Document of

The World Bank

FOR OMCAL USE ONLY

Rqet No. 5162

PROJECT COMPLETION REPORT

MEXICO

SEVENTH HIGWAY PROJECT

CLQ ON 968-ME)

June 26, 1984

Latin America and Caribbean Regional Office

ThI decumed ha a restricted distisbuth. and may he used by recipieut only in the perferinac oftheir sEfcial duties Us centeat may not odhewwse be discosed without World Dank autborvzatiom.

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FOR OFFMCIAL USE ONLY

,MEXICO

SEVENTH HIGHMAY PROJECT (LOAN 968-ME)

PROJECT COMPLETION REPORT

TABLE OF CONTENTS

Page No.

PREFACE ............ i

BASIC DATA SHEET . ii

MISSION DA.A -iii

HIMGLIGKTS iv

I. IDTRODUCTION L

II. PROJECT PREPARATION, APPRAISAL AND NEG OTIATIONS 1.

III. PROJEC- EXECUTION 4

IV. COST ESTIMATES AND DISBURSEMENTS 6

V. ECONOMIC REEVALUATION . 8

VI. PERFORMANCE OF THE BORROWE . .10

VII. ROLE OF THE BANK..11VIII. RONLUSIOWS THE .....BANK ...................... .................... 11

VIII. CONCLUSIONS..---------------------- 1.1

TABLES

1. Original Seventh Highway Project . 122. Revised Seventh Highway Project .133. Comparison Between the Appraisal & Final Cost Estimates . 144. Indicators for Economic Reevaluation .15

ANNEX

Letter from the Borrower ................................ 16

MAP

IBRD 10549R (PCR) - Mexico - Seventh Highway Project

This document has a susicted dtbutn and may be ued by cipients only m th -performanceof their offlcil duds Its contents may not othris be disclosd wbout World Bank authorizaion.

PROJEC3 COaP1ETON REPORT

MFlCO SEVENH HIGHAY PROJECr(Loan 968-NE)

PEFACE

This report presents a performance audit of the Seventh HigbwayProject in Mexico for which the Executive Directors approved Loan 968-NEin the amount of US$90 million on February 12, 1974. The loan was closed,fully disbursed, on June 30, 1982. The report consists of a ProjectCompletion Report (PCR) prepared by the Bank's Latin America and CaribbeanRegional Office and an Annex presenting the Borrower's comments on the PCRL

In accordance wlth the revised procedures for project performanceaudit reporting, this Project Completion Report was read by the OperationsEvaluation Department (OED) but the project was not audited by OED staff.The draft report was sent to the Borrower for comments; the reply is shownas an Anex.

MEXICO

SEVENTH HIGHWAY PROJECT (LOAN 968-ME)

PRojECT COMPLETION REPORT

Basic Data Sheet

Key Project Data

OriginalItem Plan Actual

Total Project Cost (US$ million) 241.4 1/ 326.9 1/Loan Amount (US$ million) 90.0 90.0

Disbursed as of July 1981 90.0 90.0Date Physical Component Completed 06/30/78 1983Economic Rate of Return (Z) 23.0 24.0

Other Project Data

First Mention in Files 04126/72Government Application - 11J17/72Negotiations 12/04/73 12/04/73Board Approval 02/12/74 02/12/74Loan Agreement Date 03/01/74Effectiveness Date 05/29/74 05129/74Closing Date 12/31/78 06/30/82Borrower Nacional Financiera S.A.

(NAFINSA)Executing Agency SAHOPFollow-On Project Highway Sector ProjectLoan Number Loan 1671-MEAmount US$120.0 million equivalentLoan Agreement 08/23/79

Country Exchange Rate

Name of Currency (abbreviation) Mexican peso (Mex$)Appraisal Year Average US$1.00 = Mex$12.5Intervening years average 2/ 1973-1975 - US$1.00 = Mex$12.5

1976 - US$1.00 = Mex$15.41977 - US$1.00 = Mex$22.6

a 1978-1979 - US$1.00 = Mex$22.81980 - US$1.00 = Mex$23.01981 - US$1.00 = Mex$24.5

1/ Project cost in the original plan refers to the original project, whilethe actual cost refers to the reduced project (para 3.06).

2/ Source: International Financial Statistics. IMF

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MEXICO

SEVENTH HIGHWAY PROJECT (LOAN 968-ME)

PROJECT COMPLETION REPORT

Mission Data

No. of No. of Staff

ype DMonth/Year Staff Weeks Weeks Date of Report

Identification 05/72 2 2 4 06/06/72Preparation 12/72 1 1/2 1/2 01/03/73Preparation 02/73 1 1/2 1/2 03/03/73Preparation 02/73 2 1 2 03/23/73Appraisal 05/73 3 3 9 11/14/73Post-Appraisal 10/73 2 1 2 N.A.

