Document of The World Bank FOR CFFICIAL USE ONLY kA a4- h Report No. P-4646-M REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED AGRICULTURAL SECTOR LOAN IN AN AMOUNT EQUIVALENT TO US$300.0 MILLION TO NACIONAL FINANCIERA, S.N.C. WITH THE GUARANTEE OF THE UNITED MEXICAN STATES February 22, 1988 Ths document bus a restued H _ and qM be sed by woly in the perouue of heir oki_al dutim ts conteat my nt otewise be dbdoud Wodd BDn kt_ Currency Unit - Peso (Mex$) On February 19, 1988, the exchange rate in the controlled market was US$1 = Mex$2,261; the free market exchange rate stood at US$1 - Mex$2,300 Fiscal Year January 1 - December 31 Weights and Measures 1 hectare (ha) - 10,000 square meters (n2) 2.47 acres (a) 1 kilometer kkm) = 0.62 mile (mi) 1 square kilometer (km2) = 0.39 square miles - 100 ha 1 kilogram (kg) - 2.205 pounds (lbs) 1,000 kilograms - 1 metric ton (t) = 0.98 long ton 1 liter (1) = 0.26 gallons (gal) Abbreviations ACF - Average Cost of Funds to Banks ASL - Agricultural Sector Loan BANCOMEXT - Foreign Trade Bank Azucar, S.A. de C.V. - National Sugar Company CETES - Treasury Bills CONASUPO - National Basic Food Company DICCONSA - Retail Affiliate of CONASUPO FERTIMEX - National Fertilizer Company FIRA - Agricultural Trust Funds in Bank of Mexico GATT - General Agreement on Tariffs and Trade GDP - Gross Domestic Product GIRA - General Interest Rate Agreement IFC - International Finance Corporation IMF - International Monetary Fund LICONSA - Milk Producing and Distributing Affiliate of CONASUPO NAFIN - National Finance Agency PAC - Program of Adjustment and Structural Change PEMEX - National Petroleum Company PIDER - Integrated Rural Development Program PSBR - Public Sector Borrowing Requirement QR - Quantitative Restriction on Trade SAP - Special Action Program SARH - Ministry of Agriculture and Water Resources SECOFI - Ministry of Commerce and Industrial Promotion SEMIP Ministry of Parastatal Industries SHCP - Ministry of Finance SPP - Ministry of Planning and Budgetting TPL - Trade Policy Loan TRICONSA - Wheat Processing Affiliate of CONASUPO FOR OFCIL USE ONLY MEXICO AGRICULTURAL SECTOR LOAN Table of Contents _age No. Loan and Program Summary .......... ............................... 1. I. The Economy 1 A. Background ......................................... 1 B. Recent Economic Developments......................... 4 C. Development Prospects ........................ 7 D. External Debt and Creditworthiness .................. 8 II. The Agricultural Sector ................................ 9 A& Performance 9............, 9 B. Status of Current Bank Lending and the Policy Dialogue for Agriculture ..................... 10 III. Policy Objectives Supported by the Proposed Agricultural Sector Loan .. ..................... 11 A. Removal of Global Food Subsidies and Targetting of Remaining Subsidies .................... 12 B. Reducing Government Intervention in Establishing Producer and Consumer Prices ..... .................... 14 C. Reducing the Role of Parastatals in Agricultural Marketing, Storage and Proaesslng ....... 17 D. Progress Toward Agricultural Trade Liberalization ........ .............................. 20 E. Reducing Subsidies on Agricultural Inputs ............ 22 F. A Satisfactory Public Investment Program in Agriculture ............................ 25 G. Decentralization and Reduction of Staff of the Ministry of Agriculture ....................... 26 IV. History and Procedures of the Proposed Loan ... ........... 27 A. Loan History ........................................ 27 Be The Borrower .... ..................................... 27 C. Disbursement, Procurement, Administration anti Auditing ....................................... .. 27 D. Effectiveness and Tranche Release .................... 28 E. Monitoring and Reporting ............................ 29 F. Benefits and Rxska ........ ........................... 29 G. Social Impact of Agricultural Sector Adjustment.... . 30 This document has a restrited disbution and may be used by recipients only In ti vtibawanco of their offcial duties Its contents may not otberwise be disclosed witout World Ban-% authorvk4 ^ ii- TAIL! OF CONTENTS (CONTINUED) Page No. V. Bank Group Operations in Mexico ........ ........... ....... 31 A* Bank Operations ....................es............... 31 Bo lFC Operations .............31 C. Bank Strategy .............32 VI. Collaboration with the IMP 34 VII. Recommendation 35 ANNEXES 1. Economic Indicators 2. Status of lank Group Orerations in Mexico 3. Supplementary Loan Data Sheet 4. Characteristics of Production and Land Distribution 5. Policy Matrix 6. Table 1 - CONASUPO's Food Subsidies Table 2 - Production Coverage of Price Controls, 1982 and 1986 Table 3 - Average Nominal Protection Coefficients for Major Crops Table 4 - Recent Nominal Protection Coefficients for Major Crops Table 5 - Percentage of Production Under Licensing Table 6 - List of Agricultural, Agro-Industry, Livestock, Forestry and Marine Products Included by SECOPI in Discussions of Liberalization under TPL II Graph 1 - Crop Support Prices - In Real Terms Graph 2 - Producer and International Prices - Maize Graph 3 - Producer and International Prices - Wheat Graph 4 - Producer and International Prices - Beans Graph 5 - Producer and International Prices - Rice Graph 6 - Producer and International Prices - Sorghum Graph 7 - Producer and International Prices - Soybeans 7. Social Impact of Agricultural Sector Adjustment Program 8. Terms of Reference for Studies 9. Agricultural Sector Objectives of the Mexican Governaent 1987-1988 10. Steps Recommended to Strengthen Food Subsidy Programs 11. Status of Multi-Facility MEXTCO AGRICULTURAL SECTOR LOAN Loan and Program Summarg Borrower: Nacional Financiera, S.N.C. Guarantor: United Mexican States Aaount: US$300.0 million equivalent. Terms: 15 years, including 3 years of grace, at the standard variable interest rate. Loan and Program Description: The proposed sector loan is the first of a series of such loans to promote greater efficiency and higher productivity in the agricultural and agro-industrial sectors. It is an important part of the package of external financing linked to implementation of Mexico's economic reform program. The proposed loan supports a program of continuing reforms and of achievements in the areas of consumer food subsidies and their targetting, improvement of producer pricing policies, privatization of parastatals, agricultural and agro-industrial trade liberalization, streamlining and decentralizing of the Ministry of Agriculture, rationalization of public investments in agriculture, and reduction of input subsidies, The loan would finance general imports with priority given to agricultural inputs and foodstuffs. Benefits and Risks: The benefits of the reform program would consist of rising productivity and allocative efficiency in both agriculture and agro-industry, as adjustments in pricing make the incentive structure correspond more closely to economic opportunity costs. In addition, fiscal savings to the Mexican Governmant would be substantial while remaining subsidies would be more selective and targetted to the poor. An expanded food stamp program for urban areas and targetting of food price subsidies only to stores in poor neighborhoods and economically depressed rural areas would buffer the impact of the adjustments of food prices on the urban poor and on poor rural groups that do not produce their own food. The result of the studies Included in the loan would assist the Government in designing a program of further reforms. - ii - The risks of the project derive from the political resistance to some of the ref orms and the stability of the macroeconomy. Also, the general growth of the macroeconomy will influence the prosperity of the agriculture sector. These risks are mitigated by the substantial forms that the Government has already taken up front and the strong commitment of the Government to continuing reform, liberalization of the economy, and sound macroeconomic management. Estimated Disbursments: The loan would be disbursed in two tranches. The first US$25 million of the first tranche (US$100 million) would be available upon effectiveness, with first tranche disburaements thereafter contingent upon removal of export controls on exportable rice and quality cuts of beef and agreement on terms of reference for certain studies, discussion of which is a second tranche release condition. The second tranche of US$200.0 million would be released upon fulfillment of specified conditions related to each of the policy areas and satisfactory completion and discussion with the Bank of all studies. Loan proceeds may be used for retroactive financing of import expenditures incurred after November 22, 1987, up to a ceiling of US$60 million. Schedule of Disbursements: Amounts in US$ Millions Bank FY 88 89 First Tranche 100.0 Second Tranche 200.0 Cumulative 100.0 300.0 Appraisal Report: This is a combined Ptesident's and Staff Appraisal Report. REPORT AND CIOIN OF THE PRESIDENT OF THE INIENTION D PSUION AnD DmAOnT TO TE EIVCUT DIRECTRS ON A PROPOSED AGRICULTUR SECR LOAN TO N&CIOAL FINNCIER}A, S.N.C. wITHTHE GWARANTE OF THE UITD IMICAN STATES 1. I submit the following report and recommendation on a proposed Agricultural Sector Loan (ASL) to Nacional Financiers, S.N,C. (NAFIN), with the guarantee of the United Mexican States, for the equivalent of US$300 million in support of the Government's program of agricultural policy reform. The loan would be repaid over 15 years, including 3 years of grace, at the standard variable interest rate. PART I - THE ECONOHY 2. An Economic Report on Mexico (Mexico: After the Oil Booms Refashioning a Strategy for Growth. No. 6659-ME) was distributed to the Executive Directors on June 239 1987. It assesses the implications of the rapid policy changes underway in Mexico, particularly from mid-1985 through early 1987. A. Backtround 3. Mexico experienced three decades of high and stable growth from the 19409 to the 1960s, based on an inward-looking growth strategy. By 1970, however, Mexico had largely exhausted the e.sy possibilities for import substitution, and growth started to slow down. The Government attempted to foster growth through an expansion of public sector expenditures, and the encouragement of high-cost, capital-intensive import substitution. This strategy failed to sustain sound economic growth, and in 1976 Mexico experienced a serious financial and economic crisis. The exchange rate was devalued, and an International Monetary Fund (InF) stand- by program Implemented. New oil revenues led to a quick economic recovery in 1977, and greatly enlarged Mexico's access to foreign borrowing. Starting in 1980, rapidly rising public expenditures, unmatched by gains in revenue, generated huge increases in public sector deficits. Although inflation rose rapidly, no significant pressure was felt to adjust, because of burgeoning oil export earnings and abundant foreign financing. As imports increased rapidly and non-oil exports declined, an appreciating real exchanga rate and lagging domestic interest rates encouraged capital flight. However, the increasing precariousness of the balance of payments was masked for a time by a frenzy of borrowing, which nearly doubled the level of external debt in just two years from US$40 billion in 1979 to US$78 billion in 1981. 4. The crisis came to a head in 1982. Public sector expenditures reached the unprecedentea level of 47.5Z of GDP, while the deficit reached nearly 18% of GDP. In February, the Bank of Mexico stopped supporting the peso, which then experienced a 402 devaluation. But a large wage adjustment, continuing slack in the oil market, and lax fiscal and monetary policies largely nullified the intended benefits of the devaluation and kept the balance of payments under strain. Inflation measured in consumer prices nearly quadrupled, from 291 in 1981 to 992 in 1982. Commercial banks, which had granted Mexico substantial credit in previous years, declined to commit new funds in the amounts required. These factors led to a second devaluation of 35Z in August 1982 and the suspension of amortisalion payments on most of Mexico's external public debt. The nationalization of the domestic private commercial banks in September 1982 and the forced conversion of foreign currency accounts into pesos at a controlled exchange rate, dealt additional blows to private sector confidence. The flight of capital abroad continued at a high rate. 5. With the support of an Extended Fund Facility (EFF) from the INF, the new administration of President Miguel de la Madrid undertook a stabilization pro-ram beginning in late 1982 based on a large contraction of domestic demand, mainly through fiscal, exchange rate, and monetary policies. The peso was depreciated by an inmediate 302 (in addition to the 642 cumulative depreciation carried out by the preceding government In 1982), and quantitative restrictions were extended to cover all imports. Over the next two years, public sector expenditure, excluding interest payments, declined from a high of 391 of GDP in 1982 to about 291 in 1984, while revenues rose from about 302 to 331 of GDP. Public sector investment was cut from an average of around 1OZ of GDP in the late 1970s to 7.51 in 1984, a contraction of over one-quarter in real teoms. Between 1982 and 1984, the public sector borrowing requirement declined from 17.71 of GDP to 8.4Z, while the inflation-adjusted fiscal deficit (excluding the inflationary component of interest payments on domestic debt) shifted from a deficit of 8.21 to 3.01 of GDP. Real wages fell 20-25Z, while most public sector prices were raised sharply in real terms. And a massive foreign debt restructuring was successfully negotiated in 1983 and again in 1984. 6. The results of the 1983-84 stabilization effort were initially impressive. In those two years, nominal Imports fell cumulatively by 251, non-oil export earnings (including the earnings of in-bond industries) rose 54X, and the balance of trade on goods and non-factor services shoved unprecedented surpluses averaging around 9% of GDP. Despite declining oil prices, net foreign reserves increased from US$2.0 billion to US$6.5 billion between the end of 1982 and the end of 1984. And a strong turn- around in economic activity from -5.31 in 1983 to 3.71 in 1984 led many to believe a long-term recovery was underway. However, a large part of the adjustment took the form of drastic cuts in imports and investment. In contrast, long-term obstacles to growth were not confronted. The anti- export bias of the trade regime was actually intensified with the introduction of additional import controls. Nor was the system of industrial incentives overhauled in ways which might have enhanced Mexico's international competitiveness. 7. The optimism generated by Mexico's initial adjustment success soon started to fade. The declines in inflation became smaller and smaller, until the trend began to reverse in 1985. As the Government prepared for -3- the mid-term Congrestional elections of July 1985, monetary policy became accomodating, the fiscal deficit rose well above program targets, and the exchange rate appreciated rapidly In real terms Optimism turned to disenchantment, as it became clear that stabilization in the absence of more fundamental structural reforms could not restore either sustainable economic growth or stable prices. 8. Most IM? program targets were missed in 1985. The fiscal deficit rose to 9.5S of GDP, inflation increased to 63.7S, non-oil export earning. declined by over 10 from their 1984 levels, and most components of the balance of payments deteriorated. Speculative pressures on the exchange rate increased, and net foreign reserves declined by US$3.4 billion. The, crowding out of the private sector in credit markets became saoere toward the end of the year, as financial disintermediation accelerated and the share of the public sector in total credit reached unprecedented levels, in excess of 751. 9. Following the elections, a policy shift occurred. Macro- stabilization measures were complemented with the structural reforms needed to deal with Mexico's long-term development problems. At the heart of these reforms was the Government's desire to increase the efficiency of Mexican industry through greater exposure to international competition, to reduce the economy's dependence on oil exports and foreign borrowing, and to create a new stimulus for growth. The first major reforms included removing import licensLng requirements from 40Z of merchandise imports, merging, liquidating, or selling several hundred smaller state-owned companies, and starting the rationalization of major parastatal operations In steel, fertilizers, agriculture, petrochemicals, trucks and sugar. 10. As for the macro-stabilization measures, the Government introduced further spending cutbacks in the public sector, and eliminated some 25,000 full-time positions. Sustained positive real interest rate levels were restored, the controlled exchange rate was devalued by 201, and a flexible daily crawl introduced which responded to developments in the balance of payments, rather than, as before, to a pro-announced schedule. The new exchange rate policy greatly narrowed the margin between the controlled and free rates and, combined with tighter domestic credit, helped bring capital flight to a virtual halt toward the end of 1985. 11. This new adjustment cum structural reform effort received a set- back in early 1986 with the collapse of oil prices. As a result of this, Mexico lost revenues equivalent to 6.51 of GDP (i.e., over US$8 billion). However, instead of closing the economy, as in 1983, the Government now accelerated its structural reforms. To lend credibility ..o its commitment for integration with the world economy, the country joined the General Agreement on Tariffs and Trade (GATT), announced a three-year program to lower tariffs to a maximum of 301, and ptomised to further reduce non- tariff barriers (NTBs). Foreign investment procedures were simplified and public finances strengthened through tax reform, price adjustments, and spending cuts. The restructuring of the parastatals began in earnest, with the closure of a major steel plant in Monterrey and the privatization, liquidation, or transfer of some 600 smaller publicly-owned companies. The Government restructured the finances of the state-owned agricultural marketing enterprise, CONASUPO, and sharply reduced general food subsidies. -4- Fiscal performance In 1986 was in line with IMF targets, even though due to an acceleration of inflation the public sector borrowing requirement rose from 9.52 to 15.62 of GDP. In spite of the drastic reduction in oil revenues, the inflation-adjusted fiscal deficit increased only from 4.02 GDP in 1985 to 6.2Z of GDP In 1986. The real devaluation of the psos was accelerated, real interest rates rose to exceptionally high levels, and a squeeze on credit to the private sector helped turn around capital flows, resulting in the repatriation of as much as US$3.0 billion during the period from September 1986 to mid-1987. However, 1986 Inflation reached 1062, and real GDP contracted by some 3.82. 12. Mexico's program was supported by a financial package signed in March 1987, which will provide up to US$10.7 billion in net flows, including a US$5 billion parallel commercial bank new money facility carrying a World Bank guarantee of US$750 million, US$1 billion in cofinancing, a US$0.5 billion Growth Facility, and an IMF stand-by and contingent oil facilities. Because oil prices have not dropped below an agreed threshold during 1987 the oil facility was cancelled in December 1987. Also, the Growth Facility has not been activated as of the end of February 1988. Some US$68.7 billion commercial bank debt was restructured, with new maturities varying between 8 and 20 years, and grace periods between 4 and 9 years. US$1.8 billion in official bilateral debt was also rescheduled. The current status of the multi-facility is shown in Annex 11. 3. Recent Economic Develoiments 13. Over the past five years, Mexico made important progress in solving its fundamental macro imbalances. Progress was especially Impressive in the external accounts, as manufactures export earnings grew at over 202 annually, the trade surplus ranged between 7-10% of GDP and net official reserves were raised from -US$2 billion at the end of 1982 to roughly US$9 billion at the end of 1987, tha highest level in Mexican history. On the internal front, major parastatals, including FERTIMEX and CONASUPO, are in various stages of restructuring, roughly 600 smaller firms have been divested, price controls have been loosened, significant reforms of the value-added and corporate income taxes have been introduced, and global food and credit subsidies have been sharply reduced. 14.. However, other developments have not been as favorable. After decades of economic growth averaging over 6% annually, cumulative real output contracted by about 2S during 1983-87, while real per capita consumption declined by about 142, and real investment by 20% (402 since 1980). And not least among these disappointments was the failure to reduce inflation. Having inherited a then-record rate of 1002 in 1982, the current Government reduced this to under 60% by 1984. However, since then, inflation has risen to nearly 1602 in 1987. The unfavorable terms of trade shock and the heavy burden of Mexico's external debt have had, in the short run, negative effects on Mexico's overall economic performance. 15. Behind inflation lies the large, seemingly intractable public sector borrowing requirement (PSBR), estimated at 16.6% of GDP for 1987, i.e., almost as large as in 1982 during the height of Mexico's balance of payments crisis. However, this high PSBR masks a significant adjustment in the inflation-adjusted fiscal deficit, which has fallen from 8.2% of GDP in 1982 to 3.02 in 1984, before rising under pressure of oil-export related losses to 6.22 in 1986. It fell sharply once again to an estimated 1.12 of GDP in 1987 (although, if transitory fiscal gains like the public sector's abnormally low real borrowing costs and the upswing In oil export income were removed from the calculation, the 1987 inflation-adjusted deficit would have been closer to 52 of GDP). 16. Other fundamentals whose behavior worried financial markets in 1987 included the October collapse of world stock markets, which triggered a 752 decline in the Mexican bolsa in just a month and a halfg an acceleration in the size and frequency of wage adjustments since 1986, which, combined with growing labor unrest and electoral campaign pledge3, had convinced many economic agents that wage policy could become a pro- inflationary factor for the first time since 1981; increasing distortions in relative prices, due to seriously delayed adjustments of controlled prices in the public sector and agriculture; declining real interest rates; and a small, but worrisome appreciation of the real exchange rate, albeit from a very favorable starting level at the end of 1986. 