DOCUMENT OF THE WORLD BANK

FOR OFFICIAL USE ONLY

' REPORTNO. 27627-MX

INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT

PROGRAM DOCUMENT

FOR A PROPOSED

PROGRAMMATIC LOAN

IN THE AMOUNT OF US$ 100 MILLION

TO THE

UNITED MEXICAN STATES FOR

AFFORDABLE HOUSING AND URBAN POVERTY

SECTOR ADJUSTMENT LOAN

APRIL 27,2004

FINANCE, PRIVATE SECTOR AND INFRASTRUCTURE MEXICO AND COLOMBIA 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. I t s contents may not be otherwise disclosed without World Bank authorization.

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CURRENCY EQUIVALENTS Currency Unit : Mexican Peso

BANSEFI CAS CBO CENAPRED CNBV CODEVISU CONAFOVI CONAVI COPLADE COPLADEMUN CORRETT

EXCHANGE RATE Dec. 3 1,2000 Mexican $9.59 = US$1 Dec. 31,2001 Mexican $9.13 = US$1 Dec. 31,2002 Mexican $10.27 = U S $ l Dec. 31,2003 Mexican $1 1.25 = US$1

Bank o f National Savings and Financial Services Country Assistance Strategy Congressional Budget Office National Center for Disaster Prevention National Banking and Securities Commission Coordination Agreement for Housing and Land Development National Housing Commission National Council o f Housing Planning Committee for State Government Planning Committee for Municipalities Land Regularization Committee

WEIGHTS AND MEASURES Metric System

EA FDI FONAEVI FONDEN FONHAPO

FISCAL YEAR January 1 - December 31

Environmental Assessment Foreign Direct Investment National Fund for Low-Cost Housing National Fund for Natural Disasters Low-Income Housing Fund

ABBREVIATIONS AND ACRONYMS

FOVI FOVISS STE

Financial Housing Aid Fund Housing Fund for the Social Security Services Institute o f the Public Workers

1 DDS I Direct Demand Subsidies I

Vice President: Country Director: Sector Director: Sector Manager:

David de Ferranti Isabel Guerrero Danny Leipziger John Henry Stein

I Task Team Leader: Anna Wellenstein I Page ii

FOR OFFICIAL USE ONLY

GOM HUSAL

HUTAL

I GDP I Gross Domestic Product I Government o f Mexico Programmatic Affordable Housing and Urban Poverty Sector Adjustment Loan Housing. and Urban Technical Assistance Loan

IBRD IDB INDESOL INFONAVIT LICONS A

International Bank for Reconstruction and Development Inter- American Development Bank National Institute for Social Development Institute for National Housing Fund for Public Workers Industrial Milk ConasuDo

MW

NAFTA NGO OECD

I PROCEDE I Program for Ej ido and Urban Land Regularization

Minimum Wage (1MW= MX $1,20O/month = US$lOS)/month) North American Free Trade Agreement Non-Governmental Organization Organization for Economic CooDeration and DeveloDment

~

PROSAVI SEDESOL Social Development Ministry SHCP

Special Program for Housing Credit and Subsidies

Secretarv o f the Treasurv and Public Credit SHF SOFOLES UDI VIVAH WBI

This document has a restricted distribution and may be used by recipients only in the performance of their official duties. I t s contents may not be otherwise disclosed

' Federal Mortgage Corporation Financing Societies with Limited Purposes Investment Unit Savings and Subsidies Program for Housing World Bank Institute

/without W o r l d Bank authorization. I

TABLE OF CONTENTS PAGE

LOAN AND PROGRAM SUMMARY ................................................................................................................. v

1.

11.

111.

A. B. C. D. E. F. G.

Iv. A. B. C. D. E. F.

V.

VI.

VII.

VIII.

M.

RATIONALE AND OBJECTIVE ........................................................................................................... 1

HISTORICAL CONTEXT ....................................................................................................................... 2

MEXICO’S HOUSING AND URBAN REFORM AGENDA 2001 - 2006 .......................................... 6

NATIONAL HOUSING POLICY AND INSTITUTIONAL FRAMEWORK.. ... ... ... . .. . ..... ... . ..... HOUSING SUBSIDIES. ............................................ 7 HOUSING CREDIT AN URBAN REAL PROPERTY REGISTRIE NATIONAL URBAN POLICY, S L U M UPGRADING AND INSTITUTIONAL STRENGTHENING 14 LOW AND MODERATE INCOME LAND DEVELOPMENT .............................................................. 15 DISASTER PREVENTION AND MANAGEMENT ....

THE PROPOSED LOANS ..................................................................................................................... 17

OBJECTIVES OF THE PROGRAM ... CONTENT OF THE! PROGRAM ........ ..................................................................................... 18 ANALYTICAL UNDERPINNINGS . . . ......... . . . .. . ........ .... . . .... .. ......... CONTENT OF THE LOANS ...... .. . ..... . . ... . . ... . .... . .... . .. . .... . . ..... . .. ......... . . . . .. .... . . . . ..... . ...... . ... . . .. ... . .... . ... . .. . .. . . 18 FINANCIAL ASSISTANCE & INSTITUTIONAL & IMPLEMENTATION ARRANGEMENTS. ... . .. 22 ENVIRONMENT AND RESETTLEMENT ...................................................................................... 23

THE MACROECONOMIC FRAMEWORK FOR THE PROPOSED OPERATION .................... 24

BANK STRATEGY ................................................................................................................................ 25

BENEFITS ............................................................................................................................................... 26

RISKS AND MITIGATION ................................................................................................................... 27

RECOMMENDATIONS ........................................................................................................................ 28

...............

TABLE 1: SUMMARY LEXICON OF AFFORDABLE HOUSING AND URBAN DEVELOPMENT IN MEXICO .............................................................................. .................................................................... 4

TABLE 2: OVERVIEW OF MEXICO HOUSING AND URBAN SECTOR ADJUSTMENT PROGRAM ....... 20 TABLE 3: MEXICO’S MAIN MACROECONOMIC INDICATORS ... . ..... . . ..... . ... . ... . .. . .. .... . .. ... . ... ... ... ... .. . . .. . .. . ... 24

ANNEXES 29

Annex 1 : Policy Matrix Annex 2: Annex 3: Annex 4: Annex 5: Annex 6: Annex 7:

Letter o f Development Policy Environmental and Social Aspects of the HUSAL Mexico - Fund Relations Status o f Bank Group Operations Statement of IFC’s Held and Disbursed Portfolio Mexico at a Glance

29 38 44 48 49 50 52

Page iii

This operation was prepared by a World Bank team composed o f D. Bil ler, T. Campbell, R. Chavez, L. Chiquier, M. Freire, W. Gwinner, M. Hoek-Smit, E. Mosqueira, K. Oleson, C. Piedrafita, P. Pini, M. Sabella, V. Serra, T. Solo, J. Stein, C. Velazco-Weiss. The team was lead by A. Wellenstein and Bruce Ferguson. Peer Reviewers were Christine Kessides, Omar Razzaz, Jan Brzeski, Robert Buckley, and Wi l l i am Cobbett. The team worked under the general guidance of John Henry Stein (Sector Manager), Mar ia Emi l ia Freire (previous Sector Manager), Isabel Guerrero (Country Director), and Danny Leipziger (Sector Director).

Page i v

MEXICO AFFORDABLE HOUSING AND URBAN POVERTY PROGRAMMATIC SECTOR ADJUSTMENT LOAN

LOAN AND PROGRAM SUMMARY

Borrower

Implementing Agency

Poverty Category Amount Terms

Commitment Charge

Front-End Fee

Objectives, description, and benefits

United Mexican States

Secretary of the Treasury and Public Credit

Not Applicable US$ 100 million Standard IBRD Terms

0.85% on undisbursed loan balances for f i rst four years, standard charge o f 0.75% on undisbursed balances thereafter, beginning sixty days after signing, less any waiver.

1% of loan amount

The operation proposed in this Program Document represents the first of a series o f quick disbursing loans to support the Government o f Mexico’s (GoM) low- income housing and urban program. The proposed first Affordable Housing and Urban Poverty Sector Adjustment Loan (HUSAL I) in an amount of US$ 100 mill ion wi l l support initiatives already completed. The second HUSAL of US$ 100 million and third HUSAL o f US$ 200 mill ion wi l l follow 12 and 24 months later, depending on the pace o f reform implementation. A Housing and Urban Technical Assistance Loan (HUTAL) wi l l accompany this three-year adjustment program.

Mexico i s at a critical point in i t s demographic history where affordable housing and related urban development represent crucial challenges for the country’s socio-economic development. Although population growth rates have slowed dramatically, the formation of new families by the “baby boom” o f the 1970s and 1980s wi l l double the number o f total households and the resulting demand for housing and basic services between the years 2000 and 2030 as this group comes of age. The institutions and financial architecture necessary to serve about 60 percent o f families are largely in place. Low and moderate-income families, however generally lack formal-sector support. If this problem goes unaddressed, the resulting informal settlement, lack o f housing, and attendant social, economic, environmental, and health problems w i l l generate enormous private and public costs. The Government has committed to address this critical challenge by doubling formal-sector housing production to 750,000 housings solutions per year by 2006.

This operation furthers this goal in seven key areas, which compose the objectives o f the program:

Page v

Risks

Develop a sound national policy and institutional framework for housing and urban development; Design and put in place a unified housing subsidy policy that facilitates access of low/moderate-income families to housing and leverages household savings and private credit finance; Strengthen the housing credit and savings systems, and move these systems downmarket; Strengthen urban real property registries and rights; Increase the supply o f urban land and access by the poor and improve this market’s function; Coordinate and support physical and social investments to systematically upgrade poor neighborhoods; and Better prevent and manage the impacts o f natural disasters.

The cross-sectoral approach i s relatively ambitious, and -thus- may risk timely approval of the second and third loans. However, the natural synergies and complementarity among these areas require a comprehensive package to be effective. The GoM and the Bank address this risk through a well-designed, integrated strategy and a small number of key prior actions.

The project must also deal with several agencies to achieve the intended reform. The Program deals with this risk by relying on the leadership of the Ministry o f Finance (SHCP) -the key counterpart o f the loan - while worhng closely with the sectoral agencies in charge - CONAFOVI for housing policy, SHF for housing finance, and SEDESOL for urban development.

Net Present Value Not Applicable

Project PO7037 1 Identification Number

Page vi

IBRD PROGRAM DOCUMENT FOR A PROPOSED PROGRAMMATIC LOAN TO THE UNITED MEXICAN STATES FOR

AFFORDABLE HOUSING AND URBAN POVERTY SECTOR ADJUSTMENT

I. RATIONALE AND OBJECTIVE

1. Affordable housing and related urban development represent crucial challenges at this critical point in the Mexico’s demographic and socio-economic development. Population growth rates have decreased a percentage point every twenty years, going from 3% per annum in the 1960s to around 1% in 2002. However, the coming of age of the “baby boom” o f the 1970s and 1980s wi l l accelerate the pace of new household creation, doubling the number of total households and the resulting demand for housing and basic services between the years 2000 and 2030. This demand w i l l increase at even higher rates in cities as the country continues to urbanize. The institutional and financial architecture necessary to serve about two-thirds o f the families i s largely in place. However, low/moderate-income families generally lack formal-sector support. If this problem goes unaddressed, the resulting informal settlements, lack of housing, and attendant social, economic, environmental, and health problems w i l l generate enormous private and public costs. Housing and urban investment also account for around 10% of Mexico’s GDP and the construction sector consistently generates 9% of all employment. Finally, housing i s the main asset o f most families. GoM has responded by giving housing a high priority, setting a bold goal - to double production to match the rate o f new household formation (750,000 housing solutions per annum) - and putting in motion reforms to support housing and land markets, target assistance to the poor, and generate economic growth through housing investment.

2. This operation supports Mexico’s medium-term reform agenda in affordable housing and urban poverty. I t consists of a quick-disbursing loan (US$ 100 million) that w i l l be followed in the second and third years by quick-disbursing loans of an estimated US$ 100 mill ion and US$ 200 million, depending on reform progress. A Technical Assistance Loan w i l l accompany this three-year sector adjustment program in order to support the related policy changes.

3. The program’s overall objective i s to assist the Government’s efforts to improve the l iving conditions and access to real assets of low/moderate-income households. Specifically, the operation supports GoM to: (a) develop a sound national policy and institutional framework for housing and urban development; (b) design and put in place a unified federal housing subsidy system; (c) strengthen the housing credit and savings systems, and move these systems downmarket; (d) strengthen urban real property registries and rights; (e) coordinate physical and social investments to systematically upgrade poor neighborhoods; (f) increase the supply o f urban land and access by the poor and improve this market’s function; and (g) better prevent and manage the impacts o f natural disasters.

4. The program helps Mexico to achieve three objectives o f the CAS discussed by the Board on April 15, 2004: poverty reduction, competitiveness, and environmental sustainability. Most fundamental, the project wi l l improve affordable housing and basic services, and strengthen the real assets o f the poor. In addition, housing often serves as a key source o f capital accumulation and income generation for low/moderate-income households. Improving urban development enhances the efficiency o f cities, which account disproportionately for national economic growth. The project w i l l generate highly positive environmental impacts through upgrading existing slums and promoting formal-sector development on appropriate sites with rational layout.

5. The Government’s Letter of Development Policy (Annex 2) and the multi-year matrix of policy and institutional reforms for the proposed operation and potential subsequent loans (Annex 1) lay out the medium-term reforms supported by this program.

11. HISTORICAL CONTEXT

6. Access to housing and urban services strongly support both economic growth and poverty reduction. Mexico has a robust urban economy. About 66% of the population lives in urban centers and 80% of GDP originates in cities.’ Under previous administrations, many aspects o f housing and urban policy have clashed with attracting investment and reducing poverty. About 40% o f newly formed households (300,000 per year) earn less than 3 minimum wages (below US$ 327 per month) and cannot afford a finished house in a serviced neighborhood. National government has largely lacked the means to reach this group. Most federal programs and policy have, in effect, targeted moderate and higher income households, while financial institutions and developers have yet to reach the low/moderate-income market . 7. As a result, lowlmoderate-income families have mainly resorted to informal settlement and incremental building of their own units over five to fifteen years in order to afford homeownership. When unsupported and unguided by the private and public sector, such development generates enormous public and private costs; in the form of insecure tenure, poor construction, low quality, unhealthy environments, and inadequate and costly service provision. Roughly half o f all new housing production continues to occur informally without support from formal-sector institutions, prejudicing the country’s socio- economic development and these families’ l i fe prospeck2

8. The Government has committed to address this critical problem by doubling production of housing solutions and by promoting a sustainable expansion of the sector. To attain this goal, the administration i s taking measures to reform institutions and policies and to address the key bottlenecks in the sector. These actions include: (i) increase the efficiency and equity o f housing subsidy programs, harmonizing these efforts so that they provide comparable levels o f subvention for similar uses, and coordinating their administration; (ii) expand and diversify market-rate housing credit; and (iii) reform urban development, property rights, and land markets.

9. The operation proposed in this Program Document represents the f irst of a series o f quick disbursing loans to support the Government of Mexico’s (GoM) low-income housing and urban program. The proposed first Affordable Housing and Urban Poverty Sector Adjustment Loan (HUSAL I) in an amount o f US$ 100 million wi l l support initiatives already completed. The second HUSAL of US$ 100 mill ion and third HUSAL of US$ 200 mill ion w i l l follow 12 and 24 months later, depending on the pace of reform implementation. A Housing and Urban Technical Assistance Loan (HUTAL) wi l l accompany this three-year sector adjustment program.

