nacional Financiera, S.A. Guarantor: United Mexican States Amount: US$120 million equivalent Terms: Payable in 17 years, including 3-1/2 years of grace, at an interest rate of 8.2 percent per annum. Project Description: The project consists of directly productive, productive support and social infrastructure components of a program designed to raise the income and improve the standard of living of poor rural families in 20 selected micro-regions in Mexico. The rural industrial component would also be extended to the 30 micro-regions of the Bank-assisted PIDER I project. The individual project components are summarized below: Directly Productive Components (70% of project) (a) Construction and rehabilitation of small-scale water facilities including pump schemes, storage dams and distribution networks to irrigate about 34,000 ha and to provide for domestic and livestock use; (b) Development of rural industries, including: provision of development credit; technical assistance for rural industries; and training of personnel. The rural industries supported would provide employment to some 6,000 rural dwellers; (c) Development of about 500 livestock units through land clearing, pasture establishment, fencing, and construction of watering and handling facilities; (d) Soil and water conservation, including construction of contour ridges, terraces, checkdams or other conservation works on about 80,000 ha; (e) Pilot fruit production units, including planting of a total of 7,500 ha; (f) Provision of seasonal production credit, and medium- and long-term development credit to enable more effective use of infrastructure facilities; 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. - 11 - (g) Other productive investment, including beekeeping, small stock, forestry and fisheries development. Productive Support Components (20% of project) (a) Construction of about 2,000 km of feeder roads using labor intensive methods to the extent feasible; (b) Installation of electric power distribution systems in 300 villages benefitting about 131,000 persons; (c) Support of a rural marketing program; (d) Organization and training of farmers for greater participation in development programs; (e) Provision of intensive technical assistance packages to promote adoption of improved farming methods; and (f) Assistance for preparing feasibility studies for directly productive investments in each micro-region. Social Infrastructure (9% of project) (a) Installation of water supply systems to serve about 214,000 persons; (b) Construction or renovation and equipping of 1,500 classrooms to accommodate about 60,000 students; (c) Provision of materials and equipment for self-help activities in ejidos and villages, such as housing improvements, and community centers. Monitoring and. Evaluation (1% of project) (a) The Center for Research in Rural Development would carry out project related evaluation and applied research and train PIDER planning and administrative staff. - iii - Estimated Cost: The cost of the project is estimated at US$255.0 million equivalent, with foreign exchange costs of US$46 million. The breakdown of the estimated costs is presented below: -----US$ Million----- Foreign Components Local Foreign Total Exchange I. Directly Productive A. Infrastructure Irrigation 25.4 8.5 33.9 25 Soil and Water Conservation 9.0 1.4 10.4 14 Livestock 14.1 3.5 17.6 20 Fruit, Forestry and Fisheries 8.3 0.9 9.2 10 Rural Industries 3.0 2.0 5.0 40 B. Development Credit Agriculture and Livestock 40.0 10.0 50.0 20 Rural Industries 5.4 3.6 9.0 40 C. Incremental Production Credit 11.7 1.6 13.3 12 Sub-total 116.9 31.5 148.4 21 II. Productive Support Feeder Roads 14.8 1.1 15.9 7 Rural Electrification 5.5 1.8 7.3 25 Farmers' Organization 5.3 0.2 5.5 4 Extension and Field Demonstration 9.4 0.6 10.0 6 Rural Marketing 0.8 - 0.8 0 Feasibility Studies 3.6 - 3.6 0 Sub-total 39.4 3.7 43.1 9 III. Social Infrastructure Education 4.5 0.8 5.3 15 Rural Water Supply 8.2 2.1 10.3 20 Self-Help 3.9 - 3.9 0 Sub-total 16.6 2.9 19.5 15 IV. Evaluation 0.9 0.1 1.0 10 V. Total Baseline Cost 173.8 38.2 212.0 18 Physical Contingencies 10.7 2.4 13.1 Expected Price Increases 24.5 5.4 29.9 VI. Total Project Cost 209.0 46.0 255.0 - iv - Financing Plan: US$ Million % Government 127.8 50 Beneficiaries 7.2 3 Bank 120.0 47 TOTAL 255.0 100 Estimated Disbursements: FY Year-by-Year Cumulative Amount (US$ million) (US$ million) 1978 7.0 7.0 1979 27.0 34.0 1980 48.0 82.0 1981 38.0 120.0 Procurement Arrangements: The following procurement procedures would be applied for civil works and building construction, machinery, equipment, materials and supplies: (i) In order to obtain as much competition in bidding as possible, contracts would be grouped into larger packages, where feasible. (ii) Contracts and purchases exceeding US$250,000 equiv- alent would be awarded under international competi- tive bidding in accordance with Bank Guidelines for Procurement. A preference of up to 15 percent for domestic suppliers would be permitted in evaluation of bids for manufactured items. (iii) Contracts of less than US$250,000 equivalent would be let under local competitive bidding, or as nego- tiated contracts under normal government procedures which are satisfactory, or executed by force account. It is anticipated that because of the decentralized nature of the proposed project, few contracts would be let under international competitive bidding and that because of the competitiveness of local suppliers, few international firms would be attracted to bid. Consulting Services: Provision is made for local consultant services to identify and carry out feasibility studies of productive investments in the micro-regions (1,700 man-months to cost about US$3.6 million). The average cost per man-month of local consul- tant services has been estimated at US$2,100. Economic Rate of Return: Average economic rate of return on the directly productive and productive support components is 23.7 percent. Completion Date: January 31, 1981 Appraisal Report: Report No. 1480a-ME, dated May 31, 1977 Central Projects Staff Agriculture and Rural Development Department INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO NACIONAL FINANCIERA, S.A. WITH THE GUARANTEE OF UNITED MEXICAN STATES FOR AN INTEGRATED RURAL DEVELOPMENT PROJECT -- PIDER II 1. I submit the following report and recommendations on a proposed loan to Nacional Financiera, S.A. with the guarantee of United Mexican States for the equivalent of US$120 million to help finance an integrated rural development project. The loan would have a term of 17 years, including 3-1/2 years of grace with interest at 8.2 percent per annum. PART I - THE ECONOMY 2. Some of the major features of the Mexican economy were analyzed in "An Updating Report on the Economy of Mexico" (1110-ME), distributed to the Executive Directors on March 23, 1976. An economic mission visited Mexico in April-May 1977 and its report is now in preparation. The discussion which follows and the country data sheets contained in Annex I reflect the prelim- inary findings of this mission. Past Performance 3. For most of the three decades preceding the mid-seventies, the Mexican economic system has been outstandingly successful in achieving sus- tained and rapid growth while maintaining stability in prices and the balance of payments. Since 1940, the annual average GDP growth rate has exceeded 6 percent. Inflation averaged less than 5 percent a year from the mid-1950's to 1972, and the dollar value of the peso fixed in 1954 was maintained until the September 1976 devaluation. 4. The Mexican development strategy has relied on a combination of public action and private profit. During most of the last three decades the role of the Government centered upon carrying out direct investments in key industries such as power, steel and petroleum and creating a stable regulatory and institutional framework for private sector growth. This system worked well to achieve rapid growth, but it led to a sharpening of contrasts between classes and among regions. The scope of redistributive policies was neces- sa'rily limited as government revenues remained under ten percent of national income. The Government did play a crucial role in the development of private commercial agriculture (through provision of irrigation and c-redit), in industry (through the provision of infrastructure and protection from imports), and in education. While land redistribution under the reform of 1915 was continued, fiscal resources were insufficient to develop major programs to - 2 - improve the economic status of its beneficiaries. It was not until the 1970's that the Government began to give a high priority to programs and policies directed at a broader distribution of the benefits of growth and, in parti- cular, at the problem of poverty in rural areas. 5. Rapid population growth has made social equity even more difficult to achieve. Population growth in Mexico accelerated steadily from 1930 to 1970, primarily as a result of reduced death rates, reaching 3.4 percent per annum in 1970. It has since declined to about 3.2 percent per annum (unoffi- cial estimates for 1976) as birth rates have begun to decline. The rate at which Mexico's population is growing is still one of the highest in the world, however, and presents a formidable challenge for socio-economic development. The most rapid rates of natural increase are in rural areas. In spite of rapid and sustained economic growth, the high demographic growth rate made adequate absorption of the labor force in productive employment difficult. It is estimated that 40 percent of the labor force was, and still is, either engaged in marginal occupations, relatively unproductive and hence poorly paid, or openly unemployed. 6. Income distribution in Mexico is uneven. The estimated share of the poorest 20 percent of Mexican families in total national disposable income was only 2.1 percent in 1975, while the upper 20 percent received 60.2 percent --a ratio of almost 30 to one. Most of the very poor are in rural areas. Estimates for 1975 show that families headed by hired agricultural laborers have incomes averaging 45 percent below the national average while families headed by self-employed agricultural workers earned an average of 35 percent less than the national average; these two groups together account for 31 percent of all families in the nation. 