RESTRICTED

FLE Ecopy Report No. P-937

This report was prepared for use within the Bank and its affilioted organizations.They do not accept responsibility for its accuracy or completeness. The report maynot be published nor may it be quoted as representing their views.

INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT

REPORT AND RECOMMENDATION

OF THE

PRESIDENT

TO THE

EXECUTIVE DIRECTORS

ON PROPOSED LOANS TO

EMPRESAS PUBLICAS MUNICIPALES DE PALMIRA

FOR A

WATER SUPPLY AND SEWERAGE PROJECT

AND TO

EMPRESA DE ACUEDUCTO Y ALCANTARILLADO DE BOGOTA

FOR A

SECOND WATER SUPPLY PROJECT

BOTH WITH THE GUARANTEE

OF THE

REPUBLIC OF COLOMBIA

May 13, 1971

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INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT

REPORT AND RECOIlENDAT IONOF THE

PRESIDENT TO THE EXECUTIVE DIRECTORSON PROPOSED LOANS TO

EMPRESAS PUBLICAS MUNICIPALES DE PALMIRA FOR AWATER SUPPLY AND SEWERAGE PROJECT

AND TOEMPRESA DE ACUEDUCTO Y ALCANTARILLADO DE BOGCIA

FOR A SECOND WATER SUPPLY PROJECTBCTH WITH THE GUARANTEE

OF THEREPUBLIC OF COLOMBIA

1. I submit the following report and recommendation on two proposedloans for water supply projects in Colombia, one in an amount equivalentto US$2 million to the Empresas Publicas Nlunicipales de Palmira (EPMP)and the other in an amount equivalent to US$88 million to Empresa deAcueducto y Alcantarillado de Bogota (EAAB). Both loans would be guaran-teed by the Republic of Colombia, and both would carry an interest rateof 7½1 percent. The loan to EPMP would be for a term of 25 years includ-ing a four-year period of grace; the loan to EAAB would be for a term of30 years, including a seven-year grace period.

PART I - HISTORICAL

2. The first Bank loan in Colombia's water supply and seweragesector was made in June 1968 for US$1 4 million to EAAB for the expansionand improvement of Bogota's water supply system in association with jointfinancing of US$0.6 million from West Germany, and US$4.0 million fromthe United States; a second loan of US$18.5 million was made in June 1970to the Establecimiento Publico Empresas Municipales de Cali (Emcali) forthe Cali Water Supply and Sewerage Project.

3. The Palmira Water Supply and Sewerage Project was originallyappraised in July 1969. Negotiations began in April 1970 but had to besuspended for a year, pending politically difficult decisions byEP.2P upcn water tariff incruasos adequate to ccm.plete the financingplan fcr the propcsed Project, and thc renegotiation of a supplier's creditfor telephone equipment, on which EPMP had fallen into arrears. The Projectwas re-appraised in November 1970 and negotiations were completed inApril 1971 after EPMP had proposed a tariff program apprcpriate to theProject,and had renegotiated the supplier's credit.

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4. The proposed loans would bring the total number of loans madeto Coloroia to forty-seven and would increase the total amount of Bank

loans to Colombia to US$831.8 million (net of cancellations), of whichUS$572. 4 million is now held by the Bank. Colombia has received one IDAcredit of US$19.5 million for highways. A summary statement of Bankloans and IDA credits to Colombia and their status of disbursements asof March 31, 1971 was included in my Report and Recommendation on theloan for the Caqueta Land Colonization Project (P-921), dated April 21,

1971.

5. IFC has made 35 investments and underwriting commitments in18 enterprises in Colombia, totalling US$18.5 million (net of cancella-tions), of which IFC now holds US$11.3 million.

PART II - THE ECONOMY

6. A summary of recent developments and a favorable conclusionregarding Colombia's creditworthiness for additional external borrowing-eze contained in paragraphs 20-23 of my Report and Recommendation onthe loan for the Caqueta Land Colonization Project (P-921), dated April21, 1971. A Country Data sheet is attached as Annex II.