17. In this climate of growing malaise about the economic fundamentals, any major unexpected economic developments were almost certain to be destabilizing. One such development--the sharp decline in world stock market values in October--was previously mentioned. A second, which occurred at roughly the same time, was a one-time opportunity for private companies to buy up their external debt at discounts of 502 or more, as part of a debt rescheduling agreement signed with foreign commercial banks. A huge temporary additional demand for foreign exchange put strong pressure on the free exchange rate in October and in the first half of November. Initially, the Central Bank tried to dampen this pressure by selling foreign reserves. But after losing over US$1 billion in one month, the monetary authority withdrew from the market on November 19, triggering a one-day depreciation of the free exchange rate of nearly 60%. Panic buying, demands by labor for an emergency wage increase of 46%, and continued speculative attacks on both the free and controlled exchange rates intensified the crisis, leading eventually to wholesale revisions of the 1988 budget and macroeconomic program. 18. On December 14, the Government announcedt i) a 222 one-step depreciation of the controlled exchange rate from Mex$1,803/US$1 to Mex$2,200IUS$l, accompanied by; iI) a reduction in the maximum import tariff rate from 452 to 20%. This was followed the next day by the announcement of an Economic Solidarity Pact signed by representatives of labor, farming, industry, and the Government, which contained additional features, namely: iiI) an immediate increase of all wages by 152, with a second increase in the minimum wage of 202 granted on January 1, 1988. Contractual wages come up for their annual negotiations in large numbers during this period, but - 6 - efforts will be made to limit floor adjustments to the 201 increase granted for the minimum wage. With that allowance, all wages are then to be frozen until March 1, 1988, at which time they are to be adjusted monthly in line with the projected average price changes in an index of basic goods and services. Monthly wage adjustments would continue, so long as inflation remained above a 21 monthly rate. In the event the forward-looking monthly adjustments of basic goods prices were to lag observed inflation by more than 5 percentage points cumulatively, a catch-up increase for the full differential would be granted to wage earners. iv) immediate increases of 17-852 in the prices of key public goods and services, after which public prices are to be frozen until March 1, 1988, and then adjusted in line with wages; v) corrective price increases for basic consumer goods and guaranteed farm prices before the end of 1987, followed by a 2-month freeze, and then by subsequent price adjustments in line with wages and. public goods. Guaranteed farm producer prices for 1988 are to be maintained at 1987 levels in real terms. Increased public sector imports of basic goods are to be used to combat shortages, while sanctions for hoarders and price control violators have been promised; vi) an increase of the primary fiscal surplus by 2.91 of GDP in 1988 to a level of 8.32 of GDP, though approximately equal increases in revenues and reductions in non-interest public spending. vii) a program of accelerated divestment of state-owned companies, of which 52 new companies have already been placed for sale, including a copper company valued at roughly US$1 billion; viii) a ceiling on domestic banking credit to the private sector outstanding by lending institutions equal to 901 of the average nominal balance of December 1987 for January and 851 of the December nominal balance for February; and ix) sharp increases in treasury bill and other short-term nominal interest rates from 81 monthly in October to over 131 in January 1988. 19. The sequencing of the Mexican stabilization program can be split into two periods. The first period, lasting until the end of February 1988, is transitional, during which the once-and-for-all impact of relative price corrections would be felt. The second period would start in March 1988, and, if all goes well, last some 9-10 months. Major nominal prices (wages, basic goods, and public prices) would follow a concerted declining pathway geared toward reducing inflation, while preserving a rebalanced and -7- essentially fixed structure of relative prices. While the Government is committed to reducing consumer price controls in the long run, during this period It will have to use the instruments of consumer price controls selectively. 20. Following the adjustment of wages, public tariffs and prices, and the exchange rate in December, the Government predicted that Inflation would accelerate significantly in January (indeed, it subsequently reached 18.2S at the producer level, 15.5Z at the consumer level), to be followed by a marked deceleration in February to around 7-8S. The transitional phase is designed to correct major disequilibria in relative prices (real wages, real public utility and basic commodity prices, and the real exchange rate), and, then, to maintain them from March 1988 onwards through forward-looking adjustment of the major nominal variables. 21. Assuming the behavior of inflation during February confirs approximately to Governmental expectations, then the subsequent adjustment of wages, public and basic prices, and the exchange rate uniformly, and in a declining monthly pattern, will provide a strong nominal anchor which, with support from the strong monetary, fiscal, and import adjustments the Government has committed to, can gradually break the inertial components of inflation. 22. The Economic Solidarity Pact reflects a carefully thought out stabilization strategy which draws upon the lessons learned from experience in other countries, adapting them to Mexican circumstances. It quite rightly elevates the goals of attacking high inflation and correcting severely distorted relative prices to priority objectives, needed to consolidate the structural reforms and continue an export-led growth strategy. This effort will be reinforced by accelerated public enterprise reforms, and accelerated import liberalization which goes well beyond the earlier commitments the Government undertook in connection with TPL I and II. 23. Needless to say, policy fine-tuning is extremely difficult at high rates of inflation with volatile private sector expectations. The chances of unintended, but critical, policy errors are, correspondingly, high. Ultimately, a successful stabilization effort will largely depend on whether policymakers demonstrate a strong preference to err on the side of caution. If the Impact of the program on economic activity were immediately and strongly adverse, steady, calm support for continuing the basic lines of the Pact would be crucial. Corrective policies could be adopted only gradually, so as not to risk undermining the credibility of the original commitment to the Pact, while avoiding over-reaction. C. Development Pros-ects 24. Provided the Government is persistent in pursuing its current stabilization program, accompanied by the major structural adjustment policies already described and a reasonably favorable international environment, the fundamentals for future recovery look promising. First, Mexico has a rich natural and human resource base and close proximity to the world's largest market. Secondly, the rationalization of the trade regime of the last two years and the recent policy announcements about its - 8 - future direction have created a set of incentives favoring international competition. Thirdly, the drastic fall in the terms of trade is beginning to turn around now that world oil and other commodity prices significant for Mexico's exports have partially recovered. This improvement In the terms of trade should have significant salutary effects on fiscal, financial, and balance of payments performance, as well as on growth, investment, and employment. Fourthly, the over 402 decline in real wages since 1981 has made Mexican unit labor coats highly competitive internationally, well below those of Southeast Asia. Therefore, under moderately favorable external and domestic conditions, Mexico's economic growth could reach 4-52 a year in the early 1990s. 25. Progress in the areas of poverty alleviation and social sector development has slowed in the wake of the 1982 crisis. As the economy gradually begins to recover, it is possible to foresee a significant increase in the emphasis on social sector issues in Mexico. Given the continued stringency of public budgetary resources, this increased emphasis will depend heavily upon better cost-recovery and Improved efficiency in the targeting and delivery of social services. 26. Historically, ecological and natural resource management issues have ranked low on the list of policy priorities. However, in recent months, pollution control, soil erosion, deforestation, and other issues in Mexico's management of its ecology and natural resources have received increasing Governmental and Bank attention. D. External Debt and Creditworthiness 27. Mexico's gross external public and private debt increased by nearly US$17 billion during 1983-87, but net debt by only about US$6 billion, taking into account the roughly US$11 billion Improvement in net official reserves over that period. The debt service ratio fell from 612 In 1982 to 502 in 1987. At the end of that year, the Bank's share of Mexico's long-term debt was 7.12, and its share of Mexico's long-term debt service was 7.42. The Bank's exposure in Mexico was 8.12 of its total portfolio. With its expanded assistance program in Mexico, this latter ratio is expected to rise somewhat by the end of this decade, but will remain below 10 of the Bank's total portfolio. In the expectation that sound economic policies continue, and that the external environment remains favorably for the execution of these policies, Mexico is considered creditworthy for Bank lending. -9- PART II - THE AGRICULTURAL SUCTOR A. Po 28. In the 1970s and 1980s agriculture has turned in a largely lackluster performance relative to its historically dynamic role. From the end of World War II to the mid-1960s, Mexican agriculture was a success, growing faster than in any other Latin American country, largely because cultivated and irrigated areas expanded. More specifically, in the 1950 to 1965 period, agricultural GDP growth averaged 4.3% per annum. However, beginning in the late 1960s several factors began to converge to retard growth. As the costs of bringing marginal land into production rose, expansion of irrigated areas slowed down. In the 1970s, exchange rate and pricing policies discriminated against agriculture and further contributed to the deceleration of the growth of agricultural production. As income growth in other sectors and rapid population growth of over 3% per year expanded the demand for food, food imports increased and the sector's share of exports fell. While before 1970, Mexico produced sufficient food to feed its population and export substantial surpluses, by the end of the 1970s, it had become a major importer of basic foodstuffs. These adverse circumstances resulted in a growth rate of agricultural GDP averaging 2.3% per annum between 1970 and 1980, compared to overall GDP growth of around 5% and industrial GDP growth of around 7%. 29. In March 1980, the Government resorted to drastic measures to reverse the decline of agriculture by making use of the growing revenues from oil. Higher support prices, more input subsidies, and expansion in subsidized credit, coinciding with favorable weather, led to substantial increases of agricultural production of 6X in 1980 and in 1981. However, with declining oil prices, rising interest rates and debt service, and growing consumer subsidies, these Government actions in support of agriculture proved to be unsustainable. In 1982, when farmgate prices were allowed to fall in real terms in the face of high inflation, agricultural production declined by 1%. At the end of 1982, the costly push for agricultural recovery was largely abandoned; the set of policies designed to solve food problems by channeling a large share of the country's new petroleum wealth into the sector and into providing cheap food for urban dwellers was an early victim to Mexico's continuing economic crisis. 30. Beginning in 1983 and through the 1985 crop year, agricultural production recovered moderately to an average growth of about 2.52, primarily due to a supportive exchange rate and favorable weather. However, in 1986, agricultural production fell by close to 3%. Crop output declined by 3.5%, partly due to poor weather, while livestock production fell as demand for meat and milk contracted dramatically (a result of falling incomes and the high income elasticity of demand for these products) and higher costs of production and price controls made it difficult to maintain profits in this sector. However, increasing exports (led by coffee and fresh fruits and vegetables) and declining consumption of higher valued products (particularly meat and, thus, imported feedgrains), produced a substantial agricultural trade surplus estimated at over US$1 billion. This was the first agricultural trade surplus since 1979. For the first half of 1987, the agricultural trade balance deteriorated by about 15% but remained in surplus primarily due to strong performance in the manufactured foods sector (exports up by over 40%). - 10 - 31. The Government continues to seek remedies to critical rural and agricultural problems. Instead of reverting to the kinds of costly subsidies used in the early 1980s, the Government has turned its attention to improving the effectiveness of public investments, reducing and targetting remaining subsidies, and limiting its intervention in the market. In this context, the Government has been implementing policy reforms that will bring about greater sectoral efficiency. B. Status of Current Bank TLendig and the Policy Dlalogue for Agriculture 32. Current Bank lerding in agriculture is directed at supporting the Government's program to improve the efficiency of agricultural infrastructure and production. Proposed loans currently under preparation or appraisal include projects to rehabilitate and enhance the efficiency of irrigation systems, to revitalize and promote small- and medium-scale agro-industrial development, to expand and conserve forestry resources, and to improve efficiency and productivity in dairying. Furthermore, a recently approved loan would assist in improving the efficiency and impact of agricultural research and extension. In addition, a Ninth Agricultural Credit Project that addresses financial self-sustainability of apex financial institutions (e.g., FIRA) and the question of interest rate subsidies, is beir.g implemented. The Fertilizer Sector Project being presented to the Board ir. parallel with the ASL aims at restructuring the fertilizer industry and reeucing subsidies. And the second Trade Policy Loan, combined with further tariff reductions of the Pact, further reduced industrial protection and improved the internal terms of trade for the agriculture sector. 33. An active policy dialogue is also being pursued to support the Bank's lending strategy in the agricultural sector. A critical juncture in this dialogue for agriculture was reached in 1986. As part of the Bank's overall policy dialogue, a paper on agricultural sector issues was presented to the Mexican Government in mid-January 1986. This paper, prepared for the Country Programming and Iuplementation Review, proposed a sector adjustment loan in agriculture to assist the Government in achieving and reinforcing its policy objectives in the areas of (a) agricultural export promotion and trade reform; (b) subsidy control and targetting; (c) price deregulation; (d) marketing deregulation; and (e) public sector investment and expenditure in agriculture. The paper indicated that, if the Government was prepared to implement a program of policy initiatives and reforms to achieve these objectives, the Bank would consider a quick-disbursing policy loan to support the Government's program. Officials of the Mexican Government indicated an interest in this approach. Subsequent missions followed and significant headway on a program of policy reform began to emerge after January 1986. These reforms were supported and reinforced by two Trade Policy Loans (TPL's) and the entry of Mexico into GAMT, which began the reduction of industrial protection and provided the basis for improved internal terms of trade for agriculture and thus better incentives to this sector. The Bank proposes to reinforce the momentum building up behind the initial policy reform program by means of the ASL. - s l - m*E xII - OLICE OIJUCtZVES SUmKw lSD ill PI-OPOStD 34. As a consequence of the economic cirisis facing Mexico, the Government has begun a far-reaching program to restructure the economy to achieve greater allocative efficiency and equity. An integral part of this restructuring is a program of agricultural and food policy reforms that include: (a) sharply reducing global consumer subsidies and better targetting remaining subsidies so that they benefit the truly needy; (b) bringing agricultural producer prices closer in line with prices; (c) rendering the storage, processing, distribution and marketing activities of parastatals more efficient including, where appropriate, privatization of these; (d) moving towards economic prices for agricultural inputs (e.g., fertilizers and water); (e) liberalizing, over time, the trade regime with regard to the import and export of agricultural inputs and products (including not only progress in the removal of prohibitions and quantitative restrictions but also providing the private sector greater access to import activities); (f) diminishing credit subsidies by moving towards market-determined interest rates; (g) achieving a sound investment program; (h) rationalizing pricing and promoting privatization and efficiency in the sugar sector; and (i) restructuring and decentralizing the Ministry of Agriculture with an eye to reducing superfluous employment and to having a higher percentage of Ministry staff directly assisting farmers. 35. To assist the Government in achieving these objectives, the Bank is furthering the policy dialogue through sector work and project and policy lending, and, in particular, through a series of proposed agricultural sector adjustment loans. The basis of the first proposed ASL described in this report is an agricultural sector policy statement that provides the framework for the Government's policy with respect to the sector. This statement, prepared by the Ministry of Agriculture with the assistance of the Ministries of Finance, Planning and Budget and Commerce, is in congruence with the policy objectives of the Bank's dialogue with the Government. The statement is included in Annex 9 of this report. 36. The Government has already made important reforms in many of the areas outlined in its policy statement. Some of these reforms represent radical departures from previous approaches to the sector and are important--and politically difficult-steps in the right direction. The proposed loan would support the Government in continuing to implement this program. In the following paragraphs, the policy objectives, the progress in achieving these objectives and the steps to be further supported by the proposed loan are presented. Summary backgrounds to the policies are also included to help set the context for the Government's reforms. A Policy Matrix in Annex 5 provides an overview of the policy objectives and reforms. The basis for the loan would be the Government's sectoral policy statement, comprised of the text in Annex 9 and the Policy Matrix of Annex 5. - 12 - A. Reoval of Global Food Subsidies and Tangetting oRemainlng SubsiMes 37. Background. Global subsidies on food products-that is, subsidies available to all consumers, regardless of income--became particularly pronounced during the early 1980s. While guaranteed producer prices were raised to stimulate domestic production of basic foods, consumer food prices were held down to avoid upward pressure on wages. The difference between producer and consumer prices led to large food subsidies on such products as maize (for tortilla production), wheat, sorghum, soybeans, sugar, rice, barley, beans, cooking oil, powdered milk, and noodles. All subsidies,'except for that on sugar, were administered by the state-owned National Basic Foods Company, CONASUPO, through one of two mechanisms: either by selling the products at reduced prices to processors (who themselves were subject to controlled prices on outputs) or by reimbursing processors directly for costs not covered by sales revenue. By 1983, global food subsidies exceeded 1% of GDP. With spending of the poorest 30% of the population accounting for only 15% of national food expenditures while that of the richest 30X accounted for about 50% of these expenditures, these global subsidies represented enormous transfers to the upper income groups while benefiting much less the poorest in Mexico's urban and rural areas. 38. Achievements to Date. As shown in Annex 6, Table 1, the real value of food subsidies administered by CONASUPO has been reduced dramatically during the past several years, reflecting the major changes that have been made to reduce the drain of subsidies on the government budget. Global subsidies have been phased out for all products except sugar and (in some years) maize 2/. The real prices of many foodstuffs have more than doubled. This major reduction in CONASUPO subsidies already achieved, up front, constitutes a major break with the past. Indeed, it is the single most significant subsidy reduction effort undertaken by the de la Madrid Administration. By the end of 1986, subsidies administered by CONASUPO were running at an annual rate of only about 0.02% of GDP while the sugar subsidy was about 0.05% of GDP. 39. Despite the fact that the poor gained relatively less than the rich from global subsidies, the near elimination of food subsidies has harmed many of the poor. As global food subsidies have been phased out since 1983, increases in the prices of basic products have eroded the real purchasing power of the poorest 20% of the population by about 6.5%. Aware of this effect on the poors' consumption, the Government has recently instituted a system of food coupons ("tortibonos") that allow recipients to purchase a fixed amount of tortillas (approximately 2-3 kg per day per family) for less than 25% of the market price. The Government is distributing coupons through CONASUPO's stores (DICCONSA and LICONSA) in poor urban areas to families with total income less than twice the legal minimum wage (or under US$5 per day). A small percentage of the coupons (15%) are also currently being distributed through trade unions. 