10. Demand for Housing and Urban Services. New household formation - and, hence, demand for new housing and related urban services (basic infrastructure, and land) - runs at about 750,000 houses per year. According to CONAPO (National Population Council) the maturation o f Mexico’s “baby boom” of the 1970s and 1980s wi l l result in a doubling o f demand by the year 2030 by adding 23 mill ion new households to Mexico’s existing 22 mill ion households in the year 2000. About 40% o f this demand (300,000 per year) comes from families earning less than three minimum wages who in general cannot afford to purchase a market-financed commercially-built unit even with significant subvention. In

T h i s refers to the system of urban areas made up o f cities with populations over 15,000. Al l together, these cities account for 68,000,000 inhabitants. * Over the last decade, institutional mortgage finance has financed an average of around 325,000 units annually - roughly half of new household formation o f 750,000 families per year.

Page 2

comparison, current formal housing production financed by an institutional mortgage ran over 500,000 units in 2003.3

11. While rapid new household formation requires expanding new housing and urban services, improving existing homes and communities holds equal importance. Over 80% of Mexicans already have rights to the property in which they live.4 However, a large portion of these homes and attendant urban services and those of the surrounding communities are of poor quality. Approximately 2.5 mill ion houses require major improvements and 1 million need replacement. These less-expensive “housing solutions” cost a fraction o f the purchase of a new commercially-built home5 and - thus - represent the financially- sustainable alternative for most low/moderate-income families. In addition, surveys show that Mexican low-income households - as those in other countries - strongly prefer improving their existing home and their community to moving to a new unit in a social housing development far from work and critical social networks (friends, family - i.e. social capital). For various reasons, improving the existing housing stock and poor neighborhoods - in effect, support o f the progressive building and upgrading process - holds key importance for low-income households.

12. National housing policy and institutional framework. Until the last three years, the federal government lacked an effective vision for reform o f the housing sector. Similarly, the federal agencies involved in housing - FOVI (which has become SHF, and has lead responsibility for development of market-rate housing credit in Mexico), FONHAPO (a federal social housing agency), and INFONAVIT and FOVISSSTE (off-budget provident funds that receive mandatory contributions from, respectively, formally employed private-sector employees and federal-government employees) - operated with neither an overall strategy nor coordination. N o agency existed with responsibility for sector policy.

13. Housing subsidies. Over the last five years, Mexico has launched two small-scale (total funding of US$ 300 million in 2003) housing subsidy programs - Prosavi now operated by SHF (previously by FOVI), and Tu Casa (formerly called “Vivah”) now operated by FONHAPO. These two subsidy programs used wildly different levels and methods o f subvention. Until recently, the Prosavi program transferred a federal subsidy o f approximately US$ 6,000 (in 2002) for purchase o f an expandable unit built by private-sector developers and financed by private-sector financial institutions. In turn, Tu Casa operated by FONHAPO delivered a federal subsidy o f US$ 3,000 (matched by $3,000 from local government) for a core unit developed and financed by state and local housing institutes. These initial on- budget federal housing-subsidy programs have proved useful trials, but can be substantially improved - a pre-requisite for expansion of funding to a level necessary to have an important impact in reaching the government’s goal o f producing 750,000 housing solutions per year as intended. However, until the last three years, no plan or policy agency has existed for building on these subsidy programs to develop a unified national subsidy program - the mechanism that has proved most effective in Latin America.

For 2003, this included approximately: 291,400 units financed by INFONAVIT; 54,300 by SHFBOVI; 68,300 by FOVISSSTE; 23,000 by FONHAPO, and 63,000 by other sources. T h i s production covers new demand and some of the backlog in the above 3 minimum salary income household segment.

About 60% of these homeowners hold full legal title, while 40% have various degrees of para-legal rights to their property. The Mexican homeownership rate of over 80% compares to that of 67% in the US and in Canada, and an average of 61% in 16 Westem European countries.

The least expensive commercially produced unit costs US$ 16,000 and i s affordable only to families earning above five minimum salaries without subsidies. In contrast, major home improvement and/or expansion costs US$2,000 to US$4,000 and i s affordable to households earning 1.5 to 2.0 minimum salaries. Other relatively low-cost housing solutions include construction of a core unit on a lot already owned by a household (US$6,000 to US$ 8,000), and purchase of an existing unit in a low-income settlement (around US$ 10,000).

Page 3

Table 1 - Summary Lexicon of Affordable Housing and Urban Development in Mexico

BANSEFI. Th is federal institution was created in 2001 in order to promote household savings, help popular finance institutions adjust and prosper under the new Law for Popular Savings and Credit that phases in requirements between 2001 and 2004, and coordinate govemment support to financial institutions that focus on serving lowhnoderate-income households (“popular financial institutions”).

CONAFOVI. Formed in 2001. this federal institution - a dependency of SEDESOL that also reports to the President - develops housing policy and coordinates national housing institutions, particularly the federal housing institutions (SHF and FONHAPO), but also INFONAVIT and FOVISSSTE.

CONAVI. Created under the same law as that of CONAFOVI, this organization serves as a forum for public and private-sector input into housing policy and programs. and is managed by and reports to CONAFOVI.

CORETT. A dependency of SEDESOL, this organization has lead responsibility for regularizing informally-urbanized ejidos, and has operated on a massive scale. The process involves purchase of ejido land by the federal government (expropriation), regularizing title. and sale to the existing occupants.

Ejido land. Created by Article 27 of the Mexican Constitution, this form of communal property (often termed “social land”) was intended to protect rural farming communities and i s regulated by a complex set of federal laws and institutions. With urbanization, two-thirds of the land on the fringe of Mexico’s cities now consists of ejidos and constitutes the main source of developable parcels for new housing.

FONHAFW. Historically, this institution has served as the federal govemment’s main support to low-income housing. Poor repayment on below market-rate loans made by FONHAPO to state and local housing institutes that on-lent these funds to low-income households led to th is organization’s near bankruptcy, from which it has now recovered. A presidential decree has given the organization - along with FONAEVI - the mandate to develop a unified housing subsidy system. Currently, FONHAPOs main program is Tu Casa.

FONAEVI. A division of FONHAPO, this entity will receive, account for, and disburse funds under the unified housing subsidy system. and currently performs this function for Tu Casa.

FOVI. FOVI had the mandate to develop market-rate mortgage finance as a second-tier institution until the creation of SHF in 2002, which has assumed this role. FOVI continues as a trust within SHF with a number of specific functions mainly related to covering liabilities created during i t s former lending operation.

FOVISSSTE. This institution gets funding from a compulsory contribution of 5% of the salary of federal public-sector workers. I t then uses these resources to extend mortgage finance for housing at below-market interest rates graduated to favor lower-income households. FOVISSSTE accounts for around 14% of all mortgage finance. In addition to home lending, FOVISSSTE forms part of the pension fund for its contributing workers,

INFONAVIT. Governed by representatives of formally-employed workers, employers, and government, this institution gets funding from a governed compulsory contribution of 5% of the salary of private-sector workers and applies these monies to extend mortgage finance for housing at below. market interest rates graduated to favor lower-income households. INFONAVIT accounts for around 60% o f all mortgage finance. In addition tc home lending, INFONAVIT forms part of the pension system for i ts contributing workers.

Low-income household. A household earning 3 minimum wages (currently US$327 per month) and below

Minimum Wage. A measure used for social programs including housing programs. Currently, one minimum wage i s approximately US$ 109 pel month.

Moderate-income household. A household earning above 3 minimum wages to 6 minimum wages (currently US$ 327 to US$655 per month).

Prosavi. A subsidy program started by FOVI and now operated by SHF that provides an upfront grant (currently, about US$ 5,000). Households earning 4 to 6 minimum wages join this grant with a mortgage loan (currently from SOFOLES that receive their funding from SHF and that channe the Prosavi grant to specific projects) and a downpayment in order to purchase an expandable unit (around 40 m2; price: US$ 13,900) built b) developers.

SEDESOL. The Social Development Ministry holds overall responsibility for government action in urban development.

SHF. Created in 2002 as the successor to FOVI, the Federal Mortgage Society enjoys backing of the faith and credit of federal govemment for 1: years in order to lead the development of primary and secondary market-rate home lending. SHF operates as a second tier-finance institution tha provides liquidity and guarantees to first-tier lenders (currently, mainly the SOFOLES). SHF accounts for around 11% of total mortgage finance.

SOFOLES Hipotecarias. Following the withdrawal o f banks in 1995, these specialized lenders have become Mexico’s main source of private home lending. These institutions can make loans and raise debt on capital markets, but cannot accept deposits from the public.

Tu Casa (formerly “Vivah). A subsidy program operated by FONHAPO that delivers a federal grant (currently about US$3,000) that state and loca governments must match - typically with a serviced lot. The local government contracts the construction of a basic unit (up to 30 m2) that household: earning 2.5 minimum wages and below purchase by making a downpayment and, sometimes, their self-help labor in the construction.

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14. The bulk o f Mexico’s housing subsidies come in the form of below-market interest rates - off- budget subsidies mainly provided by INFONAVIT. In 2000, interest rate subsidies from INFONAVIT amounted to an estimated US$ 2.2 bi l l ion6 INFONAVIT and FOVISSSTE granted the highest subsidies on a per credit basis, near US$9,000 per borrower. Although all formally-employed households pay into these pension funds in principle, the interest-rate subsidies in these housing loans have gone mainly to the moderate-income households that can afford the mortgage payments necessary to purchase a finished, commercially-built unit. As low-income households cannot afford the finished housing financed by these subsidized mortgages, INFONAVIT has served these families far less than higher-income households.

15. Despite some advances in recent years, the credit finance system remains weak relative to other countries at a similar level o f socio-economic development. Outstanding mortgage loans represented 5.2% o f GDP in 2000, compared to over 10% in Colombia and Chile, and 35% to 40% on average for OECD countries. Below-market rate loans for the middle class via the provident funds for federal and private formal-sector employees (FOVISSSTE and INFONAVIT, respectively) s t i l l account for about 75% of all mortgages. The funding method o f INFONAVIT and FOVISSSTE - 5% of formal-sector payroll - has provided the cash flow for considerable housing production, even during times o f economic stagnation or/and instability. However, the heavy subvention embedded in these government loans has crowded out the private sector, hindered the mobilization o f private savings, reduced liquidity in the private housing market, and provided few housing options for low-income households.

Housing credit and household savings.

16. Mexico’s home-credit finance has been characterized by a narrow range of products and, while expanding, has yet to reach a large portion o f the potential market. The mortgage-finance industry focuses on lending for the purchase of new developer-built units affordable to a small share o f moderate- income people accompanied by a substantial subsidy and to the middle class and above at market rates. These mortgage institutions provide virtually no credit for the lower-cost housing solutions suited to the low/moderate-income majority, including home improvement, expansion, a serviced site, and purchase o f low-cost existing unit. Similarly, savings for housing i s quite low. Although those who save do so mainly for housing, 70% of Mexican families lack any type o f relation with a formal-sector financial institution, including a savings account. As a result of low savings, the family contribution necessary to leverage credit and subsidies i s small or missing.

17. The lack o f agreement on basic legal and administrative principles, operational inefficiency, and the antiquated and insecure information systems o f the great bulk o f Mexico’s 32 state property rights registries has helped make real private property ownership difficult and expensive. Widespread insecurity o f tenure and informal ownership has followed as low/moderate-income households opt out o f this costly, cumbersome system.

Urban real property registries and rights.

18. National urban policy, slum upgrading and institutional strengthening. Until recently, slum upgrading has occurred - if at all - in piecemeal fashion, without planning, neighborhood participation, sequencing o f investments, or integration of physical and social improvements. The fragmentation o f these functions within different areas o f SEDESOL - the government ministry in charge o f urban development - also impeded an integrated approach.

19. Low and moderate income land development. The supply o f urban land in Mexico represents a major problem for low/moderate-income households. According to the National Urban Development Program 2001-2006, an estimated 32,000 hectares o f land are currently available for urban use -

The estimate of total subsidies i s based on the net present value o f the implicit interest rate subsidy for the life of all INFONAVIT loans originated in 2000. The implicit interest rate subsidy was estimated as the difference between the rate offered on the mortgage and the conservative estimate o f 7.1% real interest rate on government funds.

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sufficient to meet only two years of demand. Myriad, complex and costly building and subdivision regulations have contributed to making low and moderate-income land development an uneconomic venture for the private sector. The bulk o f residential land development in urban areas occurs informally, at costs far higher than that o f formal-sector development.

20. The difficulties of developing ejido land have exacerbated this problem. About two-thirds o f the land on the periphery of medium and large towns consists o f ejidos, while high-end private-sector developers control most of the remainder. T h i s form o f communal landownership dating from the Mexican Revolution has had a complicated legal regimen that contributes to making private freehold ownership, assembly of parcels of significant size, and rational land development difficult and expensive. Since 1992, ejido lands can be privatized, but the process i s cumbersome and centralized under the federal government. Municipalities must then get the explicit authorization of the federal authorities - which i s often slow in coming - to intervene, raising the cost o f subsequent regularization. Many o f Mexico’s cities show discontinuous spatial patterns as formal development leap-frogs over ejido lands in search o f lower-cost parcels far from cities and employment centers, creating much higher costs for infrastructure provision and congestion (extra traffic, air pollution).

21. These problems have resulted in government provision of virtually all the parcels used in social housing projects, massive government purchase of informally-urbanized ejido land in order to subsequently regularize and transfer title o f these lots to their de-facto occupants, and the accumulation of land reserves by government - often, a problematic process in other countries - for these two other purposes (social housing projects and ejido regularization).

22. Disaster prevention and management. Vulnerable to earthquakes, hurricanes, and other natural disasters, Mexico has, until recently, assisted the victims post-event. In contrast, taking measures to prevent the damage from disasters can avoid immense suffering and cost. In response to the devastation caused by the earthquake of 1985, Mexico began to set aside reserves for emergency reaction and reconstruction after natural disasters. Recently, however, SEDESOL has focused on mitigating the vulnerability o f unplanned poor communities. The f irst step involves assessment based on GIS information. This assessment leads to mapping o f risk hazards and to the development o f mitigation measures and a community emergency plan. SEDESOL intends to take this process a step further by completing risk maps for 60 cities.

111. MEXICO’S HOUSING AND URBAN REFORM AGENDA 2001 - 2006

IMPLICATIONS FOR THE PROGRAM

23.

A.

The Fox administration has responded in each o f these areas:

National Housing Policy and Institutional Framework

24. Strategy and Institutions. The recently formulated National Housing Policy for 2001-2006 state the importance of increasing access o f the poor to shelter. In line with the promises o f President Fox - who gives high priority to housing as a driver o f economic growth and social development - the Government has committed to doubling formal housing production by 2006 (to 750,000 housing solutions per year) through a decentralized and market-based approach. The pillars underlying this Administration’s housing strategy include: (i) targeting lowlmoderate-income households; (ii) a unified system of housing subsidies to be administered by a single agency complemented by credit and savings; (iii) expanding housing finance by putting in place the methods and institutions to develop primary and secondary markets, and by working with financial institutions experienced in serving low/moderate-

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income groups to develop products for financing low-cost housing solutions (improvement, expansion, purchase of existing housing); and (iv) strengthening property rights.