PART III - THE PROJECTS

A. Problems of Financing Water Supply and Sewerage in Colombia

7. The growth of Colombiats urban population from 4.5 million to12.7 million over the past twenty years, has placed great strains uponthe supply of urban public services. The supply of electric power haskept up with demand better than other services. For example, in Bogota,power generation has been adequate since 1962, while two-thirds of thepopulation is still affected by inadequate water supply (low pressuresand intermittent supply). Foreign loans for the power sector in Colombiaamounted to US$383 million over the past decade, as compared with US$125million for water supply and sewerage (of which the Bank provided US$219.1million for power and US$32.5 million for water). The Colombian central

and municipal authorities are concerned to make up for the lag in thedevelopment of the water supply and sewerage sector, and over the pastsix years have developed a substantial program of preinvestment studiesfor urban water supply and sewerage projects, which has led to the Banklending noted in paragraph 2.

8. The projects in the larger cities, such as Bogota and Cali,are of a size appropriate for individual project loans. However, if theBank is to support a balanced development of the sector in which thesmall and medium sized cities would also share, it confronts the pros-pect of making a large number of loans to individual cities, ranging in

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amount as low as a few hundred thousand dollars, which would presentproblems of loan administration difficult to deal with from the Bank'sheadquarters. To overcome this difficulty, arrangements are beingworked out with the Colombian authorities for aggregating a number ofprojects in small and medium sized cities with a loan for each aggrega-tion rather than for each project. Such loans would be channelled througha central agency, the Colomibian Institute for Municipal Development(INSFOPAL), which would share with the Bank in the responsibility forloan administration. Thus, I would not expect to present another loanfor a water supply project in Colombia of as small an amount as theUS$2.0 million for the proposed Project in Palmira.

9. The water supply and sewerage sector also presents specialproblems of raising sufficient funds from taxation and from water rates.Over the past four years the tax revenue of the Central Government hasincreased in real terms by 46 percent, permitting an increase of 130 per-cent in the contributions of the Central Government budget to investmentsby public agencies. This has enabled the Colombian public sector to under-take more investments, including investments in projects which do notgenerate enough income and therefore have to rely partly on budget funds.To illustrate this, a few years ago there were only six Bank-financedprojects which relied on contributions from the Central Government budgetfor all or part of their local financing. Today, there are 13 suchprojects and two more may be approved in the current fiscal year. Theseprojects would claim a total of over Col.$l billion, or nearly 20 per-cent, of the Central Government's investment budget for 1971. The 1971budget, indicating a need to raise additional funds, was described inparagraph 22 of my Report and Recommendation on the loan for the CaquetaLand Colonization Project (P-921) of last April 21.

10. However, the requirement for public investment to meet bothsocial and economic needs is steadily increasing. Therefore, whilemobilizing resources from general taxation, the Colombian central andmunicipal authorities have also pursued a policy of increasing therevenue of the public sector from the earnings of public utility serv-ices. In the areas of the public sector which earn income from the saleof water, power, and telecommunications, the Colombian Government hastaken the position that the Colombian share in the cost of investment proj-ects should be financed to the maximum extent from the earnings of thepublic utilities concerned, together with the proceeds of bond sales tothe private sector, and only when these possibilities are exhaustedshould the enterprises seek contributions from the Central Government bud-get. This policy is mitigated by the Government's recognition that thesmaller municipal enterprises may have special difficulty in generatingadequate profits, and in selling bonds, as the smaller cities often havea low per capita income. Thus, though an exemplary effort to mobilizelocal resources has been made by both Bogota and Palmira, no budgetary

contributions are needed for the proposed Bogota Project, while theGovernment would contribute 28 percent of the financing requirementsof the proposed Palmira Project.