7. The Echeverria Government (1971-1976) attempted to combine past growth policies with several major institutional reform measures. For rural Mexico these included a revised Agrarian Reform Law (1971) and a new Federal Water Law (1972), both of which were intended to promote a more equitable distribution of basic agricultural resources. These measures were complemen- ted by increases in the availability of credit to low-income farmers and the maintenance of more remunerative support prices for basic foodcrops. The Government also increased outlays for agricultural research, training and extension services, paying particular attention to the needs of small farmers. One of the most significant innovations was the new PIDER program f or integ- rated rural development, begun in 1973, with which the Bank has been associated from an early stage with a loan of US$110 million in May 1975 (Loan 1110-ME) and a second loan now under consideration. Urban-industrial development was also promoted by heavy public investment in basic industries--petroleum, chemicals and steel being outstanding examples--and an innovative workers' housing program. 8. Recognizing the implications of Mexico's demographic trends, the authorities initiated a national family planning program in 1972 with the objective of reducing f ertility rates and improving the health standards of families. Government health agencies have steadily expanded their services, - 3 - and the number of family planning acceptors rose from 900,000 in 1973 to 1.7 million in 1976. However, most new acceptors have come from urban areas; coverage rates of 45 percent were achieved in cities as compared to only 5 percent in rural areas. The new Government has indicated its intention to intensify family planning efforts. The President's declared goal is to reduce population growth to 2.6 percent by the end of 1982. 9. In its efforts to improve both the country's productive base and the living conditions of lower-income groups, the Government doubled public sector expenditures in real terms over the period 1970-1976. Government revenues were also substantially increased, but not enough to compensate for the in- crease in expenditures, and the difference had to be financed by internal and external borrowing. These policies, together with frequent wage increases in excess of productivity gains (especially since 1974) led to high inflation. The inflation, when combined with the fixed parity of the peso, led to rapidly increasing balance of payments deficits on current account. Growing inflation, rising labor costs, preemption of credit for financing rapidly growing public expenditures, and some Government pronouncements that were interpreted as inimical to private entrepreneurship led to a virtual stagnation of private sector fixed investment, a reduction in deposits of savings in financial inter- mediaries and related speculative behavior by domestic savers. The rate of growth of GDP slowed from an annual average of 6.8 percent during 1965-1970 to about 5.0 percent during 1971-1976, dropping to 2 percent in 1976--the lowest growth rate experienced by Mexico since the mid-thirties--implying a decline in terms of per capita income. 10. The short-run disequilibria affecting the country at the end of 1975 and the accompanying social and labor unrest and loss of confidence built up strong devaluationary expectations which in turn led to large capital outflows during 1976. Under these circumstances, on September 1, 1976 the authorities abandoned the fixed exchange rate of 12.50 pesos per dollar which had prevailed since 1954 and let the peso float. After some sizable fluctua- tions before the inauguration of the new Administration in December, the peso has remained rather stable at rates fluctuating between 21 and 23 pesos per dollar. 11. Following the devaluations, Mexico obtained major support from the IMF. In the last quarter of 1976, Mexico was able to draw on the Fund for US$480 million. For 1977-79, an Extended Fund Facility accompanied by a com- prehensive three-year stabilization program has been negotiated, which could provide as much as an additional US$861 million once the increase in Fund quotas becomes effective. Thus, total IMF support for the Government's program may exceed US$1.3 billion. The new Government ratified the agreement with the IMF shortly after taking office on December 1, 1976. Current Economic Policy 12. The present Government inherited a difficult situation upon taking office last December. Many factors indicated a need for economic stabiliza- tion. Inflation, fed by high public sector deficits, large wage increases, -4- and finally the devaluation of around 80 percent was rising faster than at any time in Mexico's recent history--at an annual rate of 57 percent in the three months after the devaluation; moreover, a large amount of private capital had left the country in 1976. Foreign borrowings, which had grown rapidly to make up for reduced domestic savings and to finance the growing public sector deficits, had left Mexico's public sector with a foreign debt of some US$20 billion (including short-term debt). On the other hand, the situation also called for more expansionary policies; economic activity had slowed down, net private investment was virtually nil, and the gap between new job creation and growth of the labor force was increasing. High world prices for petroleum and related products offered profitable investment opportunities in the petroleum and petrochemicals sectors; indeed, increased production for export of these products seemed by far the best way to meet a large part of Mexico's high debt service requirements in the coming years. 13. Faced with these conflicting needs, the Mexican authorities are adopting a mixed strategy aimed at reducing lower-priority public expen- ditures and increasing public revenues, while proceeding with petroleum and other high-priority investments. The objectives of the Government's program include progressive control of inflation--the target is to reduce it to inter- national levels no later than the end of 1979--together with a return to historic high rates of economic growth by the end of 1978. Better management of public sector expenditures, more rational pricing and cost control in public sector enterprises, promotion of private savings, limiting wage in- creases to justifiable levels, and more effective cooperation with the private sector are other important parts of the Government's economic strategy. 14. With only a few weeks in which to submit its budget for 1977, the Government made only slight modifications in the proposals prepared by the outgoing Administration. However, the President formally instructed his Cabinet to regard budgeted spending levels as ceilings. Any new expenditure authorizations, limited to projects carrying the highest priority, would have to be accommodated by reducing expenditures on lower priority projects. The only exception to this compensation requirement is the investment program of PEMEX, the state-owned petroleum company, which is to be increased by Mex$20 billion above the initially approved budgetary allocation of Mex$30 billion to realize a rapid increase in production and exports of petroleum and products (see para 22). However, it is planned to finance these additional expenditures through a combination of additional external borrowing and increases in revenues. 15. With effective implementation of the above-mentioned decisions, the Government would be able to contain total expenditures broadly within the budget ceilings; this would represent a major break with the past few years, when actual public sector expenditures averaged about 20 percent higher than initially budgeted. Moreover, to increase public revenue, the tax base has been broadened and the prices of some goods and services produced by the public sector have recently been increased (examples: power rates went up by 52%, petroleum product prices increased by 25%, steel by 15%, fertilizers by -5- 25%, telephone rates by 30%). The Government also expects that delays in the execution of the budget to be expected during the first year of a new Administration will result in a spending shortfall of about 5 percent of budgeted expenditures. The net effect of these measures (expenditure restraint and revenue increases) would be to reduce public sector net borrowing require- ments from the original budget figure of 8 percent to an estimated 6 percent of expected GDP. (In comparison, in 1976, public sector net borrowing require- ments were about 9 percent of GDP. 1/) 16. Other measures taken by the new Administration include: A far-reaching administrative reform, including a new law giving the Treasury more effective control over public sector external borrowings, another law to improve and modernize the budgetary process and to centralize it under the new Secretariat of Programming and Budgeting, and the centralization of direction of government programs related directly to production activities in two ministries, the Secretariat of Agriculture and Water Resources and the Secretariat of National Property and Industry. An increase of only 10 percent in the annual minimum wage review in January 1977, which is widely considered as a demonstration of the serious nature of the Government's intentions to stabilize prices, and its support from labor. An excess profits tax. Price, production, and investment agreements with the private sector to encourage domestic production of wage goods at low prices and to promote private investment of about Mex$100 billion during the next several years. A set of measures aimed at inducing a recovery of financial savings and intermediation, in order to relieve the extremely tight credit situation affecting the private sector. Reserve requirements were modified so as to increase the lending to the private sector; interest rates on term deposits are to be allowed to increase gradually so as to better reflect market conditions; new limits were imposed on the liabilities and assets of the banking system so as to increase its stability and independence and to avoid undue concentration of credit, and new financial assets were created in the form of an issue of Mex$2.0 billion of "Petrobonds" (indexed to the peso equivalent of the international price of petroleum). 