TOTALS 8 18

Supervision

Supervision 04/74 1 1 1 05/21/74Supervision 11/74 2 2 4 N.A.Supervision 05/75 1 2 2 06/13/75

Supervision 07/75 2 2 4 09/10/75

Supervision 02/76 1 1 1 03/17/76Operational 06/76 1 1 1 06/17/76

Supervision-Operational 07/76 2 2 4 08/30/76

Supervision 04/77 2 1 2 05/25/77

Supervision 09/77 2 1 2 10/02/77

Supervision 01/78 2 2 4 02/07/78

Supervision 04/78 3 1-1/2 4-1/2 05/12/78Supervision 04/79 1 1 1 04/06/79Supervision 06/79 1 1 1 06/29/79Supervision 10/79 1 2 2 11/02/79Supervision 04/80 1 2 2 05/29/80

Supervision 11/80 2 1 2 12/19/80

Supervision 07/81 1 1 1 07/31/81

Total Supervision Effort (Staff Weeks)

FY1974 FY1975 FY1976 FY1977 FY1978 FY1979 FY1980 FY1981 FY1982 Total

0.9 4.1 8.0 7.2 12.5 4.3 4.5 2.1 2.2 45.8

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PROJECr COMPLETION REPORT

MEXICO

SEVENTH HIGBRAY PROJECT (LOAN 968-ME)

HIGELIGHTS

1. Loan 968-ME for US$90 million supported widening and constructionof about 1,245 km of Mexico's highway network. Of these, three main highways

4 were widened to four lanes (127.5 km) and seven major new roads were constructed(1,118 km).

2. The project had originally included four roads (201 km) to bewidened to four lanes a-d twelve new roads (1,674 km) to be constructed, acontemplated total of 1,875 km. Due to long dElays, calused by a shortage oflocal funds, in beginning implementation of the project, estimated projectcosts increased by a factor of three. By April 1966, almost three yearsafter loan signature, when the Government proposed a major reduction inproject scope, no work had yet begun on any of the portions of the project tobe deleted. Progress on other project roads had reached about 25Z ofcompletion.

3. Despite the delays and increases in costs, the project was generallysuccessful in achieving its objective of assisting in modernizing andconstructing key sections of Mexico's road network. Economic returns onthe investments were satisfactory because cost increases were offset byincreases, in real terms, in vehicle operating cost savings and time savings.

4. The following points may be of particular interest:-

(a) increases in costs, reasons therefore and actiontaken (paras. 3.01 to 3.06); and

(b) effects of inflation, design changes and shortagesof local funds (paras. 4.01 and 4.02).

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PROJECT COMPLETION REPORT

MEXICO SEVWNTH HIGHWAY PROJECT (WAN 968-ME)

I. INTRODUCTION

1.01 mexico's large size, rugged topography and dispersed populationhave made transport a crucial element of the country's development policy.In the highway subsector, the main emphasis from the mid-1950s to 1970 was oncompleting the primary radial network from the central region to importantstate capitals and toward key border points. In the early 1970s, this effortwas continued, and major new highways were built to open up the BajaCalifornia peninsula and link the regions along the Pacific and Gulf ofMexico coasts respectively. Emphasis then shifted to rural roads invest-ments, and 73,000 km of feeder roads were built over the period 1971-1976(corresponding to one fifth of new investment expenditures), bringing some6.4 million people living in 7,400 small and isolated localities into themainstream of economic life. The highway network now includes about 62,000km of paved roads, 88,000 km of gravel roads, and 48,000 km of earth roads;in general, the network is adequately maintained and of good standard.

1.02 Over a period of 18 years, since 1964, the Bank has made eighthighway loans to Mexico for a total of US$387 million equivalent. Out of atotal primary network of some 40,000 km, the Bank has assisted or is assist-ing in the improvement or construction of about 14,000 km. In the course ofthis long association, the Secretariat of Public Works (now the Secretariatof Human Settlements and Public Works - SAHOP) 1/ has achieved considerableprogress in all aspects of highway planning, evaluation and execution. Thequality of the works executed under past Bank projects has been satisfactory.

II. PROJECT PREPARATION, APPRAISAL AND NEGOTIATIONS

2.01 In May 1972, a reconnaissance mission visited Mexico to identify apossible Seventh Highway Project. Government officials originally presentedthe mission members with a preliminary list of two roads needing wideningfrom two to four lanes (35 km) and four roads for reconstruction (685 km).The list was subsequently extended, and, late in 1972, the Mexican Governmentformally requested Bank assistance to finance the improvement or constructionof 18 main roads in several regions of the country. The economic informationand engineering studies for the proposed roads were being prepared by SAHOPand were expected to be completed at various dates through the end of 1973.The preliminary cost estimate of the project was about US$200 million.

2.02 Detailed engineering for six of the project roads 2/ was not goingto be completed by the assumed date of Board presentation, but the MexicanGovernment requested that the package of 18 roads be appraised at one time.The Bank agreed to include works on 16 roads, totaling about 1,875 km, in theproposed project (Table 1). For those roads on which detailed engineeringwas not completed, the evaluation would be based on preliminary cost fig res,and disbursement would be conditional upon confirmation of the economicjustification based on the cost estimates after detailed engineering wascompleted. Such confirmation was subsequently received.