11. In 1968, the Government established a Public Utilities TariffBoard, charged with regulating tariffs to produce an adequate rate ofreturn on assets realistically valued, in order to facilitate the fi-nancing of the investment program of public utilities. The Board wasalso required to take considerations of income distribution into accountby regulating tariff structures in accordance with the capacity to pay ofdifferent classes of consumers. The Board initially encountered majorproblems in the water supply sector. Because of lags in the developmentof the sector, the projects tended to be rather large, requiring sub-stantial amounts of financing, while water tariffs and other charges weregenerally insufficient to cover even operating costs. Accounting andbudgeting practices were frequently inadequate, particularly among thesmaller enterprises, presen-ting the Board with technical problems of cal-culating rates of return. MIuch of 1969 and 1970 was thus spent in clear-ing the ground for the implementation of the Government's policy, butby late 1970, tariff regulation had been rationalized for about 250public utilities, mostly in the water supply sector, increasing theirability to finance projects from their own earnings.

12. This may be illustrated by the cases already mentioned of thewater supply enterprises of Bogota, Cali and Palmira. In 1967, the netrevenue of EAAB produced a return of 2.9 percent on assets. By 1971,net income is expected to have increased seven times and the return isexpected tc be 10 percent, as a result of two tariff increases, one of80 percent in 1968 and another of 30 percent in 1970. In the case ofEmcali, the water division earned a return of 2.6 percent in 1969. Aspublic opinion in Cali had reacted against abrupt tariff increases whichhad taken place in 1968, Emcali established a program of gradual in-creases in water rates over the three years 1971-73 to finance part ofthe local cost of the Cali Water Supply and Sewerage Project, which wouldleave tariffs about 50 percent higher at the end than at the start ofthe period. At the time of the initial appraisal of the proposed proj-ect of EPMP, a rate increase of no less than 100 percent would have beenrequired just in order to achieve a zero rate of return; further increaseswould have been necessary to make some contribution to the costs of theproposed Project. As noted in paragraph 3, EPIP was initially unable toobtain the agreement of its Board to an adequate rate program, and nego-tiations with the Bank were consequently suspended. When they were resumedin March 1971, EPMP had already instituted a rate increase of 60 percent,and planned further increases of 56 percent in July 1971 and 20 percentin January 1973, to gradually improve the rate of return from 4percent in 1971 to 9 percent in 1977.

B. The Palmira Water Supply and Sewerage Project

13. A report entitled "Appraisal of the Palmira Water Supply andSewerage Project - Colombia" (PU-33b) is attached.

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14. The proposed Borrower is an autonomous municipal entity whichprovides water supply, sewerage and local telephone services, and oper-ates the slaughterhouse and two markets in Palrira, a city with a popu-lation of 160,000, grcwing at an annual rate of about 6 percent. TheProject will help to increase the population served directly by watersupply and sewerage from about 140,000, representing 87 percent of thetotal present population, to more than 210,000 by 1977, which would re-present 94 percent of the population at that date. The Project includesprimarily new water supply treatment and distribution works. The sewer-age portion of the Project is relatively small, consisting of only themost urgent sewerage and drainage works.

15. The Project's financial requirements total US$4.2 millionequivalent of which US$3.8 millicn would be for the estimated projectcost and US$0.4 million for the estimated interest during constructionon the Bank's and a Government loan. The proposed Bank loan of US$2.0million would finance 47 percent of total requirements covering theestimated foreign exchange cost of US$1.2 million and local currency costof US$0.8 million. The Government loan would finance 28 percent of thetotal requirements and the remaining 25 percent would be financed frominternally generated funds. The financing of US$0 .8 million of localcosts seems fully justified, especially since the Bank's share in thetotal cost would remain less than one half. As set forth in some detailin the Bank's latest economic report on Colombia (WH-200a, of November 1,1970), Colombia has a well conceived developrment program, but, in spiteof its efforts to mobilize domestic resources in its support, requiresexternal assistance in excess of the foreign exchange component ofdevelopment projects suitable for external financing.