25. Institutionally, the Fox administration has taken bold steps to achieve these national priorities. B y harmonizing and defining the roles of federal housing agencies. CONAFOV17 - a new institution - now coordinates other federal housing agencies (SHF, FONHAPO, and - to some extent - the off-budget autonomous national institutions, INFONAVIT and FOVISSSTE) and defines policy for the sector. CONAVI - also new - serves as a consultative forum o f public and private stakeholders for CONAFOVI. GoM has created a new housing finance institution - SHF - to take the lead in developing market-rate primary and secondary mortgage markets. FONAEVI - a new institution that works in coordination with CONAFOVI and FONHAPO - receives, accounts for, and disburses housing subsidy funds.

26. Decentralized Execution. CONAFOVI has entered into coordination agreements (CODEVISU) with state governments that establish federal housing funding requirements and amounts, and policy goals. These agreements joined with the strengthening o f state housing institutes w i l l contribute to effectively decentralizing housing programs. FONHAPO wi l l assist municipal governments in assessing their needs, inventorying their resources, and developing a request for selected federal support programs best suited to local conditions. Eventually, this system could evolve into a housing block-grant program that flexibly allows a range o f program options and requires a local match - an approach with wide currency i n large federal countries with widely varying regional conditions (e.g. the U.S.).

27. While many aspects o f decentralization and local capacity building extend beyond the scope of this initiative, the HUSAL program supports government in the following measures: (a) FONHAPO wi l l develop models for the administration and programs o f state and local housing institutes; and b) CONAFOVI, SHF and SEDESOL wi l l enhance systems for data-collection and analysis of housing/housing finance and urban planning, to inform local decision-makers (see paragraph 46 for local capacity building efforts in support o f urban policy).

B. Housing Subsidies

28, New Subsidy Proposal. The GOM has committed to standardize federal housing subsidies across i t s previously-fragmented, uncoordinated programs by: (a) conveying comparable amounts for comparable uses; and (b) placing all on-budget federal housing subsidies under the control o f one operating fund, FONAEVI (a division of FONHAPO). The following basic principles w i l l help ensure the consistency o f this system and lay the basis for expansion to more significant scale:

a) Match objectives and instruments. A first step in the creation of a housing subsidy system consists o f defining and balancing objectives. The implicit objectives o f the housing subsidy structure in Mexico consist o f (i) helping low-income households acquire adequate shelter (e.g. Tu Casa); and (ii) teasing private housing development and lending down-market to serve moderate-income households that mainly require this extra purchasing power to afford a basic unit, and to develop financial and real estate markets (e.g. Prosavi). However, these two objectives require explicit definition and clear balancing in a unified subsidy system.

CONAFOVI has formulated a five-year housing policy/strategy for the country and has: (i) assessed housing requirements for different income groups; (ii) established a decentralized and participatory institutional architecture for the housing sector; (iii) formulated a general strategy for the four critical housing supply sectors - land, regulations/taxation, productiodinfrastructure and finance; (iv) prepared proposals for a unified housing subsidy system, and (v) started a well-orchestrated agenda of committee/commission meetings at the federal and state levels.

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b) Eficiency. The efficiency o f housing subsidy programs depends most on three factors: (i) type o f subvention; (b) per-unit amount and choice o f housing solution; and (iii) benefit versus cost.

Direct demand subsidies (“DDS”) have proved the most efficient type o f homeownership subvention for moderate and middle-income households in Latin America. Essentially, DDS are portable vouchers that bridge the gap between the amount households can afford (by joining an affordable mortgage, a downpayment, and the subsidy) and a housing solution. T h i s form o f subvention most effectively stimulates competition among supply agents (developers and financial institutions) and furthers development of the financial sector. Securitization o f accompanying market-rate home credit becomes feasible with DDS, whereas it i s generally unviable when subvention takes the form o f below-market interest rate loans. Once subsidy programs reach a significant size and continuity, they also develop important economies o f scale necessary for systemic improvement o f housing conditions as supply agents increase their knowledge o f and ability to use these programs. However, developers, financial institutions, and other formal-sector institutions (e.g. secondary mortgage markets, insurers, property registries etc.) often find serving low-income groups uneconomic if they have other options even if these families have direct demand subsidies.

Hence, countries with successful low-income subsidy programs have also facilitated supply through policy changes and through programs.* These supply bottlenecks - particularly the lack o f land and credit for low-income households - require direct action (e.g. assistance in development of housing microfinance and low-income housing credit, expanding independent mortgage insurance, reducing land development standards and streamlining the process, etc.)

Provision o f the lowest per-unit subvention feasible for the least costly type o f housing solution appropriate to the family constitutes a second important aspect of efficiency. Third, calculating the costs and benefits of the subsidy types that compose a system provides critical information for the creation of an overall strategy, a key measure o f efficiency, and the fiscal justification for expansion o f a subsidy system.

Mexico has partly met these efficiency criteria, but has considerable distance to go. Prosavi has operated on a small scale as a direct demand subsidy program for moderate income households - those earning up to 5 minimum wages (MW). Also on a minute scale relative to Mexico’s size, V i v a m u Casa has provided both a grant and assistance to supply in order to serve low-income groups -those earning up to 3 minimum salaries.

The experience o f these programs since their inception in 1998-99 provides part o f the basis for ramping up to more significant levels o f funding and impact. However, neither o f these programs has received a comprehensive evaluation nor incorporated important features that make similar programs work well in other countries. The available evidence, however, suggests two lines o f reform.

First, neither Prosavi or Tu Casa effectively address the two most critical supply barriers facing most low/moderate-income families in Mexico: (i) foremost in importance, access to an appropriately located serviced ∧ (ii) second, access to small loans to finance low-cost housing solutions (improvement, expansion, purchase o f a serviced site, etc.) In addition to mandating that local governments provide land to the project as the required match for the federal subsidy - the current approach o f Tu Casa - further efforts are need to improve the function of

~

* Here, direct federal govemment development and finance has generally worked poorly, whereas use o f NGOs and municipalities to organize poor households and get access to a parcel has worked better (Costa Rica).

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land markets. The Mexican Government has taken a first step in addressing this problem under Habitat through support of land reserves for the poor.

Second, the present subsidy level of both Tu Casa (including both federal and local subvention) and Prosavi i s quite high - about US$ 6,000 and US$ 5,000 respectively. Such high per-unit subsidies greatly l imit the reach o f the program. At the funding level o f US$ 300 mill ion per annum, Tu Casa and Prosavi served only about 33,700 households in 2002. In comparison, low- income household formation (a proxy for need) runs at about 300,000 families per annum and moderate-income household formation (a group also frequently unable to access minimally adequate market-rate housing unassisted) at an additional 245,000 per year. As more sustainable modes of housing finance (market-rate credit and household savings) expand, per-unit subsidy amounts should be lowered and favor less costly solutions, such as serviced sites and home improvement, as recommended by Mexico’s official national housing strategy. In addition, i t underlines the importance o f reforming these subsidy programs and quantifying their benefits (relative to their cost) in order to justify increasing the level o f on-budget housing subsidies towards international norms.

In summary, both Prosavi and Tu Casa could operate with a lower level o f subsidy per unit, and could focus more on lower-costs housing solutions for lower-income households than currently.

c) Equity. An equitable housing subsidy system typically has the following characteristics: (i) progressivity or neutrality in targeting o f subsidies to income groups; (ii) delivering comparable subsidy amounts to households in comparable situations; and (iii) regional adjustments for price/cost/income levels and local fiscal capacity.

“Progressivity” means targeting the subsidy system to lower-income families by either delivering more subvention per low-income family or by assigning more total resources to low-income groups. The first alternative - delivering a greater subsidy amount per family to low-income households - has proved difficult and, sometimes, impossible for many reasons. However, at a minimum, an equitable subsidy system assigns more resources to low-income groups, thus meeting the second criterion for progressivity. Taken as a whole, however, Mexico’s current housing subsidy system i s heavily regressive as INFONAVIT - the main source of subsidies - goes largely to moderate and middle-income families that are formally employed.

Mexico has made progress in harmonizing the levels o f subsidies across i t s on-budget programs (Prosavi and Vivah). These programs now deliver roughly comparable levels o f subsidy per family taking into account all sources of subvention. However, Mexico requires development o f regional housing cosdprice indices in order to adjust subsidy levels as well as other parameters to reflect local costlprice variations and fiscal capacity - a task recently begun by SHF and CONAFOVI.

d) Overcoming market and policy failures. In addition to neglecting credit and land bottlenecks, a number o f other market and policy failures hinder the creation o f a national subsidy program. Heavily subsidized lending by local governments as well as FONHAPO undermines development of credit markets for low/moderate-income households. Instead, FONHAPO and local housing institutes could usefully concentrate on the management o f an upfront grant program, rather than a subsidized credit system.

29. GoM i s planning the following reforms to deal with these issues:

4 FONHAPO and States w i l l withdraw from the credit market. Government (SHF) wi l l focus on measures to foster the capacity o f the Cajas de Ahorro y PrCstamo, credit unions, and

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other financial institutions to extend housing credit to low/moderate-income families for a range of low-cost housing solutions.

In tandem, Government (BANSEFI) w i l l develop and expand housing savings programs with the goal of increasing the household contribution that complements the housing subsidy provided by various programs (Tu Casa, Prosavi, INFONAVIT).

INFONAVIT wil l focus i t s subsidies increasingly on low-income households. GoM wi l l eliminate joining subsidy amounts from different programs - such as INFONAVIT and Tu Casa - to reach totals above those mandated for these programs separately (“double dipping”), or adjust the amounts for households receiving different sources o f subvention to correct for double dipping.

Government wil l conduct a comprehensive and coordinated evaluation o f all national subsidy programs, starting with Prosavi and Tu Casa, but also including those of INFONAVIT and FOVISSSTE. This evaluation wi l l include a quantitative analysis of the costs and benefits of these programs, and the fiscal, social, and economic implications of the expansion of Prosavi and Tu Casa once reformed.

Both Prosavi and Tu Casa wi l l be changed to deliver a smaller per-unit subsidy for lower- cost housing solutions for lower-income households, as follows:

For Prosavi: (i) the federal government subsidy per unit w i l l decrease from i t s current level of around $5,000 per unit; (ii) local or state government w i l l be asked to contribute a modest amount in cash or in-kind (e.g. land) to these projects; and (iii) the total amount o f subsidy w i l l be progressive - that is, lower-income households w i l l receive more than higher-income families.

For Tu Casa: (i) the eligible solution w i l l change from the purchase o f a complete finished unit to a serviced lot joined with a small loan to assist the construction o f a basic unit; (ii) the subsidy amount o f both the federal and state/local governments (currently, about U S $3,000 each) wi l l decrease; (iii) local government wi l l facilitate land assembly for developers, NGOs, employers, and others to develop these projects and sell them to families.

A series o f studies w i l l further define the parameters o f the new Prosavi and Tu Casa, the project cycle of these new interventions, and the transition from the current programs to the new ones.

Government wi l l conduct quantitative studies o f the present value of subsidies embedded in INFONAVIT financing.

Capacity building for local governments aimed at dealing with supply constraints in urban land and property rights wi l l help deal with these structural issues unaddressed by housing subsidies.

Housing Credit and Household Savings

The Government views reform of the housing finance system as critical to meeting i t s goals in both the housing and urban sectors. GoM’s program builds on important structural reforms initiated under FOVI and continuing with SHF - the successor o f FOVI - and includes: (i) leveraging market-oriented private resources, mainly through guarantees o f private-sector debt on capital markets and elsewhere, rather than government borrowing directly to provide liquidity; and (ii) improving the efficiency and increasing the capacity o f the existing home lending institutions (banks, SOFOLES, SHF, and the

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provident fundshousing lenders INFONAVIT and FOVISSSTE). measures described in the rest of this section.

Future actions wi l l include the

3 1, Foreclosure and Transparency. All but three states have already modernized their legislation through c iv i l code proceedings on mortgage liens and foreclosure. In some instances, however, foreclosure remains ineffective due to judicial and political resistance. Congress has recently approved a financial transparency law to protect and better inform mortgage borrowers. The next step i s to build confidence o f lenders and investors in the enforceability o f mortgage contracts. The GoM i s moving forward on further judiciary reforms at the national level, including recent passage o f a new guarantee law that allows expedited foreclosure through a trust collateral instrument.

32. Development of secondary mortgage markets, SHF, and SOFOLES. The growth and diversification o f Mexican institutional investors provide ample opportunity for secondary market development.' Since i t s creation in 2001, SHF has successfully advanced the development o f primary and secondary Mexican mortgage markets. I t s contributions include: (i) steady access to long-term priced funding; (ii) revised actuarially-priced first-loss credit insurance products; (iii) improved risk management and pricing (refinancing and guarantees); (iv) consistent rating policy applied to SOFOLES; (v) stimulating access to private bond markets and funding diversification; and (vi) an acceleration in Prosavi execution. Additional key actions to be tackled in the near future with related milestones under the HUSAL program include the following: (i) expand SHF mortgage-related products (refinancing, guarantees) both in UDIs and pesos; (ii) design and expand the use o f products for the credit finance o f low-cost housing solutions such as home improvement, serviced sites, and purchase of existing housing; and (iii) develop rules (property appraisal and disclosure of lending costs) as required by the new financial transparency law.

33. Commercial banks, which had been the main market-rate home lenders, largely withdrew from the mortgage market after large losses from the 1994-95 peso crisis. Since then, 16 SOFOLES have become the main market-rate mortgage lenders and main clients o f SHF. SOFOLES currently get 90% of their funding from SHF. The lead SOFOLES, however, have begun to issue debt on domestic and international markets as planned under the SHF's broader mandate. The H U S K program wi l l support SHF's development o f and private-sector participation in a mortgage-risk database essential for secondary markets and mortgage insurance.

34. Subsidies and the Fideicomiso Fondo Nacional de Habitmiones Populares (FONHAPO). FONHAPO has acted as Government's lead institution in funding low-income housing. Over the last five years, the organization has recovered from i t s quasi-bankruptcy resulting from the subvention and high arrears o f on-lending to state housing institutes by recouping debt. Continued below-market rate lending to state institutes would not only jeopardize FONHAPO's hard-won financial solvency, but also undermine the Government's strategy to promote market-rate lending." Hence, this second-tier lending - which i s already at a low level'' - w i l l phase out during the program and be replaced by more financially sustainable approaches to supporting low income housing. Specifically, the funding o f social housing by FONHAPO from newly-budgeted monies w i l l occur in the form o f grants and not loans.

35. Rather than channel home credit - a function o f SHF - FONHAPO wi l l unify the federal govemment's housing subsidy programs for low-income households. In this regard, FONHAPO wi l l work with SHF to design and monitor Prosavi grants.

More than US$90 billion between mutual funds, provident funds, pension funds, and insurance companies. lo FONHAPO lends at minimum wage (MW) plus 4% to 6% to state housing institutes that provide state guarantees. '' Funded only by payments on FONHAPO's loan portfolio, which are small and shrinking fast in real value. In addition, most of the reflow from FONHAPO's loan portfolio goes to support this organization's administrative cost, leaving little for these below-market rate loans.

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36. In lieu o f FONAHPO’s second-tier lending to states, SHF wil l guarantee micro and mortgage housing credits to l o w and moderate-income loans originated by private financial institutions for both purchase and renovation of existing homes. Sustainable low-income housing finance requires strengthening o f the regulations and standards for this business, access to a range o f new SHF products, and institutional capacity building.