1/ Throughout this report, the Secretariat is referred to as SAHOP.

2/ Items 1, 4, 6, 7, 8 and 10 in Table 1.

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2.03 The project was appraised in April 1973. Most of the project roadswere justified on the basis of savings in vehicle operating costs and trafficgrowth, but the economic justification of four of the roads was based largelyon agricultural development 3/. To achieve this development, the Bankconsidered indispensable the carrying out of small irrigation works alongthree of those roads 4/ at a total cost of about US$5 million. Theabove-mentioned works were supposed to start six years later (in 1978);therefore, the Bank requested and obtained Government assurances that theworks would be included In the long-term program of the Government and wouldbe carried out in a timely manner. The works were subsequently carried outin the context of the large Mexican irrigation and rainfed agriculturalschemes.

2.04 The Issues Paper was circulated on June 7, 1973; its highlightsincluded.

(a) Foreign Exchange Component. The Mexican Government recalculatedthe foreign exchange component of the proposed project and found itto be about 40%, as compared to the 33% used in the previous one.The reason presented for the increase was that standards, as wellas better specifications and their strict enforcement in highwayconstruction, had led to the use of additional and more sophis-ticated imported equipment. The Bank, after reviewing the analysiscarried out by SAHOP, found the increase justified.

(b) Reserved Bidding for Part of Proposed Works. SAROP requested thatcertain works, such as specific bridge works and signalization,amounting to 12% of estimated project cost, be reserved for localcontractors although still awarded on the basis of competitivebidding. The Bank recognized that, in practice, because of thestrength of the local industry, bidding for highway projects inMexico is virtually limited to the domestic contracting industry.It thus agreed that the advertising of the above-mentioned works,when not exceeding US$24.3 million, could be limited to newspapersof general circulation in Mexico.

(c) Conditions for Board Presentation. The Second Railway Project(Loan 825-ME) included provisions to carry out a road user chargesstudy. Since the start of the study was experiencing extensivedelays, the Bank decided to make the finalization of a contractwith the consultants for carrying out the study a condition forBoard presentation of the proposed Seventh Highway Project.

2.05 Negotiations took place in Washington between the 3rd and 5th ofDecember 1973. By the end of January 1974, substantial progress toward theinitiation of the above-mentioned road user charges study had been made.The executing agency for the study (SCT) 5/ was negotiating the details of a

3/ Table 1, Items 13, 14, 15 and 16.

4/ Table 1, Items 13, 15 and 16.

51 Secretaria de Comunicaciones y Transportes, the Secretariat incharge of Transport policies.

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contract with the consultants who had made the best technical offer. TheBank felt that there was little chance that those negotiations would not leadto the signature of a contract and that the condition of such signature forBoard presentation would only delay the implementation of the project.Therefore, the Bank agreed to waive that condition 6/,. A loan for the amountof US$90 million equivalent was approved by the Executive Directors onFebruary 2, 1974, and the loan became effective on May 29, 1974.

2.06 The estimated cost of the project, as given in the appraisalreport, was:

US$ Million ForeignLocal Foreign Total Exchange

a. Highways

Ci) to be widened 22.1 14.7 36.8 40(ii) to be constructed 88.8 59.2 148.0 40

Subtotal 110.9 73.9 184.8

b. Contingencies

(i) Physical (1OZ) 11.0 7.5 18.5 40Cii) Escalation (11.62) 12.8 8.6 21.4

Subtotal 23.8 16.1 39.9

Total Construction Cost (a+b) 134.7 90.0 224.7 40

C. Supervision of Construction 13.5 - 13.5 1/C6Z of (a+b)

d. Right-of-Way 3.2 - 3.2 1/

Subtotal 16.7 16.7

Total Project Cost 151.4 90.0 241.4

1/ Not financed under the project.

2.07 This Completion Report is based on information obtained from theMinutes of the Board Meeting, the Bank's Record Center, LAC InformationCenter, and reports prepared by SAHOP, in charge of the project supervision.

6/ The Project Completion Report for the Second Railway Project, datedFebruary 9, 1979, states that the study was carried out.

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III. PROJECT EXECUTION

3.01 Project implementation suffered substantial delays almost from thestart because of a sbortage of local funds due to a sudden change in theeconomic performance of the country. Mexico, after a long period of pricestability, experienced, in 1973, the beginning of a strong and continuing inrflationary process. During the initial period of project execution, SAHOPfound itself in a financial squeeze which left it with an eroded budget inrsufficient to fulfill its commitments. Later on, the shortage of funds wasthe result of Government stabilization policies which included not only a re-duction in overall expenditures but also a concentration of available fundsin projects considered of the highest priority and expected to have a large .9and prompt impact upon the productive capacity of the country. During 1974,1975, and 1976, budgetary allocations for the Seventh Highway Project wereMex$ 14.8 million, Mex$ 270.0 million, and Mex$ 506.0 million respectively,over a total original project cost of Mex$ 2,808.9 million and a scheduledcompletion date of mid-1978. Furthermore, by mid-1975, SAHOP estimatedproject cost increases of 53% and expected them to reach 88% by the tine thatthe works were completed. In the fall of 1975, the Seventh Highway Projectwas placed on the list of problem projects.