16. EPMP would be committed to increase the rates of return onits water and sewerage services by stages from 4 percent in the firstyear (1971) to 9 percent in the seventh year (1977) at which level EPMPcould cover all operating expenses, debt service and have a small sur-plus for its continuing investment requirements. In order to meet therate of return required for 1971, EPMP would, as a condition of effec-tiveness of the proposed loan, increase its water supply and seweragetariff 56 percent to Col$1.25/m3 . EPNP agreed that it would also main-tain tariffs on its slaughterhouses and markets sufficient to coveroperating expenses and depreciation. On its telecommunications service,EPMP would be required to earn a return on revalued assets sufficientto finance the service on old debts, and cover part of the cost of futureexpansion.

C. The Second Bogota Water Supply Project

17. The proposed Project is described in detail in the attachedreport entitled "Appraisal of the Second Bogota Water Supply Project -Colombia" (PU-66a).

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18. The proposed Project would be the second phase of the longrange expansion prcgram of the Bogota water supply system. The firstphase, being implemented very satisfactorily under the First Bogota WaterSupply Project, will,upon its completion in 1972, terminate the presentsupply deficit and keep water supply ahead of demand through 1976. Theprcposed second Project is to be completed in 1976, and would cover demandthrough 1985. It will divert, treat, and distribute water originating inthe Chingaza area 40 km east of Bogota by means of a dam on the ChuzaRiver, a 39 km conveyance system (consisting of 33 km of tunnels and 6 kmof pipelines from the dam to the city), a treatment plant, and additionsto the Bogota water distribution system.

19. The Chingaza area has a very large potential yield of water, ofwhich 35 percent would be developed by the proposed Project. Neverthe-less, it is necessary to include the full conveyance system of tunnelsand pipelines in this Project, and this accounts for the long constructionperiod (1971-76) and large capital requirements of the Project. Highlymechanized construction methods are required for the conveyance systemin particular, and this accounts for the foreign exchange component of70 percent, which is high by comparison with most other water supply proj-ects.

20. While the financing of some local costs is justified on macro-economic grounds (see paragraph 15), US$86 million of the proposed loanwould cover foreign costs, and only a maximum of US$2 million would befor local costs of engineering services -- this in order to put competentforeign and Colombian consultants on an equal footing by financing 50 per-cent of the costs of engineering services irrespective of origin. Theproposed loan of US$88 million is equivalent to about 75 percent of thetotal project financing requirements of US$118 million, including US$14million interest during construction on the proposed Bank loan. However,external financing plays a relatively less important role in EAAB's total1971-76 investment program of US$228 million, accounting for only 39 per-cent of financing forthcoming from all sources. EAAB's investment programincludes important sewerage, drainage and flood control works, which werepostponed from 1968-70 in order to permit the available local financingto be used for the First Water Supply Project, and which would have tobe further delayed if the Bank loan did not cover the full foreign ele-ment of the Project's financing requirements.

21. Internally generated resources would finance 49 percent ofEAAB's investment program and less than two percent would be requiredfrom the Government budget (remainder of Government contribution forFirst Project). Earnings have been satisfactory with rates of return of9 to 10 percent on a revalued rate base. Future earnings are expectedto yield rates of return of 9 to 12 percent during the period of construc-tion, and the draft Loan Agreement provides for a minimum rate of returnof 9 percent during 1971-73 and 10 percent thereafter. It was alsoagreed during negotiations that the rate of return required after the con-struction period would be reconsidered upon the completion of the Projectin the light of EAAB's financial requirements. Present estimates indicatethat a rate of return of 7-8 percent would be adequate after 1976.

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22. The Project and subsequent developments of the Chingaza areawould increase the hydroelectric potential of the Bogota River whichis exploited by plants of the Empresa de Energia Electrica de Bogota(EEEB). BEEB has therefore agreed to make a contribution of Col$280million to the financing of the Project, equivalent to 12 percent ofProject cost, or 5 percent of EAAB's total 1971-76 investment program.