2/ The Government is currently studying how to revise its sugar pricing policies (para 64) to reduce or eliminate subsidies in this area as well, and conditionality contained in the ASL (para 68) will ensure that there is no back-tracking in this area. - 13 - 40. Further Steps to be Taken under the Sector Loan. Because of the precarious nutritional status of the poor in Mexico (over 30X of preschoolers suffer from serious malnutrition), the elimination of all global food subsidies without a sufficiently funded, targetted program of food subsidies for the poor would threaten to create a serious breach in the social safety net. If this happened, it would cause great suffering, and could also undermine support for the Government's program of reforms and put pressure either to reintroduce global subsidies or to reduce prices to farmers. The Mexican Government has already begun to address this issue through the use of food coupons for tortillas and targetted distribution of reconstituted milk in urban areas. However, these programs are limited, under-budgetted, and deficient in controlling targetting and review of eligibility. Furthermore, targetted food subsidies are largely not available to rural communities where the need is greatest. 41. The proposed ASL would support expanding the food coupon and milk programs through increasing the number of families covered in urban areas and developing selective price subsidies on certain basic foods in poor urban neighborhoods and economically depressed rural areas. It would also support the development of other targetted food programs in poor areas. It would seek to minimize manipulation and diversion of the subsidies from the target population through better supervision and monitoring of existing and future programs. It would change the manner in which the food coupon program operates, so that the coupons' purchase price would be tied to the market price. It would support a food subsidy budget for targetted programs that should largely compensate for the effects of the policy reforms on the very poor. If targetted to the poorest 20% of the population (16 million persons), a funding level of US$250 million would be approximately sufficient to raise their purchasing power to the levels of 1983, before subsidies began to be phased out. To the extent possible, the program would be designed to reach the rural as well as the urban poor. Specifically, as a condition of second tranche release, the Government would be required to demonstrate that in 1988 it had: (a) funded targetted food programs at a level sufficient to compensate the poor for the effects of the elimination of global subsidies between 1983 and 1986 (US$250 million); (b) implemented administrative procedures to minimize the diversion of subsidies from the target group; (c) expanded targetted food subsidies to needy rural areas on a pilot basis; (d) r'vised the criteria for eligibility in urban areas to correspond more closely with need (e.g., using anthropometric measurements) and to recognize budget constraints; (e) linked the price of tortilla food coupons to the price of tortillas so as to make the subsidy transparent and controllable and maintain it in real terms at a constant level per recipient to levels not higher than those existing as of the date of effectiveness of the loan, so as to maximize the number of beneficiaries; (f) studied expansion of other food programs to relieve the impact of the adjustment program on the poor (study to be carried out under terms of reference to be agreed with the Bank by May 31, 1988); and (g) presented a satisfactory action plan for expansion of the program of nutritional monitoring, including representative samples of both rural and urban areas (See Annex 10 for more details). While this loan would not seek commitments beyond the current administration's horizon (commitments that the administration would be incapable of realistically making), it is envisioned, based upon projected food prices, that the cost of these programs should not exceed approximately 0.2% of current GDP (around US$335 million annually) by 1991. - 14 - B. Reducizg Govermuent Intervention in & tablishing Producer and Consumer Prices 42. Background. For major agricultural products, both the prices paid by consumers and those received by producers are set or determined by the Government using direct consumer price controls, Government procurement from producers at guaranteed priees, export and import controls., and (until very recintly) direct subsidies to private and parastatal processors. The major decisions related to pricing and trade controls are made by the Agricultural Cabinet and by the Ministry of Commerce and Industrial Promotion (SECOFI), which has considerable discretion to decide what products are placed under these controls, as well as what ceiling is set for each price and what quantity is authorized for imports and exports of each product under controls. Based upon projections of domestic supply for a product, the Government decides simultaneously on domestic prices (at farmgate and levels further along in the processing chain) for the product, anc how much should be imported or exported to sustain that price. Importers of major basic commodities such as maize, sorghum and oilseeds must also be processors and are given authorization to import a fraction of the global quota corresponding to their share of purchases of the total domestic production. Export controls are used to reinforce consumer price controls that maintain domestic prices at levels below international levels. 43. The Government's most important objective in these interventions in the market has been to keep consumer food prices low as part of its development strategy of encouraging industrial development through low-cost labor. As a secondary objective, throughout the 1970s and especially during the early 1980s, the Government attempted to raise rural incomes and achieve "food sovereignty" by setting farmgate prices through Government procurement at higher levels than those that would have prevailed given the low consumer food prices. The losses occurring from this pricing policy were absorbed by direct and indirect transfers from the Government to both private and parastatal firms. However, in response to the current crisis, the Government has had to phase out subsidies both to private and parastatal processors, so that the current low levels of controlled retail prices are tending to depress producer prices. Furthermore, restrictions on exports and imports are inhibiting investments in agro-industry. 44. Consumer Price Controls. Before the introduction of the temporary Economic Solidarity Part, an estimated 48% of domestic production were under some form of price control at the consumer level. Although price controls covered a wide set of goods, food prices were generally the most strictly controlled. Even though global food subsidies were largely eliminated, retail prices for many foodstuffs remained below equivalent world levels due to these price controls. Prices were controlled through four lists. The first list was for products under strict price control. For these products, no price changes were permitted without the approval of the SECOFI and adherence to the controls was monitored by special inspectors. Twenty-one products, almost exclusively food and agro-industrial products (representing approximately 15% of national production value), were under strict price controls. Of these 21 products (e.g., wheat flour, maize flour, edible oils, rice), 10 had export controls. Of the 16 products where international price comparisons are meaningful, 13 had prices below international levels. Survey data (1984-85) comparing - 15 - official prices with market prices in Mexico City show that price controls were generally binding. 45. The second list, introduced in October 1985, consisted of prices that could be automatically adjusted up to 95% of the rate of inflation. Producers wishing to raise prices more had to show that the increase was "justified" by increased costs of production. This list consisted primarily of industrial products, mainly consumer durables. 46. A third list consisted of goods that required only ex ante registration of price changes. Besides submitting a statement of cost changes, no other more formal justification of price changes was required. For goods on the fourth list, the only requirement was that the seller notify SECOFI within ten days after increasing prices. 47. Under the temporary Economic Solidarity Pact, the strict control list has been extended to all basic commodities as part of the anti-inflationary strategy for 1988. These controls will expire at the end of 1988. The intention of the Government is to return to the previous system of controls at the expiration of the Pact and then to gradually phase out controls in the long run. 48. Farmgate Prices. On the producer side, the Government has in the past set guarantee or minimum prices for 13 crops, including basic food grains, major animal feeds and oilseeds, and actual prices received by farmers have tended to follow guarantee prices closely. These guarantee prices are administered by CONASUPO. Sugar prices are also set by the Government but not administered by CONASUPO, and are currently above international levels. The Government currently sets guarantee prices for 12 crops, having stopped setting a specific price for feed barley since it is only a by-product of malt barley. These prices are intended to cover a weighted average of production costs for a variety of representative technologies and areas. International prices are intended to serve only as a reference. Because production costs vary widely in Mexico, the setting of guarantee prices supposedly based on costs of production in reality has been a politic4l process, a struggle between farmer interests on one hand and urban and agro-industrial interests on the other, with the Ministries of Finance (SHCP) and of Planning and Budget (SPP) attempting to minimize the consequences of these deliberations on the Government's budget. As a consequence, international prices, representing the opportunity costs of domestic procurement to processors, have historically been important criteria in setting prices for only some crops, such as soybeans, for which imports and agro-industrial interests are large. 49. More generally, the levels of producer prices relative to international orices have varied across time and crops (Annex 6, Graphs 2-7), depending on the state of the exchange rate (i.e., under- or over-valued), the Government's priorities, and its fiscal ability to support a differential between low consumer and high producer prices. The Government's inability to subsidize this differential caused farmgate prices to fall significantly in 1986, s0 that the ratio of producer to international prices were at the lowest levels of recent history: 1.01 for maize, 0.85 for wheat, 0.75 for rice and 0.75 for soybeans (Annex 6, Tables 3 and 4). Since that time, some prices have increased substantially relative to international prices with others lagging stiln further behind, creating great dispersion among crops. In recent periods - 16 - of high inflation, the guarantee price, which is maintained constant in nominal terms over a growing season, is steadily eroded in real terms until it is increased for the following season. 50. Producer prices are set at the same level in all parts of Mexico, effectively penalizing production in areas close to consumption centers (which in a free market would tend to have higher prices because of the low cost of transporting the product to market) and subsidizing production in areas far away. This pan-territorial pricing has also encouraged the location of agro-industry in the consuming, rather than producing areas. Furthermore, while prices are occasionally adjusted (generally semi-annually), the adjustments are not based on economic criteria such as the cost of storing the crop, and are far too infrequent in a period of rapid inflation. Thus, over the course of the year, the real support price steadily falls for a number of months due to inflation, then makes a large discrete jump when a new procurement price is announced. This pan-seasonal pricing distorts production decisions and makes storage unprofitable. As a consequence, storage remains primarily in the hands of the public sector. 51. Producer prices for fruits and vegetables, coffee, cotton and tobacco are not determined by the Government. Because of dependence on export markets, they are closely aligned with international prices, and thus their production is strongly influenced by exchange rate policies and international market forces. 52. Producer prices for other products, including sugarcane, are subject to Government intervention to varying degrees. For example, producer prices for sugar are set by the SUCP in consultation with the public and private sector industry. 53. Achievements to Date. With regard to consumer price controls, prior to the Economic Solidarity Pact the Government had been reducing the number of goods under price control. Table 2 in Annex 6 gives a breakdown of bow the production coverage has shifted from 55Z in December 1982 to 48Z in September 1986. With regard to producer prices the Government has pledged, as part of its Economic Solidarity Pact, to set all crop guarantee prices on March 1, 1988, at their average levels (in real terms) for 1987, and then to adjust them monthly at the rate of inflation. This will avoid the problem of continual intrayear erosion mentioned above. 54. Further Steps to be Taken under the Sector Loan. The ASL tackles pricing issues in several ways. First, on the producer side, it reinforces the Government's commitment under the Economic Solidarity Pact to maintain guarantee prices during 1988 at real 1987 levels throughout the year. For 1989 the Government will create a price band around international price levels (90-125X) for each crop with a ceiling as well as a floor, for all guarantee prices administered by CONASUPO except maize and beans. This would be a condition of second tranche release. The price band is designed with an upper limit of 125% of international prices to give the Government flexibility to raise agricultural prices to levels that would redress any biases in the industrial-agricultural terms of trade that might be created by use of the 20X maximum tariff to protect the industrial sector. International prices would be adjusted for transport costs, quality differentials and processing margins. - 17 - Mexican maize prices are currently well above international maize prices. But Mexico produces largely white food-quality maize while international trade is largely in yellow feed-quality maize, and the world market for white maize is poorly developed. Yellow maize is only an imperfect substitute for white maize and price comparisons are therefore not straightforward. For beans, it is even more difficult to make meaningful comparisons between domestic and international prices as beans are a heterogeneous commodity and Mexico possesses some monopoly power in a very thin international market. 3/ At a time when the previously highly-protected industrial sector has seen its pricing brought more closely in line with international levels, the producer price conditions of the loan will ensure that internal industrial-agricultural terms of trade are close to international levels, furthering the Government's objectives of making the Mexican economy efficient and competitive in world markets. 55. The loan would also require a thorough review of the guarantee price system. This review would include sections aimed at determining which of the 12 crops that currently have guarantee prices should continue in the system, how prices could be adjusted over time and geographical area to simulate pricing patterns in a free market, and how the price baud system established under the loan can be fine-tuned. So that work can begin quickly, agreement on the terms of reference for the studies would be reached as a condition of disbursements exceeding US$25 million of the first tranche, with satisfactory completion of the studies and discussion of the results being a condition of second tranche release. These results will then be available to the Government and the Bank to form the basis of future dialogue on agricultural pricing policy. 56. With respect to food prices at the consumer level, the anti-inflation measures included in the Economic Solidarity Pact make it infeasible to seek further liberalization of consumer price controls at this time. However, the loan's conditionality on producer prices and on limits to the CONASUPO budget available for general food subsidies does ensure that food prices will not be kept artificially low. As described above, producer prices will be linked to international prices. Transfers to CONASUPO to cover operating losses will be specifically limited in 1988 and 1989 to their budgetted 1988 levels (para 66). Since CONASUPO's ability to borrow from external sources is severely circumscribed by previous agreement with the Government, the limit on operating losses means that it would be unable to finance the global food subsidies through artificially low consumer prices, as was done in the past. The loan also specifically requires that no global food subsidies be introduced through institutions other than CONASUPO (para 66). Thus, the loan ensures that consumer food prices, although still formally under control, will move in line with producer prices. C. Red!ucIn the Role of Parastatals in Agricultural NrIetriD8 Storage and Processing 57. Background. The Government's involvement in agricultural marketing, storage, sad processing is mainly through CONASUPO, some parastatals controlled by the Ministry of Agriculture (SARR) and the public sugar company, AZUCAR, S.A. de C.V. Although some of the parastatals are well-managed and operated, 3/ How to use international prices as a yardstick to domestic price policy is therefore an issue for further study. - 18 - many of these enterprises have suffered financially from restrictive pricing and subsidy policies and operationally from bureaucratic and political burden while inhibiting effective and flexible allocation of resources, including private investment. 58. CONASUPO and its affiliates (collectively referred to here as "CONASUP0") have acted as the Government's agents for exercising control over the market for basic food products, other than sugar. They procure crops from farmers ait prices set by the Government, process some of the crops into food products, and sell them to consumers, also at Government-established prices. In the period before subsidies were eliminated, that is, when consumer prices were set far below producer prices and costs of processing and distribution, CONASUPO's role as purchaser, processor, and distributor entailed significant losses. It incurred further losses from other sources as well. First, it sold some crops it had procured to processors at subsidized prices. Second, it paid subsidies to processors who procured directly from farmers to reimburse them for losses they would otherwise incur because of Government policies that kept the price of their raw material high relative to the price of their finished product. And finally, CONASUPO had sole authority to import basic food products, for which it had to pay international prices, while selling them at much lower prices domestically. Through its role as a monopoly importer, it incurred a large dollar-denominated debt in the early 1980s, and this debt becrme increasingly burdensome as rapid devaluations created sizeable exchange rate losses. 59. As CONASUPO's role in the economy grew and its debt mounted, the Government was forced to increase its fiscal transfers to the parastatal. These rose (in constant 1980 pesos) Crom 9.9 billion (0.3% of GDP) in 1977 to 54.6 billion (1.21% of GDP) in 1984, before being reduced to 32.4 billion (0.74% of GDP) in 1986. This need for ever-increasing transfers was a key factor in the Government's decision to impose limits on CONASUPO's role in the economy. 60. Besides CONASUPO, forty parastatals under the control of SARH are involved in production, marketing and processing of coffee, tobacco, forestry and wood products, animal feed, cotton, seeds, vegetable oils, and fruit. Fiscal transfers to these companies in 1986 were under US$50 million (less than 0.02% of GDP). 61. Another significant parastatal involvement in agriculture is in the sugar sector. Azucar, S.A. de C.V. is the state-owaed enterprise responsible for operation of 52 of the country's 70 sugar mills and 75% of production. It is heavily supported by Government transfers; in 1985 the budgeted transfer was 107.2 billion pesos (about US$200 million, or 0.05% of GDP). 62. Achievements to Date. The Government has recently taken major steps to restructure CONASUPO, as outlined in the agreement ("convenio") between CONASUPO and the Government concluded April 15, 1986. Through this and subsequent agreements, the Federal Government assumed over 80% of CONASUPO's accumulated debt, equalling US$1.8 billion. CONASUPO in return promised to abide strictly by the budget approved by the Chamber of Deputies and to make basic structural changes in its operations, including: (a) reducing its level of intervention in the market for basic crops to that necessary for the - 19 - enforcement of price regulations, while promoting private sector participation; (b) eliminating subsidies by closing the differential between purchase and sale prices; (c) reorganizing CONASUPO itself and merging some aifiliates to reduce costs and increase efficiency; (d) eliminating sales on credit; and (e) establishing an information system to permit more careful monitoring of operations and finances. In addition to the internal financial and structural changes outlined in the agreement, the role of CONASUPO in importing has been altered significantly (para 74). 63. Some progress has also been made with respect to SARH's parastatals. Since 1985, the number of public sector bodies under the control of SARH has been reduced. From a total of 89 entities, 31 non-operating entities had been liquidated by the end of 1986, including 18 companies with a majority state share-holding, 3 with a minority holding and 10 trust funds. 