3.02 To enable broader international competition, roads were dividedinto 33 bidding sections. Contractors could bid for one or more sections,and contracts would be awarded on the basis of (a) the lowest evaluated bidfor the entire road or (b) the lowest evaluated combination of bids for itssections. The shortage of funds (para 3.01) slowed the pace of biddingconsiderably. Only three international bids were invited in 1974, 15 in 1975and none in 1976.

3.03 Inflationary pressures were also the cause of bid proposals beingsubstantially higher than expected, with increases ranging from 0 to over100% of the estimated bids. The problem was exacerbated by the lack of anescalation clause in the contracts, which added to the bidders' uncertaintiesregarding future prices. Early in 1975, SAHOP organized a working groupresponsible for finding an adequate price escalation formula to be includedin subsequent contracts. A proposed clause was submitted for approval to ahigh level committee comprising four Under-Secretaries and a representativeof the Chamber of the Construction Industry, and a final clause was approvedand implemented in early 1976, resulting in an evident reduction of the bidprices. The escalation clause stated that, when the costs that were thebasis for estimating the bid unit prices underwent an increase of more than5% of the works not yet carried out, the contractor could request theadjustment of his unit prices providing a full justification for such action.

3.04 By mid-1975, progress on project implementation was minimum, and nodisbursements had been made. By that time, it was evident that measures totackle the problem of substantial cost increases, coupled with budgetaryconstraints, were needed. The Bank and SAHOP started to study alternativesolutions, which included:

(a) reducing the scope of the project on the basis of a revised costestimate, deleting some of the project roads so that the Bank couldcontinue its participation at the same 40Z rate of disbursement;

(b) reducing Bank participation so that the original scope of theproject could be maintained; and

Cc) a combination of (a) and (b).

One year later, no decision had been reached, although both SABOP and theBank favored a reduction in the size of the project. By then, the Mexicanauthorities preferred to leave the final decision regarding changes in thescope of the project to the new government that was going to be inauguratedin December 1976.

3.05 On April 19, 1977, the Government formally proposed to the Bank aprogram for implementing project works, which included the reduction of thescope of the project by deleting five roads and part of a sixth road; theproject's original total length of roads, 1,875 km, was therefore reduced by659 km to 1,216 km 7/. Nb contracts had been awarded for works on any ofthe roads to be deleted.

3.06 SAHOP's proposal included two important features: (a) the totalloan amount would be maintained at US$90 million; and (b) the disbursementpercentage would be kept at 40%; in fact, the size of the project reductionwas tailored so that the disbursement rate would not be affected. The pro-posal also included a yearly investment program, road by road, for the re-duced project. The Bank, after confirming that the roads in the project werestill economically justified in spite of the increased costs, and satisfiedthat the Government proposals were an important step toward the successful(albeit delayed) completion of the now reduced project by June 30, 1981,agreed to it. The Loan Agreement was changed accordingly on July 31, 1977.

3.07 The pace of civil works on the project roads improved substantiallyafter the reduction of the project scope, and, in early 1978, the Bankdeleted the loan from the list of problem projects. By the middle of 1979,project completion was estimated at 73% as compared to the 17% progress onthe reduced project by the end of 1976 (two and a half years after loaneffectiveness).

3.08 In November 1979, the Mexican Government requested that the Coatza-coalcos-Minatitlan road also be deleted from the project. The original pro-posal was to widen the road from two- to four-lane to accommodate increasingtraffic between Coatzacoalcos and Minatitlan as well as between that area andTehuantepec, Veracruz, Mexico City and Villahermosa. What was not foreseenthen was the tremendous economic growth, based on the petroleum developmentthat had occurred in the region since 1975. As a result, traffic on thecritical Coatzacoalcos bridge, the only practical gateway between the leftbank of the Coatzacoalcos river and the State of Tabasco, had doubled to14,000 vehicles a day, reaching capacity. Since the bridge, not theCoatzacoalcos-Minatitlan road, had become the major transport bottleneck, the

71 Subsequent changes in the design of some of the roads brought the totallength of project roads to 1,245.5 km.

Mexican Government decided to build a new bridge, closer to Minatitlan, with31 km of access roads (including a bypass of the town), at an estimated totalcost of US$60 million. The construction of the bridge would change thetraffic pattern in the area, making it possible to delay widening of theproject road. The Bank agreed to the deletion of the road from the projectand to the reallocation of the thus freed funds to the remaining works underthe loan.