1/ These figures do not include the deficit of public financial intermed- iaries. The contrast in fiscal policies between 1976 and the 1977 program is somewhat greater than these figures indicate because of the effect of the devaluation in increasing the deficit in 1977. -6- For balance of payments management, the most important measure is the more realistic exchange rate now in effect. Strong government support of tourism development, as well as the restoration of normal export incentives for manufactures, should help increase exports even more; the Government's intended review of the import licensing system and move towards more reliance on tariffs rather than on quantitative restric- tions in controlling imports would increase efficiency in domestic production as well as provide a further spur to exports. Prospects 17. The measures instituted in recent months, as well as some fortuitous events, have already produced good results. Inflation in the first three months of 1977 slowed to an average rate of 2.2 percent per month, as compared to 4.0 percent per month in the last three months of 1976. The deficit in the current account of the balance of payments has fallen drastically (US$245 million in January-March 1977, as compared to US$666 million in the same period of 1976), owing both to reduced imports (in turn caused by reduced economic activity) and to increased exports of petroleum and manufactures as well as higher earnings from export of food crops such as tomatoes, cotton and coffee. For the entire year the current account deficit is estimated at US$2.4 billion, compared to US$3.4 billion in 1976. Mobilization of resources by the banking system increased considerably in the first quarter of 1977, signalling the return of part of the previous year's withdrawals. Perhaps most importantly, there is a general feeling of increased confidence in the Government's economic policy. 18. Nevertheless, 1977 will inevitably be a year of transition. The public sector deficit, while lower, will still be high; inflationary pressures will continue, and debt service (equivalent to 37 percent of exports in 1976) will be a heavy burden. To return to economic growth and price stability will require continued progress in the directions already taken by the Government: public savings must be increased still further through control of expenditures, tax reform, and increased prices for public goods and services; additional domestic savings must be captured by realistic interest rates and otherwise attractive financial assets; balance of payments control requires maintenance of the current realistic exchange rate in real terms, as well as adequate export incentives; efficient growth also depends on increased efficiency and productivity of public spending. 19. In the longer run the prospects for resumption of economic growth with relative price stability are good. Mexico's historically strong economic potential has been further strengthened in recent years by the large invest- ments in agriculture, petroleum, petrochemicals, electricity, steel, and basic infrastructure. - 7 - 20. In agriculture, the large investments in irrigation, recent revision of the structure of support prices, the new Administration's stated intention to emphasize smaller irrigation and drainage projects over the next few years, and the more realistic exchange rate, all promise a resumption of growth of production for both domestic and export markets. 21. Industry has potential for considerable growth in many sectors, including efficient import substitution in chemicals, petrochemicals and capital goods as well as exports of many different manufactured products. 22. An outstanding example of the benefits of recent public sector in- vestments are the new possibilities opened to the Mexican economy through the recent discoveries of rich petroleum fields. Proven oil reserves are esti- mated to be at least 11 billion barrels, which gives a production/reserve ratio (computed at the 1977 production rate) of more than 30 years. On the basis of these known reserves and PEMEX plans, production of petroleum could grow at an average annual rate of 19 percent between 1977 and 1982, reaching 2.2 million barrels per day in 1982 (1976 production was 0.8 million barrels per day); exports could increase at an annual average rate of almost 50 per- cent over the period, reaching 1.1 million barrels per day in 1982, the equiv- alent of US$7.8 billion per annum in projected 1982 prices. 23. The prospect of rapidly rising petroleum exports has greatly streng- thened the balance of payments outlook. Increases in tourism earnings, recovery of agricultral exports, and resumption of growth of manufactured exports are also expected. Thus, even on the basis of somewhat more conserva- tive projections of petroleum production and exports than those mentioned above (see Annex I), the current account deficit can be expected to decline steadily over the next several years, thus reducing Mexico's net external borrowing requirements. The debt service ratio is expected to continue to rise over the next year or two and then to decline sharply to levels around 20 percent in the early 1980's. 24. Thus, Mexico remains creditworthy for borrowing on conventional terms because of its medium- and long-term potential and the Government's decision to adopt the comprehensive gradual stabilization program mentioned above. The Bank currently holds about 8 percent of total medium- and long-term public debt, and this ratio is not likely to increase in the next few years. PART II - BANK GROUP OPERATIONS IN MEXICO Bank Operations 25. As of April 30, 1977, Mexico had received 46 loans from the Bank amounting to US$2,512.7 million net of cancellations and terminations; of these, 28 loans totalling US$1,286.7 million were fully disbursed. As of April 30, 1977, the Bank held US$2,065.3 million of which US$799.8 million had not yet been disbursed. Some 35 percent of Bank lending has been for agricul- ture and rural development (14 loans for US$903.7 million), 27 percent for power (12 loans for US$704.8 million) and 21 percent for transportation - 8 - projects (12 loans for US$546.7 million); the remaining 17 percent has been for industry (US$205.5 million), water supply (US$130 million) and tourism (US$22 million) projects. The implementation of several projects fell behind schedule during 1976 and 1977 mainly as a result of a scarcity of counterpart funds. Annex II contains a summary statement of Bank loans as of April 30, 1977 and notes on the execution of on-going projects. 26. Bank lending was active in FY75 with four loans totalling US$360 million, and in FY76 with four loans totalling US$315 million. In July 1976 the Executive Directors approved a US$95 million loan for a second steel project but, as stated in a memorandum distributed to the Executive Directors on April 5, 1977 (SecM77-258), the new Mexican Administration has reconsidered its investment program for the immediate post-devaluation years and decided to concentrate a greater share of its investment resources in fields which have a rapid impact on output and foreign exchange earnings; considering the magni- tude and long gestation period of the second steel project, the Government has decided to postpone it sine die, and the loan was consequently terminated on April 15, 1977. The Executive Directors approved a US$42 million loan for a tourism project in May 1977. IFC Operations 27. As of April 30, 1977, IFC had made 13 investment commitments in Mexico, for a total of US$69.1 million, of which US$37.4 million had been sold, repaid or cancelled. The balance held by the Corporation, US$31.7 mil- lion, consists of US$27.2 million in loans and US$4.5 million in equity. A summary statement of IFC investments as of April 30, 1977 is presented in Annex II. Bank Strategy 28. The main objectives of Bank lending in Mexico have been to: (i) support policies and programs leading to a wider distribution of the benefits of economic growth; (ii) strengthen policies and programs leading to continued economic growth, by helping to finance projects that are to make directly or indirectly significant contributions to output, exports, and employment; (iii) help resolve critical adjustment problems induced by Mexico's continued economic growth; and (iv) complement Mexico's domestic savings by helping to finance economic and social investments in a framework of internal and external financial stability. In the coming years, the Bank will preferen- tially support projects that make relatively modest demands on budgetary resources and have a strong positive balance of payments effect, and projects of high social priority that improve living standards, attain higher levels of employment and help to decentralize economic activity. 29. For the time being, Mexico's budgetary stringency and heavy external debt burden, together with its need to concentrate an important part of its investment program in social sectors with a low foreign expenditure component, makes the availability of sufficient freely disposable foreign exchange parti- cularly important. To this end, the Government is borrowing heavily from financial intermediaries on a non-project basis. In addition it expects -9- project financing agencies to finance reasonable proportions of the total cost of projects, even if this involves a certain amount of local expenditure financing as it is likely to be needed in some of the highest priority social sectors. Given the special circumstances of Mexico at this time, this seems a reasonable approach. 30. In view of the difficult structural problems of Mexico's agricul- ture and the sector's crucial importance to the country's further develop- ment, the Bank has made agriculture the leading sector for its lending. Consistent with the overall framework of country and sector objectives, a three-tier approach has been developed. First, to strengthen irrigation and agricultural credit programs so as to meet the demands of a rapidly growing population more adequately and to generate the foreign exchange needed for rising import requirements. Second, to raise the incomes of the rural poor and improve their standards of living through a combination of directly productive, productive support and social infrastructure investments. Third, to strengthen Mexico's institutional capability to use scarce agricultural resources more efficiently. 