37. Redefining the role of the Znstituto del Fondo Nacional de la Vivienda para 10s Trabajadores. (INFONAVIT) has initiated an impressive array o f reforms under the current government. In 2003, INFONAVIT made a record of 291,000 loans. This high production has relied on: i) large inflows o f compulsory wage contributions of formal sector workers - many o f whom wi l l not receive a loan; ii) low servicing costs due to direct payroll deductions; and iii) less stringent capital and provisioning rules than for primary credit institutions. Improved management practices on the credit side have come from more transparent credit allocation, a better system for originating and managing loans; reformed internal organization, an active and out-sourced debt recovery program, improved management o f credit risk12 and operation risks,13 new minimum down-payment requirements, a simplified scoring system, extraordinary loan-loss provisions (US$ 2 billion in 2002) made for non-performing loans, and piloting the use of INFONAVIT savings to leverage private credits for higher-income members (article 43 bis). On the savings side, INFONAVIT expects to pay an annual return o f the minimum wage (“MW’) + 2.5% on i t s savings accounts, exceeding i t s minimum requirement and paying closer to private pension fund benchmarks (net o f management fees). After many years of poor performance, this trend reflects the increasing importance o f INFONAVIT’s role as a mandatory saving institution, in addition to i ts traditional home lender role. FOVISSTE - a providentiary institution that operates similarly to INFONAVIT but for federal public-sector employees - has also made important operational impr0~ements. l~

38. Despite this progress in improving i t s operation, INFONAVIT’s conflicting roles continue tc undermine the development of housing credit markets. INFONAVIT’s roles include functioning as: a) an efficient housing lender that provides loans to an ever higher proportion o f contributing members,15 achieving a better social match between the “taxed” contributors and borrowers, and leveraging more market-oriented credits with private lenders; b) a social housing agency contributing to the provision and targeting of subsidies; and c) a profitable pension fund increasing pension returns for retiring members and improving liquidity by permitting early withdrawals for housing investment purposes. These three roles create multiple contradictions. Most fundamental, the extension o f subsidized housing loans reduces the returns available to pay contributors’ pensions.

39. Over the medium term, the GoM aims to foster a transition to private market-rate housing finance and rationalize INFONAVIT’s conflicting roles. However, the Mexican housing finance system’s current dependency on INFONAVIT (which provides two-thirds o f all mortgages) and the institution’s complex governance structure complicate the transition. Hence, rationalization o f INFONAVIT’s role requires time and a clear plan in order to build broad support among stakeholders, avoid potentially devastating disruption of mortgage lending, and facilitate increased private lending. The challenges and path to reform of FOVISSSTE - an organization that operates similarly to INFONAVIT but for public-sector

Mostly when members become unemployed, or change jobs, notably to the informal sector where there i s no automatic payroll deduction. l3 Mostly due to improper payroll deduction by the employer. I4 FOVISSSTE has contracted SOFOLES as professional originators of i t s loans. Better management and credit recovery have resulted in accumulated liquidity and increased lending in 2002-2003. Non-performing loans are relatively low, at 3%. The proportion of members (public-sector employees) expected to receive a subsidized housing credit i s expected to rise from 26% to 40% by 2006. l5 With a current low “cover” ratio st i l l less than 20%.

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employees but at much smaller scale - parallel those o f the much larger institution and - hence - wi l l be subsumed under those of INFONAVIT in the program and the remainder of this document.

40. Savings products and BANSEFZ. In Mexico, over 60% of households that save in informal and formal-sector institutions dedicate these accumulated funds to housing, mainly to improvement o f their existing home. Hence, housing savings product are crucial for low-income households, particularly non- wage earners without bank accounts, in order to help them build equity, encourage financial discipline, achieve a “bankable” credit score, make use of formal financial institutions (go from “unbanked” to “banked”), and facilitate eligibility for housing subsidies. Larger savings can also reduce the cost of the subsidy program, which tries to compensate for miniscule downpayments (i.e. savings) for purchasing a house by increasing the level o f subvention. These higher downpayments also lower the credit risk of home lending by reducing loan-to-value ratios.

41. BANSEFI was created in April 2001 in order to promote household savings, help popular finance institutions adjust and prosper under the new Law for Popular Savings and Credit that phases in requirements between 2001 and 2004, and coordinate government support to financial institutions that focus on serving lowlmoderate-income households (“popular financial institutions”). In the last three years, the number of savers in BANSEFI’s 560 branches has grown from 800,000 to 1.7 million, and i s currently increasing by about 10,000 clients per month. BANSEFI has created a technical platform to connect i t s branches with those of several other popular finance institutions - the “people’s network.” BANSEFI has begun to partner separately with INFONAVR and FONHAPO to help households applying to these institutions for support by opening savings accounts that help them meet eligibility criteria. SHF and BANSEFI are poised to launch a similar savings initiative shortly. The HUSAL program has milestones for developing these savings links to credit and subsidies.

D. Urban Real Property Registries and Rights

42. About 40% of those who say they own their property, in fact, lack full legal title. This problem arises not only from the complications o f the ejido system (see paragraph 20), but also from the cumbersome and costly procedures of the 32 state real property registries and an ineffective legal framework. With few exceptions, these state real property registries depend on manual data entry in paper books with entries arranged chronologically (rather than the modern standard o f electronic files for each property), involve 30 to 100 separate steps to register relatively simple transactions (a mortgage lien, for example), remain unlinked to the municipal cadastre (the other main source o f land information), and lack transparency.

43. Well aware of the importance of real (and housing) property rights for many markets and for social stability (including the development of housing finance, urban real estate taxation, extension and charging o f public utilities tariffs, safeguarding o f family relations, and general well-being o f housing dwellers), the GoM has initiated a project to strengthen the real property registries in two states through CONAFOVI. (i) analyze and reform the institutional and legal framework for property registrylrights; (ii) re-engineer the processes and work flow of the property registry in order to cut time, improve efficiency and accuracy, and reduce costs; (iii) shift from manual entry of transactions in chronological order to electronic folios of properties; (iv) digitize historical data as necessary in order to incorporate it into the electronic system; (v) permit remote consultation of the property registry; and (vi) link the state property registry to the municipal cadastre in order to unify land information. The HUSAL sets milestones for extending this project from the original two states to other states and for agreement on a legal framework.

CONAFOVI’s assistance matches each state’s counterpart resources in order to:

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E. National Urban Policy, Slum Upgrading and Institutional Strengthening

45. Strategy and Institutions. The recently formulated National Urban Development Plan for 2001- 2006 focuses on achieving sustainable and spatially-balanced urban development. The pillars o f the Government’s urban strategy include: (i) upgrading low-income communities through joining physical and social investments guided by planning and community participation; (ii) increasing land availability for the poor; and (iii) moving from mitigating the costs o f disasters to prevention. To support the achievement o f these goals, SEDESOL has joined control over the activities necessary for integrated slum upgrading - including both physical and social investments - in one division. In recognition of the growing importance of urban poverty, the Government has expanded Oportunidades - i t s major program of social support to the poor - from a rural focus to include urban areas.

46. The success of the GoM urban policy also largely depends on implementation capacity at the local level, particularly in land development and planning, community development, and property rights where local govemments have the main power and responsibility. The lack o f local planning agencies and financial capacity represents an important bottleneck to the implementation o f the GoM program. Over the last two decades, Mexican municipalities have gained increased political, administrative and financial autonomy, but many still lack the technical capacity and funds to perform their new roles. For example, while the reform o f constitutional article 115 decentralized responsibility for construction and operation of infrastructure and urban services to states and municipalities, federal transfers through Ramo 33 s t i l l fund the bulk o f local infrastructure investment. Proposals for fiscal reform and the government’s on-going decentralization program promise to further strengthen local and state governments. As previously mentioned, while many aspects o f decentralization extend beyond the scope of this program, the HUSAL wi l l provide support SEDESOL to launch a comprehensive program to build capacity of municipal and state governments on land management, local economic development, and community-based planning.

47. Slum Upgrading and the Habitat Program. Unable to access formal housing or land, about 100,000 poor families each year settle in marginal areas with overwhelming infrastructure deficits and without urban planning. The layout o f many Mexican barrios appears orderly in comparison to others in the region (e.g. those o f Venezuela or Brazil). However, location in hazardous or sensitive areas, scarcity of public facilities and goods, distance from infrastructure and services and the absence o f mechanisms for community input frequently damage these neighborhoods and raise the cost o f regularizing them to well above that of new formal-sector development. The cost to organize and provide public goods ex post exceeds the capacity o f households as well as communities and usually requires public support.

Decentralized Execution.

48. The GoM (SEDESOL) has developed an integrated program called Habitat to address precarious poor neighborhoods. Habitat provides support for neighborhood upgrading, access to land, and prevention o f natural disasters and includes initiatives to support community facilities, day-care centers for working mothers, and local development agencies that bring together community, private sector, and local government. Habitat channels federal funds (under Ramo 20) as matching grants to municipalities for programs that benefit families earning up to 3 MW.

49. The urban upgrading subprogram o f Habitat includes: (i) preparatory studies such as municipal urban-poverty diagnostics and action plans, comprehensive barrio upgrading plans, and detailed engineering for infrastructure projects; as well as (ii) investments in urbanization including water, sewerage, storm drainage, paved access roads, electricity and street lighting, rehabilitation or construction of community facilities, and improved solid waste management. The program has started in 60 medium and large cities, and invested around US$ 90 mill ion in 2003. HUSAL I includes as prior actions the integration of upgrading activities under Habitat and the programs approval and funding by Congress.

50. HABITAT includes several design innovations to improve targeting and program impact:

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Capacity. Habitat wi l l create local capacity among municipal authorities, NGOs and CBOs and related agencies. A capacity building program run by SEDESOL in proposed collaboration with the World Bank Institute (WBI) wi l l help strengthen local actors to implement the upgrading program. Poverty Targeting. SEDESOL has developed detailed geo-referenced poverty data down to the block level for eligible municipalities that allows for accurately allocating Ramo 20 funds. Neighborhoods must include at least 50% poor households, or 30% in special cases as specified in Habitat’s regulations, with federal government support matched by local government and beneficiaries’ contributions. Eligibility criteria for participating cities include the level o f poverty, city rate of growth, potential to generate wealth (per capita GDP), level o f inequality, and environmental sustainability (availability o f water). Based on the prioritization o f such criteria, appropriate blocks and neighborhoods are selected. Multiyear program of improvement. The program supports the development and execution o f multi-year plans for neighborhood improvement, helping to overcome some o f the transaction costs and capacity limitations o f progressive investment.

Although an important advance, the upgrading component of Habitat requires further action for the program to-fulf i l l i t s potential. The program design stipulates important procedures essential to i ts performance such as community participation, neighborhood investment plans, and an appropriate level and sequencing o f investment in each community. However, the rapid expansion o f the Program in i t s f irst year (2003) and the urgency o f meeting initial investment goals (the Program disbursed the budgeted amount of approximately US$ 90 mill ion in 2003) have sometimes taken precedence over these other aspects. SEDESOL i s fully committed to meeting these other milestones by the HUSAL Program’s second and third years o f operation.

F. Low and Moderate Income Land Development

52. In formal housing development, public goods such as environmental quality, green and community spaces, access, and storm drainage come at the beginning o f the development process. Middle-income families can afford to pay for these services upfront in the form o f the price of the new house and local taxes. Most low/moderate-income households, however, lack the financial ability to pay these sums upfront, and must stage them over time to make them affordable, thus reversing the process, which often starts with informal settlement.

53. Thus, most o f Mexico’s low/moderate-income residential land development occurs illegally, often on ejido lands. The dominant method of land supply for the poor consists o f an agile system o f illegal subdivisions, followed by a costly and time-intensive process o f expropriation and regularization by the Government through CORETT. When unassisted by the formal-sector - as i s usually the case -the incremental settlement and building process has one crucial virtue: it puts low-income households on the first rung o f the ladder o f homeownership. In the process, however, i t generates enormous public and private costs. From the families perspective, securing their property and building a house over many years involves a huge investment in time and labor, during which the family must live in inadequate and unhealthy environments. From a public-sector perspective, informal settlement leads to a broken settlement pattern that often costs two to three times the amount (generally o f government funds) to fix than planned formal-sector development (generally, private funds) would have initially.16 Hence, replacing informal settlement with low-cost formal sector land development holds crucial importance. Although some preliminary analysis has occurred in Mexico, the costs o f informal development and their

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l6 A Colombian study has calculated the costs of provision o f basic infrastructure to informal development at three times the cost of that to formal-sector development. A number of studies of land development in Mexico has reached a similar conclusion, but without quantification.

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impact on diverse participants in the process - households, landowners, local government, federal government - have yet to be quantified and publicized. In effect, the costs of the dominant approach to low/moderate-income land development in Mexico - informal urban settlement o f ejido land, regularization, and slum upgrading of many o f the resulting areas - remain undocumented, as do the costs and benefits o f other options.

54. In turn, formal-sector low/moderate-income land development represents a small fraction o f the total. Most formal-sector low/moderate-income land development occurs as part o f housing projects financed by federal agencies (INFONAVIT, FOVISSSTE, SHF, and FONHAPO) and local and state government housing institutes. Local and state government usually provides the land at discounted rates to the developers o f these federal and locally-assisted affordable housing projects. Most states and local governments, however, do not own substantial amounts o f developable land. Hence, in order to attract and make possible these low/moderate-income housing projects, most state and local governments purchase land to constitute “land reserves”. Here, too, however, no study has quantified the costs and benefits of land reserves, or o f the feasibility o f and changes necessary to improve profitability and spur formal private-sector involvement. Analysis o f successful experiences in Mexican states and other Latin American countries could shed light on options for low/moderate-income land development from deregulation to land readjustment.

55. In summary, the next steps in land are to: (a) quantify the costs and benefits o f informal vs. formal-sector development; and (b) analyze the experience o f selected Mexican states and other Latin- American countries in low/moderate-income settlement in order to develop viable options for reform. Based upon this analysis, GoM intends to put in place a pilot program. The HUSAL program supports these actions.

56. subsequent reform program:

A number o f factors require consideration in this analysis of costs, benefits, and options, and a

a) Rural-to- Urban Land ConversiodEjido System. Without an agile process for talung ejido land to the market, ejidatarios illegally parcel their land without attention to urban plans and regulations yielding unserviced plots and leapfrog development. The PROCEDE certificate was clearly an important step forward, but i t appears that the subsequent processes for conversion to full legal title or the development o f ejido real estate companies remain cumbersome and ~omplicated.’~ Thus, the next steps for reform are unclear and await definition.

b) Regulations and standards. SEDESOL has carried out studies to identify the incongruities and omissions in urban and standards and problems in compliance. An analysis of the costs and benefits o f informal vs. formal-sector development, and o f viable options for low/moderate-income development represent the missing complements to develop a program.

c) Govemment role in low/moderate-income land supply. In the face o f the pressing need for increased land supply, G o M continues to encourage and fund state and local governments to amass land reserves. In certain instances, this solution provides a short- term response but, as experiences in other countries have shown, has some important drawbacks: (i) increases in land prices; (ii) slowness o f the transactions under the reserve process; iii) inefficiency o f government in identifying the most desirable land offerings; iv) tendency o f the agencies handling land reserves to become large and inefficient; and v) a large percentage of the land reserves used for other than social purposes. SEDESOL

” PROCEDE i s a program to register and certify ejido property.

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i s considering ways to minimize the shortcomings. Possible measures may include restricting support for land reserves to housing agencies that are: (i) at the local level and target a limited range o f objectives; (ii) well capitalized and managed; (iii) focused on functions that the private sector has difficulty performing, e.g. provision o f costly trunk infrastructure to suburban areas; (iv) using the private sector to perform other aspects o f development, such as the finance and construction o f houses; and (v) politically independent. SEDESOL wi l l also explore alternatives to land reserves, from demand- side subsidies for purchase o f serviced lots to land readjustment.