3.09 The project continued to experience large cost increases, causedmainly by inflation but exacerbated by design modifications due, in somecases, to increased traffic projections, but mostly to unexpected works indifficult mountainous areas. Revision of cost estimates performed in late1979 showed the total costs of the reduced project to be Mex$ 6,000 millionrather than the Mex$ 4,500 estimated in June 1979. It was then clear that,even with the deletion of the Coatzacoalcos-Minatitlan road, the US$90 mil-lion of the loan were about US$27.6 million short to cover the foreignexchange component of the project. The Bank started to consider alternativeactions that would enable it to participate until the end of the constructionworks, but it was finally decided that the solution that would best corres-pond to the spirit of the Sector Loan (Loan 1671-ME signed on August 23,1979) would be to continue disbursements at the rate of 40X 8/ until fundsran out, provided that the remainder of the road sections would not befinanced out of the Highway Sector Loan. This alternative would confirm thebasis on which the Sector Loan was made, i.e., that the Bank had confidencein the programs carried out by SAHOP, on which there were periodic consulta-tions, and that the Bank expected that road sections, once started, would becompleted. The provision of funds for completion of the works on three roadsthat would remain after disbursement of all loan funds would be monitoredthrough the semi-annual consultations on budget and multi-year programs onwhich the Bank was given opportunities to comment. The Mexican Governmentagreed to this approach, and the loan was fully disbursed by July 1981.

3.10 Three of the project roads (Temascatelpec-Zihuatanejo, Playa Azul-Coahuayana and Pochutla-Salina Cruz) are expected to be completed by the endof 1982. The reasons for the slippage of these roads are: (a) unrealisticschedule of complicated works and (b) low budget allocations triggered by ashift of Government concerns toward modernizing the existing network.

IV. COST ESTIMATES AND DISBURSEMENTS

4.01 The outstanding characteristic of the project was the sharp in-crease of final project costs in current Mexican pesos. Nominal constructioncosts of the revised project increased more than 300Z over initial costestimates, when expressed in current Mexican pesos, and 126% in US dollars(Table 3) . These Increases took place in an unprecedented period of infla-tion which started in 1973 (para 3.01), but were exacerbated by the cost in-

8/ Actually 42% of 95Z (expenditures -5% retention) (para 4.03).

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cr-eases resulting from changes in design (para 3.10). SAROP carried out theconstruction supervision (not Bank-financed) with its own staff, and thecosts incurred in this task are not available.

4.02 While construction prices were increasing rapidly, the public sec-tor budget was not keeping pace as inflation control measures were taken.The road budget was cut in real terms to reduce the impact of the publicsector deficit. The domestic component for completing the project onschedule was not available, and Bank funds could not be disbursed. The Bankinsisted unsuccessfully that budget allocations be increased for the projectroads, and loan disbursements lagged far behind appraisal estimates, as sbownbelow:

Accumulated Disbursements in -JS$ uiUior

Actual as XFiscal Year Appraisal Estimates Actual of Appraisal

1974 0.4 0 01975 9.0 0 01976 28.0 7.0 251977 54.0 22.8 421978 82.0 32.2 391979 90.0 54.0 601980 90.0 75.1 831981 90.0 88.3 981982 90.0 90.0 100

4.03 The Mexican Government retains 5% of payments under civil workscontracts, for a period of one year, as a guarantee that the contract hasbeen properly executed. After much discussion with Mexican autborities, theController's Department decided that the Bank could not disburse against thisretention until it was actually disbursed to the contractor 9/. This led toa considerable record-keeping problem for the Government and NAFINSA, and,during the negotiations for the Small Scale Agricultural InfrastructureProject (Loan 1643-ME) in November 1978, the Bank agreed to disburse againstthe value of civil works contracts, less the amount retained, but thedisbursement rate-would he increased slightly in order to finance the sameportion of total project costs. NAFINSA, in a letter dated March 2, 1979,requested that the Bank adopt the sme approach to several other loans,includIng Loan 968-BE. The Bank agreed to NAFIRSA'Ws request, and, in August1979, the loan agreement was amended: disbursement percentage for civilworks was increased to 42%, and guarantee retentions were excluded from thedisbursement base.

4.04 The allocation of proceeds of the loan wa revised once, asfollows:

9/ Contractors were given a bond, equivalent to the 5% retention, which wasdiscountable at commercial banks before the one year-period ended.

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Revisions

Category Orgnl(11/30/1979)

I CivLil works. for part A ofthe project 14,700,000 90,000,000

II Civil works for part B ofthe projet -59,200,000 0

III Unallocated 16,100,000 0

Total 90,000,000 90,000,000

At the tim of the reallocatiLon, iLt was decided to place all civil works inthe project under category I.