31. Bank lending for industry has been aimed at assisting the Govern- ment's efforts to reduce the balance of payments deficit and decentralize industrial activities away from the major (and increasingly congested) urban areas. Thus, the Executive Directors approved a Second Industrial Equipment Fund Loan in FY76 for US$50 million, aimed at financing industrial projects with a positive effect on the balance of payments; a US$50 million loan made in FY75 to support a fertilizer project is promoting new poles of development in the resource-rich southeast region and the north central area and will help make Mexico independent of imported urea fertilizer in the medium term. 32. As regards infrastructure, the Bank's operations have been focused on investments in key areas of the country as well as on institutional reforms and sector policies aiming, inter alia, at suitable pricing mechanisms to help generate additional resources for investment financing. For example, the Airports Development Project (FY74) of US$25 million was designed in support of the Government's policy of regional integration; the railway loan (FY76) of US$100 million supported improvements of institutional aspects and financial management of the sector. The Mexico City Water Supply Project (FY73) of US$90 million has been instrumental in the establishment of a specialized institution for efficient management of water resources in the Mexico Valley, and in the pricing of water at levels more closely related to costs; a follow-up project is now being prepared. 33. The new Administration is currently preparing a comprehensive *investment program covering its six years of office (1977-1982) and, pending finalization of its development program, has announced its decision to con- centrate the bulk of its investment resources in fields which have a rapid impact on output and foreign exchange earnings, such as agriculture, petro- leum and tourism. It also plans to carry out programs of high social priority to improve health standards, to obtain high levels of employment and to con- tinue to decentralize economic activity. The Government also wishes to support a substantial expansion of private investment in priority industries and in tourism. In consultation with the Government, the Bank is working on several - 10 - projects that meet these criteria. The Bank's support to Mexico's development effort would give high priority to: (a) projects requiring a minimum of counterpart funds from the budget, e.g., lines of credits to private entrepre- neurs in industry, agriculture and tourism; (b) projects in the designated priority areas (e.g. agriculture, energy, petrochemicals, water supply, regional dispersion of economic activities) where budget support during the stabilization period would be assured. More specifically, the following projects are under active consideration: (i) a family planning project was prepared in accordance with the wishes of the previous Administration. The new Government, while implementing a comprehensive program with its own resources, is now considering whether to seek active association of an international institution for a substantial expansion of the program into rural areas; (ii) a project to develop the conurbation zone of Lazaro Cardenas into a growth pole, thereby reducing migration from the Balsas basin to Mexico City has been appraised, and may be ready for submission to the Executive Directors in the coming months if the new Government's present review of the project reaches a favorable conclusion; (iii) a tourism credit project in support of private investment in hotels and ancillary facilities is presently under appraisal; (iv) credit projects to support agriculture and livestock development, and for export oriented and efficient import substitution industries are in preparation; (v) a medium and small industry project is under preparation; (vi) in response to the pressing needs of the Mexico City Metropolitan area, a water supply project has been prepared and is due to be appraised in the fall of 1977. The Government proposes to further review with the Bank its borrowing prior- ities on completion of its six-year investment program when the projects listed above will be complemented with such additional ones as are consistent with the objectives stated in paragraph 28 above. PART III - THE RURAL SECTOR 34. Mexico's rural sector is a composite of striking differences. On the one hand, it includes commercial farms under the management of efficient and sophisticated rural entrepreneurs who were decisive, until the late 1960s, in Mexico's success in satisfying the demand of a rapidly growing population - 11 - and in transforming the country from a net importer to a net exporter of agri- cultural products. On the other hand, it comprises a large number of small- holders in subsistence agriculture with small plots in unfavorable ecological conditions. These farmers work by traditional methods, barely participate in the market economy, live in poor social conditions and subsist on a modicum of food production from their farms. 35. More than 21 million people live in Mexico's rural areas. Agricul- ture is by far their most important employment and income source. About 4 million families, representing close to 40 percent of Mexico's labor force, depend on agriculture for their livelihood. They comprise three distinct groups: 1.5 million families living on ejidos, 1/ 1.2 million families living on private farms and about 1.3 million landless families. The number of landless agricultural workers is increasing rapidly, a consequence of limited farm land in relation to an annual rural population growth of 2 percent. It is estimated that 2 million rural families had incomes of less than US$150 per capita in 1974. The income spread, limited employment possibilities and the lack of infrastructure and social services have resulted in massive migration from rural to urban areas. 36. Mexico's efforts to develop its rural areas have featured two major themes in recent decades: growth in agricultural production and consolida- tion of land reform efforts begun following the 1910 revolution. In the period from 1940 to 1965, Mexican agricultural production more than tripled, making its growth rate among the highest in Latin America. In addition, more than half of all arable and pasture lands were distributed to previously land- less families. Income inequalities, however, widened as the economy was unable to provide employment for the poorer sectors of the rural population, particularly those living in rainfed agricultural areas. Per capita rural income in Mexico is one-third of the national average, and the disparity in its distribution--17 percent of the total farm income accrues to 51 percent of farm holders, and at the other extreme 20 percent of income to only 4 percent of farmers--makes the life of the rural poor particularly hard. Since 1967, the growth rate in agricultural production slowed markedly to about 1.8 percent per year despite a continuing increase in internal demand. Mexico has now become an importer of milk powder and dairy stock and, over the last three years, a net importer of basic grains, especially corn. 37. In the early 1970s, the Government began to reassess its rural growth and development strategies. Securing wider participation of the rural population in the market economy became essential for expanding agri- cultural production as well as for improving the income distribution for social stability in the rural areas. The major efforts were undertaken by five groups: (i) The Secretariat of the Presidency (recently restructured as the Secretariat of Programming and Budgeting, SPP) commissioned task forces to develop policies for achieving self-sufficiency in basic grains and for investments to assist the rural poor. These study I/ A form of land tenure based on usufruct. - 12 - groups were later institutionalized as major coordinating entities including PIDER. (ii) The Secretariat of Public Works (recently restructured as Secretariat of Human Settlements and Public Works, SAHOP) initiated a nation-wide program of labor-intensive feeder road construction in 1971. Five years later some 112,000 km of roads had been constructed, giving temporary employment to some 190,000 rural persons. (iii) The Secretariat of Hydraulic Resources (recently merged with Agriculture and renamed Secretariat of Agriculture and Hydraulic Resources, SARH) further extended its major program to develop the irrigation potential of substan- tial numbers of small farmers. The Water Law of 1972 estab- lished a framework for more efficient water resource manage- ment and a more equitable distribution of the benefits of irrigation to small holders. SARH also developed new criteria and administrative systems and adapted technologies for small scale irrigation works. (iv) A new Agrarian Reform Law was passed in 1971. The Secretariat of Agrarian Reform (SRA), created in 1974, undertook a complete review of legislation affecting ejido farming, and revised the procedures for the granting of land titles. (v) Only 15 percent of the farmers received technical assistance of any kind in the past, and few of the small holders had access to institutional credit. Recent Government efforts to correct this situation have been impressive. Specific allocations of credit resources are now reserved in favor of the low-income producers and a comprehensive technological package is being delivered to them through financial institu- tions and through the national rural development program. The Bank of Mexico, operating through its agricultural credit trust funds and following a study of credit systems oriented to small farmers, promulgated new regulations to encourage the banking system to intensify its operations with smaller farmers. Other agencies, such as CONASUPO (food marketing) and CFE (Federal Electricity Commission) also reworked their investment programs to increase assistance to the rural population. 38. To coordinate and focus these efforts in the most needy areas, a new investment program for rural development (PIDER) was developed. Micro- regions, 1/ with a high concentration of the rural poor were chosen and 1/ Micro-regions comprise an average of 50,000 poor persons located in two to seven contiguous rural municipalities within a state. They are selected using criteria that balance poverty levels (per capita incomes averaging below US$100) with potential for income increasing productive activities. - 13 - specific micro-regional investment programs were prepared. A goal was set to develop 100 such regions, and a capital expenditure budget of US$1.2 billion was programmed. By 1977, investment programs were being implemented in 86 micro-regions with a population of some 4 million persons, and expendi- ture in the period 1973-1976 had amounted to US$471 million. These invest- ments cover a variety of activities, principally directly productive and productive support activities, but also including social infrastructure. Over the period 1977-1982 an additional US$700 million of public investment is to be allocated to further develop the micro-region program. Some 5 million rural persons, i.e., about 25 percent of the rural population, are expected to benefit when the program is complete. PIDEk I 39. The Bank made a loan of US$110 million in May 1975 (1110-ME) to assist the integrated rural development program in 30 micro-regions; in late 1975 the Inter-American Development Bank also made a loan of US$40 million to assist 15 micro-regions. The proposed PIDER II project will provide Bank assistance to 20 additional micro-regions, and with the proposed loan the two agencies together will support the program in 65 micro-regions out of the total of 86 operational in the beginning of 1977. 