64. Progress that promises to be significant has also been achieved with respect to the sugar sector. In August 1985, an agreement was signed between the Federal Government, Financiera Nacional Azucarera, and Azucar, S.A. de C.V. The agreement specifies a number of important steps that will be taken to strengthen the operations and improve the financial status of the sugar industry. The rationalization of capacity, including the closure of high-cost mills, the reduction of staffing levels, the improvement of the cane purchasing systems, and the restructuring of pricing policy are identified as essential steps to allow the efficient operation of the industry on a self-sustaining basis. 65. Progress has already been made towards a sounder sugar sub-sector. Staff reductions of 2,800 have been made, mainly in administrative areas. Four mills have closed since 1986. The cane planting program has been marginally reduced, in order to help move production into line with consumption, but there has been no progress on efforts to change the method of cane purchase to one based on cane quality. 66. Further Steps to be Taken under the Sector Loan. The proposed ASL -ould sustain these reforms. Specifically, as a condition of second tranche release, the Government would limit fiscal transfers to CONASUPO (other than for debt service, investment, the food stamp program, LICONSA's milk program, or other targetted subsidies) to less than US$85 million in 1988 and 1989. (These transfers were estimated to have been about US$215 million in 1987). The loan would also require, as a condition of second tranche release, that no global food subsidies be introduced through institutions other than CONASUPO. In addition, as a condition of second tranche release CONASUPO would close or move to poor neighborhoods 500 major retail outlets of CONASUPO's retail affiliate, DICCONSA, that are now in middle or high income urban areas, and would liquidate CONASUPO's wheat processing affiliate, TRICONSA, which controls about 5% of the market in Mexico City. 67. With respect to the parastatals in the agricultural sector, a condition of second tranche release would be satisfactory progress in the sale or closure of 15 parastatals. The 15 companies represent 2.6% of total parastatal budget and 0.8% of fiscal transfers to such public companies in the agricultural sector. As such, they are not significant entities in terms of budgetary allocations but represent a symbolically important additional step in - 20 - the privatization and liquidation of sectoral parastatals. The remaining parastatals, in particular INMECAFE, TABAMEX, ALBAKEX, ALGODONERA and PRONASE, but also including a number of other entities that are recipients of fiscal transfers, would need to be addressed in subsequent loans. 68. With respect to the sugar sub-sector, a condition of second tranche release would be satisfactory progress in the closure or sale of an additional 2 mills. (Four mills have been closed already). A further condition of second tranche release would be discussion with the Bank of the results of a study to design a rational policy of pricing for sugar cane and for sugar at the factory and consumer stages. The policy would aim at reducing subsidies and would eventually allow financial self-sufficiency of efficient mills and companies, while taking into account international measures of efficiency. Draft terms of reference for this study are included in Annex 8. D. Ptogres Toward Aaricd tural Trade Liberalization 69. Background. Historically, the Government has used trade policy to reinforce internal policies, such as consumer price controls. For basic imported foods, including maize, wheat, sorghum, beans, rice, oilseeds, soybeans, barley, and powdered milk, the state exercised control by giving CONASUPO exclusive importation rights. For a few exports as well (notably coffee and sugar), parastatals have monopolized foreign trade. For other products, the Government has controlled foreign trade indirectly, by the use of quotas, licensing requirements, and tariffs. 70. Imports of almost all major agricultural commodities and exports of some commodities are subject to quotas. For basic grains and oilseeds, import quotas are set every six months by estimating the size of the coming domestic harvest and the amount of imports that will be necessary to satisfy domestic demand. 71. Imports and exports of all goods with quotas, and many other goods as well, can be carried out only with licenses issued by SECOFI. Import licenses are required for products that comprise over 86% of agricultural production and 22Z of livestock production. In the GATT negotiations, the Mexican Government stated explicitly that it had no intention of eliminating licensing requirements for its major agricultural imports. Exportation of some products (including cattle, shrimp, coffee, and a number of grains and vegetables) require licenses from both SECOFI and some other ministry, such as the Secretary of State. 72. Most agro-industrial and many agricultural product categories are subject to import duties, in some cases in addition to licensing requirements. Basic food imports are generally free of tariffs, being regulated by quotas and licensing. Although many products are subject to export controls, export duties are few. They include a 0% to 302 tax on coffee exports (depending on the international price) and a tax of 0.5% on exports of cotton lint. 73. Achievements to Date. Agricultural trade liberalization in Mexico is complicated by the following: (a) effective rates of protection for many agricultural and agro-industrial products appear to be negative, with agriculture being taxed relative to international prices; (b) a system of - 21 - stable guaranteed prices requires some level of variable protection since international prices fluctuate widely; and (c) the internal terms of trade have historically been biassed against agriculture, with protection substantial for industrial products. 74. Nevertheless, the Government has made major progress on trade liberalisation on several fronts. Beginning at the end of 1984, it eliminated CONASUPO's import monopoly on all goods except powdered milk. The private sector has responded, and the division between private and public imports in 1986 is estimated by CONASUPO to be as follows: 1986 Estimated Imports (In '000 tons) CONASUPO PRIVATE SECTOR Maize 1,800 700 Wheat 0 0 Sorghum 750 900 Beans 200 0 Rice 0 0 Oilseeds 0 2,561 Barley 0 0 Milk Powder 122 0 Mexico has also reduced tariffs on at least 66 categories, mainly on items not produced in Mexico or in shortage-seeds, milk, fats, raw skins and hides. With support from the Bank's TPLs, the maximum tariff rate has been reduced from 100% to 20%. The Government has also eliminated the use of official reference prices, which were maintaIned at artificially high level in order to indirectly tax imports at rates above official tariff levels. In their place, the Government is substituting a modern system of protection against dumped goods. Under TPL I, the Government reduced coverage of licensing requirements by 5% of national production, of which 2.82% came from agricultural or agro-industrial product categories. Furthermore, the list of items for which applications for import licenses are automatically denied, which formerly included a number of agricultural commodities, has been eliminated completely. Finally, export licensing requirements have been eliminated for wheat, some meats, and some other agricultural commodities. 75. Licensing has been an important bureaucratic impediment to free entry of firms into importing and to the establishment of agro-industries that require imported inputs. Also, licensing provides the potential for the imposition of high and non-transparent levels of protection. The Bank, therefore, has continued to support the Government's program of steady reduction in coverage under these restrictions. As part of the TPLII, the Government has agreed to reduce the coverage of licensing requirements for both agricultural and manufactured goods from coverage of 49.8% of national production (after the second tranche of TPLI in November of 1986) to 43.1%. Of this reduction, approximately 5% of national production coverage is likely to come from agricultural and agro-industrial product categories. - 22 - 76. Further Steps Sought under the Sector Loan. The proposed ASL would support a continuation of this liberalization process. First, as a condition of second tranche release, approximately 5X of national production in agricultural and agro-industrial product categories would be freed from import licensing requirements. (This 5 would also be counted toward the liberalization requirements of TPLII). This will reduce the production coverage of quantitative restrictions from 54Z before TPLII, to 39% of production in these sectors. As shown in Annex 6, Table 5, this could be achieved by elimination of licensing for agro-industrial products or by a combination of reduction in liceusing for agro-industrial products and agricultural goods.4/ Second, for some basic grains, beans and oilseeds 'that would most likely remain under licensing, a study would be conducted that would address the administrative feasibility of implementing a variable tariff for these commodities. (Annex 8 contains draft terms of reference for this study and other studies on pricing issues required under the loan.) It would also determine how to implement transparent and non-arbitrary anti-dumping regulations for agricultural commodities. The study would be confined to agricultural commodities, which receive special treatment under GATT. Satisfactory completion of these studies and discussion of the results with the Bank is a condition of second tranche release. Removal of export controls on quality cuts of beef and high quality rice (represerting less than 0.8% of national production value) would be a condition of disbursements exceeding US$25 million of the first tranche. Fruits and vegetables have been one of the most dynamic export-oriented agricultural subsectors in Mexico, and have responded strongly to trade liberalization. The Government's intervention in the sector has been minimal compared with other sectors, though it has imposed selective export restrictions, either as a means of setting quality standards for exports or to control domestic supply (as in the case of chilies). The system of export control is now essentially self-regulated by producer-exporters. The ASL would ensure continuation of this status by requiring as a condition of second tranche release that the Government refrain from controlling exports while encouraging farmer organizations to set quality standards for exports. S. Reducisg Subsidies on Agricultural Inputs 77. Background. As noted before, agricultural prices have been maintained at low levels as part of the Government's industrial development policy. To counterbalance this discrimination against agriculture, the Government has resorted to compensating input subsidies. Almost all inputs to agricultural production-including fertilizer, fuel, credit, water, and crop insurance--are subsidized by the Government. 78. The most important subsidies-fertilizer, credit and water--have distorted resource use and have had detrimental effects on the institutions supporting agriculture, in addition to burdening the fiscal situation. The fertilizer subsidy has promoted use of inappropriate levels and types of fertilizer while supporting an inefficient and ponderous parastatal, FERTIMEX. 4/ Table 6 of Annex 6 displays the specific product groups tentatively proposed for liberalization by SECOFI in discussions regarding two possible scenarios under the TPLII. The percentage of agricultural production that will be removed from quantitative restrictions has been discussed extensively by missions for both the proposed ASL and the TPLII. - 33 - FRTIMEX received a direct transfer from the federal government in 1985 equal to almost 0.3S of GDP, and an indirect transfer of almost 0.12 of GDP in the form of low ammonia prices. The subsidy received by farmers, measured by the difference between world prices and the prices paid by farmers was about 0.22 of GDP as of the end of 1986. The credit subsidy, which was around 0.7Z of GDP in 1985, has over-capitalized some aspects of agriculture while Inhibiting the building of self-sustainable financial intermediaries. The water subsidy, equal to around 0.05S of GDP In 1981, has contributed to salinity problem and the raising of the water table in the commercial northern irrigated areas. Lack of sufficient funds for operation and maintenance (in part caused by inadequate cost recovery) has also contributed to a deterioration of irrigation canals and drains. 79. The proposed Fertilizer Sector Adjustment Loan is seeking institutional reforms and further reductions in input subsidies for the fertilizer sector. Specifically, it seeks agreement on a program and timetable to liberalize fertilizer distribution and to raise prices to farmers toward international equivalent prices by reducing fiscal transfers (so as to achieve financial self-sufficiency of FERTINEX), and by requiring that FERTDMEX pay for ammonia a price that would cover the costs of ammonia production, with natural gas valued at its domestic price to users. (FERTIMEX already pays international prices for two out of the three primary raw materials used -- phosphate rock and sulphur.) Furthermore, the loan would ensure that fertilizer could continue to be imported by anyone without non-tariff restrictions. These important adjustments would ensure that efficiency objectives are furthered, whilst eliminating the sector's huge fiscal subsidy. Based on the phasing in of ammonia price increases, the Government would have to increase fertilizer prices by an estimated 12.31 per year in real dollar terms for 5 years. The proposed ASL is integrally linked to the Fertilizer Sector Adjustment Loan, since the increases in fertilizer price envisioned under the latter must be accompanied by the increases in crop prices that are a condition of the former. Otherwise, the fertilizer price rise could have a detrimental impact on agriculture. 80. Achievements to Date. Specific subsidies for various inputs that have been reduced are outlined below: (a) Fertilizer. Prices of fertilizers are fixed by SHCP with the approval of the Economic Cabinet. In 1986, the ex-factory equivalent fertilizer prices for nitrogen and phosphate were about 251 of border prices.5/ These prices at the railhead (includLng transportation and distribution) were about 502 of the equivalent border prices of nitrogen and phosphate fertilizer (respectively accounting for 71% and 231 of total nutrient use). The subsidy on potassic fertilizer, accounting for the remaining 62 of total use, has now been eliminated. With respect to nitrogen and phosphatic fertilizer, in 5/ The price of fertilizer is set at the same level, whether the buyer picks it up at the factory or has it delivered to the railbead near its final destination. For this reason, virtually no fertilizer is sold at the factory. The "ex-factory equivalent" price was derived by subtracting approximate distribution costs from the railhead price. - 24- :WIte of d&c,aiAv intentions, the Government has not been able to close the gap significantly between domestic and international prices and has, at best, only maintained domestic prices in real terms. (b) Interest Rates. Significant adjustments are being made to interest rates. In 19U84, the Bank and the Government of Mexico negotiated a General Interest Rate Agreement (GIRA), in which the Government agreed to raise lending rates In relation to the Average Cost of Funds (ACF) and make them variable., The ACF was chosen as a benchmark rate because It is the closest proxy for an index of a market borrowing rate that is readily available In the heavily regulated environment in Mexico. While the Government sets the rates that determine the ACF, Its freedom to manipulate the rate is tightly constrained by the ease with which capital can be taken out of the country If rates paid to savers move out of line with international market rates. Thus, the ACF generally approximates these rates (adjusted for exchange rate movements) and is positive in real terms. GIRA requires semi-annual adjustments relative to a variable ACF. (c) Irrigation Water Charges. The percentage of irrigation operation and maintenance costs covered by water charges has increased on a national basis from about 12X in 1982 to 36% in 1986. The stated goal of the Government is that irrigation charges eventually cover all operation and maintenance costs in commercial areas and 602 of such costs in marginal areas. Recent legislation has been passed that provides the legal basis for achieving these objectives but progress in implementing the goal has been slow. 81. Further Steps to be Taken under the Sector Adjustment Loan. Because of their large size, high visibility, and political sensitivity, input subsidies have been, and will continue to be, difficult to deal with. Nonetheless, reform in this area mus"t be an important component of a program to improve productive efficiency. For water charges, the ASL would require as a condition of second tranche release a satisfactory plan of action (based on a study under the loan) to implement at the district level the Government's program for 100% recovery of operation and maintenance costs in commercial and export-oriented areas and 602 in marginal production areas except under any specific circumstances provided under Mexican law. This plan would form the basis for further dialogue on operation and maintenance cost recovery issues. Issues of capital cost recovery will be dealt with through the proposed Northwest Irrigation Project and future irrigation projects. P. A Satisfactory Public Iowestme_t Program in Asriculture 82. Background. Public investment in agriculture and rural development'/ in Mexico has been falling as the result of current economic 6/ Public investments in agriculture and rural development include rural roads, water systems for urban areas, potable water, capital expenditures for universities and research, etc., besides more directly productive investments such as in irrigation works. About 40% of the public investments directly administered by SARR for the sector fall into the directly productive category. - 25 - difficulties. After averaging about 15 percent of total public investment during the 1970-1982 period, agriculture's share of public investment in 1987 came to only about 12% (about 0.7% of GDP). The budget for agricultural public investment in 1988 is budgetted at about US$331 million (only about 60X of its 1986 level) excluding an allocation of US$104 million from the growth contingency (Annex 11). 83. Within the sector, a major shift has occurred as to who executes public investment. In the past, SARH undertook the bulk of investment, mainly in an ambitious program of irrigation works. More recently, however, a growing share of agricultural public investment has been carried out by the states In keeping with a federal government decision to "divest" increasing power and responsibility for expenditures to the states. The SPP finances these state-executed agricultural investments under what is, in effect, a revenue sharing scheme, but it otherwise exercises very little control over state-executed projects. About half of Mexico's agricultural public investment is federally-executed-by SARR-with the other half in the hands of state governments. 84. Achievements to Date. Because of the strict budgetary restraints, SARK has devoted priority to finishing projects nearing completion; stopping long gestation, lower-return large scale projects in their early stages; and emphasizing small-scale projects that would yield immediate benefits or promote exports. SARH is now carefully planning its investments and subjects all its projects to a rigorous cost-benefit analysis. In the process, it has made major headway in cleaning up its portfolio. In 1987, only 6% of SARH projects were uneconomic versus 26% in 1986. None of the uneconomic projects could be classified as "white elephants", either by size (the largest constituted less than 2% of total SARH investment costs) or by economic return (only 0.8% of investment c8sts had a benefit-cost ratio of less than 0.8). SARK's 1987 investment portfolio for irrigation, drainage, and rehabilitation had an estimated average benefit-cost ratio of 1.9 (based upon a 12% opportunity cost for capital) and with a net present value of over US$200 million. SARH's 1988 investment budget has been reviewed and together with funds from the Growth Facility of the international financial package (Annex 11), is satisfactory to the Bank in both quality of projects and total funding with sufficient funding for Bank-financed projects. 85. The qdality of state-executed agricultural public investment is much less clear. SPP requires that each project be analyzed on an economic and/or social cost-benefit basis at the state level. Because these investments are carried out by states and most of the projects are scattered and small, it is virtually impossible for the Bank to evaluate the portfolio systematically. The Bank's experience-through the PIDER projects where an ex-post analysis revealed that Bank-financed stated-executed investments had an economic rate of return of 27%--suggests that many of these investments are sound. However, this sample is too small to conclude that state-executed agricultural investments on a country-wide basis are satisfactory. 