V ECONOMIC REEVALUATION

5.01 The Seventh pighway Project was justified at appraisal90, 0 inly onthe basis of quantifiable benefits accruiLng to road users from reduced vehi-cle operating costs and travel time which would result from improwements inroad design and surface characteriLsticr. In the case of three of the projectroads 0II benefits were derived from expected agricultural development.The al;raisal estimate of the weighted economic rate of return (ERR) was 23%,whiJle reevaluation, based on SAHOP' s Fn-al Report of February 1982 amnl oncomposite savings In vehicle operating costs derived from simi1 r projects inMexico and other Latin Americau countries, resulted in a weighted ERK of24%. Lack of relevant data precluded an economic analysis based onagricultural development for the three above-mentioned roads.

5.02 For the purpose of the eronomic reevaluation, costs were expressedIn constant 1981 Mexican pesos using the construction industry price indexprovided by the BRank of MAexico. W hen expressed in constant 1981 pesos, thereal total cost of the project increased by only 23Z, mainly due to designchanges justified by larger-thai-expected traffic growth rates and by dt-planned extra works in difficult mutiosterrain. Whbat follows takes acloser look at the economic performance of individual. project roads.

Highway Widened from Two to Four Lanes

5.03 As shown in Table 4, the three roads under this category -

Monterrey-Morelos, Mazatan-Aeropuerto and Los Reyes-Lecheria - have ERRs of71Z, 84% and 68% respectively, substantially above the appraisal ERRs ofabout 30%. Although not enough Information was available to reproduce theappraisal analysis, the ofst likely reason for the important difference isthe appraisal underestimation of time saviengs in projects designed to avoidor reduce congestion.

10/ Items 8, 9 and 10 in. Table 2.

9

5.04 In the case of the Mazatlan-Aeropuerto road, the real cost of civilworks was 92% above that estimated at appraisal. The reason was that abigher level of service was considered necessary for the level of trafficwhich was occurring on the road, and design changes, such as overpasses andservice-roads, were thus incorporated. The real cost of theMonterrey-Montemorelos road suffered an increase of 22% while that of LosReyes-Lecheria declined by 10%.

Construction of New Roads

5.05 The roads under this category show ex-post economic returns remark-aoly close to appraisal expectations (Table 3). The four roads already com-pleted - Ruixta-Comalapa, Mararatio-Zinapecuaro, Tlapa-Tecomatlan andCerrero-Nuevo Laredo - have satisfactory rates of return ranging from 10.5Zto 36Z. 111. Of the remaining roads, Playa AzuIl-Coahanyana and Pochutla-Santa Cruz show rates of return (and first year benefits) below the oppor-tunity cost of capital, considered for this exercise to be 12%. The MexicanGovernment, aware that investments in these roads might have been premature,delayed their completion in favor of highly justified reconstructionprojects.

5.06 Table 3 shows that the real cost of the civil works of four of theroads experienced increases ranging between 20% and 42%, whitle the real costof the other roads deelined. The four roads mentioned above cross verydifficult mountainous terrain, and construction required extra works thatwere not contemplated at appraisal time.

5.07 Current traffic on the new roads, based on counts carried out bySAROP, are, in general, somewhat below the very optimistic levels expected atthe time of appraisal (Table 3), mainly because most of the roads have onlyrecently been completed. In the case of the still uncompleted roads(para 5.05), traffic estimations are the result of extrapolating currenttraffic in already completed sections of the road, thus probably underesti-mating traffic growth when the roads will be operational for soie time.

Conclusion

5.08 In spite of the financial problems encountered during project exe-cution and the ensuing delays in project completion, the Seventh Highway Pro-ject shows a satisfactory economic performance. Increases in costs, becauseof design changes and delays in project implementation, have mostly beenoffset by the increase in real terms of the value of vehicle operating costssavings and the value of time savings.

11/ Excluding Guerrero-Nuevo Laredo, the remaining roads have ERRs equal orabove 13%. Guerrero-Nuevo Laredo was justified at appraisal on thebasis of agricultural development. The economic analysis in this PCR isbased on savings in time and vehicle operating costs.

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VI. PERFORMANCE OF THE BORROWEI

6.01 Considering the serious economic problems experienced by Mexicoduring the execution of the project, the Borrower's performance was generallysatisfactory. What follows discusses the major covenants of the GuaranteeAgreement and the Borrower's effort to comply with them.

6.02 Section 3.01. Prompt provision of funds as required for projectexecution.' To cope with the inflationary process that started in 1973, theMexican Government drastically reduced public expenditures in real terms,forcing SAHOP to limit anTal allocations for the project roads. Such apolicy, although detrimental for the pace of project execution, served itspurpose of spreading the restricted funds among several projects, thussatisfying the need to proceed in all regions of the country and allowing alarger number of contractors to continue to work. Om the other hand, theinsufficient allocation of funds during the early 1980s and the consequentslippage of the completion of three project roads to the end of 1982 were nolonger the result of macroeconomic stabilization policies but of the shift ofSAHOP's emphasis from new construction to the upgrading of the primary roadnetwork. This shift was Justified by the extraordinary traffic growthaccompanying the country's economic recuperation that started in late 1977.