40. To date about US$34 million of the Bank loan has been disbursed and physical progress of the program in the 30 micro-regions is summarized in the table below: (1) (2) (3) (4) Projected Actual Column 3 Development Development in as % of Unit in 3 Years First 2 Years Column 2 Directly Productive Irrigation Ha 30,000 14,349 47.8 Soil and Water Conservation Ha 91,000 28,887 31.7 Fruit Production Ha 9,500 2,778 29.2 Productive Support Feeder Roads Km 1,900 1,773 93.3 Demonstration and Extension No. of Staff 400 709 177.3 Marketing Market/Stores 65 52 80.0 Electrification Persons served 160,000 138,709 86.7 Social Infrastructure Health Center and Posts No. 290 71 24.5 Primary Education Classroom 1,150 960 83.5 Drinking Water Persons Served 170,000 131,313 77.2 - 14 - Productive support and infrastructure investments are nearing completion and provide the necessary base for completion of directly productive investments in accordance with the overall program schedule. Though the overall attain- ment of targets has been satisfactory, the performance has varied consider- ably across micro-regions, states and executing agencies. These variations have resulted from factors such as: (i) the quality and quantity of staff; (ii) the priority given to PIDER by the state and local government; and (iii) government-community relations. In the current phase of project imple- mentation, successful experiences are being extended to the less progressive micro-regions. 41. PIDER has been instrumental in bringing about far-reaching and much needed institutional change. The implementation capacity of the many agencies involved under PIDER has been increased and activities directed towards im- provement in the productivity and living conditions of the rural poor. The program is now well known and is viewed as highly successful both at local and federal governmental levels. As a result of initial PIDER experiences, agen- cies have undergone internal reorganization. For example, the reorganization of the national extension service was initiated in response to PIDER efforts. PIDER has been a vehicle for facilitating the testing and introduction of a variety of new technical packages developed for small farmer applications including: (i) a new extension methodology specifically directed toward rain- fed agriculture (now institutionalized as the National Program for Extension in Rainfed Areas, PRONDAAT) is currently being applied in 15 micro-regions; (ii) improved farm storage, irrigation, pasture development and soil manage- ment techniques in drier areas; and (iii) wider introduction of small stock on project farms. While only two years of an estimated eight-year period to full development have elapsed, in areas where PRONDAAT is in operation, production and income increases are apparent and generally above estimates made when the program was launched. In areas still served by the traditional extension systems, progress is slower -- in many cases the PIDER-supported services represent the first contacts small farmers have had with extension agents. However, generally PIDER has been instrumental in improving the income of small farmers because of- three related factors: (i) investment in irrigation works has brought about immediate production increases, (ii) where techno- logical packages and credit have been effectively delivered production has increased, and (iii) investment in feeder roads has facilitated access to markets. 42. After the initial problems of coordinating the accounts for such a complex operation were resolved and satisfactory procedures established the pace of disbursements began to accelerate. About 30 percent of the loan funds were disbursed during the last year and papers for several further substantial expenditure items are being processed for submission to the Bank. As the table in paragraph 40 shows, the physical progress under PIDER I project is ahead of the loan disbursement. Part of the explanation for slow disbursement lies in the inherent time lag between incurring of the expenditure and sub- mission of accounts for disbursement to the Bank. Moreover, the effect of devaluation has also been to reduce the dollar equivalent of peso expendi- tures. - 15 PART IV - THE PROJECT Background 43. A report, entitled "Rural Development Project--PIDER II" No. 1480a-ME, dated May 31, 1977 is being circulated separately to the Executive Directors. Negotiations took place in Washington, D.C. from May 19 to May 23, 1977. The Mexican negotiating team was led by Mr. Pedro Galicia, Manager, International Operations, Nacional Financiera, S.A. Project Description 44. The project consists of directly productive, productive support and social infrastructure components designed to raise the income and improve the standard of living of poor rural families in 20 selected micro-regions spread throughout Mexico (please see the map attached). When the PIDER I loan was approved, the project description was based on Bank appraisal of 15 micro- regions, with agreed selection criteria for the remaining 15 micro-regions; the Government subsequently submitted satisfactory investment plans fcr the latter group of micro-regions which formed the basis for Bank support. By the time PIDER II project was appraised, investment programs were ready for about 41 additional micro-regions from which 20 were selected on the basis of criteria such as size, poverty level, productive potential and need for infrastructure. Investments in rural industrial development, a new activity under PIDER, would be extended to the 30 micro-regions covered under the Bank-assisted PIDER I project. 45. About 70 percent of the project funds would be channeled into productive investments in livestock, irrigation, rural industries, fruit production, soil and water conservation, and associated farm development credit; 20 percent to productive support investment for the development of feeder roads, markets, extension services, electrification, and farmer organi- zation efforts; 9 percent to investment in social infrastructure, such as construction of primary education and drinking water facilities, and materials for self-help projects on a local initiative basis; and 1% to project evalua- tion, applied research, and training. The COmDiDation of investments contemp- lated for each micro-region has been detailed in individual micro-regional plans. Assurances have been obtained that: (i) investment plans shall be agreed upon by the Guarantor and the Bank, (ii) not less than 70 percent of the total cost of each such investment plan shall be for productive invest- ments, and (iii) the estimated return thereon shall not be less than 10 percent (draft Guarantee Agreement, Section 3.03). Average investment program for a micro-region under PIDER I was US$9.8 million, as compared to US$12.5 million under the proposed project; the higher nominal unit costs under PIDER II are because of the mix of the investment activities and inflation in the interven- ing period. Rural Industries 46. The project would provide about US$14.0 million in support of the development of rural industries. Because this represents a new component, not - 16 - included under PIDER I, the funds would be available for projects both in the 20 micro-regions financed under the proposed project axid in the 30 micro- regions supported under PIDER I. The basic strategy would be: (i) to develop industries for exploitation of natural resources of the micro-region in order to strengthen small-farm and ejido production; and (ii) to finance small-scale village industry to serve local markets and to provide employment at low cost by utilizing intermediate technologies. The strategy would support the new Government's policy for the development of rural industries. The project would finance: (a) Development credit for about 50 rural industries located within the micro-regions and owned by ejidatarios and small farmers. About US$4.3 million of the loan would be utilized as credit for rural industries. (b) Investments in about 300 small scale, labor intensive rural industries (village industries). Such investments would be limited to US$35,000 equivalent per enterprise. The Government is preparing a plan, to be submitted to the Bank before June 30, 1978, for village industries specifying agencies and criteria for eligibility (draft Guarantee Agreement, Sec- tion 3.09). (c) Technical assistance to identify, prepare and assist rural industries as well as to train staff of participating agencies. Technical assistance would comprise: (i) expansion of technical staff and; (ii) financing for preparation of rural industry projects in the micro-regions and for assistance to already established enterprises. Rural Credit 47. Expansion of credit availability to small farmers is an important component of the PIDER project. About US$24 million, or 19 percent of the proposed loan, would be utilized as medium- and long-term credit for on- farm development; in addition about US$24 million of incremental develop- ment credit would be provided by Mexican financial institutions. Seasonal production credit would be provided by Mexican institutions but not re- imbursed from the proposed loan. Development loans would be made on terms identical with those under other Bank-financed credit programs for low income producers, and any changes in terms under such programs would be automatically applied to new lending under the PIDER II project (Schedule to the draft Project Agreement, Paragraph 2). The Government has recently decided to raise the interest rates for agricultural credit by 2 percentage points from 7.6 percent to 9.5 percent and from 9.0 percent to 11.0 percent. The same institutional arrangements would be used under this project as under other Bank-financed agricultural credit programs in Mexico. A group of trust funds (FIRA) under the control of the Bank of Mexico would rediscount loans to project beneficiaries made by private and public lending institutions. 