57. More systematic land data i s essential in order to inform the analysis o f costs, benefits, options, and land policy - in general. In 2003 and 2004, SEDESOL wi l l carry out surveys in several major cities to collect land prices across formal and informal markets in order to pass this information on to local authorities to strengthen their planning capacity. SEDESOL wi l l also develop a system for information and monitoring o f urban land, including planning and development information (urban development plans, cadastres, legal subdivisions, identified informal settlements, etc.), drawn directly from local authorities and complemented with information from satellite images to register the process o f settlements.

G. Disaster Prevention and Management

58. The Disaster Prevention and Mitigation subprogram o f Habitat addresses the risks resulting from unplanned urbanization in vulnerable areas by providing federal funding for planning and for investments such as retaining walls and storm drainage. The Habitat Program also includes resources for vulnerability assessments at the neighborhood level that identify risk areas, and structural and non-structural mitigation measures. These actions should be complemented with city-level assessments in order to provide a more complete view of risks helpful for strategically targeting limited resources. Traditionally, Mexico has focused on ex-post natural disaster clean-up - a relatively costly and reactive strategy - as opposed to ex- ante mitigation. Thus, this new focus on prevention supported by the HUSAL program represents an important step forward in SEDESOL’s approach.

IV. THE PROPOSED LOANS

A. Objectives of the Program

59. The Housing and Urban Development Sector Adjustment Program (comprised o f four operations: HUSAL I, HUSAL II, H U S K 111, and HUTAL) supports the Govemment’s efforts over a three-year period to improve the l iving conditions o f the poor and strengthen access o f low-income people to real assets, notably housing and serviced land. The Govemment’s program to be supported by the Bank loans has the following objectives:

Develop a sound national policy and institutional framework for housing and urban development; Design and put in place a consistent and unified housing subsidy policy that facilitates access of low/moderate-income families to housing and leverages household savings and private credit finance; Strengthen the housing credit and savings systems, and move these systems downmarket; Strengthen urban real property registries and rights; Increase the supply o f urban land and access by the poor and improve this market’s function; Coordinate physical and social investments to systematically upgrading poor neighborhoods; and Better prevent and manage the impacts o f natural disasters.

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B. Content o f the Program

60. The H U S A L program wi l l support a subset of the GoM’s medium-term reform agenda in the housing and urban sectors through three programmatic sector adjustment loans and an accompanying technical assistance loan. Key milestones have been selected as prior actions for adjustment loan approval. The milestones for H U S K I that are necessary for disbursement have been reached, as detailed by the Policy Matrix in Annex 1. The program aims to facilitate the development and implementation o f policies, plans, and instruments, in a selective and flexible manner, in response to the GoM’s review o f i ts program and emerging issues. As such, the next adjustment loan w i l l take place when the next set of key prior actions have been met, and at the same time a critical mass o f reform measures from the broader matrix have been achieved, such that there i s sufficient confidence in substantial progress towards the development outcomes in the housing and urban sectors. Figure 1 below presents an overview of the adjustment program to be supported (see Annex 1 for the detailed policy matrix.)

C. Analytical underpinnings

61. The program rests on a solid foundation o f analysis carried out by the GoM, the Bank and other development partners over the past three years. Recently-completed work includes two major Bank reports: A Contribution to an Urban Strategy for Mexico, Report no. 22525-ME, July 15,2002, and Low Income Housing, Issues and Options, Report no. 22534-ME, September 16, 2002. The f irst document examines the urban sector in Mexico and makes policy recommendations on: (i) land use, housing and transport; (ii) the backlog of infrastructure investment; and (iii) the concentration of poverty in peri-urban areas; and (iii) developing institutions to manage and implement these policies. The low-income housing study examines the access of the poor to housing (both finished and progressive housing), quantifies housing needs in terms o f stocks and flows, and discusses the inefficiencies created by the present system of indirect and direct subsidies. The report also sets out the major building blocks o f a more sustainable low-income housing strategy. The proposed program has also drawn on the on-going technical assistance project to the State of Mexico for a new low-income housing policy for the periphery o f Mexico City (Cities-Alliance funded). In addition, major work has been performed on housing finance under the ongoing FOVYSHF project.

D. Content of the Loans

62. The program consists of three Affordable Housing and Urban Poverty Sector Adjustment Loans, scheduled to disburse in mid 2004,2005, and 2006, and an accompanying Technical Assistance Loan to support necessary reforms, scheduled to be implemented from 2004 to 2006.

63. following actions already completed by the GoM (see Annex 1 for the detailed policy matrix):

The disbursement o f the first adjustment operation, HUSK 1, o f US$lOO mill ion supports the

Macroeconomic Framework

0 Maintenance o f sound macroeconomic framework consistent with policy objectives and programs described in the Letter o f Development Policy.

National Housing Policy and Institutional Framework

0 The Government has approved and presented the National Housing Development Policy, strengthened transparency through presentation o f annual report on policy implementation and provision o f information on related programs to the public through the internet.

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The Government has harmonized and defined the roles o f federal housing agencies: CONAFOVI i s the overall coordinator and policy body; CONAVI serves as a consultative forum for public and private stakeholders; SHF takes the lead in developing market-rate primary and secondary mortgage markets; FONHAPO i s in charge o f housing subsidies; and FONAEVI receives, accounts for, and disburses housing subsidy funds.

Government has completed an environmental assessment (EA) o f the housing sector.

Housing. Subsidies

The Government has mandated a unified housing subsidy program to be administered by FONHAPOlFONAEVI that i s efficient, progressive, and equitable as established through presidential decree.

CONAFOVI has set up an on-going working group that includes all main agencies involved in housing subsidy andor administration at the national level in order to consolidate objectives and programs for the unified housing subsidy program and i t s continuous refinement.

FONHAPO has established a database o f beneficiaries o f Tu CasaNivah.

Housing Credit and Household Savings

Congress has approved a set of reforms that strengthen the legal framework at the national level for mortgages (credito hipotecario), allowing adjudication o f defaulted mortgage liens in federal courts, simplifying documentation required to prove the existence of the lien, and allowing for extra-judicial foreclosure of collateral trusts.

Congress has approved a new financial transparency law related to mortgage loans, providing standardized, clear and comparative information and contracts to borrowers. S H F has issued rules for the licensing o f property appraisers, and the calculation o f costs disclosed for residential mortgage loans.

SHF has designed and put in place a database for mortgage risk assessment, and the private sector i s contributing information on loans.

SHF has expanded i t s products to include financing and guarantees both in UDIs and pesos.

Bansefi has launched savings programs for low- and moderate-income households linked to lending by Infonavit and to Fonhapo’s Tu Casa subsidy program

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Table 2. Overview of Mexico Housing and Urban Sector Adjustment Program

Govt. actions completed (2003)

Presented National

Development Programs

Unified program of housing subsidies legally mandated and overall concept achieves broad acceptance

Public property registry pilot project launched in two states

Financing housing and urban management capacity-building program for states & municipalities

Advance reforms on housing finance including establishment of SHF, approval on guarantee package and transparency laws, and establishment of mortgage risk database

The Govemment has integrated its physical and social interventions in urban communities for slum upgrading (Habitat), as approved and funded by Congress

Community level risk analysis, city level risk mapping and sensitization and mitigation projects initiated

Base land data collected and preliminary studies completed

Rest of Program (2004-06)

Clarify federal mechanisms for housing and urban policy implementation

Consolidate federal housing subsidy framework that includes Tu Casa, Prosavi, and INFONAVIT

Extend property registry project to other states; GoM and states reach consensus on a legal framework and national program to strengthen real property rights

Develop a model for local housing institute administration and programs, and train municipal staff in planning, upgrading, and community participation

Improved regulatory framework for securitization fosters expansion of private housing finance; new home lending products expand to finance low-cost housing solutions (improvement, expansion, purchase of existing units); housing savings instruments develop, spread, and increasingly leverage credit and subsidies; and the private sector uses and supports mortgage risk database

Use o f integrated neighborhood development plans as a means to prioritize investments strengthens Habitat program

Risk mapping efforts and sensitization and mitigation projects taken to scale

Analytic studies lead to streamlining development standards and identifying effective methods for a program to increase low/moderate-income land development and the role o f the private sector

Long-term vision

Low-income housing and neighborhood upgrading become national priorities with well-defined delivery systems funded in a :onsistent way by government subsidies, private-sector credit, and family savings

Transparent and equitable subsidies leverage private-sector credit and household savings for an appropriate mix of low-cost housing solutions. Reformed subsidy system expands to play a major role in resolving low-income housing problems

The time and cost of registering property rights falls substantially and reliability rises, enhancing the housing assets held by low/moderate-income households

State and municipal housing institutes have the technical capacity to prepare, execute, and monitor programs to be jointly financed with the federal government

Housing finance in Mexico i s operated mainly by private sector, under supervision from Central Bank and regulatory bodies. Market- rate lending for low-cost housing solutions affordable to lowhoderate-income families becomes widespread, accompanied by entry of new lenders into this business. Empirical data on mortgage outcomes replaces the impression of high risk held by commercial banks, leading to rapid expansion of private-sector lending.

On-going govemment funding and sustainable sources o f finance such as housing microcredit allow well- synchronized investment to upgrade poor neighborhoods

Disaster mitigation capacity of cities i s strengthened through risk analysis and its incorporation into long-term planning

Complexity and costs of land development fall, private-sector starts playing a substantial role in developing land foi low/moderate-income housing, and scale 01 low/moderate-income land development increases

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Urban Real Property Registries and Rights

0 Two state govemments have started to implement property registry modernization programs with support from CONAFOVI

National Urban Policv, Slum Upwading and Institutional Strengthening

The Government has approved and presented the National Urban Development and Territorial Planning Policy and strengthened transparency through presentation o f an annual report on policy implementation and provision o f information on related programs to the public through the internet.

SEDESOL Poverty mapping has been completed and used for targeting social programs (Habitat, Oportunidades, Liconsa).

SEDESOL has integrated i t s physical and social interventions in urban communities under a single umbrella slum-upgrading program (Habitat), as approved and funded by Congress.

Government has modified i t s regulations to expand i t s major social program (Oportunidades) from a rural focus to include urban areas, reflecting the growing levels o f urban poverty

SEDESOL has completed an environmental assessment (EA) o f the urban sector.

Low and Moderate Income Land Development

0 SEDESOL has completed a full assessment o f state and municipal land regulations in two regions to rationalize and simplify the land development process.'8

0 SEDESOL has finished studies that: (a) inventory developable urban land; and (b) analyze the legal and financial options for residential land development.

Disaster Prevention and Management

0 SEDESOL has carried out at least 30 community-level risk analyses under i t s HABITAT program.

0 SEDESOL has carried out at least 15 sensitization and mitigation projects under i t s HABITAT program.

0 SEDESOL has put forward at least 10 proposals to organize land use in order to prevent natural disasters.

64. The second operation wi l l follow on the development o f the policy changes initiated under the first with the following key prior actions: (i) maintenance o f sound macroeconomic framework consistent with policy objectives and programs described in the Letter o f Development Policy; (ii) Government has completed an evaluation o f federal housing subsidy programs taking into account land and infrastructure subsidies delivered at the local level to federally assisted housing projects, and the results &e reflected in

The two regions include the states o f Baja California, Baja California Sur, Chihuaha, Coahuila, Durango, Nuevo Leon, Sinaloa, Sonora and Tamaulipas.

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the subsidy programs designed for 2005; (iii) SHF has designed and put in practice pilot projects, in accordance with standards agreed between the Government and the Bank, for financing home improvement, additions, and purchase o f existing housing; (iv) five additional state governments have implemented property registry modernization programs, in accordance with standards agreed between the Government and the Bank; (v) SEDESOL has strengthened Habitat through participatory planning, coordination, and sequencing o f investments; and (vi) Government has completed a quantitative analysis of the costs and benefits o f different modes of low/moderate-income land development, and developed an action plan that facilitates lowlmoderate-income residential land development. Key prior actions for the third operation include: (i) maintenance of sound macroeconomic framework consistent with policy objectives and programs described in the Letter of Development Policy; (ii) Government has designed - as reflected in the approved 2006 budget - a unified subsidy system across federal subsidy programs that: (a) improves equity, progressivity, and increased beneficiary contributions across programs; (b) does not allow joining subsidies from a variety o f federal programs (“double dipping”) thereby resulting in a total amount of subvention per-unit that exceeds agreed-upon ceilings; (c) adjusts state and municipal contribution requirements to federal subsidy programs based on the poverty level in the jurisdiction; (d) establishes consistent rules for beneficiary selection, for linking receipt of the subsidy to household savings, and for the subsidy amount; and e) increases portability o f subsidies; (iii) SHF mainstreams financing of home improvement, addition and purchase o f existing housing, in accordance with standards agreed between the Government and the Bank; and (iv) satisfactory implementation of a pilot program that facilitates low/moderate-income residential land development. Additional non-prioritized actions expected as part of program implementation can be found in annex 1.

E. Financial Assistance and Institutional and Implementation Arrangements

65. The proposed US100.00 mill ion H U S A L l in the form of a fixed spread, U S Dollar Loan, wi l l be made to the United Mexican States. The full amount of the loan i s expected to be disbursed upon effectiveness based on actions completed prior to presentation of the loan to the World Bank Board of Directors. The proposed loan would cover the f i r s t o f three adjustment operations in this program. The subsequent adjustment loans wi l l be based on the Government’s implementation o f i t s medium term program as shown by the actions outlined in paragraphs 64 and Annex 1. It i s expected that the second and third loans o f this program take place in August 2005 and August 2006 respectively. The closing date for the first SECAL (HUSAL 1) i s December 31, 2004. The companion Technical Assistance Loan supporting reform implementation i s expected to be presented for Board approval shortly.

66. subsidiary agreement (contrato de mandato).

Sociedad Hipotecaria Federal (SHF) wi l l act as financial agent for the Borrower under a

67. Disbursement. Loan disbursement wi l l be made under simplified disbursement procedures. Proceeds wi l l be disbursed against satisfactory implementation o f the adjustment program, including compliance with stipulated effectiveness conditions. The Borrower has already fulfil led the conditions for disbursement as a condition o f Board presentation o f the operation. In accordance with the Operational Directive on Simplification o f Disbursement Rules under Structural Adjustment and Sector Adjustment Loans (February 8, 1996), disbursements w i l l not be linked to specific purchases and, hence, there wi l l be no procurement requirements. Once the loan becomes effective, the Borrower w i l l open and maintain a corresponding deposit account in dollars at the Banco de Mexico. When the loan becomes effective (assuming no policy or macroeconomic reversals), the Borrower w i l l submit a simplified withdrawal application against which the Bank w i l l disburse the corresponding loan proceeds into the deposit account for the Borrower’s use. If, after deposit in this account, the proceeds o f the loan are used for ineligible purposesas outlined in the Loan Agreement, the Bank w i l l require the Borrower to either:

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(a) return that amount to the account for use for eligible purposes; or (b) refund the amount directly to the Bank (in which case the Bank wil l cancel an equivalent undisbursed amount of the loan).

68. The Mexico Country Financial Accountability Assessment (CFAA) was completed in October 2003. The CFAA focused on the national level public sector, which i t considered to have generally sound FM systems and institutions. Country financial management risk was rated as Moderate and all individual risk factors were rated Low or Moderate. Although, the direct impact of this CFAA on Project FM system i s low because project implementation wil l be handled by a national financial agency Sociedad Hipotecaria Federal (SHF), CONAFOVI and SEDESOL; project funds wi l l go through public financial management systems.

Financial Management - Country Issues.