6.03 Section 3.06 -The guarantor shall undertake, or cause to beundertaken, a study of the economic effects of the guarantor's road transportregulations.- This study was not carried out as originally envisaged in theGuarantee Agreement. However, the serious transport bottlenecks produced bythe reactivation of the economy (begun in 1977) required measures to relaxregulation controls in order to -temporarilyi increase the supply of roadtransporters. These measures were adopted permanently in August 1980, whenthe Government enacted a new Regulation for the use of roads under theexisting Highway Law, and are expected to be improved in the foreseeablefuture with tbe implementation of the Federal Road Transport DevelopmentProgram. The Government's efforts in the area of transport regulations areof a magnitude beyond what the Bank expected at the time of the loansignature and fulfill, in spirit, the above covenant. The dialogue betweenthe Mexican Government and the Bank on this subject is currently beingcarried out under the framework of the Highway Sector Loan (Loau 1671-ME).

6.04 Section 4.02 -The Guarantor shall continue to: (i) cause all theroads and bridges of its federal highway system to be adequately maintained,and all necessary repairs thereof to be promptly made, all in accordance withsound engineering practices; and (ii) take all reasonable steps (includingappropriate application of regulations on axle loading and vehicle size)necessaxy to ensure the proper use of such roads and bridges.' The effortsof the Borrower to comply with this covenant bave been satisfactory. Roadmaintenance in Mexico is adequate. Regarding weight controls, SCrestablished a working group in 1977 to study and propose new legislation forthe use of roads under the existing Highway Law. Under the leadership ofSCr, representatives of SAHOP, the Secretary of Industry, shippers such asPEMEX, vehicle manufacturers and trucking asociations worked for three yearsin drafting the new regulations, which were enacted by the President onOctober 3, 1980. The main changes brought about by the new regulations arein the areas of (a) the classification of vehicles and the roads on which

- 11 -

they can operate; (b) the maximum weight and dimensions allowed for each; and(c) the special conditions for exceptions. The new regulations relate higheraxle weights to vehicle speeds, which are, therefore, given much emphasis.The gist of the new regulations lies in the establishment of a new documentissued to each truck - the Certificate of Weight and Dimensions (and speedlimits) - which should be consulted by shippers and loaders; it serves as thebasis for enforcement of the law, carried out by the Highway Police. Insummary, the new regulations seek to put weight and dimension limits mDre inline with the current technological developments in roads and vehicles. As aresult, a more efficient operation of the fleet and a drastically reducedincidence of overloading are expected. The new regulations are based on thepremise of bigher load limits, coupled with strict control on the manufac-ture, reinforcement or enlargement of chassis, and on the use of vehiclescapable of carrying higher loads. The issuing of the new truck Certificateof Weight and Dimensions is viewed as a deterrent for overloading as much asa means for facilitating enforcement. There is still no informationavailable to the Bank to assess the impact of these new regulations.

VII. ROLE OF THE BANK

7.01 The Bank contributed, during project preparation, through reviewand comments on the feasibility and engineering studies. During execution,the Bank showed the necessary degree of flexibility in agreeing to projectuodifications and, in the spirit of sector loan approach, to the fulldisbursement of the loan before physical completion of all project roads.

VIII. CONCLUSIONS

8.01 The Seventh Highway Project has been successful, in spite of thecost and time overruns, in meeting its main objective of mDdernizing andconstructing key sections of Mexico's road network with a satisfactory econo-mic return on the investment.

8.02 The initial project scope and implementation schedule implied anoverall level of highway expenditures that was well above the Government'sfinancial capabilities. In order to pursue the project as originallyplanned, SAHOP would have had to give it preferential budget treatment at theexpense of other highway expenditures of equal or greater priority. Suchmeasures would certainly have improved the loan rating from the Bank's pointof view, but might not bave been the optimal policy for the country.

8.03 The problems encountered with the Seventh Highway Project illus-trated the limitations of conventional project lending in Mexico, a countrywith a highway infrastructure in the hands of mature and well developed ins-titutions. With Bank funds tied to a few large projects, failure to allocatedomestic funds for these projects (for reasons of budget limitations orchanges in priorities after signing the loan agreement) leads to a slow dis-bursing project about which there is little the Bank can do. The approachfollowed in the Highway Sector Loan to Mexico (Loan 1671-ME) is intended toovercome those limitations and to allow the Bank to better integrate its con-tribution into SAHOP's planning and budgeting process.