86. Furtbhr Steps to be Taken under the Sector Loan. Since the 1988 investment budget has already been reviewed and deemed satisfactory to the Bank, the ASL would concentrate on the 1989 budget. Although the Government - 26 - cannot make unequivocal commitments regarding a future budget, which may be changed by Congress, it has agreed as a condition of second tranche release to do the following. First, in order to revise the alarming decline in the agricultural investment program since 1986, the Government will submit a 1989 budget request to Congress that would increase SARH's investment budget by at least US$200 million in real terms over the base 1988 level of US$331 million. (The budget request will include funding for the planned Northwest Irrigation Project to be financed partially by the Bank.) Second, Government will establish procedures to solve a problem that has arisen in the past because of the fungibility of funds within the budget of the Ministry of Agriculture. Because of this fungibility under an overall budget ceiling, the Ministry can reallocate funds to projects which receive no external funding and therefore has little incentive to execute the program supported by external funds. The budgetting procedures to be developed by the Government under this loan will create the proper incentives for SARH to execute externally-funded projects. G. Decentralization and Reduction of Staff of the Ministry of Agriculture 87. Background. The Ministry of Agriculture (SARH), has been characterized as over-staffed, too bureaucratic, overly politicized, and insufficiently dispersed throughout the country. As of 1982, SARH employed about 152,000 people, with about 33,000 (21.5%) of them in the capital. Agencies and departments dealing with closely related areas, such as agriculture, livestock, and forestry, were separated and uncoordinated. Because so much ministerial authority was concentrated in Mexico City, officials at the local level were unable to make even simple decisions or to process straightforward administrative requests from primary producers or agro-industry. One of the principal objectives of the current Minister of Agriculture has been to rectify this situation. 88. Achievements to Date. SARH has made significant progress in meeting its goals. Some of the more important steps taken already include the following: (a) in spite of the political cost of reducing staff in a period of such high unemployment, SARH cut its payroll from 152,000 in 1982 to about 114,000 in 1988; (b) remaining staff have been and are being decentralized. Staff in Mexico City was reduced from about 33,000 (21.5% of all employees) to about 18,000 (13.5%) between 1982 and the end of 1985; (c) fourteen agricultural parastatals are being moved out of Mexico City. In this process, about one-third of their work-force will be eliminated; (d) an internal reorganization in SARH has eliminated some of the bureaucratic overlap and lack of coordination among departments. In the process, several commissions that are no longer needed have been eliminated; (e) authority to handle 231 routine procedural requests from producers and agro-industry has been delegated to the local level. In some cases, this has reduced the required processing time from 6 months to 15 days. Routine administrative and budgetary decision-making has also been delegated to the local level; and (f) a program has been started to improve the training of extension workers. Furthermore, extension and research are now multidisciplinary in their approach and extension staff operate a system of routine visits with technical support from district level subject matter specialists. The focus - 27 - is on rural development and the administrative elements are similar to the training and visit system. 89. Further Steps to be Taken under the Sector Adjustment Loan. After SARH's continuous progress throughout the period of appraisal and negotiation of the ASL, it provided to the Bank at negotiations budget and other information indicating that its objectives in decentralizing, restructuring, and streamlining have been achieved. Combined with the planned restoration of the agricultural investment budget, a highly desirable shift will also occur in the balance of recurrent versus investment expenditures. PART IV - HISTORY AND PROCEDURES OF THE PROPOSED LOAN A. Loan History 90. As described more fully in previous paragraphs, the Government over the last several years has acted to loosen its control over the economy, to increase its integration into the world economy and encourage the private sector to assume an increasingly important role. These reforms have been politically difficult for the Government and have imposed considerable costs on certain segments of the population, while improving prospects for future growth. Similar reforms planned for the future promise similar costs but long-term benefits for the economy at large. Consequently, to assist in the reform process, the Government requested that the Bank provide financial and technical support for the structural adjustments in agriculture and other sectors. The Bank responded by sending a pre-appraisal mission for the proposed Agricultural Sector Loan in October and November 1986, followed by an appraisal mission in April and May 1987. Negotiations took place in Washington, D.C. in December 1987 and February 1988, with the Mexican delegation led by Jorge Delgado. The proposed loan is envisioned as the first of several agricultural sector adjustment loans that will support a continuing series of reforms in the sector, some of which would be based on the results of studies supported under this loan. B. The Borrower 91. The borrower for the proposed loan would be Nacional Financiera, S.N.C. (NAFIN). NAPIN has also been the borrower for other loans to the agriculture sector, the most recent of which was the Agricultural Extension Project (Ln. 2859). C. Disbursesent, Procurement, Administration and Auditing 92. The proposed ASL would disburse quickly, financing general imports. The ASL would be disbursed in two tranches: the first of US$100 million and the second of US$200 million. Financing would be retroactive to November 22, 1987 with a cap of US$60 million. The first tranche would - 28 - become available upon effectiveness 7/, and the second upon fulfillment of specific conditions related to each of the policy areas described in Part II1. If these latter conditions remain unfulfilled by March 31, 1989, the second tranche will be cancelled, unless otherwise agreed between the Borrower and the Bank. 93. The proceeds of the ASL would be used to reimburse lOOZ of the foreign exchange cost of eligible general imports, with preference given to agricultural inputs, including agricultural chemicals, pesticides (with a negative list excluding certain pesticides according to Bank guidelines), seeds, machinery, agro-industrial inputs, and storage and transport equipment. Ineligible imports include goods financed from other official multilateral or bilateral sources, goods intended for military or paramilitary use, goods subject to quantitative restrictions, and certain luxury goods. Both private and public sector imports would be eligible for financing. Contracts under US$5 million each would be awarded on the basis of the normal procurement practices of the purchaser. Contracts for other goods and services, estimated to cost US$5 million or more each, will be procured through international competitivea bidding in accordance with Bank Guidelines. 94. NAPIN would be responsible for maintaining loan accounts and for the preparation and submission of withdrawal applications. In accordance with disbursement procedures adopted under the First Trade Policy Loan, disbursements from the proposed loan would be made on the basis of a summary from the Banco de Mexico detailing individual transactions in each relevant period in respect of eligible imports, together with a certification of payments of the amounts involved, and of their eligibility under the loan. Applications for withdrawals would be consolidated and submitted in amounts not less than US$1 million. The disbursement procedures would be coordinated with that of the Trade Policy Loan II and the proposed Fertilizer Sector Adjustment Loan to ensure that these loans do not disburse against the same transactions. 95. Audits of the supporting documentation for the statements of expenditure used for disbursements will be carried out annually by independent auditors acceptable to the Bank. The audit reports would be submitted to the Bank within six months of the end of the fiscal year. D. Effectiveness and Tranche Release 96. The loan would be declared effective when the Mexican Government provides to the Bank evidence that its macroeconomic policy framework is consistent with the agricultural sector adjustment program and completes the appropriate contractual arrangements with NAFIN. The second tranche of the ASL would be conditional upon satisfactory fulfillment of the conditions in each of the policy areas described above and in Annex 5, and upon satisfactory progress in carrying out the macroeconomic program supportive of 7/ Certain conditions of the loan that are very close to fulfillment (removal of export controls on quality cuts of beef and high quality rice) or are necessary in order to assure successful completion of the loan (agreement on terms of reference for studies and provision for procedures to coordinate disbursement) have been designated as conditions of disbursements exceeding US$25 million of the first tranche. -29- agricultural growth. It is anticipated that this would be completed by March 31, 1989. B. Itowinand REs 97. The Bank will monitor the Government's progress in implementing its reform program through regular supervision and exchange of views with the borrower and the Government covering both policy instruments and performance :argets in each of the policy areas touched by the proposed loan. NAFIN will prepare and submit every three months to the Bank a report on progress in implementing the loan and trends in the agricultural sector including domestic and cif and fob prices of both inputs and outputs and policy actions implemented by the Government. An exchange of views with the Government in connection with the release of the second tranche would take place by January 1989. Draft Terms of Reference for studies that must be completed and discussed before disbursements exceeding US$25 million of the first tranche (sugar pricing, variable tariffs, and territorial and seasonal pricing issues) are attached to this report as Annex 8. F. Benefits and Risks 98. The benefits of the reform program would consist of rising productivity and allocative efficiency in both agriculture and agro-industry, as adjustments in pricing make the incentive structure correspond more closely to economic opportunity costs. In addition, fiscal savings to the Mexican Government would be substantial while remaining subsidies would be more selective and targetted to the poor. Changes in the Government's fiscal outlays would come from several sources: the decreased subsidies on inputs (mainly fertilizer, paras 77-81), the changes in consumer subsidies (paras 37-41), the reduction of CONASUPO's operating losses (paras 57-68), and the changes in sugar pricing and subsidy policy (paras 57-68). The net effect of all of these would be an annual fiscal cost reduction of between US$1 billion and US$1.2 billion, depending on the year of the program (see Annex 7). The loan would also result in studies that would be useful to the Government in designing a program of further reforms, as well as to the Bank in advancing its dialogue with the Government on agricultural sector issues. The risks of the project derive from the political resistance to some of the reforms and the stability of the macroeconomy. While the current government has demonstrated its willingness to push forward with many reforms that are not politically popular, a new administration is likely to take office before second tranche release. While there are indications that the current policies will be carried over, there will certainly be political pressure to reverse the course. On the other hand, discussion of the second tranche conditions will also provide the Bank with an early opportunity to discuss the broad agricultural strategy with the incoming government. Also, the general vitality of the macroeconomy will influence the prosperity of the agriculture sector and hence the impact of the reforms. Furthermore, if there is a substantial appreciation of the real exchange rate, the viability of tradeable sectors such as agriculture could be harmed. These risks to the proposed loan are mitigated by the substantial steps that the Government has already taken up front (as described in this Report, many of the conditions proposed for a sector adjustment loan since January 1986 and during the preparation of the loan have already been fulfilled, while many of the others-for example sale of parastatals-are in advance stages of - 30 - implementation) and the strong commitment of the Government to continuing reform, liberalilation of the economy, and sound macroeconomic management. G. Social Impact of Lauiculturmi Sector Adjstmmt 99. The structural adjustment process for agriculture will have both positive and negative impacts, though the former wlll far outweigh the latter. The major positive impact will be felt by: (a) the Government in the form of fiscal savings, efficient public investments, a reduced parastatal sector, and better information antd analysis in its policy making and evaluation; and (b) producers in the form of improvements in the operation of SARH, higher faragate prices, and greater productive efficiency. The negative Impact, much of which has already been felt, will be borne by high and middle-income consumers, while the impact on the poor will be redressed for now and in the future by a targetted food stamp program and other food and nutrition programs. 100. An important question about the program envisioned in the ASL is whether the subsidies targetted to the poor will be sufficient to offset the effects of rising food prices, as consumer prices are raised above producer prices at the same time that producer prices are themselves increasing. Based upon the purchasing patterns of the poorest 20% of the population (16 llUion persons), and the assumption of administrative costs and leakages of 25%, the initial subsidy of US$250 million annually, as contemplated by the ASL, would restore the purchasing power of the poor eroded by price increases since 1983. The subsequent increases up to 0.2% of GDP in 1991 would then compensate for projected increases in the prices of basic foods each year (see Annex 7). 101. Another important issue is whether farm output prices would compensate for fertilizer price rises without reducing producers' net income and without excessive fiscal costs and nutr'tional declines. Regarding the Impact on profitability, it is important to note that over the course of the adjustments envisioned by the loan, three factors would be simultaneously having some impact on producer profitability. First, the increase in fertilizer prices would tend to depress profitability, all other things being equal. Second, at the same time, the Government would be modifying its pricing system so that output prices would be at least at International levels, while, third, these prices being linked at their minimum to international prices would themselves be changing. Based on projected changes in international prices, through 1991 the net impact of all these factors on profitability would be positive for each of five crops that comprise over 90X of barvested area and almost 60X of production value. The average of the change in the ratio of price to production cost for all of these crops, with each weighted by its share in production value, indicates that overall profitability would increase by 12.51 (see Annex 7). - 31 - pAST I - SAM GIU OPERATIOUS IN MECD A. B 102. As of September 30, 1987, Hexico had received 103 loans from the Bank, amounting to US$9.7 billion, net of cancellations and terminations; of these, 70 loans totalling US$4-7 billion were fully disbursed. The Bank held US$7.3 billion, of which US$2.47 billion had not yet been disbursed. Some 35% of Bank lending has been for agriculture and rural development, 20% for industry, 8% for power, 16% for transportation and 5X for policy-based lending; the remaining 16% has been for water supply, tourism, urban development, and vocational training. 103. Of the US$9.7 billion total lending, about US$5.35 billion was for establishing or strengthening institutions for channelling credit to areas where credit supply was deficient or non-existent, and setting up in the commercial banking system the ability to carry out project-related appraisal investments in agriculture, industry, and tourism. These credit programs have facilitated lending to low-income farmers and small- and medium-scale lidustrial and tourism enterprises. 104. Adequately funded and properly monitored, Bank-assisted projects had been implemented satisfactorily until mid-1982. Disbursements, as a result, rose from US$91 million in FY78 to US$448 million in PY82. However, the 1982 financial crisis caused delays in the provision of counterpart funds; consequently, disbursements declined to US$389 million in FY83. A Special Action Program (SAP) was established in early 1983 to help the Government by alleviating the counterpart funding constraints on development projects. A total of 18 Bank-financed projects (including the US$350 million first Export Development Loan approved in mid-1983) received support under the Program. Partly as a result of the SAP, disbursements improved, reaching US$528.87 million in FY84, about 35% over the levels disbursed in FY83, and increased further by about 49%, to US$787.93 million, in FY85. But, disbursements dropped by about 18% to US$656.7 million in FY86. This decline is attributed mainly to the acute shortage of counterpart peso funding, lack of credit demand, and the delays in declaring some projects effective. However, disbursements picked up again, increasing in FY87 by about 53%, to US$1.22 billion. This increase can largely be attributed to the fast disbursement of the Trade Policy Loan, which became effective in November 1986. S. IIC Operations 105. As of September 30, 1987, IFC had made investment commitments in 32 companies in Mexico, for a total of US$831.7 million, of which US$650.9 million had been sold, repaid, or cancelled. IFC has been working together with the Bank to: (a) identify investment opportunities which would best suit the needs of the private sector in the current phase of Mexico's growth-oriented adjustment program; and (b) assist the Government in reviewing the requirements of the country's capital markets, both through economic sector work and specific proposals for venture capital operations. The IFC has carried out three operations in the motor vehicle and cotton seed business. The provision of foreign exchange and export production have been principal objectives of these operations. - 32 - C. Bank Strategy 106. The Bank's major objectives in Mexico prior to the 1982 crisis were to: (a) support policies and programs leading to a wider distribution of the benefits of economic growth; (b) help finance projects that, directly or indirectly, contributed significantly to output and employment; (c) help reduce Mexico's urban/regional imbalances; and (d) help free bottlenecks which prevent rapid growth. These continue to be important objectives of Bank assistance to Mexico. However, following the 1982 economic crisis and a reassessment of the Bank's role in Mexico, the Bank management concluded that (a) increased Bank lending, critical to Mexico's recovery, must be linked to central policy reforms; and (b) the Bank should play a central role in assisting Mexico's return to voluntary lending by commercial banks. In its new role, the Bank has intensified and broadened its economic and sector work. Specific policy reforms that are being pursued through a dialogue with the Mexican Government cover priority macroeconomic and cross-sectoral issues, such as trade liberalization, rationalization of preferential credit systems, improvement in public sector pricing and investment, and subsidy reduction. Traditional lending incorporating project- or sector- specific policy issues is being conducted in parallel with policy dialogue on cross-sectoral or macro policy issues. 107. As a result of these initiatives, the Bank contributed to Mexico's external financing needs in 1986-87 in a very especial way through continued project lending and quick-disbursing operations in support of policy reforms and structural adjustment in key sectors. The Bank's annual commitments in 1987 reached US$1.7 billion, assisting Government initiatives in trade, export development, agriculture, industry, transport, and manpower training. To lend broader support to Mexico's adjustment process, the Bank has, with the Board's authorization, put in place guarantees for the commercial banks' cofinancing and growth-contingency facilities up to a total of US$750 million. 108. Because of the difficult structural problems of agriculture and the sector's crucial importance for one-third of the nation's population living in rural areas, the Bank has made agriculture the leading sector for its lending. The Bank's agricultural lending program in Mexico aims at: (a) a more efficient and rational use of natural resources to increase production; (b) productivity improvements of cultivated lands, with emphasis on the productivity of small farmers; and (c) promotion of employment-generating investments in rural areas. To support these goals, infrastructure investments in Bank-assisted projects have been complemented with support services, such as extension, marketing programs, and credit. The Bank has made 16 loans in FYs 80-87 totalling US$2,638.93 million, for irrigation, rural and agricultural investment projects, and agro-industrial and livestock credit programs. Projects for irrigation rehabilitation, extension and forestry, and agro-industry are in various stages of preparation. Special emphasis has been placed in recent years on the development of rainfed areas. 109. The Bank's long-term policy objectives in Mexico's agricultural sector are to help the Government: (a) to reduce consumer subsidies and better target remaining subsidies so that they benefit the truly needy; (b) to phase out price controls on foodstuffs; (c) to render more efficient CONASUPO's and other parastatals' storage, processing, distribution and - 33 - marketing activities including, where appropriate, privatization of these; (d) to move towards economic prices for agricultural inputs (e.g., fertilizers and water); (e) to bring domestic producer prices in line with international prices; (f) to liberalize, over time, the trade regime with regard to the import and export of agricultural products and foodstuffs (this includes not only progress in the removal of prohibitions and quantitative restrictions but also providing greater access to import activities to the private sector); (g) to diminish credit subsidies by moving towards market-determined interest rates; (h) to achieve a sound investment program; (i) to rationalize pricing and promote privatization mnd efficiency in the sugar sector; and (j) to restructure and decentra'ize tne Ministry of Agriculture with an eye to reducing superfluous employment and to having a higher percentage of Ministry staff actually coming into contact with farmers. The proposed loan would support the above policy orientation. 