PART IV - LEGAL INSTRUME2ITS ASD AUTHORITY

23. The draft Loan Agreements between the Bank and EPNP andSAAB and the draft Guarantee Agreements between the Republic of Colombiaand the Bank as well as the Reports of the Committee provided for inArticle III, Section (iii) of the Articles of Agreement and the textsof the Resolutions approving the proposed loans are being distributedto the Executive Directors separately.

24. The draft Agreements contain covenants normally included inagreements for public utilities projects. Under Section 5.13 of theLoan Agreement for the Palmira Water Supply and Sewerage Project, theBorrow,er would be committed to financial targets for its water supplyand sewerage services as wiell as its telecommunications services, marketplaces and slaughterhouse. Special features of the draft Loan Agreementfor the Second Bogota Wvlater Supply Project are commitments by theBorrower to consult with the Bank on its investment plans cutside theProject (Section 3.05) and on the results of studies on pollution controland thedr implementation (Section 3.07), and to inspect periodically theChuza Dam and related works (Section 4.03).

25. I am satisfied that the proposed loans would comply with theArticles of Agreement of the Bank.

PART V - RECOMMENDATIOIN

26. I recommend that the Executive Directors approve the proposedloans.

Robert S. McNamaraPresident

Attachments

Washington, D.C.

ANhEX IPage 1 of 2 pages

LOAN AND PROJECT DATA SHEET

I. PAL1LRA WATER SUPPLY AIND SEWERAGE PROJECT

A. LOAN SLMURY

Borrower: Empresas Publicas Municipales de Palmira.

Guarantor: Republic of Colombia.

Amount: US$2 million equivalent.

Terms and Conditions: Payable in 25 years with 4 years of grace, at 7¼percent per annum, with a commitment charge of 3/4of one percent per annum.

B. PROJECT DATA

Project Description: The Project would include a new water treatmentplant, improvements to the existing plant, a newwater main from the plant to the city and substan-tial additions to the distribution system; the mosturgent sewerage and drainage works would also beconstructed.

Estimated Cost: Local Foreign Total(US$ Million)

Treatment Plant and Related Works 0.h6 0.40 o.86Water Main O.U2 0.07 0.49Distribution and Connections 0.73 0.19 0.92Sewerage Works 0.49 0.03 0.52Engineering and Administration 0.21 0.06 0.28Contingencies O.55 0.17 0.71

Total Project Cost 2.86 0.92 3.78

Financial Forecastsfor Water Supply andSewerage Division: 1971 1973 1975

Water billed (million m3) 9.6 11.4 15.1

Total Revenues - including non-operating income (Col$ million) 10.1 17.6 23.3Total Operating Expenses - in-cluding depreciation (Col$million) 7.9 11.9 13.8

Income before Interest (Col$million) 2.2 5.7 9.5Rate of Return (percent) .o 4.7 7.6

ANlNEX IPage 2 of 2 pages

II. SECOND BOGOTA WATER SUPPLY PROJECT

A. LOAN SUi'MARY

Borrower: Empresa de Acueducto y Alcantarillado de Bogota.

Guarantor: Republic of Colombia

Amount: US$88 million equivalent.

Terms and Conditions: Payable in 30 years with 7 years of grace, at71- per-cent per annum, with a commitment charge of 3/4 ofone percent per annum.

B. PROJECT DATA

Project Description: The Project would include a dam on the Chuza River,a 39 km conveyance system (consisting of 33 km oftunnels and 6 km of pipelines) from the dam toBogota, additions to the city's distribution system,equipment, and engineering services.