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TABLE 1

MEXICO

SEVENTH HIGHWAY PROJECT (LOAN 968-ME)

PROJECT COMPLETION REPORT

Original Seventh Highway Project

Highways to be Widened Length (km)

1. Monterrey-Linares 1012. Coatzacoalcos-Minatitlan 223. Mazatlan-Aeropuerto 144. Los Reyes-Texcoco-Lecheria 64

Subtotal 201

Highways to be Constructed

5. Tepalcatepec-Tecalitlan 966. Mihuatlan-Santa Elena 1117. Temascaltepec-Zihuatanejo 3268. HuixtIa-Motozitla-Comalapa 1119. Maravatio-Zinapecuaro 42

10. Ameca-Puerto. Vallarta 18011. TLapa-uainttitlanr-Tecomatlan 8712. Naucalpan-Atlacomulco 10213. Playa Azul-Coahuayana 20314. Sayula-Rio Uspanapa 12015. Pochutla-Salina Cruz 18516. Guerro-Nuevo Laredo 131

Subtotal 1,674

Total 1,875

.a

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TABLE 2

MEXICO

SEVENTH HIGHWAY PROJECT (LOAN 968-NE)

PROJECT COMPLETION REPORT

Revised Seventh Highway Project

Highways to be Widened 1/ Length (km)

1. Nouterrey-Monremorelos 50.02. Mazatlan-Aeropuerto 13.53. Los Reyes-Texcoco-Lecheria 64.0

Subtotal 127.5

Construction of New Roads

4. Temascaltepec-Zihuatanejo 330.25. Ebi,xtla-Comalapa 106.26. Maravatio-Zinapecuario 46.87. Tlapa-Huamuxtitlan-Remocatlan 91.08. Playa Azul-Coahuayana 235.69. Pochutla-Salina Cruz 178.1

10. Ciudad Guerrero-Nueva Laredo 130.1

Subtotal 1,118.0

Total 1,245.5

1/ The revised project included the Coatzacoalcos-Minatitlan road, whichwas deleted from the project more than two years after the projectscope reduction (paras 3.08, 3.09).

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TABLE 3

MEXCO

SEVENTH HIGHWAY PROJECT (LOAN 968-ME)

PROJECT COMPLETION REPORT

Comparison Between the Appraisal and Fiual Cost Estimates

Appraisal 1/ Final CostsMexican S US$ / Mexican $ US$ 31

Roads to be Widened

1. Monterrey-Montemorelos 90.5 7.24 605.0 23.542. Mazatlan-Aeropuerto 24.8 1.98 130.0 5.73. Los Reyes-Lecheria 284.8 22.78 805.0 34.26

Roads to be Constructed

4. Temascaltepec-Zihuatanejo 418.4 33.47 2,294.3 91.105. ldixtla-Comalapa 172.3 13.78 439.0 23.216. Maravatio-Zinapecuaro 34.0 2.72 60.0 3.177. Tlapa-Tecomatlan 81.6 6.53 422.0 15.838. Playa Azul-Coabuayana 367.3 29.38 1,946.5 80.959. Pochutla-Salina Cruz 234.2 18.74 912.0. 38.93

10. Guerrero-Nueva Laredo 98.4 7.87 220.0 10.22

Total 1,806.3 144.49 7,833.8 326.91(100) (100) (434) (226)

1/ lcluding contingencies.2/ Based on exchange rate at the time of the appraisal.3/ Based on exchange rate at the time of work.

MEXICO

SEVENTH HIGHWAY PROJECT (LOAN 968-ME)

PROJECT COMPLETION REPORT

Indicators for Economic Reevaluation

Construction Costs (millions) Traffic Growth ERR(Constant 1981 Pesos)

Appraisal 1/ Actual Change Appraisal Actual Appraisal Actual

1. Monterrey-Montemorelos 635 775 +22 12 10 28 71 35 3/2. Mazatlan-Aeroperto 125 240 +92 11 13 29 84 34 3/ I

3. Los Reyes-Lecheria 1,480 1,335 -10 10 7 36 68 32 3/ M

4. Temascaltepec-Zihuatanejo 2,345 3,320 +42 19 11 21 185. Huixtla-Comalapa 855 1,025 +20 14 12 21 196. Maravatlo-Ziapecuaro 195 165 -15 10 6 32 367. Tlapa-Tecomatlan 610 580 - 5 15 9 15 138. Playa Azul-Coahuayana 2,215 2,970 +34 12 10 11 89. Pochutla-Salina Cruz 1,170 1,615 +38 10 11 10 1110. Guerrero-Nueva Laredo 505 455 -10 9 12 13 10

Total 10.135 12,480 +23% 23 2/ 24 2/

1/ Appraisal estimates x 5.196 to reflect the increase in the construction index, and correcting forvariations in length actually executed.

2/ Weighted averages./ ERRs not including value of time savings.

ANNEX

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E-1229/84May 15, 1984Spanish (Mexico)OEDJCB:ecc

Direcci6n General de Planeacion

Secretaria de Comunicaciones y Transportes

Mexico City, April 17, 1984105-84/000346

Mr. Shiv S. KapurDirector, OEDWorld BankWashington, DC 20433

Re: Project CoMpletion Report - Loan 968-ME

Dear Mr. Kapur:

I have pleasure in informing you that having reviewed the

above-mentioned document, enclosed with your letter of March 22, we find no

significant discrepancies between your figures and data and those contained in

our own records. We therefore approve the content.

Very truly yours,

/s/ Ing. Alejandro Gonzales CuetoDirector General

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