110. Bank lending for industry between FYs 80-87 amounted to US$1,572.25 million, covering areas of small- and medium-scale industry, mining, capital goods Industries development, industrial technology development and export development. After the 1982 crisis, a US$350 million loan was approved to assist in Mexico's non-oil export sector. The loan contributed to an intensive and continuous policy dialogue between the Bank and Mexican authorities regarding: (a) export promotion and trade liberalization policies; (b) administrative and institutional aspects of export promotion; and (c) financial support for non-oil exports. Based on the lessons of experience under that sector adjustment operation and broad economic sectorwork, a new comprehensive assistance strategy has been formulated to guide the Bank's lending work for industry. This strategy supports: (a) trade policy reform to move towards greater uniformity of incentives and greater international competitiveness; (b) complementary financial sector policies to reverse the prolonged contraction experienced by Mexico's financial system, including its securities market; and (c) measures and programs required to encourage adequate supply responses, particularly in export promotion and industrial restructuring. 111. Working towards the objectives of its strategy, the Bank has, in FY88, processed a US$135.0 million Highway Maintenance Loan, a US$80.0 million Manpower Training Operation and a US$500.0 million Second Trade Policy Loan (TPL II), which were complemented by a US$400.0 million Steel Sector Restructuring Project. TPL II disbursed US$94.0 million from the first tranche. Projects in industrial restructuring include the Fertilizer Sector Loan and operations in the steel, automotive parts, textile, and agroindustry sectors which are under preparation, and would help achieve the strategy objectives over the medtum term. The proposed Industrial Restructuring Loan (IRL) is inte2ded to provide financing to firms undertaking restructuring operations in subsectors or product lines that are being freed of Non-Tariff Barriers (NTBs), price controls, domestic content requirements, and the like. Finally, restructuring of subsectors dominated by parastatals are being undertaken under the proposed loan, the Fertilizer Sector Loan being processed in parallel, and the Steel Sector Restructuring Loan that was submitted for Board action on March 1, 1988. In addition to trade and pricing issues, these operations also address issues of private sector involvement, decentralization, and management autonomy and accountability. - 34 - 112. Bank lending for transport has focussed on regional development, strengthening of institutions, and rationalization of public investment outlay and pricing policies. Between FYs 80-87, six loans amounting to US$752.84 million were approved, including two in each of the following three subsectors: highways, railways, and ports. Additional projects tc support similar goals in the urban sector were undertaken. During FYs 80-87, ten loans were approved, totalling US$1,263.50 million, in the fields of water supply and sewerage and urban development, including a first US$125.0 million Urban Transport Project, which was approved on May 28, 1987. In reeponse to Mexico's 1985 earthquake emergency, the Bank processed a US$400 million Earthquake Rehabilitation Project, which the Executive Directors approved in March 1986. A federal Highway Maintenance Project was approved in October 1987. Additional projects are under consideration in the transport and urban sectors, which would aim at strengthening the various institutions in the areas of planning, management, and finance. 113. The Economic Development Institute (EDI) is assisting Mexico through various courses/seminars dealing with policy alternatives and institutional reforms. EDI training is specifically directed at courses/seminars on water supply and sanitation sector management, transport policy, agricultural policy, industrial development and finance, and macro policy analysis. 114. The Inter-American Development Bank (IDB) is the second largest source of multilateral aid to Mexico. The IDB has made loans to Mexico totalling US$3.54 billion as of June 30, 1987. Over 502 of the total has gone to agricultural and rural development projects, and the balance to transportation, industry, water supply and sewerage, tourism infrastructure, education, municipal development, and preinvestment. The IDB and the Bank have coordinated their assistance on several projects. Each has made loans for the national integrated rural development program (PIDER), agricultural and livestock credit, small- and medium-scale industries development, and hotel development projects. The IDB is also providing a program of assistance for earthquake rehabilitation and reconstruction, and two loans in the health sector, totalling US$41.3 million, were approved on June 27, 1986. A loan of US$100.0 million was provided for a tourism hotel in the private sector in December 1986. The International Fund for Agricultural Development (IFAD) has approved a loan of US$22.0 million for a rural development project in the State of Oaxaca, which was appraised by the Bank's staff and for which the Bank is acting as executing agency. PART VI - a o i Tu InF 115. Since 1982, the IMF has supported Mexico through: (a) an Extended Fund Facility (EFF) negotiated in late 1982 for a total of SDRs 3.6 billions, covering the three years through December 1985; because of non-compliance with some of the performance criteria for the second and third quarters of 1985, this facility became inoperative, with about SDRs 908 million undrawn; (b) a special emergency assistance drawing, for SDRs 291 million, in support of Mexico's earthquake reconstruction needs approved in early 1986; (c) and 18- month stand-by for SDRs 2.4 billion, approved in November 1986. - 35 - 116. Performance under the stand-by program was satisfactory in 1986 and the first three quarters of 1987. Final information for December 1987 is not yet available. and therefore the IMF end-of-year review is still In progress. Details of the performance on the stabilization program in 1986 and the macroeconomic framework for 1987 are presented in Part I above. Coordination between the two institutions has and will continue to be close on monitoring of the macroeeonomic program and the harmonization of lending programs. PART VII -0 117. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank and recommend that the Executive Directors approve the proposed loan. Barber B. Conable President Attachments Washington, D.C. February 22, 1988 -36- A. Oba .1 0mg Oos Oatta P90ut D. Gowth tatse (2 PMr aum) (fin -~ :. pCUl data) (ftco csmt~ pxi.e daa 1I6 1873 1160 lo5 im0 I987 1965-73 973-SO issO-OS 1to6 198 Gross milxtop 0.0 100 100 0. 0. 100.0 .9 .2 0.8 -LI9 1.0 not Znaiio CS4. 5.0 8.3 . . . . . hnrtiItwst 14.4 11.4 8.4 9.0 9. . 3.1 3. 4 2.3 -3.i Zuatry 31.1 20.4 37.3 39.8; 38.6 ..8.3 7.0 0.3 5.3 (of VW& m&fsatmwias) 21.0 23.7 23.0 24.7 23.5 ..8.3 6.7 -0.9 -5.4 Sezyices 54.4 56.4 54.4 51.2 52.4 ..6.8 6.2 0.8 -2.6 lesoqm 3.1mm. -1.0 -1.1 -0.9 5.2 3.6 . . . Lasof am 9.3 8.4 12.6 16.1 16.9 .. 6. 8.5 8.8 5.2, 10.:1 3ap.za of Ms 10.3 9.5 13.3 10.9 13.2 ..4.3 9.9 -5.4 412.3 _0.7 Total Uupmiitex. 101.0 101.1 100.9 94.8 96.4 ..6.8 4.3 -2.2 -5.5 2.1 Total CmUAuxiac 79.2 79.7 72.8 73.6 74.3 ..6.5 5.9 0.1 -4.7 2.6 Privatte cunmaytim 72.2 70.5 62.0 64.1 64.3 ..6.2 5.6 -0.4 -5.5 2.8 0.l Ge ut 7.0 9.2 10.8 9.5 10.0 ..8.7 7.3 3.3 1.2 1.0 Gross oinastio invst= 21.7 21.4 28.1 22.2 22.1 . 8.5 7.8 -9.0 -9.2 -4.4 1ixo Invstmet 17.4 19.3 24.2 .. . .9.5 7.2 -10.6 -11.7 cimass 11% stock - 4.2 2.1 4.0 . .. . .. 6.4 GrD os mestic say1m 20.8 20.1 27.2 26.7 25.3 26.5 8.5 8.6 -3.4 -17.2 -1.6 ant Tamto lVamg -0.6 -1.3 -3.2 -4.7 -6.1 -4.4 . . set Ouzan Tamnfet . 0.2 0.1 0.1 0.4 0.7 . . ace", Verimmi 0bs ..w 19.2 23.7 22.1 19.6 21.8 17.4 7.8 -5.6 -23.0 1.9 To d.111com, at Lar. 1165 1973 1960 198 1986 198 (St o.astuitlSI=rloI) - - - -- _ Omuan omstic Product 1403 2758 4276 4262 4452 4497 6.9 6.1 0.8 *1.8 1.0 Capasi ty as hmoxt 130 225 537 506 357 ..6.7 12.3 -2.3 -29.4 Ten. of Tadw Adjustment -a -107 0 -268 -468 -413 . . Gross; omeati Incme 1535 2631 4276 4360 393 408 6.9 6.5, -0.8, -8.6, 2.5 aor"s Veticsm Produt 1508 272 4138 4419 4228 4309 7.8 6.0 0.4 -4.3 1.9 GM". Isthami nm ~ 1439 2616 4138 4151 3760 S89" 7.9 6.3 -1.2 -9.4 3.5 - --(1960G- 100)------ ---R--nltm ates (2 ..)--- C. Pei". lotA10 1180 Ig3 1984 1985 1 19 1987 1965-73 1973-80 1980-85 1186 l987p Conumer PC"". (IF 64 00.0 410.2 679.0 U1047.7 189.7 4314.4 4.3 20.3 60.0 77.5 132.0 Waes l. xi. (M 63) 28.0 402.7 686.0 105.4 1984.4 4675.8 4.0 22.3 60.1 68.4 148.0 Isplicit Deflstator 100.0 394.6 638.1 984. 1746.0 4049.0 4.0 22.3 66.2 77. 132.0 Wl1ie z amdauze Deflato 100.0 39.8 658.8, 1029.0 1919.0 ..3.6 8.0 7.5 3.4 D. Other Indcastoxe 1985-73 1973-80 1980-85…-------- Growth Rate. (2 P.&.) : pepulatiat 3.3 3.0 2.6 Dateaon the Iaombi Indicators tables Labor Foraest... shwild follow the definitions and axr.s Isttm1 1m P.C. 4.4 3.2 -3.7 caoapt. of the Standard TabIsa mid PrLmta Ca-mutisa p.o. 2.8 2.6 -2.9 Stuandad Attachmts. The Windators should Inculde data thrmzgh the most lapost alsatilctyt recently ompletud calendar yeaw (or upset. (GIWS) GM (up) 1.0 1.6 -19.5 fiescl year in the ease of fiscal year caumtthas). Staff estimates may be umed lbx*ml Sadsps Retest if final or Preliminary' actual. wet ntt ago". Itiamal ftiu .... yet available. The ume of estimaes WAd Goxss vmstic savinm 1978. 16.2 Prelmlnary fiuras should be indicated Mm (pact"d smxaas)t 2.8 3.5 15.9 7 Share of Total, 1965 1973 198 1985 P - preliminary data Labw ox lox.tnt- Agrioutume 34.7 30.4 26.1 26.6 Indutry 20.7 22.1 23.5 20.9 Services 44.6 47.5 50.4 52.5 Total 100.0 100.0 100.0 100.0 ---- -- - 37 - _ __ utg zosi Xa VOli Tade. (SW 100)a Vaa at Cm=mt wims (milion W6): S. _Hu1Ae b 1ow 15 64 1ow 16 S 1960 1165 1964 19too 1166 lift 1gtOu 10.0 185.0 165.0 113.0 155.0 153.3 96.O 15143.0 15196.0 14766.0 6507.0 8700.0 Coatt. 100.0 42.4 75.2 36.5 06.9 .. 16.7 115. 20.2 16.7 72.4 55.0 t.tU 100.0 135,4 141.9 15. 284.0 .. 422.4 6. 424.4 512.0 619.0 46.0 Haa*mtgm 100.0 1W0.0 194.2 V. 1.4 22357 217.2 21.0 45.7 3,.3 41.0 7W.7 9711.0 Ctr aats 100.0 109.1 130.3 121.2 106.1 104.5 2m.9 204.6 2915.1 15.3 1136.9 1952.0 Total IVA=bae 3ot, me 100.0 139.0 165.9 14a.0 151.2 167.3 1606.0 22515.0 24196.0 21665.0 141.0 20944.0 P. 3ImdiwAae ?qza CaseAm Goods 100.0 11.? 21.9 27.1 21.4 21.9 249.6 613.9 6"4.1 1061.1 646.4 153.0 Znt*inilt. cows 100.0 49.$ 40.9 10.1 55.4 56.7 11206.7 5740.4 765.4 6965. 7?1.9 942.0 C'pi al da 1010.0 27.5 31.1 56.6 3a.5 51.2 5174.0 2116.7 2572.6 518.6 295.0 0.0 Total Ihda1. apoaaa clr 100.0 59.6 46.3 56.6 49.5 50.7 186. 6509 &5.3 131.2 1432.3 13021.0 0. S. of Tde (1160 - 100) 1960 196 1064 1965 1966 IlSip Estes: haWh. Enact ftaLi Ide 100.0 67.4 91.9 65.2 66.0 77.9 thgoh. roata Pits. lad. 100.0 114.1 1M2.7 124.0 122.6 136.4 Data e the KonIl Indicats tables 1mo Lae Tens of Tbad 100.0 76.6 74.3 67.2 53.8 57.1 ahold follo, the 4eflaitlmw aA a-mopts of the Stadaud Tabls sd us$ rdlam (at F pets..): Stu2dazd Attasbte. Mm Indicators .__- _ ----- -- _ _ suld mold. data ahzow4 th mat 11. selwA of Fra" 1160 1195 114 1985 1966 iS9ip r_tly Comleted cemde row (or _ _ _ *-_ _ ----- -- -- --fiol . ear in the ea" of fiscal yoeu Ear of Goode ad Ns 24356 2717 3015 21624 22006 26214 owatrls). Staff eatuntes m be u_ed )*bsvAie (PM) 16066 22312 24196 21665 16041 2094 if fi1l or piellany aatual. ae not #ut-Factr services 7390 4667 590 59 5965 7270 Yet available. Mm use of eatimles and prellaInary f4ut.s shoAl bh indicated awpots af Goode sd WS 25620 12691 16079 18366 16307 17967 bys 1edindLse (FO) l1ow2 6 11254 1212 11432 13021 ut-Pactog Servloa 676 4140 425 56 4875 49S6 p ' ptelmny data Reesuce BSlame -216 1488 14077 9256 5699 10227 Net Facter i9 -6209 -957 -104 -9 -749 -6669 (Irt.et pet M) 4590 615 10268 9436 6542 1959 Net Stma TAfaga 271 30 411 10 490 30 (estet _. tta) .o a A _ e lsuase -6m 5418 4241 1251 -I260 4568 1c-Tea.pitel infi 775? 4176 2451 -400 144 5528 Dimat iaxest 2162 461 90 491 905 2500 Off: il capital c .. .. .. Net LT loan ( data) 669 2361 1603 -S61 955 3928 Othe L infloS) (Nlt) -121 m 456 -340 -1116 -1100 Total Othe Itams (Net) 1U2 -6904 -4542 -56 130 -3096 let hawz-taw Cepta 5136 -560 -3537 -1695 1412 -1100 Capital rims .B.I. 0 0 0 0 0 0 Ezges ad Omi -53 -104 -1015 -1875 -1262 -1996 _ge in not 1 _serwas -90 -3250 -2150 2751 916 -6600 Net Ciedat futl DV -16 1059 1100 610 917 650 Othr Bosom Qap. ( - tlditas VMeSS) -SU -4289 -3250 2121 69 -7250 As .bns of G:P. lesagoe BRelCKe -1.2 10.2 8.2 5.2 4.7 8.2 Zategeat _qamts 3.5 5.7 7.0 6.1 6.6 6.4 fzwreag t Senc -4.4 5.6 2.5 0.7 -1.0 3.5 Imetath. Itma: b"tet'l Peaerve (Cl. 09$) 2960 3915 1372 4906 5670 Reeze 1mi. 0old (aIl. Us$) 4197 41d9 8011 5691 6664 Official X-Rate ClOUsaIS) 22.95 120.09 167.83 256.67 611.77 1462.70 Iadam V*al SU. X- Wn n 83.10 100 7.1 65.60 66.25 60.40 5S.51 (Millios of Us9$) 1633 142736 171296 17155 127136 121935 - 38 - OD - C _ ef IIDW tX °-< S e.-.)~~~~~~~3 f owna SC089 (2) Oueth gnas (2 o.&.) I. Om.1ad 1 Sese. 13 18 134 196 13 l19 10 - 84 198 13 13 OUIIM RIstp 24.3 5.* 31.5 50.4 29.3 50.5 4.1 -4. 4.2 Ouwit qidLtuea 24.0 56.7 55.5 56.1 40.5 42.4 6. 1.9 21.4 0 c a i _tsus 1.4 - .9 - .2 -5.7 -1z.2 -12.1... ... Cita flceF .. .. ........ Cata 94 . -4.2 .5. -4.4 -.5 4.5 4.7 -4.2 oul Defii -0 -9.4 4.4 -9.5 -1.5 --1.4 .. lkg Dtbsina s(s$ *&asll ) u e tt k tSi Diabure (DS ea.) J. hie.dCap.ital nra,Debt aid Debt e tatle 198 13 1* 1965 136 17, 1#0 135 1t6 1985 1_6 1967 Paul* a pl1oly Gteed LT 59 226 13e 94 3M s9 337 6759 7071 72530 7496 a Oflfoll CusItou 7 -265 84 43 m2 1745 41 674 7469 gm7 lon1 15 lutlater.l 501 -520 7 7 979 945 3189 42 40 s57 79 72 of Mm .553 176 419 43 668 5s 2065 2870 5289 m2 "16 6 ofe m .. .. .. .. .. .. .. .. .. .. IllatmI 296 257 li4 -19 395 3 1292 2541 2639 2853 S36 568 PmSCd 434 26 55 262 -7 4 2007 6021 6667 659 6402 -32 in -I5 6 -1 1 257 343 203 2u 216 313 lIinlal k*ata 45 2643 509 25" -76 40 20 5958 424" 63531 640 7079 PuLuts LSgauated 170 0 B4 -420 -200 -560 7300 1480 17500 140 la" 15 TOtl LT 9G 2 2 32 1005 53 4327 69 e7sn 8900 9062 96472 fl Nst Credit -16 19 1100 6" 917 650 0 I260 2360 2969 4060 4678 aft shot-TM Capital 51m -50 -357 -16 40 -1100 14 1019 440 5450 6306 s02 Total Anobadiog fl & Nat 8s 13 -26 -45 -755 1962 4960 57450 92 9737 97429 101450 l615S B d A Bt 190 1 194 15 198. 1987. ------ ~~~~~~~~~- ---- : oes Share of Total DIWT am i. I as 21 Of toal 5.00 3.52 5.76 4.24 4.65 7.14 S Of the PiAtO Iadi*atow tabl_ 2, IDA as I Totel 0.00 0.00 0.00 0.00 0.00 0.00 f ebsl ill th dfalltIs. ad 3. IWID A as X of last 5.00 5.52 3.76 4.26 4.65 7.14 e _AePt of the 8ctdOW Tabe S d &mce of Tteal IS Debt 8egeLoe Standard Attuta. Mmindicators 1. IB a o Total 2.7 5.07 3.11 4.32 5.80 7.44 abwjd toolid data _bw*h the moat 2. IDA on 2.f Total 0.00 0.00 0.00 0.00 0.00 0.00 rectly osplt edaladar yea (or 3. IODM an Xoef Stal 2.75 5.07 5.11 4.52 5.60 7.44 1.0.1 YOM In the me of fISal yeog oertea). Staff eatintee o be used DaD-to-RAWOt RatIea it 1Ifal Or preliAXY eataaS nt yet available. Ths ue of eatimate ad 1. L -T Debtl0hpozt 176.02 300.08 290.39 322.22 413.81 341." prOLlUM7 firum s14d be ladloated 2. VW Coeditizhporta 0.00 4." 7.85 10.75 16.45 16.56 by: 3. Shrt-Tea DsbtlNorta 68.91 37.30 21.34 19.73 28.66 17.75 4. LT+DWlU DI0E_Jorts 2".93 42.02 3229 352.70 40.#92 374.26 DOD-to-W ~~~~~~~~~~~~~~~~~~p *preUiahaxy daft 1. Ltm-Tm DebtIe? 22.1k 57.1 51.12 50.1 n.6 79.12 2. Dlr CzitIGP 0.00 0.88 1.36 1.67 3.19 3.84 3. Sboht-Tem DebtIOW 6.67 7.10 5.76 5.07 4.96 2.54 4. LTMxFlWS DUarP 30.63 65.13 56.84 54.93 03.20 85.20 Debt Ser1aIBouta 1. PubLlc & _mted L 32.06 40.04 34.93 36.90 59.50 2. ftLwat* Emt-0MiAet LST 5.9 5.40 14.26 11.25 11.55 S. Total LT Debt Servie 37.97 45.44 49.19 4.15 51.0S 4. VW lapmae + Sew ia. 5. intst Oar anST Debt 6. Totel (I.T+D 462 SSt.) .9D0 45." 47.20 49.30 56.70 50.40 -39 - ANX 2 0TATUS or BANK 30oop OplUATZOu to3 llXtCO 1/ Page 1 of 2 A. Stotsut of lah LotLa IA o@ f Soptosbo 35J. SS tI) 010*1- Assis%tZ ULoss lal- Less go. Veer garrgugr Purpose C*esstlmtlosu beroed 70 eo.. tally disbsePed 4,700.01 lal-5 1376 RAPISSA tIrrigotles 30.00 * e.el 1550-5 logs SAPISA Irrigation 7g*gg sees, 1513 lol1 savossAs Water supptl leS.0s 44.48 tloe Iasi UAiSllA5 orb** sevotopmost II 154.33 61.S4 1U43 150 loseEAp Imtg&ot zsd Roost Dee. 175.@0 aloes 3143 lose SAPIUSA Capitlt **ed toZdustry |t5.s5 70.7e 3154 1l3s NAPIUSA PsIuztito lostrat I1.0l 11.51 3134 less BANOSCIA Urban lmslsseresg e.a0 5.07 use loss SAP rSA Aerieaslersl Surkutsig 115.00 40.45 3asi less 3AUOURA3 Third Water lupply 105.00 56.33 3eas 1e3s NAPRSA tbsid ets/Ne ladsetry 175.50 $.03 goal loss UAUUOSUXT export Osvtspuaut 510.00 sl.3e 3433 1334 3*305*AS Ntghou-y 305.00 108.51 3488 1334 3ANPE5CA Prt$S ?3.8o s3.7? loss lose %AFINSA OblPeso surst Neeso as3.0 loses alsO lose WAPISA Cbhiapa Aorta Dow. 300.08 77.04 3540 1333 NAP19A Su/Nj Seats Mining St *05.00 Sss esee 1o1 CAPINA wVesetionel Eduestios l3.00 53.Se Sa37 135 DANODUA3 Net alus V 33o0.00 ea.s.0 3010 lOse NAP14MA Agrisertural credit 100.03 5.05 *3s0 Isle ss 8A03*A Low-tnee-s Mevelng I lo0.l lO$,se ton3 lose lAFIN Proderj th 1I 103.00 86.47 gses tsee SANODURA *erthbqeke Rehab. 400.00 1s6.33 *see tees SANOSUAS usleipel 3tressgtbeinu 40.00 37.03 3f50 legs BAUOGRA8 solid est*e P1t ot 33.00 33.3 3745 1e07 *AUCOONXT Trede Pe1t6w Loon I oO0.00 10.00 874s 1337 lAFIN t3odsdrt t *l eoveory 150.30 117.73 3747 1337 NAFPI Toestoelgy Oewevepuent 45.00 33.37 3777 1367 on0c Eaport Wovltope-at It 830.00 0tO.15 3234 1337 SANOERAS Urban Treopeort 135.00 135.s0 357 1307 NAVIN AeroZeutsoret Credit 400.00 350.3s 3053 3/ 107 SlAFI* So/Ned tIdeetr1io IV oss.0s 133.00 3350 1337 lAPIN sllreslturet Intaesion 30.50 17.41 TOTAL O 703.U1 Of sblei ue* beso relpid to the look 3,431.33 T1us Dow *"steadiag --;.;;3 Assent eutd 3.384 Of *bseb of been repaid 23.34 0.00 Tod*& aus botd by look S3/ 7e3e.sg Totat *edieberesd 3,477.73 1/ The states ef the prejesto tisted In Part A Is la a *eoperted report an Ott SoaktIOA finesued projests In eueoutigu, whichis t pdated toles )earLy oan GtPouAted0 to the lassutts1 Otreetsre en Aprit 00 and Oetober J1. 3/ Prior to *seashog edjoeset s. o/ Not lot effiestie. Lo*mSt*ssaUIt "NXCmAI ...J75 USAraeotorLARGO Ostuhor see 1337 -40- ANEX 2 Page 2 of 2 *. SCetesee et tf0 Reweeoo"st As at septoobee asI loop t o* ItStlOll _-_-__________-------------------- ___---_---------_-----------__----------------___ Veer Obligetr Type of Bsiel*e 3qalty Less VotaL 1*33/53 tmduestvle P*efeot Oluele 3.A. e/ SduetelOL Squlpeest sea 3*3 see ¶333 Swest edoe soals 3.A. a/ A.3. sgols* Owveeoet s.e s.e s.e Iasi &.*Fe ftlet? B.A. a/ Twl*t $#IL* sea see as. 13 8/0/S/ Psodldeo S***teetey* B.A. O/ *$Gtl 31*4 *.e *a., 13 Tebse dos de wore So Scaxte otWateve Stl Pipes 9.t s.3 1 1333 3.1..*- de& S*op S.A. el S.dins seIpote 3.* 3*1 3*7 1834/ Isdoetrlo dot PIerte. S.A. OosZstrsstls Sqelpsest .3* 3.3 a.3 1373 Riser* deL Ratio a/ Ire.t Sr. vistas see 1.3 1.3 1371 Sole**e seat*oese 3.5. s/ To*atLe. 3.3 1g.o 1s.3 1373 Prossotre de Pepst Pftledleao. $.A. de 3.*. 6/ Putl ead Paper b/ see b/ 1373/3 O*e*esee Vereorsa. B.A. basest S.l 13.3 13.$ 13,4/31 Coeaum Arlt'so Metal bartb- 6s i.e 1.3 1373/73 "ealssa$ 3.5. S*t*olOce St*el s.e 13.3 13.3 1373/31/33 Popees. Posdersee. S.A. Pulp sod Pepoc 3.0 13.7 13.7 1073 TeesfialLtee Soalaesee. 3.A. Petreebesle0Lo f.o 13.3 13.3 1137/31 Xetol Seals. tSet e atpoe. 3.A. do 3.1. Touries 4.3 Do. 4.3 1373/33 lSproges ltoooe. S.5. Gesost 7.3 1s3.o 173.3 1373 O6600setoes seslrerrto G.5. lstGOSelt Vite a 30310 g.3 13.3 le.0 13Os IZsdosplae asseolat. 3.A. Peetlele Boeed G.O s3.e 33. 1lo3 Videlo Pleas do **ax**s 3.A. Ft*t $Less s.e 114.3 114.3 lose 011**T lisot de Asslete B.A. de 3.1. stelae 3.0 113.0 113.0 1331 Oetlleloso Oantaures 3.A. a/ Ptp aned Peper O-O 84.3 64.3 1331 GOerPePeolS £groladvsstrel. 3.A. ao 0.v. Astg-Uuelasseeo 3.o 1. 14.3 1333 SpISt,l 9oad* PoolLtp o/ Gopliel Geeds Ploessolg G.O 133.0 133.0 1334 Hstoese 3.&. SAte Obesle 1.4 d.3 4.4 1334 Presoloom. G.A. do 0.V. Asts-***loseo 3.3 s.0 *3. 1ot3 Promestesse sadvetrlese Saleses 3.5. do 3.d . ctoveboleeseol 0.3 13.4 13.4 133e Saluleso v Pepot do Datreso. G.A. do 3.W. Putp sod Pope . 13.0 11. 133 Agrspse Pbooe I 153351 Weg. 4, pealt Proo.eselm . 1.3 3.3 l3ss SuLleasa ShOtOlesl a ptr*eeeeo 3.. ... 3.g 3.o 1ose &poes S*so*t 3 .0 43.0 43.0 Totot re.. cesttes$*o 3. 1733 331. Lose Sesalletalese. Teorelstleas. Nepapsose$ *no Saes. 33.3 3374 M30. eteSL Ooaalt.soSt low Sold by WO3.7 131 3. eTeIL Sedlaobrood tileltdlag perSlolpeaste)33 111. of Z eeesohtb*b baye been tulIt seseeltlod tereleeetds *rlttos eff. etas, redeemed of repad. o/ steudes 4gg6*ggg copltalloed istoroot. LeosStetueg 2301 SNXC51 ... .7. ISAreo SteaLASSO ostaber 37. 1337 - 41 - ANNEX 3 Page 1 of 3 NEXCO AGRICULTURAL SECTOR ADJUSTMENT LOAN Supplementary Loan Data Sheet Section I - Timetable of Key Processing Events (a) Time taken by country to prepare loan: About two years (b) Loan prepared by: Government with Bank assistance (c) First Bank mission: September 1986 (d) Departure of appraisal mission: April 1987 (e) Negotiations completed: February 1988 (f) Planned date of effectiveness: March 1988 Section 1I - Special Conditions (a) Conditions of effectiveness: (i) Provision to the Bank of evidence that macro-economic policy framework is consistent with the program of agricultural sector adjustment program (para 96). (b) Conditions of first tranche disbursements exceeding US$25 million: (i) Provision to the Bank of terms of reference for studies acceptable to the Bank (paras 55, 76). (ii) Removal of export controls on quality cuts of beef and high quality rice (para 76). (iii) Preparation of disbursement procedure to coordinate disbursements with transactions covered by Trade Policy Loan II and Fertilizer Sector Loan (para 94). (c) Conditions for second tranche release: 1. Food Security (paras 37-41) - Implementation in 1988 of a satisfactory targetted program of food stamps or other well-targetted food subsidy program at adequate levels of funding sufficient to compensate poor for elimluation of global food subsidies between 1983 and 1986 (about US$250 million or about 0.1S of GDP), using mechanisms to - 42 - ANNEX 3 Page 2 of 3 minimize diversion of stamps from the target population. Linkage of price of tortibonos to price of tortillas to maintain subsidy per recipient at constant real levels. Pilot introduction of targetted food assistance in rural areas. Revision of criteria for eligibility. Study of expansion of other programs (e.g., school feeding) to buffer impact of adjustment program. Preparation of a satisfactory action plan for expansion of nutritional monitoring program for urban and rural areas. 