17 - 48. PIDER is designed to provide low income producers in isolated micro-regions with both social and productive infrastructure, as well as increased amounts of technical assistance and production credit. FIRA and PIDER staff have jointly assessed the credit needs of the micro-regions and are currently resolving the organizational problems inherent in operating a sound credit system covering subsistence farmers over such a dispersed area. Unit Costs 49. To prevent investment in works with excessive unit costs or works benefiting only a few families, the following limits would apply: - For irrigation, a ceiling of US$32,000 would be continued for small-scale irrigation projects of 25 ha or less each, with a maximum investment of US$5,000 per family of beneficiaries; a per hectare ceiling of US$2,500 equivalent would be imposed; to be eligible, a family's pre-project net agricultural annual income should not exceed US$2,500 (draft Guarantee Agreement, Section 3.05 (a)); - Installation cost of rural electrification would not exceed US$150 per person (draft Guarantee Agreement, Section 3.14 (a)); - - The Government's contribution for rural water systems would not exceed US$100 per person (draft Guarantee Agreement, Section 3.15 (a)); and - A maximum of US$40 of material and equipment per beneficiary of self-help projects would be provided (draft Guarantee Agreement, Section 3.16 (b)). Organizatior. and Mana&ement 50. The Secretariat of Programming and Budgeting (SPP) would have principal responsibility for execution of the project. Under its direction, the following Government Departments and Agencies would participate: the Secretariats of Agriculture and Water Resources, Finance, Public Works and Human Settlements, Health and Assistance, and Agrarian Reform, Federal Elec- tricity Commission, National Company for Popular Subsistance (CONASUPO), Committee for Administration of the Federal School Construction Program, National Arid Zones Commission, National Indigenous Institute, National Institute for Rural Community Development and Low Cost Housing, the National Rural Credit Bank and the Agricultural Trust Funds (FIRA). 51. The need to coordinate closely the activities of so many independent organizations has led to the formation of a three tier structure described below. The basic philosophy behind this structure is to place appropriate responsibilities at the federal, state and local levels, while encouraging and supporting organization of PIDER beneficiaries and their participation in program formulation and project execution. - 18 - 52. At the federal level, PIDER policy is developed and coordinated through the Directorate of Promotion and Regional Operations of the SPP. This Directorate is supported by a Sub-Directorate of Rural Development (i.e., PIDER) with a staff of some 95 technicians responsible for reviewing invest- ment plans, management operations and monitoring investment. 53. At the state level, coordination of the programs is handled by a Coordinating Committee consisting of the state level directors of the partic- ipating agencies under the chairmanship of the state governor. Actual manage- ment is the responsibility of the new state level SPP representative who is the technical secretary of the State Committee. The SPP representative is assisted by a technical secretariat of professionals including a state level PIDER coordinator and resident coordinators for each of the states' micro- regions who work closely with local elected officials and community leaders. 54. At the local level, the peoples' participation, essential to the implementation of PIDER investments, is achieved through a variety of schemes which depend on the political, social and administrative characteristics of the sector and micro-region. In some cases such programs as feeder roads or small irrigation works have served to launch permanent village committees which then undertake additional PIDER activities. As a rule, SRA field personnel take the lead in organizing communities at the start, involving municipal chiefs, ejido presidents, teachers, or other appropriate persons. These local leaders in turn generate community participation as well as provide an information link to the state-level technical secretariat. 55. Experience to date indicates that the three tier system works satisfactorily and without undue inter-agency friction. The system enables effective two-way communications: the micro-region staff provides to the federal and state-level authorities a more realistic assessment of ejido and village development preferences. While the authority for approval of the overall investment programs remains at the federal level, the responsibility for plan preparation and coordination of the different agencies is taken over increasingly at the state level. Local participation is essential for success of the rural development program and is encouraged by making beneficiaries increasingly aware of the impact of the projects on the community and their role in implementing and operating those facilities. The individual project works are executed by the appropriate public agency, as determined by the central coordinating committee and concurred in by the state committee. Opera- tion and maintenance, other than for larger works, are increasingly being trans- ferred to the benefiting communities. Evaluation 56. The national program has an inbuilt evaluation arrangement to ensure the effectiveness of PIDER. Evaluation is carried out by the Rural Development Research Center (CIDER) which has institutional autonomy from PIDER. CIDER is responsible for evaluating the impact of the rural development program in Mexico; its principal focus is on PIDER, though it has undertaken studies of other related programs also. In addition, CIDER is involved in devising an improved rural investment programming methodology and assisting PIDER in - 19 - its implementation, in undertaking various research efforts, and in the training of PIDER field staff. CIDER's role is to estimate the real benefit to rural communities from rural development efforts, and in addition to measuring yield and income changes, CIDER gives attention to analyzing admin- istrative and structural changes that are required for the program to result in self-sustaining growth. Thus, in addition to economic analysis, CIDER evaluates (i) the effectiveness of institution building under the PIDER investment and service strategy; and (ii) the degree and quality of local participation in programming and execution of the investment program. Improvements 57. While the system as described has worked reasonably satisfactorily, the areas described below are being improved: (i) Interagency coordination between PIDER and FIRA has been improved and formalized through the implementation of an operational agreement between SPP and the Bank of Mexico. Similar agreements have been signed by PIDER with SRA and SARH; (ii) Construction of works would continue to make the maximum possible use of labor-intensive technologies; feeder road construction would be scheduled to provide the minimum interference with agricultural activities (draft Guarantee Agreement, Sections 3.11, 3.12); (iii) Planning would be strengthened by requiring (a) feasibility studies for productive investments (draft Guarantee Agreement, Section 3.10), (b) technical and economic plans for soil and water conservation works (draft Guarantee Agreement, Section 3.07), and (c) for irrigation works, the continuation of SARH's practice of conducting feasibility studies (draft Guarantee Agreement, Section 3.05); (iv) Farmer response to technical assistance has varied across regions, but a clear pattern is evident supporting the effectiveness of the PRONDAAT program. PRONDAAT will be extended to the PIDER II micro-regions by December 31, 1980 (draft Guarantee Agreement, Section 3.13); and (v) Written agreements with beneficiaries to operate and maintain works would be required prior to commencement of construction (draft Guarantee Agreement, Section 3.06). Financing. Beneficiary Contribution and Cost Recovery 58. A breakdown of costs is presented in the Loan and Project Summary. Total project costs are estimated at US$255 million equivalent. The proposed loan would finance 47 percent of project costs and would cover the foreign exchange costs of US$46 million and US$74 million of local expenditures. The balance (US$128 million) would be provided by the Government and by the - 20 - beneficiaries (US$7 million in cash). Beneficiaries would contribute an additional US$40 million worth of material and labor; the value of these non-cash contributions is not included in the US$255 million cost of the project. 59. As explained earlier, Mexico is passing through a difficult stabili- zation program. The Government is engaged in reviewing the fiscal situation with a view to reduce the deficit of the public sector. Along with measures that enable the economy to return to an equilibrium growth path, Mexico faces a major problem of finding gainful employment for the new additions to the rural work force, to stem migration away from the villages and to provide a minimum acceptable nutrition level to the poorest of its people. The national rural development program that the Government is now consolidating is modest with respect to the scope of the problem that exists in Mexican villages even though the demand on its limited fiscal resources is significant in the aggre- gate. 60. The Government's policy is to recover as much as feasible of investments from beneficiaries taking into account the extent to which private benefits are identifiable and beneficiaries have the capacity to repay. Thus, while the Government would aim at substantial recovery of directly productive investments, repayment rates would depend on the income levels of beneficiaries and would be agreed upon in writing with the benefi- ciaries prior to construction (draft Guarantee Agreement, Section 3.06). Although the benefits of this project would go to the rural poor, who will need part of the project-related incremental income to meet subsistence needs, it is estimated that 61% of investments in directly productive activities would be recovered. Further, 6% of productive support services and 11% of the cost of social infrastructure would be recovered. The cost of maintaining and operating