69. Auditing. Upon the Bank’s request, the Borrower w i l l have the Deposit Account audited by independent auditors acceptable to the Bank and in accordance with specific audit terms o f reference for this project, agreed with the Bank. Copies of any audit wi l l be submitted to the Bank no later than four months after the date of the Bank’s request for such as audit. The Bank wi l l review those report, evaluate i ts acceptability, and provide comments and recommendations (if any).

70. Loan administration w i l l be the responsibility o f the financial agent, SHF, designated by the Borrower. The financial agent w i l l be responsible for preparing the withdrawal application, maintaining the Deposit Account and arranging for i t s timely audit (if requested by the Bank), and monitoring overall loan implementation. The financial agent w i l l also be responsible for coordinating the preparation o f the Borrower’s contributions to the Implementation Completion Report and for writing those sections relating to loan administration. Monitoring o f reform program implementation w i l l be supported by the accompanying technical assistance loan.

Loan Management and Monitoring.

F. Environment and Resettlement

7 1. During project preparation, the Mexican Government complete an environmental assessment (EA) of the housing and urban sectors (see Annex 3 on the “Environmental and Social Aspects o f the HUSAL.”). These reports detail policies, technological options, and planning methods, and make recommendations. The EAs indicate that formal-sector development has highly positive environmental impacts that can nonetheless be enhanced. Informal development, however, occurs frequently at considerable distance from infrastructure lines, on environmentally sensitive or risky sites, and lacks proper solid waste and sanitation services, and spaces for public utility, and requires some re-platting on upgrading. The EAs conclude that the foreseen reforms o f the HUSAL w i l l have widespread positive environmental impacts, largely by increasing the share o f formal-sector development and mitigating the problems o f informal development. Some localized negative impacts, however, are to be expected. For this reason, the project i s rated Category “B”. The SECAL does not finance direct investments and the Bank‘s Involuntary Resettlement Policy (OP 4.12) does not apply.

72. Given the nature of these potential impacts, one o f the aims o f the program wi l l be to mainstream environmental and resettlement concerns into housing, land and urban policy. As part of these efforts, a strategic environmental assessment (SEA) wi l l be prepared with procedures and standards agreed between the Government and the Bank, with financial and technical support from the accompanying technical assistance loan.

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v. THE MACROECONOMIC FRAMEWORK FOR THE PROPOSED OPERATION

73. After enactment of N m A in 1994, the Mexican export sector experienced strong expansion. As the U S economy slowed in 2001, the Mexican economy went in a recession from which it i s presently recovering. Real GDP grew at 0.7% per annum in 2002 and at an estimated 1.3% in 2003. The economic downtum was explained by several factors. Mexico’s market share of non-oil exports in U.S. imports fell from 11.4% in 2001 to 10.7% in 2003. Exports o f manufactured goods, that had quadrupled over the previous decade, dropped from their 2000 high point to an average US$ 141 billion in the past three years. Finally, a sharp contraction o f private investment, associated with global economic uncertainties and lack of domestic structural reforms, led to a deceleration o f domestic demand and weak output growth.

74. Mexico has been able to maintain financial and price stability and access to capital markets during the international economic downturn and emerging market turbulence o f the past few years. The recession was the f i r s t in Mexico’s recent history not associated with a balance o f payments or financial crisis. There are s t i l l concerns about loss o f competitiveness, but Mexico should be able to benefit from a sustained recovery in the U.S. and attain higher rates o f economic growth over the coming years (see Table 3 below.) Industrial production and trade figures for the last quarter of 2003 already show a strong response to the upturn in US. economic activity.

I Table 3. Mexico’s M a i n Macroeconomic Indicators 1

75. The government’s economic policy remains focused on price stability as a precondition to economic growth while pursuing structural reforms to boost private investment and increase the country’s medium-term competitiveness. Monetary policy aims at controlling inflation at about 3% with a margin of pludminus 1 percent. The gradual decline in inflation over the past few years and a 2003 year-end inflation within the medium-term target range has contributed to the credibility o f the monetary policy framework and the authorities’ commitment to the medium-term goals. This, in turn, has allowed the easing o f monetary policy, leading to substantially lower domestic market interest rates, and the development of the longer-term fixed-rate debt market (the government recently issued a 20-year fixed rate peso denominated bond). Historically low interest rates are also improving the availability o f credit to the private sector.

76. The govemment has maintained tight fiscal policies, largely meeting i t s annually established fiscal targets and setting objectives for further, medium-term fiscal consolidation. Fiscal deficit targets have gradually been reduced, moving toward a balanced budget by the end o f the government’s term. Automatic budget adjustment rules.requiring expenditure cuts in case o f lower-than-expected revenue and allocating higher-than-budgeted revenue have been adopted and applied through the annual budget laws. A broader Public Sector Borrowing Requirements (PSBR) deficit measure has also been adopted and published on an annual basis, strengthening the case for further medium-term fiscal consolidation. Mounting public expenditure pressures in areas o f social sector spending, public infrastructure, public sector pension reform, and declining o i l revenue w i l l require a renewed effort at tax reform

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77. Mexico’s external accounts do not pose a risk to macroeconomic stability. The country’s extemal deficit (i.e. the balance of payments’ current account) has been reduced over the past two years to about 2 percent of GDP as a result of strong oil export revenue, rapidly increasing workers’ remittances, lower interest payments on external debt and subdued net import demand. Strengthening of the external accounts and sound macroeconomic management allowed the country to broaden access to international capital markets and meet i ts external financing requirements.

78. Mexico adopted a floating exchange rate regime following the balance o f payments cr is is of 1994-95, with interventions in the exchange market normally limited to rule-based mechanisms. The flexible exchange rate provides a useful buffer against external shocks, such as a sudden fall in o i l prices, a significant drop in capital inflows or increased international competition. In reaction to the limited progress on a competitiveness-enhancing reform program, over the past two years the peso depreciated with respect to the U S dollar. While this may initially compensate part o f the deterioration o f extemal competitiveness, in the medium term, a continued depreciation o f the currency i s likely jeopardize the country’s price stability and growth objectives.

79. The internal economic transition i s proving much more challenging than would have been expected a decade ago. After the resolution of the debt crisis and the implementation o f NAFTA, Mexico was believed to be in route to a long and sustained period o f economic development. However, the mid ninety’s crisis and the recent prolonged stagnation o f economic activity highlight the fact that there are s t i l l unresolved structural development challenges. The legacy o f the 1994-95 crisis remains with Mexico as poverty levels only just recovered to early 1990’s levels and the advantages brought by NAFTA could be undermined if Mexico does not tackle the competitiveness agenda.

VI. BANK STRATEGY

80. The Country Assistance Strategy (CAS). The HUSAL I wi l l help the World Bank support Mexico’s efforts to achieve three objectives of the CAS approved on April 15, 2004: poverty reduction, competitiveness, and environmental sustainability. Most fundamentally, the project w i l l result in improved housing, basic services, and access to real assets by low-income households. The project addresses this key aspect of poverty through support o f a national slum upgrading program and new housing and land development for low-income families. The project also targets increased competitiveness through increasing the efficiency o f housing and urban development, housing finance, and property registries and rights systems. Many low/moderate income homes contain microenterprises as well as provide shelter, while homeowners often build accessory units to rent or for family members. Thus, the housing unit often serves as a key source o f capital accumulation critical to building a strong middle class. By supporting measures to reduce the housing system’s reliance on inefficient public housing finance and to bolster a stable financial system, the loan w i l l help reduce r isks to the federal government o f bailouts and reduce demand for Government support. Finally, the project w i l l have a strongly positive environmental impact through improving conditions in existing slums and by promoting formal-sector development on appropriate sites with rational layout.

81. The proposed Technical Assistance Loan (HUTAL) wi l l provide support for implementation o f the policies and reforms o f HUSAL I, and foster continuity between this first operation and the second and third HUSAL loans. The sector adjustment program wi l l also complement the ongoing FOVVSHF operation. Although both of these operations deal partly with “housing”, FOVI and HUSAL have quite different target clientele, purposes, and methods. The FOVI project mainly provides liquidity and technical assistance for reform of SHF - an institution that serves primarily middle-income families - whose central role i s to lead the

Complementarity with Other Operations by the World Bank.

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development o f primary and secondary mortgage markets for this group. The HUSAL program mainly targets low-income families through broader sector reforms involving housing subsidies, moving housing finance and savings programs downmarket, slum upgrading, and low/moderate-income land development. Similarly, the adjustment loan wil l support a strong national policy and programming framework for the housing and urban sectors, and complement efforts for adjustment and funding for infrastructure at the state level by the Decentralization Program. The HUSAL program wi l l also work with SEDESOL to develop policy and programming focusing on disaster mitigation. The ongoing Disaster Management Program (FONDEN) has focused on funding disaster clean up.

82. The IFC has a number of operations in the housing finance area, and in the pipeline that total US $215 million. These projects offer different types o f investments (equity, debt, and guarantees) and include primary and secondary mortgage finance and construction finance. The largest o f these projects was an equity stake in General Hipotecario, the largest SOFOL, which was sold two years ago. At that time, the IFC invested as a shareholder in the second-largest SOFOL, Su Casita, and supported this financial institution’s first mortgage bond issue.

83. Finally, the program helps lay the groundwork for a broader effort in property rights reform for which the Government has requested Bank support. The new CAS contains a specific operation on Property Rights for FY 05. The HUSAL and i t s accompanying T.A. loan wi l l pave the way for this broader program by: (a) continuing the property registry modernization pilot project that i s a priority o f the Fox Administration and important to show immediate results; (b) conducting studies on property rights reform necessary to effectively design the broader Property Rights program; and (c) establishing working relationships between Bank staff and relevant government agencies in the area of property rights.

84. Complementarity with ZDB Operations. The proposed adjustment loan wi l l complement the ongoing IDB loan supporting Prosavi housing subsidies. As with the FOVI project, the proposed Bank adjustment loan goes beyond the more limited objectives o f the IDB Prosavi loan to assess institutions and programs across both the housing and urban sectors, and to develop a unified and effective housing subsidy system.

VII. BENEFITS

85. The program coordinates reforms in the multiple areas that affect affordable housing and urban poverty to galvanize progress in this sector. Formal-sector housing production (with accompanying urban services and land) w i l l increase from the current pace o f around 500,000 formal-sector housing solutions currently to a figure approaching 750,000 per year by 2006 - the official government goal. Typically, this new production w i l l benefit low to moderate-income families (2 to 6 MW). In addition, the program wi l l support joining physical and social interventions to improve the l iving environment o f 90,000 households per year in the poorest urban communities (below 2 MW). These slum upgrading efforts w i l l likely have long term effects as they help break the cyclical poverty that occurs as a result o f the fact that youth and children suffer most from slum conditions; visible housing and infrastructure disparities fuel social tensions and crime; and unplanned expansion of urban settlements make delivery o f services and conventional infrastructure more costly over the long-term. Overall, the, HUSAL wi l l benefit the range of income groups requiring assistance for adequate shelter and settlement. Reaching a broad range of incomes holds particular importance as experience shows that higher income groups w i l l find ways to take the housing, land, and assistance targeted to lower-income groups if they (higher-income groups) have no other alternatives.

86. underlie advance in these sectors.

Equally important, the program supports the strengthening o f the systems and institutions that As regards systems, the HUSAL furthers reforms that improve

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secondary mortgage markets, housing microfinance for low/moderate-income households (for low-cost housing solutions), safety and soundness regulation o f home-finance institutions, property appraisal, full disclosure o f finance costs, secure tenure and property registration, low/moderate-income land development, community participation, and disaster mitigation. As regards institutions and programs, the program sets milestones for improving the interventions o f a wide range o f organizations involved in housing and urban poverty - including CONAFOVI, SHF, FONHAPOFONAEVI, BANSEFI, financial institutions, state property registries, SEDESOL, state and local housing institutes, and local governments.

!%I. RISKS AND MITIGATION

87. The program has three main risks. &, the comprehensive, cross-sectoral approach i s relatively ambitious, and - thus - may risk timely approval o f the second and third loans. Reform o f housing and urban development, however, must deal with credit finance, subsidies, land development and planning, property rights, slum upgrading, disaster management, and policy. Hence, the natural synergies and complementarity among these areas require a comprehensive package. Moreover, Mexico’s housing and urban sectors have suffered from fractionalized policy-making and implementation. As a result, a cross- cutting program best addresses the housing and urban sectors. The GoM and the Bank team intend to address this risk through a well-designed, integrated strategy and a modest number o f key prior actions as triggers for the different phases o f the program.

88. Second, the project faces institutional r isks as several agencies must contribute to achieve the intended reform. The Program deals with this risk by relying on the leadership o f the Ministry o f Finance (SHCP) - the key counterpart of the loan. While the Bank team has worked extensively with SEDESOL - the lead agency in the urban sector - CONAFOVI - the lead agency in affordable housing, and SHF - the lead agency on housing finance reform, SHCP can provide leadership across ministries, ensure the fiscal sustainability o f the program, and link the real and the financial side o f the program. In addition, the accompanying technical assistance loan (HUSAT) wi l l provide an extensive program o f support tailored to mitigate technical and human-resource constraints.

89. Third, the lack of federal fiscal reform severely constrains immediate possibilities for increasing the housing and urban development programs that depend on subsidies. HUSAL deals with this risk by improving these programs and making their benefits clear in order to prepare them for expansion when funding becomes available.

Page 27

IX. RECOMMENDATIONS

90. recommend that the Executive Directors approve it.

I am satisfied that the proposed loan complies with the Articles o f Agreement o f the Bank, and

James D. Wolfensohn President

Washington, D.C. May 25,2004 Attachments

Page 28

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ANNEX 2

LETTER OF DEVELOPMENT POLICY

SllBSECRETARlA DE HACIENDA Y CREDIT0 PUBLICO

102-8- 039

Ml!xico, D.F., a 10 de mayo de 2004

Mr. James D. Wolfensohn President The World Bank Washington, D.C. 20433 US.A.

Dear Mr. Walfensohn

This letter of Sector Dedelopment Policy describes Mexico's current economic conditions and its on-going process a'f financial sector reforms in order to improve the housing and urban sector. The proposed refor-ms include modifying the incentive6 faced by the different economic agents, strengthening the legal and regulatory framework, as well as completing the restructuring of the sector related iniititutions. To implement these reforms and manage the associated fiscal costs the Government requests financial assistance from the World Bank.

I Macroeconomic Framework

Matro-economic stabilization and the reduction in inflation have created a favorable context for reform in the housing anti urban sector. In particular, these macro improvements have dnven down mortgage interest rates from over 30% per annum in much of the late 1990s to around to 15% - 17% nominal (2004). Ceteris Paribus, this change has made housing and urban development more affordable.

Since 2000, the Government of Mexico has been engaged in a broad range of reforms specifically related to housing and urban development. We have developed an official housing strategy and an official urban development strategy that set overall goals and approaches in the sector. The Gowrnment has also launched a series of programs and created new institutions in these sectors.

The major reforms in housing include:

Creation of a new organization, CONAFOVI, to coordinate other housingrelated institutions and to dew op housing policy, along with the formation of CONAVI as a public-private forum to stimulate and organize the participation of key actors in the sector into policy and programs.