2. Reduction of role of parastatals (paras 57-68) - Lmitation of transfers to CONASUPO to less than US$85 million in 1988 Public Budget. - No introduction of global food subsidies through institutions other than CONASUPO. - Satisfactory progress on compliance with timetable for 500 DICONSA outlets beLng closed or moved to poor neighborhoods. - Liquidation of CAIASUPO's wheat-processing affiliate, TRICONSA. - Satisfactory progress in sale or closure of 15 parastatals in the agricultural sector. - Satisfactory progress in closure or sale of 2 sugar mills(four mills have been closed already). - Discussion of study on sugar pricing policy, including cane, fob mill, and consumer prices so as to reduce subsidies and to promote greater efficiency. 3. Trade Liberalization (paras 69-76) - Satisfactory completion of a study of variable tariffs and discussion of its results with the Bank. - No imposition of export controls on fruits and vegetables. - Encourage farmer organizations to establish and control export quality for vegetables antd fruits while eliminating Government-imposed quantitative restrictions. - Reduction of QR coverage of import licensing on agricultural and agro-industrial products by 5 percent of national production coverage. - 43 - ANNEX 3 Pa'ge 3 of 31 4. Liberalization of Agricultural and Food Pricing (paras 42-56) - All guarantee prices administered by CONASUPO maintained at least at real 1987 levels in 1988* Guarantee prices for all crops except maize and beans maintained in 1989 within a range of 90X to 125Z of comparable international prices, adjusted for processing margins, transport costs and quality differentials according to an agreed upon methodology. (Upper limit of 125X may be revised pursuant to results of study described below if agreed by both parties.) - Review and discussion with the Bank of the results of a study on the guarantee price system, including issues of pan-territorial and pan-seasonal prices. 5. Revision of Input Pricing (paras 77-81) - Provision of a plan of action satisfactory to the Bank to implement a system of charges for water used in agriculture that will achieve recovery of OEM costs except under specific circumstances estalished by Mexican law. 6. Sound Public Investment Budget (paras 82-86) - Establish procedures to encourage and facilitate disbursement of loans from international agencies in support of the investment budget of SAR. Submission of 1989 budget request to Congress that increases investment budget of SARH by at least US$200 million in real terms. Budgetted funds will be made available to SARH as needed for timely implementation of agricultural investments. - 44 - Annex 4 Page 1 of 1 Characteristics of Production and Lad Distribution 1. A wide range of crops can be grown in Mexico as a result of the considerable variety in agro-ecological conditions. Agricultural productivity varies considerably depending on the extent of commercially- oriented farming, public sector investment, and the use of inputs. In the irrigated and intensively farmed northwest, yields are twice and labor productivity three times the national average, whereas in the rainfed plateau states, both measures of productivity are well below national averages, reflecting the lack of investment in infrastructure as well as certain intrinsically poor characteristics of the environment. 2. The most Important domestic crops, in terms of area planted, are maize (42.52 of the area planted to the 37 most important crops in 1984), beans (10.91), and sorghum (10.01). These crops represent 24.41, 2.62, and 6.8% of the total value of agricultural production. Fruits and vegetables occupy 8.81 of area planted but exceed all other crops in value of production and account value. Of the basic grains, Mexico is self- sufficient in wheat and rice but imports significant amounts of maize and sorghum. Soybeans and milk powder are other products that are heavily Imported. 3. In 1985, some 5.4 million ha of irrigated land were harvested, representing 251 of the cropped area. Expansion of irrigated areas, at one time the most significant factor in the increase in agricultural production, has slowed in recent years, as the supply of land suitable for irrigation has run low. The scope for new schemes is becoming smaller and development more costly. Government policy therefore has tended to favor rainfed (temporal) agriculture in recent years, where the scope for productivity increases using available technology is high. Investment costs in rainfed agriculture are lower than in large-scale irrigation, and social benefits are higher. 4. After a half-century of land reform, about 3 million people own or have rights to land according to the 1970 census (the 1980 census has not been released as yet). About 4.5 million people remain landless. Collectively organized aejidos' farm over 401 of the land area and constitute what the Government calls the social sector. The remaining individually-owned private farms are relatively small with 652 under 5 hectares and 801 under 10 hectares. Large parcels over 100 hectares are mainly in range land in the northern states. About 72 of the farms covering 191 of the cropland use modern technologies; about half the farms covering 342 of the cropland produce mainly for subsistence. The remaining are classified as traditional farms, producing for the market, but using antiquated technology. Although the Mexican Administration has reformed land policies to allow more consolidated use of ejido land, and reduced the threat of expropriation of larger land holdings, reportedly little has changed as a consequence. The threat of expropriation, whether real or implied, continues to constrain land use in some parts of Mexico. Actix Prior to Bond Pgeutatim tCo~±m for Dlsbniewm of Swmd Tnwb Pblic Objativ Adden (stimts4 dae of Aieb 1- M1 31, 1909) _MIuitimi of Slow - Iacim of gt food - Iumlatidn in 1988 bf a satisfat taqettad subsidAm and estebislmot absidls ele: for ur. prog of food st o r tr welnarptted food stbsi of a satisfactory targett Gkim susd , previously x is at dapate lels of findu afficat to food subsd prog aft 12 of G1, dituU eliuetet pow for re&%tka of global foo sdi alui'at~e fuig. (pa. in 1987 qPI mapr (0.019 of bstwmn 1983 and 1986, im d%W to min*ad 32-36) a?P). di of st frau the Capt pyuthm. a" $250 miliZo or 0.12 of GM umld be uuldwe an dUut lve Aiep o PriS Cf Ort2M top eofp d - aEtroducti of food staii totlla by ad1jstiiu tortlb pim, tdda lito for totila (abuat 0.2 of £idmtia tim prim o totila and toi mm of GIP In 198). iItlit, i aS :xt to imeme thie subsy In al t_ pwr te o8ot to lewls s,atw tbo thr e3dotU aB of tSim ffactve Iaes of the lon. P1la ftra&mtic of tarpettad food asslom In rural axem n. leisk of cditeida for eltgbidity. Sft of egimi of utriti p cgm to bdfwr Iac of adotjnt pI S Ptintation of a satisf8 to aetim plan for amaimio of matritiarmi iunttori Ir to rura aid orm are. FActim of role of - [ e_ mat ai - Timitatin oif r f opmtz ulsm to pw.tAas. and of 3!O In 1968 to abt 1VW85 nUl (pa. 50-61) ObIN ad affliates. - lb Inmo&ctiom af Slo. fod subsidi tlwi tatims tlr M O *0. - Satysfactoy programs an complianc it timtb le fr - De f tiA*ic Of SW 5ODI(XI bel t cltued or wid to powr aMO pirdam to 6 wmigl _ Io.4 Cd1tim- for p uof - Uipuldti of M s i affae, 0 prIC aiPPOrt. U1(oXAO 0 to - Satisfactoy Onplm4 ith tiwidi for age orP clnm of 15 paratatals In rloa"tral I. - Clasue of 31 dfmxt - Sissio to CO0s of a 19891: i fbq pr-statala unr SAM for opratpeiosm to 0aw 18 a to thos awrsty Iadptted for tim 1968 in r.el tein. - 46 -Anex 5 Page 2 of 3 2/19/88 II~~~~t | *' '453hi' A8sSn>Tatl II~~~~~~~0 I tti 'fj,l 'Ugill X ,.,j 4 v jI X 11 0 ~~~~~~~~~'~~~~~~i a '4 is' iuiiii!ii~~~~i _47- Anex 5 Page 3 of 3 2/19/88 i3 'ItflilI i"if. Il ii ili3a S3IjbII liit411 ;ji w~~~~~~~~~~t ~ ~ ~ ~ ~ ~ ~ ~ ~ t ii iiiifliujIj I, g B 1k X}g - 48 - Annex 6 Table 1 CONASUPO'S FOOD SUNSIDlES (Drect end Indirect) (million peso.) Current Constcnt 1982 % GDP 1982 58,737.9 58,737.9 .62 1983 173,205.1 95,799.2 1.01 1984 271,656.6 94,390.8 .94 1985 205,089.6 43,524.9 .45 1986** 143,795.6 17,438.2 - .18 Does not include sugar subsidies, which are not administered by CONAStPO. ** Budgeted amount. Source: COIASUPO estimates 49 - Annex 6 Table 2 Podlucton Coverage of Price Controls, 1982 and 1986 1/ mplementng Agency/ Decembr September Type of control 1982 1986 'SICOP? Strict Controls. 23.292/ 10.98% Registered Controls N*A. 6.302 Registerd 6.59X 4.862 COwAso 3/ Grais 3.022 3.022 Oilssids .54 .542 AZUCAR SA Sugar '.932 .932 t4olasseO .092 .092 PEX Crudn Oil 15*932 15.93t Iefined Oil 4.622 4.622 lic Petroch cal .98 .982 TOTAL 55.092 48.252 1/ Production coverage Ls based on the methodolog mployed in the Tradt Policy Loan 27445-H. Only 3 of the products subject to controls are not In the ample of products used by the mthodology. 2/ This d0oes not include balc pharmaceuticals w1 ch were not included in the lit provided by SZCOFI. This is estimated to lead to an additional .52 of prouction undr price controls. 3/ Maise and wheat are no longer under SECOPI controls In 1986, but still withia COMtASUPO controls. - 50 _ Annex 6 Table 3 Average Nominal Protection Coefficients for Ma(jor Crops a/ Not Trade Price Ratio 8/ 1970/75 1975179 1979/82 1983/86 Position-1985 Maize Guarantee/CIF (landed) b/ 1.01 1.04 1.44 ^ 1.28 Net importer- Guarantee/FOB b/ 1.13 1.14 1.59 1.39 Wheat Guarantee/CIF (landed) 0.77 0.78 0.83 0.88 Self-sufficient; Guarantee/FOB 0.85 0.84 0.89 0.95 large surplus in 1985 i1ce Guarantee/ClF (landed) 0.70 0.69 0.71 0.97 Net Importer Guarantee/FOB 0.79 0.75 0.78 1.10 Guarantee/ClF (landed) n.a. n.a. 0.78C1 1.13d/ Self-sufficient to net Importer Sorghum Guarantee/CIF (landed) 0.80 0.87 0.91 0.89 Net importer Guarantee/FOB 0.90 0.96 1.01 0.97 Soybeans Guarantee/CIF (landed) 0.96 0.96 1.18 1.08 Net Importer Guarantee/FOB 1.04 1.01 1.25 1.15 a/ Nominal Protection Coefficients (basically the ratio of domestic to international prices) are uad us ted for under and over valuation of the xchange rate. Adjusting for exchange rates would lower the protection up until about 1982/83. In the oid-years of the 1980s, it would raise the coefficients of protection. b/ Ratio of support or guarantee price to CI? or FOB price. c/ 1980-82. t/ 1985. - 51 - Annex 6 Table 4 R*cent Mhmdul Protetloe e Cosftl eumt foir Mjor CroM ,/ not Trade 1983-6 Aptil 66 ov. 1986 April 198 position Gur at elCly (lUaded) 1.28 1.37 1.05 1.01 Mat imrter Whet Giu rate/POB 0.95 0.88 0.58 0.83 Large arplus in 1985 lice 'ganar tee/CIC (landed) 0.97 066 0.74 0.75 let Isporter a^unteeICIi (lauded) 1.13j n.e. o.a- a* Self aufticlet to set ilporter Guarsut.e/CIP (lauded) 0.89 0.92 0.71 0.57 Not Ilporter OnaranteerCIP (landed) 1.08 0.81 0.65 0.75 Not Importer aI uatlo of domestlc (Goarantee) priceo to international prlces, at current exchmge r-te. =1 1985. Industry Departrnt January 1987 Annex 6 -52 - Tabl-e5 fercentape of Productlon Under Licensing (as of March 31, 1986) z Sare of Sector 2 Share of Sector S of Total ?Iational Sector Is No oil Production Undor LScensing Produ. Under LIceansing I. Agriculture 10.2 87.4 7.0 IX. Agro-ludustry 23.9 65.0 12.3 III. Livestock, torestry, and Marino 7.8 25.8 1.6 IV. tanerals 3.5 2.9 0.1 V. Manufacturing 7.7 56.4 3.4r VI. Other Manufacturing 46.8 26.9 9.96 VII Petroleum and Derivatives - - Annex 6 Table 6 page 1 LIST OF AGRICULTURAL, AGRO-INDUSTRY, LIVESTOCK, FORESTRY AND MAIRZ PRODUCTS INCLUDED aY SZCOF. IX DISCUSSIONS OF POSSIBLE LIBERAZATION UNDER TPL II (Numbers represent 2 of production) SCENARIO I SCENARIO 2 8.32 REDUCTION 3.12 REDUCTION LAN Q2SLiF QL 1 Agriculture 1.34 0.04 0603001 Flores Frescos x x 0603.999 Los 1n x x 0604&003 Arboles do Navtdad x x 0701.001 Papa* (patatas except. fracclof 0701&002 x 0701aOOS Cebollas x 07014008 Ajo para Sembra x x 0705.002 Frijoles (porotos) exc. fraccion 0705.004 0705.004 Frijol par. siembra x 0801.999 Los Doas x -O86a003 NMabtillos x 0807a999 Los DemOs x 0808aO01 Freas Frescas x 0809aO01 Las Deoms Frutas Frosesas s 10010999 Los Dom" x 1002a001 Centeno x a 1003a999 Los Dems x 1004.001 Avena Extepto la fraccion 1003.002 x 1005.004 Mtad par. siembra x 1007a002 Sorgo pars siembra x 1201a003 Semtllas de Soya *xc. frac. 1201a007 x l201aO06 De Nabo x 1201.007 Seadllas de Soya (soja) pars siembre x 1201aO08 De Girsol para sie* bra x 1201a009 De Cart.a. pars siembra x 2 Livestock 0.10 0.10 0104a004 Caprinoo para Abastos x I 0104999 Los Doeus x x 0106M004 Abej.s x x 4 Fnsh and Seafood 0.68 0.0 0302.999 Los-euas 03030999 Los Dowcs a 11 Meat and Milk Products 0.56 0.0 0205aO01 Tocino con exclusion del que tongs. part Annex 6 Table 6 Page 2 1601e001 Imbutldo ee o cars dJfespoj*s coup.. dtbl. x 19 iscellaneoeu Food 0.57 0.27 1006a001 Armo entero docasca1llado Pultdo/Abrt. a 1006.002 Aro. entero. Si. Dscasc rillat . (wiSrc ) it a 1002a001 Avess est cascara sin despuentr 31 tritu. 1203.014 De Calabsaz x 1604.002 Atunes 3 x 1604a004 Sardlnas a x 1604a999 Los Dome x 1605aO02 Centolls x 1605S003 Chotos Cholgas Locos o ach"s x 1605.004 Ejillones x 1605&005 Derbereches a 1605.006 Vavajas 1605a007 atburrio a 1605a999 Los Deem x 1806.001 Oulies o loubones x 2301.001 Marinas de "nLale Z arinoo A 17 Animl and Vegetable Ois 0.10 0.0 1507.001 Asattei de Ajonjolt a 21 Malt Beverages 0.06 0.06 1107.001 Malta$ lncluso tootsd x x 12 Processed FtuSts and Vegetables 003 0.03 0804.002 PFa. de Ova x x O8O8aOOl Freoaa Frescas x x 2007.001 D'Eranjas C/Dooi4ad haste d*1.20 a 15o x 13 NllIna Produa-a n077 f 77 1906.&999 Los Dames x 23 Tobacco Products 0.6 0.0 2401999 Lo bas a 2501.001 Sal (Crudo. de Sodic) TOTAL 4'81 1.27 Mexico Orop Support Prices - In Real Terms 3000 2750 Boons 2500 2250 24'000 1750 . 1500 , ~'*7~4~ I\Ric. ..J 1250 *wtn / i e _ 1000/ 500 Sorghum 250-4-- I 1970 1972 1974 1976 1978 1980 1982 1984 1986-Apr. 1971 1973 1975 1977 1979 1981 1983 1985 Year Mexico Producer & International Prices - Maize 275'9 25 Guarontse 1R175E *;z 'btS, .... 11o~~~~~~~~~* 250 1 22.5 Actualt 200~~~~~~~~~~~~~~~~~~~~ 175 3t' '" Stxn 150 125O ... 175 -93 1 Y o a r . * Mexico Producer & International Prices - Wheat 200 /¶CIF.londod ~- 175 150 I~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~V PL125 1D Actual Guarantoe 1010I H*S.I.i,... . ~~~~~~~~._ 75- 50 L 1970 1972 1974 1978 197d 1980 1982 1984'1986-Apr.. 1971 1973 1975 1977 1979 1981 1983 1985 Yeoa r Mexico Producer 8 International Prices - Beans 800 SIntornotlonol 700 Actual! 600 ti$U -500 U'O ~400 :~~~~~~I / : Ye .Guarantee A 300 .***.* 200- 100 4 1970 1972 1974 1976 1976 1980 1982 1984 1986-Apr., 1971 1973 1975 1977 1979 1981 1983 1985 Year Ji Mexico Producer & International Prices - Rice 600 5350 ,Ai r ,, ^CIFtfndded 500 1\ , I',,,/ A 450 12400 i/*~~ FOB Now Orleans CL 350 ~~~~~~~~~~~~~tActual 300 . .A * * * * * * * .c 250 :U 200 V~ .; urnteFOB Bangkok 150 2mZ. 100-4--- p 1970 1912 1974 1976 1978 1980 1982 1984 1986-Apr. 1971 1973 1975 1977 1979 1981 1983 1985 Y ear Mexico Producer & International Prices - Sorghum 170 160 IC 150 A .Actual 140 130 CIF,tanded 120 ~110 a. ~ ~ ~ ~ _ 0w100/ i*h~-,'A 90 : 80 70 / ~~~~ FOB Gulf v...Ow- Guarantee 40 1970 1972 1974 1978 19*5 1980 1982 1984 1986-Apr 1971 1973 1975 1977 1979 1981 1I983 1985 Y e ar Mexico Producer & International Prices - Soybeans 450 400 .1Il 50 ___ _Actul CIF.landed .300 VI 250 2001Gurne 150 100 - , , , , , . . 1970 1972 1974 1976 1976 1980 1982 1984 1986-Apr. 1971 1973 1975 1977 1979 1981 1983 1985 Year - 62 - Annex 7 Page I of5 Social Impact of Agricultural Sector Adjustment Program 1. Impact on Farm Prices. As of end-1986 (the base year for the calculations below), domestic price of maize was 51 above world levels while the price of rice was 26X below, the price of wheat 121 below, the price of sorghum 81 and the price of soybeans 151 below equivalent vorld price levels. If the subsidy on fertilizer is removed and its price increased by approximately 1431, as initially projected in the Fertilizer Sector Loan, the costs of production of these crops would rise by 10 for msize, 131 for rice, 11% for wheat, 191 for sorghum, and 71 for soybeans. The resulting change in the share of fertilizer in the cost of production, assuming fertilizer use per unit of output stays constant, is displayed in the table below. Share of Fertilizer in Cost of Production (Z) Maize lice Wheat Sor;hum Soybeans Beans Winter Vegetables 1986 7 9 8 13 5 2 2 1991 9 12 11 16 7 3 3 However, world prices for these commodities other than wheat are projected to increase sufficiently such that if farmers received world prices, the fertilizer cost rises could be absorbed fully. That is, if farmers were paid at least world prices (a condition of the loan), the profitability of production of aU crops would be enhanced. These calculations are summarized in the following table. Effect of Fertilizer Cost Increases On Profitability of Flive MaJor Crops Maize lice Wheat Sorghum Soybeans 1. Projected change in world price of crop, 1986-1991 (Z) 28 16 1 27 12 2. Plus change in 1986 support price to reach 1986 world price (Z) -5 26 12 8 15 3. Minus change in cost of production coming from increased fertilizer price (Z) I/ 10 13 11 19 7 Net Change in Producer Price Relative to Cost +13 +29 +2 +16 +20 1 Assumes increase in domestic fertilizer price of 1431, as initially projected in Fertilizer Sector Loan documents. - 63 - Annex 7 Page 2 of 5 The five crops in the table account for about 912 of the 1985 harvested area and about 58X of 1985 production value in Nexico. A reasonable index of the net effect of these changes on the sector as a whole is the average of the net change in price relative to cost, with each crop weighted by its share in total production value of all 5 crops. (This approximates the change in the ratio of the sum of output value from all crops to the sum of cost of production of all crops, assuming that each crop has the same share in the total Cost of production as it has in total output value, and that outputs do not change.) By this measure, the profitability of agriculture would improve by about 12.51. By an alternative measure-an index with each crop weighted by its share in harvested area-profitability Improves by 11X. 2. Fiscal Impact. The impact on fiscal outlays of the Government that would stem from adoption of the program proposed ln the fertilizer sector and the agricultural sector reforms would come primarily from four sources. First, by raising fertilizer prices, Fertimex would realize major increases in revenue and would require much smaller transfers from the Treasury. Second, the direct and indirect subsidies given to food processors to maintain low consumer prices would be eliminated and replaced with less costly subsidies targetted directly to needy consumers. Third, CONASUPO's operating losses (exclusive of food subsidies and losses on foreign denominated debt that would come from exchange movements) would be reduced to a maximum of US$85 million per year. These operating losses result not only from inefficiency, but also from providing services such as transportation and storage for procured crops, without reflecting these costs in the margin between purchase and sales price. Fourth, the elimination of pricing policies that result in the subsidization of sugar consumption would curtail transfers to Asucar SA de CV. All of these fiscal effects are summarized by year in the table below. They indicate annual fiscal cost reductions ranging from US$1,053 million to US$1,226 million, depending on the year. 3. Consumption Impact and the Food Stamp Program. An integral part of the program set forth in the ASL is the substitution of food subsidies targetted to the poor in place of global food subsidies. The Sector Loan supports the expansion of the limited program of targetted subsidies now in progress (funded at a level of around US$60 million per year) to an eventual size of approximately 0.21 of GDP. The Sector Loan envisions that the current program of food stamps for tortillas would be expanded to other commodities and would be funded initially at around US$250 million, rising to eventually reach approximtely 0.21 of GDP. 4. An important question about the program as a whole is whether this amount of targetted subsidies will be sufficient to off-set the impact of rising food prices as domestic restrictions and distortions have been and continue to be lifted, allowing domestic prices to reflect international levels. Between the end of 1983 and the end of 1986, as food subsidies declined, incresses in the prices of the consumption staples of the poor steadily eroded their purchasing power. Based upon the purchasing patterns of the poorest 210, an increase of approximately US$12.20 would be needed in the per capita incomes of this group to restore their purchasing power to its end-1983 level (see Table below). - 64 - Annex 7 Page 3 of 5 Fiscal Savings from Adjustment In Agricultural and Fertilizer Sectors (US$ MNllion) 1987 1988 1989 1990 1991 1. Raising fertilizer prices over 5 years 1/ 129 182 201 286 386 2. Replacing subsidies to processors with targetted consumer subsidies / 560 578 536 480 476 3. Reduce CONASUPO's operating losses 21 248 248 248 248 248 4. Reform of Sugar Price Policy 116 116 116 116 116 5. Total 1,05S 1,124 1,101 1,130 1,226 1/ Assumes that transfers to FERTIMEX will be decreased according to schedule in Fertilizer Sector Loan documents, whereas without the adjustment, the transfers would remain at 1986 levels (US$386 million per year). 2/ Assumes without-project subsidies at 1985 levels. With-project subsidies begin at US$250 million, then rise at approximately the rate required for lowest 2 deciles to maintain purchasing power as prices of staples increase. Because prices of some crops, notably maize, were projected to fall between 1986 and 1988, subsidies were projected to fanl in 1988. (This causes the fiscal savings to increase in that year). Subsidies are then projected to rise, reaching US$334 million in 1991. Subsidies include 25X administrative cost and leakanges. 