directly productive facilities would be borne fully by beneficiaries. They would also be charged the full operating costs for marketing, electricity, drinking water and selfhelp projects, and would contribute to education (draft Guarantee Agreement, Sections 3.14 and 3.15). At full development, the addi- tional fiscal burden for Government would be US$8 million per annum, a small part of which (10 percent) would be offset through additional tax revenues as a result of incremental production and income from the project. Procurement 61. This project includes a diversity of relatively small construction jobs spread over a wide area and at several sites with difficult access. Addi- tionally, many project works are designed to use local materials and will be constructed during agriculturally slack periods with labor intensive methods to maximize benefits to the local population. In these circumstances the procurement procedures summarized below would be applied for civil works, machinery, equipment, material and other supplies: (i) Contracts would be grouped, where feasible, into packages to encourage competition in bidding; - 21 - (ii) All contracts and purchases exceeding US$250,000 equivalent would be awarded under international competitive bidding in accordance with Bank Guidelines. A preference for domestic suppliers of up to 15 percent would be permitted in the evaluation of bids for equipment items; and (iii) All contracts of less than US$250,000 equivalent would be let under local competitive bidding, negotiated contracts or force account, in accordance with Government's regular pro- cedures which are acceptable to the Bank. For such contracts, appropriate unit prices would be pre-established. It is anticipated that because of the decentralized nature of the proposed project, few contracts would be let under international competitive bidding and that because of the competitiveness of local suppliers, few international firms would be attracted to bid. Disbursement 62. The Bank would reimburse at the rate of 51 percent of total expendi- tures for civil works, equipment, vehicles and technical services of agencies participating in the program, against appropriate documentation, and 56 per- cent of the rediscounts of the development credit component administered by FIRA, against certificates of expenditure. As agreed for PIDER I, documenta- tion for the credit component and for civil works by force account would be retained within Mexico and held available for inspection by the Bank during the course of supervision missions. The statements of expenditure, certified by the Secretariat of Finance, would reflect the expenditures made by each agency in each approved micro-region. The loan is expected to be disbursed in four years, 1978 through 1981. Project Risks 63. The project has risks. First, while two-thirds of the micro-regions would be in the higher rainfed areas (over 700 mm annually), the remaining third would be located in areas with less rain where the introduction of irrigation, crop and pasture improvement and water conservation works would be emphasized to reduce farmer risks. Improved field demonstration closely tied with intensified extension efforts would be emphasized under the Project. Assurances have been obtained that the improved extension services (PRONDAAT) would be applied in PIDER II micro-regions (draft Guarantee Agreement, Section 3.13). The operational soundness of this approach has been demonstrated under PIDER I. Secondly, while on average the estimated rates of return at micro- region level embody expectations about final outcomes that are reasonable and realistic, the caliber of local leadership and of staff will bear importantly on these outcomes. It would be unrealistic to suppose that staff and leader- ship quality will be uniform. So, in some regions, expectations may not be fulfilled while in others better than anticipated results may be achieved. However, the PIDER coordinating mechanism has demonstrated a capacity to respond quickly and flexibly to problems of execution, and the CIDER will continue to undertake major evaluation efforts as a basis for ongoing adapta- tion of the program in the light of changing needs and circumstances. More- over, the Project would emphasize responsiveness to local needs, self-help - 22 - activities, creation of users' associations, and the development of local leadership in order to improve the probability that the Project investments and services would eventually lead to a self-sustaining development momentum at the local level. Thirdly, previous efforts to promote rural industries in Mexico have met with mixed success. The PIDER rural industry project will provide extensive technical assistance in organization and management of industries as opposed to merely providing buildings and equipment. Project Impact 64. The project would benefit areas with a total rural population of about 1 million. Beneficiaries targeted for project support have family incomes ranging from US$250 to US$750, placing them in the lower 40% of the national income distribution. Under the proposed project, about 46,000 farm families would benefit from directly productive activities. Some 32,000 farm families (190,000 people) would be expected to achieve a near doubling of income over a period of eight years. The incomes of an additional 14,000 farm families benefiting from the 34,000 ha to be irrigated would be expected to triple from present levels at full development. Some 200,000 people would have access to improved rural infrastructure; about 65,000 man-years of temporary employment and 30,000 permanent jobs would be created. Rural industries supported under the project would provide the equivalent of full- time employment to approximately 4,000 persons. The industry component is an important model for further rural investments to increase job opportunities for the large number of rural unemployed and underemployed. Economic Evaluation 65. The estimated average economic rate of return for the project as a whole is 23.7 percent; this would vary for micro-regions, ranging from 13.2 to 36.5 percent. In computing the rates of return, only the costs and benefits of directly productive and productive support components have been considered. The costs of social investment (10 percent of total project cost) have not been charged against the project, nor have the benefits from improved health and education, social awareness, and community development been credited to it. In calculating the economic cost of labor, shadow prices varying by micro-region from 100% of the minimum government daily wage to 52% were used. The differences reflect mainly the relative uniformity of officially deter- mined wage minima vis-a-vis variations in the minimum supply price of labor, the latter being influenced by severity of rural underemployment. PART V - LEGAL INSTRUMENTS AND AUTHORITY 67. The draft Loan Agreement between the Bank and Nacional Financiera, S. A., the draft Guarantee Agreement between the United Mexican States and the Bank, the draft Project Agreement between the Bank and the Banco de Mexico, S. A., the report of the committee provided for in Article III, Section 4 (iii) of the Articles of Agreement, and the text of a Resolution approving the proposed loan are being distributed to the Executive Directors separately. - 23 - 68. The special conditions of the project are listed in Section II of Annex III. 69. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank. PART VI - RECOMMENDATIONS 70. I recommend that the Executive Directors approve the proposed loan. Robert S. McNamara President By J. Burke Knapp Attachments May 31, 1977 fO 4 p. TABLE 3A MEXICO - SOCIAL INDICAroRS DAoT4 SHEET LANC AREA (THOU KUI2I LAND AREA _THO_ NEXICO REFERENCE COUNTRIES l1970) TOTAL 1912.5 MOST RECENT AGRIC. 948.9 1960 1970 ESTIMATE BRAZIL CHILE sPAINm GNP PER CAPITA (USAI 420o.o 7O.0 1i-o.o 54O.o 40.o 1560.0 _ _--------------- POPULATION AND VITAL STATISTICS POPULATION IMID-YR, MILLIONI 36.0 50.4 60.1 92.8 9.7 33.6 POPULATION DENSITY PER SQUARE KM. 18.0 26.0 30.0 11.0 13.0 67.0 PER SO. KN. AGRICULTURAL LAND 35.0 52.0 63.0 49.o 60_0 105. VITAL STATISTICS AVERAGE BIPTH RATE I/THOUI 46.1 43.8 42.0 38.4 32.9 21.0 AVERAGF DEATH RATE (/THOUI 14.0 i0.2 8.6 9.9 11.0 8.8 INFANT MORTALITY RATE I/THOUI 74.0 68.5 52.0 110.0 79.0 27.9 LIFE EXPECTANCY AT BIRTH IYRS) 56.3 62.4 64.7 59.7 60.6 70.5 GRCSS REPRCcUCTION RATE 3.2 3.1 3.0 2.6 2.2 1.4 POPULATI')N GROWTH RATE R15 TOTAL 3.1 3.4 3.3 2.9 2.4 1.1 URBAN 4.9 4.8 5.1 5.0 3.5 2.0 URBAN POPULATION (K OF TOTAL) 50.7 58.7 63.3 56.0 76.0 59.1 AGE STRUCTURE (PERCENT) 0 TO 14 YEARS 44.2 46.2 46.3 42.0 39.0 27.8 15 TO 64 YEARS 52.1 50.1 50.3 55.0 56.3 62.5 65 YEARS AND OVER 3.7 3.7 3.4 3.0 4.7 9.7 AGE DEPENDENCY RATIO 0.9 1.0 1.0 0.8 0.8 0.6 ECONOMIC DEPENDENCY RATIO 1.7 2.0 1.8 /i 1.5 1.6 1.1 FAMILY PLANNING ACCEPTORS (CUMULATIVE. THOU) .. 55.5 321.1 250.0 403.5 USERS (X OF MARRIED WOMENI .. .. 13.1 1.6 EP'LOYMENT TOTAL LABOR FORCE (THOUSAND) 11300.0 13000.0 16600.0 29600.0 2900.0 11900.0 LABOR FORCE IN AGPICULTURE I) 54.0 I45.o 41.0 44.0 21.0 25 .0 UNEMPLOYED (I OF LABOR FORCEI .. . .. .. 4.1S 1.1 INCCmE DISTRIBUTION X OF PRIVATE INCOME REC*D BY- HIGHEST 5s OF HOUSEHOLDS 28.6 Ia 27.2 30-7 35.0 31.0 HIGHEST 208 OF HOUSEHOLDS 58.1 7 5 £8.1 60.2 62.07& 55.8 LOWEST 20S OF HOUSEHOLOS 3.7 3.4 2.1 3.0 j 4.8 LOWEST 40t OF HOUSEHOLDS 10.S 10 T.7 8.2 10.0 1 13.0 DISTRIBUTION OF LAND OWNERSHIP _ _ -------_-_ - _ _ _ _ _---- _ _ _ s CWNED BY TOP 10% OF OWNERS .. 37.1 .. 45.0 s OWNED RY SMALLEST 10o OWNERS .. 0.3 .. 1.5 HEALTH AND NUTRITION _ _ - --- _ - _ --__------- POPULATION PER PHYSICIAN 1800.0 1480.0 .. 1910.0 2210.0 A 7 40.0 PCPULATION PER NURSING PERSON 2830.0 1620.o /c 3 3220 0 5830.0 POPULATION PER HOSPITAL BED 590.0 960.0 830.0 & 260.0 270.0 220.0 PEP CAPITA SUPPLY OF - CALORIES (K OF REQUIPEMENTS) 107.0 1to.0 115.0 109.0 101.0 107.0 PROTEIN (GRAMS PER DAY) 65.0 65.0 61.0 o4.0 71.0 81.0 -CF WHICH ANIMAL ANO PULSE 29.0 /d 28.0 / *- 39.0 32.0 40.0 DEATH RATE (/THOU) AGES 1-4 12.7 9.8 8.4 .. 3.9 0.9 EDUCATION ADJUSTED ENROLLMENT RATIO PRIMARY SCHOOL 81.0 106.0 107.0 /d 87.0 103.0 131.0 SECONDARy SCHOOL 11.0 23.0 24 0 2 8.0 36.0 57.0 YEARS OF SCHCCLING PROVIDED IFIRST AND SECOND LEVEL) 12.0 12.0 12.0 13.0 12.0 11.0 VOCAT IONAL ENROLLMENT it CF SECONDARYI 24.0 24.0 .. 17.0 33.0 20.0 ADULT LITERACY RATE (X) 62.0 / 76.0 76,0 68.0 90.0 94.0 HOUSING PERSONS PER POOM (AVERAGE) 2.6 2.2 ..1.0 1.3 OCCUPIED CWELLINGS WITHOUT PIPED WATER (K) 76.0 I 61.0 b .. 