Page 38

SUBSECRETARIA DE HAClENDA Y CREDIT0 PUBLICO

- 2 -

Formation of a new secondary-tier housing credit institution, the SHF, with the powers essential to develop this market. Although the SHF inherited important assets from FOVl - the beneficiary of considerable govemment and donor capitalization in which the World Bank has participated - the SHF increasingly relies on private-sector funding and is developing a range of new products critical to expansion of the market-rate home credit. Development of BANSEFI in order to stimulate household savings, in general, and the link between household savings and housing credit, in particular. Expansion and improvement of two subsidy programs - “Prosavi” and ”Tu Casa” and harmonization of these subsidy programs, and creation of a new organization - FONAEVI - to centralize information and operation of’a unified housing subsidy system. Substantial improvement in the operation of INFONAVIT (e.g. a substantial drop in arrears, and new products, auch as expansion of 43b that use8 INFONAVIT accounts to enhance piivate-sector credit). A pilot property rights registry modemization program in three states that is now set for expansion to five more.

These improvements have resulted in increased production of housing solutions - from somewhat over 300,000 in 2000 to over 500,000 in 2003. Improvement in housing - and the social and economic benefits it brings - represents an important accomplishment of this Administration.

The urban sector has also seen important progress including:

Creation of a national !slum upgrading program, “Habitat”. This program focuses a range of physical and social investments in poor urban communities. Support of local and state governments in getting access to land for low-income housing development. Spreading a range of poverty relief efforts - such as “Opottunidades” - from rural to urban areas. Substantial expansion in naturaldisaster relief and mitigation efforts. We are convinced that mitigating and, thus, preventing the damage caused by natural disasters is much more effective than post-disaster aid and are strengthening this aspect of our disaster policy and programs. Strengthening of SEDESOL so that this Ministry more effectively develops and executes urban policies and programs.

Page 39

s JBSECRETARIA DE HACIENDA Y CREDITO puecico

102-B- 039

We are interested in a programmatic adjustment program - with this $100 million operation as the first operation in order to continue the reform momentum and to assist these and other efforts in the housing and urban sectors,

If Strategies and Actions

This section highlights some of the main strategies and actions that Government had implemented in recent years and will implement in the medium term to deepen recent and on-going reforms and to provide the ltamework for donor-assisted program in the housing and urban development sectors. These measures are aimed at facilitating and building markets, strengthening institutions, and targeting assistance to low-income households that would otherwise be unable to afford basic housing and urban services.

Macro-economic stabilization. A critical element in this medium-term program is the maintenance of fiscal discipline and macfo-economic stability. Housing and urban development are particularly sensitive to macro-economic conditions for a number of reasons. Foremost, long-term mortgage interest rates are set off the yield curve on the Govemment’s debt. In turn, the level of .mortgage interest rates plays a crucial role in the ability of households to afford adequate housing and the urban sewices financed with it (land. tenure, water, sanitation) in formal-sector development. Hence, the most fundamental policy for Govemment in this sector is to bring down nominal and real interest rates through continued macro-economic stabilization and fiscal discipline.

Macro-economic stabilization ha6 had substantial positive impact throughout the sector and on the financial positiori of public and private organization8 that serve it. For example, this decrease in long-term interest rates has brought INFONAVIT loans to middle- income households to levels that are close to market rates. In contrast, the same nominal rates on such INFONAVIT loans were previously substantially below market, with this burden assumed by this autonomous public financial organization. The drop in nominal interest rates has also substantially expanded the potential market for mortgage lending and the potential for development of a secondary mortgage market by SHF, as more and more households can afford these loans. Hence, Govemnient’s most fundamental action in the housing and urban sectors consists of maintaining macroaconomic stability, which has produced a sharp decline in the level of nominal interest rates and a gradual decline in the level of real interest rates.

Page 40

SIJBSECRETARIA DE HACIENDA Y CREDIT0 PUBLICO

Even with such macro-economic improvements, however, a substantial share of Mexicans are unable to afford adequate housing and urban services, while developing markets (for credit, land, urban services) also requires support. Hence, the Government is pursuing a series of sector-specific actions to be supported by the programmatic adjustment loan, based on the following principles;

Housina strateav and institutions. The recently formulated National Housing Policy for 2001 -2006 states the importance of increasing production and access of the poor to shelter. The Government has set as an over-arching goal the doubling formal housing production by 2006 (to 750.000 housing solutions par year) through a decentralized and market-based approach. The pillars undertying this Administration’s housing strategy include: (i) targeting lowlmoderate-income households; (ii) a unified system of housing subsidies to be administered by a single agency complemented by credit and savings; (iii) expanding housing finance by putting in place the methods and instilutions to develop primary and secondary markets, and by working with financiai institutions experienced in serving lowhnoderate-income groups to develop products for financing low-ccst housing solutions (improvement, expansion. purchase of existing housing); (iv) strengthening property rights.

Housina subsidy P r o m s and policy. Mexico has standardized federal housing subsidies across previously-fragmented, uncoordinated programs - “Proaavi’ and “Tu Casa” - by: (a) cpnveying comparable amounts for comparable uses for these programs; and (b) placing all on-budget federal housing subsidies under the control of one operating fund, FONAEVI (a division of FONHAPO). This Administration will continue this reform under the first loan by completing evaluations of all national housing subsidy programs and designing a new unified housing subsidy program that meets agreed-on principles of efficiency and equity.

Housina credit and household savinas. This Administration views reform of the housing finance system as critical to meeting its goals in both the housing and urban sectors. GoM’s program builds on important structural reforms initiated under FOVl in the previous administration and continuing with $HI= -the successor of FOVl - under the current government that include: (a) leveraging market-oriented private resources, mainly through guarantees of private-sector debt on capital markets and elsewhere. rather than government borrowing directly to provide liquidity; and (b) improving the efficiency and increasing the capacity of the existing home lending institutions (banks, SOFOLES, SHF, and the provident funddhousing lenders INFONAVIT and FOVISSSTE). The Govemment has also approved a new credit-guarantee law and a financial-transparency law, while SHF has expanded its products to include financing and guarantees both in UDls and pesos.

Page 41

SLIBSECRETARIA DE HACIENDA Y CREDIT0 PUBLICO

102-B- 039

Other reforms in housing :redit under this loan will include: (a) issue of rUkS on property appraisal methods and disclo:;ure of costs for construction loans: (b) making available a mortgage credit-risk database to the! private sector; (c) adjusting SHF pricing to reflect the effectiveness of foreclosure practices in states; and (d) SHF development of financial products for finance of low-cost housing solutions to lowlmoderate-income households.

Prooertv riahts modernization. The Mexican Government places great priority on securing property rights as key to the development of many markets and socio-economic benefits, including those for mortgage and housing credit, urban real estate taxation, extension and charging of public-utility tariffs, safeguarding of family relations. and the general welfare, In this regard, we have established a property rights registry modernization program in three states and will expand this program to five additional states during the period of the first Programmatic loan.

National urban develoom~ant policy and slum upcaradins. The Govemment has recently formulated an Urban Oevelopment Plan for 2001 -2006 that emphasizes reaching poor communities with physical infrastruct*Jre and social services. In line with this priority, this Administration has established a nationwide slum upgrading program, called "Habitat", that now works in 60 cities. This program uses poverty mapping to target investments and has established local planning agencies to promote local development. During the period of the first Programmatic loan, the GoM will ostablish local planning agencies in an additional 45 municipalities, spread the use of poverty mapping widely to local govemments and communities, and assess and strengthen the participatory aspects of "Habitat" to help improve the investment process.

Land deVelODment and CICCBSS bv the Door. Land access for the poor is a particularly crucial problem. Currently, one component of "Habitat" helps local govemments access land for low-income housing development. As in many other countries if the poor are unable to access land formally, they typically do so informally, although such informal methods temporarily provide a solution to the individual family's immediate problem, the evidence suggests the such irregular settlement creates great costs to government in subsequent re- ordering and infrastructure provision, and to households in the form of a poor, unhealthy living environment. During the period of the first Programmatic loan, this Administration will conduct a quantitative analysis of formal vs. informal development aimed at creating effective methods for facilitating and providing land to low and moderate-income households that leverage the abilities of the private sector.

Mitisation of natural disasters. The Mexican experience shows that taking preventative measures can eliminate up to 90% of the costs of post-disaster aid. Hence, the Government is interested in develop ng new methods of disaster mitigation and prepare risk atlases for 25 cities, train the media, disseminate disaster mitigation information through school curricula, and promote risk-transfer or tions such as insurance.

Page 42

S(JBSECRETAR1A DE HACIENDA Y CREDIT0 PUBLICO

Ill World Bank Support

In recent years, the Goveriment of Mexico has made many substantial advances in housing and urban development. However, we recognize that much progress is still neessary to reach the goal of producing 750,0110 housing solutions per annum on a sustainable basis. The above measures will help addrefis the sectdo constraints and promote economic growth and job creation, as well as provide social benefits ta families with new or improved homes and urban services. The proposed Affofidable Housing and Urban Poverty Program will play an important role in facilitating the necewary reforms.

c.c.p.- Unidad de Crbdito PQblico, St1CP.- Presente. Oireccidn General Adjunta de Deuda Publica, SHCP.- Presente.

Page 43

ANNEX 3

ENVIRONMENTAL AND SOCIAL ASPECTS OF THE MEXICO AFFORDABLE HOUSING AND URBAN POVERTY PROGRAMMATIC SECTOR ADJUSTMENT LOAN

A. Environmental considerations of the HUSAL

The HUSAL, a sectoral adjustment loan, w i l l support government efforts in the housing and urban sectors. In contrast to informal settlements which typically suffer from environmental and social problems due to lack of service provision, formal settlements are characterized by infrastructure provision, access to green spaces, public transportation, and access to social services such as health clinics and education. The transition from informal to formal settlement wi l l alter the current trend o f environmental degradation. The reforms supported by the HUSAL aim to increase access o f poor and moderate income families to formal sector housing - including finished housing, home improvements and neighborhood upgrading - to reduce the negative environmental impacts of informal settlement, among other benefits. While the foreseen reforms w i l l have widespread positive environmental impacts, some localized negative impacts are to be expected. For this reason, the project i s rated Category “B”.

To ensure that environmental issues are incorporated into the design and instrumentation o f the Government’s actions, that the project capitalizes on opportunities to promote sound environmental management and that any negative environmental impacts are mitigated, the Government o f Mexico contracted a consulting firm to complete an environmental assessment (EA) during project preparation. Due to administrative separation o f the housing and urban sectors within the Government, the same consultant group prepared two separate EAs. The EAs are rapid assessments containing: a description o f key environmental aspects in the sector; an assessment o f the feasibility o f integrating environment into specific government actions; and, recommendations for activities to be undertaken.

The objectives o f the EAs are to:

0 Review and analyze the principal institutions that are involved in the sector, and the most

Review and analyze, in detail, the programs related to housing and urban development relevant jurisdictional aspects o f decentralization;

and their intersection with environment. The analysis includes an evaluation o f the legal, fiscal and regulatory frameworks important for mitigating possible future environmental impacts; Make recommendations for future actions; and, Include case studies where appropriate.

0

0

0

B. Main findings,of the EAs

Geophysical and ecological characteristics. The EAs reviewed the geophysical and ecological characteristics and land-use trends o f the country and found that the location o f economic activities contrasts with the availability of natural resources. Aquifers, biodiversity and archeological sites are concentrated in the south-east of the country, whereas economic activity i s concentrated in Mexico City and the northem border. Even so, direct links are evident between economic growth and environmental degradation, and between poverty and degradation. The country’s natural resources are under constant threat from indiscriminant urban and agricultural expansion. Environmental quality in urban areas has

Page 44

deteriorated, resulting in salt water intrusion from groundwater mining, aquifer contamination from lack o f sewerage, illegal trash disposal and resultant health problems due to lack o f solid waste management and air pollution due to poor housing design and construction (in the case o f indoor air pollution), and trash burning and traffic (in the case o f outdoor air pollution).

An overview o f environmental services and risks o f natural and man-made disasters i s presented. The importance o f specific geo-morphological and hydro-meteorological r isks are evaluated, as well as man- made risks such as industrial accidents, forest fires, land degradation, and pollution. The administration o f such r isks i s Federal, and the pertinent policies and institutions are discussed.

Policy, institutions and legal frameworks. The EAs outline the legal framework governing urban development and housing and make specific recommendations for rationalizing the policy, legal and institutional frameworks. Few policies relevant to the sectors include environmental considerations, even though institutions exist to protect environmental interests. Sectorahation o f institutions, programs and policies and weak inter-institutional coordination have resulted in unsustainable development. Inefficient policies have led to environmental and historical deterioration. A lack o f integration o f urban and environmental considerations in planning, neglect of historic areas, speculative land purchases, passivity o f public administration in limiting illegal settlements, disordered settlements with little community identity, and inadequate resource allocation to local governments to effectively address urban problems have al l resulted in negative impacts. Some policies, such as those promoting industrial growth, have lead to direct environmental degradation in urban areas.

Decentralization o f decision-making has suffered from a lack o f participation and consensus, especially related to resource allocation and monitoring. Within the urban development context, the institutional and legal frameworks need updating to become coherent in terms of environmental and social protection.

Currently, environmental issues are mainly considered at the programmatic level within the urban and housing sectors. In theory, plans should include environmental policies and technical standards, though in practice, this rarely happens. Even when included, the implementation o f such policies, norms and standards are rarely carried out or enforced. For example, improper use o f construction material i s one of the major environmental problems related to housing, despite strict laws.

The regulatory and administrative frameworks for project-specific EMS, permits and licenses are complex and a succinct overview i s presented in the EAs. For new c iv i l works in urban areas, an EL4 needs to be presented when the works signify a risk to the community, cultural, historical, archeological or artistic property. Protection of cultural property i s strictly regulated; the EA outlines the procedures and rules.

Social and economic factors. As i s expected, socioeconomic aspects play a prominent role in the analysis o f the sectors. Urban development and housing efforts need to focus not only on the needs of formalizing informal settlements, but also on their causes. Quality o f urban l i fe has suffered from fragmentation o f communities, poor environmental conditions, lack o f social services, loss o f community identity, concentration of informal housing, growing unemployment, poverty, social exclusion, family instability, lack o f infrastructure, and vulnerability to natural disasters. The fact that the majority of the population cannot afford housing in the formal market means that existing regulations apply to only half o f settlements and home construction. Low densities have made it nearly impossible to provide basic services to many existing informal settlements. Housing design and construction quality i s important for indoor air pollution prevention, vulnerability reduction to natural disasters, and overall contentment; however, no program to-date includes concrete actions to improve the environmental conditions of construction.

Page 45

C. Recommendations within the EAs

The EAs analyze myriad topics. Some recommendations are on the macro level of policy/legal/institutional frameworks, such as that urban development policies avoid focusing all attention on large cities, and rather focus on medium-sized cities, where stresses from current migration are acutely felt. Other recommendations are focused on more specific actions for the next years, such as development o f sustainability indicators and institutional strengthening. Some o f these recommendations are summarized below.

Sustainability indicators for the housing sector. I t i s recommended that CONAFOVI begin to collect information to take into account the environmental costs o f sector activities. This may be done through intergovernmental coordination with SEDESOL, SEMARNAT, the Secretary o f Energy, CONACYT and the industry chambers. The indicators should be based on the causes o f environmental problems, the related processes and possible technical solutions to allow CONAFOVI to evaluate and adjust housing programs on an annual basis in order to improve environmental management.

Fostering progressive housing. The housing sector EA advocates a shift in housing policy to place greater emphasis on starter houses @ie de casu) and the progressive housing process, The shift toward provision o f lower costs housing options w i l l increase access to formal housing for the large number of low income families - housing which takes into account environmental costs in i t s design. Along these lines, policy should promote densification of urban areas through recuperation and recycling of existing units. This w i l l allow use o f existing infrastructure, recuperation o f historic and central zones of cities and reduce environmental impact by slowing urban expansion.