3/ Compared to 1985 levels. - 65 - Annex 7 Page 4 of 5 Increase in Real Income Needed to Restore Purchasing Power of Poorest Two Deciles Lost by Increases in Real Prices of Staples Between October 1, 1983 and November 1, 1986 Change in Share in Increase in Increase in Food Price (X) Expenditure (X) Income Needed (x) Income Needed (US$) Tortillas * 52 2.36 1.23 2.3 Bread 79 1.93 1.52 2.9 Beans 66 2.47 1.63 3.1 Milk 18 2.48 0.45 0.8 Eggs 73 1.98 1.45 2.7 Sugar 49 1.66 0.81 1.5 Vegetable Oil 20 1.43 0.29 0.5 Beef -23 3.62 -0.83 -1.6 TOTAL - 16.28 6.55 12.2 * Includes maize dough and flour. In addition, if domestic prices are brought to the level of world prices and allowed to rise as world prices trend upward between 1986 and 1991, as they are projected to do, the purchasing power of the poor will erode still further. As displayed in Table below, projected increases in prices of saize, rice, wheat and vegetable oil will require compensatory per capita income increases of US$4.30. Increase in Real Income Needed To Maintain Purchasing Power of Poorest Two Deciles after Projected Increases in Prices of Selected Food Crops, 1986-1991 Maize * Rice Wheat ** Vegetable Oil Total Z Total Expenditure Represented by Crop 6.2 0.7 2.7 1.4 11.0 I Rise in Price 20 57 7 32 2 Increase in Income Needed 1.2 0.4 0.2 0.4 2.2 Absolute Value of Increase in Income Needed (US$) **** 2.3 0.8 0.4 0.8 4.3 * Includes maize in grain, tortillas, maize flour, and maize dough. ** Includes breads, cookies, and noodles. *** Projected price increase of soybeans. **** Based on per capita expenditure of around US$188. Source: Based on figures on expenditure from "Food Consumption and Expenditure in Mexico and the Income Effects of the Removal of Food Subsidies" by Cheryl W. Gray, December 12, 1986, mimeo; and per capita expenditure figure of US$225 for bottom 3 deciles, provided by Ma. Gray. Per capita expenditure of US$188 for poorest two deciles was computed by using this figure and the total expenditure figures by decile from Table 6 of the above-mentioned paper. - 66 - Annex 7 Page 5 of 5 5. Allowiing for administrative costs and leakages of 201, an initial subsidy of abvut US$250 million, if targetted to the poorest 201 of the population, would raise per capita income in that group by slightly over US$12, sufficient to redress the loss in purchasing power since 1983 due to removal of global food subsidies and other factors influencing domestic prices. Over the subsequent 5 years, the subsidy would increase as a percentage of GDP, if the subsidies were linked to international prices. Again assuming costs and leakages of 202, the eventual subsidy of 0.2Z of GDP in 1991 would raise per capita incomes in the bottom 201 by approximately US$18 if both GDP and the target population remained at their current levels. This would more than compensate for the increases since 1983, as well as projected future increases in international prices. Realistically, while both GDP and the target population would grow, GDP would most likely grow faster, implying that a subsidy of 0.2Z of GDP would provide some cushion for greater than expected leakages, administrative costs, and price increases. - 67 - ANNEX 8 Page 1 of 6 Terms of Reference of a Study on Agricultural Pricina Issues 1. In accordance with the objectives, terms, and conditions of the Agricultural Sector Loan, it is agreed between tha Government of Mexico and the World Bank that a study will be undertaken of the Government's pricing policies for crops that are Included in the guaranteed price system. The purpose of the study will be to identify policy reforms that would minimize the distortionary effects of governmentally established agricultural prices while still meeting the legitimate goals of the pricing system. 2. This study will be carried out by private contractors under the supervision of an inter-ministerial group with representatives of SHCP, SARH, SPP, the Bank of Mexico, and CONASUPO. A representative of SEMIP will also be included in the supervision of the study of sugar pricing policies. 3. There will be four separate but related components of the study on agricultural pricing issues, which components will be defined as follows: A. Crop by crop analysis of the benefits and costs of governmentally established guaranteed prices. 1. Benefits. a) Original and current purpose of inclusion of each crop in guarantee program, and benefits (social and economic) derived from guarantee prices (stabilize prices, 14mit market power of oligopsonistic buyers, provide income support for poor regions or producers, etc.). b) Historical performance of system in meeting its social and economic goals for each crop. c) Current status of problematic situation that was the reason for including each crop under price supports (current market concentration of buyers, income levels of producers, etc.). 2. Costs. a) Fiscal cost to Government. b) Economic costs due to deviation of prices from economically efficient levels ($.e., border prices). 3. Distributional aspects - Identification of the principal groups that would gain or lose from removal of each crop from the guarantee system, and quantification of gains or losses. - 68 - ANNEX8 Page 2 of 6 a) Geographical distribution of gains and losses (depending on geographical distribution of crop production). b) Distribution of gains and losses by income level, farm sixe, irrigated-rainfed, etc. 4. Alternative means of achieving objectives of price guarantee system in cost-effective ways (variable levies to stabilize prices, anti-trust actions to make market more competitlve, direct transfers to support incomes of poor producers, etc.). B. Alternatives to quantitative Importlexport restrictions in stabilization of domestic producer prices of basic crops and off-setting *dumped prices for agricultural commodities. 1. Effects of current system of quantitative restrictions. a) Purpose and goals (stabilization, reinforce guarantee prices, off-set dumped prices, etc.). b) Effectiveness in meeting goals. c) Costs (1) Total fiscal and economic (1i) Distribution of costs by income level of consumer for goods with positive protection. 2. Variable tariffs. a) Design and implementation in other countries (Chile, EEC). b) Advantages and disadvantages relative to quantitative restrictions (more transparent protection, less susceptibility to political manipulation, etc.). c) Suggested design for Mexico. (i) Quantitative objectives (desired degree of stabilization, etc.). (ii) Mechanism. (iii) Simulation using historical data to determine tariff rates required to stabilize prices to the desired degree for each crop. (iv) Consistency with GATT and other international obligations. - 69 - ANNEX 8 Page 3 of 6 (v) Implications for variable tariff scheme of subsidized production in developed countries (producer subsidy equivalents). 3. Anti-dumping regulations. a) Legal implications and feasibility under GATT rules for agricultural products. b) Design and implementation in other countries. c) Suggested design for Mexico. (i) New legislation required. (ii) Special attention to the issue of how the system can be made transparent and non-arbitrary. C. Mechanism for and effects of establishing guarantee prices that would approximate market-determined prices. 1. Linkage of guarantee prices to world market by setting guarantee prices uithin a band around international prices. a) Appropriateness of comparing domestic prices with International prices (appropriate comparators-- including extent of substitutability between internationally traded and domestic varieties; geographic sources for comparable commodities; adjustments for international transport costs where relevant; adjustments for costs of internal transport, processing margins, and quality differences to make domestic and international prices comparable; and extent of Mexico's influence on international prices). b) Appropriateness of establishing floor and/or ceiling for the band, and appropriate level for such floor and/or ceiling. c) For the special cases of maize and beans, conslstency of specific levels of price band ceilings with poverty alleviation of both producers and consumers, subsidy control and minimizatLon of storage costs. 2. Adjustment of prices over time. a) Description and effects of current system, including path of real guarantee price for each crop monthly since 1980, and monthly pattern of deliveries from producers to buyers. - 70 - Page 4 of 6 b) Calculation of -ex mt economic rate of rCturn to *torlng crops - monthly Nad yerly - for each crop since 1980. C) Caleulation of price adjustmetnt for each crop that would have been necessary to make private storage viable (1.., cower inflation and th. cost of storage) - thi wi11 require estimtes of storage costs. d) Design of prlcing adjustment mechanism that would encourage private storoge (on-frm and off-farm)t effects of implementing system, including the effect on production timLng decisions and estimate of savings to Government If private sector assumes greater responslbility for storage. 3. Geographically differentiated pricing. a) Principle of geographically differentiated pricing - difference between farugato price and sales price to processor or consimer must be sufficient to cover transport and handling margins, so In areas from which transportation to processing or consumption centers is more costly, farmgate prices should be lower. b) Calculation of transport cost from different production areas to processing or consumption centers; estimation of what farmgate prices should be to cover transport costs. c) Comparlson of economically efficient farmgate prices (as estimated in (b)) to actual prices; implicit subsidy or tax for each area (subsidy or tax would equal tha product of the quantity produced in each area and tho difference between the economically correct price and the actual price). d) Distributional Impact of subsidy and tax calculated in (c). a) Design of system of geographlcally differentiated prices that would encourage: (I) Private purchasers to become more involved In purchasing at farmgat. (11) Agro-industry to locate more plants In producing areas ratber than near consumption centers. f) Benefits of geographically differentiated pricings (1) Estim_te of fiscal savigs to CONASUPO If private sector assumes responsibility for purchasing more of the crop. - 71 - ANNE 8 Page 5 of 6 (11) Economic efficitncy. D. sugar pricing pollcy. 1. Analysis of the existing system a) Prices at different parts of the production chain are determined by separate and unrelated criteria; the different procedures followed will be described in detail. b) Disequilibria in the system are resolved by subsidios via credit, production and marketing costs; the transfer of fiscal resources to the sector will be analysed in detail. c) Can purchase by the mills is based on the provisions of the Decreto Canero of 1979; the existing practices would be analysed, and differences in practices between regions and mills detailed. d) The Interactions between decision-makers and interest groups in government, Industry and agriculture would be analysed, their motives and objectives described, and an assessment made of the potential gainersllosers in a process of rationalisation and change. 2. Scope for change a) The stated objective of the Convenlo and the Programa de Reconverslon is the achievement of financial self- sufflciency, and It s explileitly recognised that the design and lmplementation of an lntegrated pric policy Is essential. The range of options open will be analysed with detailed consideration of systems in operation in other major sugar producing and exporting countries. b) The policy ultimately adopted should allow Mexico to exploit its comparative advantage in sugar production. The role to be played by the world sugar economy In the definition of domestic pollcy would be analysed in detail. The international market, in spite of major imperfections, represents the opportunlty cost of acquirlng or disposing of sugar and Mexico's long-term economic interests will be best served by explicitly recognising the signals generated in the world sugar - 72 - ANNEX 8 Page 6 of 6 economy. The study would consider how best to generate an appropriate border price based on long-run prices in International trade and establish a formula for maintaining it up-to-date. c) The study would include an analysis of the world sugar economy and prospects for the medium and long-term (i.e., up to 2000). d) Projections of domestic demand under different price assumptions would be made, and a comparison drawn with total supply (based on present process capacity and attainable output and productivity targets). e) The study would consider the alternative schemes available for cane purchase by the mills based on sucrose content and cane quality, including premia/penalties, testing systems, the appropriateness of pan-territorial pricing and differences in technical capacities of factories to extract sucrose. f) The study will consider the appropriateness of targetting subsidies to the poor and the implications of this for the sugar marketing system. 3. Recommendations The study will make specific recommendations on the following: a) The appropriate method for determining a border reforence price, the translation of the price to ex- factory levels; the methods available to defend the price during periods of low world prices; and the degree of and mechanism for assistance (if any) to be given to producers exporting at low world prices; b) The appropriate method of determining consumer and end-user prices, assuming the continued existence of the present monopsonistic marketing structure, which would avoid any transfer of fiscal resources; c) The most effective and efficient means of targetting consumption subsidies for sugar to an identified section of the population and its estimated fiscal cost; and d) The appropriate method or methods for purchasing cane based on quality and sucrose content. - 73 - ANNEX 9 Agriculture Sector Objectives of the Mexican Government, 1987 - 1988 The Mexican Government has assigned a high priority to rural areas. The Governmental Policy of Integrated Rural Development has as a fundamental purpose the improvement of social welfare of the rural population and increasing the levels of production, employment and income, through an increase in the efficiency of agrlcultural production, agroindustrial processing, and marketing. In addition, it established strengthening of food sovereignty of the country as one of the principle objectives. To achieve this, the Mexican Government has enacted a group of actions oriented toward rationalizing the subsidies to food and agricultural inputs; toward liberalizing external trade for agriculture and agroindustry; toward rationalizing pricing policies for producers and consumers; and toward a selective participation of the public sector in the production, marketing, storage, and distribution of agriculture and livestock products. During this year and the next, the Government intends to strengthen and consolidate the policy developed during the last years. In addition, it is proposed to maintain an adequate program of investment and to provide basic support services in an efficient and decentralized manner. Specifically, the program of the Government in this period is oriented toward achieving a solid program of public investments, based on economic and social criteria; toward making more efficient the basic services provided by government agencies, through their restructuring and decentralization so that a higher proportion of personnel will be in direct contact with farmers; Increasing the efficiency of storage, processing, distribution, and marketing, considering if it is necessary to liquidate or privatize parastatal enterprises; giving a greater role to market mechanisms in the formation of agricultural product prices at the producer and consumer levels; expanding the opportunities of farmers to export their products and import inputs; giving the private sector better access to importing; diminishing the subsidies to agricultural inputs, such as water and fertilizer, and to interest rates for agricultural and livestock sector credit; and eliminating global consumer subsidies, maintaining selective subsidies for the population of lower income in rural and urban areas, with the purpose of protecting their purchasing power. The Mexican Government has made important advances toward the achievement of the objectives indicated. What has been done to date and the actions that will be carried out in the rest of the current sexenio are presented in the attached table (Annex 5). - 74 - Aaesz L° Page 1 of 3 Steps Recommended to Strengthen Food Subsidy Programs I. Tortibono food distribution progrsm - For Urban Are"s. A. CONASUPO/DISCONSA unit in charge of the distribution and monitoring be strengthened to do the following: 1) reassess eligibility of current participants, and 2) reassess eligibility every 6 months. B. Criteria for eligibility of participants be reduced to 1.5 inimum wages in urban areas. 1) More rigorous criteria of economic well-beiug be developed to eventually replace definitions of eligibility in term of of only wage income. 2) Review eligibility criteria with respect to budgetary allocations. C. Impact of program be re-assessed. 1) Household level surveys be conducted to assess impact of program on food consumption and real incomes (see attached outline for study). Do Price of Tortibonos be linked to price of tortillas so as to maintain constant subsidy per beneficiary. E. Study be conducted to examine whether certain basic food stuffs should be nutritionally fortified. II. Food Subsidies for the Rural Poor A. DICONSA rural stores be center for rural food subsidies through price discounts given from ration cards or iatroduction of system of food stamps. (i) Local DICONSA committee and/or IMSS/Coplamr committees screen applicants (basic eligibility criteria based upon socLo-economic and when possible anthropometric indicators). (li) Availability be for 5 to 8 months when food and mployment are the most scarce (generally April througb September are the most critical). (iii) Eligibility be reassessed each year. (iv) Nutrition and health education be included in the program for eligible participants. - 75 - Annex 10 Page 2 of 3 D. Rural network be upgraded. (i) Transportation, storage and working capital requiremnts of rural network be reviewed and supplemented as needed. III. )onitorin Food Securitg and Nutrition A. Plan for a continuous food consumpltion program be finalized for both urban and rural areas. (i) INCO in collaboration with other relevant agencies be given responsibility for designing and implementing the program. - 76 - Annex 10 Pag. 3 of 3 Proposed Outline of Study of the Existing Food Stamp ("Tortibono") Program Justification: There is no reliable information on the impact of the program on real incomes, food consumption and nutrition among the various population groups. Such information would be useful for decision-making on future program modifications and implementation. Decisions on coverage. size of subsidy per household, distribution channels, commodities to be covered and related issues would benefit from information on who is currently benefitting and the impact of current and alternative program formulations. The program has now operated for more than a year and enough exprience has been gained for such a study to be successful. Objectives: The objectives of the study would be: (1) to evaluate the impact of the existing program by stamp distribution channel (DICONSA, LICONSA, Labor Unions, Coabastos, community associations) on real incomes, food consumption and nutritional status of each of a predetermined number of households groups, (2) to assess the magnitude of leakage to households with incomes above two minimum wages, and (3) to explore how alternative programs or program formulation might affect impact, leakage, and cost-effectiveness. Methodology: The study should be based on data collected by household surveys and surveys of agencies which ,6ssue stamps. The household surveys should cover random samples of households for each of the stamp distribution channels and samples of similar households not participating, e.g. households on waiting lists. Data should be collected on dietary patterns, food acquisition, total expenditures, incomes, household demography, weight and height of preschoolers, and other variables to be determined. Data analysis should be based on multiple regression. The survey of stamp issuing agencies should cover a random sample of each of the four major types (DICONSA, LICONSA, Labor Unions, community associations). Data should be collected on procedures and criteria used to determine household eligibility, controls, and other process variables. - 77 - ANNEX 11 -~ ~ ~~"Mi m myn M.S. M bililo gR Tyep of FlowlSoure Amount Pro nplCurrent Torms Status oturit/race Interest Note (YTer) Now money lO 7 Tom-mrcii l nanks j6 0f 44 (Parallel New Monoy Fcility - I (6.03!} 8.42/ 12/5 LIBORt * 13/16 (Co I noeIng N w Money F cilIty - It (l.9) 1.0 16/9 LIBOR * 18/10 Multilateral Development Banks 2.7 (TMRO) (2.8)!& 1 4 (IDS) (f 41 10. IMF Stand-by *.4 5 0.8 Japan I.'/ 0 t ccc 0. 9.8 (as of 6/39/07) Cont;n nt Momn 2.3 aroial sanks (Investment Support Facility - IV) (1.2) Cnce llod (12/ 8/4 LIBOR * 13/16 (Growth Cotinancing Facility - III) (9.S1 I 10/67) .12/7 .IBOR * 18/16 IMF Oil Contingency Mechanicm .8 _ Debt Restruetrint 7096 Coumorcil Banks 087 (Pre-198B Debt) (48.7) 29/7 LIBOR * 13/10 (1988-84 Debt) (6.8) 14/5 LIBOR * 13/16 (Private FICORCA Debt) (11.2) Terms comparsble to those covering renegotiated public debt. (Interbank Credit Lines) (5 21 Level to be m*intaiond until 6/3/89/. Paris Club 1.85 10/6 Appropriate market rats. / Disbursements contingent upon compliance with IMV stand-by and processing p eitic World Bank loans, closing date is June 80, 1988. V/ Sum to be reduced quarterly by the amount Mexico saves as a reult of the shift from a prime rate to a LIBOR reference rate and lower spresds on restructure debt during 1987. Reduction through 12/81/87 aount to US1.9 -1.1 bilIon, leaving a balance of about US2O.6 billion. 8/ 8-loan cofinanelg with World Bank transport sector loans. A non-accelerable World Bank loan guarantee for US5690 million is also provided. 4/ Includes an estimated present value of US$200 mtillea for two World Bank guarantes totalling US$760 million. Drawings shown represwnt net disbursments both for IBRD and IDB. S/ The IMF stand-by would provide SOR 1.4 billion in gross financing over the period of October 1, 1988 to March 81, 1988. At current SDR-U.S. dollar conversion rates, this would amount to approximately US$1.7 billion; the net transfer has been estimated at US60.4 billion. 6/ Includew cofTnancing of US9260 million (10/8/87) with the World Bank Second Export Dovelopment Policy Loan, US2590 million (7/27/87) for steel projects, and USS608 million (8/6/87) for the the Pacific Potroloum Project; these dollar equivolents for the Y200 billion facility are based on Y269.9=US81.00 fixed In the Exlm Japan/Mexico agreement. 7/ Covered by a US8260 million non-accelerable loan guarantee of the World Sank, none drawn to date, with closing date of March 31, 1988. 8/ The IMF commitment is for the lesser of SDR800 million or US$68 million, but conditions for drawing have not been met and It Is unlikely that any would be drawn. 9/ Rescheduling of 19OX of the principal and SOX of tho interest falling due on debt outstanding as of the end of 1986 during the period of October 1, 1988 to Morch 31, 1988. Source: I8RD staff estimates. January 13, 1988