73.0 2 40.0/c ACCESS TO ELECTRICITY (X OF ALL DWELLINGS) .. 59.0 .. 48.0 RURAL DWELLINGS CONNECTED TO ELECTRICITY 1K) .. 28.0 .. 8.0 CONSUMPTI ON RADIO RECEIVERS (PER THOU POP) 95.0 276.0 311.0 60.0 143.0 214.0 PASSENGER CARS (PER THOU POP) 14.0 24.o 31.0 25.0 18.0 71.0 ELECTRICITY (KWH/YR PER CAP) 313.o 567.0 707.0 491.0 806.0 1634.0 NEWSPRINT (KG/YR PER CAP) 2.8 3.2 2.5 2.7 5.0 5.8 SEE NnTES AND CEFINITIONS ON REVERSE am ades" otfou.l" noted, data for 1960 ret.r to aw yenr betwo. 1959 and 196, for 1970 betwen 1968 and 1970, and for Moat Recent Ratimat. baUteen 1973 and 1975. a am' pwr anita eolat dot 6. ot refisot the a±gudf1mmt d.,eusant of ploe In Asget 1976. dp ain baa boem a"leoted as - objectivn nocntry beomae. it. per natita men.n is bl1.r than Mmdicc' , and bacoum both ncuntriea have in c the isportanne of touxim and tho oianflunc of nearby rich., countries. SMOD US A 19631 t 3holud.. aidwifer7 and euvman amxdlaoi.sj ag 1962i Zg 1961-62, Le Six yews and cverj 4C Inside ~22~ 196J4-66; & Inside onlay /a 3Doleding assistant across. M00T ERXCT ISTflCUSe /a 1973-75 official .etimatej /b 1970-75s /a DAtin of populaticn under 15 and 65 and nove to total labor faresl Li 1n7 /i 1972. RRA= 19Z0 Ai honoical.27 actie poplaUtions & Snapital paomonnlj La Melde inly. 0 2 = AiGyso Sntiagi /b Paweomnal in government s.reiloos-colys /a Inaida only. M2A j,O ALi hplqmnt. offln. aatimtaj A Registered, not all pmoainn in tbo oontry. RB, May 26, 1977 nWVXTIiU O? SOCIAL INICATORS Land Araa (thou- 2 ou.tn . orion Par.o - Popl.tion divided by n0bar of practticig T To- otal SurfaceSr.. c-priolg land aras ad Linlad wetars. male ala radu-te nuea t-ilod" or ea.rtified" nur ..a. aod Astir. -Moat r.'c.t .atisate of agiulua ara od tempOrar ily or p5..- .miliary parnnnl with training or experienc. neatly for rops. p-mcres, arkat & kitohen gardans or to lia failo.. Pou1otiosn Per hoanitl bad - Popultiot divid.d by oisber of hoapita1 hod. evail.bl. in pubLn nod privan S.-ar.I and *p..i.iisad hoapital ond GNP omr -solts (Wi) - GE? per c.pita ..tinat.a at current arkat pricas, hsbbilitation oata:nltd*. m-Iig bin .nd d.t.blainaocta for caloioIted by .m -conerain cathod na World Bank Atlna (1973-75 booLal; oatodi.1 and proacativ care 1960; 1970 and 1975 data, Per canit. sunoly of oalori.a (% of reewirsoaau) - Conptcad frn -negy aq.1-lalet of met food aupplina availabl. in coutry par capit. par day; Populatito sad vital atatistic, ovailabla auppli.a omeprian dmaa tic production * iports len anport., aod Ponulation (sid-y-a nillion) As of July firnt: if not -avelbla, avoraga thins, In atock; oat ..pplino ...lcde .obtal food, aend., quantitia. uaod of two, an-7ar natinatma; 1460, 1970 nod 1975 data, in food proce-ing and loan.. in distribution; roquirnnta waro .ntinntad by YAO b ..d.00 ph- ilnialoda f or --Ina attiviy and health .onad- Populaion d-nit, - oar Os-ar ho - Mid-y-a population p.r squr kilmoart acing a-vc tal taap-.nrtc, body weight., age and non diatrihutioa of (100 notaoa o totl am . ofpo:Pulatio, and n11io.in 101 for wnat. at houahbld imoe. pop1aio h aary-no oar - of nogrio. land - Conptsd a. abowe for frtit uoyfOranfrm arday) - Protnin noatant of par .apita agrituItural land only. net aupply of food pa;rtda,;oat auPPIly of food is dafinad on bwov; roquire- mento for oil ,toutrins eatablinbed by USDA E.cnmi RD.aaarh Sarviens Vitalat1 ntc provid. for a ninian allonanc of 60 er-, of total protein par day. ond Crud. hirtb rota oar thound. ayearna - Anoa lion birth. per ithunand of 20 grin of on1Ina and pal.. p-toint, of which 10 gr-o ObOld ho .ninol nid-y..r popuintion; ten-year -ritboeti. everegn anding in 1960 and 1970. prot.in; thoa stand.rda are Io.ar than thoac of 75 gm of totai p-otein nod fivn-y*ar -vrag. amding in 1975 f or most rmeant extineta. and 23 garm of -nim1 protein an on -oareg for tho ,aorId, propoSod by FAO Cr,,d. death rats par thcuaand. overag. - An-o,a death. par tbouand of mid-year in tho Third WorId Food Survy. population; ton-year aritinasti. vaeragas endtng In 1960 and 1970 and f iv.- Por -Pnit. protein -unoly fran acnhal and pilan - Protein aupply of food oeaeaeading is 1975 for not rooet eatinata. dnrived fran nnnL-1 and pu1... in grina par day. ,lf.ner Soclirrtn fthou) - Annua d.ath. of infant. ond.r 0- y.ar of as. Death rat (/thou) Mon i-4 - An-usl dnatha par thousand in ag. grop 1-4 ,par t= ,aadliv. birtha. year, to children in this nan groop; .ngoosted oasa niao of Lifn as Stme t birt ib fre) - Avr.rnp -br of yenrn of life reasining at tmalurtion. birth; unualy five-year overnag. ending in 1960, 1970 and 1975 for devnloP- ing co,mtri... g~~~~~~~~~~~d-otion. ;roon reord= .io rate - overage nishn of live daghtnre a wo- will hoar Adloated enro1lnentrratio - _rina-, sohool -ifnrollnat of all agee as par- in hor norma reprdctiv. period if eh. epreenprsent ge-ep-ific c-anin. of p64"r acoaepopulation -inodn c hildre nand 6-1l year fertil Ity rain.; moolly fiv-year v.ragoa noding in 1960, 1970 and 1975 but adjuatd for different length. of primay sducation; for cootrina with for develping mam.oieeleducation, anollant nay encood 1001 SI-n-cam pupils..no below Ppopl.tion groth rote M1 - total - Conpcod annua grooth rst.. of mid-year or abowe the offi.in1 school age. population for 1950-60, 1960-70 and 1970-75. Adluwtod an1olnet rstio - ..oondrv School - Conputed Se bhov; -noodar Population gr h rib t MI - urban - Conputed liko growth rate of total education requires nt lacet fou year. of approved prinary itsirution; population; diffemnt d.finitioco of urban am. my affect cnparbility of providon gannrn1, voction-l o- teacher troinig iatruttion. for pupil. dnia n..g to,ottril- of 12 to 17 yearn of age; corepondence courses am ge...rally -acided. Urban onulatibo (-1 of torsi) - Otilo of urben to tota poP.Intion ; difftrent er.o holnnrvedfitadscnd 1llvta Total year. of dfiioaoorban area may nffact Oc"abeility of data Soog counctrin. nodoldg;atfe7t lee,Veati_ intruto may ho partially or 05 trcue nrc )-t ChIdre (0-14 year.), wokblg-eg. (15-64 y.nre), Voctional enrollmet Cl of encondary) - Vocationa i-titictioca, include and rtirnd (65 years an over) as p-atanag of mid-year populattion, technical, idutrial or othr progres hitih oprnte Ind.ped.ntly or as Age doeMdeocy ra tio - Ratio of populatin onder 15 nod 65 and ovr to tboec d.partuanit of ecrondary i-t itutiocan. of age. 15 thro'h hi. -Adlt literacy rote (%) - Lit-rt. adc1t (eble to red end -rit.) a. par- icLonon denondency ratio - Ratio of popultion ondr 15 ond 65 and over to ...ntags of total adult popul.tioc aged 15 years and over. - the labor force in e:gtgroup of 15-64 years. foniiy planning -t tcetoefc live. thou) - Cunlative nunhr of Scepor toui of birth-control device. under aupice of national faniiy plnning prngrem P pen ar roan (urbnn) - Ave- eoag oc brof p-roon per roo In occpied L..c iconpti_o. convenIonal dwellings in urban -rae dwellinge exclude nn-peem-net Femily P-olanm - oe 7 f naried Sae) Pecnan of e ird ""ne of tiructur: ad unoccpied pa-t.. chl-otigae('15-44 yerhpooe li-oto dei, toalere ouid d"ellin. without opipd water (7.) - Oc-pied convetional dw.iiioge aeIt m g group. in urbon and ruro Inmna without imidn or outaid. piped w.tor focilitina ae percetage of all- oupiod dvliing. ftniovoot Acc... to electricity Cl of all, dwelinn) - Conventional doellinga with Total lnhor force (th-oand) - Oconanicaly acti-n parvon, including armd electricity In living quarter. a. percent of total dumIling. torban and forcee and uneplyed hot eolding bhunew1v. stdente, etc..; definition.-. rural a.. Invario co:tirie am nMt canparable. Rura dwellin," cnneted to al1otriclty a7) - Conputed on above for rur.i Labor force In giutr (7.) - Agrioultuca1 labor forc (i forming, forestry, dwellings only. bunting and finbig) an p-arctage of total labor force. Unmaplored (7X of labor force) - Unspioyed em -:uaIIy defined an pr.on who ConnoPtio non able and illing to tak. a Job, out of a Job on a given day, remand out Radio receivers (oar thou pop) - All typon ofreive for radio br.adc.ets of a j ob, and aebing work for a specified ninin period not mncnding on to geeral public per thowo"d of populati"n; -nolde" uIicemed receivere week Say not be canpareble hotwee cotiri.. due to different definition In omntrig, and In yearn whan registration of radio eta yea, in effect; of unplyed and noncom of data, e.g., employmet office atetinLica, .aple datm for recent ynar my not ho anparable Sinc noe.. coutriea aholinhed eu-vye, canpul1oy anmploymet leua .licensig. pa.!ooner cara (oa touo) - Pa...eeger care canprise ootor coca neatiog 10ci dia'trihution - Prerat.go of private bncoo (both in ca.h ond bind) less than aight pomna Inoldee onbulanon, hoareen and military rciebyrichost 51, ribhast 201, pooreat 20X, and pooret 401 of hooae- ehiclon. holds. Elnotri.ity fhkh/yr par cap) - Annua con,aption of iaduatri.1, cnril public and priva te ee-tri.iry In kilonatt bour par -npit., generally Distribution of land menhrip - Percetage. of land opwned by weethibiet 10. booed on prodotion data, ithoutalonc for I-a. in grid. but allow- and poorest 101 of land nanin for luports and emport of el1ctri.icy. Newaorict (kg/yr par cap) - Par capitaS.. anua caunption In kilogrin Re-lt, and Nutrition estimated fran donatic production pin net itport. of noenprint. pom'Iit!io oa heyalian - Population divided by msher of prncticig pbooae ulified fran a medical school at ni-verity level. .40t00> a o a.ooooo 0- aoaooo 0 oat, - 10 .0000 0000 .0.00,0,0.. 00000.000 j oa000 ' i' to o.ICCoOtoo.l0o 000. 0.-.0000C00 H0.OtoO   o o'oao W0 0000000000 ..aro.oo s-i'.. pop..., oOO.0 0. 000 - .00000.0 0.o. 0.O0000 000000 0- 000 0000a00000000000000000 0000.00 0 o <0.0 0 00000 0 00 000.0 -O .0000-00 0 000 0 00 0. 0 *a0000 00 0000. 100. 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' ZUMRIENEL.-CLERA.I.. r COZME © IZUCAR DE MATAMOROS, Puo. LOCATION OF AREAS J I S C 0 \gtIDALOO1 0 l 8 RANID-ERZ . H)A © CALVI LLD JESUS MANIA' AOCTI. O ARASRI GRNDE ' © FRANCISCOSARABIA,Dn. D, Pider II _ ' t'j 10I ( 1(I®' HBUASTECA Hger. QgBxir (a.3( , OUINTANA ROO/ I&CENTRO DR YUCATAN P-Ide ESC'-' ''1'- © NORTEDECQUINTANARODO Other Pider (Not Ior) _EMICHOACAN L XICQ "F I SOTO LA MARINA, Ton. Inter-American Development Bank COLIMA I _ , ,_ LJE8LA C r, "N.4,hz-MTE E C H E MAZAHUA Men. --A . ' C, - ------ State Boundaries \ U E R R E R '° _ A i- BELIZE InternOtional Boundaries rtuit- XA C A ½ - MEXICO - 'N , e H A - RURAL DEVELOPMENT PROJECT-PIDER ' I GUATEMALA ,' / ~~~~HONDURAS 0 100 200 300 400 500 H O KILOMETERS 1 lOp 10I O, .I EL'AA-V.O,