Estimated Cost: local Foreign Total(Us Nillion)

Chuza-Bogota Conveyance 7.6 25.6 33.2Other Civil Works 7.3 11.8 19.1Equipment 1.5 12.2 13.7Land Acquisition 1.0 - 1.0

Engineering 5.4 1.1 6.5Contingencies 9.2 21.0 30.2

Total Project Cost 32.0 71.7 103.7

Financial Forecasts:1971 1976 1979

Water billed (million m3) 155 315 415

Total Revenues - including non-operating income (Col$ million) 347 931 1,283

Total Operating Expenses - in-cluding depreciation (Col$million) 206 515 721

Income before Interest (Col$million) 141 h1.6 562

R2te of Return (percent) 10.0 11.9 8.0

Annex II

COLOMBIA: COUT'TRY DATA

Area: 439,825 square miles

Population: Estimate, mid-1970: 21.6 rillion; Growth Rate 3.3 percent

Gross Domestic Product:

Total GDP in 1968 Col.$ 96,384 millionApproximate US$ Equivalent US$ 6,060 millionReal Growth in 1968 6.1 percentAverage Real Growth, 1964-68 4.8 percentPer Capita GDP in 1968 US$ 300

Percentage Contribution to GDP: 1958 1968

Agriculture 37.3 30.6Mianufacturing 16.2 16.8Other 46.5 52.6

Saving and Investment:

Gross Fixed Domestic Investment as Percentage of GDP:

1966 1967 1968

16.7 17.6 19.5

Percentage Composition of Investmentand Saving in 1968:

Gross Fixed Domestic Investment 92.2Construction 57.4Transportation Equipment 9.0Machinery and Other Equipment 25.8

Inventory Change 7.8

Gross Domestic Investment 100.0Corporate Saving 11.3Perscnal Saving 6.2Government Saving 26.6Current Account Deficit 16.0Capital Consumption Allowance 39.9

Central Government Finances 1967 1968 1969(?lillions of Col.Pesos)

Current Revenues 6,688 8,057 9,250Current Expenditures 4 293 5 122 6,1a8

Current Surplus 2 2,832Investment Outlays 2,626 3,646 3,987

Overall Deficit 231 711 1,155

Money Supply End End End1967 1968 1969

Millions of Pesos: 13,150 15,435 18,448

Prices 1967 1968 1969

National Consumer Price Index(Annual Averages, 1958 = 100) 262 281 305

Wholesale Price Index(Annual Averages, 1958 = 100) 252 267 290

Exchange Rate End End End1967 1968 1969

Principal ixchange Rate, Selling(Pesos per U.S. Dollar) 15.82 16.91 17.90

Balance of Payments in 1968(Millions of U.S. Dollars)

F.o.b. M4erchandise Excports 609(Of which, coffee) (368)

F.o.b. Merchandise Imports 615Net Services - 72Factor Payments to Foreigners -113Net Transfers 31Current Account Balance -160Net Private Capital 52Net Public Capital 90Errors and Omissions 12Increase in Central Bank Reserves - 62Decrease in Commercial Bank Reserves 68

E~xternal Public Debt(Millions of U.S. Dollars) End 1968 End 1969

IBRD Total IBRD Total

Disbursed 290 948 318 1J083Undisbursed 163 372 176 429

Total 453 1,320 494 1,152

1968 1969

Debt Service Ratio 12.8 11.6

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Net International Reserves of the Central Bank(Millions of U.S. Dollars)

End End End196? i968 X969

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IMPF Position at End of 1969

Quota US3$125 millionNet Drawings US$139 millionFund Holdings of Pesos Col$233 millionFund Holdings of Pesos

as Percentage of Quota 187 percent

Rate of exchange as of April 3Q, 1971 Col$19.7 per US$

Social Indicators

1965 1967 1970

Population Growth Rate, % 3.2 - 3.3Urban Population Growth Rate, % 6.5-8.0 - 6.5-8.oBirth Rate, per 1,00a 47.2 - 43.4Urban Unemployment Rate, $ - 114.0 8.0

May 13, 1971