Structure of housing markets. The reports proposes financial and institutional strengthening o f the federal and state entities that support the housing market to reach a greater proportion of families with housing finance instruments. Most of the current financing goes to formal sector employees of moderate income and above, leaving the majority o f the population with only informal housing options that do not follow development regulations and do not include environmental considerations in the informal housing development.

Housing construction technology. The EA recommends the use o f environmentally friendly innovations in construction technology for housing in terms o f water, energy, solid waste and wastewater to reduce environmental costs. I t i s recommended that criteria for innovation be included and favored in bidding documents for public housing and incorporated into municipal construction regulations. Funding to sector organizations in association with CONACYT could be an avenue to foster the development of environmental friendly technologies for housing in Mexico. Finally, public education campaigns could effectively be used to promote good practice in the use o f water and energy and recycling o f household waste.

Sustainability indicators for the urban sector. As in the housing sector, the urban sector EA recommends that SEDESOL begin collecting information to take environmental costs into account in sector activities. Again, this may be done through intergovernmental coordination with SEMARNAT, the Secretariats o f the Government, Energy, Health, and Communications and Transport, CONACYT and the states.

Institutional Strengthening. The EA suggests that SEDESOL take on sustainability of urban development as an explicit function. This could be done through the current structure o f the Secretariat at the central level or through the creation o f a deconcentrated entity that would develop, monitor and enforce sustainability objectives. The EA also advocates the creation o f a capacity building program for urban development professionals in city, state and federal government. The program would cover the

Page 46

following topics: holistic vision of the urban development process and the explicit environmental sustainability links; how to apply environmental topics in urban development and land use plans and the development and use of related environmental indicators.

Geographic information systems. The EA outlines the need to strengthen geographic information systems at the state level. The information should support improvements in cadastre and civi l protection systems. They should incorporate at least the geographic information o f the programs o f CORETT and PROCEDE, as well as environment and social information generated from states and facilitate the interchange o f information between municipalities and the states.

Strategic Environment Assessment (SEA). A major recommendation o f the EAs i s the need to carry out a Strategic Environmental Assessment as part o f the housing and urban program. The SEA i s intended as an instrument to systematically evaluate housing and urban development policies in far greater depth than possible in the rapid EA. The SEA focuses on an interactive process involving key policy makers and stakeholders with the aim o f identifying urban, housing and environmental linkages and ultimately to inform decision makers to facilitate policy choices which better take environmental impacts into consideration. .

D. Coverage o f Safeguard Policies

Per Bank guidelines, a SECAL triggers only O.P. 4.01. Nonetheless, the EA addresses issues related to al l applicable Bank Safeguard Policies, including Natural Habitats, Cultural Property and Involuntary Resettlement. Regarding the latter, even though the O.P. on Involuntary Resettlement i s not triggered, the SEA wi l l include discussion o f current policies governing resettlement under the various housing and urban development programs. As the HUSAL does not finance any direct investment, mitigation measures for environment and resettlement are foreseen to be at the policy level, rather than a project- specific level. That said, the project i s dedicated to addressing environmental and social issues in an open, transparent and constructive manner; and has full buy-in of the Mexican government in the effort to build coherent, just and sustainable policies in the urban and housing sectors.

E. Public consultation and disclosure

The EAs were submitted to the Bank and were reviewed by the project team, and found to cover all the relevant topics required by the Bank Safeguard Policies. The documents have been made available to the public on the Bank Infoshop and in the main offices o f the Mexico sectoral agencies - Conafovi (housing) and SEDESOL (urban development). Public consultation i s a main activity of the SEA, as such many opportunities wi l l be presented to solicit public opinions on the environmental issues related to the supported programs.

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I.

11.

111.

IV.

V.

VI.

VII.

VIII.

ANNEX 4

MEXICO-FUND RELATIONS (As of January 31,2004)

Membership Status: Joined December 3 1, 1945; Article VIII.

General Resources Account: SDR Million Quota 2,585.80 Fund holdings of currency 2,05 9.3 2 Reserve position in Fund 526.53 Financial transaction plan transfers (net) 87.00

SDR Department: SDR Million Net cumulative allocation 290.02 Holdings 29 1.64

Outstanding Purchases and Loans: None

Financial Arrangements: None

% Quota 100.00 79.64 20.36

% Allocation 100.00 100.56

Projected Obligations to the Fund: 5 SDR 50,000 (annually 2004-2007)

Exchange Rate Arrangement: Mexico has a floating exchange rate regime since December 22, 1994. Mexico maintains an exchange system that i s free o f restrictions on the making of payments and transfers for current international transactions.

Article I V Consultation: The last Article IV consultation was concluded by the Executive Board on October 15, 2003. The relevant staff report was SM/03/326.

IX. Resident Representative: None.

Page 48

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ANNEX 6: STATUS OF BANK GROUP OPERATIONS

M e x i c o Sta tement o f IFC's

H e l d and D isbu rsed Por t fo l i o A s o f 9 / 3 0 / 2 0 0 3

F Y A p p r o v a l C o m p a n y L o a n E q u i t y Q u a s i Pa r t i c L o a n E q u i t y Q u a s i Pa r t i c 198 8/9 1 /92 /9 3/95 A pasco 0 28.8 7.2 0 0 28.8 0 ?-I

1995199

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2000/0 1

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1998 A y v i 0 B B V A - B a n c o m e r

B a r i n g M e x F n d 1998 C I M A M e x i c o 1998 C I M A Pueb la

C T A P V 0 C h i a p a s - P r o p a l m a

1997 C o m e r c i a l i z a d o r a 2 0 0 1 C o m p a r t a m o s 2003 C o p a m e x 2002 C o p p e l 1999 C o r s a 2 0 0 1 E c o m e x 2000 E d u c a c i o n

1998 F o r j a M o n t e r r e y 2 0 0 1 G F N o r t e

1993 G I D E S A

F o n d o C h iapas

G I B S A

G I R S A 0 G r u p o B B V A

1998 G r u p o C a l i d r a 1989 G r u p o F E M S A 1997 G r u p o M i n s a

G r u p o Posadas 1998 G r u p o San fand i l a 2000 H o s p i t a l A B C 2 0 0 0 I T R 2 0 0 0 I n n o p a c k

0 I n t e r o y a l I n v e r C a p

1998 M e r i d a I11 2003 M e x m a l

M e x p l u s Puer tos 1996/99 /00 /0 1 N E M A K

2003 O c c i d e n t a l H o ...

2003 P O L O M E X S .A . 2000 Pan A m e r i c a n 2001 P la ta 2002 Puertas F inas 2002 Q u a l i t a 2000 R i o B r a v o 2000 Sa l t i l l o S . A . 2000 Serv i c ios 2001 S u Cas i ta 1997 T M A 1992 T o l u c a T o l l R o a d

0 Z N M e x i c o 11 1998 Z N M x c E q t y F u n d

T o t a l P o r t f o l i o :

0 O c c i h o l

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6.43 42.35

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6.75 1.93

0 1.75

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8.36 5

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9.29 5 0

13.52 0

38.57 0 8 0

13.14 23.68

6.08 3 0 12 0 0 0

27.78 10

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10 13 0

47 .69 33.31

9 1.76 1.98 1.25

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1.89 0 4.8 0

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1.02 0 0 1.25

0.66 0 0 0 0 0 3 0

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3.53 0 3 0 0 0 0 0 0 0 0 0

2.67 0 6 0

2.85 0 0 0 0 10 0 0 0 0 0 0

15 0 0.0 1 0 0.07 0

0 0 0 0

1.4 1 0 0 1.51 0 0

9.99 0 0 0 9 0 0 0 0 0

2.5 3.5 0 0 0 0

1.9 0 10.62 0

0 2.75 0 0

10 0 15.3 0

0 0 0 0 0 0 0

2.5 0 0 0 0 0 0 0

9.29 0

45.48 0

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55.06 39.46

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9 1.76 1.98 1.25

0 0

590.32 106.72 20.06 395.11 432.51

0 0

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0 0 0 0 0

1 .os 0

1.25 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0

10 0 0 0 0 0 0 0 0 0

1.5 1 0 0 0 0 0 0

3.5 0 0 0 0

2.75 0 0 0

20.06

0 0 0 0 0 0 0

2.5 0 0 0 0 0 0 0

9.29 0

45.48 0

51.43 0 5 0

18.78 0

2.45 7.21 3.33

0 0 0

64.34 0 0 0

4 0 0 0 0 0 0 0

55.06 39.46

8.33 0

6.86 0 0 0

388.32

Page 50

Approvals Pending Commitment Loan Equity Quasi Partic

1999 BANAMEX LRF I1 50 0 0 0 2001 BBVA-Bancomer CL 100 0 0 0 1998 Cima Hermosillo 7 0 0 0 2003 Copamex 7 0 0 60 2001 Ecomex 3.5 0 0 0 2000 Educacion 3.2 0 0 0 200 1 GFNorte-CL 50 0 0 100 2003 Mexmal 0 0 5 0 2003 Polomex 2 0 0 0 2003 Rio Bravo I11 50 0 20 170 2003 Rio Bravo I V 50 0 20 170 2003 Tizayuca 25 0 10 30

Total Pending Commitment: 347.7 0 55 530

Page 5 1

Mexico at a glance

I T

9/3/03

POVERTY and SOCIAL

2002 Population, mid-year (millions) GNI per capita (Atlas method, US$) GNI (Atlas method, US$ billions)

Average annual growth, 199642

Population ("A) Labor force (%)

Most recent estimate (latest year available, 1996-02) Poverty (% of population below nabonal poven'y line) Urban population (% of total population) Life expectancy at birth (years) Infant mortality (per 1,000 live bilths) Child malnutrition (% of children under 5) Access to an improved water source PA ofpopulabon) Illiteracy (% of population age f5+) Gross primary enrollment (% of school-age population)

Male Female

KEY ECONOMIC RATIOS and LONG-TERM TRENDS 1982

GDP (US$billions) 173 7 Gross domestic InvestmentlGDP 22 9 Exports of goods and serviceslGDP I 5 3 Gross domestic savings/GDP 27 9 Gross national savings/GDP 21 5

Current account balance/GDP -3 4 Interest paymentdGDP 4 5 Total debt/GDP 49 6 Total debt service/exports 52 3 Present value of debtlGDP Present value of debtlexports

1982-92 1992-02 (average annual growth) GDP 1 9 3 2 GDP per capita -0 1 1 6 Exports of goods and sewices 5.1 134

100.9 5,920 597.0

1.4 2.4

75 74 25 8

88 8

113 114 113

1992

363 6 23 3 15 2 18 3 16 6

-6 7 1 6

30.9 33 8

2001

-0.3 -1.8 -3 6

527 3,280 1,727

1.5 2.2

76 71 27 9

86 11

130 131 128

2001

623.9 20.9 27.4 18.6 17.9

-2.9 1.9

25.4 26.3

2002

0.9 -0.6 1.4

Latin America

Mexico & Carib.

Upper- middle- income

331 5,040 1,668

1.2 1.8

75 73 19

90 7

105 106 105

2002

637.2 20.3 27.2 18.3 18.0

-2.2 1.7

24.2 18.8

2002-06

3.8 2.1 5.6

Development diamond'

Life expectancy

GNI Gross per primary

nrollment capita

I

i Access to improved water source

~ Mexico Upper-middle-income group I ___-

Economic ratios"

Trade

T + Investment Domestic

savings

Indebtedness

Mexico Upper-middle-income group

-a

. .

STRUCTURE of the ECONOMY

(ss of GDP) Agriculture Industry

Services

Private consumption General government consumption Imports of goods and services

Manufacturing

(average annual growth) Agriculture Industry

Services

Private consumption General government consumption Gross domestic investment Imports of goods and services

Manufacturing

1982 1992 2001

8.1 6.7 4.1 33.4 28.1 27.1 21.7 20.2 19.6 58.4 65.2 68.7

61.6 71.8 69.6 10.5 9.9 11.8 10.3 20.3 29.7

1982-92 1992-02 2001

0.7 1.7 3.3 2.5 3.7 -3.5 3.0 4.3 -3.7 2.0 3.1 0.7

2.7 2.9 2.7 2.1 1.5 -1.2 2.5 4.7 -5.2

11.2 11.8 -1.5

2002

4.0 26.6 18.9 69.4

70.0 11.8 29.2

2002

-0.4 0.0

-0.6 1.4

1.2 -1.3 0.5 1.6

Growth of investment and GDP (%) i

-GDI -GDP I Growth of exports and imports (%)

20

10

0

-10

Note: 2002 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.

Page 52

PRICES and GOVERNMENT FINANCE

Domestic prices (% change) Consumer prices Implicit GDP deflator

Government finance (% of GDP, includes current grants) Current revenue Current budget balance Overall surplus/deficit

TRADE

(US$ millions) Total exports (fob)

Oil Agriculture Manufactures

Total imports (cif) Consumer goods Intermediate goods Capital goods

Export price index (7995=1001 Import price index (i995=iOO) Terms of trade (1995=100)

BALANCE of PAYMENTS

(US$ millions) Exports of goods and services Imports of goods and services Resource balance

Net income Net current transfers

Current account balance

Financing items (net) Changes in net reserves

Memo: Reserves including gold (US$ millions) Conversion rate (DEC, local/US$)

EXTERNAL DEBT and RESOURCE FLOWS

(US$ millions) Total debt outstanding and disbursed

iBRD IDA

Total debt service IBRD IDA

Composition of net resource flows Official grants Official creditors Private creditors Foreign direct investment Porlfolio equity

World Bank program Commitments Disbursements Principal repayments Net flows Interest payments Net transfers

1982 1992 2001 2002 I Inflation (%)

58.9 15.5 60.9 14.4

27.4 23.7 -6.0 5.0

-14.1 1.4

1982 1992

24,055 46,196 16*477 8.307 1,233 2,112 5,843 35,420

17,011 62,129 1,517 7,744

10,991 42,830 4,502 11.556

127 91 74 91

171 100

1982 1992

28,169 55,387 22,841 73,617

5,328 -1 8,230

-12,261 -9,595 1,043 3,386

-5,890 -24,438

2,316 26,184 3,574 -1,745

914 18,975 5.64E-2 3.1

1982 1992

86,081 112,315 2,692 11,966

0 0

15,684 20,751 328 1,874

0 0

76 14 1,577 615 6,391 -531 1,655 4,393

0 4,783

540 1,313 408 1,352 133 981 275 371 195 892 80 -522

6.4 5.0 6.5 4.6

21.8 22.6 1.9 0.2

-0.7 -1.2

2001 2002

158,443 160.813 12,799 14,475 3,903 3,998

141,353 141,951 168,396 168,949 19,752 21,178

126,149 126,778 22,496 20,992

103 106 103 104 101 102

2001 2002

171,103 173,374 184,614 185,419 -13,511 -12,045

-13,835 -12,282 9,338 10,268

-18,008 -14,058

25,347 19,851 -7,339 -5,793

44,814 50,607 9.3 9.7

2001 2002

158,291 153,923 10,883 10,596

0 0

48.729 35,254 2,178 2,093

0 0

-669 -432 3,198 -3,932

25,334 13,627 151 -104

880 1,322 749 1,247

1,314 1,356 -565 -108 864 737

-1,429 -845

I GDPdeflalor -CPI I

Export and import levels (US$ mill.)

/ ~ . m T

96 91 98 99 W 01 02

Exports Imports

Current account balance to GDP (x)

1

/Composition of 2002 debt (US$ mill.)

F 1 16,503

A - IBRD B - IDA D - Other multilateral F. Private C - IMF

E - Bilateral

G - Short-term

Development Economics 9/3/03

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